UNITED STATES
SECURITIES AND EXCHANGE COMMISSION
Washington, D. C. 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 March 31, 2005.
[ ] Transition Report Pursuant to Section 13 or 15(d) of the Securities Exchange
Act of 1934
Commission File No. 0-16761
HIGHLANDS BANKSHARES, INC.
(Exact name of registrant as specified in its charter)
West Virginia 55-0650793
- ----------------------------------- --------------------
(State or Other Jurisdiction of (I.R.S. Employer
Incorporation or Organization) Identification No.)
P. O. Box 929
Petersburg, West Virginia 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) filed all reports
required to be filed by Section 13 or 15(d) of the Securities Exchange Act
of 1934 during the past 12 months (or for such shorter period that the
registrant was required to file such reports), and (2) has been subject to
such filing requirement for the past 90 days. Yes X No
--- ---
Indicate by check mark whether the issuer is an accelerated filer
(as defined in Rule 12b-2 of the Act). Yes No X
--- ---
State the number of shares outstanding of each of the issuer's classes of
common equity, as of the latest practicable date. As of April 30, 2005,
1,436,874 shares of Common Stock, $5 Par Value
1
HIGHLANDS BANKSHARES, INC.
INDEX
Page
PART I FINANCIAL INFORMATION
Item 1. Financial Statements
Unaudited Consolidated Statements of Income - Three Months
Ended March 31, 2005 and 2004 2
Unaudited Consolidated Balance Sheet - March 31, 2005 and
Audited Consolidated Balance Sheet--December 31, 2004 3
Unaudited Consolidated Statements of Changes in Stockholders'
Equity - Three Months Ended March 31, 2005 and 2004 4
Unaudited Consolidated Statements of Cash Flows - Three Months
Ended March 31, 2005 and 2004 5
Notes to Consolidated Financial Statements 6
Item 2. Management's Discussion and Analysis of
Financial Condition and Results of Operations 8
Item 3. Quantitative and Qualitative Disclosures about Market Risk 20
Item 4. Controls and Procedures 22
PART II OTHER INFORMATION
Item 1. Legal Proceedings 23
Item 2. Unregistered Sales of Equity Securities and Use of Proceeds 23
Item 3. Defaults upon Senior Securities 23
Item 4. Submission of Matters to a Vote of Security Holders 23
Item 5. Other Information 23
Item 6. Exhibits 23
SIGNATURES 24
2
Part I Financial Information
Item 1. Financial Statements
HIGHLANDS BANKSHARES, INC.
CONSOLIDATED STATEMENTS OF INCOME
(In Thousands of Dollars)
Three Months Ended
March 31,
2005 2004
(unaudited) (unaudited)
Interest Income
Interest and fees on loans $ 4,390 $ 4,072
Interest on federal funds sold 30 41
Interest on time deposits 5 3
Interest and dividends on investment securities
Taxable 165 179
Nontaxable 26 35
--------- --------
Total Interest Income 4,616 4,330
--------- --------
Interest Expense
Interest on deposits 1,115 1,187
Interest on borrowed money 149 61
--------- --------
Total Interest Expense 1,264 1,248
--------- --------
Net Interest Income 3,352 3,082
Provision for Loan Losses 225 195
--------- --------
Net Interest Income After Loan Losses 3,127 2,887
--------- --------
Noninterest Income
Service charges 173 168
Investment in insurance contracts 67 51
Insurance related income 37 47
Other 93 68
--------- --------
Total Noninterest Income 370 334
--------- --------
Noninterest Expense
Salaries and employee benefits 1,219 1,156
Equipment and occupancy expense 299 288
Data processing 153 177
Directors Fees 85 86
Legal and Professional Fees 82 72
Other 378 385
--------- -------
Total Noninterest Expense 2,216 2,164
--------- --------
Income Before Income Taxes 1,281 1,057
Provision for Income Taxes 432 345
--------- --------
Net Income $ 849 $ 712
========= ========
Per Share Data
Net Income $ .59 $ .50
========= ========
Cash Dividends $ .20 $ .15
========= =========
Weighted Average Common Shares Outstanding 1,436,874 1,436,874
========= =========
The accompanying notes are an integral part of these statements.
3
HIGHLANDS BANKSHARES, INC.
CONSOLIDATED BALANCE SHEETS
(In Thousands of Dollars)
March 31, December 31,
2005 2004
(unaudited) (audited)
ASSETS
Cash and due from banks - noninterest bearing $ 6,667 $ 6,187
Time deposits in other banks 805 651
Federal funds sold 4,929 4,006
Securities held to maturity (note 2) 1,161 1,162
Securities available for sale (note 2) 24,429 24,702
Other investments (note 3) 1,213 1,165
Loans, net of unearned interest (note 4) 253,831 248,517
Allowance for loan losses (note 5) (2,623) (2,530)
Bank premises and equipment 6,674 6,810
Interest receivable 1,581 1,436
Investments in insurance contracts (note 6) 5,870 5,809
Other assets 1,919 2,077
------- -------
Total Assets $306,456 $299,992
======= =======
LIABILITIES
Deposits:
Noninterest bearing demand deposits $ 38,706 $ 37,522
Interest bearing
Savings and interest bearing demand deposits 73,738 75,342
Time deposits (note 7) 143,114 141,527
------- -------
Total Deposits 255,558 254,391
Short-term debt 2,000
Long-term debt 14,559 8,377
Accrued expenses and other liabilities 4,189 3,569
------- -------
Total Liabilities 274,306 268,337
------- -------
STOCKHOLDERS' EQUITY
Common stock ($5 par value, 3,000,000 shares
authorized) 7,184 7,184
Surplus 1,662 1,662
Retained earnings 23,590 23,028
Accumulated other comprehensive loss (286) (219)
-------- --------
Total Stockholders' Equity 32,150 31,655
------- -------
Total Liabilities and Stockholders' Equity $306,456 $299,992
======= =======
The accompanying notes are an integral part of these statements.
4
HIGHLANDS BANKSHARES, INC.
CONSOLIDATED STATEMENTS OF CHANGES IN STOCKHOLDERS' EQUITY
(In Thousands of Dollars)
Accumulated
Other
Comprehensive
Common Retained Income
Stock Surplus Earnings (Loss) Total
------ ------- -------- ------ -----
Balances, December 31, 2004 $ 7,184 $ 1,662 $ 23,028 $ (219) $ 31,655
Comprehensive Income
Net income 849 849
Net change in unrealized
appreciation on investment
securities available for sale,
net of taxes (67) (67)
------
Total Comprehensive Income 782
Dividends paid (287) (287)
------ ------ ------- ----- ------
Balances, March 31, 2005 $ 7,184 $ 1,662 $ 23,590 $ (286) $32,150
====== ====== ======= ===== ======
Accumulated
Other
Comprehensive
Common Retained Income
Stock Surplus Earnings (Loss) Total
Balances, December 31, 2003 $ 7,184 $ 1,662 $ 20,727 $ (24) $29,549
Comprehensive Income
Net income 712 712
Net change in unrealized
appreciation on investment
securities available for sale,
net of taxes 16 16
------
Total Comprehensive Income 728
Dividends paid (216) (216)
------ ------ ------- ----- ------
Balances, March 31, 2004 $ 7,184 $ 1,662 $ 21,223 $ (8) $30,061
====== ====== ======= ===== ======
The accompanying notes are an integral part of these statements.
5
HIGHLANDS BANKSHARES, INC.
CONSOLIDATED STATEMENTS OF CASH FLOWS
(In Thousands of Dollars)
Three Months Ended
March 31,
2005 2004
(unaudited) (unaudited)
Cash Flows from Operating Activities:
Net income $ 849 $ 712
Adjustments to reconcile net income to net
cash provided by operating activities:
Depreciation 164 161
Income from insurance contracts (61) (45)
Net amortization of securities 30 83
Provision for loan losses 225 195
Decrease (increase) in interest receivable (145) 181
Decrease in other assets 210 191
Increase (decrease) in accrued expenses 620 (32)
------- ------
Net Cash Provided by Operating Activities 1,892 1,446
------- ------
Cash Flows from Investing Activities:
Net change in federal funds sold (923) (3,649)
Proceeds from maturities of securities available
for sale 1,616 5,877
Purchase of securities available for sale (1,491) (1,461)
Proceeds from (investment in) of other investments (48) 6
Net change in time deposits in other banks (154) (284)
Net change in loans (5,446) 313
Purchase of property and equipment (28) (87)
------- ------
Net Cash Provided by (Used in) Investing Activities (6,474) 715
------- ------
Cash Flows from Financing Activities:
Increase (decrease) in deposits 1,167 (2,340)
Dividends paid in cash (287) (216)
Net change in short-term borrowings (2,000)
Additional long-term debt 6,300
Repayment of long-term debt (118) (98)
------- ------
Net Cash Provided by (used in) Financing Activities 5,062 (2,654)
------- ------
Net Increase (Decrease) in Cash and Cash Equivalents 480 (493)
Cash and Cash Equivalents, Beginning of Period 6,187 7,214
------- ------
Cash and Cash Equivalents, End of Period $ 6,667 $ 6,721
======= ======
Supplemental Disclosures:
Cash Paid For:
Income taxes $ 0 $ 0
Interest 1,226 1,414
The accompanying notes are an integral part of these statements.
6
HIGHLANDS BANKSHARES, INC.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
NOTE 1 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 necessary to present
fairly the financial position as of March 31, 2005 and the results of
operations for the three month periods ended March 31, 2005 and 2004.
The notes included herein should be read in conjunction with the
notes to financial statements included in the 2004 annual report on
Form 10-K.
NOTE 2 SECURITIES:
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 held to maturity
as of March 31, 2005 and December 31, 2004, are as follows (in
thousands):
2005 2004
Amortized Market Amortized Market
Cost Value Cost Value
Obligations of states and
political subdivisions $ 1,161 $ 1,187 $1,162 $ 1,187
------ ------ ----- ------
Total $ 1,161 $ 1,187 $1,162 $ 1,187
====== ====== ===== ======
The amortized cost and fair value of securities available for sale
as of March 31, 2005 and December 31, 2004 are as follows (in
thousands):
2005 2004
Amortized Market Amortized Market
Cost Value Cost Value
US Treasury securities and
obligations of US Government
corporations and agencies $18,726 $18,550 $18,248 $18,164
Mortgage-backed securities 4,051 4,059 4,669 4,693
Obligations of states and
political subdivisions 1,796 1,791 1,811 1,817
Other investments 28 29 28 28
------ ------ ------ ------
Total $24,601 $24,429 $24,756 $24,702
====== ====== ====== ======
7
HIGHLANDS BANKSHARES, INC.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
NOTE 3 OTHER INVESTMENTS:
Other investments totaling $1,213,000 include investments in the
Federal Home Loan Bank and other governmental entities whose
transferability is restricted.
NOTE 4 LOANS OUTSTANDING:
A summary of loans outstanding as of March 31, 2005 and December
31, 2004 is as follows (in thousands):
2005 2004
Commercial $ 56,158 $ 52,814
Real estate - construction 9,532 8,850
- mortgages 143,445 140,761
Consumer 44,696 46,092
------- -------
Loans outstanding $253,831 $248,517
======= =======
NOTE 5 ALLOWANCE FOR LOAN LOSSES:
A summary of transactions in the allowance for loan losses for the
three months ended March 31, 2005 and 2004 follows (in thousands):
2005 2004
Balance, beginning of period $ 2,530 $ 2,463
Provisions charged to operating expenses 225 195
Loan recoveries 43 95
Loan charge-offs (175) (220)
-------- -------
Balance, end of period $ 2,623 $ 2,533
======= =======
NOTE 6 INVESTMENT IN INSURANCE CONTRACTS:
Investment in insurance contracts consists 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 providing life insurance and retirement
benefits to certain employees. The carrying value of these investments
was $5,870,000 at March 31, 2005 and $5,809,000 at December 31, 2004.
8
NOTE 7 DEPOSITS:
Balances of time deposits over $100,000 and time deposits less than
$100,000 at March 31, 2005 and December 31, 2004 are set forth below
(in thousands):
2005 2004
Time deposits over $100,000 $ 40,756 $ 39,402
All other time deposits 102,358 102,125
------- -------
Total Time Deposits $143,114 $141,527
======= =======
Interest expense for time deposits over $100,000 and time deposits less
than $100,000 for the three months ended March 31, 2005 and March 31, 2004 are
set forth below:
2005 2004
Time deposits over $100,000 $ 304 $ 350
All other time deposits 687 751
----- -----
Total Time Deposits $ 991 $1,101
===== =====
Item 2. Management's Discussion and Analysis of Financial Condition and
Results of Operations
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.
Allowance for Loan Losses
The allowance for loan losses is an estimate of the losses in the loan
portfolio. The allowance is based on two basic principles of accounting: (i)
SFAS No. 5, Accounting for Contingencies, which requires that losses be accrued
when they are probable of occurring and estimable and (ii) SFAS 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 Company's allowance for loan losses is the accumulation of various
components that are calculated based on independent methodologies. All
components of the allowance represent an estimation performed pursuant to either
SFAS No. 5 or SFAS No. 114. Management's estimate of each SFAS No. 5 component
is based on certain observable data that management believes are most reflective
of the underlying credit losses being estimated. This evaluation includes credit
quality trends; collateral values; loan volumes; geographic, borrower and
industry concentrations; seasoning of the loan portfolio; the findings of
internal credit quality assessments and results from external bank regulatory
examinations. These factors, as well as historical losses and current economic
and business conditions, are used in developing estimated loss factors used in
the calculations.
9
Item 2. Management's Discussion and Analysis of Financial Condition and
Results of Operations (continued)
Critical Accounting Policies (continued)
Allowance for Loan Losses (continued)
Reserves for commercial loans are determined by applying estimated loss
factors to the portfolio based on management's evaluation and "risk grading" of
the commercial loan portfolio. Reserves are provided for noncommercial loan
categories using estimated loss factors applied to the total outstanding loan
balance of each loan category. Specific reserves are typically provided on all
impaired commercial loans in excess of a defined threshold that are classified
in the Special Mention, Substandard or Doubtful risk grades. The specific
reserves are determined on a loan-by-loan basis based on management's evaluation
of the Company's exposure for each credit, given the current payment status of
the loan and the value of any underlying collateral.
While management uses the best information available to establish the
allowance for loan and lease losses, future adjustments to the allowance may be
necessary if economic conditions differ substantially from the assumptions used
in making the valuations or, if required by regulators, based upon information
available to them at the time of their examinations. Such adjustments to
original estimates, as necessary, are made in the period in which these factors
and other relevant considerations indicate that loss levels may vary from
previous estimates.
Post Retirement Benefits
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 polices 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 Statement of Financial Accounting Standards No. 106,
"Employers' Accounting for Post Retirement Benefits Other Than Pensions." SFAS
No. 106 requires that an employers' 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
No recent accounting pronouncements are expected to have a material impact
on the Company's consolidated financial statements in future periods.
10
Item 2. Management's Discussion and Analysis of Financial Condition and
Results of Operations (continued)
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," or other future events. Although the
Company believes that its expectations with respect to certain words indicating
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 and timber industries, effects of mergers and/or
downsizing in the poultry industry in Hardy County, the adequacy of collateral
securing problem loans, and consumer spending and savings habits. The Company
does not update any forward-looking statements that may be made from time to
time by or on behalf of the Company.
Overview
Net income of $849,000 in the first quarter of 2005 represents a 19.24%
increase from the first quarter of a year ago. On an annualized basis, return on
average assets was 1.13% for the first quarter and return on average equity was
10.70%.
Net interest income before provision for loan loss increased 8.76% and net
interest margin on average earning assets increased from 4.43%. to 4.89%.
Increases in loan balances as compared to 2004 and closer management of the
Company's balance sheet, especially in regard to balances of and rates paid on
interest bearing liabilities, contributed largely to the increase in net
interest income. Recent increases by the Federal Reserve Board of the target
rate for fed funds has caused the average rates earned on earning assets and the
average rates paid on interest bearing liabilities to increase slightly as
compared to recent quarters.
Deterioration in 2002 and 2003 in the loan portfolios of the subsidiary
banks as evidenced by increasing delinquencies and non-performing loans has
abated and the Company saw improvement in its loan quality during 2004 and into
2005 as compared to earlier periods. Net balances of loans charged-off as a
percent of average loans were .05% (annualized at .21%) for the first quarter of
2005 as compared to .06% (annualized at .22%) in the first quarter of 2004.
Non-performing loans as a percent of total loans were .37% at March 31, 2005
compared to .91% at March 31, 2004 and .43% at December 31, 2004.
Noninterest income increased 10.78% during the quarter as compared to the
same period in 2004 as increases in service charges resulting from volume
changes and greater return on insurance investments were offset in part by a
decrease in insurance related income. Earnings related to the sale of credit
life and accident insurance continue to decline as the volume of new installment
loans, the primary borrowers insured by these insurance products, decreases as
compared to prior years.
Operations expense was relatively flat year over year. An increase of 5.51%
in employee costs was offset by decreases in data processing expense and other
miscellaneous operating expenses. The costs of legal and professional fees
increased due in large part to expanded audit engagements relating to
Sarbanes-Oxley Rule 404 compliance.
11
Item 2. Management's Discussion and Analysis of Financial Condition and
Results of Operations (continued)
Net Interest Income
The Company's net interest income rose $270,000 as compared to 2004. The
Company's net interest margin as a percent of earning assets also continues to
increase and was 4.89% in the first quarter of 2005 as compared to 4.43% a year
ago. An increase in the average loan to deposit ratio for the quarter as
compared to 2004, coupled with closer management of the Company's asset and
liability mix, have contributed to this increase in margin.
The recent increases in the target Fed Funds rate by the Federal Reserve
Bank ("The Fed"), have caused average rates paid on interest bearing liabilities
to begin to increase as compared to prior periods. However, rates earned on
earning assets have also begun to increase in concert with the Fed actions.
After sluggish loan growth during the first three quarters of 2004, the
Company's balances of loans outstanding has increased 4.67% (9.37% on an
annualized basis) since September 30, 2004. At March 31, 2005, the Company's
loan to deposit ratio was 99.32%. The ratio of average loans to average deposits
for the quarter was 97.30% compared to 86.85% during the same period in 2004.
Average balances of loans outstanding for the quarter increased 9.69% as
compared to the first quarter last year. Balances of loans outstanding increased
2.14% from December 31, 2004 to March 31, 2005.
Average balances of earning assets decreased slightly as compared to 2004
levels. Efforts by the Company to decrease average rates paid on deposits
contributed to a 3.83% drop in average balances of interest bearing deposits.
Historically, the subsidiary banks, because of competitive pressures and the
need to fund loan growth, have paid rates on deposits above those typically
offered by other similar banking organizations. During the early part of 2004,
the sluggish loan growth and high levels of liquid assets (fed funds sold and
deposits in other banks) prompted a decision by management to lower rates paid
on deposits in an attempt to curtail interest expense and decrease balances of
lower yielding liquid assets.
As balances of loans increased during the two most recent quarters,
management has chosen to fund these loans through decreases in balances of
comparatively lower earning fed funds sold and securities and through the
utilization of the borrowing capacity of the subsidiary banks. Average balances
of securities decreased 22.49% as compared to last year, and average balances of
fed funds sold decreased 81.77% and balances of borrowed funds increased
148.13%.
Throughout the fourth quarter of 2004 and the first quarter of 2005, the
Company's subsidiary banks increased the utilization of unused borrowing
capacity with the Federal Home Loan Bank (FHLB). Rates offered by the FHLB, both
on short-term and longer-term debt instruments, made this borrowing an
attractive funding alternative as compared to the increasing of deposit rates on
all accounts in an effort to attract new deposit balances. The Company has
borrowed from the FHLB to fund its recent loan growth by utilizing a mix of both
the short-term and long-term offerings of the FHLB.
Income on securities has decreased as the banks have utilized, in part,
depletion of the securities portfolio to fund loan growth. With securities
yields significantly lower than those earned on loans, management has preferred
to decrease balances of securities to fund loan growth in lieu of increasing
deposit rates to attract new deposit balances. In addition, management has been
reluctant to purchase investments with longer term maturities in anticipation of
increasing rates in the coming years.
12
Item 2. Management's Discussion and Analysis of Financial Condition and
Results of Operations (continued)
Net Interest Income (continued)
The table below sets forth an analysis of net interest income for the three
month periods ended March 31, 2005 and March 31, 2004:
Three Months Ended Three Months Ended
March 31, 2005 March 31, 2004
-------------------- --------------------
Average Income/ Average Income/
Balance 1 Expense Rates Balance 2 Expense Rates
--------- ------- ----- --------- ------- -----
Interest Income
Loans2 $ 248,299 $ 4,390 7.17% $ 226,374 $ 4,072 7.23%
Federal funds sold 3,514 30 3.46 19,272 41 .86
Interest bearing deposits 867 5 2.34 1,392 3 .87
Investments
Taxable 23,834 165 2.81 30,597 179 2.35
Tax exempt 3 2,951 41 5.63 3,960 55 5.69
-------- ------ ---- -------- ------ ----
Total Earning Assets 1 279,465 4,631 6.72 281,595 4,350 6.21
-------- ------ ---- -------- ------ ----
Cash equivalents 6,517 6,523
Allowance for loan losses (2,590) (2,492)
Insurance contracts 5,702 5,121
Non-earning assets 16,453 9,270
-------- -------
Total Assets $ 305,547 $ 300,017
======== ========
Interest Expense
Interest bearing
demand deposits 25,314 39 .62 22,900 19 .33
Savings and
money market 48,919 85 .70 49,710 67 .54
Time deposits 142,738 991 2.82 153,000 1,101 2.89
Short term borrowings 117 1 3.47
Long term debt 12,895 148 4.65 5,244 61 4.68
-------- ------ ---- -------- ------ ----
Total Interest
Bearing Liabilities 229,983 1,264 2.23 230,854 1,248 2.17
------ ---- ------ ----
Demand deposits 38,229 35,046
Other liabilities 5,150 4,106
Shareholders' equity 32,185 30,011
-------- --------
Total liabilities and
shareholders' equity $ 305,547 $ 300,017
======== ========
Net Interest Margin $ 3,367 $ 3,102
====== ======
Net Yield on Interest Earning Assets 1 4.89% 4.43%
==== ====
1 Balances include loans in nonaccrual status
2 Interest income on loans includes fees
3 Yields are on a taxable equivalent basis.
13
Item 2. Management's Discussion and Analysis of Financial Condition and
Results of Operations (continued)
Borrowed Money
Long Term Borrowings
The Company occasionally borrows funds from the Federal Home Loan Bank
("FHLB") to reduce market rate risks, provide liquidity, and to fund capital
additions. These borrowings may have fixed or variable interest rates and are
amortized over a period of one to twenty years, or may be comprised of single
payment borrowings with periodic interest payments and principal amounts due at
maturity. As competition for deposits has increased, the Company has, in its
efforts to manage interest expense and interest rate risk during the two most
recent quarters, used these available debt vehicles to fund loan growth more
frequently than was utilized the past.. During the first quarter of 2005, the
Company acquired an additional $6,300,000 in long-term borrowings from the FHLB.
Short Term Borrowings
Although the Company has traditionally not experienced the need for
overnight or other short-term borrowings, loan growth during the fourth quarter
of 2004 and the first quarter of 2005 necessitated occasional overnight
borrowings . Average overnight borrowings for the quarter were $117,000 with
associated interest expense of $1,000. During the quarter, the Company initiated
$1,500,000 in new short-term debt and made repayments of $3,500,000. At March
31, 2005, the Company had no short-term borrowings. Management prefers to fund
growth through longer term vehicles and expects future instances of overnight
borrowings to be minimal.
Parent Company Line of Credit
During the fourth quarter of 2003, the Company obtained a $2,500,000 open
line of credit with another commercial bank. This line of credit was secured by
equity securities in Capon Valley Bank subsidiary company. This debt instrument
was obtained as both a precautionary and opportunistic device for funding should
a need arise in the future. There were no advances in 2003 or 2004 from this
line and it is not anticipated that any borrowings from this debt facility will
be used to fund operating or liquidity needs.
Allowance for Loan Losses
The allowance for loan losses at March 31, 2005 was $2,623,000. This is an
increase of 3.56% over the balance at December 31, 2004. The Company's provision
for loan losses in the first quarter of 2005 was $225,000 compared to $195,000
in 2004. The allowance for loan losses represented 1.03% of gross loans at March
31, 2005 compared to 1.02% at December 31, 2004.
The allowance for loan losses is an estimate of the losses in the current
loan portfolio. The allowance is based on two principles of accounting: (i) SFAS
No. 5, Accounting for Contingencies which requires that losses be accrued when
they are probable of occurring and estimable and (ii) SFAS No. 114, Accounting
by Creditors for Impairment of a Loan, which requires that loans be identified
which have characteristics of impairment as individual risks, (e.g. the
collateral, present value of cash flows or observable market values are less
than the loan balance).
14
Item 2. Management's Discussion and Analysis of Financial Condition and
Results of Operations (continued)
Allowance for Loan Losses (continued)
Each of Company's banking subsidiaries, Capon Valley Bank and The Grant
County Bank, determines the adequacy of its allowance for loan losses
independently. Although the loan portfolios of the two banks are similar to each
other, some differences exist which result in divergent risk patterns and
different charge-off rates amongst the functional areas of the banks' portfolio.
Each bank pays particular attention to individual loan performance, collateral
values, borrower financial condition and economic conditions. The determination
of an adequate allowance at each bank is done in a three step process. The first
step is to identify impaired loans. Impaired loans are problem loans above a
certain threshold which have estimated losses calculated based on collateral
values and projected cash flows. The second step is to identify loans above a
certain threshold which are problem loans due to the borrowers' payment history
or deteriorating financial condition. Losses in this category are determined
based on historical loss rates adjusted for current economic conditions. The
final step is to calculate a loss for the remainder of the portfolio using
historical loss information for each type of loan classification. The
determination of specific allowances and weighting is somewhat subjective and
actual losses may be greater or less than the amount of the allowance. However,
Management believes that the allowance represents a fair assessment of the
losses that exist in the current loan portfolio.
The required level of the allowance for loan losses is computed quarterly
and the allowance 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 under the above formula.
Management has analyzed the potential risk of loss on the Company's loan
portfolio given the loan balances and the value of the underlying collateral and
has recognized losses where appropriate. Nonperforming loans are closely
monitored on an ongoing basis as part of the Company's loan review process.
The following table shows the allocation of loans in the loan portfolio and
the corresponding amounts of the allowance allocated by loan types as of March
31, 2005 and December 31, 2004:
March 31, 2005 December 31, 2004
-------------- ----------------
Loan Allowance Percentage Allowance Percentage
Type Allocation of Loans Allocation of Loans
---- -------------------- ---------- ---------
Commercial $ 896 22% $ 697 21%
Mortgage 762 60% 853 60%
Consumer 917 18% 970 19%
Unallocated 48 10
----- --- ---- ---
Totals $2,623 100% $2,530 100%
===== === ===== ===
As certain loans identified as impaired are brought current, collateral
values increase, or they are removed from watch lists for other reasons, other
loans become identified as imparied and replace those previously identified as
impaired. Delinquency levels within each of the portfolios change and the
allocation of the allowance among the loan types thus changes. Management
believes that the allowance is a representation of the losses present in the
portfolio and reflects historical loss trends, economic conditions and any known
credit problems as of the date of allocation. The changes in the allocation
between December 31, 2004 and March 31, 2005 are a reflection of these changes.
Management believes that the allowance is to be taken as a whole, and allocation
between loan types is an estimation of potential losses within each type given
information known at the time.
15
Item 2. Management's Discussion and Analysis of Financial Condition and
Results of Operations (continued)
Allowance for Loan Losses (continued)
The following table summarizes the Company's net charge-offs by loan type
for the three months ended March 31, 2005 and March 31, 2004:
Quarter Ended
March 31,
2005 2004
-------- --------
Charge-offs $ (175) $ (220)
Recoveries 43 95
----- -----
Total net charge-offs $ (132) $ (125)
===== =====
Components of net charge-offs:
Real estate (1) (23)
Commercial (10) (13)
Consumer (121) (89)
------ -----
Total $ (132) $ (125)
====== =====
Loan Portfolio and Credit Quality
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,
and northern Pendleton counties in West Virginia and Frederick County, Virginia.
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.
The principal economic risk associated with each of the categories of loans
in the Company's portfolio is the creditworthiness of its borrowers. Within each
category, such risk is increased or decreased depending on prevailing economic
conditions. The risk associated with the real estate mortgage loans and
installment loans to individuals varies based upon employment levels, consumer
confidence, fluctuations in value of residential real estate and other
conditions that affect the ability of consumers to repay indebtedness. The risk
associated with commercial, financial and agricultural loans varies based upon
the strength and activity of the local economies of the Company's market areas.
The risk associated with real estate construction loans varies based upon the
supply of and demand for the type of real estate under construction.
Historically, loans secured by real estate have lower loss rates than other
types of loans. The Company continues to strengthen its position in this regard
as the percentage of gross loans secured by real estate has risen in recent
periods. In addition to traditional mortgages, significant portions of the
Company's commercial loan portfolio are secured by real estate. As of March 31,
2005, 73.83% of the Company's gross loans were secured by real estate.
16
Item 2. Management's Discussion and Analysis of Financial Condition and
Results of Operations (continued)
Loan Portfolio (continued)
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. During the spring of 2004, Pilgrim's Pride Corporation announced the
pending closure of its turkey processing facilities near Harrisonburg, VA. This
closure would have impacted the local economy because turkey growers contracted
with Pilgrim's Pride would either be forced to cease growing operations or turn
to alternative contractual arrangements. The number of direct grower loans held
by the Company and which would have been impacted by this potential closure is
small. Since the announcement of the pending closure, some of the growers
impacted by the closure who have loans with the Company have contracted with
another poultry integrator. The remainder have joined a cooperative organization
that reopened the processing plant in late November. Management will monitor the
activities of this cooperative but expects no adverse impact relating to the
transitions involved with the poultry processing facility and its related
operations.
In recent periods, the Company's loan portfolio has also begun to reflect a
concentration in loans collateralized by heavy equipment, particularly in the
trucking and timber industries. In part because of rising fuel costs, and
because of continued stagnant economic conditions, the trucking sector has
experienced a recent downturn. However, the Company has experienced no material
losses related to foreclosures of loans collateralized by heavy equipment. While
close monitoring of this sector is necessary, management expects no significant
losses in the foreseeable future.
Credit Quality
Nonperforming loans include nonaccrual loans, loans 90 days or more past due
and restructured loans. Nonaccrual loans are loans on which interest accruals
have been suspended or discontinued permanently. Restructured loans are loans on
which the original interest rate or repayment terms have been changed due to
financial hardship of the borrower.
The following table summarizes the company's non-performing loans as of
March 31, 2005, December 31, 2004 and March 31, 2004:
March 31, December 31, March 31,
(in thousands) 2005 2004 2004
Non-accrual loans $ 316 $ 530 $ 982
Loans past due 90 days or more
and still accruing interest 623 535 1,084
------- ------ -------
Total $ 939 $ 1,065 $ 2,066
======= ====== =======
17
Item 2. Management's Discussion and Analysis of Financial Condition and
Results of Operations (continued)
Credit Quality (continued)
Loans are typically placed on non-accrual status once they have reached
certain levels of delinquency, 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 and management believes that collection of the amounts due is
doubtful. Charged-off loans are charged against the allowance for loan losses.
Any subsequent collection or sale of repossessed collateral is added to the
allowance as a recovery.
Real estate acquired through foreclosure was $270,000 at March 31, 2005
compared to $328,000 at December 31, 2004. All foreclosed property held as of
March 31, 2005 was in the Company's primary service area. The Company's practice
is to value real estate acquired through foreclosure at the lower of (i) an
independent current appraisal or market analysis less anticipated costs of
disposal, or (ii) the existing loan balance. The Company is actively marketing
all foreclosed real estate and does not anticipate material write-downs in value
before disposition.
As of March 31, 2005, the Company had two potential problem loan as defined
in SEC Industry Guide III that would require disclosure. In July 2004, the
Company received notice that a large commercial loan customer had filed for
Chapter 11 bankruptcy protection. Depending upon the final outcome of the
bankruptcy proceedings, the Company may be forced to reclassify the loans made
to this customer, which total approximately $1.4 million, to non-accrual status.
If these loans are reclassified to non-accrual, this will have a negative impact
on interest revenue and net income to the extent that any interest accruing to
the loans of this customer would not be recognized as income. At present, the
interest earned on the loans to this customer total approximately $100,000 per
annum. The loans to this customer are deemed by Management to be well secured,
and if a foreclosure is required, the Company expects there to be no loss on the
sale of the collateral. Since the bankruptcy filing, this customer has continued
to make payments of both principal and interest, and though remaining moderately
delinquent, these payments have been sufficient to consistently keep the
customer less than 60 days past due. During the fourth quarter of 2004, the
Company was informed by another large commercial loan customer that a Chapter 11
bankruptcy may be forthcoming. As of the date of this filing, the Company has
received no formal notice from this customer that a bankruptcy filing has
occurred. Loans to this commercial customer total approximately $450,000. This
customer continues to make payments of both principal and interest, and though
remaining moderately delinquent, these payments have been sufficient to
consistently keep the customer less than 60 days past due. Management deems the
loans to this customer to be adequately secured and, if foreclosure becomes
necessary, expects no material loss. Because no material loss is expected in the
event of foreclosure of either loan, Management has not deemed it necessary to
adjust the allowance for loan losses for these two loans.
An inherent risk in the lending of money is that the borrower will not be
able to repay the loan under the terms of the original agreement. The allowance
for loan losses (see previous section) provides for this risk and is reviewed
periodically for adequacy. This review also considers concentrations of loans in
terms of geography, business type or level of risk. While lending is
geographically diversified within the service area, the Company does have some
concentration of loans in the area of agriculture (primarily poultry farming),
timber and related industries. Management recognizes these concentrations and
considers them when structuring its loan portfolio.
Noninterest Expense
Total noninterest expense increased 2.45% for the first three months of 2005
as compared to 2004.
Of the increase, $63,000 was attributable to a rise in the expenses of
salaries and benefits due to customary salary increases and inflationary trends
of health insurance costs. The costs of legal and professional fees increased
due in large part to expanded audit engagements relating to Sarbanes-Oxley Rule
404 compliance. Data processing expense decreased by $24,000 due to a decrease
in the contractual rate charged to the subsidiary banks by a supplier of account
processing functions.
18
Item 2. Management's Discussion and Analysis of Financial Condition and
Results of Operations (continued)
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, unpledged
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 (the Company's
primary liquidity source) and decreases in secondary liquidity sources such as
balances of fed funds sold and balances of securities. In addition, the Company
has, in recent periods, used borrowing from the FHLB as a primary source of
liquidity. During recent quarters, the Company saw a significant increase in new
loans. These loans were funded primarily through secondary liquidity sources and
borrowings from the FHLB. Customer deposit balances have also decreased in
recent periods. Should the Company continue to experience significant loan
growth, it may be necessary to raise rates on deposits above current market
levels in order to attract new deposits.
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 April 1, 2005, the subsidiary banks
could pay dividends to Highlands Bankshares, Inc. of approximately $4,441,000
without permission of the regulatory authorities.
19
Item 2. Management's Discussion and Analysis of Financial Condition and
Results of Operations (continued)
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 March 31, 2005, 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 March 31, 2005 and December 31, 2004:
March 31, 2005 December 31, 2004
Actual Regulatory Actual Regulatory
Ratio Minimum Ratio Minimum
Total Risk Based Capital Ratio
Highlands Bankshares 14.75% 8.00% 14.71% 8.00%
Capon Valley Bank 12.73% 8.00% 12.82% 8.00%
The Grant County Bank 15.56% 8.00% 15.68% 8.00%
Tier 1 Leverage Ratio
Highlands Bankshares 10.24% 3.00% 10.14% 3.00%
Capon Valley Bank 8.72% 3.00% 8.57% 3.00%
The Grant County Bank 10.91% 3.00% 11.01% 3.00%
Tier 1 Risk Based Capital Ratio
Highlands Bankshares 13.61% 4.00% 13.58% 4.00%
Capon Valley Bank 11.50% 4.00% 11.57% 4.00%
The Grant County Bank 14.48% 4.00% 14.64% 4.00%
Effects of Inflation
Inflation significantly 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, as illustrated by the
gap analysis shown under the section titled Interest Rate Sensitivity in order
to minimize the effects of inflationary trends on interest rates. Other areas of
noninterest expenses may be more directly affected by inflation.
20
Item 3. Quantitative and Qualitative Disclosures About Market Risk
The greatest portion of the Company's net income is derived from net
interest income. As such, the greatest component of market risk is interest rate
volatility. In conjunction with maintaining a satisfactory level of liquidity,
management must also control the degree of interest rate risk assumed on the
balance sheet. Managing this risk involves regular monitoring of the interest
sensitive assets relative to interest sensitive liabilities over specific time
intervals. Early withdrawal of deposits, greater than expected balances of new
deposits, prepayments of loans and loan delinquencies are some of the factors
that could affect actual versus expected cash flows. In addition, changes in
rates on interest sensitive assets and liabilities may not be equal, which could
result in a change in net interest margin. While the Company does not match each
of its interest sensitive assets against specific interest sensitive
liabilities, it does review its positions regularly and takes actions to
reposition itself when necessary. With the largest amount of interest sensitive
assets and liabilities repricing within one year, the Company believes it is in
an excellent position to respond quickly to rapid market rate changes.
Interest rate market conditions may also affect portfolio composition of
both assets and liabilities. Traditionally, the Company's subsidiary banks have
primarily offered one year adjustable rate mortgages (ARMs) to its mortgage loan
customers. However, the low interest rate environment has created intense
competition, especially from larger banking institutions and finance companies
offering long term fixed rate mortgages. As a result, the Company in recent
periods has begun to write more mortgage loans with adjustable rates and
maturities greater than one year. The increase in new ARM loans with two, three
and five year adjustable rates has caused a shift in the maturity composition of
the loan portfolio.
Also as a result of the low interest rate environment, depositors seemed
reluctant to commit to longer term time deposits and in many instances appeared
to be holding monies temporarily in interest bearing transaction accounts in
anticipation of rising rates in the coming periods. As of December 31, 2003,
balances of interest bearing transaction and savings accounts were $72,098,000.
These balances had grown to $75,342,000 by December 31, 2004. As interest rates
have begun to rise, this trend appears to have begun to reverse, and the
balances in these types of accounts was $73,738,000 at March 31, 2005. Were
interest rates to rise sharply in the coming periods, some of the monies now in
interest bearing transaction and savings accounts may shift to time deposits,
causing a rise in the Company's cost of funds. Alternatively, these balances may
be transferred by customers to other financial institutions offering higher
deposit rates, and requiring the Company to match such rates.
Increases in loan demand have created the need in recent quarters for
increased borrowings from the FHLB. Should loan demand continue to grow,
increases in borrowing from the FHLB may be required. Recent rate trends have,
in certain instances, made borrowing from the FHLB more attractive than
increasing deposit balances with the utilization of rate or other incentives,
which could have the effect of increasing interest expense at a rate greater
than the increase in interest revenues. Increased deposit incentives in the form
of higher rate features may be required in coming periods if loan demand grows
at a rate whereby current sources of funds will not be sufficient to support
loan funding or if FHLB loan rates increased due to Fed actions. This would have
the effect of increasing the Company's cost of funds. The subsidiary banks of
the Company maintain sufficient ability to borrow funds from the Federal Home
Loan Bank (FHLB) for use in loan funding and there has been no recent indication
which would lead Management to believe that FHLB borrowing rates would rise to
levels which would adversely affect interest margin spreads. While Management
does not foresee paying above market rates on its funding, extreme loan growth
may cause this situation, thereby reducing the net interest margin spread.
21
Item 3. Quantitative and Qualitative Disclosures About Market Risk (continued)
The following table illustrates the Company's sensitivity to interest rate
changes as of March 31, 2005 (in thousands):
More than
5 Years
1 - 90 91 - 365 1 to 3 3 to 5 or Without
Days Days Years Years Maturity Total
EARNING ASSETS
Loans $36,356 $ 93,459 $91,190 $16,742 $16,084 $253,831
Fed funds sold 4,929 4,929
Securities 10,264 8,693 7,025 154 667 26,803
Time deposits in other
banks 605 200 805
------ ------ ------ ------ ------ -------
Total 52,154 102,352 98,215 16,896 16,751 286,368
------ ------- ------ ------ ------ -------
INTEREST BEARING LIABILITIES
Money market savings 24,795 24,795
Savings accounts 48,943 48,943
Time deposits 21,710 55,766 52,410 13,228 143,114
Borrowed money 374 1,137 3,131 3,286 6,631 14,559
------ ------ ------ ------ ------ -------
Total 95,822 56,903 55,541 16,514 6,631 231,411
------- ------ ------ ----- ------ -------
Rate sensitivity GAP (43,668) 45,449 42,674 382 10,120 54,957
Cumulative GAP (43,668) 1,781 44,455 44,837 54,957
Ratio of cumulative
interest sensitive assets
to cumulative interest
sensitive liabilities 54.43% 101.17% 121.35% 119.95% 123.75%
Assumes all transaction, money market and savings deposit accounts reprice
within 90 days.
22
Item 4. Controls and Procedures
Evaluation of Disclosure Controls and Procedures
As a result of the enactment of the Sarbanes-Oxley Act of 2002, issuers
such as Highlands Bankshares, Inc. that file periodic reports under the
Securities Exchange Act of 1934 (the "Act") are now required to include in
those reports certain information concerning the issuer's controls and
procedures for complying with the disclosure requirements of the federal
securities laws. These disclosure controls and procedures include, without
limitation, controls and procedures designed to ensure that information
required to be disclosed by an issuer in the reports it files or submits
under the Act, is communicated to the issuer's management, including its
principal executive officer or officers and principal financial officer or
officers, or persons performing similar functions, as appropriate to allow
timely decisions regarding required disclosure.
We have established our disclosure controls and procedures to ensure that
material information related to Highlands Bankshares, Inc. is made known to
our principal executive officers and principal finance officer on a regular
basis, in particular during the periods in which our quarterly and annual
reports are being prepared. These disclosure controls and procedures
consist principally of communications between and among the Chief Executive
Officer and Chief Financial Officer, and the other executive officers of
Highlands Bankshares, Inc. and its subsidiaries to identify any new
transactions, events, trends, contingencies or other matters that may be
material to the Company's operations. As required, we will evaluate the
effectiveness of these disclosure controls and procedures on a quarterly
basis, and most recently did so as of the end of the period covered by this
report.
The Company's chief executive officer and chief financial officer, based on
their evaluation as of the end of the period covered by this Annual Report
of the Company's disclosure controls and procedures (as defined in Rule
13(a)-14(e) of the Securities Exchange Act of 1934), have concluded that
the Company's disclosure controls and procedures are adequate and effective
for purposes of Rule 13(a)-14(c) and timely, alerting them to financial
information relating to the Company required to be included in the
Company's filings with the Securities and Exchange Commission under the
Securities Exchange Act of 1934.
Changes in Internal Controls
During the period reported upon, there were no significant changes in the
internal controls of Highlands Bankshares, Inc. pertaining to its financial
reporting and control of its assets or in other factors that could
significantly affect these controls.
Due to the nature of the Company's business as stewards of deposits of
customers, internal controls are of the utmost importance. The Company has
established procedures undertaken during the normal course of business to
reasonably ensure that fraudulent activity of either an amount material to
these results or in any amount is not occurring. In addition to these
controls and review by executive officers, the Company retains the services
of Yount, Hyde & Barbour, P.C., a public accounting firm, to complete regular
internal audits to examine the processes and procedures of the Company and
its subsidiary banks and to ensure that these processes are reasonably
effective to prevent fraud, both internal and external, and that these
processes comply with relevant regulatory guidelines of all relevant banking
authorities. The findings of Yount, Hyde & Barbour are presented both to
Management of the subsidiary banks and to the Audit Committee.
23
Part II Other Information
Item 1. Legal Proceedings - Not Applicable
Item 2. Unregistered Sales of Equity
Securities And Use of Proceeds- Not Applicable
Item 3. Defaults Upon Senior Securities - Not Applicable
Item 4. Submission of Matters to a Vote
of Security Holders - Not Applicable
Item 5. Other Information - Not Applicable
Item 6. Exhibits and Reports on 8-K -
(a) Exhibits
3 (i) Articles of Incorporation of Highlands Bankshares, Inc. are
incorporated by reference to Appendix C to Highlands Bankshares,
Inc.'s Form S-4 filed October 20, 1986.
3 (ii) Bylaws of Highlands Bankshares, Inc. are incorporated by reference to
Exhibit 3(ii) to Highland Bankshares, Inc.'s Form 10-Q filed May 15,
2003.
14 The Code of Ethics of Highlands Bankshares, Inc. are incorporated by
reference to Part IV, Item 15(A), Exhibt 14 to Highlands Bankshares,
Inc.'s Annual Report on Form 10-K filed March 30, 2005.
21 The Listing of Subsidiaries of Highlands Bankshares, Inc. are
incorporated by reference to Part IV, Item 15(A), Exhibt 21 to
Highlands Bankshares, Inc.'s Annual Report on Form 10-K filed March
30, 2005.
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 and Financial Officer Pursuant
to 18 U.S.C. ss. 1350.
24
Signature
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
/s/ R. ALAN MILLER
--------------------------
R. Alan Miller
Finance Officer
May 9, 2005