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UNITED STATES
SECURITIES AND EXCHANGE COMMISSION
Washington, D. C. 20549
FORM 10-Q
Quarterly Report Under Section 13 or 15(d)
of the Securities Exchange Act of 1934
For Quarter Ended Commission File No. 0-16761
June 30, 2002
HIGHLANDS BANKSHARES, INC.
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
(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 ....
State the number of shares outstanding of each of the issuer's classes of
common equity, as of the latest practicable date.
Class Outstanding at June 30, 2002
- ------------------------------------------ ----------------------------
Common Stock, par value - $5 478,958 shares
1
HIGHLANDS BANKSHARES, INC.
INDEX
Page
PART I FINANCIAL INFORMATION
Item 1. Financial Statements
Consolidated Statements of Income - Six Months
Ended June 30, 2002 and 2001 2
Consolidated Statements of Income - Three Months
Ended June 30, 2002 and 2001 3
Consolidated Balance Sheets - June 30, 2002 and
December 31, 2001 4
Consolidated Statements of Changes in Stockholders'
Equity - Six Months Ended June 30, 2002 and 2001 5
Consolidated Statements of Cash Flows - Six Months
Ended June 30, 2002 and 2001 6
Notes to Consolidated Financial Statements 7
Item 2. Management's Discussion and Analysis of
Financial Condition and Results of Operations 9
PART II OTHER INFORMATION
Item 1. Legal Proceedings 19
Item 2. Changes in Securities 19
Item 3. Defaults upon Senior Securities 19
Item 4. Submission of Matters to a Vote of Security Holders 19
Item 5. Other Information 19
Item 6. Exhibits and Reports on Form 8K 19
SIGNATURES 20
2
Part I Financial Information
Item 1 Financial Statements
HIGHLANDS BANKSHARES, INC.
CONSOLIDATED STATEMENTS OF INCOME
(In Thousands of Dollars Except Per Share Amounts)
Six Months Ended
June 30,
2002 2001
---------- ----------
Interest Income
Interest and fees on loans $ 8,556 $ 8,923
Interest on federal funds sold 96 248
Interest on time deposits 65 132
Interest and dividends on investment securities
Taxable 623 735
Nontaxable 103 79
------- ------
Total Interest Income 9,443 10,117
------- ------
Interest Expense
Interest on time deposits over $100,000 1,121 1,276
Interest on other deposits 2,863 3,655
Interest on borrowed money 103 105
------- ------
Total Interest Expense 4,087 5,036
------- ------
,
Net Interest Income 5,356 5,081
Provision for Loan Losses 260 255
------- ------
Net Interest Income After Provision for Loan Losses 5,096 4,826
------- ------
Noninterest Income
Service charges 273 290
Other 291 253
------- ------
Total Noninterest Income 564 543
------- ------
Noninterest Expense
Salaries and employee benefits 2,066 1,888
Equipment and Occupancy expense 517 470
Data processing 286 262
Other 948 868
------- ------
Total Noninterest Expense 3,817 3,488
------- ------
Income Before Income Taxes 1,843 1,881
Provision for Income Taxes 581 640
------- ------
Net Income $ 1,262 $ 1,241
======= ======
Per Share Data
Net Income $ 2.57 $ 2.47
======= ======
Cash Dividends $ .74 $ .68
======= ======
Weighted Average Common Shares Outstanding 491,359 501,898
======= =======
The accompanying notes are an integral part of these statements.
3
HIGHLANDS BANKSHARES, INC.
CONSOLIDATED STATEMENTS OF INCOME
(In Thousands of Dollars Except Per Share Amounts)
Three Months Ended
June 30,
2002 2001
---------- ----------
Interest Income
Interest and fees on loans $ 4,277 $ 4,550
Interest on federal funds sold 42 116
Interest on time deposits 32 73
Interest and dividends on investment securities
Taxable 304 380
Nontaxable 51 42
------- ------
Total Interest Income 4,706 5,161
------- ------
Interest Expense
Interest on time deposits over $100,000 541 697
Interest on other deposits 1,340 1,792
Interest on borrowed money 50 48
------- ------
Total Interest Expense 1,931 2,537
------- ------
Net Interest Income 2,775 2,624
Provision for Loan Losses 140 135
------- ------
Net Interest Income After Provision for Loan Losses 2,635 2,489
------- ------
Noninterest Income
Service charges 144 149
Other income 141 120
------- ------
Total Noninterest Income 285 269
------- ------
Noninterest Expense
Salaries and employee benefits 1,017 954
Equipment and Occupancy expense 265 241
Data processing expense 141 122
Other 514 451
------- ------
Total Noninterest Expense 1,937 1,768
------- ------
Income Before Income Taxes 983 990
Provision for Income Taxes 321 343
------- ------
Net Income $ 662 $ 647
======= ======
Per Share Data
Net Income $ 1.38 $ 1.29
======= ======
Cash Dividends $ .37 $ .34
======= ======
Weighted Average Common Shares Outstanding 480,936 501,898
======= =======
The accompanying notes are an integral part of these statements.
4
HIGHLANDS BANKSHARES, INC.
CONSOLIDATED BALANCE SHEETS
(In Thousands of Dollars)
June 30, December 31,
2002 2001
------------ ------------
ASSETS
Cash and due from banks - noninterest bearing $ 6,545 $ 6,492
Time deposits in other banks 5,785 6,334
Federal funds sold 5,789 13,284
Securities held to maturity (note 2) 1,571 1,603
Securities available for sale (note 3) 28,262 29,460
Other investments 858 792
Loans, net of unearned interest (note 5) 215,989 205,469
Less allowance for loan losses (note 6) (1,723) (1,603)
Bank premises and equipment 6,933 7,056
Interest receivable 1,926 1,818
Investment in insurance contracts (note 7) 5,188 5,100
Other assets 1,568 973
------- -------
Total Assets $278,691 $276,778
======= =======
LIABILITIES
Deposits:
Noninterest bearing
Demand deposits $ 32,686 $ 29,279
Interest bearing
Money market and checking 20,156 17,936
Money market savings 13,533 11,407
Savings 29,820 26,782
Time deposits over $100,000 42,467 45,182
All other time deposits 105,402 111,456
------- -------
Total Deposits 244,064 242,042
Borrowed money 4,276 4,523
Accrued expenses and other liabilities 2,326 1,903
------- -------
Total Liabilities 250,666 248,468
------- -------
STOCKHOLDERS' EQUITY
Common stock ($5 par value, 1,000,000 shares
authorized, 546,764 shares issued) 2,734 2,734
Surplus 1,662
1,662
Retained earnings 25,522 24,624
Accumulated other comprehensive loss 317 283
Treasury stock (at cost, 67,806 shares in 2002
and 44,866 in 2001) (2,210) (993)
-------- --------
Total Stockholders' Equity 28,025 28,310
------- -------
Total Liabilities and Stockholders' Equity $278,691 $276,778
======= =======
The accompanying notes are an integral part of these statements.
5
HIGHLANDS BANKSHARES, INC.
CONSOLIDATED STATEMENTS OF CHANGES IN STOCKHOLDERS' EQUITY
(In Thousands of Dollars)
Accumulated
Other
Common Treasury Retained Comprehensive
Stock Surplus Stock Earnings Income Total
Balance, December 31, 2001 $2,734 $ 1,662 $ (993) $ 24,624 $ 283 $ 28,310
Comprehensive Income
Net Income 1,262 1,262
Net change in
unrealized
appreciation on
investment
securities available
for sale,
net of taxes 34 34
----- ------ ------ ------ ------ ------
Total Comprehensive Income 1,296
Treasury stock purchased (1,217) (1,217)
Dividends paid (364) (364)
----- ------ ------ ------- ------ -------
Balances, June 30, 2002 $2,734 $ 1,662 $(2,210) $ 25,522 $ 317 $28,025
===== ======= ======= ======= ===== =======
Accumulated
Other
Common Treasury Retained Comprehensive
Stock Surplus Stock Earnings Income Total
Balance, December 31, 2000 $2,734 $ 1,662 $ (993) $ 22,826 $ 39 $26,268
Comprehensive Income
Net Income 1,241 1,241
Net change in
unrealized
appreciation on
investment
securities available
for sale,
net of taxes 140 140
----- ------ ------ ------ ------ ------
Total Comprehensive Income 1,381
Dividends paid (342) (342)
----- ------ ------ ------ ------ ------
Balances, June 30, 2001 $2,734 $ 1,662 $ (993) $ 23,725 $ 179 $27,307
======== ====== ======= ======= ====== =======
The accompanying notes are an integral part of these statements.
6
HIGHLANDS BANKSHARES, INC.
CONSOLIDATED STATEMENTS OF CASH FLOWS
(In Thousands of Dollars)
Six Months Ended
June 30,
2002 2001
---------- ----------
Cash Flows from Operating Activities:
Net income $ 1,262 $ 1,241
Adjustments to reconcile net income to net
cash provided by operating activities:
Depreciation 264 254
Net securities amortization 148 33
Provision for loan losses 260 255
Income from insurance investments (88) (96)
Increase in interest receivable (108) (235)
(Increase) decrease in other assets (616) 131
Increase in accrued expenses 423 263
------- ------
Net Cash Provided by Operating Activities 1,545 1,846
------- ------
Cash Flows from Investing Activities:
Net change in time deposits in other banks 548 441
Net change in federal funds sold 7,495 (605)
Proceeds from maturities of securities
available for sale 4,481 9,792
Proceeds from maturities of securities
held to maturity 31 395
Purchase of securities available for sale (3,376) (15,934)
Purchase of other investments (67) (29)
Net change in loans (10,659) (10,165)
Purchase of property and equipment (140) (615)
-------- ------
Net Cash Consumed by Investing Activities (1,687) (16,720)
-------- -------
Cash Flows from Financing Activities:
Net change in time deposits (8,769) 13,564
Net change in other deposits 10,791 808
Dividends paid in cash (364) (342)
Purchase of treasury stock (1,217)
Repayment of borrowed money (247) (422)
Advances of borrowed money 600
------- ------
Net Cash Provided by Financing Activities 194 14,208
------- ------
Net Increase (Decrease) in Cash and Cash Equivalents 52 (666)
Cash and Cash Equivalents, Beginning of Period 6,492 7,062
------- ------
Cash and Cash Equivalents, End of Period $ 6,544 $ 6,396
======= ======
Supplemental Disclosures:
Cash Paid For:
Income taxes $ 430 $ 1,002
Interest 4,052 4,970
The accompanying notes are an integral part of these statements.
7
HIGHLANDS BANKSHARES, INC.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
NOTE 1 ACCOUNTING PRINCIPLES:
The consolidated financial statements conform to generally accepted
accounting principles and to general industry
practices. In the opinion of management, the accompanying
unaudited consolidated financial statements contain
all adjustments (consisting of only normal recurring accruals)
necessary to present fairly the financial position as of June 30,
2002, and the results of operations for the three and six month
periods ended June 30, 2001 and 2002. The notes included herein should
be read in conjunction with the notes to financial statements
included in the 2001 annual report to stockholders of Highlands
Bankshares, Inc.
The Company does not expect the anticipated adoption of any newly
issued accounting standards to have a material impact on future
operations or financial position.
NOTE 2 SECURITIES HELD TO MATURITY:
The amortized cost and fair value of securities held to maturity as
of June 30, 2002 and December 31, 2001, are as follows:
2002 2001
----------------- -----------------
Amortized Fair Amortized Fair
Cost Value Cost Value
Obligations of states and
political subdivisions $ 1,566 $ 1,628 $1,597 $ 1,633
Mortgage-backed securities 5 5 6 6
------- ------ ------ ------
Total $ 1,571 $ 1,633 $1,603 $ 1,639
====== ====== ===== ======
NOTE 3 SECURITIES AVAILABLE FOR SALE:
The amortized cost and fair value of securities available for sale
as of June 30, 2002 and December 31, 2001, are as follows:
2002 2001
--------------- -------------------
Amortized Fair Amortized Fair
Cost Value Cost Value
US Treasury securities
and obligations of
US Government
corporations and
agencies $16,579 $16,836 $16,123 $16,432
Obligations of states
and political
subdivisions 5,818 5,924 6,319 6,380
Mortgage-backed securities 5,322 5,471 6,527 6,609
Other investments 34 31 42 39
------ ------ ----- ------
Total $27,753 $28,262 $29,011 $29,460
====== ====== ====== ======
8
HIGHLANDS BANKSHARES, INC.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
NOTE 4 OTHER INVESTMENTS
Other investments totaling $ 858,550 include investments in the
Federal Home Loan Bank and other governmental entities
whose transferability is restricted
NOTE 5 LOANS OUTSTANDING:
A summary of loans outstanding as of June 30, 2002 and December 31,
2001, is as follows:
2002 2001
---- ----
Commercial $ 44,706 $ 42,204
Real estate - construction 5,013 3,868
- mortgages 118,587 111,668
Consumer installment 47,789 47,927
------- -------
Total 216,095 205,667
Unearned interest (106) (198)
-------- --------
Net loans outstanding $215,989 $205,469
======= =======
NOTE 6 ALLOWANCE FOR LOAN LOSSES:
A summary of transactions in the allowance for loan losses for the
six months ended June 30, 2002 and 2001, follows:
2002 2001
---- ----
Balance, beginning of period $ 1,603 $ 1,493
Provisions charged to operating expenses 260 255
Loan recoveries 96 139
Loan charge-offs (236) (187)
-------- -------
Balance, end of period $ 1,723 $ 1,700
======= =======
NOTE 7 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 providing life insurance and retirement
benefits to employees. The carrying value of these investments was
$5,188,000 at June 30, 2002 and $5,100,000 at December 31, 2001.
9
Item 2 Management's Discussion and Analysis of Financial Condition and
Results of Operations
Overview
Year to Date Operations
The Company's year to date net income was $1,261,616, an increase of 1.69%
compared to 2001. Earnings per share were $2.57 for 2002 compared to $2.47 per
share for 2001. The Company's annualized return on average equity was 9.03% in
2002 compared to 9.17% for 2001. Return on average assets was .92% for 2002 and
..94% for 2001, respectively.
The increase in earnings per share was due primarily to a 5.41% increase in
net interest income. Growth in average earning assets (8.92%) and interest
bearing liabilities (5.57%) within the last twelve months offset a declining net
interest margin between 2002 and 2001. The increase in the tax equivalent net
interest income was 5.63% for the period. The provision for loan losses of
$260,000 was up slightly ($5,000) over the same period in 2001 and is reflective
of moderate net charge offs in 2002. Noninterest income increased 3.87% due to a
higher volume of insurance activity partially offset by decline in account
service charges. Noninterest expenses increased 9.43%, mainly the result of
operating expenses at the new branch in Gore, Virginia which opened in June 2001
and salary/benefit increases.
Quarter Ending June 30 Operations
Overall net income for the quarter ending June 30,
2002 increased 2.32% to $662,000 when compared to 2001 income of $647,000.
Earnings per share for the second quarter of 2002 were $1.38 versus $1.29 in
2001 (a 6.98% increase). Increases in the net interest income of 5.75% were
offset by increases in operating expenses of 9.56% during the period.
Net Interest Income
Year to Date Operations
The Company's net yield on interest earning assets on a tax equivalent basis
was 4.23% through the second quarter of 2002 compared to 4.36% for the second
quarter of 2001. The volume of all lending increased
substantially in the last twelve months due to a strong economy and additional
branch locations. Commercial rates decreased from 9.04% in 2001 to 8.04% in 2002
due to the Federal Reserve Bank actions over the last year. Rates on real estate
loans declined 148 basis points. Rates on consumer loans actually increased 38
basis points, largely due to a shift in demand for used vehicles and short term
personal loans. The overall decrease of 101 basis points in returns on average
loans was more than offset by decreases in the rates paid on deposits and
borrowed money (see "Deposits" below).
Through the second quarter of 2002, the Company saw an overall decrease of
160 basis points in the yields on investment securities compared to 2001
results. The decrease is reflective of recent reinvestments at lower rates.
Average investments in securities have increased over the last twelve months as
deposit growth has outpaced loan demand creating excess cash to invest. Interest
rates earned on fed funds sold and interest bearing deposits declined 285 basis
points as rates were cut eleven times in 2001 by the Federal Reserve Bank ("The
Fed") by one-quarter to one-half point each time. The increase in federal funds
is intended to serve as a source of funding should maturing, high rate
certificates leave the Banks. The Company experienced a $8.8 million
decline in the balance of certificates in the first half of 2002 due to
repricing of maturing certificates at much lower rates, but, this outflow has
been offset by increased levels of demand and savings deposits.
10
Item 2 Management's Discussion and Analysis of Financial Condition and
Results of Operations (Continued)
Net Interest Income (Continued)
Year to Date Operations (Continued)
Customers appear reluctant to commit to long-term, fixed rates on
certificates when rates are at historical lows and are instead placing their
deposits in accounts that are highly liquid and will allow them to respond
quickly when rates increase.
Interest rates paid on transaction and savings accounts declined a combined
94 basis points due to lower rates resulting from the Fed actions. The average
balance in time deposits grew 3.20% in 2002 since this same time in 2001 and has
been a source of funding for the loan growth discussed earlier. A 118 basis
point decrease in rates paid on time deposits between 2001 and 2002 reflects the
declining rate environment throughout 2002, especially after the tragedies of
September 11.
Beginning in 1999, the Company has borrowed amounts from the FHLB at fixed
rates of interest and loaned these monies to customers on a fixed rate basis.
The Company anticipates continuing to use this approach as a mechanism to
provide long-term financing to customers and limit market rate risk. In
addition, monies were borrowed on a short-term, variable rate basis to fund the
renovation and expansion at the Capon Valley Bank. The Bank anticipates
refinancing this variable rate debt when long-term interest rates are favorable.
The cost of all FHLB borrowings decreased 44 basis points from 2001 to 2002 due
to rate changes in market.
Quarter Ending June 30 Operations
The Company's net interest income on a tax equivalent basis of
$2,805,000 was 4.33% of average earning assets for the quarter ending June 30,
2002 compared to net interest income of $2,648,000 (4.39% of average earning
assets) for the same period in 2001. A 6.00% decrease in income from loans was
the result of an increase in volume which was outpaced by a 118 basis point
decline in average yields. Yields on investment securities also declined
significantly over the previous year in response to prevailing market
conditions. Outpacing the decline in asset yields was a decrease in average
rates paid on interest bearing liabilities from 4.91% in 2001 to 3.63% in 2002.
The decrease was primarily the result of a 137 basis point decline in the cost
of time deposits as high rate deposits are maturing and are being replaced by
lower rate deposits. The Company expects future deposit rates to remain stable
or decrease slightly in the second half of 2002 as rates on higher costing
certificates continue to mature and are replaced with rates in line with current
market rates.
A complete yield analysis is shown as Table I on page 17.
Noninterest Income
Year to Date Operations
Noninterest income for 2002 rose slightly from 2001 levels. Service charge
income declined by 5.86% and other operating income increased by 15.02%. Service
charge income declined as the result of a single customer being sold to new
investors who infused funds in the business and eliminated overdrafts and their
related fees. The net increase in other income is primarily due to a
corresponding increase in underwriting revenue of HBI Life Insurance Company.
Quarter Ending June 30 Operations
Noninterest interest income for the quarter ending June 30, 2002 increased
5.94% as the result of the increase in other income discussed in the preceding
paragraph.
11
Item 2 Management's Discussion and Analysis of Financial Condition and
Results of Operations (Continued)
Noninterest Expenses
Year to Date Operations
Overall noninterest expense increased 9.43% in 2002 as the result of
operating expense increases at Capon Valley Bank's new Gore Branch which opened
in June 2001, a marketing campaign with additional advertising expenses and an
increase in expenses relative to employee benefit plan administration. Personnel
expense increases of 9.43% were the result of an 8.00% increase in full time
equivalent employees due to growth and reorganization and an increase in
average wages. Expenses for occupancy, equipment and data processing expenses
increased 10.00% due to costs of upgrading data processing equipment,
equipping an additional branch facility and increasing data processing
services for stockholder services. Other noninterest expenses increased
9.22% due to asset growth and additional advertising. The overall increase in
noninterest expense of 9.43% is in line with management estimates through the
second quarter of the year and the increase in average earning assets of 8.92%.
Quarter Ending June 30 Operations
Overall, noninterest expenses increased 9.56% for the quarter ending June
30, 2002 compared to the quarter ending June 30, 2001. The reasons for the
quarterly increase are the same as for the year-to-date increases and the
percentage increases for the quarters are relatively the same as the
year-to-date increases.
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, Randolph, Mineral,
Hampshire, northern Pendleton counties in West Virginia and Frederick County
in 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.
Loans outstanding increased $10,520,000 or 5.12% in the first half of 2002
compared to levels at December 31, 2001. The first quarter of any year is
traditionally slow as farming and logging operations are hampered by weather
conditions and retail borrowing in the first quarter is put on hold until the
spring. Thus, the first quarter increase of 2.01% in the loan portfolio was not
anticipated but certainly welcomed. A 6.98% rise in real estate construction and
mortgage loans since the beginning of this year was primarily responsible for
the increase through the second quarter with consumer and commercial lending
remaining stable. The loan to deposit ratio was 88.50% at June 30, 2002 compared
to 84.89% at December 31, 2001. Loan demand is expected to remain satisfactory
in the near future barring any significant declines in the local or national
economies.
12
Item 2 Management's Discussion and Analysis of Financial Condition and
Results of Operations (Continued)
Asset Quality and Risk Elements
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. Nonaccrual loans totaled $668,000 at June
30, 2002 compared to $885,000 in nonaccrual loans at December 31, 2001. The
decrease was the result of foreclosures, which resulted in increases in other
real estate owned.
Real estate acquired through foreclosure was $596,500 at June 30, 2002 and
$77,000 at December 31, 2001. All foreclosed property held 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.
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 subsequent 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. As of
June 30, 2002, management is not aware of any significant potential problem
loans in which the debtor is currently meeting their obligations as stated in
the loan agreement but which may change in future periods.
Allowance for Loan Losses
Management evaluates the loan portfolio in light of national and local
economic changes, changes in the nature and value of the portfolio and industry
standards. The Company's loan classification system, which rates existing loans,
provides the basis for adjusting the allowance for loan losses. Management
reviews these classification totals, along with internally generated
loan review reports, past due reports, historical loan loss experience and
individual borrower's financial health to determine the necessary amount to be
provided in the allowance for loan losses. Management evaluates
nonperforming loans relative to their collateral value and makes the appropriate
adjustments to the allowance when needed.
13
Item 2 Management's Discussion and Analysis of Financial Condition and
Results of Operations (Continued)
Allowance for Loan Losses (Continued)
The provision for credit losses and changes in the allowance for credit
losses are shown below (in thousands of dollars).
Quarter Ended Six Months Ended
June 30, June 30,
------------------ --------------------
Allowance for credit losses 2002 2001 2002 2001
--------------------------- ---- ---- ---- ----
Balance, beginning of period $ 1,623 $ 1,595 $ 1,603 $ 1,493
Net charge-offs (recoveries)
Charge-offs (114) (83) (236) (187)
Recoveries 74 53 96 139
------ ------ ------ ------
Total net charge-offs * (40) (30) (140) (48)
Provision for credit losses 140 135 260 255
------ ------ ------ ------
Balance, End of Period $ 1,723 $ 1,700 $ 1,723 $ 1,700
====== ====== ====== ======
Quarter Ended Six Months Ended
June 30, June 30,
------------------ --------------------
2002 2001 2002 2001
---- ---- ---- ----
* Components of net charge-offs:
Real estate $ 22 $ $ 13 $
Commercial (2) (18) (8)
Installment (60) (30) (135) (40)
------- ------ ------- ------
Total $ (40) $ (30) $ (140) $ (48)
======= ====== ======= ======
The allowance for credit losses of $1,723,000 at June 30, 2002, was up
$100,000 from its level at March 31, 2002. The increase was due to limited net
charge offs during the second quarter of 2002 compared to the provision charged
to operations. The allowance was equal to .80% and .78% of total loans at June
30, 2002 and December 31, 2001, respectively. The Company believes that its
allowance must be viewed in its entirety and, therefore, is available for
potential credit losses in it entire portfolio, including, loans, credit-related
commitments and other financial instruments. In the opinion of management, the
allowance, when taken as a whole, is adequate to absorb reasonably estimated
credit losses inherent in the Company's portfolio.
14
Item 2 Management's Discussion and Analysis of Financial Condition and
Results of Operations (Continued)
Allowance for Loan Losses (Continued)
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
June 30, 2002 and December 31, 2001:
June 30, 2002 December 31, 2001
------------- -----------------
Loan Allowance Percentage Percentage of Allowance Percentage Percentage of
Type Allocation of Allowance Total Loans Allocation of Allowance Total Loans
Commercial $ 569 33% 21% $ 487 30% 21%
Mortgage 554 32% 57% 576 36% 56%
Consumer 525 31% 22% 450 28% 23%
Unallocated 75 4% 0% 90 6% %
----- --- --- ----- --- ---
Totals $ 1,723 100% 100% $ 1,603 100% 100%
======= ==== ==== ====== ==== ====
Until recently, the allowance allocation weighted toward commercial loans
due to its sensitivity to economic conditions. During 2001, the adoption of
FFIEC guidelines SAB 102 placed more weight of the allowance toward the actual
composition of the portfolio in combination with specific allocations toward
impaired loans. As a result, a shift of weighted allowance has moved to consumer
loans which now carries 22% of the balances and 31% of the allocation, with
mortgage at 32% and commercial at 33% of the allocation.
Securities
The Company's securities portfolio serves numerous purposes. Portions of
the portfolio may secure certain public and trust deposits. The remaining
portions are held as investments or used to assist the Company in liquidity and
asset/liability management. Total securities at June 30, 2002 were $29,833,000
compared to $31,063,000 at December 31, 2001. Securities as a percentage of
total assets were 10.70% at June 30, 2002 compared to 11.22% at December 31,
2001. The level of securities relative to total assets has dropped slightly
throughout 2002 as the demand for loans has been partially funded by investment
maturities.
The securities portfolio consists of three components, specifically,
securities held to maturity, securities available for sale and other
investments. 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. Other investments include restricted securities whose
ownership is required to participate in certain governmental programs.
The Company's recent purchases of all securities have generally been
limited to securities of high credit quality with short to medium term
maturities. Changes in the market values of securities available for sale are
reflected as changes in stockholders' equity, net of the deferred tax effect. As
of June 30, 2002, the fair value of the securities available for sale exceeded
their cost by $509,000 ($317,000 after tax considerations).
15
Item 2 Management's Discussion and Analysis of Financial Condition and
Results of Operations (Continued)
Deposits
The Company's main source of funds remains deposits received from
individuals, governmental entities and businesses located within the
Company's service area. Deposit accounts include demand deposits, savings, money
market and certificates of deposit.
Total deposits increased 0.84% between December 31, 2001 and June 30, 2002,
in all deposit areas except time deposits. The cost of funds for the first six
months of 2002 was 3.84% compared to 5.00% for the same period in 2001. The
costs on all deposit types decreased during the period. The majority of the
Company's deposits are time deposits that are attractive to persons seeking high
yields on their deposits but without the need for liquidity. The Company has
recently seen a substantial decrease in all time deposits as a result of
maturing high-rate certificates of deposits. Total deposits have grown slightly
as noted due to the shift from time deposits as they matured to savings and
money market accounts. Customers are keeping their investments in transaction
accounts waiting for market forces to increase rates.
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 June 30, 2002, the Company's total risk based capital
ratio was 14.41% which is far above the regulatory minimum of 8.0%. The leverage
ratio of total capital to total assets was 10.16% at June 30, 2002, which is
comparable to the Company's peer group.
In the second quarter of 2002, the Company repurchased stock from unrelated
parties in two separate transactions. Total shares repurchased were 22,940 at a
cost of $1,217.000.
In June 2002, the Company approved a three for one stock split effective
September 3, 2002 to shareholders of record on August 1, 2002.
Liquidity
Liquidity is the ability to meet present and future financial
obligations through either the sale or maturity of existing assets or the
acquisition of additional funds through liability management. Liquid
assets include cash, interest-bearing deposits with banks, federal funds sold,
investments and loans maturing within one year. The Company's ability to obtain
deposits and purchase funds at favorable rates determines its liquidity
exposure. As a result of the Company's management of liquid assets and the
ability to generate liquidity through liability funding, management believes
that the Company maintains overall liquidity sufficient to satisfy its
depositors' requirements and meet its customers' credit needs.
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 and the Federal Reserve Bank of Richmond.
Both subsidiary banks have lines of credit with the Federal Home Loan Bank of
Pittsburgh although utilization has been insignificant. In the past,
growth in deposits has been sufficient to fund the net increase in loans and
investment securities
16
Item 2 Management's Discussion and Analysis of Financial Condition and
Results of Operations (Continued)
Interest Rate Sensitivity
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.
At June 30, 2002 the Company had a negative gap position through the first
three months, shifting to a positive gap by the end of one year. 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 to rapid
market rate changes quickly. Early withdrawal of 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 it when necessary.
Securities and Exchange Commission Web Site
The Securities and Exchange Commission maintains a Web site that contains
reports, proxy and information statements and other information regarding
registrants that file electronically with the Commission, including Highlands
Bankshares, Inc., and the address is (http://www.sec.gov).
17
Table I
HIGHLANDS BANKSHARES, INC.
NET INTEREST MARGIN ANALYSIS
(Dollar Amounts in Thousands)
Six Months Ended Six Months Ended
June 30, 2002 June 30, 2001
-------------------- -----------------
Average Income/ Average Income/
Balance Expense Rates Balance Expense Rates
Interest Income
Loans 1, 4
Commercial $11,568 $ 461 8.04% $11,291 $ 506 9.04%
Consumer 54,207 3,147 11.71% 52,645 2,959 11.33%
Real estate 144,180 4,948 6.92% 131,075 5,458 8.40%
------- ----- ------ ------- ----- ---------
Total 209,955 8,556 8.22% 195,011 8,923 9.23%
Federal funds
sold 11,562 96 1.69% 10,223 248 4.89%
Interest bearing
deposits 5,324 65 2.20% 5,830 132 4.57%
Investments
Taxable 3 25,756 623 4.88% 22,795 735 6.50%
Tax exempt 2,3 5,695 163 5.77% 3,290 125 7.66%
----- ----- ---- ----- ----- -----
Total Earning
Assets 258,292 9,503 7.53% 237,149 10,163 8.64%
------- ----- ------- -------- ------ -------
Interest Expense
Money markets 31,842 205 1.30% 29,096 310 2.15%
Savings 28,132 206 1.48% 24,498 307 2.53%
Time deposits 150,276 3,573 4.79% 145,614 4,314 5.97%
Other borrowed
money 4,344 103 4.78% 4,059 105 5.22%
----- ----- ---- ----- ----- -----
Total Interest
Bearing
Liabilities 214,594 4,087 3.84% 203,267 5,036 5.00%
------- -------- ------ ------- ----- -------
Net Interest
Income 5,416 $5,127
===== =====
Net Yield on
Interest Earning
Assets 4.23% 4.36%
==== =====
1 Interest income on loans includes loan fees.
2 On a taxable equivalent basis based on a tax rate of 37%.
3 Average balance information is reflective of historical cost and has not
been adjusted for changes in market value.
4 Average balances include non-accrual loans.
17
Table I (Continued)
HIGHLANDS BANKSHARES, INC.
NET INTEREST MARGIN ANALYSIS
(Dollar Amounts in Thousands)
Three Months Ended Three Months Ended
June 30, 2002 June 30, 2001
------------------- -------------------
Average Income/ Average Income/
Balance Expense Rates Balance Expense Rates
Interest Income
Loans 1, 4
Commercial $11,708 $ 226 7.74% $10,337 $ 273 10.59%
Consumer 53,837 1,578 11.76% 53,362 1,276 9.59%
Real estate 148,558 2,473 6.68% 134,975 3,001 8.92%
------- ------- ------ ------- ----- -------
Total 214,103 4,277 8.01% 198,674 4,550 9.19%
Federal funds sold 9,777 42 1.76% 10,124 116 4.60%
Interest bearing
deposits 5,300 32 1.89% 6,282 73 4.66%
Investments
Taxable 3 25,104 304 4.86% 23,653 380 6.44%
Tax exempt 2,3 5,828 81 5.57% 3,464 66 7.64%
----- ----- ---- ----- ----- -----
Total Earning
Assets 260,112 4,736 7.38% 242,197 5,185 8.59%
------- ------ ------ ------- ----- ------
Interest Expense
Money markets 34,287 108 1.26% 28,697 135 1.89%
Savings 28,567 108 1.52% 25,161 144 2.30%
Time deposits 146,032 1,665 4.57% 149,122 2,210 5.94%
Other borrowed
money 4,221 50 4.75% 4,171 48 4.62%
----- ----- ---- ----- ----- -----
Total Interest
Bearing
Liabilities 213,107 1,931 3.63% 207,151 2,537 4.91%
------- ------ ------ -------- ----- ------
Net Interest
Income 2,805 $2,648
===== =====
Net Yield on
Interest Earning
Assets 4.33% 4.39%
==== =====
1 Interest income on loans includes loan fees.
2 On a taxable equivalent basis based on a tax rate of 37%.
3 Average balance information is reflective of historical cost and has not
been adjusted for changes in market value.
4 Average balances include non-accrual loans.
18
TABLE II
HIGHLANDS BANKSHARES, INC.
INTEREST RATE SENSITIVITY ANALYSIS
JUNE 30, 2002
(In Thousands of Dollars)
More than
5 Years
1 - 90 91 - 365 1 to 3 3 to 5 or no
Days Days Years Years Maturity Total
EARNINGS ASSETS
Loans $42,768 $105,640 $49,105 $ 8,700 $9,776 $215,989
Fed funds sold 5,789 5,789
Securities 4,206 8,212 11,364 1,766 5,143 30,691
Time deposits in other
banks 5,585 200 5,785
------ ------ ------ ------ ----- ------
Total 58,348 114,052 60,469 10,466 14,919 258,254
------ ------- ------ ------ ------ -------
INTEREST BEARING LIABILITIES
Transaction accounts 20,156 20,156
Money market savings 13,533 13,533
Savings accounts 29,820 29,820
Time deposits more
than $100,000 6,797 21,697 8,862 5,111 42,467
Time deposits less
than $100,000 16,885 53,162 27,531 7,441 383 105,402
Other borrowed money 1,267 31 2,978 4,276
------ ------ ------ ------ ----- ------
Total 88,458 74,859 36,424 12,552 3,361 215,654
------ ------ ------ ------ ----- -------
Rate sensitivity GAP (30,110) 39,193 24,045 (2,086) 11,558
Cumulative GAP (30,110) 9,083 33,128 31,042 42,600
Ratio of cumulative
interest sensitive
assets to
cumulative interest
sensitive liabilities 65.96% 105.56% 116.59% 114.62% 119.75%
Assumes all transaction, money market and savings deposit accounts reprice
within 90 days.
19
Part II Other Information
Item 1. Legal Proceedings - Not Applicable
Item 2. Changes in Securities - Not Applicable
Item 3. Defaults Upon Senior
Securities - Not Applicable
Item 4. Submission of Matters
to a Vote
of Security Holders - On April 9, 2002, the stockholders held
their annual meeting. The following items
were approved by the shareholders by the
required majority:
1) Election of the Board of Directors as
proposed in the proxy material without
any additions or exceptions.
2) Ratification of S. B. Hoover &
Company, L.L.P. as auditors for the
year ending December 31, 2002.
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
Appendix D to Highland
Bankshares, Inc.'s Form S-4
filed October 20, 1986.
(b)Reports on Form 8-K filed during the
three months ended June 30, 2002.
None
20
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/ LESLIE A. BARR
-------------------------------------
Leslie A. Barr
President
/s/ ALAN L. BRILL
-------------------------------------
Alan L. Brill
Secretary
Date: