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Securities and Exchange Commission
Washington, D.C. 20549
FORM 10-K
Annual Report Pursuant to Section 13 or 15(d)
of the Securities Exchange Act of 1934
For the Fiscal Year ended: Commission File Number:
December 31, 1997 430893107
Highlands Bankshares, Inc.
(Exact name of registrant as specified in its charter)
Virginia 54-1796693
________ __________
(State or other jurisdiction (I.R.S. Employer
of incorporation or organization) Identification Number)
340 West Main Street
Abingdon, Virginia 24210-1128
____________________ __________
(Address of principal (Zip Code)
executive offices)
Registrant's telephone number, including area code: (540)628-9181
Securities registered pursuant to Section 12(b) of the Act:
Not Applicable
______________
Securities registered pursuant to Section 12(g) of the Act:
Common Stock, $2.50 par value
_____________________________
(Title of Class)
Indicate by check mark whether the registrant (1) has filed
all reports required to be filed by Section 13 or 15(d) of
the Securities Exchange Act of 1934 during the preceding 12
months and (2) has been subject to such filing requirements
for the past 90 days.
Yes_X_No___
Indicate by check mark if disclosure of delinquent filers
pursuant to Item 405 of Regulation S-K (Section 229.405 of
this chapter) is not contained herein, and will not be
contained, to the best of registrant's knowledge, in
definitive proxy or information statements incorporated by
reference in Part III of this Form 10-K or any amendment to
this Form 10-K. [ ]
As of December 31, 1997, there were 1,232,250 shares of
Common Stock outstanding.
1
Documents Incorporated by Reference
List hereunder the following documents if incorporated by
reference and the Part of Form 10-K into which the documents
are incorporated:
(1) Part II incorporates information by reference from the
registrant's Annual Report to Stockholders for the fiscal
year ended December 31, 1997.
(2) Part III incorporates by reference from the
registrant's proxy statement for its Annual Meeting of
Stockholders scheduled for May 13, 1998.
(3) Part IV incorporates by reference from: (i) the
registrant's Annual Report to Stockholders for the fiscal
year ended December 31, 1997, and (ii) the registrant's
proxy statement for its Annual Meeting of Stockholders
scheduled for May 13, 1998.
The exhibit index is located on page 26.
2
Part I.
Item I. Business
General
Highlands Bankshares Inc. (the "Corporation") was
incorporated in Virginia in 1995 to serve as the holding
company for Highlands Union Bank, (the "Bank"). The
stockholders of the Bank approved the Plan of Reorganization
at the Annual Meeting on December 13, 1995, and the
reorganization was consummated on December 29, 1995 with the
Bank becoming a wholly-owned subsidiary of the Corporation.
The Bank is a state charted bank with principal offices in
Abingdon, Virginia. The Bank was incorporated in 1985.
At December 31, 1997, the Corporation had total assets
of $258,236,000, deposits of $236,646,000, and net worth of
$16,802,000.
The Corporation's principal business activities, which
are conducted through the Bank, are attracting checking and
savings deposits from the general public through its retail
banking offices and originating and servicing loans secured
by first mortgage liens on single-family dwellings,
including condominium units. All of the retail banking
offices are located in Virginia. The Corporation also lends
funds to retail banking customers by means of home equity
and installment loans, and originates residential
constructions loans and loans secured by commercial
property, multi-family dwellings and manufactured housing
units. The Corporation invests in certain U.S. Government
and agency obligations and other investments permitted by
applicable laws and regulations. The operating results of
the Corporation are highly dependent on net interest income,
the difference between interest income earned on loans and
investments and the cost of checking and savings deposits
and borrowed funds.
The Bank is a member of the Federal Deposit Insurance
Corporation ("FDIC"), and it's deposit accounts are insured
up to $100,000 as applied by FDIC guidelines. The Bank is
also a member of the Federal Reserve System, as such, the
Bank and the Corporation are subject to the supervision,
regulation and examination of the Federal Reserve. As a
Virginia state chartered bank, the Bank is also subject to
supervision, regulation and examination by the Virginia
State Corporation Commission.
The Corporation's only direct subsidiary is the Bank as
of December 31, 1997. The Corporation's only material
assets as of this date are it's building and land, the net book
value of which is approximately $1.3 million, located at 266 West
Plumb Alley, Abingdon, Virginia, and the stock of the Bank. The
Corporation's only material liability is the note payable on
this commercial building, approximately $828,000, which is
secured by a first deed of trust.
The Corporation operates five full service offices and one
express facility throughout Washington County, Virginia and
the City of Bristol, Virginia, and Marion, Virginia.
The results of operations for the fiscal years ended
December 31, 1997, 1996, and 1995 ("fiscal year 1997",
"fiscal year 1996" and "fiscal year 1995", respectively)
reflect the Corporation's strategies of expanding its
community banking operations.
See "Management's Discussion and Analysis" of
operations and financial condition, included as part of the
Annual Report to Stockholders, for a detailed discussion of
certain aspects of the Corporation's business.
Lending Activities
Residential Mortgage Lending
The Corporation's lending policy is generally to lend
up to 80% of the appraised value of residential property.
The Corporation lends up to 95% of the appraised value with
the normal requirement
of insurance from private mortgage insurance companies. This
insurance normally covers amounts in excess of 80% loan to value
up to 95%.
The in-house residential mortgages are comprised of
primarily one, three and five year adjustable rate mortgages
and a relatively small number of 15 year fixed rate
mortgages. Adjustable rate mortgages are indexed to 275
basis points over the average yield on United States
Treasury securities adjusted to a constant maturity of one,
three or five years. An adjustment limitation (increase or
decrease) of 4% over the life of the loan is included in the
one, three and five year adjustable rate
mortgages.
The corporation's existing loan contracts generally
provide for repayment of residential mortgage loans over
periods ranging from 15 to 30 years. However, such loans
normally have remained outstanding for much shorter periods
of time as borrowers refinance or prepay their loans through
the sale of their homes.
Most of the Corporation's residential mortgage loans
have "due on sale" clauses which allows the creditor the
right to declare a loan immediately due and payable in the
event the borrower sells or otherwise disposes of the real
property. Most of the Corporation's residential mortgage
loans are not assumable.
Mortgage loans exceeding $450,000 but less than
$750,000 must be approved by the loan committee of the Board
of Directors. Mortgage loans in excess of $750,000 must be
approved by the Board of Directors.
All of the Corporation's mortgage lending is subject to
loan origination procedures established by the Board of
Directors. Most originations require a property valuation by
state licensed appraisers, for a fee, approved by the Board
of Directors. Loan applications are obtained to determine
the borrowers ability to repay. Significant items are
verified through the use of credit reports, financial
statements, etc.
It is generally the Corporation's policy to require
title insurance on first mortgage loans in excess of
$100,000 (lower where deemed necessary). It is also the
Bank's general policy to require an attorney's opinion
statement on all first mortgage deeds of trust. Fire and
casualty insurance (extended coverage) is generally required
on all property serving as security for these loans. Hazard
insurance and flood insurance (where required) is generally
provided by customers prior to closing of the loan. The
borrower is generally responsible for paying insurance
premiums and real estate taxes.
Federal regulations allow the Corporation to originate
loans on real estate within the State of Virginia, and
within limits, to originate and purchase loans or loan
participations secured by real estate located in any part of
the United States. During fiscal year 1997 the Corporation's
primary lending area was Washington County, Virginia and the
City of Bristol, Virginia.
Residential loan originations come from many sources.
Some of these sources include existing customers, walk-in
applications, referrals from real estate brokers and others.
Federal regulation limits loans to one borrower to a
maximum of 15% of unimpaired capital and unimpaired surplus
of the Bank.
The Corporation receives fees in addition to interest
in connection with real estate loan originations, loan
modifications, late payments, etc. Income from these
activities varies from period to period depending on the
volume and type of loan made. Although not a significant
portion of the Corporation's income, late charges are
received when monthly payments are delinquent but are later
paid.
The Corporation also offers secondary market fixed rate
mortgages with terms up to 30 years and up to 95% loan to
value. These loans and servicing rights generally sold
immediately into the secondary market and fees received
booked into income. These loans must meet certain criteria
generally set by the secondary market and are not a
significant portion of the Bank's residential mortgage
activity.
Residential mortgages made up approximately 31.17% of
the loan portfolio as of December 31, 1997.
Construction and Commercial Real Estate Lending
The Corporation generally makes construction loans for
periods up to one year on residential and commercial real
estate property. These loans are for interim financing and
are either paid off or converted to permanent financing when
completed. At December 31, 1997 outstanding construction
loans (net of undisbursed funds) totaled $3,716,000. These
loans are generally made at 80% or less of appraised value
at completion. Funds are advanced as the project is
completed after an inspection by a staff inspector or the
appraiser as deemed appropriate. These loans are made based
on established corporate underwriting standards. Most of
these construction loans are one to four family dwellings.
The Corporation generally charges a 1% origination fee on
these construction loans in addition to applicable interest.
Loans on commercial properties, multi-family dwellings,
and apartment buildings are typically made at 75% to 80% of
the appraised value. These loans totaled $40,394,000 or
21.23% of total loans held for investment at December 31,
1997.
4
Commercial and construction loans, by nature, entail
additional risk as compared to residential mortgage lending.
They are generally more complex and involve larger balances
than typical residential mortgages. Payments are typically
dependent upon successful operation of a related real estate
project or business as compared to individual earnings on
most residential mortgages. Therefore, the market risk is
somewhat greater. Construction delays, cost overruns or the
inability of the contractor to sell the finished product add
an element of risk to such lending.
Consumer lending
The Corporation offers other types of loans in addition
to real estate mortgage and construction loans. Consumer
loans of many types are offered by the Corporation. Some of
these loans are loans to purchase automobiles, boats,
recreational vehicles and manufactured housing, as well as
other secured and unsecured consumer loans. The Corporation
further makes loans secured by savings accounts at 2% above
the rate of the savings instrument. The terms generally do
not exceed ten years for manufactured housing loans and five
years on other consumer loans. Outstanding consumer loans at
December 31, 1997 were $59,653,000.
Commercial and agriculture non-real estate loans
The Corporation also makes commercial (including
agriculture) non-real estate loans. These loans in general
have higher risk associated with them than real estate
loans. They are generally secured by inventory, equipment,
accounts receivable, etc., or unsecured in some cases backed
by appropriate financial condition as per the underwriting
standards of the Corporation. Agriculture loans are
generally secured by machinery, equipment, other
miscellaneous assets or unsecured in keeping with the
underwriting standards of the Corporation. The timely pay
back is dependent upon the successful operation of the
business or farm. The outstanding balance of non-real estate
commercial loans was $24,395,000 at December 31, 1997 and
the outstanding balance of non-real estate agriculture loans
was $865,000 at December 31, 1997.
Investments
Investment Securities
The Corporation invests in mortgage-backed securities,
agency notes and bonds, collateralized mortgage obligations
(CMO's), municipal bonds, equity securities and United
States Treasury Notes.
A substantial portion of the mortgage-backed security
portfolio consists of securities that are either insured or
guaranteed by FHLMC, FNMA or GNMA. Guaranteed securities are
more liquid than individual mortgage loans. At December 31,
1997 the Corporation's mortgage-backed securities portfolio
had a carrying value of $36,424,000 or 14.10% of total
assets compared to $24,494,000 or 11.79% of total assets at
December 31, 1996. Amortized costs of mortgage-backed
securities were $36,299,000 at December 31, 1997 and
$24,499,000 for the comparable 1996 period. Due to
repayments and prepayments of the underlying loans, the
actual maturities of mortgage-backed securities are expected
to be substantially less than the scheduled maturities.
The Corporation also holds investments in CMO's with a
market value at December 31, 1997 of $480,000 and amortized
cost of $476,000 compared to a market value of $498,000 and
amortized cost of $506,000 at December 31, 1996.
The Corporation carried at fair value, $1,503,000 and
$999,000 in United States Treasury Notes at December 31, 1997
and 1996 respectively. These investments represented approximately
0.58% and 0.48% of total assets at those dates.
The Corporation had $1,486,000 and $3,642,000 in United
States Government-sponsored Agency Obligations at December
31, 1997 and 1996 respectively. These investments represent
approximately 0.57% and 1.75% of total assets at those
dates.
The Corporation holds the following equity investments:
Federal Reserve Bank Stock of $248,150 and $246,000 as of
December 31, 1997 and 1996 respectively; Federal Home Loan
Bank Stock of $781,000 and $560,000 for the same dates as
above; and Community Bankers' Bank Stock of $54,750 and
$54,750 for the same dates as above.
5
The Corporation also holds investments in municipal
bonds of $972,000 and $1,031,000 as of December 31, 1997 and
1996 respectively. These investments represented
approximately 0.38% and 0.50% of total assets at those
dates.
Investment Activities
Under Federal Reserve regulations, the Bank is required
to maintain certain liquidity ratios and does so by
investing in certain obligations and other securities which
qualify as liquid assets under Federal Reserve regulations.
See "Regulation". As a state chartered bank, the Bank's
investment authority is limited by federal law which permits
investment in, among other things, certain certificates of
deposit issued by commercial bank, banker's acceptances,
loans to commercial banks for Federal Funds, United States
government and agency obligations of state governments, and
corporate bonds.
The Corporation's investment committee, which meets
monthly, follows Federal Reserve guidelines with respect to
portfolio investment and accounting. Such Federal Reserve
guidelines state that insured institutions must account for
securities held for investment, sale and/or trading in
accordance with generally accepted accounting principles.
The Corporation maintains a written investment policy to set
forth investment portfolio composition and investment
strategy. The investment portfolio composition policy
considers, among other factors, the financial condition of
the institution, the types of securities, amounts of
investments in those securities and safety and soundness
considerations pertaining to the institution. The
investment strategy considers, among other factors, interest
rate risk, anticipated maturity of each type of investment
and the intent of the institution with respect to each
investment.
Sources of Funds
General
Deposit accounts have traditionally been the principal
source of the Corporation's funds for use in lending and for
other general business purposes. In addition to deposits,
the Corporation derives funds from loan repayments, FHLB
advances and loan participation sales. Borrowings may be
used on a short-term basis to compensate for seasonal or
other reductions in deposits or inflows at less than
projected levels, as well as on a longer term basis to
support expanded lending activities.
Deposit Activities
The Corporation, in its continuing effort to remain a
competitive force in its markets, offers a wide variety of
deposit services, with varied maturities, minimum-balance
requirements and market-sensitive interest rates that are
attractive to all types of depositors. The Corporation's
deposit products include checking accounts, passbook savings
accounts, money market deposit accounts, negotiable orders of
withdrawal accounts, individual retirement accounts and
certificates of deposit accounts. The Corporation is able to
offer a broad array of products that are consistent with
current Federal Reserve regulations, and as a major result,
the Corporation's deposit portfolio is, for the most part,
sensitive to general market fluctuations.
6
The following table sets forth the various types of accounts
offered by the Corporation at December 31, 1997:
Weighted
Average Minimum Amount
Interest Balance In % of
Type of Account Rate Term Deposit Thousands Total
_______________ ________ ____ ________ _________ _____
Checking Account 0.00% none $ 100.00 $ 30,930 13.07%
Interest Checking 3.57 none 100.00 9,704 4.10
Passbook Accounts 4.00 none 25.00 26,808 11.33
Money Market
Deposit Accounts 3.74 none 500.00 5,361 2.26
Christmas Club Accts 4.00 none 5.00 17 0.01
Individual Retirement
Accounts 6.56 various 500.00 22,898 9.68
Certificates of Deposit
Accounts 6.06 various 500.00 140,928 59.55
________ ______
Totals $236,646 100.00%
________ ______
The variety of deposit accounts offered by the
Corporation and the competitive rates paid on these deposit
accounts has increased the Corporation's ability to retain
deposits and has allowed it to be more competitive in
obtaining new funds, reducing the threat of
disintermediation (the flow of funds away from deposit
institutions into direct investment vehicles such as
government and corporate securities). As customers have
become more rate conscious and willing to move funds to
higher yielding accounts, the ability of the Corporation to
attract and maintain deposits and the Corporation's cost of
funds have been, and will continue to be, significantly
affected by money market conditions.
The following table sets forth information relating to
the Corporation's deposits flows during the years indicated.
Years Ended December 31
______________________________
(In Thousands) 1997 1996 1995
______________ ____ ____ ____
Increase (decrease) in deposits
before interest credited $ 38,967 $ 35,813 $ 25,086
Interest credited 8,208 6,331 4,927
________ ________ ________
Net increase in deposits 47,175 42,144 30,013
________ ________ ________
Total deposits at year end $236,646 $189,471 $147,327
________ ________ ________
Borrowings
The Corporation may obtain advances from the FHLB upon
the security of the capital stock it owns in the bank and
certain of its home mortgage loans provided certain
standards related to creditworthiness have been met. Such
advances may be made pursuant to several different credit
programs. Each credit program has its own interest rate and
range of maturities and the FHLB prescribes the acceptable
uses to which the advances pursuant to each program may be
used, as well as limitations on the size of such advances.
Depending on the program, such limitations are based either
on a fixed percentage of the Corporation's net worth or on
the FHLB's assessment of the Corporation's creditworthiness.
The FHLB is required to review its credit limitations and
standards at least once every six months. FHLB advances
have from time to time been available to meet seasonal and other
withdrawals of savings accounts and to expand lending.
The Bank also has established credit arrangements with
several of it's correspondent banks. At December 31, 1997
the Bank had approximately $50,886,000 of unused lines of
credit, including FHLB unused lines of credit, to fund any
necessary cash requirements.
7
The following table sets forth certain information as
to the Corporation's advances and other borrowings at the
dates indicated. See Notes 8 and 10 to the Consolidated
Financial Statements, included as part of the Annual Report
to Stockholders, for information as to rates, maturities,
average balances and maximum amounts outstanding.
December 31
________________________
(In Thousands) 1997 1996 1995
__________________ ____ ____ ____
Advances from FHLB $1,786 $1,929 $1,000
Other borrowings 828 - -
______ ______ ______
Total borrowings $2,614 $1,929 $1,000
______ ______ ______
Employees
The Corporation at December 31, 1997, had 126 full time
employees. None of these employees are represented by a
collective agent, and the Corporation believes its employee
relations are excellent.
Competition
The Corporation encounters competition for both
deposits and loans. For deposits, competition comes from
other commercial banks, savings and loan associations and/or
savings banks, mutual money market funds, credit unions and
various other corporate and financial institutions.
Competition also comes from interest paying obligations
issued by various levels of government and from a variety of
securities paying dividends or interest. Competition for
loans comes primarily from other commercial banks, savings
and loan associations and/or savings banks, insurance
companies, mortgage companies and other lending
institutions.
Subsidiaries
The Corporation was incorporated in Virginia in 1995 to
serve as the holding company for the Bank. The Bank is a
state chartered bank with principal offices in Abingdon,
Virginia. The Bank was incorporated in 1985 under the laws
of the Commonwealth of Virginia.
Federal Home Loan Bank System
The Bank is a member of the Federal Home Loan Bank
System, which consists of 12 regional Federal Home Loan
Banks. The Federal Home Loan Bank System is regulated by
the Federal Housing Finance Board ("FHFB"). The FHFB is
composed of five members, including the Secretary of Housing
and Urban Development and four private citizens appointed by
the President with the advice and consent of the Senate for
terms of seven years. At least one director must be chosen
from organizations with more than a two-year history of
representing consumer or community interests on banking
services, credit needs, housing or financial consumer
protections.
The Bank, as a member of the FHLB of Atlanta, is
required to purchase and maintain stock in its bank in an
amount as if 30 percent of the member's assets were home
mortgage loans.
The FHFB is required to adopt regulations establishing
standards of community investment or service for members of
the Federal Home Loan Banks as a condition for continued
access to advances. The regulations are to take into
account the record of performance of the institution under
the Community Reinvestment Act of 1977 and its record of
lending to first time home buyers.
In addition, new collateral requirements for advances
are to be established which will be designed to insure
credit quality and marketability of the collateral.
8
Regulation
General
The Corporation and it's subsidiary are subject to the
supervision, regulation and examination of the Federal
Reserve Board, the Federal Deposit Insurance Corporation and
the state regulators of the Commonwealth of Virginia which
has jurisdiction over financial institutions and has
obtained regulatory approval for it's various activities to
the extent required.
Federal and State Laws and Regulations
Bank holding companies and banks are extensively
regulated under federal and state law. To the extent that
the following information describes statutory and regulatory
provisions, it is qualified in it's entirety by reference to
such statutes and regulations. Any change in applicable law
or regulation may have a material effect on the business of
the Corporation and it's subsidiary.
Bank Holding Company Regulation
The Corporation is registered as a "bank holding
company" with the Board of Governors of the Federal Reserve
System ("Federal Reserve"), and is subject to supervision by
the Federal Reserve under the Bank Holding Corporation Act
("BHC Act"). The Corporation is required to file with the
Federal Reserve periodic reports and such additional
information as the Federal Reserve may require pursuant to
the BHC Act. The Federal Reserve examines the Corporation
and the subsidiary bank.
The BHC Act requires prior Federal Reserve approval
for, among other things, the acquisition by a bank holding
company of direct or indirect ownership or control of more
than 5% of the voting shares or substantially all of the
assets of any bank, or for a merger or consolidation of a
bank holding company with another bank holding company. With
certain exceptions, the BHC Act prohibits a bank holding
company from acquiring direct or indirect ownership or
control of the voting shares of any company which is not a
bank or bank holding company and from engaging directly or
indirectly in any activity other than banking or managing or
controlling banks or performing services for it's authorized
subsidiaries. A bank holding company may, however, engage in
or acquire an interest in a company that engages in
activities which the Federal Reserve has determined by
regulation or order to be so closely related to banking or
managing or controlling banks as to be a proper incident
thereto.
Bank Regulation
The Bank, as a state chartered member of the Federal
Reserve Systems, is subject to regulation and examination by
the Virginia State Corporation Commission and the Federal
Reserve Board. In addition, the Bank is subject to the rules
and regulations of the Federal Deposit Insurance
Corporation, which currently insures the deposits of each
member bank to a maximum of $100,000 per depositor.
The commercial banking business is affected by the
monetary policies adopted by the Federal Reserve Board.
Changes in the discount rate on member bank borrowings,
availability of borrowing at the "discount window", open
market operations, the imposition of any changes in reserve
requirements against member banks' deposits and certain
borrowings by banks and their affiliates, and the limitation
of interest rates which member banks may pay on deposits are
some of the instruments of monetary policy available to the
Federal Reserve Board. Taken together, these controls give
the Board a significant influence over the growth and
profitability of all banks. Management of the Bank is unable
to predict how the Board's monetary policies (or the fiscal
policies or economic controls imposed by Federal or state
governments) will affect the business and earnings of the
Bank or the Corporation, or what those policies or controls
will be.
The references in this section to various aspects of
supervision and regulation are brief summaries which do not
purport to be complete and which are qualified in their
entirety by reference to applicable laws, rules and
regulations.
9
Federal Deposit Insurance Corporation Improvement Act
The difficulties encountered nationwide by financial
institutions during 1990 and 1991 prompted federal
legislation designed to reform the banking industry and to
promote the viability of the industry and of the deposit
insurance system. The Federal Deposit Insurance Corporation
Improvement Act of 1991 ("FDICIA"), which became effective
on December 19, 1991, bolsters the deposit insurance fund,
tightens bank and thrift regulation and trims the scope of
federal deposit insurance as summarized below.
FDICIA requires each federal banking regulatory agency
to prescribe, by regulation, standards for all insured
depository institutions and depository institution holding
companies relating to (i) internal controls, information
systems and audit systems; (ii) loan documentation; (iii)
credit underwriting; (iv) interest rate exposure; (v) asset
growth; (vi) compensation, fees and benefits; and (vii) such
other operational and managerial standards as the agency
determines to be appropriate. The compensation standards
would prohibit employment contracts, compensation or benefit
arrangements, stock option plans, fee arrangements or other
compensatory arrangements that provide excessive
compensation, fees or benefits or could lead to material
financial loss. In addition, each federal banking
regulatory agency must prescribe by regulation standards
specifying (i) a maximum ratio of classified assets to
capital; (ii) minimum earnings sufficient to absorb losses
without impairing capital; (iii) to the extent feasible, a
minimum ratio of market value to book value for publicly
traded shares of depository institutions and depository
institution holding companies; and (iv) such other standards
relating to asset quality, earnings and valuation as the
agency determines to be appropriate. If an insured
institution fails to meet any of the standards promulgated
by regulation, then such institution will be required to
submit a plan to its federal regulatory agency specifying
the steps it will take to correct the deficiency.
Prompt corrective action measures adopted in FDICIA and
which became effective on December 19, 1992, impose
significant new restrictions and requirements on depository
institutions that fail to meet their minimum capital
requirements. Under new Section 38 of the Federal Deposit
Insurance Act ("FDI Act"), the federal banking regulatory
agencies have developed a classification system pursuant to
which all depository institutions are placed into one of
five categories based on their capital levels and other
supervisory criteria: well capitalized, adequately
capitalized; undercapitalized; significantly
undercapitalized; and critically undercapitalized.
The Bank met the requirements at December 31, 1997 to
be classified as "adequately capitalized". This
classification is determined solely for the purposes of
applying the prompt corrective action regulations and may
not constitute an accurate representation of the
Corporation's overall financial condition.
An undercapitalized depository institution is required
to submit a capital restoration plan to its principal
federal regulator. The federal banking agencies may not
accept a capital plan without determining, among other
things, that the plan is based on realistic assumptions and
is likely to succeed in restoring the depository
institution's capital and is guaranteed by the parent
holding company. If a depository institution fails to
submit an acceptable plan, it will be treated as if it were
significantly undercapitalized.
Unless its principal federal regulator has accepted its
capital plan, an undercapitalized bank may not increase its
average total assets in any calendar quarter. If an
undercapitalized institution's capital plan has been
accepted, asset growth will be permissible only if the
growth is consistent with the plan and the institution's
ratio of tangible equity to assets increases during the
quarter at a rate sufficient to enable the institutions to
become adequately capitalized within a reasonable time.
An institution that is undercapitalized may not solicit
deposits by offering rates of interest that are
significantly higher than the prevailing rates on insured
deposits in the institution's normal market areas or in the
market area in which the deposits would otherwise be
accepted.
An undercapitalized institution may not branch, acquire an
interest in another business or institution or enter a new line of
business unless its capital plan has been accepted and its
principal federal regulator approves the proposed action.
An insured depository institution may not pay
management fees to any person having control of the
institution nor may an institution, except under certain
circumstances and with prior regulatory
10
approval, make any capital distribution if, after making such
payment or distribution, the institution would be undercapitalized.
Significantly undercapitalized depository institutions
may be subject to a number of requirements and restrictions,
including orders to sell sufficient voting stock to become
adequately capitalized, requirements to reduce total assets
and cessation of receipt of deposits from correspondent
banks. Critically undercapitalized institutions are subject
to appointment of a receiver or conservator.
If its principal federal regulator determines that an
adequately capitalized institution is in an unsafe or
unsound condition or is engaging in an unsafe or unsound
practice, it may require the institution to submit a
corrective action plan, restrict its asset growth and
prohibit branching, new acquisitions and new lines of
business. An institution's principal federal regulator may
deem it to be engaging in an unsafe or unsound practices if
it receives a less than satisfactory rating for asset
quality, management, earnings or liquidity in its most
recent examination.
In addition, regulators were required to draft a new
set of non-capital measures of bank safety, such as loan
underwriting standards and minimum earnings levels,
effective December 1, 1993. The legislation also requires
regulators to perform annual on-site bank examinations,
place limits on real estate lending by banks and tightens
auditing requirements.
Federal And State Taxation
General
The following discussion of federal taxation is a
summary of certain pertinent federal income tax matters as
they pertain to the Corporation. With some exceptions,
including particularly the reserve for bad debts discussed
below, the Corporation is subject to federal income tax
under the Internal Revenue Code of 1986 (the "Code") in the
same general manner as other corporations.
Bad Debt Reserves
Commercial banks such as the Bank, which meet certain
definitional tests primarily relating to their assets and
the nature of their businesses, are permitted to establish a
reserve for bad debts and to make annual additions to the
reserve. These additions, may within specified formula
limits, be deducted in arriving at the Bank's taxable
income. For purposes of computing the deductible addition
to its bad debt reserve, the Bank utilizes the experience
method.
Under the experience method, the deductible annual
addition is the amount necessary to increase the balance of
the reserve at the close of the taxable year to the greater
of (1) the amount which bears the same ratio to loans
outstanding at the close of the taxable year as the total
net bad debts sustained during the current and five
preceding taxable years to bear to the sum of the loans
outstanding at the close of those six years or (2) the lower
of (a) the balance in the reserve account at the close of
the last taxable year prior to the most recent adoption of
the experience method (the base year is the last taxable
year beginning before 1988), or (b) if the amount of loans
outstanding at the close of the taxable year is less than
the amount of loans outstanding at the close of the base
year, the amount which bears the same ratio to loans
outstanding at the close of the taxable year as the balance
of the reserve at the close of the base year bears to the
amount of loans outstanding at the close of the base year.
Minimum Tax
A 20% corporate alternative minimum tax generally will
apply to a base of regular taxable income plus certain tax
preferences ("alternative minimum taxable income" or "AMTI")
and will be payable to the extent such AMTI is in excess of
an exemption amount. The Code provides that an item of tax
preference is the excess of the bad debt deduction over the
amount allowable under the experience method. The other
items of tax preference that constitute AMTI include (a) tax-
exempt interest on newly-issued (generally, issued on or
after August 8, 1986) private activity bonds other than
certain qualified bonds and (b) 75% of the excess (if any)
of (i) 75% of adjusted current earnings as defined in the
Code, over (ii) AMTI (determined without regard to this
preference and prior to reduction by net operating losses).
11
Other
For federal income tax purposes, the Corporation
reports its income and expenses on the accrual basis method
of accounting and uses a year ending December 31 for filing
its income tax returns. The Corporation may carry back net
operating losses to the preceding two taxable years and
forward to the succeeding twenty taxable years.
The Commonwealth of Virginia imposes an income tax on
corporations domiciled in the state. The Virginia taxable
income is based on the federal taxable income with certain
adjustments for interest and dividend income on obligations
of securities of the United States and states other than
Virginia. The tax rate is 6% of taxable income.
See Note 9 to the Consolidated Financial Statements,
included as part of the Annual Report to Stockholders, for
additional information regarding the income taxes of the
Company.
Distribution of Assets, Liabilities and Shareholders'Equity; Interest
Rates and Interest Differential
Year Ended December 31,
__________________________________________________________________
1997 1996 1995
_____________________ _____________________ ______________________
(Dollars in Thousands)
Average Yield/Average Yield/Average Yield/
Balance Interest Rate Balance Interest Rate Balance Interest Rate
_______ ________ ____ _______ ________ ____ _______ ________ ____
Assets
Interest
earning
assets
(taxable-
equivalent
basis :
Loans (net
of unearned
discount
$175,542 $16,203 9.23% $131,449 $12,310 9.36% $102,216 $ 9,590 9.38%
Securities
38,158 2,363 6.19 34,350 2,082 6.06 30,079 1,793 5.96
Federal funds
sold 3,244 169 5.20 3,822 204 5.33 3,686 202 5.48
________ _______ ____ ________ _______ ____ ________ _______ ____
Total
interest-
earning
assets
$216,944 $18,735 8.64% $169,621 $14,596 8.61% $135,981 $11,585 8.52%
________ _______ ____ ________ _______ ____ ________ _______ ____
Liabilities
Interest-
bearing
liabilities:
Demand,
savings &
time
dep. $181,846 $10,099 5.55% $142,331 $ 7,714 5.42% $113,215 $ 6,086 5.37%
Other
interest-
bearing
liabilities
3,366 222 6.59 1,803 108 5.99 1,198 75 6.26
________ _______ ____ ________ _______ ____ ________ _______ ____
Total
interest-
bearing
liabilities
$185,212 $10,321 5.57% $144,134 $ 7,822 5.43% $114,413 $ 6,161 5.38%
________ _______ ____ ________ _______ ____ ________ _______ ____
Net interest
income $ 8,414 $ 6,774 $ 5,424
Net margin on
int. earning
assets on a
tax equivalent
basis 3.88% 3.99% 3.99%
Average
interest
spread 3.07% 3.18 3.14%
________________________
Tax equivalent adjustments (using 34% federal tax
rates) have been made in calculating yields on tax-free
loans and investments. Virginia banks are exempt from state
income tax.
For the purposes of these computations, non-accruing
loans are included in the daily average loan amounts
outstanding.
The yield on securities classified as available for
sale is computed based on the average balance of the
historical amortized cost balance without the effects of the
fair value adjustment required by FAS 115
12
As the largest component of income, net interest income
represents the amount that interest and
fees earned on loans and investments exceeds the interest
costs of funds used to support these earning
assets. Net interest income is determined by the relative
levels, rates and mix of earning assets and interest-
bearing liabilities. The following table attributes changes
in net interest income either to changes in average volume
or to average rates. Changes in interest due to both rate and
volume have been allocated to volume and rate changes in proportion
to the relationship of the absolute dollar amounts of the change
in each.
1997 Compared to 1996 1996 Compared to 1995
_______________________________ _____________________________
Increase Increase Increase Increase
(decrease) (decrease) (decrease) (decrease)
due to due to Net due to due to Net
Increase (Decrease) change in change in increase change in change in increase
in volume rate (decrease) volume rate (decrease)
___________________ ______ ____ __________ ______ ____ ________
INTEREST INCOME
Securities $ 278 $ 3 $ 281 $ 288 $ 1 $ 289
Federal funds sold (36) 1 (35) 7 (5) 2
Loans 3,905 (12) 3,893 2,742 (22) 2,720
_______ _______ _______ _______ _______ _______
Total income change $ 4,147 $ (8) $ 4,139 $ 3,037 $ (26) $ 3,011
_______ _______ _______ _______ _______ _______
INTEREST EXPENSE
Savings and time
deposits $ 2,377 $ 8 $ 2,385 $ 1,566 $ 62 $ 1,628
Other interest-bearing
liabilities 113 1 114 38 (5) 33
_______ _______ _______ _______ _______ _______
Total Expense
Change $ 2,490 $ 9 $ 2,499 $ 1,604 $ 57 $ 1,661
_______ _______ _______ _______ _______ _______
Increase (Decrease) in
Net Interest
Income $ 1,657 $ (17) $ 1,640 $ 1,433 $ (83) $ 1,350
_______ _______ _______ _______ _______ _______
Investment Portfolio
The following table presents the maturity distribution, market value,
book value and approximate tax equivalent yield (assuming a 34% federal
income tax rate) of the investment portfolio at December 31, 1997.
(Dollars in Thousands)
Five
One Year Years
Within Through Through After Ten Total
One Five Ten Ten Book Market
Year Years Years Years Yield Value Value
____ _____ _____ _____ _____ _____ _____
U.S.T.N.'s $ 499 $ 1,004 $ - $ - 5.90% $ 1,493 $ 1,503
U.S. Gov Agency 799 4,014 2,168 31,409 6.33 38,275 38,390
State & Muni's - 305 667 - 7.21 939 972
Other - - - 1,098 6.64 1,098 1,098
_______ _______ _______ _______ ____ _______ _______
TOTAL $ 1,298 $ 5,323 $ 2,835 $32,507 6.19 $41,805 $41,963
_______ _______ _______ _______ ____ _______ _______
13
Loan Portfolio
The table below classifies loans, net of unearned
income, by major category and percentage distribution at
December 31, 1997 for each of the past three years:
December 31,
(Dollars in thousands)
1997 1996 1995
___________________ ___________________ ___________________
Description Amount Percentage Amount Percentage Amount Percentage
___________ ______ __________ ______ __________ ______ __________
Commercial $ 24,395 12.71% $ 20,365 13.14% $ 12,699 11.17%
Real Estate 104,818 54.59 101,491 65.50 76,516 67.27
Consumer 59,653 31.07 30,128 19.44 21,785 19.15
Other 3,139 1.63 2,967 1.92 2,743 2.41
________ ______ ________ ______ ________ ______
Total $192,005 100.00% $154,951 100.00% $113,743 100.00%
________ ______ ________ ______ ________ ______
The following table shows the maturity or next repricing
opportunity of loans outstanding as of December 31, 1997. Also
provided are the amounts due after one year classified according
to the sensitivity to changes in interest rates. Fixed rate loans are
classified based upon the period in which the final payment is due.
Floating rate loans are classified based on next repricing date.
December 31, 1997
(Dollars in Thousands)
Within One After One But After Five
Year Within Five Years Years
_________________ ________________ _________________
Fixed Floating Fixed Floating Fixed Floating
Rate Rate Rate Rate Rate Rate Total
____ ____ ____ ____ ____ ____ _____
Commercial $ 4,347 $ 7,861 $11,592 $ - $ 595 $ - $ 24,395
Real Estate 10,265 32,547 29,947 15,656 16,403 - 104,818
Consumer 3,999 1,100 53,772 - 782 - 59,653
Other 925 783 1,336 - 95 - 3,139
_______ _______ _______ _______ _______ _______ ________
Total $19,536 $42,291 $96,647 $15,656 $17,875 $ - $192,005
_______ _______ _______ _______ _______ _______ ________
Non-performing loans
The loan portfolio of the Bank is reviewed regularly by
senior officers to evaluate loan performance. The frequency
of the review is based on a rating of credit worthiness of
the borrower utilizing various factors such as net worth,
credit history, customer relationship, etc. The evaluations
emphasize different factors depending upon the type of loan
involved. The commercial and real estate type loans are
reviewed on the basis of estimated net realizable value
through an evaluation of collateral and the financial
strength of the borrower. Installment loans are evaluated
largely on the basis of delinquency data because of the
large number of such loans and relatively small size of each
individual loan.
Management review of commercial and other loans may
result in a determination that a loan should be placed on a
non-accrual of interest basis. It is the policy of the Bank
to discontinue the accrual of interest on any loan on which
full collectability of principal and / or interest is
doubtful. Subsequent collection of interest is recognized as
income on a cash basis upon receipt. Placing a loan on non-
accrual status for the purpose of income recognition is not
in itself a reliable indication of potential loss of
principal. Other factors, such as the value of the
collateral securing the loan and the financial condition of
the borrower, serve as more reliable indications of
potential loss of principal.
The policy of the Bank is that non-performing loans
consist of loans accounted for on a non-accrual basis and
loans which are contractually past due 90 days or more in
regards to interest and/ or principal payments. As of the
three periods ended December 31, 1997, 1996 and 1995, non-
accrual loans amounted to $888,000, $99,000 and $235,000,
respectively. Interest income lost on non-accruing loans
was approximately $71,000, $6,000, and $12,000 for December
31, 1997, 1996, and 1995 respectively.
14
Summary of Loan Loss Experience
The allowance for loan losses is increased by the
provision for loan losses and reduced by loans charged off
net of recoveries. The allowance for loan losses is
established and maintained at a level judged by management
to be adequate to cover any anticipated loan losses to be
incurred in the collection of outstanding loans. In
determining the adequate level of the allowance for loan
losses, management considers the following factors: (a) loan
loss experience; (b) problem loans, including loans judged
to exhibit potential charge-off characteristics, loans on
which interest is no longer being accrued, loans which are
past due and loans which have been classified in the most
recent regulatory examination; and (c) anticipated economic
conditions and the potential impact these conditions may
have on individual classifications of borrowers.
The following table presents the Corporation's loan
loss experience for the past three years:
Years Ended December 31,
(Dollars in Thousands)
1997 1996 1995
____ ____ ____
Allowance for loan losses at
beginning of year $ 1,072 $ 908 $ 836
Loans charged off:
Commercial 42 170 19
Real Estate - - 122
Consumer 470 85 47
Other - - -
_________ _________ _________
Total $ 512 $ 255 $ 188
_________ _________ _________
Recoveries of loans
previously charged off:
Commercial $ 6 32 -
Real Estate - - 106
Consumer 68 13 11
Other - - -
_________ _________ _________
Total $ 74 $ 45 $ 117
_________ _________ _________
Net loans charged off $ 438 $ 210 $ 71
Provision for loan losses 1,002 374 143
_________ _________ _________
Allowance for loan losses
end of year $ 1,636 $ 1,072 $ 908
_________ _________ _________
Average total loans
(net of unearned income) $ 175,542 $ 131,449 $ 102,216
Total loans (net of
unearned income) at
year-end $ 192,005 $ 154,951 $ 113,743
Ratio of net charge-offs
to average loans 0.249% 0.160% 0.069%
Ratio of provision for
loan losses to average loans 0.571% 0.285% 0.140%
Ratio of provision for loan
losses to net charge-off 228.770% 178.100% 201.410%
Allowance for loan losses
to year-end loans 0.852% 0.692% 0.798%
15
Allocation of the allowance for loan losses
The following table provides an allocation of the allowance for loan
losses as of December 31, 1997:
Year Ended December 31, 1997
Percent of Loans on each category
(Dollars in Thousands)
Allowance Percentage Percentage
for of Total of
Loan Loss Loan Loss Total Loans
_________ _________ ___________
Commercial $ 540 33.01% 12.71%
Real Estate 167 10.21 54.59
Consumer 882 53.91 31.07
Other 6 0.36 1.63
Unallocated 41 2.51 0.00
_______ ______ ______
Total $ 1,636 100.00% 100.00
_______ ______ ______
Deposits
The following table provides a breakdown of deposits at December 31
for the years indicated is as follows:
December 31,
(Dollars in Thousands)
1997 1996 1995
____ ____ ____
Non-interest bearing
demand deposits $ 30,930 $ 26,002 $ 20,303
Interest bearing
demand deposits 15,065 13,379 11,665
Savings deposits 26,808 21,930 17,010
Time deposits 163,843 128,160 98,349
_________ _________ _________
Total Deposits $ 236,646 $ 189,471 $ 147,327
_________ _________ _________
The average daily amount of deposits and rates paid on
such deposits is summarized for the periods indicated in the
following table:
Year Ended December 31,
(Dollars in Thousands)
1997 1996 1995
____ ____ ____
Amount Rate Amount Rate Amount Rate
______ ____ ______ ____ ______ ____
Non-interest bearing
demand deposits $ 28,177 0.00% $ 22,566 0.00% $ 17,337 0.00%
Interest-bearing
demand deposits 14,029 3.58 12,566 3.60 11,294 3.64
Savings deposits 24,600 4.00 20,516 4.01 16,950 4.48
Time deposits 143,217 6.01 109,249 5.89 84,971 5.89
_________ _________ _________
Total $ 210,023 $ 164,897 $ 130,552
_________ _________ _________
16
The remaining maturities of time deposits at December 31, 1997 are as
follows (in thousands) :
Maturity
3 months or less....................................$ 33,135
Over 3 through 12 months............................ 84,993
Over 12 months...................................... 45,715
_________
Total $ 163,843
_________
Interest Rate Sensitivity Analysis
The following table provides the maturities of investment securities,
loans, and deposits as of December 31, 1997, and measures the interest rate
sensitivity gap for each range of maturity indicated: The amounts below
also reflect various prepayment assumptions.
December 31 1997
(Dollars in Thousands)
Maturing
After One
But
Within One Within After Five
Year Five Years Years Total
____ __________ _____ _____
Assets
Interest-bearing
Investment Securities $ 30,030 $ 7,493 $ 4,440 $ 41,963
Fed Funds Sold 7,213 - - 7,213
Loans 61,825 110,669 17,875 190,369
Noninterest-bearing
Other Assets 7,384 - 11,307 18,691
_________ _________ _________ _________
Total Assets $ 106,452 $ 118,162 $ 33,622 $ 258,236
_________ _________ _________ _________
LIABILITIES AND
SHAREHOLDERS' EQUITY
Interest-bearing
All Interest-
bearing Deposits $ 134,384 $ 71,332 $ - $ 205,716
Other interest-bearing
Liabilities 143 - 1,643 1,786
Noninterest-bearing
Demand Deposits
Non-interest 21,158 9,772 - 30,930
Other Liabilities - 828 2,174 3,002
Shareholders' Equity - - 16,802 16,802
_________ _________ _________ _________
Total Liabilities
and Shareholders'
Equity $ 155,685 $ 81,932 $ 20,619 $ 258,236
_________ _________ _________ _________
Interest Rate
Sensitivity GAP $ (49,233) $ 36,230 $ 13,003 $ -
17
Return on Equity and Assets
The following table highlights certain ratios for the periods indicated:
Year Ended December 31,
(Percentage)
1997 1996 1995
____ ____ ____
Net income to:
Average total assets 0.84 0.97 1.00
Average shareholders' equity 12.53 13.01 12.45
Dividend payout ratio
(dividends declared per share
divided by net income per share) 0.00 0.00 0.00
Average shareholders'equity to
average total assets ratio 6.73 7.46 8.05
Item 2. Properties
The Corporation's and the Bank's main offices are
located at 340 West Main Street, Abingdon, Virginia. The
main office is a two story brick structure owned by the
Bank. The Bank utilizes the entire structure for it's
banking operations. The Bank maintains a separate drive-thru
facility which has five customer service lanes and is
located on the main office property. The main office opened
for operations in 1985. In addition, the Bank also has two
branch locations within Washington County, Virginia. The
East Abingdon branch is a one story brick facility located
at 24412 Maringo Road which operates as a full service
facility. This branch was completed and opened for
operations in 1993.The West Abingdon Express branch is a one-
story brick express facility which operates with four drive-
thru customer service lanes and a walk-up window. This is a
limited service facility. The West Abingdon Express branch
was completed and opened for operations in 1994 and is
located at Exit 14 I-81, Jonesboro Road, Abingdon, Virginia.
The Bank also has two full service branch locations within
the City of Bristol, Virginia. The East Bristol office is
located at 999 Old Airport Road, Bristol, Virginia. This is
a two-story brick facility with interior customer loan and
deposit areas as well as a four lane drive-thru facility.
This office was completed and opened for operations in 1988.
The Commonwealth office is located at 821 Commonwealth
Avenue, Bristol, Virginia. This is a two story block
building with interior full service customer facilities and
a four lane drive thru facility. This office was completed
and opened for operations in 1995. All of the Bank's
locations have ATM's on premises. All properties are owned
by the Bank and are free of liens.
The Corporation acquired a commercial building during
1997 which is located at 266 West Plumb Alley , Abingdon,
Virginia. The building is a two-story concrete structure
which was originally constructed by another bank for use as
an operations center. The Corporation assumed the leases of
the building's current tenants. The second floor of the
structure is leased to third parties. During 1997, the
Corporation entered into a leasing arrangement with it's
subsidiary to lease the first floor to be used for its
operations center. Currently the bookkeeping, proof,
accounting, shareholder's services, human resources,
internal audit and training departments are located there.
The Corporation has provided as security a first deed of trust on
this building for the related $828,000 debt owed at December
31, 1997. The Bank constructed a two-story brick building
located at 1425 North Main Street, Marion, Virginia during 1997.
This building was placed in service during 1997 and is operational
as a full-service branch of the Bank. This Branch building is
free of all liens. The Bank also acquired another piece of
real estate located on North Main Street, Marion, Virginia
which is being developed to house a drive-up ATM. The ATM
had not been placed in service as of December 31, 1997.
This property is also free of all liens.
Item 3. Legal Proceedings
The Corporation is not involved in any pending legal
proceedings, other than non-material legal proceedings
undertaken in the ordinary course of business.
18
Item 4. Submission of Matters to a Vote of Security Holders
There were no matters submitted to a vote of security
holders during the quarter ended December 31, 1997.
Part II.
Item 5. Market for Registrant's Common Equity and Related
Stockholder Matters
There is no established trading market for the stock of
Highlands Bankshares, Inc.. At December 31, 1997 the
Corporation has approximately 966 stockholders of record.
The Corporation acts as it's own registered Stock Transfer
Agent, without charging a transfer fee, ensuring that all
applicable federal guidelines relating to stock transfers
are enforced. The Corporation maintains a list of
individuals who are interested in purchasing it's common
stock and connects these people with stockholders' who are
interested in selling their stock. These parties negotiate
the per share price independent of the Corporation. The
stock transfer agent of the Corporation attempts to keep a
record of what the stock sales are trading at by asking the
parties about the trade price per share. Please refer to
the table below entitled Common Stock Performance for a
breakdown of the trades for the four quarters of 1997. It is
the opinion of management that this range accurately
reflects the market value of the Corporation's common stock
at the present time.
Common Stock Performance-December 31 1997
Quarterly
High Low Average
____ ___ _______
First Quarter $25.00 $22.00 $23.00
Second Quarter $23.50 $22.00 $23.06
Third Quarter $25.50 $23.00 $24.38
Fourth Quarter $27.00 $23.00 $25.92
The Corporation's and the Bank's Board of Directors
determines whether to declare dividends and the amount of
any dividends declared. Such determinations by the Board
take into account the Corporation's financial condition,
results of operations, and other relevant factors. The
declaration, amount and timing of future dividends will be
determined by the Board of Directors after a review of the
Corporation's operations and will be dependent upon, among
other factors, the Corporation's income, operating costs,
overall financial condition and capital requirements and
upon general business conditions. The Corporation's only
source of funds for cash dividends will be dividends paid to
the Corporation by the Bank, which is subject to regulatory
restrictions. During 1996 the Bank declared and paid cash
dividends of $500,000 to the Corporation for operating
costs. The Corporation did not declare or pay any cash
dividends during 1997.
At December 31, 1997, there were approximately 966
holders of the Corporation's common stock (based on the
number of record holders as of that date).
19
Item 6. Selected Financial Data
The following table sets forth certain selected
consolidated financial data for the past five years.
Years Ended December 31,
(Dollars in thousands, except per share data)
1997 1996 1995 1994 1993
____ ____ ____ ____ ____
Income Statement Amounts:
Gross interest income $ 18,735 $ 14,596 $ 11,585 $ 8,425 $ 6,433
Gross interest expense 10,321 7,822 6,161 3,985 3,064
Net interest income 8,414 6,774 5,424 4,440 3,369
Provision for possible
Loan losses 1,002 374 143 120 150
Net interest income after
provision 7,412 6,400 5,281 4,320 3,219
Other operating income 888 660 488 425 395
Other operating expense 5,382 4,439 3,541 3,004 2,264
Income before income
taxes and other items 2,918 2,621 2,228 1,741 1,350
Income taxes 966 857 779 581 442
Income before cumulative
effect of change in
accounting principles 1,952 1,764 1,449 1,160 908
Cumulative effect of
change in accounting
principles - - - - -
Net income $ 1,952 $ 1,764 $ 1,449 $ 1,160 $ 908
Per Share Data :
Net income per share $ 1.59 $ 1.45 $ 1.19 $ 0.96 $ 0.98
Cash dividends per share - - - - -
Book value (at year end) 13.64 11.97 10.52 8.43 8.33
Balance Sheet Amounts (at
year-end):
Total assets $ 258,236 $ 207,739 $ 162,543 $ 128,749 $ 105,520
Total loans (net of
unearned income) 192,005 154,951 113,743 93,738 67,212
Total deposits 236,646 189,471 147,327 117,314 94,853
Long-term debt 2,614 1,929 - - -
Total equity 16,802 14,617 12,812 10,243 10,042
_______________________
Adjusted for 1995 two-for-one stock split, 1992 25% stock dividend
and 1990 20% stock dividend.
Management's Discussion and Analysis of Financial Condition
and Results of Operations
The information required herein is incorporated by
reference from pages 5 to 9 of the Annual Report to
Stockholders for the fiscal year ended December 31, 1997.
Item 8. Financial Statements and Supplementary Data
The financial statements and supplementary data
required herein are incorporated by reference from pages F-1
to F-23 of the Annual Report to Stockholders for the fiscal
year ended December 31,1997.
Item 9. Changes in Accountants and Disagreements with
Accountants on Accounting and Financial Disclosure
None.
20
Part III.
Item 10. Directors and Executive Officers of the Registrant
The information required herein is incorporated by
reference to "The Board of Directors", "Executive Officers
Who Are Not Directors", "Security Ownership of Certain
Beneficial Owners" and "Compliance With Filing Requirements
Under the Securities Exchange Act of 1934" contained in the
definitive proxy statement for the Registrant's 1997 Annual
Meeting of Stockholders to be subsequently filed.
Item 11. Executive Compensation
The information required herein is incorporated by
reference to "Remuneration" contained in the definitive
proxy statement for the Registrant's 1997 Annual Meeting of
Stockholders to be subsequently filed.
Item 12. Security Ownership of Certain Beneficial Owners and
Management
The information required herein is incorporated by
reference to "Security Ownership of Management" and
"Security Ownership of Certain Beneficial Owners" contained
in the definitive proxy statement for the Registrant's 1997
Annual Meeting of Stockholders to be subsequently filed.
Item 13. Certain Relationships and Related Transactions
The information required herein is incorporated by
reference to "Indebtedness of Management" contained in the
definitive proxy statement for the Registrant's 1997 Annual
Meeting of Stockholders to be subsequently filed.
Part IV.
Item 14. Exhibits, Financial Statement Schedules, and
Reports on Form 8-K
(a) (1) The following financial statements are
incorporated by reference into Item 8 hereof
from Exhibit 13 hereof:
Consolidated Statements of Financial Condition as
of December 31, 1997 and 1996
Consolidated Statements of Operations for each of
the years in the three year period
ended December 31, 1997
Consolidated Statements of Stockholder's Equity
for each of the years in the three year
period ended December 31, 1997
Consolidated Statements of Cash Flows for each of
the years in the three year
period ended December 31, 1997
Notes to Consolidated Financial Statements for
December 31, 1997, 1996 and 1995
Independent Auditors' Report
(a) (2) There are no financial statement schedules
required to be filed herewith
3a The following exhibits are filed as part of
this report on Form 10-K, and this list
includes the Exhibit Index.
21
Exhibits
3a None
(b) No reports on Form 8-K have been filed during the last
quarter of the period covered by this
report.
(c) See (a) (3) above for all exhibits filed herewith and
the Exhibit Index.
(d) Separate financial statements are not applicable.
22
SIGNATURES
Pursuant to the requirements of Section 13 or 15(d) 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.
Date: March 26, 1998
BY:___________________________
Samuel L. Neese
Executive Vice President and
Chief Executive Officer
Pursuant to the requirements of the Securities Exchange
Act of 1934, this report has been signed below by the
following persons on behalf of the registrant and in the
capacities indicated on March 26, 1997.
Signature Title
_________ _____
/S/ James D Morefield 03-26-98
______________________________________
James D. Morefield Date Chairman of the Board, and Director
/S/ James D. Morre, Jr. 03-26-98
______________________________________
Dr. James D. Moore, Jr. Date President
/S/ J. Carter Lambert 03-26-98
______________________________________
J. Carter Lambert Date Vice Chairman
/S/ Samuel L. Neese 03-26-98
______________________________________
Samuel L. Neese Date Executive Vice President, and
Chief Executive Officer
/S/ James T. Riffe 03-26-98
______________________________________
James T. Riffe Date Executive Vice President and Cashier
/S/ William E. Chaffin 03-26-98
______________________________________
William E. Chaffin Date Director
/S/ V. D. Kendrick 03-26-98
______________________________________
V.D. Kendrick Date Director
/S/ Clydes B. Kiser 03-26-98
______________________________________
Clydes B. Kiser Date Director
/S/ Charles P. Olinger 03-26-98
______________________________________
Charles P. Olinger Date Director
/S/ William J. Singleton 03-26-98
______________________________________
William J. Singleton Date Director
/S/ H. Ramsey White, Jr. 03-26-98
______________________________________
Dr. H. Ramsey White, Jr. Date Director
23
______________________________________________________________________________
HIGHLANDS BANKSHARES, INC.
1997 ANNUAL REPORT
______________________________________________________________________________
FINANCIAL HIGHLIGHTS
1997/ 1997/
Results of Operations 1997 1996 1995 1996 1996
____ ____ ____ ____ ____
(In Thousands except share
and per share data) Percentage Change
____________________________ _________________
Net Interest Income $ 8,414 $ 6,774 $ 5,424 24.21% 24.89%
Net Income 1,952 1,764 1,449 10.66 21.74
Financial Condition at Year-End
Assets 258,236 207,739 162,543 24.31 27.81
Loans 192,005 154,951 113,743 23.91 36.23
Securities 41,963 31,345 32,276 33.87 <2.88>
Deposits 236,646 189,719 147,327 24.74 28.77
Stockholders' Equity 16,802 14,617 12,812 14.95 14.09
Shares Outstanding 1,232 1,222 1,218 0.82 0.33
Significant Ratios
Return on average
assets 0.84 0.97 1.00 <13.40> <0.03>
Return on average
equity 12.53 13.01 12.45 <3.69> 4.50
Average stockholders'
equity to average
assets 6.73 7.46 8.05 <9.79> <7.33>
Allowance for loan
losses as a percentage
of total loans 0.85 0.69 0.80 23.19 <13.75>
Per Share Data
Based on weighted-average shares outstanding
Net Income $1.59 $1.45 $1.19 9.66 21.85
Stockholders' equity
(book value) per
shares outstanding at
year-end 13.64 11.97 10.52 13.95 13.88
COMPARISON OF RESULTS OF OPERATIONS FOR THE YEARS ENDED DECEMBER 31, 1997
AND 1996
Net interest income for the year-ended December 31, 1997 increased 24.21%,
approximately $1.64 million over 1996. Average interest earning assets
increased $47.3 million from 1996 to 1997 while average interest-bearing
liabilities increased $41.1 million. The yield on average interest-earning
assets for the year ended December 31, 1997 was 8.64% compared with 8.61%
for the comparable 1996 period. The 1997 yield on loans decreased by 13
basis points as compared to 1996 period at 9.36%. The yield on average
investments increased 0.10% to 6.11% from December 31, 1996 to 1997. The
yield on average interest-bearing liabilities increased 14 basis points
during 1997 to 5.57% as compared to 5.43% during 1996. Net income for the
year-ended December 31, 1997 was $1.95 million, an increase of 10.66% over
the 1996 period. Income tax expense for 1997 increased 12.72% to $966
thousand as compared to $857 thousand for the 1996 period.
COMPARISON OF RESULTS OF OPERATIONS FOR THE YEARS ENDED DECEMBER 31, 1996
AND 1995
Net interest income for the year-ended December 31, 1996 increased 24.89%,
approximately $1.35 million over 1995. Average interest earning assets
increased $34.1 million from 1995 to 1996 while average interest-bearing
liabilities increased $29.7 million. The yield on average interest-earning
assets for the year-ended December 31, 1996 was 8.61% compared with 8.56%
for the comparable 1995 period. The 1996 yield on loans decreased by 2
basis points as compared to the 1995 period at 9.38%. The yield on average
investments remained constant at 6.01% for December 31,1996 and 1995. The
yield on average interest-bearing liabilities increased 5 basis points
during 1996 to 5.43% as compared to 5.38% during 1995. Net income for the
year-ended December 31, 1996 was $1.76 million, an increase of 21.74% over
the 1995 period. Income tax expense for 1996 increased 10.01% to $857
thousand as compared to $779 thousand for the 1995 period.
COMPARISON OF FINANCIAL CONDITION AT DECEMBER 31, 1997 AND 1996
Total assets at December 31, 1997 totaled $258.2 million compared to $207.7
million at December 31, 1996. This 24.31% growth in assets was primarily
due to the large volume of loans originated. Total loans increased 23.91%,
or $37.1 million over the comparable 1996 period. The security portfolio
increased 33.87% to $42.0 million during 1997 as contrasted to the 1996
period. Total deposits increased to $236.6 million or 24.74% from 1996's
level of $189.7 million. Stockholder's equity increased 14.95% during 1997.
The Financial Accounting Standards Board's (FASB) Statement on Accounting
Standards No. 115 was implemented during 1994. FASB's SAS 115 required
that all securities classified as "Available-for-Sale" be adjusted to
market value through the use of a valuation account, and that any paper
gains or losses be run through the Stockholder's Equity section of the
balance sheet. The effect of implementing SAS 115 caused an decrease in
Stockholder's Equity at December 31, 1996 of $18 thousand, net of the
related deferred tax. As of December 31, 1997 the Corporation's security
portfolio had $104 thousand in paper gains, net of gains deferred taxes.
The Corporation notes that it does have the ability and intent to carry to
maturity approximately $41.9 million of the "Available-for-Sale"
securities.
COMPARISON OF FINANCIAL CONDITION AT DECEMBER 31, 1996 AND 1995
Total assets at December 31, 1996 totaled $207.7 million compared to $162.5
million at December 31,1995. This 27.81% growth in assets was primarily
due to the large volume of loans originated. Total loans increased 36.23%,
or $41.2 million over the comparable 1995 period. The security portfolio
decreased 2.88% to $31.3 million during 1996 as contrasted to the 1995
period. The majority of principal payments received were used to fund
loans, rather than reinvesting in lower yielding securities, which resulted
in the 2.88% decrease in the security portfolio. Total deposits increased
to $189.7 million or 28.77% from 1995's level of $147.3 million.
Stockholder's Equity increased 14.09% during 1996. The Financial Accounting
Standards Board's (FASB) Statement on Accounting Standards No. 115 was
implemented during 1994. FASB's SAS 115 required that all securities
classified as "Available-for-Sale" be adjusted to market value through the
use of a valuation account, and that any paper gains or losses be run
through the Stockholder's Equity section of the balance sheet. The effect
of implementing SAS 115 caused an increase in Stockholder's Equity at
December 31, 1995 of $18 thousand, net of the related deferred tax. As of
December 31, 1996 the Corporation's security portfolio had $18 thousand in
paper losses and had net unrealized holding gains of approximately $18
thousand, net of deferred taxes. The Corporation notes that it does have
the ability and intent to carry to maturity approximately $31.3 million of
the "Available-for-Sale" securities.
COMPARISON OF SIGNIFICANT RATIOS AT DECEMBER 31, 1997 AND 1996
Return on average assets dropped slightly to 0.84% for the year-ended
December 31, 1997 as compared to 0.97% for the comparable 1996 period. The
24.31% growth in assets, the absorption of the operational costs from the
new branch openings, and the addition of over one million to the allowance
for loan loss account all had significant impact relating to the decrease
in this performance ratio. Return on average equity decreased 3.69% from
13.01% at December 31, 1996 to 12.53% at year-end 1997. Average
stockholders' equity to average assets declined to 6.73% at December 31,
1997 from 7.46% at December 31, 1996. Non-performing loans to total loans
increased to 0.47% as of December 31, 1997 as compared to 0.01% for the
comparable 1996 period. Allowance for loan losses as a percentage of total
loans increased 23.19% to 0.85% at December 31, 1997. The decrease in
average stockholders' equity to average assets is primarily attributable to
the enormous amount of growth which the Corporation sustained during 1997.
COMPARISON OF SIGNIFICANT RATIOS AT DECEMBER 31, 1996 AND 1995
Return on average assets dropped slightly to 0.97% for the year-ended
December 31, 1996 as compared to the 1.00% for the comparable 1995 period.
The 27.81% growth in assets and the absorption of the operational costs
from the new Bristol Branch both had significant impact relating to the
decrease in this performance ratio. Return on average equity increased
4.50% from 12.45% at December 31, 1995 to 13.01% at year-end 1996. Average
stockholders' equity to average assets declined to 7.46% at December 31,
1996 from 8.05% at December 31, 1995. Non-performing loans to total loans
increased to 0.01% as of December 31, 1996 as compared to 0.00% for the
comparable 1995 period. Allowance for loan losses as a percentage of total
loans decreased 7.33% to 0.69% at December 31, 1996. The decreases in
average stockholder's equity to average assets and allowance for loan
losses as a percentage of total loans reflects the enormous amount of
growth which the Corporation has sustained during 1996.
COMPARISON OF PER SHARE DATA FOR THE YEARS ENDED DECEMBER 31, 1997 AND 1996
Net income per share, on a weighted average basis, increased 9.66% to $1.59
at December 31, 1997 as compared to $1.45 for the comparable 1996 period.
Book value per share of common stock increased by 13.95% to $13.64 per
share as compared to $11.97 at December 31, 1996. The Corporation had
approximately $104 thousand in paper gains as of December 31 1997, net of
deferred taxes, due to FASB;s SAS 115 which affected the book value
computation.
COMPARISON OF PER SHARE DATA FOR THE YEARS ENDED DECEMBER 31, 1996 AND 1995
Net income per share, on a weighted average basis, increased 21.85% to
$1.45 at December 31, 1996 as compared to $1.19 for the comparable 1995
period. Book value per share of common stock increased by 13.88% to $11.97
per share as compared to $10.52 at December 31, 1995. The Corporation had
approximately $18 thousand in paper losses as of December 31, 1996, net of
deferred taxes, due to FASB's SAS 115, which had virtually no effect on the
book value computation.
HIGHLANDS BANKSHARES, INC.
&
HIGHLANDS UNION BANK
BOARD OF DIRECTORS
J.D. Morefield
Chairman
J. Carter Lambert Dr. James D. Moore, Jr.
Vice Chairman President
William E. Chaffin V.D. Kendrick
Clydes B. Kiser Charles P. Olinger
William J. Singleton Dr. H. Ramsey White, Jr.
BOARD COMMITTEES
Loan Committee Audit Committee Investment Committee
William E. Chaffin V.D. Kendrick J.D. Morefield
J.D. Morefield J. Carter Lambert James D. Moore, Jr.
James D. Moore, Jr. Charles P. Olinger
Charles P. Olinger
Charles P. Olinger H. Ramsey White, Jr.
H. Ramsey White, Jr. William E. Chaffin
William J. Singleton
Personnel/Compensation Appraisal Committee Building Committee
Clydes B. Kiser V.D. Kendrick V.D. Kendrick
J. Carter Lambert J.D. Morefield Clydes B. Kiser
J.D. Morefield J. Carter Lambert J.D. Morefield
Charles P. Olinger Samuel L. Neese James D. Moore, Jr.
H. Ramsey White, Jr. C.B. Hale William E. Chaffin
William J. Singleton
HIGHLANDS BANKSHARES, INC.
OFFICERS
Dr. James D. Moore, Jr. Samuel L. Neese James T. Riffe
President Executive Vice President Excutive Vice President
Chief Executive Officer Chief Operating Officer
Robert M. Little, Jr. James R. Edmondson Melinda S. Bishop
Controller Assistant Controller Senior Internal Auditor
Monica M. Anderson
Internal Auditor
PERSONNEL
HIGHLANDS UNION BANK OFFICERS
Dr. James D. Moore, Jr.
President
Samuel L. Neese James T. Riffe C. B. Hale
Executive Vice President, Executive Vice President, Business Development
Chief Executive Officer Cashier, CRA Officer & & CRA Outreach Officer
Chief Operations Officer
W. Clark Hutton Gary L. Dutton Tim L. Robinson
Senior Vice President, Vice President, Senior Vice President, Senior
Senior Loan Officer Loan Officer-Washington Loan Officer-Bristol
County
Charles E. Holmes C. Wayne Perry John W. Snodgrass
Vice President, Vice President, Credit Vice President, Branch
Commercial Loan Officer Review & Compliance Manager
Officer
Robert M. Little, Jr. James R. Edmondson Christine S. Eldreth
Controller Vice President, Vice President, Loan
Accounting Operations, Consumer
Loan Officer
Edward T. Farmer Curtis B. Fleenor Lynda S. Hayes
Vice President, Vice President, Main Vice President,
Operations, P.C. Office, Consumer Lending Financial Services
Coordinator Manager Manager
Beth A. Morefield M. Suleen Reeder David O. Rhea
Vice President, Dealer Vice President, Mortgage Loan Vice President,
Finance Manager Loan Officer, Manager of Commercial Loan Officer
Mortgage
Darlene M. Rose Marie F. Shy Melinda S. Bishop
Vice President, Manager Vice President, Branch Senior Internal Auditor
of Consumer Loan Manager
Operations
Monica M. Anderson Robert M. Howard Janice M. Eldreth
Internal Auditor Human Resource Officer, Assistant Vice President,
Training Officer Computer Operations
Officer
Beverly A Sharrett Robin G. Frost Edna M. Moore
Assistant Vice President, Assistant Vice President, Assistant Vice President,
Assistant Branch Manager, Branch Officer Mortgage Loan Officer
Consumer Loan Officer Manager of Secondary
Market Mortgage
Malinda W. Pickett Mark B. Redman Mary Jane Robinson
Assistant Vice President, Assistant Vice President, Assistant Vice President,
Branch Manager Branch Manager, Security Student Loan Officer,
Officer Consumer Loan Officer
Mark W. Farris
Loan Officer
PERSONNEL
Dear Shareholders:
We are pleased to report the extraordinary growth
experienced during recent years by Highlands Bankshares Inc.
continued in 1997. Assets increased by $50 million or
24.3%, net loans increased by $36 million or 23.7%, and net
earnings increased by $188,000 or 10.6%. Return on equity
was 12.53% and return on assets was .84%. This was down
slightly from 1996 primarily due to the large increase in
contributions to loan loss reserve in 1997 compared to 1996.
The loan portfolio has increased $77 million the last two
years. To support this significant growth in the loan
portfolio, a total of $1,000,750 was contributed to loan
loss reserve in 1997 compared to $374,000 in 1996.
At year-end 1997, Highlands Union Bank's assets had grown to
in excess of $1/4 billion. Since opening for business in
1985, your company's growth rates have far surpassed the
industry averages. A combination of high-quality
traditional personal service as well as state-of-the-art
technology services afford us the opportunity to fill the
needs and expectations of today's customers.
We are also extremely proud of the regional and national
recognition Highlands Union Bank received in 1997. The bank
was named "Business of the Year" at the 1997 Greater Tri-
Cities Business Awards presented by The Business Journal,
NationsBank and Brown, Edwards & Company. In addition,
Highlands Union was recognized by the national publication,
Working Woman magazine, as one of the nation's best small-
business-friendly lenders. According to the magazine's
survey utilizing data released by the U.S. Small Business
Administration (SBA), Highlands Union is one of only 27
banks in the U.S. to have received a perfect score -- and
the only bank in Virginia.
Several exciting initiatives were begun in 1997, including
the opening of a new Highlands Union Bank branch in Marion,
Va. In addition, the bank began offering customers the
convenience of telebanking and Visa check cards. Also in
1997, a new financial services division of Highlands Union
was formed. Through an affiliation with Independent Bankers
Association Financial Services, fixed annuities, variable
annuities, mutual funds and discount brokerage services (all
non-insured products) were made available.
As a result of the growth and expansion, your bank has
outgrown the operational space at the main office. We were
fortunate to find the former NationsBank operation center on
Valley Street, Abingdon, available for purchase. This
additional space, purchased and occupied in mid-1997,
allowed for the relocation of most operational services to
the center, thus providing additional space at the main
office for customer service.
To provide the capital needed to support the continued
growth, we began the process of issuing $7.5 million in
capital securities. The issue is scheduled to be finalized
in January 1998. It is an issue of Trust Preferred Stock
issued by Highlands Capital Trust I and underwritten by
McKinnon and Company Inc.
As we move into the future, the directors, officers and
employees of Highlands Bankshares Inc. and Highlands Union
Bank will continue to explore opportunities for growth and
earnings enhancement.
We look forward to 1998 with excitement. On behalf of the
directors, officers and employees, thank you for your
continued confidence and support.
Sincerely,
Samuel L. Neese James T. Riffe
Chief Executive Officer Chief Operating Officer
SHAREHOLDER'S LETTER
HIGHLANDS BANKSHARES, INC. AND SUBSIDIARY
CONSOLIDATED FINANCIAL REPORT
DECEMBER 31, 1997
COVER
C O N T E N T S
Page
INDEPENDENT AUDITOR'S REPORT F1
FINANCIAL STATEMENTS
Consolidated Balance Sheets F2
Consolidated Statements of Income F3
Consolidated Statements of Stockholders' Equity F4
Consolidated Statements of Cash Flows F5
Notes to Consolidated Financial Statements F6 - F23
CONTENTS
INDEPENDENT AUDITOR'S REPORT
Board of Directors and Stockholders
Highlands Bankshares, Inc. and Subsidiary
Abingdon, Virginia
We have audited the accompanying consolidated balance sheets
of Highlands Bankshares, Inc. and Subsidiary as of December
31, 1997, 1996, and 1995 and the related consolidated
statements of income, stockholders' equity, and cash flows
for the years then ended. These financial statements are
the responsibility of the Bank's management. Our
responsibility is to express an opinion on these financial
statements based on our audits.
We conducted our audits in accordance with generally
accepted auditing standards. Those standards require that
we plan and perform the audit to obtain reasonable assurance
about whether the financial statements are free of material
misstatement. An audit includes examining, on a test
basis, evidence supporting the amounts and disclosures in
the financial statements. An audit also includes assessing
the accounting principles used and significant estimates
made by management, as well as evaluating the overall
financial statements presentation. We believe that our
audits provide a reasonable basis for our opinion.
In our opinion, the consolidated financial statements
referred to above present fairly, in all material respects,
the financial position of Highlands Bankshares, Inc. and
Subsidiary as of December 31, 1997, 1996 and 1995 and the
results of its operations and its cash flows for the years
then ended in conformity with generally accepted accounting
principles.
/s/ Brown, Edwards & Company, L.L.P.
CERTIFIED PUBLIC ACCOUNTANTS
468 East Main Street
Abingdon, VA 24210
February 13, 1998
F1
HIGHLANDS BANKSHARES, INC. AND SUBSIDIARY
CONSOLIDATED BALANCE SHEETS
December 31, 1997, 1996 and 1995
(In thousands)
1997 1996 1995
____ ____ ____
ASSETS
Cash and due from banks (Note 18) $ 7,712 $ 8,008 $ 5,618
Federal funds sold 7,213 7,948 5,535
Investment securities available
for sale (Note 3) 41,963 31,345 32,276
Loans, net of allowance for loan
losses of $1,636, $1,072 and $908
for 1997, 1996 and 1995,
respectively (Notes 4 and 5) 190,369 153,879 112,835
Premises and equipment (Note 6) 7,062 4,583 4,346
Interest receivable 1,495 1,271 1,068
Other assets (Note 9) 2,422 705 865
_________ _________ _________
Total Assets $ 258,236 $ 207,739 $ 162,543
_________ _________ _________
LIABILITIES AND STOCKHOLDERS' EQUITY
Deposits (Note 7)
Interest bearing $ 205,716 $ 163,468 $ 127,024
Noninterest bearing 30,930 26,003 20,303
_________ _________ _________
Total Deposits 236,646 189,471 147,327
_________ _________ _________
Short term borrowings (Note 8) - - 1,000
Interest, taxes and other
liabilities 2,174 1,722 1,404
Long-term debt (Note 10) 2,614 1,929 -
_________ _________ _________
4,788 3,651 2,404
_________ _________ _________
Total Liabilities 241,434 193,122 149,731
_________ _________ _________
STOCKHOLDERS' EQUITY
Common stock (Notes 12 and 14) 3,081 3,054 3,044
Surplus 5,271 5,187 5,120
Undivided profits 8,346 6,394 4,630
Net unrealized gains (losses)
on securities available for
sale, net of taxes of $54,
$(9), and $9 in 1997, 1996 and
1995, respectively 104 (18) 18
_________ _________ _________
Total Stockholders' Equity 16,802 14,617 12,812
_________ _________ _________
Total Liabilities and
Stockholders' Equity $ 258,236 $ 207,739 $ 162,543
_________ _________ _________
The Notes to Consolidated Financial Statements are an integral part of
these statements.
F2
HIGHLANDS BANKSHARES, INC. AND SUBSIDIARY
CONSOLIDATED STATEMENTS OF INCOME
Years Ended December 31, 1997, 1996 and 1995
(In thousands)
1997 1996 1995
____ ____ ____
INTEREST INCOME
Loans receivable and fees
on loans $ 16,203 $ 12,310 $ 9,590
Securities available for sale 2,363 2,082 1,793
Federal funds sold 169 204 202
__________ _________ _________
Total Interest Income 18,735 14,596 11,585
__________ _________ _________
INTEREST EXPENSE
Deposits 10,099 7,714 6,086
Federal funds purchased 29 9 11
Other borrowed funds 176 99 64
Long-term debt 17 - -
__________ _________ _________
Total interest expense 10,321 7,822 6,161
__________ _________ _________
Net interest income 8,414 6,774 5,424
Provision for loan losses 1,002 374 143
__________ _________ _________
Net interest income after
provision for loan losses 7,412 6,400 5,281
__________ _________ _________
NON-INTEREST INCOME
Securities gains (losses), net 10 23 (1)
Service charges on deposit accounts 514 474 371
Insurance commissions 25 24 25
Other service charges,
commissions and fees 207 96 58
Other operating income, rents 132 43 35
__________ _________ _________
Total Non-Interest Income 888 660 488
__________ _________ _________
NON-INTEREST EXPENSES
Salaries and employee benefits
(Note 13) 2,972 2,481 1,904
Compensation related to stock
options granted (Note 14) 32 53 4
Occupancy expense of bank premises 441 298 212
Furniture and equipment expense 596 564 510
Other operating expenses (Note 20) 1,341 1,043 911
__________ _________ _________
Total Non-Interest Expenses 5,382 4,439 3,541
__________ _________ _________
Income Before Income Taxes 2,918 2,621 2,228
Income Tax Expense (Note 9) 966 857 779
__________ _________ _________
Net Income $ 1,952 $ 1,764 $ 1,449
__________ _________ _________
Earnings Per Common Share (Note 12)$ 1.59 $ 1.45 $ 1.19
__________ _________ _________
Earnings Per Common Share-assuming
dilution $ 1.52 $ 1.38 $ 1.14
__________ _________ _________
The Notes to Consolidated Financial Statements are an integral part of
these statements.
F3
HIGHLANDS BANKSHARES, INC. AND SUBSIDIARY
CONSOLIDATED STATEMENTS OF STOCKHOLDERS' EQUITY
Years Ended December 31, 1997, 1996 and 1995
(In thousands)
Net
Unrealized
Gain (loss)
on
Securities Total
Common Stock Available Stock-
________________ Undivided for holders'
Shares Par Value Surplus Profits sale Equity
______ _________ _______ _______ ____ ______
Balance,
December 31, 1994 1,216 $3,038 $5,116 $3,181 $(1,092) $10,243
Net income - - - 1,449 - 1,449
Common stock issued
for stock options
exercised 2 6 - - - 6
Stock options
granted (Note 14) - - 4 - - 4
Net changes in
unrealized gains
(losses) on available
for sale securities,
net of taxes of $572 - - - - 1,110 1,110
_____ ______ ______ ______ _______ _______
Balance,
December 31, 1995 1,218 3,044 5,120 4,630 18 12,812
Net income - - - 1,764 - 1,764
Common stock
issued for stock
options exercised 4 10 14 - - 24
Stock options
granted (Note 14) - - 53 - - 53
Net changes in
unrealized gains
(losses) on available
for sale securities,
net of taxes of
$(19) - - - - (36) (36)
_____ ______ ______ ______ _______ _______
Balance,
December 31, 1996 1,222 $3,054 $5,187 $6,394 $ (18) $14,617
Net income - - - 1,952 - 1,952
Common stock
issued for stock
options exercised 10 27 52 - - 79
Stock options
granted (Note 14) - - 32 - - 32
Net changes in
unrealized gains
(losses) on available
for sale securities,
net of taxes of
$(63) - - - - 122 122
_____ ______ ______ ______ _______ _______
Balance,
December 31, 1997 1,232 $3,081 $5,271 $8,346 $ 104 $16,802
_____ ______ ______ ______ _______ _______
The Notes to Consolidated Financial Statements are an integral part of
these statements.
F4
HIGHLANDS BANKSHARES, INC. AND SUBSIDIARY
CONSOLIDATED STATEMENTS OF CASH FLOWS
Years Ended December 31, 1997, 1996 and 1995
(In thousands)
1997 1996 1995
____ ____ ____
CASH FLOWS FROM OPERATING ACTIVITIES:
Net income $ 1,952 $ 1,764 $ 1,449
Adjustments to reconcile net
income to net cash provided by
operating activities:
Provision for loan losses 1,002 374 143
Provision for deferred income taxes (124) (67) 596
Deferred compensation expense 32 53 4
Depreciation and amortization 328 214 157
Net realized (gains) losses on
available for sale securities (10) (23) 1
Net amortization on securities 122 125 76
(Increase) decrease in interest
receivable (224) (203) (262)
(Increase) decrease in other
assets (1,593) 227 299
Increase (decrease) in interest,
taxes and other liabilities 452 318 (58)
________ ________ ________
Net Cash Provided by
Operating Activities 1,937 2,782 2,405
________ ________ ________
CASH FLOWS FROM INVESTING ACTIVITIES:
Securities available for sale:
Proceeds from sale of securities 14,560 12,779 586
Proceeds from maturities of debt
securities 565 2,125 3,209
Purchase of securities (25,740) (14,128) (7,648)
Net (increase) decrease in
federal funds sold 735 (2,413) (5,534)
Net increase in loans (37,492) (41,418) (20,077)
Premises and equipment expenditures (2,800) (446) (1,899)
________ ________ ________
Net Cash Used in
Investing Activities (50,172) (43,501) (31,363)
________ ________ ________
CASH FLOWS FROM FINANCING ACTIVITIES:
Net increase in certificates
of deposit 35,683 29,811 22,582
Net increase in demand, savings
and other deposits 11,492 12,333 7,432
Increase (decrease) in federal
funds purchased - - (327)
Proceeds from issuance of
long-term debt 840 - -
Repayment of long-term debt (12) - -
Repayment of short-term borrowings (143) 929 1,000
Proceeds from issuance of common stock 79 36 6
________ ________ ________
Net cash provided by
financing activities 47,939 43,109 30,693
________ ________ ________
Net increase (decrease) in
cash and cash equivalents (296) 2,390 1,735
CASH AND CASH EQUIVALENTS AT
BEGINNING OF YEAR 8,008 5,618 3,883
________ ________ ________
CASH AND CASH EQUIVALENTS AT
END OF YEAR $ 7,712 $ 8,008 $ 5,618
________ ________ ________
SUPPLEMENTAL DISCLOSURE OF NON-CASH
TRANSACTIONS:
Unrealized gain (loss) in
value of securities available for
sale (net of tax effects of $63,
$(19), and $572 at December 31,
1997, 1996 and 1995, respectively $ 122 $ (36) $ 1,110
________ ________ ________
SUPPLEMENTAL DISCLOSURES OF CASH FLOW
INFORMATION:
Cash paid during the year for:
Interest $ 9,802 $ 7,595 $ 5,629
________ ________ ________
Income taxes $ 1,011 $ 901 $ 783
________ ________ ________
The Notes to Consolidated Financial Statements are an integral part of
these statements.
F5
HIGHLANDS BANKSHARES, INC. AND SUBSIDIARY
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
December 31, 1997
(In thousands)
Note 1. Summary of Significant Accounting Policies
Basis of Presentation:
The accounting and reporting policies of Highlands Bankshares, Inc. and
Subsidiary conform to generally accepted accounting principles and the
predominant practices within the banking industry. The accompanying
consolidated financial statements have been prepared on the accrual basis.
Principles of Consolidation:
The accompanying consolidated financial statements include the accounts of
Highlands Bankshares, Inc. and Subsidiary (the "Company") and its wholly-
owned subsidiary, Highlands Union Bank (the "Bank"). All significant
intercompany balances and transactions have been eliminated in
consolidation.
Nature of Operations:
Highlands Bankshares, Inc. and Subsidiary operates in Abingdon, Virginia and
surrounding Southwest Virginia, under the laws of the Commonwealth of
Virginia. The Company was organized December 29, 1995. Highlands Union
Bank, its wholly-owned subsidiary, began banking operations on April 27,
1985. The Bank operates under a state bank charter and provides full
banking services. As a state bank, the Bank is subject to regulation by the
Federal Reserve Board and the Virginia State Bureau of Financial
Institutions.
Securities Available for Sale:
Securities classified as available for sale are those debt securities that
the Company intends to hold for an indefinite period of time, but not
necessarily to maturity. Any decision to sell a security classified as
available for sale would be based on various factors, including significant
movements in interest rates, changes in the maturity mix of the Company's
assets and liabilities, liquidity needs, regulatory capital considerations,
and other similar factors.
Securities available for sale are carried at fair value. Unrealized gains
or losses are reported as increases or decreases in stockholders' equity,
net of the related deferred tax effect. Realized gains or losses,
determined on the basis of the cost of specific securities sold, are
included in earnings. Premiums and discounts are recognized in interest
income using the interest method over the period to maturity.
Loans Receivable and Allowance for Loan Losses:
The reserve for possible loan losses for financial statement purposes is
based upon management's evaluation of amounts required to maintain the
reserve at an adequate level upon consideration of losses charged to the
reserve, current economic conditions, changes in the size and character of
the loan portfolio, and other relevant factors which, in management's
judgment, deserve current recognition.
Premises and Equipment:
Premises and equipment are stated at cost less accumulated depreciation.
Depreciation is computed on the straight-line method over estimated useful
lives. Maintenance and repairs are charged to current operations while
improvements are capitalized. Disposition gains and losses are reflected in
current operations.
(Continued)
F6
HIGHLANDS BANKSHARES, INC. AND SUBSIDIARY
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
December 31, 1997
(In thousands)
Note 1. Summary of Significant Accounting Policies (Continued)
Intangible Assets:
Organizational costs are stated at cost less accumulated amortization.
Amortization is computed on the straight-line method over 60 months.
Cash and Cash Equivalents:
For purposes of reporting cash flows, cash and cash equivalents are those
amounts included in the balance sheet caption "Cash and due from banks".
Income Taxes:
Under the asset and liability method, deferred income taxes are recognized
for the tax consequences of "temporary differences" by applying enacted
statutory tax rates to the differences between the financial statement
carrying amounts and the tax bases of existing assets and liabilities.
Under SFAS No. 109, the effect on deferred taxes of a change in tax rates is
recognized in income in the period that includes the enactment date.
Income on Loans and Loan Fees:
Accrual of interest on commercial loans, mortgages and consumer single-
payment loans is based generally on the daily amount of principal
outstanding. Interest on installment loans is reported as income over the
term of the loan under the simple interest method and the sum-of-the-months'-
digits (Rule of 78's) method. The Rule of 78's method is not materially
different from the interest method. Beginning with 1996 the Bank has
discontinued the use of the "Rule of 78's".
It is the Bank's policy to discontinue the accrual of interest on loans
based on their delinquency status and evaluation of the related collateral
and the financial strength of the borrower. The accrual of interest income
is normally discontinued when a loan becomes 90 days past due as to
principal or interest. Management may elect to continue the accrual of
interest when the net realizable value of collateral is sufficient to cover
the principal balance and accrued interest. When interest accruals are
discontinued, interest accrued and not collected in the current year is
reversed and interest accrued and not collected in prior years is charged to
the allowance for credit losses when the loan is actually charged off.
For mortgage loans, the portion of loan origination fees that exceeds the
direct costs of underwriting and closing loans is deferred. The deferred
fees received are amortized to income over the estimated lives of the
mortgage loans using a straight line method. The deferred fees received in
connection with installment loans are amortized over the life of the loan.
The aforementioned amortization methods are not materially different from
the interest method.
Earnings Per Common Share:
Earnings per common share are calculated based on the weighted average
outstanding shares during the year. Earnings per common share assuming
dilution are calculated based on the weighted average outstanding shares
during the year plus stock options outstanding at year end.
Estimates:
The preparation of financial statements in conformity with generally
accepted accounting principles requires management to make estimates and
assumptions that affect certain reported amounts and disclosures. Actual
results could differ from those estimates.
(Continued)
F7
HIGHLANDS BANKSHARES, INC. AND SUBSIDIARY
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
December 31, 1997
(In thousands)
Note 1. Summary of Significant Accounting Policies (Continued)
Reclassification of Financial Statement Presentation:
Certain reclassifications have been made to the 1996 and 1995 financial
statements to conform with the 1997 financial statement presentation. Such
reclassifications had no effect on net income as previously reported.
Note 2. Business Combination
On December 29, 1995 Highlands Bankshares, Inc. issued approximately 1.2
million shares of its common stock in exchange for all the outstanding
common stock of Highlands Union Bank. In addition, outstanding employee
stock options to purchase Highlands Union Bank common stock were converted
into options to purchase shares of Highlands Bankshares, Inc. The merger
has been accounted for as a pooling of interests.
Note 3. Investment Securities
Debt and equity securities have been classified in the consolidated
statements of financial condition according to management's intent. The
amortized cost and market value of securities classified as available for
sale are as follows:
1997
_________________________________________
Gross Gross
Amortized Unrealized Unrealized Fair
Cost Gains Losses Values
____ _____ ______ ______
U.S. Treasury securities $ 1,493 $ 10 $ - $ 1,503
U.S. Government agencies
and corporations 1,500 - 14 1,486
State and political
subdivisions 939 33 - 972
Mortgage Backed Securities 36,775 129 - 36,904
Other securities 1,098 - - 1,098
________ ________ ________ ________
$ 41,805 $ 172 $ 14 $ 41,963
________ ________ ________ ________
1996
_________________________________________
Gross Gross
Amortized Unrealized Unrealized Fair
Cost Gains Losses Value
____ _____ ______ _____
U.S. Treasury securities $ 1,003 $ - $ 4 $ 999
U.S. Government agencies
and corporations 3,500 - 38 3,462
State and political
subdivisions 1,004 27 - 1,031
Mortgage Backed Securities 25,005 - 13 24,992
Other securities 861 - - 861
________ ________ ________ ________
$ 31,373 $ 27 $ 55 $ 31,345
________ ________ ________ ________
(Continued)
F8
HIGHLANDS BANKSHARES, INC. AND SUBSIDIARY
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
December 31, 1997
(In thousands)
Note 3. Investment Securities (Continued)
1995
_________________________________________
Gross Gross
Amortized Unrealized Unrealized Fair
Cost Gains Losses Value
____ _____ ______ _____
U.S. Treasury securities $ 3,008 $ - $ 20 $ 2,988
U.S. Government agencies
and corporations 8,139 68 67 8,140
State and political
subdivisions 1,331 77 - 1,408
Mortgage Backed Securities 18,861 152 182 18,831
Other securities 909 - - 909
________ ________ ________ ________
$ 32,248 $ 297 $ 269 $ 32,276
________ ________ ________ ________
Investment securities available for sale with a carrying value of $3,571,
$1,003, and $3,808 at December 31, 1997, 1996 and 1995 respectively, and a
market value of $3,595, $998, and $3,782 at December 31, 1997, 1996 and 1995
were pledged as collateral on public deposits and for other purposes as
required or permitted by law.
The amortized cost and estimated fair value of securities available for sale
at December 31, 1997 by contractual maturity are shown below. Expected
maturities may differ from contractual maturities, because borrowers may
have the right to call or prepay obligations with or without call or
prepayment penalties.
Approximate
Amortized Market
Cost Value
____ _____
Due in one year or less $ 500 $ 499
Due after one year through five years 2,643 2,639
Due after five years through ten years 789 823
Due after ten years - -
________ ________
3,932 3,961
________ ________
Mortgage-backed securities 36,775 36,904
Other securities 1,098 1,098
________ ________
37,873 38,002
________ ________
$ 41,805 $ 41,963
________ ________
(Continued)
F9
HIGHLANDS BANKSHARES, INC. AND SUBSIDIARY
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
December 31, 1997
(In thousands)
Note 3. Investment Securities (Continued)
Gross realized gains and losses for the years ended December 31, 1997, 1996
and 1995 on investment securities available for sale are as follows:
1997 1996 1995
____ ____ ____
Realized gains $ 34 $ 50 $ 3
Realized losses $ (24) $ (27) $ (4)
Note 4. Loans
The composition of the net loans is as follows:
1997 1996 1995
____ ____ ____
Commercial $ 24,404 $ 20,370 $ 12,699
Real estate 104,899 101,570 76,590
Installment 59,798 30,656 23,342
Other 3,139 2,967 2,743
_________ _________ _________
192,240 155,563 115,374
_________ _________ _________
Deduct:
Unearned discount 127 455 1,377
Allowance for
loan losses 1,636 1,072 908
Net deferred loan
fees 108 157 254
_________ _________ _________
1,871 1,684 2,539
_________ _________ _________
$ 190,369 $ 153,879 $ 112,835
_________ _________ _________
In May 1993, the Financial Accounting Standards Board issued Statement No.
114, "Accounting by Creditors for the Impairment of a Loan" which is
effective for fiscal years beginning after December 15, 1995. In October
1995, certain provisions of Statement No. 114 were amended by Statement No.
118. Statements 114 and 118 address the methods to be used by a creditor to
measure the impairment of a loan and the proper recognition of a change in
the value of an impaired loan. The Company has no loans that are considered
impaired in conformity with SFAS 114.
Nonaccruing loans totaling $888, $99, and $235 at December 31, 1997, 1996
and 1995 are included in the above loans. Interest income lost on these
nonaccruing loans was approximately $71, $6, and $12, for December 31, 1997,
1996 and 1995, respectively.
Loans have been pledged as part of the floating blanket lien to secure
Federal Home Loan Bank advances. (Note 8)
F10
HIGHLANDS BANKSHARES, INC. AND SUBSIDIARY
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
December 31, 1997
(In thousands)
Note 5. Allowance for Loan Losses
Activity in the allowance for loan losses is as follows for the periods
ended December 31, 1997, 1996, 1995:
1997 1996 1995
____ ____ ____
Balance, beginning $ 1,072 $ 908 $ 836
Provisions charged to
operations 1,002 374 143
Loans charged to reserve (512) (255) (188)
Recoveries 74 45 117
_________ _________ _________
Balance, ending $ 1,636 $ 1,072 $ 908
_________ _________ _________
Note 6. Premises and Equipment
Premises and equipment, stated at cost, are comprised of the following:
1997 1996 1995
____ ____ ____
Land $ 1,847 $ 1,451 $ 1,301
Bank premises 4,445 2,909 2,876
Equipment 2,184 1,316 1,053
_________ _________ _________
8,476 5,676 5,230
Less accumulated
depreciation 1,414 1,093 884
_________ _________ _________
$ 7,062 $ 4,583 $ 4,346
_________ _________ _________
The depreciation expense is $321, $209, and $157 thousand for 1997, 1996,
and 1995, respectively.
Note 7. Deposits
The composition of deposits is as follows:
December 31,
_______________________________
1997 1996 1995
____ ____ ____
Demand $ 45,995 $ 39,381 $ 31,968
Savings 26,808 21,930 17,010
Time deposits, $100,000 or
more 37,890 31,007 26,297
Other time deposits 125,953 97,153 72,052
_________ _________ _________
$ 236,646 $ 189,471 $ 147,327
_________ _________ _________
(Continued)
F11
HIGHLANDS BANKSHARES, INC. AND SUBSIDIARY
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
December 31, 1997
(In thousands)
Note 7. Deposits (Continued)
The remaining maturities of time deposits at December 31, 1997 are as
follows:
Three months or less $ 33,135
Three through twelve months 84,993
Over twelve months 45,715
__________
$ 163,843
__________
Note 8. Short Term Borrowings
Borrowed funds consist of Federal Home Loan Bank advances which are secured
by a floating blanket lien on loans of the Bank. Short-term borrowings for
December 31, 1997, 1996 and 1995 were $0, $0, and $1,000, respectively.
Specific mortgage loans with a balance of $55,787 at December 31, 1997 were
pledged to the FHLB as collateral.
Note 9. Income Taxes
The components of the net deferred tax asset at December 31, 1997, 1996 and
1995 were as follows:
1997 1996 1995
____ ____ ____
Deferred tax assets:
Allowance for loan
loss $ 471 $ 323 $ 245
Deferred compensation
accruals 84 90 78
Gain (loss) on securities
available for sale - 9 -
_______ _______ _______
555 422 323
_______ _______ _______
Deferred tax liability:
Depreciation
differences (155) (128) (106)
Gain (loss) on securities
available for sale (54) (-) (9)
_______ _______ _______
(209) (128) (115)
_______ _______ _______
Net deferred tax asset $ 346 $ 294 $ 208
_______ _______ _______
The net deferred tax asset is included in the balance sheet under the
caption "Other Assets".
(Continued)
F12
HIGHLANDS BANKSHARES, INC. AND SUBSIDIARY
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
December 31, 1997
(In thousands)
Note 9. Income Taxes (Continued)
The components of income tax expense (benefit) related to continuing
operations are as follows:
1997 1996 1995
____ ____ ____
Federal:
Current $ 1,090 $ 924 $ 755
Deferred (124) (67) 24
________ ________ ________
Total $ 966 $ 857 $ 779
________ ________ ________
The Bank's income tax expense differs from the statutory federal rate of 34%
as follows:
1997 1996 1995
____ ____ ____
Statutory rate applied to
earnings before income taxes $ 992 $ 891 $ 758
Tax exempt interest (10) (15) (20)
Other, net (16) 19 41
_______ _______ _______
$ 966 $ 857 $ 779
_______ _______ _______
Note 10. Long-Term Debt
During the year, Highlands Bankshares Inc. and Subsidiary had the following
long-term debt agreements:
1997 1996 1995
____ ____ ____
Note payable Federal Home Loan Bank dated
June 6, 1996 for $1,000,000 with an annual
interest rate of 6.07%, due June 8, 1998. The
note requires annual interest payments. The
loan is secured by a floating blanket lien on
assets of the Bank, including loans. $ 1,000 $ 1,000 $ -
Note payable Federal Home Loan Bank dated
June 6, 1996 for $1,000,000 with an annual
interest rate of 7.02%, due June 6, 2003. The
note requires semi-annual installments of
$71,429 plus interest. The loan is secured by a
floating blanket lien on assets of the Bank,
including loans. 786 929 -
(Continued)
F13
HIGHLANDS BANKSHARES, INC. AND SUBSIDIARY
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
December 31, 1997
(In thousands)
Note 10. Long-Term Debt (Continued)
1997 1996 1995
____ ____ ____
Note payable to Company's Subsidiary
(amount participated with other financial
institutions only) dated March 4, 1997 for
$900,000 with an annual interest rate of
8.25%, due March 4, 2002. The note
requires monthly installments of $7,669
with a balloon payment at maturity. The
loan is secured by a first deed of trust on
a commercial building. $ 828 $ - $ -
_______ _______ ________
Total long-term debt $ 2,614 $ 1,929 $ -
_______ _______ ________
Principal maturities of notes payable at December 31, 1997 are as
follows:
1998 $1,162
1999 163
2000 165
2001 166
2002 885
Thereafter 71
______
$2,612
______
Note 11. Operating Leases
The following is a schedule by years of future minimum rental payments
required under operating leases that have initial or remaining
noncancelable terms in excess of one year as follows:
Year ending December 31:
1998 $ 198
1999 111
2000 -
2001 -
2002 -
Total minimum ______
payments required $ 309
______
Total operating lease expense was $330, $359, and $261 for December 31,
1997, 1996 and 1995 respectively.
(Continued)
F14
HIGHLANDS BANKSHARES, INC. AND SUBSIDIARY
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
December 31, 1997
(In thousands)
Note 11. Operating Leases (Continued)
The Company occupies a building for use by its' subsidiary, and leases the
remaining space. The following is a schedule by years of future minimum
rental payments due to be received under operating leases that have initial
or remaining noncancelable terms in excess of one year as follows:
Year Ending December 31:
1998 $ 88
1999 72
2000 28
2001 -
2002 -
________
Total minimum
payments required $ 188
________
Total operating lease income was $90, $0 and $0 for December 31, 1997, 1996
and 1995, respectively.
Note 12. Common Stock, Stock Split, and Earnings Per Common Share
On April 13, 1996, the Board authorized a 2 for 1 stock split to be
distributed to all shareholders of record as of April 12, 1996. As a
result, authorized shares increased from 5,000,000 to 10,000,000 and par
value decreased from $5.00 to $2.50 per share. All references in the
financial statements to number of shares, per share amounts and market
prices of the Company's common stock have been retroactively restated to
reflect the increased number of common shares outstanding.
At December 31, 1997, 1996 and 1995, the Company had 1,232, 1,222, and 1,218
shares of common stock issued and outstanding, respectively. Earnings per
common share is computed using the weighted average outstanding shares of
1,228, 1,220, and 1,214 for the periods ended December 31, 1997, 1996 and
1995, respectively. The stock options (Note 14) have an antidilutive effect
on earnings per share.
The following is a reconciliation of the numerators and the denominators of
the basic and diluted earnings per common share computation:
1997
___________________________________
Income Shares Per-Share
(Numerator) (Denominator) Amount
___________ _____________ ______
Net income $ 1,952
_______
Basic Earnings per Common Share
Income available to common
stockholders 1,952 1,228 $ 1.59
_______
Effect of Dilutive Stock options
outstanding - 54
_______ _______
Diluted Earnings per Common Share
Income available to common
stockholders + assumed conversions $ 1,952 $ 1,282 $ 1.52
_______ _______ _______
(Continued)
F15
HIGHLANDS BANKSHARES, INC. AND SUBSIDIARY
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
December 31, 1997
(In thousands)
Note 12. Common Stock, Stock Split, and Earnings Per Common Share (Continued)
1996
___________________________________
Income Shares Per-Share
(Numerator) (Denominator) Amount
___________ _____________ ______
Net income $ 1,764
_______
Basic Earnings per Common Share
Income available to common
stockholders 1,764 1,220 $ 1.45
______
Effect of Dilutive Stock options
outstanding - 59
_______ _______
Diluted Earnings per Common Share
Income available to common
stockholders + assumed conversions $ 1,764 $ 1,279 $ 1.38
_______ _______ ______
1995
___________________________________
Income Shares Per-Share
(Numerator) (Denominator) Amount
___________ _____________ ______
Net income $ 1,449
_______
Basic Earnings per Common Share
Income available to common
stockholders 1,449 1,214 $ 1.19
______
Effect of Dilutive Stock options
outstanding - 60
_______ _______
Diluted Earnings per Common Share
Income available to common
stockholders + assumed conversions $ 1,449 $ 1,274 $ 1.14
_______ _______ ______
Note 13. Profit Sharing and Retirement Savings Plan
Effective January 1, 1986, the Bank adopted a profit sharing plan covering
substantially all employees with over one year of service. The plan
provides for contributions in such amounts as the Board of Directors may
annually determine, but not in excess of the amount permitted under the
Internal Revenue Code as a deductible expense. The Bank accrued to the plan
$0, $120, and $92 for the years ended December 31, 1997, 1996 and 1995,
respectively, which represents approximately 0%, 6%, and 7% of qualifying
salaries and wages of the Bank.
On July 1, 1997 the Bank converted its existing profit sharing plan to a
401(K) saving plan. The plan is available to substantially all employees
meeting minimum eligibility requirements. The Bank will make matching
contributions of 50% of employee contributions to the plan up to 6% of base
pay, and additional voluntary contributions by participating employees are
available up to an additional 9% of base pay which are not matched by the
Bank. The Bank also guarantees a 2% contribution to all employees exclusive
of employee contributions and employer matching. The cost of Bank
contributions under the savings plan was $5, $0, and $0 in 1997, 1996 and
1995 respectively.
F16
HIGHLANDS BANKSHARES, INC. AND SUBSIDIARY
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
December 31, 1997
(In thousands)
Note 14. Stock Option Plan
In 1996, Highlands Bankshares, Inc. adopted a non-qualified stock incentive
option plan, which is identical to and replaced the plan adoped by Highlands
Union Bank in 1986, for key employees, officers, and directors and reserved
150,000 shares of common stock for issuance thereunder. Options granted
under the plan expire ten years from date of grant.
Shares under options which subsequently expire, or are canceled are
available for subsequent grant. Option prices are determined by the Board
of Directors, but shall not be less than the greater of the par value of
such stock or 100% of the book value of such stock as shown by the Company's
last published statement prior to granting of the option. Proceeds received
upon exercise of options are credited to common stock, to the extent of par
value of the related shares, and the balance is credited to surplus. During
1997, 1996 and 1995 11,650, 12,900, and 700 shares were granted at $23.00,
$15.000, and $9.333 per share at grant date, respectively.
Options outstanding at option price for the years ended December 31, are as
follows:
1997 1996 1995
___________________ __________________ ___________________
Dollars Number of Dollars Number of Dollars Number of
(Thousands) Shares (Thousands) Shares (Thousands) Shares
___________ ______ ___________ ______ ___________ ______
Options outstanding
January 1 $ 266 73,788 $ 226 65,082 $ 225 66,742
Granted 32 11,650 53 12,900 4 700
Exercised (18) (10,462) (13) (4,194) (3) (2,360)
______ _______ ______ _______ ______ _______
Options outstanding
December 31 $ 280 74,976 $ 266 73,788 $ 226 65,082
______ _______ ______ _______ ______ _______
At the time options are granted, the difference in the market value of the
stock and the option price is recorded as an expense and the related accrual
is included in surplus. For 1997, 1996 and 1995 $32, $53 and $4 thousand
was recorded as compensation as a result of options granted. The 1997 stock
options were granted at the current market value of the stock. As of
December 31, 1997, 1996 and 1995 $280, $266 and $226 thousand remained as
accrued stock options outstanding included in surplus.
Note 15. Commitments, Contingencies and Concentrations of Credit
The Bank is party to various financial instruments with off-balance sheet
risk arising in the normal course of business to meet the financing needs of
their customers. Those financial instruments include commitments to extend
credit and standby letters of credit. These commitments include standby
letters of credit of approximately $2,408, $2,026, and $218 and unused
portions of credit lines of $12,297, $10,335 and $8,202 for the years ended
December 31, 1997, 1996 and 1995, respectively. These instruments contain
various elements of credit and interest rate risk in excess of the amount
recognized in the statements of financial condition.
The Bank's exposure to credit loss, in the event of non-performance by the
other party to the financial instrument for commitments to extend credit and
standby letters of credit, is the contractual amount of those instruments.
The Bank uses the same credit policies in making commitments and
conditional obligations that they do for on-balance sheet instruments.
The Bank has made arrangements with and has available from other
corresponding banks, approximately $50,886 of unused lines of credit to fund
any necessary cash requirements. The Bank has $1,786 of Federal Home Loan
Bank advances outstanding as of December 31, 1997.
(Continued)
F17
HIGHLANDS BANKSHARES, INC. AND SUBSIDIARY
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
December 31, 1997
(In thousands)
Note 15. Commitments, Contingencies and Concentrations of Credit
(Continued)
The Bank grants various types of credit including but not limited to,
agribusiness, commercial, consumer, and residential loans to customers
primarily located throughout Southwest Virginia. Each customer's credit
worthiness is examined on a case by case basis. The amount of collateral
obtained, if any, is determined by management's credit evaluation of the
customer. Collateral held varies, but may include property, accounts
receivable, inventory, plant and equipment, securities and other income
producing properties. Although the loan portfolio is generally well
diversified and geographically dispersed within the region, aggregate loans
extended for real estate mortgages represent greater than 50% of the loan
portfolio. A substantial portion of the customers' ability to honor their
contractual commitment is largely dependent upon the economic conditions of
the region.
Note 16. Fair Values of Financial Instruments
The carrying amounts and fair values of the Bank's financial
instruments at December 31 were as follows (asset/liability):
1997 1996
____________________ ____________________
Carrying Fair Carrying Fair
Amount Value Amount Value
______ _____ ______ _____
Cash and short-term
investments $ 14,925 $ 14,925 $ 15,956 $ 15,956
Investments in
securities 41,963 41,963 31,345 31,345
Loans, net 190,369 195,020 153,879 156,977
Deposits (236,646) (237,429) (189,471) (190,071)
Long-term
debt (2,614) (2,448) (1,929) (1,837)
Cash and Short-Term Investments
The carrying amount reported in the balance sheets for cash and short-term
investments approximates fair value.
Investments in Securities
The carrying amount reported in the balance sheets for cash and short-term
investments approximates fair value.
Loans
The fair values of loans represent the amount at which the loans of the Bank
could be exchanged on the open market, as determined based on the current
lending rate for similar types of lending arrangements discounted over the
remaining life of the loans.
Deposits
The fair values of deposits represent the amount at which the liabilities of
the Bank could be exchanged on the open market, as determined based on the
incremental borrowing rate of the Bank for similar types of borrowing
arrangements.
(Continued)
F18
HIGHLANDS BANKSHARES, INC. AND SUBSIDIARY
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
December 31, 1997
(In thousands)
Note 16. Fair Values of Financial Instruments (Continued)
Long-Term Debt
Rates currently available to the Company for debt with similar terms and
remaining maturities are used to estimate fair value of existing debt.
Commitments to Extend Credit, Stand-by Letters of Credit, and Financial
Guarantees
The amount of off-balance sheet commitments to extend credit, stand-by
letters of credit, and financial guarantees, is considered equal to fair
value. Because of the uncertainty involved in attempting to assess the
likelihood and timing of commitments being drawn upon, coupled with the lack
of an established market and the wide diversity of fee structures, the
Company does not believe it is meaningful to provide an estimate of fair
value that differs from the given value of the commitment.
Note 17. Related Party Transactions
In the normal course of business, the Bank has made loans to and received
deposits from directors and officers of the Bank. All loans and commitments
made to such officers and directors and to companies in which they are
officers or have significant ownership interest have been made on
substantially the same terms, including interest rates and collateral, as
those prevailing at the time for comparable transactions with unrelated
persons, and did not involve more than the normal risk of collectibility or
present other unfavorable features. The activity of such loans and deposits
are approximately as follows:
1997 1996 1995
____ ____ ____
Balance, beginning $ 5,541 $ 6,317 $ 5,712
Loan additions 3,889 2,712 3,525
Amounts collected (3,664) (3,488) (2,920)
________ ________ ________
Balance, ending $ 5,766 $ 5,541 $ 6,317
________ ________ ________
Unused Commitments $ 216 $ 107 $ 247
________ ________ ________
Note 18. Restrictions on Cash
The Bank is required to maintain reserve balances in cash with the Federal
Reserve Bank. The total of those reserve balances at December 31, 1997 and
1996 were $1,034 and $789, respectively.
Note 19. Undivided Profits and Capital
Banking laws and regulations limit the amount of dividends that may be paid
without prior approval of the Bank's regulatory agency. Under that
limitation, the Bank could have declared dividends of $3,189, $3,211 and
$3,517 in 1997, 1996 and 1995 respectively. The Bank declined to pay cash
dividends for 1997 and 1995, in order to maintain the capital necessary to
support the present rate of growth.
(Continued)
F19
HIGHLANDS BANKSHARES, INC. AND SUBSIDIARY
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
December 31, 1997
(In thousands)
Note 19. Undivided Profits and Capital (Continued)
The Bank is subject to various regulatory capital requirements administered
by its primary regulator, the Federal Reserve Board. Failure to meet the
minimum regulatory capital requirements can initiate certain mandatory and
possible additional discretionary actions by regulators, that if undertaken,
could have a direct material affect on the Bank and the consolidated
financial statements. Under the regulatory capital adequacy guidelines and
the regulatory framework for prompt corrective action, the Bank must meet
specific capital guidelines involving quantitative measures of the Bank's
assets, liabilities, and certain off-balance-sheet items as calculated under
regulatory accounting practices. The Bank's capital amounts and
classification under the prompt corrective action guidelines are also
subject to qualitative judgments by the regulators about components, risk
weightings, and other factors.
Quantitative measures established by regulation to ensure capital adequacy
require the Bank to maintain minimum amounts and ratios of: total risk-
based capital and Tier I capital to risk-weighted assets (as defined in the
regulations), and Tier I capital to adjusted total assets (as defined).
Management believes, as of December 31, 1997, that the Bank meets all the
capital adequacy requirements to which it is subject.
As of December 31, 1997, the most recent notification from the Federal
Reserve Board of Richmond dated May 8, 1997 stated that the Bank was
categorized as well capitalized under the regulatory framework for prompt
corrective action. To remain categorized as well capitalized, the Bank will
have to maintain minimum total risk-based, Tier I risk-based, and Tier I
leverage ratios as disclosed in the table below. There are no conditions or
events since the most recent notification that management believes have
changed the Bank's prompt corrective action category.
The Bank's actual and required capital amounts and ratios are as follows
(dollars in thousands):
For To Be Well Capitalized
Capital under the Prompt
Adequacy Corrective Action
Actual Purposes Provisions
______________ ______________ ______________
Amount Ratio Amount Ratio Amount Ratio
______ _____ ______ _____ ______ _____
As of December 31, 1997:
Total Risk-Based Capital
(to Risk-Weighted Assets) $17,874 9.74% $14,686 > 8.0% $18,358 > 10.0%
Tier I Capital - -
(to Risk-Weighted Assets) 16,238 8.85% 7,343 > 4.0% 11,015 > 6.0%
Tier I Capital - -
(to Adjusted Total Assets) 16,238 6.53% 9,942 > 4.0% 12,427 > 5.0%
- -
As of December 31, 1996:
Total Risk-Based Capital
(to Risk-Weighted Assets) $15,213 10.12% $12,022 > 8.0% $15,028 > 10.0%
Tier I Capital - -
(to Risk-Weighted Assets) 14,141 9.41% 6,011 > 4.0% 9,016 > 6.0%
Tier I Capital - -
(to Adjusted Total Assets) 14,141 6.82% 8,298 > 4.0% 10,372 > 5.0%
- -
(Continued)
F20
HIGHLANDS BANKSHARES, INC. AND SUBSIDIARY
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
December 31, 1997
(In thousands)
Note 19. Undivided Profits and Capital (Continued)
As of December 31, 1995:
Total Risk-Based Capital
(to Risk-Weighted Assets) $13,702 13.00% $ 8,432 > 8.0% $10,540 > 10.0%
Tier I Capital - -
(to Risk-Weighted Assets) 12,753 12.10% 4,216 > 4.0% 6,324 > 6.0%
Tier I Capital - -
(to Adjusted Total Assets) 12,753 8.32% 6,131 > 4.0% 7,664 > 5.0%
- -
Note 20. Other Operating Expenses
Other operating expenses consist of the following:
1997 1996 1995
____ ____ ____
Data processing $ 9 $ 9 $ 22
FDIC insurance 24 2 134
Postage and freight 197 161 130
Regulatory agency assessments 40 33 34
Supplies 183 146 124
Bank stock tax 151 122 126
Other 737 570 341
_______ _______ _______
$ 1,341 $ 1,043 $ 911
_______ _______ _______
Note 21. Subsequent Events
In January, 1998, Highlands Bankshares, Inc. issued $7,500 in Trust-
Preferred Capital Securities with a rate of 9.25% and a maturity of 30
years. Trust-Preferred Capital Securities have two primary benefits: the
interest payments are tax deductible and the debt can be included in the
Tier I capital ratio up to 25% of the total capital after the issue.
In January 1998, Highlands Bankshares, Inc. paid off their note payable to
Highlands Union Bank. The balance of the note payable at December 31, 1997
was $828.
Note 22. Condensed Parent Company Financial Statements
The condensed financial statements below relate to Highlands Bankshares,
Inc. for December 31, 1997 and 1996 and for the years then ended. Highlands
Bankshares, Inc. was formed December 29, 1995 and exchanged common stock for
the common stock of Highlands Union Bank.
(Continued)
F21
HIGHLANDS BANKSHARES, INC. AND SUBSIDIARY
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
December 31, 1997
(In thousands)
Note 22. Condensed Parent Company Financial Statements (Continued)
CONDENSED BALANCE SHEETS
1997 1996 1995
____ ____ ____
ASSETS
Cash $ 1 $ 331 $ -
Investments in subsidiaries 16,343 14,122 12,812
Premises and equipment, net 1,276 141 -
Other assets 86 24 10
________ ________ ________
Total Assets $ 17,706 $ 14,618 $ 12,822
________ ________ ________
LIABILITIES AND STOCKHOLDERS' EQUITY
Interest, taxes and other
liabilities $ 23 $ - $ 10
________ ________ ________
Long-term debt 886 - -
________ ________ ________
Total Liabilities $ 909 $ - $ 10
________ ________ ________
STOCKHOLDERS' EQUITY
Net unrealized gains (losses)
on securities 104 (18) 18
Common stock 3,081 3,055 3,044
Surplus 5,271 5,187 5,120
Undivided profits 8,341 6,394 4,630
________ ________ ________
Total Stockholders'
Equity 16,797 14,618 12,812
________ ________ ________
Total Liabilities
and Stockholders'
Equity $ 17,706 $ 14,618 $ 12,822
________ ________ ________
CONDENSED INCOME STATEMENTS
1997 1996
____ ____
Cash dividends received from subsidiary $ - $ 500
Revenues 102 -
Long-term debt interest expense (61) -
Operating expense (57) (5)
________ ________
$ (16) $ 495
Income tax (expense) benefit 5 (2)
Equity in undistributed earnings
of subsidiary 1,963 1,271
________ ________
Net income $ 1,952 $ 1,764
________ ________
(Continued)
F22
HIGHLANDS BANKSHARES, INC. AND SUBSIDIARY
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
December 31, 1997
(In thousands)
Note 22. Condensed Parent Company Financial Statements (Continued)
CONDENSED STATEMENTS OF CASH FLOWS
1997 1996
____ ____
Cash flows from operating activities:
Net income $ 1,952 $ 1,764
Adjustments to reconcile net income to
net cash provided by operating activities:
Depreciation and amortization 25 5
Equity in undistributed earnings of
subsidiary (1,963) (1,271)
(Increase) decrease in other assets (62) (24)
Increase (decrease) in other liabilities 25 (2)
________ ________
Net cash provided by operating activities (23) 472
________ ________
Cash flows from investing activities:
Net purchases of premises and equipment (1,154) (141)
________ ________
Net cash provided by investing activities (1,154) (141)
________ ________
Cash flows from financing activities:
Net increase in long-term debt 900 -
Repayment of long-term debt (14) -
Purchase of subsidiary stock (39) -
________ ________
Net cash provided by financing activities 847 -
Net increase (decrease) in cash
and cash equivalents (330) 331
Cash and cash equivalents
at beginning of year 331 -
________ ________
Cash at end of year $ 1 $ 331
________ ________
F23