Highlands Bankshares 10Q 2011 Q3 Quarterly report

UNITED STATES

SECURITIES AND EXCHANGE COMMISSION

Washington, DC 20549

FORM 10-Q

(Mark One)

x	QUARTERLY REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES EXCHANGE ACT OF 1934

For the quarterly period ended September 30, 2011.

o	TRANSITION REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES EXCHANGE ACT OF 1934

Commission File Number: 0-16761

HIGHLANDS BANKSHARES, INC.

(Exact name of registrant as specified in its charter)

West Virginia		55-0650793
(State or Other Jurisdiction of Incorporation or Organization)		(IRS Employer Identification No.)

P.O. Box 929

3 North Main Street

Petersburg, WV 26847

(Address of Principal Executive Offices, Including Zip Code)

304-257-4111

(Registrant’s Telephone Number, Including Area Code)

Indicate by check mark whether the registrant (1) has filed all reports required to be filed by Section 13 or 15(d) of the Securities Exchange Act of 1934 during the preceding 12 months (or for such shorter period that the registrant was required to file such reports), and (2) has been subject to such filing requirements for the past 90 days. Yes x No o

Indicate by check mark whether the registrant has submitted electronically and posted on its corporate Web site, if any, every Interactive Data File required to be submitted and posted pursuant to Rule 405 of Regulation S-T (§ 232.405 of this Chapter) during the preceding 12 months (or for such shorter period that the registrant was required to submit and post such files). Yes x No o

Indicate by check mark whether the registrant is a large accelerated filer, an accelerated filer, a non-accelerated filer, or a smaller reporting company. See the definitions of “large accelerated filer,” “accelerated filer” and “smaller reporting company” in Rule 12b-2 of the Exchange Act.

Large Accelerated Filer	Accelerated Filer o
Non-accelerated filer o (Do not check if a smaller reporting company)	Smaller reporting company x

Indicate by check mark whether the registrant is a shell company (as defined in Rule 12b-2 of the Exchange Act). o Yes x No

Indicate the number of shares outstanding of each of the issuer’s classes of common stock as of the latest practicable date. As of November 14, 2011: 1,336,873 shares of Common Stock, $5 Par Value

HIGHLANDS BANKSHARES, INC.
Quarterly Report on Form 10-Q For The Period Ended September 30, 2011

INDEX
		Page
PART I	FINANCIAL INFORMATION

Item 1.	Financial Statements

	Unaudited Consolidated Statements of Income Nine Months Ended September 30, 2011 and 2010	3

	Unaudited Consolidated Statements of Income Three Months Ended September 30, 2011 and 2010	4

	Unaudited Consolidated Balance Sheet for September 30, 2011
	and Audited Consolidated Balance Sheet for December 31, 2010	5

	Unaudited Consolidated Statements of Changes in Stockholders’
	Equity for the Nine Months Ended September 30, 2011 and 2010	6

	Unaudited Consolidated Statements of Cash Flows for the Nine
	Months Ended September 30, 2011 and 2010	7

	Notes to Consolidated Financial Statements	8

Item 2.	Management’s Discussion and Analysis of Financial Condition
	and Results of Operations	23

Item 3.	Quantitative and Qualitative Disclosures About Market Risk	38

Item 4.	Controls and Procedures	38

PART II	OTHER INFORMATION

Item 1.	Legal Proceedings	38

Item 1A.	Risk Factors	38

Item 2.	Unregistered Sales of Equity Securities and Use of Proceeds	38

Item 3.	Defaults Upon Senior Securities	38

Item 4.	(Removed and Reserved)	38

Item 5.	Other Information	38

Item 6.	Exhibits	39

SIGNATURES		40

PART I.

Item 1. Financial Statements

HIGHLANDS BANKSHARES, INC.

CONSOLIDATED STATEMENTS OF INCOME

(In Thousands of Dollars, Except Per Share Data)

	Nine Months Ended September 30
	2011			2010
	(unaudited)			(unaudited)
Interest Income
Interest and fees on loans	$	15,455		$	16,611
Interest on federal funds sold		13			12
Interest on deposits in other banks		5			4
Interest and dividends on securities		475			560
Total Interest Income		15,948			17,187

Interest Expense
Interest on deposits		3,256			4,467
Interest on borrowed money		329			363
Total Interest Expense		3,585			4,830

Net Interest Income		12,363			12,357

Provision for Loan Losses		2,985			2,896

Net Interest Income After Provision for Loan Losses		9,378			9,461

Non-interest Income
Service charges		1,079			1,157
Life insurance investment income		198			198
Gains on securities transactions		15			34
Other non-interest income		261			297
Total Non-interest Income		1,553			1,686

Non-interest Expense
Salaries and employee benefits		4,773			5,187
Occupancy and equipment expense		1,112			1,085
Data processing expense		868			819
Directors fees		267			292
Legal and professional fees		341			455
Office supplies, postage and freight expense		258			304
FDIC premiums		504			495
Loan and foreclosed asset expense		225			264
(Gains) losses on sale of foreclosed property		(15	)		28
Losses on impairment of other real estate		155			88
Other non-interest expense		716			733
Total Non-interest Expense		9,204			9,750

Income Before Provision For Income Taxes		1,727			1,397

Provision for Income Taxes		596			423

Net Income	$	1,131		$	974

Per Share Data
Net Income	$	0.85		$	0.73
Cash Dividends	$	0.45		$	0.79
Weighted Average Common Shares Outstanding		1,336,873			1,336,873
The accompanying notes are an integral part of these financial statements.

HIGHLANDS BANKSHARES, INC.

CONSOLIDATED STATEMENTS OF INCOME

(In Thousands of Dollars, Except Per Share Data)

	Three Months Ended September 30
	2011			2010
	(unaudited)			(unaudited)
Interest Income
Interest and fees on loans	$	5,102		$	5,499
Interest on federal funds sold		6			2
Interest on deposits in other banks		5			1
Interest and dividends on securities		170			187
Total Interest Income		5,283			5,689

Interest Expense
Interest on deposits		1,008			1,371
Interest on borrowed money		112			124
Total Interest Expense		1,120			1,495

Net Interest Income		4,163			4,194

Provision for Loan Losses		638			591

Net Interest Income After Provision for Loan Losses		3,525			3,603

Non-interest Income
Service charges		363			402
Life insurance investment income		66			66
Gains on securities transactions		0			1
Other non-interest income		101			117
Total Non-interest Income		530			586

Non-interest Expense
Salaries and employee benefits		1,484			1,742
Occupancy and equipment expense		365			356
Data processing expense		275			274
Directors fees		92			105
Legal and professional fees		110			137
Office supplies, postage and freight expense		86			95
FDIC premiums		162			168
Loan and foreclosed asset expense		85			153
(Gains) on sale of foreclosed property		(32	)		(11	)
Losses on impairment of other real estate		6			88
Other non-interest expense		238			236
Total Non-interest Expense		2,871			3,343

Income Before Provision For Income Taxes		1,184			846

Provision for Income Taxes		419			262

Net Income	$	765		$	584

Per Share Data
Net Income	$	0.57		$	0.44
Cash Dividends	$	0.00		$	0.25
Weighted Average Common Shares Outstanding		1,336,873			1,336,873

The accompanying notes are an integral part of these financial statements.

HIGHLANDS BANKSHARES, INC.

CONSOLIDATED BALANCE SHEETS

(In thousands of dollars)

	30-Sep-11			31-Dec-10
	(unaudited)			(audited)
ASSETS
Cash and due from banks	$	6,223		$	8,282
Interest bearing deposits in banks		2,772			3,532
Federal funds sold		15,610			5,836
Investment securities available for sale		36,476			25,324
Restricted investments, at cost		1,822			2,087
Loans		318,154			329,336
Allowance for loan losses		(5,631	)		(5,407	)
Bank premises and equipment, net of depreciation		9,490			9,901
Interest receivable		1,610			1,791
Investment in life insurance contracts		7,229			7,031
Foreclosed assets, net of valuation allowance		5,033			4,700
Goodwill		1,534			1,534
Other intangible assets, net of amortization		707			830
Other assets		4,545			5,123
Total Assets	$	405,574		$	399,900

LIABILITIES
Deposits
Non-interest bearing deposits	$	58,936		$	54,693
Interest bearing transaction and savings accounts		83,023			77,392
Time deposits over $100,000		75,430			75,003
All other time deposits		128,516			135,724
Total Deposits		345,905			342,812

Long term debt instruments		11,703			9,393
Accrued expenses and other liabilities		5,996			6,327
Total Liabilities		363,604			358,532

STOCKHOLDERS’ EQUITY
Common Stock, $5 par value, 3,000,000 shares authorized, 1,436,874 shares issued, 1,336,873 shares outstanding
		7,184			7,184
Surplus		1,662			1,662
Treasury stock (100,001 shares, at cost)		(3,372	)		(3,372	)
Retained earnings		37,694			37,165
Other accumulated comprehensive loss		(1,198	)		(1,271	)
Total Stockholders’ Equity		41,970			41,368

Total Liabilities and Stockholders’ Equity	$	405,574		$	399,900

The accompanying notes are an integral part of these financial statements

HIGHLANDS BANKSHARES, INC.

CONSOLIDATED STATEMENTS OF CHANGES IN STOCKHOLDERS’ EQUITY

Nine Months Ended September 30, 2011 and 2010

(In Thousands of Dollars)

	Common Stock		Surplus		Treasury Stock			Retained Earnings			Accumulated Other Comprehensive Income (Loss)			Total

Balances at December 31, 2009	$	7,184	$	1,662	$	(3,372	)	$	36,963		$	(1,015	)	$	41,422

Other Comprehensive Income:
Net Income									974						974
Change in other comprehensive income for unrealized gains or losses on investment securities available for sales												(13	)		(13	)
Total Comprehensive Income															961

Dividends Paid									(1,056	)					(1,056	)

Balances September 30, 2010	$	7,184	$	1,662	$	(3,372	)	$	36,881		$	(1,028	)	$	41,327




Balances at December 31, 2010	$	7,184	$	1,662	$	(3,372	)	$	37,165		$	(1,271	)	$	41,368

Other Comprehensive Income:
Net Income									1,131						1,131
Change in other comprehensive income for unrealized gains or losses on investment securities available for sales												73			73
Total Comprehensive Income															1,203

Dividends Paid									(602	)					(602	)

Balances September 30, 2011	$	7,184	$	1,662	$	(3,372	)	$	37,694		$	(1,198	)	$	41,970


The accompanying notes are an integral part of these financial statements

HIGHLANDS BANKSHARES, INC.
CONSOLIDATED STATEMENTS OF CASH FLOWS
(In Thousands of Dollars)
	Nine Months Ended September 30
	2011			2010
	(unaudited)			(unaudited)
Cash Flows From Operating Activities
Net Income	$	1,131		$	974
Adjustments to reconcile net income to net
cash provided by operating activities
(Gains) on securities transactions		(15	)		(34	)
(Gains) losses on sale of foreclosed property		(15	)		24
Depreciation		587			561
Income from life insurance contracts		(198	)		(164	)
Net amortization of securities premiums		181			111
Provision for loan losses		2,985			2,896
Write-down on foreclosed assets		155			107
Deferred income tax benefit		(18	)		(319	)
Amortization of intangibles		140			147
Decrease in interest receivable		181			104
Decrease in other assets		578			827
Increase (decrease) in accrued expenses		(369	)		586
Net Cash Provided by Operating Activities		5,323			5,820

Cash Flows From Investing Activities
Proceeds from sale of foreclosed assets and fixed assets		776			335
Proceeds from maturity of securities available for sales		2,276			8,829
Proceeds from sale of securities available for sale		6,774			2,544
Purchase of securities available for sale		(20,256	)		(13,009	)
Net change in other investments		265			0
Net change in interest bearing deposits in other banks		760			156
Net change in federal funds sold		(9,774	)		5,107
Net (increase) decrease in loans		7,172			(583	)
Purchase of property and equipment		(176	)		(1,259	)
Net Cash Provided by (Used in) Investing Activities		(12,183	)		2,120

Cash Flows From Financing Activities
Net change in time deposits		(6,781	)		(10,194	)
Net change in other deposit accounts		9,874			3,844
Additional long term borrowing		3,500			0
Repayment of long term borrowings		(1,190	)		(352	)
Dividends paid in cash		(602	)		(1,056	)
Net Cash Provided by (Used in) Financing Activities		4,801			(7,758	)
Net (decrease) increase in Cash and Cash Equivalents		(2,059	)		182
Cash and Cash Equivalents, Beginning of Period		8,282			7,062
Cash and Cash Equivalents, End of Period	$	6,223		$	7,244

Supplemental Disclosures
Cash paid for income taxes	$	910		$	438
Cash paid for interest	$	3,668		$	5,082
Noncash Investing and Financing Activities for other
real estate acquired in settlement of loans	$	1,248		$	1,951
The accompanying notes are an integral part of these financial statements.

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS

NOTE ONE:

ACCOUNTING PRINCIPLES

The consolidated financial statements conform to U. S. generally accepted accounting principles and to general industry practices. In the opinion of management, the accompanying unaudited consolidated financial statements contain all adjustments, consisting solely of normal recurring adjustments, necessary to present fairly the financial position as of September 30, 2011 and the results of operations for the three and nine month periods ended September 30, 2011 and 2010.

The results of operations for the nine month periods ended September 30, 2011 and 2010 are not necessarily indicative of the results to be expected for the full year.

The notes included herein should be read in conjunction with the notes to financial statements included in the Company’s 2010 annual report on Form 10-K.

Certain reclassifications have been made to prior period balances to conform to the current year’s presentation format.

NOTE TWO:

LOANS

A summary of loans outstanding as of September 30, 2011 and December 31, 2010 is shown in the table below (in thousands of dollars):

	September 30, 2011		December 31, 2010
Commercial Mortgage	$	143,433	$	142,896
Commercial Other		12,431		15,037
Consumer Mortgage		138,194		142,505
Consumer Other		24,096		28,898
	$	318,154	$	329,336

The following is a summary of information pertaining to impaired loans by portfolio segment at September 30, 2011 and December 31, 2010 (in thousands of dollars):

Impaired Loans

As of September 30, 2011

		Recorded Investment		Unpaid Principal Balance		Related llowance		Average Recorded Investment		Interest Income Recognized
With no related allowance recorded:
Commercial Mortgage	$	23,074	$	23,074	$	0	$	27,715	$	876
Commercial Other		206		206		0		221		11
Consumer Mortgage		619		619		0		626		29
Sub-total	$	23,899	$	23,899	$	0	$	28,562	$	916

With an allowance recorded:
Commercial Mortgage		4,370		4,370		888		4,455		91
Commercial Other		155		155		90		176		11
Consumer Mortgage		1,034		1,034		327		1,037		32
Sub-total	$	5,559	$	5,559	$	1,305	$	5,668	$	134

Total
Commercial Mortgage		27,444		27,444		888		32,170		967
Commercial Other		361		361		90		397		22
Consumer Mortgage		1,653		1,653		327		1,663		61
Total	$	29,458	$	29,458	$	1,305	$	34,230	$	1,050

Impaired Loans
As of December 31, 2010
	Recorded Investment		Unpaid Principal Balance		Related Allowance		Average Recorded Investment		Interest Income Recognized

With no related allowance recorded:
Commercial Mortgage	$	18,455	$	18,455	$	0	$	26,557	$	137
Commercial Other		840		840		0		1,159		13
Consumer Mortgage		253		253		0		256		2
Sub-total	$	19,548	$	19,548	$	0	$	27,972	$	152
With an allowance recorded:
Commercial Mortgage		5,692		5,692		904		6,871		272
Commercial Other		148		148		21		203		19
Sub-total	$	5,840	$	5,840	$	925	$	7,074	$	291
Total
Commercial Mortgage		24,147		24,147		904		33,428		409
Commercial Other		988		988		21		1,362		32
Consumer Mortgage		253		253		0		256		2
Total	$	25,388	$	25,388	$	925	$	35,046	$	443

The average recorded investment in impaired loans was $14,550,000 and $33,625,000 for the three months ended September 30, 2010 and 2011, respectively, and $14,128,000 for the nine months ended September 30, 2010. The interest income recognized on impaired loans was $188,000 and $435,000 for the three months ended September 30, 2010 and 2011, respectively, and $601,000 for the nine months ended September 30, 2010.

No loans were identified as impaired with potential loss as of September 30, 2011 or December 31, 2010 for which an allowance was not provided. The table above includes troubled debt restructurings (TDR) of $14,817,000 and $5,607,000 as of September 30, 2011 and December 31, 2010, respectively. Loans are identified as TDR if concessions are made related to the terms of the loan beyond regular lending practices in response to a borrower’s financial condition. Restructured loans performing in accordance with modified terms consist of twenty-one commercial mortgages and twenty-two consumer mortgages. Restructured loans not performing in accordance with modified terms consist of five commercial mortgages and seven consumer mortgages. These loans were balloon renewals or restructurings of borrowers experiencing financial difficulties at either current market rates for borrowers not experiencing financial difficulties, were modified to reduce interest rates, or provide for interest-only payment periods. These loans did not have any additional commitments to extend credit at September 30, 2011.

Balances of non-accrual loans at September 30, 2011 and December 31, 2010 are shown below (in thousands of dollars):

	September 30, 2011		December 31, 2010
Loans on non-accrual status
Commercial Mortgage	$	5,752	$	2,215
Commercial Other		0		139
Consumer Mortgage		2,776		4,240
Consumer Other		25		385
Total non-accrual loans	$	8,553	$	6,979

Certain loans identified as impaired are placed into non-accrual status, based upon the loan’s performance compared with contractual terms. Not all loans identified as impaired are placed into non-accrual status. The interest on loans identified as impaired and placed into non-accrual status that was not recognized as income throughout the year (foregone interest) was $452,000 for the nine month period ended September 30, 2011.

The following table presents the contractual aging of the recorded investment in past due loans by class as of September 30, 2011 and December 31, 2010 (in thousands of dollars):

Age Analysis of Past Due Financing Receivables
As of September 30, 2011
	30-59 Days Past Due		60-89 Days Past Due		Greater Than 90 Days		Total Past Due		Current		Total Financing Receivables		Recorded Investment > 90 Days and Accruing

Commercial - Mortgage	$	1,281	$	870	$	4,754	$	6,905	$	136,528	$	143,433	$	73
Commercial -Other		187		61		71		319		12,112		12,431		71
Consumer - Mortgage		4,510		2,338		2,257		9,105		129,089		138,194		312
Consumer - Other		964		174		61		1,199		22,897		24,096		51
Total	$	6,942	$	3,443	$	7,143	$	17,528	$	300,626	$	318,154	$	507

Age Analysis of Past Due Financing Receivables
As of December 31, 2010
	30-59 Days Past Due		60-89 Days Past Due		Greater Than 90 Days		Total Past Due		Current		Total Financing Receivables		Recorded Investment > 90 Days and Accruing

Commercial - Mortgage	$	3,691	$	663	$	2,188	$	6,542	$	136,354	$	142,896	$	301
Commercial -Other		234		396		46		676		14,361		15,037		46
Consumer - Mortgage		5,391		2,952		4,089		12,432		130,073		142,505		397
Consumer - Other		917		580		171		1,668		27,230		28,898		122
Total	$	10,233	$	4,591	$	6,494	$	21,318	$	308,018	$	329,336	$	866

Troubled Debt Restructurings:

Impaired loans also include loans the Banks may elect to formally restructure due to the weakening credit status of a borrower such that the restructuring may facilitate a repayment plan that minimizes the potential losses, if any, that the Banks may have to otherwise incur. These loans are classified as impaired loans and, if on nonaccrual status as of the date of the restructuring, the loans are included in the nonaccrual loan balances noted above. Not included in nonperforming loans are loans that have been restructured that were performing in accordance with modified terms as of September 30, 2011.

The following tables present the Company’s loans restructured during the three and nine months reporting periods ending September 30, 2011 considered troubled debt by loan type (in thousands of dollars except number of contracts):

	Troubled Debt Restructurings For the Nine Month Period Ended September 30, 2011
	Number of Contacts		Pre-Modification Outstanding Recorded Investment		Post-Modification Outstanding Recorded Investment		Allowance associated with TDR's
Troubled Debt Restructurings
Commercial Mortgage	15	$	9,604	$	9,411	$	427
Commercial Other	2		122		119		0
Consumer Mortgage	6		1,269		1,278		327
Consumer Other	1		30		29		0
Total	24	$	11,025	$	10,837	$	754

	Troubled Debt Restructurings
	For the Three Month Period Ended September 30, 2011
	Number of Contacts		Pre-Modification Outstanding Recorded Investment		Post-Modification Outstanding Recorded Investment		Allowance associated with TDR's
Troubled Debt Restructurings
Commercial Mortgage		8	$	3,804	$	3,623	$	276
Commercial Other		1		122		119		0
Consumer Mortgage		3		409		415		65
Consumer Other		0		0		0		0
Total		12	$	4,335	$	4,157	$	341

The following table presents the Company’s loans restructured during the prior twelve months which defaulted during the three and nine months reporting periods ended September 30, 2011:

	Defaulted Troubled Debt Restructurings
	For the Nine Month Period Ended September 30, 2011
	Number of Contacts		Recorded Investment		Allowance associated with Defaulted TDR's
Troubled debt restructurings:
Commercial Mortgage		0	$	0	$	0
Commercial Other		1		25		0
Consumer Mortgage		0		0		0
Consumer Other		0		0		0
Total		1	$	25	$	0

	Defaulted Troubled Debt Restructurings
	For the Three Month Period Ended September 30, 2011
	Number of Contacts		Recorded Investment		Allowance associated with Defaulted TDR's
Troubled debt restructurings:
Commercial Mortgage		0	$	0	$	0
Commercial Other		1		25		0
Consumer Mortgage		0		0		0
Consumer Other		0		0		0
Total		1	$	25	$	0

NOTE THREE:

ALLOWANCE FOR LOAN LOSSES

A summary of the transactions in the allowance for loan losses for the nine month periods ended September 30, 2011 and December 31, 2010 is shown below (in thousands of dollars):

Allowance for Credit Losses and Recorded Investment in Financing Receivables
For the Nine Month Period Ended September 30, 2011
	Commercial Mortgage		Commercial Other			Consumer Mortgage		Consumer Other			Unallocated			Total

Allowance for Credit Losses:
Beginning Balance 12/31/2010	$	1,345	$	887		$	1,662	$	968		$	545		$	5,407
Charge-offs		2,321		163			463		277			0			3,224
Recoveries		127		136			10		190			0			463
Provision		3,406		(327	)		516		(371	)		(239	)		2,985
Ending Balance 9/30/2011	$	2,557	$	533		$	1,725	$	510		$	306		$	5,631
Ending Balance: individually evaluated for impairment		888		90			327		0			0			1,305
Ending Balance: collectively evaluated for impairment		1,669		443			1,398		510			306			4,326

Financing Receivables:
Ending Balance		143,433		12,431			138,194		24,096			0			318,154
Ending Balance: individually evaluated for impairment		27,444		361			1,653		0			0			29,458
Ending Balance: collectively evaluated for impairment	$	115,989	$	12,070		$	136,541	$	24,096		$	0		$	288,696

Allowance for Credit Losses and Recorded Investment in Financing Receivables
As of and For the Year Ended December 31, 2010
	Commercial Mortgage		Commercial Other		Consumer Mortgage		Consumer Other		Unallocated		Total

Allowance for Credit Losses:
Ending Balance 12/31/2010	$	1,345	$	887	$	1,662	$	968	$	545	$	5,407
Ending Balance: individually evaluated for impairment		904		21		0		0		0		925
Ending Balance: collectively evaluated for impairment		441		866		1,662		968		545		4,482

Financing Receivables:
Ending Balance		142,896		15,037		142,505		28,898		0		329,336
Ending Balance: individually evaluated for impairment		24,147		988		253		0		0		25,388
Ending Balance: collectively evaluated for impairment	$	118,749	$	14,049	$	142,252	$	28,898	$	0	$	303,948

The following table presents the company’s loans by internally assigned grades and by loan type (in thousands of dollars).

Credit Quality Indicators
As of September 30, 2011

Credit Risk Profile by Internally Assigned Grade

	Commercial		Commercial		Consumer		Consumer		Total
	Mortgage		Other		Mortgage		Other
Grade:
Excellent	$	813	$	1,507	$	2,563	$	2,796	$	7,679
Very Good		12,025		635		28,222		4,160		45,042
Pass		77,194		8,608		90,042		15,388		191,232
Pass-Watch		14,982		391		2,244		93		17,710
Special Mention		10,066		843		5,542		1,153		17,604
Substandard		28,320		447		8,727		506		38,000
Doubtful		33		0		854		0		887
Loss		0		0		0		0		0
Total	$	143,433	$	12,431	$	138,194	$	24,096	$	318,154

Credit Quality Indicators
As of December 31, 2010

Credit Risk Profile by Internally Assigned Grade

	Commercial		Commercial		Consumer		Consumer		Total
	Mortgage		Other		Mortgage		Other
Grade:
Excellent	$	1,573	$	968	$	2,964	$	2,793	$	8,298
Very Good		16,509		1,648		28,611		5,765		52,533
Pass		88,366		8,610		91,889		18,104		206,969
Pass-Watch		3,160		619		1,228		120		5,127
Special Mention		7,262		1,876		6,050		1,526		16,714
Substandard		24,194		1,025		6,747		450		32,416
Doubtful		0		0		0		0		0
Loss		0		0		129		0		129
Total	$	141,064	$	14,746	$	137,618	$	28,758	$	322,186

Loans classified as “special mention” have potential weaknesses that deserve management’s close attention. Loans classified as “substandard” have been determined to be inadequately protected by the current collateral pledged, if any, or the cash flow and/or the net worth of the borrower. “Doubtful” loans have all the weaknesses inherent in substandard loans, with the added characteristic that the weaknesses make collection or liquidation in full, on the basis of currently existing facts, conditions and values, highly questionable and improbable. Loans classified as “loss” are loans with expected loss of the entire principal balance. The loan may be carried in this classified status if circumstances indicate a remote possibility that the amount will be repaid, however, the principal balance is included in the impairment calculation and carried in the allowance for loan losses. Loans not categorized as special mention, substandard, or doubtful are classified as “pass”, “very good” or “excellent” loans and are considered to exhibit acceptable risk. Additionally, the Company classifies certain loans as “pass-watch” loans. This category includes satisfactory borrowing relationships that require close monitoring because of complexity, information deficiencies, or emerging signs of weakness.

NOTE FOUR:

INVESTMENT IN INSURANCE CONTRACTS

Investment in insurance contracts consist of single premium insurance contracts which have the dual purposes of providing a rate of return to the Company which approximately equals the Company’s average cost of funds and of providing life insurance and retirement benefits to certain executives.

NOTE FIVE:

SECURITIES AND RESTRICTED INVESTMENTS

The Company’s securities portfolio serves several purposes. Portions of the portfolio secure certain public and trust deposits while the remaining portions are held as investments or used to assist the Company in liquidity and asset/liability management.

The amortized cost and market value of securities as of September 30, 2011 and December 31, 2010 is shown in the table below (in thousands of dollars). All of the securities on the Company’s balance sheet are classified as available for sale.

	Available For Sale Securities
	As of September 30, 2011
			Gross		Gross
	Amortized		Unrealized		Unrealized		Market
	Cost		Gains		Losses		Value


U.S. Treasuries and Agencies	$	19,284	$	233	$	0	$	19,517

Mortgage backed securities		4,827		181		0		5,008

Collateralized mortgage obligations		3,644		10		49		3,605

States and municipalities		1,619		59		0		1,678

Certificates of deposit		6,645		27		4		6,668


Total Available For Sale Securities	$	36,019	$	510	$	53	$	36,476

	Available For Sale Securities As of December 31, 2010
			Gross		Gross
	Amortized		Unrealized		Unrealized		Market
	Cost		Gains		Losses		Value


U.S. Treasuries and Agencies	$	9,132	$	133	$	7	$	9,258

Mortgage backed securities		5,505		153		7		5,651

Collateralized mortgage obligations		1,764		0		0		1,764

States and municipalities		2,123		34		0		2,157

Certificates of deposit		6,442		25		2		6,465

Marketable equities		15		14		0		29

Total Available For Sale Securities	$	24,981	$	359	$	16	$	25,324

Information pertaining to securities with gross unrealized losses at September 30, 2011 and December 31, 2010, aggregated by investment category and length of time that individual securities have been in a continuous loss position is shown in the table below (in thousands of dollars):

As of September 30, 2011	Total					Less than 12 Months					12 Months or Greater
	Fair Value		Gross Unrealized Losses			Fair Value		Gross Unrealized Losses			Fair Value		Gross Unrealized Losses

Investment Category
U.S. Treasuries and Agencies	$	0	$	0		$	0	$	0		$	0	$	0
Mortgage backed securities		0		0			0		0			0		0
Collateralized mortgage obligations		2,233		(49	)		2,233		(49	)		0		0
Certificates of deposit		944		(4	)		944		(4	)		0		0
Total	$	3,177	$	(53	)	$	3,177	$	(53	)	$	0	$	0

As of December 31, 2010	Total					Less than 12 Months					12 Months or Greater
	Fair Value		Gross Unrealized Losses			Fair Value		Gross Unrealized Losses			Fair Value		Gross Unrealized Losses

Investment Category
U.S. Treasuries and Agencies	$	993	$	(7	)	$	993	$	(7	)	$	0	$	0
Mortgage backed securities		2,283		(7	)		2,283		(7	)		0		0
Collateralized mortgage obligations		827		0			827		0			0		0
Certificates of deposit		494		(2	)		494		(2	)		0		0
Total	$	4,597	$	(16	)	$	4,597	$	(16	)	$	0	$	0

Securities are classified as available for sale. Securities available for sale are carried at fair value, with unrealized holding gains and losses reported separately in shareholders’ equity, net of tax. Interest income includes net amortization of purchase premiums and discounts. Realized gains and losses on sales are determined using the amortized cost of the specific security sold. Securities are written down to fair value when a decline in fair value is considered other-than-temporary. In estimating other-than-temporary impairment losses, management considers (1) the length of time and the extent to which the fair value has been less than cost, (2) the financial condition and near-term prospects of the issuer, and (3) the intent and ability of the Corporation to retain its investment in the issuer for a period of time sufficient to allow for any anticipated recovery in fair value.

Restricted investments consist of investments in the Federal Home Loan Bank, the Federal Reserve Bank and West Virginia Bankers’ Title Insurance Company. Restricted investments are carried at face value and the level of investment is dictated by the level of participation with each institution. Amounts are restricted as to transferability. Investments in the Federal Home Loan Bank act as collateral against the outstanding borrowings from that institution.

NOTE SIX:

EARNINGS PER SHARE

Earnings per share represent income available to common stockholders divided by the weighted average number of common shares outstanding during the period. During 2011 and 2010, there were no changes to the outstanding shares of common stock. The Company does not offer a stock option program to its employees.

NOTE SEVEN:

DEBT INSTRUMENTS

The Company has borrowed money from the Federal Home Loan Bank of Pittsburgh (FHLB). This debt consists of both borrowings with terms of maturities of nine months or greater and also certain debts with maturities of thirty days or less.

The borrowings with long term maturities may have either single payment maturities or amortize. The interest rates on the various long term borrowings at September 30, 2011 range from 1.68% to 5.96%. The weighted average interest rate on the borrowings at September 30, 2011 was 3.76%.

In addition to utilization of the FHLB for borrowings of long term debt, the Company also can utilize the FHLB for overnight and other short term borrowings. At September 30, 2011 and December 31, 2010, the Company had no overnight or other short term borrowings.

NOTE EIGHT:

INTANGIBLE ASSETS

The Company’s balance sheet contains several components of intangible assets. At September 30, 2011, the total balance of intangible assets was comprised of Goodwill and Core Deposit Intangible Assets acquired as a result of the acquisition of other banks and also an intangible asset related to the purchased naming rights for a performing arts center located within the Company’s primary business area. The Company performs an impairment test on an annual basis for goodwill. No impairment has been recorded to date. Other intangible assets are amortized based upon the estimated economic benefits received.

NOTE NINE:

EMPLOYEE BENEFITS

The Company's two subsidiary banks each have separate retirement and profit sharing plans which cover substantially all full time employees at each bank.

Capon Valley Bank has a defined contribution pension plan with 401(k) features that is funded with discretionary contributions by the Bank. The bank matches, on a limited basis, the contributions of the employees. Investment of employee balances is done through the direction of each employee. Employer contributions are vested over a nine year period.

The Grant County Bank is a member of the West Virginia Bankers' Association Retirement Plan. Benefits under the plan are based on compensation and years of service with 100% vesting after seven years of service. The Bank has recognized a liability of $1,856,000 at September 30, 2011 for the unfunded portion of the plan. The following table provides the components of the net periodic benefit cost for the plan for the three and nine month periods ended September 30, 2011 and 2010 (in thousands of dollars):

	Three Months ending						Nine Months ending
	September 30,						September 30,
	2011			2010			2011			2010
Service cost	$	51		$	47		$	152		$	141
Interest cost		81			76			244			227
Expected return on plan assets		(88	)		(84	)		(265	)		(252	)
Recognized net actuarial loss		38			24			116			73
Net periodic expense	$	82		$	63		$	247		$	189

NOTE TEN:

FAIR VALUE MEASUREMENTS

ASC 820, Fair Value Measurements and Disclosures (previously SFAS No. 157, Fair Value Measurements), defines fair value, establishes a framework for measuring fair value, establishes a three-level valuation hierarchy for disclosure of fair value measurement and enhances disclosure requirements for fair value measurements. The valuation hierarchy is based upon the transparency of inputs to the valuation of an asset or liability as of the measurement date. The three levels are defined as follows:

·	Level One: Inputs to the valuation methodology are quoted prices (unadjusted) for identical assets or liabilities in active markets.

·	Level Two: Inputs to the valuation methodology include quoted prices for similar assets and liabilities in active markets, and inputs that are observable for the asset or liability, either directly or indirectly, for substantially the full term of the financial instrument.

·	Level Three: Inputs to the valuation methodology are unobservable and significant to the fair value measurement.

Following is a description of the valuation methodologies used for instruments measured at fair value on the Company’s balance sheet, as well as the general classification of such instruments pursuant to the valuation hierarchy:

Securities

Where quoted prices are available in an active market, securities are classified within level 1 of the valuation hierarchy. Level 1 securities would include highly liquid government bonds, mortgage products and exchange traded equities. If quoted market prices are not available, then fair values are estimated by using pricing models, quoted prices of securities with similar characteristics, or discounted cash flow. Level 2 securities would include U.S. agency securities, mortgage-backed agency securities, obligations of states and political subdivisions and certain corporate, asset backed and other securities. In certain cases where there is limited activity or less transparency around inputs to the valuation, securities are classified within level 3 of the valuation hierarchy. Currently, all of the Company’s securities are considered to be Level 2 securities.

Impaired Loans

The fair value measurement guidance applies to loans measured for impairment using the practical expedients permitted by authoritative accounting guidance, including impaired loans measured at an observable market price (if available), or at the fair value of the loan’s collateral (if the loan is collateral dependent). Fair value of the loan’s collateral, when the loan is dependent on collateral, is determined by appraisals or independent valuation which is then adjusted for the estimated cost related to liquidation of the collateral. At September 30, 2011, the Company had impaired loans with an unpaid principal balance of $29,458,000 of which $5,559,000 required an allowance of $1,305,000. (see Note Two).

Other Real Estate Owned

Certain assets such as other real estate owned (OREO) are measured at fair value. Real estate acquired through foreclosure is recorded at an estimated fair value less cost to sell. At or near the time of foreclosure, a real estate appraisal is obtained on the properties. In the event that a sales agreement is in place at the time of valuation, the fair value of the collateral is determined to be the agreed-upon sale price, net of anticipated selling costs (Level 1). In the absence of a sales agreement, the real estate is then valued at the lesser of the appraised value, net of anticipated selling costs, or the loan balance, including interest receivable, at the time of foreclosure less an estimate of costs to sell the property. Appraised values are typically determined utilizing an income or market valuation approach based on an appraisal conducted by an independent, licensed appraiser (Level 2). If the acquired property is a house or building in the process of construction or if an appraisal of the real estate property is over twelve months old, the fair value is considered Level 3. The estimate of costs to sell the property is based on historical transactions of similar holdings.

The Company, at September 30, 2011 and December 31, 2010 had no liabilities subject to fair value reporting requirements. The table below summarizes assets at September 30, 2011 and December 31, 2010 measured at fair value on a recurring basis (in thousands of dollars):

September 30, 2011	Level 1		Level 2		Level 3		Total Fair Value Measurements
U.S. Treasuries and Agencies	$	0	$	19,517	$	0	$	19,517
Mortgage backed securities		0		5,008		0		5,008
Collateralized mortgage obligations		0		3,605		0		3,605
States and municipalities		0		1,678		0		1,678
Certificates of deposit		0		6,668		0		6,668
Marketable equities		0		0		0		0
Total Available For Sale Securities	$	0	$	36,476	$	0	$	36,476

December 31, 2010	Level 1		Level 2		Level 3		Total Fair Value Measurements
U.S. Treasuries and Agencies	$	0	$	9,258	$	0	$	9,258
Mortgage backed securities		0		5,651		0		5,651
Collateralized mortgage obligations		0		1,764		0		1,764
States and municipalities		0		2,157		0		2,157
Certificates of deposit		0		6,465		0		6,465
Marketable equities		0		29		0		29
Total Available For Sale Securities	$	0	$	25,324	$	0	$	25,324

The table below summarizes assets at September 30, 2011 and December 31, 2010, measured at fair value on a non recurring basis (in thousands of dollars):

	Level 1		Level 2		Level 3		Total Fair Value Measurements		Three Months Ended September 30, 2011Total gains/(losses)		Nine Months Ended September 30, 2011 Total gains/(losses)
Other real estate owned	$	0	$	1,999	$	3,034	$	5,033	$	26	$	(140	)
Impaired Loans		0		3,931		323		4,254		0		0
Total	$	0	$	5,930	$	3,357	$	9,287	$	26	$	(140	)

	Level 1		Level 2		Level 3		Total Fair Value Measurements		Twelve Months Ended December 31, 2010 Total gains/(losses)			Twelve Months Ended December 31, 2010 Total gains/(losses)
Other real estate owned	$	0	$	1,042	$	3,658	$	4,700	$	(159	)	$	(159	)
Impaired Loans	$	0	$	0	$	4,915	$	4,915	$	0		$	0
Total	$	0	$	1,042	$	8,573	$	9,615	$	(159	)	$	(159	)

The information above discusses financial instruments carried on the Company’s balance sheet at fair value. Other financial instruments on the Company’s balance sheet, while not carried at fair value, do have fair values which may differ from the carrying value. GAAP requires disclosure relating to these fair values. The following information shows the carrying values and estimated fair values of financial instruments and discusses the methods and assumptions used in determining these fair values.

The fair value of the Company's assets and liabilities is influenced heavily by market conditions. Fair value applies to both assets and liabilities, either on or off the balance sheet. Fair value is defined as the amount at which a financial instrument could be exchanged in a current transaction between willing parties, other than in a forced or liquidation sale.

The methods and assumptions detailed below were used to estimate the fair value of each class of financial instruments for which it is practicable to estimate that value:

Cash, Due from Banks and Money Market Investments

The carrying amount of cash, due from bank balances, interest bearing deposits and federal funds sold is a reasonable estimate of fair value.

Securities

Fair values of securities are based on quoted market prices or dealer quotes. If a quoted market price is not available, fair value is estimated using quoted market prices for similar securities.

Restricted Investments

The carrying amount of restricted investments is a reasonable estimate of fair value.

Loans

The fair value of loans is estimated by discounting the future cash flows using the current rates at which similar loans would be made to borrowers with similar credit ratings and for the same remaining maturities, taking into consideration the credit risk in various loan categories.

Deposits

The fair value of demand, interest checking, regular savings and money market deposits is the amount payable on demand at the reporting date. The fair value of fixed maturity certificates of deposit is estimated using the rates currently offered for deposits of similar remaining maturities.

Long Term Debt

The fair value of fixed rate loans is estimated using the rates currently offered by the Federal Home Loan Bank for indebtedness with similar maturities.

Short Term Debt

The fair value of short-term variable rate debt is deemed to be equal to the carrying value.

Interest Payable and Receivable

The carrying value of amounts of interest receivable and payable is a reasonable estimate of fair value.

Life Insurance

The carrying amount of life insurance contracts is assumed to be a reasonable fair value. Life insurance contracts are carried on the balance sheet at their redemption value as of September 30, 2011. This redemption value is based on existing market conditions and therefore represents the fair value of the contract.

Off-Balance-Sheet Items

The carrying amount and estimated fair value of off-balance-sheet items were not material at September 30, 2011 or December 31, 2010.

The carrying amount and estimated fair values of financial instruments as of September 30, 2011 and December 31, 2010 are shown in the table below (in thousands of dollars):

	September 30, 2011				December 31, 2010
	Carrying		Estimated		Carrying		Estimated
	Amount		Fair Value		Amount		Fair Value
Financial Assets:
Cash and due from banks	$	6,223	$	6,223	$	8,282	$	8,282
Interest bearing deposits		2,772		2,772		3,532		3,532
Federal funds sold		15,610		15,610		5,836		5,836
Securities available for sale		36,476		36,476		25,324		25,324
Restricted investments		1,822		1,822		2,087		2,087
Loans, net		312,523		313,634		323,929		324,780
Interest receivable		1,610		1,610		1,791		1,791
Life insurance contracts		7,229		7,229		7,031		7,031

Financial Liabilities:
Demand and savings deposits		141,959		141,959		132,085		132,085
Time deposits		203,946		207,291		210,727		211,590
Long term debt instruments		11,703		12,145		9,393		10,142
Interest payable		405		405		488		488

NOTE ELEVEN: SUBSEQUENT EVENTS

The Company evaluates subsequent events that have occurred after the balance sheet, but before the financial statements are issued. There are two types of subsequent events: (1) recognized, or those that provide additional evidence about conditions that existed at the date of the balance sheet, including the estimates inherent in the process of preparing financial statements, and (2) non-recognized, or those that provide evidence about conditions that did not exist at the date of the balance sheet but arose after that date.

Based on management’s evaluation through the date these financial statements were issued, the Company did not identify any recognized or non-recognized subsequent events that would have required adjustment or disclosure in the consolidated financial statements.

Item 2.

Management’s Discussion and Analysis of Financial Condition and Results of Operations

Introduction

The following discussion focuses on significant results of the Company’s operations and significant changes in our financial condition or results of operations for the periods indicated in the discussion. This discussion should be read in conjunction with the preceding financial statements and related notes, as well as the Company’s Annual Report on Form 10-K for the period ended December 31, 2010. Current performance does not guarantee, and may not be indicative of, similar performance in the future.

Forward Looking Statements

Certain statements in this report may constitute “forward-looking statements” within the meaning of the Private Securities Litigation Reform Act of 1995. Forward-looking statements are statements that include projections, predictions, expectations or beliefs about future events or results or otherwise are not statements of historical fact. Such statements are often characterized by the use of qualified words (and their derivatives) such as “expect,” “believe,” “estimate,” “plan,” “project,” “anticipate” or other similar words. Although the Company believes that its expectations with respect to certain forward-looking statements are based upon reasonable assumptions within the bounds of its existing knowledge of its business and operations, there can be no assurance that actual results, performance or achievements of the Company will not differ materially from any future results, performance or achievements expressed or implied by such forward-looking statements. Actual future results and trends may differ materially from historical results or those anticipated depending on a variety of factors, including, but not limited to, the effects of and changes in: general economic conditions, the interest rate environment, legislative and regulatory requirements, competitive pressures, new products and delivery systems, inflation, changes in the stock and bond markets, technology, downturns in the trucking, mining, and timber industries, downturns in the housing market affecting manufacturers of household cabinetry and thus, employment, effects of mergers and/or downsizing in the poultry industry in Hardy County, continued challenges in the current economic environment affecting our financial condition and results of operations, continued deterioration in the financial condition of the U.S. banking system impacting the valuations of investments the Company has made in the securities of other financial institutions, and consumer spending and savings habits, particularly in the current economic environment. Additionally, actual future results and trends may differ from historical or anticipated results to the extent: (1) any significant downturn in certain industries, particularly the trucking and timber industries are experienced; (2) loan demand decreases from prior periods; (3) the Company may make additional loan loss provisions due to negative credit quality trends in the future that may lead to a deterioration of asset quality; (4) the Company may not continue to experience significant recoveries of previously charged-off loans or loans resulting in foreclosure; (5) the Company is unable to control costs and expenses as anticipated, (6) legislative and regulatory changes could increase expenses (including changes as a result of rules and regulations adopted under the Dodd-Frank Wall Street Reform and Consumer Protection Act); (7) the effects of the recent down grade of U.S. Government Securities by one of the credit rating agencies could have a material adverse effect on the company’s operations, earnings and financial condition; and (8) any additional assessments imposed by the FDIC. Additionally, consideration should be given to the cautionary language contained elsewhere in this Form 10-Q. The Company does not update any forward-looking statements that may be made from time to time by or on behalf of the Company.

Critical Accounting Policies

The Company’s financial statements are prepared in accordance with accounting principles generally accepted in the United States (“GAAP”). The financial statements contained within these statements are, to a significant extent, financial information that is based on measures of the financial effects of transactions and events that have already occurred. A variety of factors could affect the ultimate value that is obtained either when earning income, recognizing an expense, recovering an asset or relieving a liability. In addition, GAAP itself may change from one previously acceptable method to another method. Although the economics of these transactions would be the same, the timing of events that would impact these transactions could change.

Disclosure of the Company’s significant accounting policies are included in Note Two to the Consolidated Financial Statements of the Company’s Annual Report on Form 10-K for the period ended December 31, 2010. Some of the policies are particularly sensitive, requiring significant judgments, estimates and assumptions by management.

Allowance for Loan Losses

The allowance for loan losses is an estimate of the losses that may be sustained in the loan portfolio. The allowance is based on two basic principles of accounting: (i) ASC 450, Contingencies, which requires that losses be accrued when they are probable of occurring and estimable and (ii) ASC 310, Receivables, (previously Statement of Financial Accounting Standards No. 114, Accounting by Creditors for Impairment of a Loan), which requires that losses be accrued based on the differences between the value of collateral, present value of future cash flows or values that are observable in the secondary market and the loan balance.

The allowance consists of specific, general and unallocated components. The specific component relates to loans that are determined to be impaired. For such loans, an allowance is established when the discounted cash flows (or collateral value or observable market price) of the impaired loan is lower than the carrying value of that loan.

The general component covers non-impaired loans and is based on management’s internal risk ratings as well as historical loss experience adjusted for qualitative factors. The following risk factors relevant to the loan portfolio are reviewed and evaluated:

·	Changes in lending policies and procedures, including changes in underwriting standards or collection, charge-off and recovery practices.

·	Changes in national, regional, and local economic and business conditions and developments that affect the collectability of the portfolio, including unemployment trends and GDP and other leading economic indicators.

·	Changes in the nature and volume of the portfolio.

·	Changes in the experience, ability and depth of lending management and staff.

·	Changes in the volume and severity of past due and classified loans, the volume of nonaccrual loans, troubled debt restructurings and other loan modifications.

·	Changes in the quality of the Banks’ loan review systems.

·	The existence and effect of any concentrations of credit, and the changes in the level of such concentrations.

·	Changes in the value of underlying collateral.

·	The effect of other external factors such as competition and legal and regulatory requirements on the level of estimated credit losses in the existing portfolio.

An unallocated component is maintained to cover uncertainties that could affect management’s estimate of probable losses. The unallocated component of the allowance reflects the margin of imprecision inherent in the underlying assumptions used in the methodologies for estimating specific and general losses in the portfolio.

A loan is considered impaired when, based on current information and events, it is probable that the Company will be unable to collect the scheduled payment of principal or interest when due according to the contractual terms of the loan agreement. Factors considered by management in determining impairment include payment status, collateral value, and the probability of collecting scheduled principal and interest payments when due. Loans that experience insignificant payment delays and payment shortfalls generally are not classified as impaired. Management determines the significance of payment delays and payment shortfalls on a case-by-case basis, taking into consideration all of the circumstances surrounding the loan and the borrower, including the length of the delay, the borrower’s prior payment record, and the amount of the shortfall in relation to the principal and interest owed.

Impairment is measured on a loan by loan basis for commercial loans by either the present value of expected future cash flows discounted at the loan’s effective interest rate, the loan’s obtainable market price, or the fair value of the collateral if the loan is collateral dependent. Large homogeneous loans are determined to be impaired if management feels it is unlikely that the borrower will perform in accordance with the terms of the original agreement.

Large groups of smaller balance homogeneous loans are collectively evaluated for impairment. Accordingly, the Banks do not separately identify individual consumer and residential loans for impairment disclosures, unless the loans are the subject of a restructuring agreement.

Authoritative accounting guidance does not specify how an institution should identify loans that are to be evaluated for collectability, nor does it specify how an institution should determine that a loan is impaired. Each subsidiary of the Company uses its standard loan review procedures in making those judgments so that allowance estimates are based on a comprehensive analysis of the loan portfolio. For loans that are individually evaluated and found to be impaired and collaterally dependent, the associated allowance is based upon the estimated fair value, less costs to sell, of any collateral securing the loan as compared to the existing balance of the loan as of the date of analysis.

All other loans, including individually evaluated loans determined not to be impaired, are included in a group of loans that are measured under ASC 450 to provide for estimated credit losses that have been incurred on groups of loans with similar risk characteristics. The methodology for measuring estimated credit losses on groups of loans with similar risk characteristics in accordance with ASC 450 is based on each group’s historical net charge-off rate, adjusted for the effects of the qualitative or environmental factors that are likely to cause estimated credit losses as of the evaluation date to differ from the group’s historical loss experience.

Intangible Assets

The Company carries intangible assets related to the purchase of two banks. Amounts paid to purchase these banks were allocated as intangible assets. Generally accepted accounting principles were applied to allocate the intangible components of the purchases. The excess was allocated between identifiable intangibles (core deposit intangibles) and unidentified intangibles (goodwill). Goodwill is required to be evaluated for impairment on an annual basis, and the value of the goodwill adjusted accordingly, should impairment be found. As of December 31, 2010, the Company did not identify an impairment of this intangible. In addition to the intangible assets associated with the purchases of banks, the company also carries intangible assets relating to the purchase of naming rights to certain features of a performing arts center in Petersburg, WV. Intangible assets other than goodwill, which are determined to have finite lives, are amortized based upon the estimated economic benefits received.

Post Retirement Benefits and Life Insurance Investments

The Company has invested in and owns life insurance policies on key officers. The policies are designed so that the Company recovers the interest expenses associated with carrying the policies and the officer will, at the time of retirement, receive any earnings in excess of the amounts earned by the Company. The Company recognizes as an asset the net amount that could be realized under the insurance contract as of the balance sheet date. This amount represents the cash surrender value of the policies less applicable surrender charges. The portion of the benefits, which will be received by the executives at the time of their retirement, is considered, when taken collectively, to constitute a retirement plan. Therefore the Company accounts for these policies using guidance found in ASC 715, Compensation –Retirement Benefits. ASC 715 requires that an employer’s obligation under a deferred compensation agreement be accrued over the expected service life of the employee through their normal retirement date. Assumptions are used in estimating the present value of amounts due officers after their normal retirement date. These assumptions include the estimated income to be derived from the investments and an estimate of the Company’s cost of funds in these future periods. In addition, the discount rate used in the present value calculation will change in future years based on market conditions.

Recent Accounting Pronouncements

In January 2010, the Financial Accounting Standards Board (FASB) issued Accounting Standards Update (ASU) 2010-06, “Fair Value Measurements and Disclosures (Topic 820): Improving Disclosures about Fair Value Measurements.” ASU 2010-06 amends Subtopic 820-10 to clarify existing disclosures, require new disclosures, and includes conforming amendments to guidance on employers’ disclosures about postretirement benefit plan assets. ASU 2010-06 is effective for interim and annual periods beginning after December 15, 2009, except for disclosures about purchases, sales, issuances, and settlements in the roll forward of activity in Level 3 fair value measurements. Those disclosures are effective for fiscal years beginning after December 15, 2010 and for interim periods within those fiscal years. The adoption of the new guidance did not have a material impact on the Company’s consolidated financial statements.

In July 2010, the FASB issued ASU 2010-20, “Receivables (Topic 310) – Disclosures about the Credit Quality of Financing Receivables and the Allowance for Credit Losses.” The new disclosure guidance significantly expands the existing requirements and will lead to greater transparency into a company’s exposure to credit losses from lending arrangements. The extensive new disclosures of information as of the end of a reporting period became effective for both interim and annual reporting periods ending on or after December 15, 2010. Specific disclosures regarding activity that occurred before the issuance of the ASU, such as the allowance roll forward and modification disclosures, will be required for periods beginning on or after December 15, 2010. The Company has included the required disclosures in its consolidated financial statements.

In December 2010, the FASB issued ASU 2010-28, “Intangible – Goodwill and Other (Topic 350) – When to Perform Step 2 of the Goodwill Impairment Test for Reporting Units with Zero or Negative Carrying Amounts.” The amendments in this ASU modify Step 1 of the goodwill impairment test for reporting units with zero or negative carrying amounts. For those reporting units, an entity is required to perform Step 2 of the goodwill impairment test if it is more likely than not that a goodwill impairment exists. The amendments in this ASU are effective for fiscal years, and interim periods within those years, beginning after December 15, 2010. Early adoption is not permitted. The adoption of the new guidance did not have a material impact on the Company’s consolidated financial statements.

In December 2010, the FASB issued ASU 2010-29, “Business Combinations (Topic 805) – Disclosure of Supplementary Pro Forma Information for Business Combinations.” The guidance requires pro forma disclosure for business combinations that occurred in the current reporting period as though the acquisition date for all business combinations that occurred during the year had been as of the beginning of the annual reporting period. If comparative financial statements are presented, the pro forma information should be reported as though the acquisition date for all business combinations that occurred during the current year had been as of the beginning of the comparable prior annual reporting period. ASU 2010-29 is effective for business combinations for which the acquisition date is on or after the beginning of the first annual reporting period beginning on or after December 15, 2010. Early adoption is permitted. The adoption of the new guidance did not have a material impact on the Company’s consolidated financial statements.

The Securities Exchange Commission (SEC) issued Final Rule No. 33-9002, “Interactive Data to Improve Financial Reporting.” The rule requires companies to submit financial statements in extensible business reporting language (XBRL) format with their SEC filings on a phased-in schedule. Large accelerated filers and foreign large accelerated filers using U.S. GAAP were required to provide interactive data reports starting with their first quarterly report for fiscal periods ending on or after June 15, 2010. All remaining filers are required to provide interactive data reports starting with their first quarterly report for fiscal periods ending on or after June 15, 2011. The Company complied with this Rule beginning with the filing of the June 30, 2011 Form 10-Q.

In March 2011, the SEC issued Staff Accounting Bulletin (SAB) 114. This SAB revises or rescinds portions of the interpretive guidance included in the codification of the Staff Accounting Bulletin Series. This update is intended to make the relevant interpretive guidance consistent with current authoritative accounting guidance issued as a part of the FASB’s Codification. The principal changes involve revision or removal of accounting guidance references and other conforming changes to ensure consistency of referencing through the SAB Series. The effective date for SAB 114 is March 28, 2011. The adoption of the new guidance did not have a material impact on the Company’s consolidated financial statements.

In April 2011, the FASB issued ASU 2011-02, “Receivables (Topic 310) – A Creditor’s Determination of Whether a Restructuring Is a Troubled Debt Restructuring.” The amendments in this ASU clarify the guidance on a creditor’s evaluation of whether it has granted a concession to a debtor. They also clarify the guidance on a creditor’s evaluation of whether a debtor is experiencing financial difficulty. The amendments in this ASU are effective for the first interim or annual period beginning on or after June 15, 2011. Early adoption is permitted. Retrospective application to the beginning of the annual period of adoption for modifications occurring on or after the beginning of the annual adoption period is required. As a result of applying these amendments, an entity may identify receivables that are newly considered to be impaired. For purposes of measuring impairment of those receivables, an entity should apply the amendments prospectively for the first interim or annual period beginning on or after June 15, 2011. The Company has adopted ASU 2011-02 and included the required disclosures in its consolidated financial statements.

In April 2011, the FASB issued ASU 2011-03, “Transfers and Servicing (Topic 860) – Reconsideration of Effective Control for Repurchase Agreements.” The amendments in this ASU remove from the assessment of effective control (1) the criterion requiring the transferor to have the ability to repurchase or redeem the financial assets on substantially the agreed terms, even in the event of default by the transferee and (2) the collateral maintenance implementation guidance related to that criterion. The amendments in this ASU are effective for the first interim or annual period beginning on or after December 15, 2011. The guidance should be applied prospectively to transactions or modifications of existing transactions that occur on or after the effective date. Early adoption is not permitted. The Company is currently assessing the impact that ASU 2011-03 will have on its consolidated financial statements.

In May 2011, the FASB issued ASU 2011-04, “Fair Value Measurement (Topic 820) – Amendments to Achieve Common Fair Value Measurement and Disclosure Requirements in U.S. GAAP and IFRSs.” This ASU is the result of joint efforts by the FASB and IASB to develop a single, converged fair value framework on how (not when) to measure fair value and what disclosures to provide about fair value measurements. The ASU is largely consistent with existing fair value measurement principles in U.S. GAAP (Topic 820), with many of the amendments made to eliminate unnecessary wording differences between U.S. GAAP and IFRSs. The amendments are effective for interim and annual periods beginning after December 15, 2011 with prospective application. Early application is not permitted. The Company is currently assessing the impact that ASU 2011-04 will have on its consolidated financial statements.

In June 2011, the FASB issued ASU 2011-05, “Comprehensive Income (Topic 220) – Presentation of Comprehensive Income.” The objective of this ASU is to improve the comparability, consistency and transparency of financial reporting and to increase the prominence of items reported in other comprehensive income by eliminating the option to present components of other comprehensive income as part of the statement of changes in stockholders’ equity. The amendments require that all non-owner changes in stockholders’ equity be presented either in a single continuous statement of comprehensive income or in two separate but consecutive statements. The single statement of comprehensive income should include the components of net income, a total for net income, the components of other comprehensive income, a total for other comprehensive income, and a total for comprehensive income. In the two-statement approach, the first statement should present total net income and its components followed consecutively by a second statement that should present all the components of other comprehensive income, a total for other comprehensive income, and a total for comprehensive income. The amendments do not change the items that must be reported in other comprehensive income, the option for an entity to present components of other comprehensive income either net of related tax effects or before related tax effects, or the calculation or reporting of earnings per share. The amendments in this ASU should be applied retrospectively. The amendments are effective for fiscal years and interim periods within those years beginning after December 15, 2011. Early adoption is permitted because compliance with the amendments is already permitted. The amendments do not require transition disclosures. The Company is currently assessing the impact that ASU 2011-05 will have on its consolidated financial statements.

In August 2011, the SEC issued Final Rule No. 33-9250, “Technical Amendments to Commission Rules and Forms related to the FASB’s Accounting Standards Codification.” The SEC has adopted technical amendments to various rules and forms under the Securities Act of 1933, the Securities Exchange Act of 1934, and the Investment Company Act of 1940. These revisions were necessary to conform those rules and forms to the FASB Accounting Standards Codification. The technical amendments include revision of certain rules in Regulation S-X, certain items in Regulation S-K, and various rules and forms prescribed under the Securities Act, Exchange Act and Investment Company Act. The Release was effective as of August 12, 2011. The adoption of the release did not have a material impact on the Company’s consolidated financial statements.

In September 2011, the FASB issued ASU 2011-08, “Intangible – Goodwill and Other (Topic 350) – Testing Goodwill for Impairment.” The amendments in this ASU permit an entity to first assess qualitative factors related to goodwill to determine whether it is more likely than not that the fair value of the reporting unit is less than its carrying amount as a basis for determining whether it is necessary to perform the two-step goodwill test described in Topic 350. The more-likely-than-not threshold is defined as having a likelihood of more than 50 percent. Under the amendments in this ASU, an entity is not required to calculate the fair value of a reporting unit unless the entity determines that it is more likely than not that its fair value is less than its carrying amount. The amendments in this ASU are effective for annual and interim goodwill impairment tests performed for fiscal years beginning after December 15, 2010 . Early adoption is permitted, including for annual and interim goodwill impairment tests performed as of a date before September 15, 2011, if an entity’s financial statements for the most recent annual or interim period have not yet been issued. The Company is currently assessing the impact that ASU 2011-08 will have on its consolidated financial statements.

Overview of First Nine Months Results

Net income for the first nine months of 2011, as compared to the same period in 2010, increased 16.0%. The increased income was primarily the result of decreases in non-interest related expenses.

Total assets increased 1.4% from December 31, 2010 to September 30, 2011 with gross loan balances decreasing 3.4% during the same period. Average balances of earning assets and interest bearing liabilities, for the first nine months of 2011, decreased 1.2% and 2.7%, respectively, compared to the same period in 2010. Interest income on earning assets decreased 7.3%, on a fully tax equivalent basis, which was primarily offset by the decrease in interest expense on interest bearing liabilities of 25.8% on a fully taxable equivalent basis.

The Company’s allowance for loan losses increased to 1.77% of total gross loans at September 30, 2011 as compared to 1.64% at December 31, 2010.

Non-interest income decreased $133,000 in the first nine months of 2011 as compared to the same period in 2010 driven primarily by the reduction in service charge and fee revenues.

Non-interest expense decreased $546,000 in the first nine months of 2011 as compared to the same period in 2010 primarily due to reductions in employee related costs and legal expenses.

Performance Measures

The following table compares selected commonly used measures of bank performance for the nine month periods ended September 30, 2011 and 2010:

	Nine months ended September 30,
	2011			2010
Annualized return on average assets		0.37	%		0.30	%
Annualized return on average equity		3.70	%		3.19	%
Net interest margin (1)		4.45	%		4.41	%
Efficiency Ratio (2)		66.14	%		69.19	%
Earnings per share (3)	$	0.85		$	0.73

(1)	On a fully taxable equivalent basis and including loan origination fees.

(2)	Non-interest expenses for the period indicated divided by the sum of net interest income and non-interest income for the period indicated.

(3)	Per weighted average shares of common stock outstanding for the period indicated.

Securities Portfolio

The Company's securities portfolio serves several purposes. Portions of the portfolio are used to secure certain public and trust deposits. The remaining portfolio is held as investments or used to assist the Company in liquidity and asset liability management. Total securities, including restricted securities, represented 9.4% of total assets and 91.2% of total shareholders’ equity at September 30, 2011.

The securities portfolio typically will consist of three components: securities held to maturity, securities available for sale and restricted securities. Securities are classified as held to maturity when management has the intent and the Company has the ability at the time of purchase to hold the securities to maturity. Held to maturity securities are carried at cost, adjusted for amortization of premiums and accretion of discounts. Securities to be held for indefinite periods of time are classified as available for sale and accounted for at market value. Securities available for sale include securities that may be sold in response to changes in market interest rates, changes in the security's prepayment risk, increases in loan demand, general liquidity needs and other similar factors. Restricted securities are those investments purchased as a requirement of membership in certain governmental lending institutions and cannot be transferred without the issuer’s permission. The Company's purchases of securities have generally been limited to securities of high credit quality with short to medium term maturities.

The Company identifies at the time of acquisition those securities that are available for sale. These securities are valued at their market value with any difference in market value and amortized cost shown as an adjustment in stockholders' equity. Changes in market values of securities which are considered temporary changes due to changes in the market rate of interest are reflected as changes in other comprehensive income, net of the deferred tax effect. Any changes in market values of securities deemed by management to be attributable to reasons other than changes in market rates of interest would be recorded through results of operations. As of September 30, 2011, management determined that all securities with fair values less than the amortized cost, are related to increases in the current interest rates for similar issues of securities, and that no other than temporary impairment for any securities in the portfolio exists because of downgrades of the securities or as a result of a change in the financial condition of any of the issuers. A summary of the length of time of unrealized losses for all securities held at September 30, 2011 can be found in Note Five to the financial statements. Management reviews all securities with unrealized losses, and all securities in the portfolio on a regular basis to determine whether the potential for other than temporary impairment exists.

Loan Portfolio

The Company is an active residential mortgage and construction lender and generally extends commercial loans to small and medium sized businesses within its primary service area. The Company's commercial lending activity extends across its primary service areas of Grant, Hardy, Hampshire, Mineral, Randolph, Tucker, and northern Pendleton counties in West Virginia, Frederick County, Virginia and Garrett County, Maryland. Consistent with its focus on providing community-based financial services, the Company does not attempt to diversify its loan portfolio geographically by making significant amounts of loans to borrowers outside of its primary service area.

Credit Quality and Allowance for Loan Losses

Non-performing loans increased 15.5% from December 31, 2010 to September 30, 2011 due to a $1.58 million increase in non-accrual loans partially offset by a $359,000 decrease in loans 90 days or more past due. Non-accrual loans have increased as a result of the deterioration of loan performance due to the current economic conditions. As a result of the decline of property values, management has chosen to be more conservative in its evaluation of potential non-performing loans. Non-performing loans represented as a percentage of total loans increased to 2.85% during the first nine months of 2011, as compared to 2.38% of total loans at December 31, 2010, due to the increase in non-accrual loans mentioned above. The allowance for loan losses as a percentage of total loans increased from the December 31, 2010 level of 1.64% to 1.77%. As noted in Note Two to the unaudited consolidated financial statements, the carrying value of impaired loans increased from $25.4 million at December 31, 2010 to $29.4 million at September 30, 2011.

Restructured loans performing in accordance with modified terms consist of twenty-one commercial mortgages and twenty-two consumer mortgages. Restructured loans not performing in accordance with modified terms consist of five commercial mortgages and seven consumer mortgages. Based on Management’s analysis, $1,174,000 is included in the allowance related to restructured loans. The remaining restructured loans are well secured and no losses are anticipated; therefore, no additional allowance was provided.

Each of the Company’s banking subsidiaries determines the adequacy of its allowance for loan losses independently using the same allowance for loan loss methodology. The allowance is calculated quarterly and adjusted prior to the issuance of the quarterly financial statements. All loan losses charged to the allowance are approved by the boards of directors of each bank at their regular meetings. The allowance is reviewed for adequacy after considering historical loss rates, current economic conditions (both locally and nationally) and any known credit problems that have not been considered elsewhere in the calculation. Although the loan portfolios of the two banks are similar to each other, some differences exist which result in divergent risk patterns and different historical charge-off rates amongst the functional areas of the banks’ loan portfolios. Each bank pays particular attention to the individual loan performance, collateral values, borrower financial condition and economic conditions. A committee, with representatives from both subsidiary banks, meets to discuss the overall economic conditions that impact both subsidiary banks in the same fashion.

The determination of an adequate allowance at each bank is done in a four step process. The first step is to identify impaired loans. Impaired loans are problem loans above a certain threshold which are not expected to perform in accordance with the original loan agreement. Impaired loans and their resulting valuation allowance are disclosed in Note Two to the Company’s unaudited consolidated financial statements. The second step is to identify loans above a certain threshold which are problem loans due to the borrower’s payment history or deteriorating financial condition. Losses in this category are determined based on historical loss rates of loans in the category over the prior 12 months. The third step is to calculate a loss for the remainder of the portfolio using historical loss information for each loan category. The final step is to calculate the potential impact of the economic environment on future loan performance. The determination of specific allowances and weighting is subjective and actual losses may be greater or less than the current amount of the allowance. However, management believes the current level of the allowance for loan losses represents a fair assessment of the losses inherent in the loan portfolio.

The following table illustrates certain ratios related to quality of the Company’s loan portfolio:

	September 30, 2011			December 31, 2010
Allowance for loan losses as a percentage of gross loans		1.77	%		1.64	%
Non-performing loans as a percentage of gross loans		2.85	%		2.38	%
Ratio of allowance for loan losses to non-performing loans		0.62			0.69

Non-performing loans include non-accrual loans and loans 90 days or more past due (including non-performing restructured loans). Non-accrual loans are loans on which interest accruals have been suspended. Loans are typically placed on non-accrual status once they have reached certain delinquency status, depending on loan type, and it is no longer reasonable to expect collection of principal and interest because collateral is insufficient to cover both the principal and interest due. After loans are placed on non-accrual status, they are returned to accrual status if the obligation is brought current by the borrower, or they are charged off if payment is not made.

The following table summarizes the Company’s non-performing loans, restructured loans accruing interest and other real estate owned at September 30, 2011 and December 31, 2010 (in thousands of dollars):

	September 30, 2011		December 31, 2010
Loans on non-accrual status	$	8,553	$	6,979
Loans delinquent 90 days or more still accruing	$	507	$	866
Total non-performing loans	$	9,060	$	7,845

Restructured loans still accruing	$	12,607	$	6,710
Other real estate owned (OREO)	$	5,033	$	4,700

Total non-performing loans and other risk assets	$	26,700	$	19,255

Restructured loans are loans on which the original interest rate or repayment terms have been changed due to financial hardship of the borrower. Restructured loans that are performing in accordance with modified terms are $11,736,000 and $5,219,000 at September 30, 2011 and December 31, 2010, respectively. Restructured loans not performing in accordance with modified terms totaled $3,945,000 as of September 30, 2011. All restructured loans are included in impaired loans in Note 2. The increase in restructured loans is the result of including loan balloon renewal agreements in accordance with the new

Restructured loans are loans on which the original interest rate or repayment terms have been changed due to financial hardship of the borrower. Restructured loans that are performing in accordance with modified terms are $12,607,000 and $6,710,000 at September 30, 2011 and December 31, 2010, respectively. Restructured loans not performing in accordance with modified terms totaled $4,003,000 as of September 30, 2011. All restructured loans are included in impaired loans in Note 2. The increase in restructured loans is the result of including loan balloon renewal agreements in accordance with the new guidelines adopted with ASU 2011-02.

The following table summarizes the Company’s net charge-offs by loan type for the nine month periods ended September 30, 2011 and 2010 (in thousands of dollars):

	2011			2010
Charge-offs
Commercial Mortgage	$	(2,321	)	$	(465	)
Commercial Other		(163	)		(461	)
Consumer Mortgage		(463	)		(487	)
Consumer Other		(277	)		(524	)
Total Charge-offs	$	(3,224	)	$	(1,937	)

Recoveries
Commercial Mortgage	$	127		$	8
Commercial Other		136			73
Consumer Mortgage		10			32
Consumer Other		190			252
Total Recoveries	$	463		$	365

Total Net Charge-offs	$	(2,761	)	$	(1,572	)

Charge-offs increased 66.4% the first nine months of 2011 compared to the same period during 2010. This increase was driven by a charge-off sustained as a result of one commercial mortgage relationship.

Management believes that the allowance is to be taken as a whole, and the allocation between loan types is an estimation of potential losses within each type given information known at the time. The following table shows the allocation for loans in the loan portfolio and the corresponding amounts of the allowance allocated by loan type as of September 30, 2011 and December 31, 2010 (in thousands of dollars):

	September 30, 2011					December 31, 2010
	Amount		Percent of Loans			Amount		Percent of Loans
Loan Type
Commercial Mortgage	$	2,557		45	%	$	1,345		43	%
Commercial Other		533		4	%		887		5	%
Consumer Mortgage		1,725		43	%		1,662		43	%
Consumer Other		510		8	%		968		9	%
Unallocated		306					545
Totals	$	5,631		100	%	$	5,407		100	%

Because of its large impact on the local economy, management continues to monitor the economic health of the poultry industry. The Company has direct loans to poultry growers and the industry is a large employer in the Company’s trade area. In addition, multiple manufacturers of household cabinetry are large employers in the Company’s primary trade area. Due to the downturn in the housing market nationally, there have been indications that the demand for cabinetry has decreased, impacting the performance of these manufacturers. Because of the impact on the local economy, management monitors the performance of this industry as it relates to local employment trends. Additionally, the Company’s loan portfolio contains a segment of loans collateralized by heavy equipment, particularly in the trucking, mining and timber industries. Because of the impact of the slowing economic conditions on the housing market, the timber sector has experienced a recent downturn. The Company has experienced losses related to the downturn in this industry.

Net Interest Income

The Company’s net interest income, on a fully taxable equivalent basis, was relatively the same for the first nine months of 2011 as compared to the same period in 2010, as a result of the changes in average rates earned on assets and paid on interest bearing liabilities and the changes in the relative mix of earning assets and interest bearing liabilities.

For the nine month period ended September 30, 2011, the Company’s average earning assets decreased 1.2% compared to the same period in 2010 while average interest bearing liabilities, comparing the same periods decreased 2.7%. The average balances of time deposits and long-term debt, both comparatively more expensive interest bearing liabilities, decreased 5.5%. These changes in the relative mix of earning assets and interest bearing liabilities and the change in the average yields largely offset, resulting in the slight change in the Company’s net interest income.

The Company believes that its deposits will be sufficient to fund the current and expected loan demand. Should the loan demand increase beyond the Company’s current expectations, the Company may be required to fund these loans with borrowings which could result in a reduction of net interest margin. However, management believes total net interest income would not be adversely affected.

Also, balances of non-performing loans and other real estate acquired through foreclosure have increased from December 31, 2010 to September 30, 2011. Increases in balances of non-accrual loans and other real estate acquired through foreclosure have adverse effects on net interest income. Should balances of non-accrual loans and other real estate acquired through foreclosure continue to increase, net interest margin may decrease accordingly.

The table below illustrates the effects on net interest income, on a fully taxable equivalent basis, for the first nine months of 2011 compared to the same period in 2010, of changes in average volumes of interest bearing liabilities and earning assets from 2010 to 2011 and changes in average rates on interest bearing liabilities and earning assets from 2010 to 2011 (in thousands of dollars):

EFFECT OF RATE-VOLUME CHANGES ON NET INTEREST INCOME

Increase (Decrease) Nine Months Ended September 30, 2011 compared to Nine Months Ended September 30, 2010

	Due to change in:
	Average Volume			Average Rate			Total Change
Interest Income
Loans	$	(469	)	$	(687	)	$	(1,156	)
Taxable investment securities		62			(96	)		(34	)
Nontaxable investment securities		(50	)		(25	)		(75	)
Interest bearing deposits		0			1			1
Federal funds sold		3			(2	)		1
Total Interest Income		(454	)		(809	)		(1,263	)

Interest Expense
Demand deposits		1			0			1
Savings deposits		6			(42	)		(36	)
Time deposits		(189	)		(987	)		(1,176	)
Borrowings		(5	)		(29	)		(34	)
Total Interest Expense		(187	)		(1,058	)		(1,245	)

Net Interest Income	$	(267	)	$	249		$	(18	)

The table below sets forth an analysis of net interest income for the nine month periods ended September 30, 2011 and 2010 (Average balances and interest/expense shown in thousands of dollars):

	2011										2010
	Average			Income/							Average			Income/
	Balance (2)			Expense				Rate (1)			Balance (2)			Expense				Rate (1)
Earning Assets
Loans (3)	$	323,787		$	15,455	(4	)		6.36	%	$	333,615		$	16,611	(4	)		6.64	%
Taxable investment securities		30,008			438				1.95	%		25,765			472				2.44	%
Non-taxable investment securities		1,823			52				3.80	%		3,564			127				4.75	%
Interest bearing deposits		3,250			5				0.21	%		2,935			4				0.18	%
Federal funds sold		11,599			13				0.15	%		9,072			12				0.18	%
Total Earning Assets	$	370,467		$	15,963				5.75	%	$	374,951		$	17,226				6.13	%

Allowance for loan losses		(5,574	)									(4,599	)
Other non-earning assets		40,775										39,957
Total Assets	$	405,668									$	410,309

Interest Bearing Liabilities
Demand deposits	$	24,468		$	23				0.13	%	$	23,144		$	22				0.13	%
Savings deposits		55,875			103				0.25	%		52,702			139				0.35	%
Time deposits		209,094			3,130				2.00	%		221,797			4,306				2.59	%
Long-term debt		10,518			329				4.17	%		10,693			363				4.53	%
Total Interest Bearing Liabilities	$	299,955		$	3,585				1.59	%	$	308,336		$	4,830				2.09	%


Demand deposits		57,103										53,466
Other liabilities		7,826										8,839
Stockholders’ equity		40,784										39,668
Total liabilities and stockholders’ equity	$	405,668									$	410,309

Net Interest Income				$	12,378									$	12,396
Net Interest Margin									4.45	%									4.41	%

Notes:

(1) Yields are computed on a taxable equivalent basis using a 30% tax rate

(2) Average balances are based upon daily balances

(3) Includes loans in non-accrual status

(4) Income on loans includes fees

The table below sets forth an analysis of net interest income for the three month periods ended September 30, 2011 and 2010 (Average balances and interest/expense shown in thousands of dollars):

	2011									2010
	Average			Income/						Average			Income/
	Balance (2)			Expense			Rate (1)			Balance (2)			Expense			Rate (1)
Earning Assets
Loans (3)	$	318,918		$	5,102	(4)		6.40	%	$	333,377		$	5,499	(4)		6.60	%
Taxable investment securities		34,336			158			1.84	%		27,301			161			2.36	%
Non-taxable investment securities		1,650			16			3.88	%		3,396			38			4.48	%
Interest bearing deposits		2,873			5			0.70	%		3,036			1			0.13	%
Federal funds sold		14,673			6			0.16	%		4,572			2			0.17	%
Total Earning Assets	$	372,450		$	5,287			5.69	%	$	371,682		$	5,701			6.14	%

Allowance for loan losses		(5,437	)								(5,368	)
Other non-earning assets		39,502									40,706
Total Assets	$	406,515								$	407,020

Interest Bearing Liabilities
Demand deposits	$	25,386		$	8			0.13	%	$	23,119		$	7			0.13	%
Savings deposits		56,629			33			0.23	%		52,528			45			0.34	%
Time deposits		206,971			967			1.87	%		218,116			1,319			2.42	%
Long-term debt		11,829			112			3.79	%		10,577			124			4.68	%
Total Interest Bearing Liabilities	$	300,815		$	1,120			1.49	%	$	304,340		$	1,495			1.96	%


Demand deposits		57,847									54,130
Other liabilities		6,323									8,063
Stockholders’ equity		41,530									40,487
Total liabilities and stockholders’ equity	$	406,515								$	407,020

Net Interest Income				$	4,167								$	4,206
Net Interest Margin								4.48	%								4.53	%

Notes:

(1) Yields are computed on a taxable equivalent basis using a 30% tax rate

(2) Average balances are based upon daily balances

(3) Includes loans in non-accrual status

(4) Income on loans includes fees

Provision for Loan Losses

Provision for loan losses increased $89,000 or 3.1% for the first nine months of 2011 compared to the same period during 2010. During the three month period ended September 30, 2011 the provision for loan losses increased $47,000 or 8.0% compared to the same period in 2010. Management believes the current level of the allowance for loan losses represents a fair assessment of the losses inherent in the loan portfolio.

Non-interest Income

Non-interest income decreased $133,000 in the first nine months of 2011 as compared to the same period in 2010 driven primarily by the reduction in service charge and fee revenues.

Service charges on deposit accounts decreased 6.7%. The largest portion of these charges is non-sufficient funds fees on non-interest bearing transaction accounts.

Life insurance investment income was the same during the first nine months of 2011 compared to the same period in 2010.

The quarter-to-quarter comparisons are primarily due to the same items as described above.

Non-interest Expense

Non-interest expense decreased $546,000 or 5.6% for the first nine months of 2011 as compared to the same period in 2010 primarily due to reductions in employee related costs and legal expenses.

The quarter-to-quarter comparisons are primarily due to the same items as described above.

Changes in salary and benefits expense

The following table compares the components of salary and benefits expense for the nine month periods ended September 30, 2011 and 2010 (in thousands of dollars):

Salary and Benefits Expense
	2011			2010		Increase (Decrease)

Employee salaries	$	3,337		$	3,355	$	(18	)
Employee benefit insurance		910			829		81
Payroll taxes		274			258		16
Deferred loan origination costs		(169	)		0		(169	)
Non-recurring post retirement adjustment		(70	)		0		(70	)
Post retirement plans		491			745		(254	)
Total	$	4,773		$	5,187	$	(414	)

The decrease of 8.0% in employee related cost for the first nine months of 2011 compared to the same period during 2010 is mainly the result of the implementation of the Financial Accounting Standard ASC 310-20 Nonrefundable Fees and Other Costs and the reversal of accrued expenses associated with discretionary post retirement contribution for 2011. The Company began deferral of costs associated with loan origination at the beginning of 2011, upon determination that its impact was becoming material, and is amortizing the cost over the life of the loan.

Quarter-to-quarter comparisons are similar to the change described above for the first nine months of 2011 compared to the first nine months of 2010.

Changes in data processing expense

Data processing expense increased $49,000 or 6.0% for the first nine months of 2011 compared to the same period in 2010. The increase was driven by a credit received from the Company’s core system vendor during the first nine months of 2010 for an error in billing during the system conversion in the fall of 2009.

Quarter-to-quarter comparisons are similar to the change described above for the first nine months of 2011 compared to the first nine months of 2010.

Changes in occupancy and equipment expense

The following table illustrates the components of occupancy and equipment expense for the nine month periods ended September 30, 2011 and 2010 (in thousands of dollars):

	2011		2010		Increase (Decrease)
Depreciation of buildings and equipment	$	587	$	565	$	22
Maintenance expense on buildings and equipment		258		282		(24	)
Utilities expense		112		99		13
Real estate and personal property tax		75		71		4
Other expense related to occupancy and equipment		80		68		12
Total occupancy and equipment expense	$	1,112	$	1,085	$	27

The increases in occupancy and equipment expenses during the first nine months of 2011 are related to a new subsidiary bank branch opened during the third quarter of 2010.

Quarter-to-quarter comparisons are similar to the changes described above for the first nine months of 2011 compared to the first nine months of 2010.

Changes in miscellaneous non-interest expense

Director fees decreased in the first nine months of 2011 compared to the same period during 2010 by $25,000 or 8.6% from $292,000 during 2010 to $267,000 during 2011 driven by a reduction in the number of meetings held and a reduction in the fees paid per meeting.

Legal and professional fees decreased in the first nine months of 2011 compared to the same period during 2010 by $114,000 or 25.1% from $455,000 during 2010 to $341,000 during 2011 driven by outsourcing reporting services and legal consultations during 2010.

Office supplies, postage and freight expenses decreased in the first nine months of 2011 compared to the same period during 2010 by $46,000 or 15.2% from $304,000 during 2010 to $258,000 during 2011 largely driven by the reduction of courier services between branches.

FDIC premium expense increased in the first nine months of 2011 compared to the same period during 2010 by $9,000 or 1.8% from $495,000 during 2010 to $504,000 during 2011 driven by rate changes.

Loan and foreclosed asset expenses decreased 4.0% or $15,000 during the first nine months of 2011 compared to the same period in 2010 due to non-recurring expenses related to a couple foreclosed properties during 2010.

Other non-interest expense decreased $17,000 or 2.6% during the first nine months of 2011 compared to the same period in 2010.

The table below illustrates components of other non-interest expense for the nine month periods ended September 30, 2011 and 2010 (in thousands of dollars). Significant individual components of other non-interest expense are itemized.

	2011			2010			Increase (Decrease)
ATM expense		(82	)		(51	)		(31	)
Amortization of intangible assets		140			146			(6	)
Advertising and marketing expense		116			116			-
Miscellaneous components of other non interest expense		542			522			20
Total	$	716		$	733		$	(17	)

Provision for taxes

The provision for taxes has increased $173,000 for the first nine months of 2011 compared to the same period in 2010 as a result of the 23.6% increase in income before provision for income taxes as well as the change in the ratio of non-taxable income to taxable income.

Borrowed Funds

The Company borrows funds from the Federal Home Loan Bank (“FHLB”) to reduce market rate risks or to provide operating liquidity. Management typically will initiate these borrowings in response to a specific need for managing market risks or for a specific liquidity need and will attempt to match features of these borrowings to best suit the specific need. Therefore, the borrowings on the Company’s balance sheet as of September 30, 2011 and throughout the periods ended September 30, 2011 and December 31, 2010 have varying features of amortization or single payment with periodic, regular interest payments and also have interest rates which vary based on the terms and on the features of the specific borrowing.

Liquidity

Operating liquidity is the ability to meet present and future financial obligations. Short term liquidity is provided primarily through cash balances, deposits with other financial institutions, federal funds sold, non-pledged securities and loans maturing within one year. Additional sources of liquidity available to the Company include, but are not limited to, loan repayments, the ability to obtain deposits through the adjustment of interest rates and the purchasing of federal funds. To further meet its liquidity needs, the Company also maintains lines of credit with correspondent financial institutions, the Federal Reserve Bank of Richmond and the Federal Home Loan Bank of Pittsburgh.

Historically, the Company’s primary need for additional levels of operational liquidity has been to fund increases in loan balances. The Company has normally funded increases in loans by increasing deposits and with decreases in liquid assets such as balances of federal funds sold and balances of securities. The Company also utilizes existing borrowing facilities for additional levels of operating liquidity. In choosing which sources of operating liquidity to utilize, management evaluates the implications of each liquidity source and its impact on profitability, balance sheet stability and potential future liquidity needs.

The parent Company’s operating funds, funds with which to pay shareholder dividends and funds for the exploration of new business ventures have been supplied primarily through dividends paid by the Company’s subsidiary banks Capon Valley Bank (CVB) and The Grant County Bank (GCB). The various regulatory authorities impose restrictions on dividends paid by a state bank. A state bank cannot pay dividends without the consent of the relevant banking authorities in excess of the total net profits of the current year and the combined retained profits of the previous two years. As of September 30, 2011, the subsidiary banks could pay dividends to Highlands Bankshares, Inc. of approximately $2,536,000 without permission of the regulatory authorities.

Capital

The Company seeks to maintain a strong capital base to expand facilities, promote public confidence, support current operations and grow at a manageable level. As of September 30, 2011, the Company was above the regulatory minimum levels of capital. The table below summarizes the capital ratios for the Company and its subsidiary banks as of September 30, 2011 and December 31, 2010:

	September 30, 2011						December 31, 2010
	Actual			Regulatory			Actual			Regulatory
	Ratio			Minimum			Ratio			Minimum
Total Risk Based Capital Ratio
Highlands Bankshares		15.00	%		8.00	%		14.49	%		8.00	%
Capon Valley Bank		13.11	%		8.00	%		12.50	%		8.00	%
The Grant County Bank		15.08	%		8.00	%		14.58	%		8.00	%

Tier 1 Leverage Ratio
Highlands Bankshares		10.14	%		4.00	%		9.91	%		4.00	%
Capon Valley Bank		8.52	%		4.00	%		8.33	%		4.00	%
The Grant County Bank		10.37	%		4.00	%		10.26	%		4.00	%

Tier 1 Risk Based Capital Ratio
Highlands Bankshares		13.74	%		4.00	%		13.24	%		4.00	%
Capon Valley Bank		11.85	%		4.00	%		11.24	%		4.00	%
The Grant County Bank		13.82	%		4.00	%		13.32	%		4.00	%

Effects of Inflation

Inflation primarily affects industries having high levels of property, plant and equipment or inventories. Although the Company is not significantly affected in these areas, inflation does have an impact on the growth of assets. As assets grow rapidly, it becomes necessary to increase equity capital at proportionate levels to maintain the appropriate equity to asset ratios. Traditionally, the Company's earnings and high capital retention levels have enabled the Company to meet these needs. The Company's reported earnings results have been minimally affected by inflation. The different types of income and expense are affected in various ways. Interest rates are affected by inflation, but the timing and magnitude of the changes may not coincide with changes in the consumer price index. Management actively monitors interest rate sensitivity in order to minimize the effects of inflationary trends on interest rates. Other areas of non-interest expenses may be more directly affected by inflation.

Legislative Developments

Dodd-Frank Wall Street Reform and Consumer Protection Act

On July 21, 2010, President Obama signed into law the Dodd-Frank Wall Street Reform and Consumer Protection Act (the “Act”). The Act will result in sweeping financial regulatory reform aimed at strengthening the nation’s financial services sector.

The Act’s provisions that have received the most public attention generally have been those applying to larger institutions or institutions that engage in practices in which we do not engage. These provisions include growth restrictions, credit exposure limits, higher prudential standards, prohibitions on proprietary trading, and prohibitions on sponsoring and investing in hedge funds and private equity funds.

However, the Act contains numerous other provisions that likely will directly impact us and our banking subsidiaries. These include increased fees payable by banks to regulatory agencies, new capital guidelines for banks and bank holding companies, permanently increasing the FDIC insurance coverage from $100,000 to $250,000 per depositor, new liquidation procedures for banks, new regulations affecting consumer financial products, new corporate governance disclosures and requirements, and the increased cost of supervision and compliance more generally. Many aspects of the law are subject to rulemaking by various government agencies and will take effect over several years. This time table, combined with the Act’s significant deference to future rulemaking by various regulatory agencies, makes it difficult for us to anticipate the Act’s overall financial, competitive and regulatory impact on us, our customers, and the financial industry more generally.

Item 3. Quantitative and Qualitative Disclosures About Market Risk

Not required for smaller reporting companies.

Item 4. Controls and Procedures

The Company’s management, with the participation of the Company’s Chief Executive Officer and Chief Financial Officer, has evaluated the effectiveness of the Company’s disclosure controls and procedures as of September 30, 2011. Based on this evaluation, the Company’s Chief Executive Officer and Chief Financial Officer concluded that the Company’s disclosure controls and procedures are effective as of September 30, 2011. The Company has established procedures undertaken during the normal course of business in an effort to reasonably ensure that fraudulent activity of either an amount material to these results or in any amount is not occurring.

Changes in Internal Controls

During the period reported upon, there were no significant changes in internal controls of Highlands Bankshares, Inc. pertaining to its financial reporting and control of its assets or in other factors that materially affected or are reasonably likely to materially affect such control.

PART II OTHER INFORMATION

Item 1. Legal Proceedings

Management is not aware of any material pending or threatened litigation in which the Company or its subsidiaries may be involved as a defendant. In the normal course of business, the banks periodically must initiate suits against borrowers as a final course of action in collecting past due loans. In addition, to management’s knowledge, no governmental authorities have initiated or contemplated legal action against the Company.

Item 1A. Risk Factors

Not required for smaller reporting companies.

Item 2. Unregistered Sales of Equity Securities and Use of Proceeds.

None

Item 3. Defaults Upon Senior Securities

None

Item 4. (Removed and Reserved)

None

Item 5. Other Information

None

Item 6. Exhibits

EXHIBIT INDEX
Exhibit Number		Description
3(i)		Articles of Incorporation of Highlands Bankshares, Inc., as restated, are hereby incorporated by reference to Exhibit 3(i) to Highlands Bankshares Inc.’s Form 10-Q filed November 13, 2007.
3(ii)		Amended Bylaws of Highlands Bankshares, Inc. are incorporated by reference to Exhibit 3(ii) to Highlands Bankshares Inc.’s Report on Form 8-K filed January 9, 2008.
31.1		Certification of Chief Executive Officer Pursuant to section 302 of the Sarbanes-Oxley Act of 2002 Chapter 63, Title 18 USC Section 1350 (A) and (B).
31.2		Certification of Chief Financial Officer Pursuant to section 302 of the Sarbanes-Oxley Act of 2002 Chapter 63, Title 18 USC Section 1350 (A) and (B).
32.1		Statement of Chief Executive Officer Pursuant to 18 U.S.C. §1350.
32.2		Statement of Chief Financial Officer Pursuant to 18 U.S.C. §1350.
101.INS		XBRL Instance Document (1)
101.SCH		XBRL Taxonomy Extension Schema Document (1)
101.CAL		XBRL Taxonomy Extension Calculation Linkbase (1)
101.LAB		XBRL Taxonomy Extension Label Linkbase (1)
101.PRE		XBRL Taxonomy Extension Presentation Linkbase (1)
101.DEF		XBRL Taxonomy Extension Definitions Linkbase (1)

Signatures

Pursuant to the requirements of the Securities Exchange Act of 1934, the Registrant has duly caused this report to be signed on its behalf by the undersigned thereunto duly authorized.

	HIGHLANDS BANKSHARES, INC.

	/s/ C.E. Porter
	C.E. Porter
	President & Chief Executive Officer

	/s/ Jeffrey B. Reedy
	Jeffrey B. Reedy
	Chief Financial Officer
November 14, 2011

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Highlands Bankshares (HBSI) Inactive 10-Q2011 Q3 Quarterly report

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