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UNITED STATES
SECURITIES AND EXCHANGE COMMISSION
Washington, D. C. 20549
FORM 10-Q
(Mark One)
[X ] Quarterly Report Under Section 13 or 15(d)of the Securities Exchange Act
of 1934
[ ] Transition Report Pursuant to Section 13 or 15(d) of the Securities
Exchange Act of 1934
For the quarterly period ended September 30, 2003
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
(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). [ ]
State the number of shares outstanding of each of the issuer's classes of
common equity, as of the latest practicable date. As of October 31, 2003:
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 - Nine Months
Ended September 30, 2003 and 2002 2
Unaudited Consolidated Statements of Income - Three Months
Ended September 30, 2003 and 2002 3
Consolidated Balance Sheets - September 30, 2003
(Unaudited) and December 31, 2002 (Audited) 4
Unaudited Consolidated Statements of Changes in Stockholders'
Equity - Nine Months Ended September 30, 2003 and 2002 5
Unaudited Consolidated Statements of Cash Flows - Nine Months
Ended September 30, 2003 and 2002 6
Notes to Consolidated Financial Statements 7
Item 2. Management's Discussion and Analysis of
Financial Condition and Results of Operations 9
Item 3. Quantitative and Qualitative Disclosures about Market Risk 23
Item 4. Controls and Procedures 23
PART II OTHER INFORMATION
Item 1. Legal Proceedings 24
Item 2. Changes in Securities and Use of Proceeds 24
Item 3. Defaults upon Senior Securities 24
Item 4. Submission of Matters to a Vote of Security Holders 24
Item 5. Other Information 24
Item 6. Exhibits and Reports on Form 8K 24
SIGNATURES 25
2
PART I FINANCIAL INFORMATION
Item 1. Financial Statements
HIGHLANDS BANKSHARES, INC.
CONSOLIDATED STATEMENTS OF INCOME
(In Thousands of Dollars Except Per Share Amounts)
(Unaudited)
Nine Months Ended
September 30
2003 2002
Interest Income
Interest and fees on loans $ 12,795 $12,974
Interest on federal funds sold 170 126
Interest on time deposits 44 85
Interest and dividends on investment securities
Taxable 681 913
Nontaxable 120 154
------- ------
Total Interest Income 13,810 14,252
------- ------
Interest Expense
Interest on time deposits over $100,000 1,320 1,573
Interest on other deposits 3,473 4,161
Interest on borrowed money 175 154
------- ------
Total Interest Expense 4,968 5,888
------- ------
Net Interest Income 8,842 8,364
Provision for Loan Losses 995 470
------- ------
Net Interest Income After Provision for Loan Losses 7,847 7,894
------- ------
Noninterest Income
Service charges 454 431
Gains on investment in insurance contracts 169 107
Insurance income 159 149
Other 248 205
------- ------
Total Noninterest Income 1,030 892
------- ------
Noninterest Expense
Salaries and employee benefits 3,251 3,116
Equipment and occupancy expense 851 780
Data processing 441 423
Other 1,461 1,498
------- ------
Total Noninterest Expense 6,004 5,817
------- ------
Income Before Income Taxes 2,873 2,969
Provision for Income Taxes 927 956
------- ------
Net Income $ 1,946 $ 2,013
======= ======
Per Share Data
Net Income $ 1.35 $ 1.38
======= ======
Cash Dividends $ .42 $ .38
======= ======
Weighted Average Common Shares Outstanding 1,436,874 1,461,792
========= =========
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)
(Unaudited)
Three Months Ended
September 30
2003 2002
Interest Income
Interest and fees on loans $ 4,289 $ 4,418
Interest on federal funds sold 48 30
Interest on time deposits 15 20
Interest and dividends on investment securities
Taxable 213 290
Nontaxable 39 51
------- ------
Total Interest Income 4,604 4,809
------- ------
Interest Expense
Interest on time deposits over $100,000 379 452
Interest on other deposits 1,097 1,298
Interest on borrowed money 67 51
------- ------
Total Interest Expense 1,543 1,801
------- ------
Net Interest Income 3,061 3,008
Provision for Loan Losses 240 210
------- ------
Net Interest Income After Provision for Loan Losses 2,821 2,798
------- ------
Noninterest Income
Service charges 166 158
Gains on investment in insurance contracts 58 52
Insurance income 52 53
Other income 72 65
------- ------
Total Noninterest Income 348 328
------- ------
Noninterest Expense
Salaries and employee benefits 1,110 1,050
Equipment and Occupancy expense 285 263
Data processing expense 156 137
Other 525 550
------- ------
Total Noninterest Expense 2,076 2,000
------- ------
Income Before Income Taxes 1,093 1,126
Provision for Income Taxes 363 375
------- ------
Net Income $ 730 $ 751
======= ======
Per Share Data
Net Income $ .51 $ .52
======= ======
Cash Dividends $ .14 $ .13
======= ======
Weighted Average Common Shares Outstanding 1,436,874 1,436,874
========= =========
The accompanying notes are an integral part of these statements.
4
HIGHLANDS BANKSHARES, INC.
CONSOLIDATED BALANCE SHEETS
(In Thousands of Dollars)
September 30, December 31,
2003 2002
ASSETS (Unaudited) (Audited)
Cash and due from banks $ 6,281 $ 8,226
Time deposits in other banks 5,809 4,500
Federal funds sold 18,723 14,625
Securities held to maturity (note 2) 1,365 1,369
Securities available for sale (note 3) 32,618 23,496
Other investments (note 4) 961 672
Loans (note 5) 226,763 225,754
Allowance for loan losses (note 6) (2,414) (1,793)
Bank premises and equipment 6,610 6,873
Interest receivable 1,828 1,821
Investments in insurance contracts (note 7) 5,481 5,338
Other assets 1,525 1,466
------- -------
Total Assets $305,550 $292,347
======= =======
LIABILITIES
Deposits:
Noninterest bearing demand deposits $ 35,668 $ 31,785
Interest bearing
Money market and checking 21,350 20,936
Money market savings 16,011 16,996
Savings 31,896 29,503
Time deposits over $100,000 49,316 45,392
All other time deposits 113,767 112,899
------- -------
Total Deposits 268,008 257,511
Borrowed money 5,393 4,030
Accrued expenses and other liabilities 2,029 1,890
------- -------
Total Liabilities 275,430 263,431
------- -------
STOCKHOLDERS' EQUITY
Common stock ($5 par value, 3,000,000 shares
authorized, 1,436,874 outstanding) 7,184 7,184
Surplus 1,662 1,662
Retained earnings 21,192 19,850
Accumulated other comprehensive income 82 220
------- -------
Total Stockholders' Equity 30,120 28,916
------- -------
Total Liabilities and Stockholders' Equity $305,550 $292,347
======= =======
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)
(Unaudited)
Accumulated
Other
Common Treasury Retained Comprehensive
Stock Surplus Stock Earnings Income Total
Balance, December 31, 2002 $ 7,184 $ 1,662 $ 0 $19,850 $ 220 $ 28,916
Comprehensive Income
Net Income 1,946 1,946
Net change in unrealized
appreciation on
investment
securities available
for sale,
net of taxes (138) (138)
------
Total Comprehensive Income 1,808
Cash dividends paid (604) (604)
----- ------ ------ ------- ------ ------
Balances, September 30,
2003 $ 7,184 $ 1,662 $ $21,192 $ 82 $ 30,120
======= ====== ======= ====== ====== =======
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 2,013 2,013
Net change in unrealized
appreciation on investment
securities available
for sale,
net of taxes 39 39
------
Total Comprehensive Income 2,052
Treasury stock repurchased (1,217) (1,217)
Treasury stock retired (340) 2,210 (1,870)
Stock split effected in
the form
of dividend 4,790 (4,790)
Cash dividends paid (552) (552)
----- ------ ------ ------- ------ -------
Balances, September 30,
2002 $ 7,184 $ 1,662 $ $ 19,425 $ 322 $ 28,593
======= ====== ======== ========= ======= =======
The accompanying notes are an integral part of these statements.
6
HIGHLANDS BANKSHARES, INC.
CONSOLIDATED STATEMENTS OF CASH FLOWS
(In Thousands of Dollars)
(Unaudited)
Nine Months Ended
September 30
2003 2002
Cash Flows from Operating Activities:
Net income $ 1,946 $ 2,013
Adjustments to reconcile net income to net
cash provided by operating activities:
Depreciation 460 392
Net securities amortization 410 227
Provision for loan losses 995 470
Gains on investment in insurance contracts (143) (137)
Increase in interest receivable (7) (170)
Increase in other assets (59) (286)
Increase in accrued expenses 139 55
------- ------
Net Cash Provided by Operating Activities 3,741 2,564
------- ------
Cash Flows from Investing Activities:
Net change in time deposits in other banks (1,309) 2,967
Net change in federal funds sold (4,098) 5,035
Proceeds from maturities of securities available
for sale 12,459 6,817
Proceeds from maturities of securities held
to maturity 1 232
Purchase of securities available for sale (22,124) (3,876)
Purchase of other investments (290) (67)
Net change in loans (1,383) (19,903)
Purchase of property and equipment (199) (305)
-------- ------
Net Cash Consumed by Investing Activities (16,943) (9,100)
-------- ------
Cash Flows from Financing Activities:
Net change in time deposits 4,792 (4,613)
Net change in other deposits 5,705 14,430
Dividends paid in cash (604) (552)
Purchase of treasury stock (1,217)
Repayment of borrowed money (421) (366)
Additional borrowed money 1,785
------- ------
Net Cash Provided by Financing Activities 11,257 7,682
------- ------
Net Increase (Decrease) in Cash and Cash Equivalents (1,945) 1,146
Cash and Cash Equivalents, Beginning of Period 8,226 6,492
------- ------
Cash and Cash Equivalents, End of Period $ 6,281 $ 7,638
======= ======
Supplemental Disclosures:
Cash Paid For:
Income taxes $ 1,050 $ 956
Interest 5,030 6,078
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 U. S. generally
accepted accounting principles and to general industry practices. In
the opinion of management, the accompanying unaudited consolidated
financial statements contain all adjustments (consisting of only
normally occurring accruals) necessary to present fairly the financial
position as of September 30, 2003 and the results of operations for
the three month periods and nine month periods ended September 30,
2003 and 2002.
The notes included herein should be read in conjunction with the
notes to financial statements included in the 2002 annual report to
stockholders of Highlands Bankshares, Inc.
NOTE 2 SECURITIES HELD TO MATURITY:
The amortized cost and fair value of securities held to maturity as
of September 30, 2003 and December 31, 2002, are as follows (in
thousands):
2003 2002
---------------- ---------------
Amortized Fair Amortized Fair
Cost Value Cost Value
Mortgage-backed
securities $ 2 $ 2 $ 4 $ 4
Obligations of states and
political subdivisions 1,363 1,457 1,365 1,447
------ ------ ----- ------
Total $ 1,365 $ 1,459 $1,369 $ 1,451
====== ====== ===== ======
NOTE 3 SECURITIES AVAILABLE FOR SALE:
The amortized cost and fair value of securities available for sale
as of September 30, 2003 and December 31, 2002 are as follows (in
thousands):
2003 2002
--------------- ----------------
Amortized Fair Amortized Fair
Cost Value Cost Value
US Treasury securities and
obligations of US
Government
corporations and agencies $ 19,111 $ 19,232 $ 8,844 $ 8,961
Mortgage-backed securities 7,307 7,367 5,410 5,582
Obligations of states and
political subdivisions 3,692 3,744 4,238 4,350
Other investments 2,269 2,275 4,540 4,603
-------- ----- ------- --------
Total $ 32,379 $ 32,618 $ 23,032 $ 23,496
====== ====== ====== ======
8
HIGHLANDS BANKSHARES, INC.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
NOTE 4 OTHER INVESTMENTS
Other investments totaling $ 961,000 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 September 30, 2003 and
December 31, 2002, is as follows (in thousands):
2003 2002
Commercial $ 42,701 $ 47,089
Real estate - construction 7,090 6,813
- mortgages 128,145 121,558
Consumer installment 48,827 50,294
------- -------
Net loans outstanding $226,763 $225,754
======= =======
NOTE 6 ALLOWANCE FOR LOAN LOSSES:
A summary of transactions in the allowance for loan losses for the
nine months ended September 30, 2003 and 2002 follows:
2003 2002
Balance, beginning of period $ 1,793 $ 1,603
Provisions charged to operating expenses 995 470
Loan recoveries 206 117
Loan charge-offs (580) (409)
-------- -------
Balance, end of period $ 2,414 $ 1,781
======= =======
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 approximately equal to the Company's average
cost of funds and providing retirement benefits to employees. The
carrying value of these investments was $5,481,000 at September 30,
2003 and $5,338,000 at December 31, 2002.
9
HIGHLANDS BANKSHARES, INC.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
NOTE 8 CAPITAL STOCK TRANSACTIONS:
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 stock split effected in the form of a
dividend which was distributed September 3, 2002 to shareholders of record as of
August 1, 2002. This transaction resulted in an increase of shares outstanding
from 478,958 as of June 30, 2002 to 1,436,874 as of September 30, 2002. Earnings
per share and dividends per share calculations for prior periods were adjusted
for this stock dividend. The Board of Directors also voted to retire 67,806
shares of treasury stock in the third quarter of 2002.
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.
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.
Recent Accounting Pronouncements
No recent accounting pronouncements had a material impact on the
Company's consolidated financial statements.
10
Item 2. Management's Discussion and Analysis of Financial Condition and
Results of Operations (Continued)
Forward Looking Statements
This filing may contain certain forward-looking statements (as defined in
the Private Securities Litigation Act of 1995), which reflect management's
beliefs and expectations based on information currently available. These
forward-looking statements are inherently subject to significant risks and
uncertainties. These risks and uncertainties can include, but are not limited
to, changes in general economic and financial market conditions, the Company's
ability to effectively carry out business plans, changes in regulatory or
legislative requirements, or changes in competitive conditions. Although
Management believes the expectations reflected in such forward-looking
statements are reasonable, actual results may differ materially.
Overview
Year to Date
The Company's net income for the first nine months of 2003 decreased 3.33%
compared to the same period in 2002. Earnings per share were $1.35 for 2003
compared to $1.38 for 2002. The Company's annualized return on average equity
was 8.75% in 2003 compared to 9.47% for 2002. Return on average assets was .85%
for 2003 and .96% for 2002, respectively.
Net interest income before provision for loan losses increased 5.71% from
2002 despite a decrease in the average loan balances year-to-date to deposit
ratio from 86.44% in 2002 to 83.89% in 2003. Due to regulatory guidance and the
recognition by Management of a need for additional allowance for loan losses
caused by increased delinquencies and the threat of continued economic decline,
the provision for loan losses charged against income during the nine months of
2003 was $995,000, up from $470,000 during the first nine months of 2002.
Noninterest income rose as net insurance earnings by HBI Life Insurance
Company increased 205.04% and fiduciary earnings by Highlands Bankshares Trust
Company increased 78.65%. Service charge incomes were up 5.33% as the Company's
operations continue to expand.
Noninterest expenses increased 3.21%. Salary expenses grew 4.33% due largely
to customary employee merit pay increases and increases in pension costs. Data
processing expense continues to grow as the company's asset base grows and
equipment expenses have increased as multiple projects have been begun to
upgrade operational systems.
Quarter Ending September 30
Net income for the quarter ending September 30, 2003 decreased to $730,000
from $751,000 during the third quarter of 2002. Annualized return on average
assets for the quarter were .95% and return on average equity was 9.72%.
A 1.76% increase in net interest income and a 6.10% increase in noninterest
income were offset by increases in noninterest expense (3.80%) and an increase
in the provision for loan losses (14.29%).
11
Item 2. Management's Discussion and Analysis of Financial Condition and
Results of Operations (Continued)
Net Interest Income
Year to Date
Net interest income for the first nine months of 2003 was 5.72% greater than
net interest income of the same period in 2002. The company experienced a net
interest margin of 4.15% during the first nine months of 2003, down from 4.28%
during the same period in 2002.
Compared to recent prior quarters, increases in loan demand slowed
considerably during the latter part of 2002, and this continued into 2003.
Average loan balances January through September grew 13.25% from 1999 to 2000,
14.23% from 2000 to 2001 and 9.19% from 2001 to 2002. From 2002 to 2003, the
Company's growth of average loan balances January through September increased
5.13% and the gross loan balance as of September 30, 2003 was .45% greater than
at December 31, 2002. While loan demand has been stable enough to maintain
current balances of loans outstanding, Management expects that due to continued
sluggish conditions in both the national and local economies, coupled with
increased competition for loans, loan growth in the near future will remain
relatively low. Continued decreases by the Federal Reserve Board (the "Fed")
during 2002 of the target rate for fed funds coupled with increased competition
for loans, both from local community banks and larger state and national
mortgage firms, contributed to a drop of 49 basis points on interest earned on
loans.
Demand for deposit products was strong through the later parts of 2002 and
early portions of 2003. This caused the average balance of interest bearing
deposits during the first nine months of 2003 to increase 8.08% when compared to
2002. The largest portions of this growth was seen during the first quarter of
2003 as deposits grew 4.68% from December 31, 2002 to March 31, 2003. As loan
demand growth began to flatten over this same time period, both of the Company's
subsidiary banks began to experience increasing balances of lower earning liquid
assets such as deposits in other banks and fed funds sold and lowered deposit
rates accordingly to slow deposit growth. Deposit balances have declined .58%
from March 31, 2003 to September 30, 2003. Historically, levels of competition
for deposits in the Company's service area and the cash needs generated by loan
growth have caused the Company's subsidiary banks to traditionally pay higher
rates on deposits than larger, statewide financial institutions. The increasing
liquidity position through the first nine months of 2003 caused it to be
unnecessary to pay significantly higher deposit rates than other local
institutions, and the rates at both of the Company's subsidiary banks are at
present typically near those of other local banks and depository institutions.
Older, above market time deposits continued to mature during 2003 and have been
replaced by time deposits with lower rates, causing a 91 basis point decline in
average rates paid on time deposits during 2003 compared to 2002.
During 2001 and 2002, loan growth was funded in part through reductions in
balances of fed funds sold and investment securities. As loan growth slowed and
deposit growth increased early in the year, the funds from the increased
deposits were used in part to increase balances of investment securities and fed
funds sold. A 109.90% increase in average fed funds sold offset a 59 basis point
decline in rates to cause a $44,000 increase in earnings on fed funds sold. An
8.59% increase in average securities balances was offset by a decline in rates
earned on securities due to the depressed interest rate environment.
12
Item 2. Management's Discussion and Analysis of Financial Condition and
Results of Operations (Continued)
Net Interest Income (Continued)
The Company periodically borrows money from the Federal Home Loan Bank
(FHLB). These borrowings are typically used to fund loan growth but have also
been used to fund renovation of Capon Valley Bank's main office building.
Expenses related to other borrowed fund rose from $154,000 during 2002 to
$175,000 during 2003. Year to date average balances of borrowed funds increased
6.30% from the first nine months of 2002 compared to the same period in 2003 and
the September 30, 2003 balance of other borrowed funds was 33.82% higher than at
December 31, 2002. Although the Company has found itself in an extremely
favorable liquidity position such that new loans could be funded through
balances of more liquid lower earning assets such as fed funds sold, the Company
during 2003 has chosen to fund certain larger fixed rate commercial loans by
borrowing from the Federal Home Loan Bank (FHLB). In borrowing from the FHLB at
fixed rates and maturity periods similar to these larger commercial loans, the
Company has attempted to minimize future interest rate risk.
Quarter Ending September 30
Net interest income on a taxable equivalent basis for the period ending
September 30, 2003 increased 1.51% compared to the same quarter in 2002. The
average balance of all interest bearing assets during the quarter increased
9.19% over the same period a year ago while the balance of interest bearing
liabilities grew 7.05%. Rate cuts by the Fed during 2001 and 2002 contributed to
declining yields as higher yielding loans and securities matured and were
replaced by lower yielding assets. This decline in yields was offset in part by
a reduction on the average cost of interest bearing liabilities. Balances of fed
funds sold and interest bearing deposits increased substantially as the loan
growth experienced in recent years slowed and was outpaced by deposit growth.
A complete yield analysis is shown as Table I on page 21.
Noninterest Income
Year to Date
Noninterest income totaled $1,030,000 during the first nine months of
2003, an increase of 15.47% from the same period a year ago. Service charge
income on accounts increased 5.33%. Income related to the sale of insurance
products and the insurance earnings of HBI Life Insurance Company increased
76.77% from a year ago to $189,000. Gains on sales of other real estate owned
decreased from $22,000 in 2002 to $8,000 in 2003. As the company's asset and
customer base continues to grow, transaction related fees rose 12.14% during
2003 as compared to 2002.
Quarter Ending September 30
Noninterest income for the quarter ended September 30, 2003 increased 6.10%
compared to the same period a year ago. Service charge income increased compared
to 2002 due to expanded operations. Although insurance related income and trust
fees have increased year to date, both areas of these operations decreased
during the third quarter of 2003 as compared to 2002. Transaction related fees
increased 12.48% during the third quarter of 2003 compared to 2002.
13
Item 2. Management's Discussion and Analysis of Financial Condition
and Results of Operations (Continued)
Noninterest Expenses
Year to Date
Noninterest expense totaled $6,004,000 during the first nine months of 2003,
an increase of 3.21% over the same period in 2002.
The cost of salaries and employee benefits increased 4.33%. While customary
merit increases contributed to the increase, also playing a significant role in
the increase were increases in pension costs. Due to the depressed investment
market, costs relating to Grant County Bank's defined benefit plan have
increased.
Occupancy and equipment expense increased 9.10%. As the Company's subsidiary
banks have sought to improve their operational capabilities, projects have been
undertaken to upgrade systems. This has caused the Company's equipment
depreciation expense to increase 17.35% compared to 2002. As these upgrades
continue, the company expects these costs to continue to rise in the near
future, with this increase being offset by cost advantages in other areas as
these systems provide greater efficiency. Advertising expense fell 35.69% during
the first nine months of 2003 compared to the same period in 2002: during 2002,
The Grant County Bank incurred fees for a celebration of its 100th year
anniversary. Director Fees increased 14.70% and largely due to expanded audit
procedures and regulatory examinations, legal and professional fees increased
17.68%.
Quarter Ending September 30
Overall, noninterest expenses increased 3.80% for the quarter ending
September 30, 2003 compared to the quarter ending September 30, 2002 for largely
the same reasons as the year-to-date increases in noninterest expense.
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,
and northern Pendleton counties in West Virginia and western 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.
14
Item 2. Management's Discussion and Analysis of Financial Condition and
Results of Operations (Continued)
Loan Portfolio (Continued)
The loan to deposit ratio was 84.98% at September 30, 2003 compared to
87.67% at December 31, 2002 and 89.37% one year ago. The downturn in both the
national and local economies has had an impact on the slowing loan growth as
quality loans have been more difficult to obtain. However, loan demand has
remained strong enough such that the Company has been able to maintain its loan
balances. Barring any significant changes in the local or national economies,
loan demand is expected to remain satisfactory in the near future. Significant
growth in loan balances is not expected in the coming quarters, but Management
expects current balances of loans to continue at or near their current levels.
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.
The following table summarizes the company's non-performing loans for the
periods ended September 30, 2003 and December 31, 2002.
September 30, December 31,
(in thousands) 2003 2002
---- ----
Nonaccrual loans $ 958 $ 299
Restructured loans 642 662
Loans past due 90 days or more
and still accruing interest 2,797 1,918
Total $ 4,397 $ 2,879
======== ========
Growth of delinquencies in the consumer loan portfolio has been a primary
cause of the balances of loans 90 days or more past due rising 45.83% since
December 31, 2002. Unless collections on these loans improve and balances are
reduced, a larger portion of these loans than has been historically customary
may need to be charged off in the coming quarters. This may have an effect of
lowering the Allowance for Loan Losses to unacceptable levels and the Company
may need to contribute a larger provision to the Allowance than has been
customary.
Real estate acquired through foreclosure was $263,000 at September 30, 2003
and $517,000 at December 31, 2002. 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 September 30, 2003,
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.
15
Item 2. Management's Discussion and Analysis of Financial Condition and
Results of Operations (Continued)
Allowance for Loan Losses
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
5, Accounting for Contingencies which requires that losses be accrued when they
are probable of occurring and estimatable and (ii) SFAS 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).
Each of Company's banking subsidiaries, Capon Valley Bank and The Grant
County Bank, determines its allowance for loan losses independently. Each bank
pays particular attention to individual loan performance, collateral values,
borrower financial condition and overall national and local economic conditions.
The determination of adequate allowance at each bank is done in a three step
process. The first step is to identify problem loans above a certain threshold
and estimated losses are 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 weights is in some part 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
loan portfolio.
Both banks classify loans into the following categories: impaired,
doubtful, substandard, special mention and other loans past due 90+ days and
assign loss rates to each. Within these categories, Real Estate, Installment
Loans, Commercial Loans and Lines of Credit are assigned a specific loss rate
based on historical losses and management's estimate of losses. The allowance
associated with loans classed as impaired is calculated at 100% of the
identified impairment.
Loans 90 days or more past due and nonaccrual loans are included in one of
the five categories above. Credit card balances 90 days or more past due are
categorized as substandard and are assigned a loss rate of 50%. Generally, all
loans in excess of $250,000 are evaluated individually as well as any loan
regardless of size that is classified as loss, doubtful, substandard or special
mention. This detailed review identifies each applicable loan for specific
impairment and a specific allocation for that impaired amount is set aside as
the first element in the calculation. Rates assigned each category may vary over
time and between the banks as historical loss rates, loan structure and economic
conditions change.
The remaining portfolio balances are assigned a loss factor based on the
historical net loss after recoveries over the last five years. Loss experience
per classification varies significantly based on risk and collateral.
Installment and commercial loans generally have higher loss volumes than secured
real estate loans. The net result creates a low and high range of allocated
allowance. The Company's actual allowance balance is compared to this range and
adjusted as deemed necessary.
16
Item 2. Management's Discussion and Analysis of Financial Condition and
Results of Operations (Continued)
Allowance for Loan Losses (Continued)
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.
Management reviews the loan loss allowance at the end of each quarter. Based
primarily on the Company's loan classification system, which classifies problem
credits as substandard, doubtful or loss, additional provisions for losses are
made monthly. The ratio of the allowance for loan losses to total loans
outstanding was 1.07% at September 30, 2003, 1.05% at June 30, 2003, .85% at
March 31, 2003 and .79% at December 31, 2002. This increasing ratio represents
Management's belief that rising delinquencies and continued economic stagnation
have created larger losses in the loan portfolio. As economic conditions
continue to be stagnant, delinquencies have continued to rise and loans which
have not previously been classified as impaired, doubtful, substandard, or
special mention in recent periods have been moved into one of these categories.
This increase in delinquencies, coupled with a request by bank examiners of
Capon Valley Bank to increase that Bank's allowance for loan loss, has led to a
$995,000 provision charged against income during 2003.
In early 2003, during the course of routine examination of the Company's
two subsidiary banks, The Grant County Bank and Capon Valley Bank, examiners
identified certain supervisory issues. Results of these regulatory examinations
are not published or publicly available. During these examinations, one of the
regulatory agencies exerting supervisory control on the Company's subsidiary
banks indicated that a requirement for an increased allowance for loan losses
would be directed to Capon Valley Bank. In prior 10-Q and 10-K filings, the
Company indicated that Management of the Bank did not agree with the regulator's
conclusions, that the regulatory directive did not meet the requirements of
GAAP, and was in the process of appealing those conclusions. During recent
months, a directive for an increase in the allowance, significantly reduced from
earlier indications, was presented to the Bank. This reduced amount, coupled
with a continued rise in delinquencies and loan impairments, prompted a
Management decision to comply with the reduced requirement and to increase the
allowance for loan losses during the second quarter of 2003.
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. Loan requests for poultry house loans or expansion continue to be
presented for approval. In June of 2003, Pilgrim's Pride Corporation announced
the purchase of certain divisions of ConAgra Foods, Inc. including processing
facilities operated by ConAgra in Hardy County. Management anticipates that this
purchase will have no adverse impact on operations of either subsidiary bank or
on the operations of the non-bank subsidiaries. In the fall of 2002, Perdue
Farms, Inc. ceased operations at its Petersburg processing plant. At present,
this facility sits idle. In part because of this closure, the unemployment rate
in Grant County grew from 6.7% in October of 2002 to 12.20% in May of 2003.
However, this rate has been declining in recent months, and the unemployment
rate for the County stood at 7.7% in September 2003. While management believes
that this closure has contributed to the slow-down in loan growth, the overall
impact of the closure on the Company has been minimized by the Company's
geographic diversity as the other counties in the Company's primary service area
maintain healthy economies.
17
Item 2. Management's Discussion and Analysis of Financial Condition and Results
of Operations (Continued)
Allowance for Loan Losses (Continued)
The adequacy of the allowance for loan losses is computed quarterly and the
allowance, if necessary, is 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. The Company believes that its
allowance must be viewed in its entirety and, therefore, is available for credit
losses in its 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.
An analysis of the loan loss allowance for the nine month periods ended
September 30, 2003 and September 30, 2002 and for the quarters ended September
30, 2003 and September 30, 2002 is set forth in the following table (in
thousands):
Quarter Ended Nine Months Ended
September 30, September 30,
Allowance for loan losses 2003 2002 2003 2002
------------------------- ---- ---- ---- ----
Balance, beginning of period $ 2,376 $ 1,723 $ 1,793 $ 1,603
Net charge-offs (recoveries)
Charge-offs (287) (173) (580) (409)
Recoveries 85 21 206 117
------ ------ ------ ------
Total net charge-offs (202) (152) (374) (292)
Provision for loan losses 240 210 995 470
------ ------ ------ ------
Balance, End of Period $ 2,414 $ 1,781 $ 2,414 $ 1,781
====== ====== ====== ======
An analysis of the components of net charge-offs for the nine month periods
ended September 30, 2003 and September 30, 2002 and for the quarters ended
September 30, 2003 and September 30, 2002 is set forth in the following table
(in thousands):
Quarter Ended Nine Months Ended
September 30, September 30,
---------------- -----------------------
2003 2002 2003 2002
---- ---- ---- ----
Components of net charge-offs:
Real estate $ $ (19) $ (33) $ (6)
Commercial (51) (74) (40) (92)
Installment (151) (59) (301) (194)
------- ------ ------- ------
Total $ (202) $ (152) $ (374) $ (292)
======= ====== ======= ======
18
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
September 30, 2003 and December 31, 2002:
September 30, 2003 December 31, 2002
------------------ -----------------
Loan Allowance Percentage Percentage of Allowance Percentage Percentage of
Type Allocation of Allowance Total Loans Allocation of Allowance Total Loans
Commercial $ 740 31% 19% $ 543 30% 21%
Mortgage 831 34% 60% 504 28% 57%
Consumer 762 32% 21% 652 37% 22%
Unallocated 81 3% % 94 5% %
------ ---- ---- -------- ----- ---
Totals $ 2,414 100% 100% $ 1,793 100% 100%
======= ==== === ====== ===== =====
Securities
The Company's securities portfolio serves numerous purposes. While
providing the Company with a return, portions of the portfolio may secure
certain public and trust deposits and the remaining portions are used to assist
the Company in liquidity and asset/liability management. Securities as a
percentage of total assets were 11.44% at September 30, 2003 compared to 8.74%
at December 31, 2002. During 2002, loan growth was funded in part through
reductions in securities holdings. As loan growth slowed through the fourth
quarter of 2002 and into 2003, securities relative to total assets have been
increased.
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 September 30,
2003, the fair value of the securities available for sale exceeded their cost by
$239,000 ($151,000 after tax considerations).
19
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.
Deposit balances increased 4.08% from December 31, 2002 and September 30,
2003. The average cost of deposits for the first nine months of 2003 was 2.72%
compared to 3.52% for the same period in 2002. 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.
Capital
The Company seeks to maintain a strong capital base to expand facilities,
promote public confidence, support current operations and grow at a manageable
level. As of September 30, 2003, the Company's total risk based capital ratio
was 12.55% which is above the regulatory minimum of 8.0%. The leverage ratio of
total capital to total assets was 9.66% at September 30, 2003.
Highlands Bankshares, Inc. operating funds, funds with which to pay
shareholder dividends and funds for the exploration of new business ventures
have been, in the past, supplied through dividends paid by subsidiary banks. 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 October 1, 2003,
the subsidiary banks could pay dividends to Highlands Bankshares, Inc. of
approximately $1,593,000 without permission of the regulatory authorities. The
following tables summarize the dividend limits (in thousands) as of October 1,
2003 for Capon Valley Bank (CVB) and The Grant County Bank (GCB).
2001 2002 2003 Year to Date Dividend
Net Net Net Limit
Income Dividends Income Dividends Income Dividends October 1,
2003
----------------------------------------------------------------------
CVB $1,110 $1,532 $ 1,076 $ 975 $ 562 $ -- $ 241
GCB 1,468 1,531 1,627 975 1,417 653 1,352
----- ----- ------ --- ------ ----- -----
Total $2,578 $3,063 $ 2,703 $ 1,950 $ 1,979 $ 653 $1,593
In addition to regulatory restrictions on dividends, the Company's
subsidiary banks must maintain certain regulatory minimum levels of capital.
During 2001 and 2002, the Company funded the creation of Highlands Bankshares
Trust Company and repurchased shares of the Company's stock through dividends
from the subsidiary banks. Although these large subsidiary dividends, coupled
with decreased return on average assets during recent quarters, have created the
need for the Company to more closely manage its Capital, management does not
foresee the need for a reduction in shareholder dividends in the foreseeable
future or for there to be a problem with the subsidiary banks being able to
dividend operating funds to the holding company.
In addition to funds from the subsidiaries, the Company has at its disposal
other options for funding which include, but are not limited to, Trust Preferred
Securities and debt. The Company is currently pursuing a line of credit with a
commercial bank. This line of credit will be used to more closely manage capital
to maximize the business opportunities of the Company and it subsidiaries. It is
anticipated that this debt will be obtained during the fourth quarter of 2003.
20
Item 2. Management's Discussion and Analysis of Financial Condition and
Results of Operations (Continued)
Liquidity
Liquidity is the ability to meet present and future loan commitments,
deposit withdrawals and operating cash needs. Liquidity is provided primarily
from cash provided by operations and reduction of cash on hand, funds deposited
with other financial institutions and fed funds sold. Additional liquidity needs
can be met through the acquisition of deposits, borrowings from the Federal Home
Loan Bank, and through fed funds purchased. To further meet its liquidity needs,
the Company also maintains lines of credit with correspondent financial
institutions and the Federal Reserve Bank of Richmond.
As of September 30, 2003, the Company's total of cash, due from banks and
fed funds sold totaled $30,813 or 11.19% of total liabilities. 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. In the past,
growth in deposits has been sufficient to fund the net increase in loans and
investment securities.
The primary needs for liquidity with the Company exist within the
operations of the subsidiary banks. However, certain operations such as
administrative functions occur within the parent company. Operating liquidity
for Highlands Bankshares Inc. comes from dividends from its subsidiaries.
Although the additional management of dividends as discussed above is needed,
the Company expects that no regulatory dividend restriction will cause the
subsidiary banks to not be able to dividend funds to Highlands Bankshares, Inc.
and that the Company will be able to meet the operational obligations of it's
parent organization.
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 September 30, 2003 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 quickly to
rapid market rate changes. 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).
21
TABLE I
HIGHLANDS BANKSHARES, INC.
NET INTEREST MARGIN ANALYSIS
(Dollar Amounts in Thousands)
Nine Months Ended Nine Months Ended
September 30, 2003 September 30, 2002
--------------------------- --------------------------
Average Income/ Average Income/
Balance Expense Rates Balance Expense Rates
Interest Income
Loans 1, 3
Commercial 5 $ 11,278 $ 702 8.30% $ 13,543 $ 716 7.05%
Consumer 48,979 3,710 10.10% 53,715 4,509 11.19%
Real estate 5 165,838 8,383 6.74% 147,813 7,749 6.99%
------- ------ ------ ------- ----- -----
Total 226,095 12,795 7.55% 215,071 12,974 8.04%
Federal funds
sold 21,219 170 1.07% 10,109 126 1.66%
Interest bearing
deposits 5,952 44 .99% 5,055 85 2.24%
Investments
Taxable 4 29,044 681 3.13% 24,932 913 4.88%
Tax exempt 2,4 3,974 188 6.30% 5,473 244 5.94%
----- ----- ---- ----- ----- -----
Total Earning
Assets 286,284 13,878 6.46% 260,640 14,342 7.34%
--------- ----- ------- ------- ------ -----
Interest Expense
Money markets 21,186 113 .71% 19,293 175 1.21%
Savings 47,937 313 .87% 43,255 424 1.35%
Time deposits 165,560 4,367 3.52% 154,587 5,134 4.43%
Borrowed money 4,589 175 5.08% 4,317 154 4.76%
----- ----- ---- ----- ----- -----
Total Interest
Bearing
Liabilities 239,272 4,968 2.77% 221,452 5,887 3.54%
------- ------- ------ ------- ----- -----
Net Interest Income $ 8,910 $ 8,455
===== =====
Net Yield on
Interest Earning
Assets 4.15% 4.33%
==== =====
1 Interest income on loans includes loan fees.
2 On a taxable equivalent basis based on a tax rate of 37%.
3 Average Balances include non-accrual loans
4 Average balance information is reflective of historical cost and has not
been adjusted for changes in market value.
5 Loans classified as Commercial loans in this analysis are loans for
commercial purposes not secured by real estate. Loans for commercial
purposes and secured by real estate may be classified as
Commercial loans elsewhere in this document.
21 (Continued)
TABLE I
HIGHLANDS BANKSHARES, INC.
NET INTEREST MARGIN ANALYSIS
(Dollar Amounts in Thousands)
Three Months Ended Three Months Ended
September 30, 2003 September 30, 2002
-------------------------- --------------------------
Average Income/ Average Income/
Balance Expense Rates Balance Expense Rates
Interest Income
Loans 1, 3
Commercial 5 $ 10,008 $ 227 9.08% $ 14,062 $ 256 7.28%
Consumer 48,907 1,116 8.94% 55,549 1,361 9.80%
Real estate 5 167,895 2,946 7.02% 153,227 2,801 7.31%
------ ------ ----- ------- ----- -----
Total 226,810 4,289 7.56% 222,838 4,418 7.93%
Federal funds sold 20,565 48 .93% 7,257 30 1.65%
Interest bearing
deposits 6,263 15 .96% 3,636 20 2.20%
Investments
Taxable 4 30,624 213 2.79% 23,803 290 4.87%
Tax exempt 2,4 4,043 60 5.89% 5,225 81 6.20%
----- ----- ---- ----- ----- -----
Total Earning
Assets 288,305 4,625 6.42% 262,759 4,839 7.37%
------ ----- ------ ------- ----- ------
Interest Expense
Money markets 21,110 24 .45% 20,590 57 1.10%
Savings 48,211 73 .61% 46,463 132 1.21%
Time deposits 165,244 1,379 3.34% 154,188 1,561 4.05%
Borrowed money 5,366 67 4.99% 4,195 51 4.86%
----- ----- ---- ----- ----- -----
Total Interest Bearing
Liabilities 239,931 1,543 2.57% 224,136 1,801 3.21%
------- ----- ------ ------ ----- ------
Net Interest Income $ 3,082 $ 3,038
===== =====
Net Yield on Interest
Earning
Assets 4.28% 4.62%
==== =====
1 Interest income on loans includes loan fees.
2 On a taxable equivalent basis based on a tax rate of 37%.
3 Average Balances include non-accrual loans
4 Average balance information is reflective of historical cost and has not
been adjusted for changes in market value.
5 Loans classified as Commercial loans in this analysis are loans for
commercial purposes not secured by real estate.
Loans for commercial purposes and secured by real estate may be classified as
Commercial loans elsewhere in this document.
22
TABLE II
HIGHLANDS BANKSHARES, INC.
INTEREST RATE SENSITIVITY ANALYSIS
SEPTEMBER 30, 2003
(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 $58,484 $ 88,451 $ 53,972 $11,953 $13,903 $226,763
Fed funds sold 18,723 18,723
Securities 12,715 12,304 7,486 933 1,506 34,944
Time deposits in other
banks 5,609 200 5,809
------ ------ ------ ----- - ----- ------
Total 95,531 100,755 61,658 12,886 15,409 286,239
------ ------- ------ ------ ------ -------
INTEREST BEARING LIABILITIES
Transaction accounts 21,350 21,350
Money market savings 16,011 16,011
Savings accounts 31,896 31,896
Time deposits more
than $100,000 7,080 21,888 12,506 7,842 49,316
Time deposits less
than $100,000 19,816 50,058 31,624 12,269 113,767
Borrowed money 154 462 1,233 1,233 2,311 5,393
------ ------ ------ ------ ----- ------
Total 96,307 72,408 45,363 21,344 2,311 237,733
-------- ----- ------ ----- ------ -------
Rate sensitivity GAP (776) 28,347 16,295 (8,458) 13,098 48,506
Cumulative GAP (776) 27,571 43,866 35,408 48,506
Ratio of cumulative
interest sensitive
assets to
cumulative interest
sensitive liabilities 99.19% 116.34% 120.49% 115.04% 120.40%
Assumes all transaction, money market and savings deposit accounts reprice
within 90 days.
23
Item 3. Quantitative and Qualitative Disclosures About Market Risk
Not Applicable
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.
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 assets 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 to
ensure that these processes are both 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.
24
PART II OTHER INFORMATION
Item 1. Legal Proceedings--Not Applicable
Item 2. Changes in 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.
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.
(b) Reports on Form 8-K filed during the three months ended September
30, 2003--None
25
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/ R. ALAN MILLER
---------------------------
R. Alan Miller
Finance Officer
Date: November 12, 2003