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EX-32.1 - STATEMENT OF CHIEF EXECUTIVE OFFICER - HIGHLANDS BANKSHARES INC /VA/ex32-1.htm
EX-32.2 - STATEMENT OF CHIEF FINANCIAL OFFICER - HIGHLANDS BANKSHARES INC /VA/ex32-2.htm
EX-31.2 - CERTIFICATION OF CHIEF FINANCIAL OFFICER - HIGHLANDS BANKSHARES INC /VA/ex31-2.htm
EX-21 - SUBSIDIARIES OF THE CORPORATION - HIGHLANDS BANKSHARES INC /VA/ex-21.htm
EX-23.1 - CONSENT OF BROWN, EDWARDS & COMPANY, LLP - HIGHLANDS BANKSHARES INC /VA/ex23-1.htm
10-K - FORM 10K - HIGHLANDS BANKSHARES INC /VA/hbi10k03302016.htm
EX-31.1 - CERTIFICATATION OF CHIEF EXECUTIVE OFFICER - HIGHLANDS BANKSHARES INC /VA/ex31-1.htm
Exhibit 13.1

HIGHLANDS BANKSHARES, INC.  AND SUBSIDIARY

CONSOLIDATED FINANCIAL REPORT

DECEMBER 31, 2015












C O N T E N T S
 

 
Page
 
REPORT OF INDEPENDENT REGISTERED PUBLIC ACCOUNTING FIRM
2
 
     
Management’s Annual Report on Internal Control over Financial Reporting
3
 
     
FINANCIAL STATEMENTS
   
Consolidated Balance Sheets
  4  
Consolidated Statements of Income
  5  
Consolidated Statements of Comprehensive Income
  6  
Consolidated Statements of Stockholders' Equity
  7  
Consolidated Statements of Cash Flows
  8-9  
Notes to Consolidated Financial Statements
  10-55  





 
 

 


 








REPORT OF INDEPENDENT REGISTERED PUBLIC ACCOUNTING FIRM



To the 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, 2015 and 2014, and the related consolidated statements of income, comprehensive income, stockholders' equity, and cash flows for each of the years in the two-year period ended December 31, 2015. The Company’s management is responsible for these consolidated financial statements. Our responsibility is to express an opinion on these consolidated financial statements based on our audits.

We conducted our audits in accordance with the standards of the Public Company Accounting Oversight Board (United States). Those standards require that we plan and perform the audit to obtain reasonable assurance about whether the financial statements are free of material misstatement. The Company is not required to have, nor were we engaged to perform, an audit of its internal control over financial reporting. Our audit included consideration of internal control over financial reporting as a basis for designing audit procedures that are appropriate in the circumstances, but not for the purpose of expressing an opinion on the effectiveness of the Company's internal control over financial reporting. Accordingly, we express no such opinion. An audit also includes examining, on a test basis, evidence supporting the amounts and disclosures in the financial statements, assessing the accounting principles used and significant estimates made by management, as well as evaluating the overall financial statement 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, 2015 and 2014, and the consolidated results of its operations and its cash flows for each of the years in the two-year period ended December 31, 2015, in conformity with accounting principles generally accepted in the United States of America.
 

                         
 
 
 CERTIFIED PUBLIC ACCOUNTANTS



Bristol, Virginia
March 29, 2016


 
2

 


 
Management's Annual Report on Internal Control Over Financial Reporting


Management is responsible for establishing and maintaining adequate internal control over financial reporting (as such term is defined in Rule 13a-15(f) under the Exchange Act).  Our internal control over financial reporting includes those policies and procedures that (i) pertain to the maintenance of records that, in reasonable detail, accurately and fairly reflect the transactions and dispositions of our assets; (ii) provide reasonable assurance that transactions are recorded as necessary to permit preparation of financial statements in accordance with U.S. generally accepted accounting principles, and that our receipts and expenditures are being made only in accordance with authorizations of our management and directors; and (iii) provide reasonable assurance regarding prevention or timely detection of unauthorized acquisition, use, or disposition of our assets that could have a material effect on the financial statements.

Because of the inherent limitations in any internal control, no matter how well designed, misstatements may occur and not be prevented or detected.  Accordingly, even effective internal control over financial reporting can provide only reasonable assurance with respect to financial statement preparation.  Further, the evaluation of the effectiveness of internal control over financial reporting was made as of a specific date, and continued effectiveness in future periods is subject to the risks that controls may become inadequate because of changes in conditions or that the degree of compliance with the policies and procedures may decline.

Management conducted an evaluation of the effectiveness of our system of internal control over financial reporting as of December 31, 2015 based on the framework set forth in the Committee of Sponsoring Organizations of the Treadway Commission’s 2013 Internal Control - Integrated Framework. Based on its evaluation, management concluded that, as of December 31, 2015, Highlands Bankshares Inc.’s internal control over financial reporting was effective.



 
3

 

 

HIGHLANDS BANKSHARES, INC. AND SUBSIDIARY
CONSOLIDATED BALANCE SHEETS
December 31, 2015 and 2014
(Amounts in thousands)

 
 
2015
 
2014
        ASSETS
       
 Cash and due from banks
 
 $       26,713
 
 $       15,018
 Federal funds sold
 
20,178
 
40,792
         
                Total Cash and Cash Equivalents
 
46,891
 
55,810
         
 Investment securities available-for-sale (Note 3)
 
79,860
 
84,335
 Other Investments, at cost (Note 4)
 
6,592
 
6,767
 Loans, net of allowance for loan losses of  $5,654 and $5,477 in 2015 and 2014, respectively (Note 5)
 
 
426,429
 
 
401,520
 Premises and equipment, net (Note 6)
 
20,612
 
20,236
 Deferred Tax Assets, net (Note 8)
 
12,126
 
10,744
 Interest receivable
 
1,761
 
2,235
 Bank Owned Life Insurance
 
14,585
 
14,183
 Other Real Estate Owned, net
 
5,694
 
6,685
 Other assets
 
2,432
 
2,599
   
 
 
 
                Total Assets
 
 $     616,982
 
 $     605,114
   
 
 
 
              LIABILITIES AND STOCKHOLDERS' EQUITY
 
 
 
 
 Deposits (Note 9)
 
 
 
 
  Noninterest bearing
 
 $       129,634
 
 $       118,557
  Interest bearing
 
365,278
 
364,940
         
                Total Deposits
 
494,912
 
483,497
         
 Interest, taxes and other liabilities
 
761
 
1,014
 Short term borrowings (Note 10)
 
20,052
 
20,051
 Long-term debt (Note 11)
 
47,698
 
47,750
                Total Other Liabilities
 
68,511
 
68,815
         
                Total Liabilities
 
563,422
 
552,312
   
 
 
 
 STOCKHOLDERS' EQUITY
 
 
 
 
 Common stock, 7,851 shares  issued in 2015 and 2014,
 authorized 40,000 shares, par  value
 $0.625 per share  (Note 15)
 
4,907
 
4,907
   
Preferred stock,  2,092 shares issued in 2015 and 2014,
authorized  10,000 shares, par value $2.00 per share
 
4,184
 
4,184
 Additional paid-in capital
 
17,944
 
18,180
 Retained Earnings
 
26,773
 
25,436
 Accumulated other comprehensive income (loss)
 
(248)
 
95
                Total Stockholders' Equity
 
53,560
 
52,802
         
                Total Liabilities and Stockholders' Equity
 
 $     616,982
 
 $     605,114
 
The Notes to Consolidated Financial Statements are an integral part of these statements.
 
 
 
4

 

 
HIGHLANDS BANKSHARES, INC. AND SUBSIDIARY

CONSOLIDATED STATEMENTS OF INCOME
Years Ended December 31, 2015 and 2014
(Amounts in thousands, except per share data)

 
2015
 
2014
 
INTEREST INCOME
           
        Loans receivable and fees on loans
$     20,930
 
$     21,332   30,33383
 
      Securities available for sale:
       
         Taxable
1,165
 
1,005
 
         Tax-exempt
361
 
483
 
         Other investment income
222
 
215
 
      Federal funds sold
85
 
136
 
            Total Interest Income
22,763
 
23,171
 
 
 
 
 
 
 INTEREST EXPENSE
 
 
 
 
     Deposits
2,169
 
2,539
 
    Other borrowed funds
2,388
 
2,685
 
           Total interest expense
4,557
 
5,224
 
 
 
 
 
 
           Net interest income
18,206
 
17,947
 
         
 PROVISION FOR LOAN LOSSES (Note 5)
1,469
 
1,324
 
         
           Net interest income after provision for loan losses
16,737
 
16,623
 
 
 
 
 
 
 NON-INTEREST INCOME
       
      Securities gains
                          16   
 
            1
 
      Service charges on deposit accounts
1,685
 
1,915
 
      Other service charges, commissions and fees
1,647
 
1,649
 
      Other operating income
584
 
710
 
             Total Non-Interest Income
3,932
 
4,275
 
 
 
 
 
 
 NON-INTEREST EXPENSE
 
 
 
 
      Salaries and employee benefits (Note 14)
10,242
 
10,025
 
      Occupancy expense of bank premises
1,131
 
1,069
 
      Furniture and equipment expense
1,370
 
1,166
 
      Other operating expenses (Note 17 and 23)
                       6,049
 
5,356
 
      Foreclosed Assets –Write-down and operating expenses
1,745
 
1,533
 
             Total Non-Interest Expenses
20,537
 
19,149
 
         
            Income (Loss) before Income Taxes
132
 
1,749
 
 
 
 
 
(1,197)
 
      Income Tax Benefit  (Note 8)
(1,205)
 
 (777)
 
 
 
 
 
 
             Net Income
$                     1,337  
 
$      2,526  
 
         
 Earnings Per Common Share (Note 13)
$                       0.17    
 
$       0.36 
 
 
 
 
 
 
 Diluted Earnings Per Common Share (Note 13)
$                       0.13    
 
$        0.28 
 
 
The Notes to Consolidated Financial Statements are an integral part of these statements.

 
5

 


HIGHLANDS BANKSHARES, INC. AND SUBSIDIARY

CONSOLIDATED STATEMENTS OF COMPREHENSIVE INCOME
Years Ended December 31, 2015 and 2014
 (Amounts in thousands, except per share data)

 
2015
 
         2014
 
         
Net Income
     $    1,337     
 
           $  2,526
 
     Other Comprehensive Income
       
          Unrealized gains (losses) on securities during the period
          (504)
 
              1,408
 
           Less: reclassification adjustment for gains included
       
           in securities gains in the Consolidated Statement of
(16)
 
(1)
 
           Income
       
           Other Comprehensive Income  (Loss) before tax
(520)
 
1,407
 
           Income tax expense (benefit) related to Other
(177)
 
478
 
           Comprehensive Income (Loss)
       
   Other Comprehensive Income (Loss)
(343)
 
929
 
 
       
 COMPREHENSIVE INCOME
$    994
 
$   3,455
 
         
 
The Notes to Consolidated Financial Statements are an integral part of these statements.



 
6

 


HIGHLANDS BANKSHARES, INC. AND SUBSIDIARY

CONSOLIDATED STATEMENTS OF STOCKHOLDERS' EQUITY
Years Ended December 31, 2015 and 2014
(Amounts in thousands)



 
Common Stock Shares
Par Value
Preferred Stock
Shares
Par Value
Additional Paid
In Capital
Retained
Earnings
Accumulated
Other
Comprehensive
Income (Loss)
Stockholders’
Equity
Balance
December 31, 2013
 
5,011
 
$ 3,132
 
-
 
-
 
$   7,783
 
 
$  22,910
 
$    (834)
 
$  32,991
 
Net Income
         
 
   $   2,526
 
 
 $ 2,526
Issuance of
Common Stock
 
2,840
 
$1,775
   
 
$7,643
   
 
$9,418
Issuance of
Preferred Stock
   
 
2,092
 
$4,184
 
$2,754
   
 
$6,938
Other
Comprehensive
Income
           
 
$ 929
 
$ 929
 
Balance, December 31, 2014
 
7,851
 
$ 4,907
 
2,092
 
$4,184
 
$   18,180
 
 
$25,436
 
$  95
 
$   52,802
 
Net Income
         
 
$ 1,337
 
 
 
$    1,337
 
Additional Paid
In Capital
       
 
 
(236)
   
 
 
$    (236)
Other
Comprehensive
Loss
           
 
 
$  (343)
 
 
$      (343)
Balance
December 31, 2015
 
7,851
 
$4,907
 
2,092
 
$ 4,184
 
$ 17,944
 
$ 26,773
 
$    (248)
 
$ 53,560
                 
 
The Notes to Consolidated Financial Statements are an integral part of these statements
 
 
 
7

 

 
HIGHLANDS BANKSHARES, INC. AND SUBSIDIARY

CONSOLIDATED STATEMENTS OF CASH FLOWS
Years Ended December 31, 2015 and 2014
(Amount in thousands)

 
2015
 
              2014
 
CASH FLOWS FROM OPERATING ACTIVITIES:
       
Net income
$         1,337
 
$         2,526
 
Adjustments to reconcile net income to net cash
       
provided by operating activities:
       
Provision for loan losses
1,469
 
1,324
 
Provision for deferred income taxes
232
 
517
 
Depreciation and amortization
1,024
 
883
 
Valuation adjustment of deferred tax assets
(1,000)
 
(1,000)
 
Net realized gains on available-for-sale securities
(16)
 
(1)
 
Net amortization on securities
1,059
 
732
 
Amortization of capital issue costs
-
 
29
 
Valuation adjustment of other real estate owned
1,275
 
486
 
(Increase) decrease in interest receivable
(474)
 
(64)
 
(Increase) decrease in other assets
(175)
 
(399)
 
Increase (decrease) in interest, taxes and other
       
liabilities
253
 
(1,581)
 
      Net cash provided by operating activities
4,984
 
3,452
 

 
 
 
 
 
CASH FLOWS FROM INVESTING ACTIVITIES:
 
 
 
 
Securities available for sale:
       
Proceeds from sale of debt and equity securities
            1,025
 
                               -
 
Proceeds from maturities of debt and equity securities
17,759
 
11,094
 
Purchase of debt and equity securities
(15,875)
 
(39,434)
 
(Purchase) redemption of other investments
175
 
(2,057)
 
Net (increase)  in loans
(30,510)
 
(9,188)
 
Proceeds from sales of other real estate owned
3,447
 
3,547
 
Proceeds from cash surrender value of life insurance
-
 
360
 
Premises and equipment expenditures
(1,288)
 
(887)
 
       Net cash used in investing activities
(25,267)
 
(36,565)
 
 
 
 
8

 
 
 
 
     
CASH FLOWS FROM FINANCING ACTIVITIES:
 
     
Net decrease in certificates of deposit
(14,089)
 
(15,531)
 
Net increase in demand, savings and other deposits
         25,504
 
         10,754
 
Net increase (decrease) in short term borrowings
1
 
(3,449)
 
Net decrease in long-term debt
(52)
 
(52)
 
Net decrease in capital securities
-
 
(3,150)
 
Issuance of common stock
-
 
9,418
 
Issuance of preferred stock
-
 
6,938
 
       Net cash provided by financing activities
11,364
 
4,928
 
Net increase (decrease) in cash and cash equivalents
             (8,919)
 
                                     (28,185)
 
 
 
 
 
 
CASH AND CASH EQUIVALENTS AT BEGINNING OF YEAR
55,810
 
83,995
 
         
CASH AND CASH EQUIVALENTS AT END OF YEAR
 $       46,891
 
 $       55,810
 
         
SUPPLEMENTAL DISCLOSURES OF CASH FLOW INFORMATION:
       
Cash paid during the year for:
       
Interest
 $       6,630
 
 $       6,630
 
Income taxes
 $               -
 
 $               -
 
         
SUPPLEMENTAL DISCLOSURES OF NONCASH TRANSACTIONS
       
Transfer of loans to other real estate owned
$       4,131
 
$       3,304
 
Loans originated from sales of other real estate owned
$          390
 
$       1,748
 
                                
       The Notes to Consolidated Financial Statements are an integral part of these statements
 
 
 
9

 

 
HIGHLANDS BANKSHARES, INC. AND SUBSIDIARY
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
December 31, 2015
(Amounts in thousands)

Note  1.                       Summary of Significant Accounting Policies

Basis of Presentation and Consolidation

The accompanying consolidated financial statements include the accounts of Highlands Bankshares, Inc., (the “Parent Company”) and its wholly-owned subsidiary, Highlands Union Bank (the "Bank").  The statements also include Highlands Union Insurance Services, Inc., Highlands Union Financial Services, Inc., Blue Ridge Hospitality, LLC, and Russell Road Properties, LLC which are wholly owned subsidiaries of the Bank. Blue Ridge Hospitality, LLC, formed in June 2014 and Russell Road Properties, LLC, formed in March of 2015 are also subsidiaries of the Bank created to hold and manage certain properties acquired by the Bank through foreclosure or deed in lieu of foreclosure.  All significant intercompany balances and transactions have been eliminated in consolidation.  The accounting and reporting policies of Highlands Bankshares, Inc. and its subsidiaries, (collectively the “Company”) conform to U.S. generally accepted accounting principles and to standard practices within the banking industry.

Nature of Operations

The Company operates in Abingdon, Virginia, and surrounding southwest Virginia, eastern Tennessee, and western North Carolina under the laws of the Commonwealth of Virginia.  The Parent Company was organized on December 29, 1995.  The Parent Company is supervised by the Federal Reserve Bank under the Bank Holding Company Act of 1956, as amended. The Bank began banking operations on April 27, 1985 under a state bank charter and provides a wide range of financial services to individuals and businesses.  The Bank’s primary lending products include mortgage, consumer and commercial loans, and its primary deposit products are checking, savings, and certificates of deposit.  As a state bank and a member of the Federal Reserve Bank of Richmond, the Bank is subject to regulation by the Virginia State Bureau of Financial Institutions, the Federal Deposit Insurance Corporation, and the Federal Reserve Bank.  Highlands Union Insurance Services, Inc. became effective October 8, 1999 for the purpose of selling insurance through Bankers Insurance LLC. The only activity in Highlands Union Financial Services is the receipt of life insurance commissions.

Cash and Cash Equivalents

For purposes of the consolidated statements of cash flows, cash and cash equivalents include cash and due from banks and federal funds sold, all of which mature within ninety days. The Company maintains its cash in bank deposit accounts which, at times, may exceed federally insured limits. The Company has not experienced any losses in such accounts. The Company believes it is not exposed to any significant credit risk on cash and cash equivalents.

Securities Available-for-Sale

Securities classified as available-for-sale are those debt and equity 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 other comprehensive income, net of the related deferred income tax effect.  Realized gains or losses are included in earnings on the trade date and are determined on the basis of the amortized cost of specific securities sold.  Premiums and discounts are recognized in interest income using the interest method over the period to maturity. On a quarterly basis the Company reviews any securities which are considered to be impaired as defined by accounting guidance. During this review, the Company determines if the impairment is deemed to be other than temporary. If it is determined that the impairment is other than temporary, i.e. impaired because of credit issues, the investment is written down by a charge in the Statement of Income.

Loans

The Company makes mortgage, commercial and consumer loans to customers.  Included in mortgage lending are loans secured by real estate such as single family and multifamily dwelling units as well as  commercial properties both owner occupied and held for lease to others.  Commercial loans include those primarily secured by business assets or land or may be unsecured. Consumer loans include second mortgages and equity lines of credit and other personal loans which may be secured or unsecured. The Company also makes farmland loans and other agricultural type loans such as financing farming activities.
 
 
 
10

 
 
HIGHLANDS BANKSHARES, INC. AND SUBSIDIARY

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
December 31, 2015
(Amounts in thousands)

Note  1.                      Summary of Significant Accounting Policies (Continued)

Loans that management has the intent and ability to hold for the foreseeable future or until maturity or pay-off generally are reported at their outstanding unpaid principal balances adjusted for charge-offs, the allowance for loan losses, and any deferred fees or costs on originated loans. Interest income is accrued on the unpaid balance.  Loan origination fees, net of certain direct origination costs, are deferred and amortized to income over the estimated lives of the loans using the straight-line method which is not materially different from the interest method. The accrual of interest on a loan is discontinued at the time the loan is 90 days delinquent unless the credit is well-secured and in process of collection.  Credit card loans and other personal loans are typically charged off no later than 180 days past due.   In all cases, loans are placed on non-accrual or charged-off at an earlier date if collection of principal or interest is considered doubtful. Payments on non-accrual loans are applied to principal or applied on a cash basis. All interest accrued but not collected for loans that are placed on non-accrual or charged off status is reversed against interest income.  The interest on these loans is accounted for on the cash-basis or cost-recovery method, until qualifying for return to accrual.  Loans are returned to accrual status when all the principal and interest amounts contractually due are brought current and future payments are reasonably assured.

Allowance for Loan Losses

The Company monitors and maintains an allowance for loan losses to absorb an estimate of probable losses inherent in the loan portfolio.  The Company maintains policies and procedures that address the systems of controls over the following areas of maintenance of the allowance: the systematic methodology used to determine the appropriate level of the allowance to provide assurance the loan loss reserve is maintained in accordance with accounting principles generally accepted in the United States of America; the accounting policies for loan charge-offs and recoveries; the assessment and measurement of impairment in the loan portfolio; and the loan grading system.

The Company’s Credit Review and Analysis Department evaluates various loans individually for impairment as required by Financial Accounting Standards Board ASC 310, Receivables –Subsequent Measurement.  Loans evaluated individually for impairment include classified loans, non-performing loans, loans on non-accrual, loans past due by 90 days or more, restructured loans and other loans selected by management.  The evaluations are based upon discounted expected cash flows or collateral valuations.  If the evaluation shows that a loan is individually impaired, then a specific reserve is established for the amount of impairment.   For loans that are not individually evaluated, the Company makes estimates of losses for groups of loans as required by ASC 450-20, Accounting for Contingencies.  Loans are grouped by similar characteristics, including the type of loan, the assigned loan grade and the general collateral type.  Assigned loan grades include Quality, Satisfactory, Acceptable, Special Mention, Substandard and Doubtful, each with an increasing risk of potential loss. A loss rate reflecting the expected loss inherent in a group of loans is derived based upon estimates of default rates for a given loan grade, the predominant collateral type for the group and the terms of the loan.  The resulting estimate of losses for groups of loans are adjusted for relevant environmental factors and other conditions of the portfolio of loans, including:  borrower and industry concentrations; levels and trends in delinquencies, charge-offs and recoveries; changes in underwriting standards and risk selection; level of experience and ability of lending management; and, national and local economic conditions.

The amounts of estimated impairment for individually evaluated loans and groups of loans are added together for a total estimate of loan losses.  This estimate of losses is compared to the allowance for loan losses of the Company as of the evaluation date and, if the estimate of losses is greater than the allowance, an additional provision to the allowance is made.  If the estimate of losses is less than the allowance, the degree to which the allowance exceeds the estimate is evaluated to determine whether the allowance falls outside a range of estimates.  If the estimate of losses is below the range of reasonable estimates, the allowance is reduced by adjusting the provision for loan losses.  The Company recognizes the inherent imprecision in estimates of losses due to various uncertainties  and variability related to the factors used, and therefore a reasonable range around the estimate of losses is derived and used to ascertain whether the allowance is too high or too low.  If different assumptions or conditions were to prevail and it is determined that the allowance is not adequate to absorb the new estimate of probable losses, an additional provision for loan losses would be made, which amount may be material to the consolidated financial statements.

Premises and Equipment

Land is carried at cost.   Premises and equipment are stated at cost less accumulated depreciation. Depreciation is computed on


 
11

 
 
HIGHLANDS BANKSHARES, INC. AND SUBSIDIARY

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
December 31, 2015
(Amounts in thousands)

Note 1.                      Summary of Significant Accounting Policies (Continued)

Premises and Equipment (Continued)

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. Purchased software costs are included in other assets and expensed over periods ranging from 3-5 years.

Other Real Estate Owned

Assets acquired through, or in lieu of, loan foreclosure are held for sale and are initially recorded at fair value at the date of foreclosure, establishing a new cost basis. Subsequent to foreclosure, valuations are periodically performed by management using updated appraisals and other information and the assets are carried at the lower of carrying amount or fair value less cost to sell.  Generally, appraisals are updated every 24 months for all individually significant properties or when current events indicate that a property may have suffered a material decrease in value.  Revenue and expenses from operations and gains and losses on disposals are included in Non-interest expense captioned “Foreclosed Assets-Write-down and operating expenses”.

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 ASC 740, the effect on deferred taxes of a change in tax rates is recognized in income in the period that includes the enactment date. Management evaluates the Company’s tax circumstance and filings under the most current and relevant accounting rules and believes the Company has incurred no liability for uncertain beneficial tax positions (or any related penalties and interest) for the periods open to normal jurisdictional examinations (2012 through 2014).

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 common stock equivalents at year end.

Stock Compensation Plans

The Company accounts for stock compensation plans under the guidance of ASC 718 which requires all share-based payments to employees, including grants of employee stock options, to be recognized in the income statement based on their grant-date fair values.  No options were granted during 2015 or 2014.

Use of Estimates

In preparing consolidated financial statements in conformity with U.S. generally accepted accounting principles, management is required to make estimates and assumptions that affect the reported amounts of assets and liabilities as of the date of the balance sheet and reported amounts of revenue and expense during the reporting period.  Actual results could differ from those estimates.  Material estimates that are particularly susceptible to significant change in the near term relate to the determination of the allowance for loan losses, and the valuation of foreclosed real estate, deferred tax assets and investment securities.


Business Segments

The Company reports its activities as a single business segment.  In determining the appropriateness of segment definition, the Company considers components of the business about which financial information is available and regularly evaluated relative to resource allocation and performance assessment.


 
12

 

HIGHLANDS BANKSHARES, INC. AND SUBSIDIARY

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
December 31, 2015
(Amounts in thousands)

Note 1. Summary of Significant Accounting Policies (Continued)


Recent Accounting Pronouncements

In January 2014, the FASB issued ASU No. 2014-04, Receivables – Troubled Debt Restructurings by Creditors (Subtopic 310-40). The amendments in this Update clarify that an in substance repossession or foreclosure occurs, and a creditor is considered to have received physical possession of residential real estate property collateralizing a consumer mortgage loan, upon either (1) the creditor obtaining legal title to the residential real estate property upon completion of a foreclosure or (2) the borrower conveying all interest in the residential real estate property to the creditor to satisfy that loan through completion of a deed in lieu of foreclosure or through a similar legal agreement. Additionally, the amendments require interim and annual disclosure of both (1) the amount of foreclosed residential real estate property held by the creditor and (2) the recorded investment in consumer mortgage loans collateralized by residential real estate property that are in the process of foreclosure according to local requirements of the applicable jurisdiction. The amendments were effective for annual periods, and interim periods within those annual periods beginning after December 15, 2014. The adoption of this ASU did not have a material impact on the Company’s financial statements.

In May 2014, the FASB issued ASU No. 2014-09, Revenue from Contracts with Customers (Topic 606). ASU 2014-09 is a comprehensive new revenue recognition model that requires a company to recognize revenue to depict the transfer of goods or services to a customer at an amount that reflects the consideration it expects to receive in exchange for those goods or services. ASU 2014-09 also requires additional disclosure about the nature, amount, timing and uncertainty of revenue and cash flows arising from customer contracts, including significant judgments and changes in judgments and assets recognized from costs incurred to obtain or fulfill a contract. ASU 2014-09 was effective for annual reporting periods, and interim periods within that period, beginning after December 15, 2016. ASU No. 2015-14 issued in August 2015 deferred the effective date of this Update to annual reporting periods beginning after December 15, 2017, including interim reporting periods within that reporting period. Earlier application is permitted only as of annual reporting periods beginning after December 15, 2016, including interim reporting periods within that reporting period.  The adoption of this ASU is not expected to have a material effect on the Company’s current financial position or results of operations; however, it may impact the reporting of future financial statement disclosures.

In April 2015, the FASB issued ASU No. 2015-03 Interest-Imputation of Interest (Subtopic 835-30), which requires debt issuance costs related to a recognized debt liability to be presented in the balance sheet as a direct deduction from the carrying amount of that debt liability. The recognition and measurement guidance for debt issuance costs are not affected by the amendments in this Update.  The amendments will be effective for financial statements issued for fiscal years beginning after December 15, 2015, and interim periods within those fiscal years, with early adoption permitted. An entity should apply the new guidance on a retrospective basis, wherein the balance sheet of each individual period presented should be adjusted to reflect the period-specific effects of applying the new guidance. Upon transition, an entity is required to comply with the applicable disclosures for a change in an accounting principle. The Company does not expect these amendments to have a material effect on its financial statements.

In August 2015, the FASB issued ASU No. 2015-15 Interest-Imputation of Interest (Subtopic 835-30) Presentation and Subsequent Measurement of Debt Issuance Costs Associated with Line-of-Credit Arrangements Amendments to SEC Paragraphs Pursuant to Staff Announcement at June 18, 2015 EITF Meeting to clarify the SEC staff’s position on presenting and measuring debt issuance costs incurred in connection with line-of-credit arrangements which were not addressed in authoritative guidance within Update 2015-03. An entity is allowed to defer and present debt issuance costs as an asset and subsequently amortize the deferred debt issuance costs ratably over the term of the line-of-credit arrangement, regardless of whether there are any outstanding borrowings on the line-of-credit arrangement.  The Company does not expect these amendments to have a material effect on its financial statements.

In January 2016, ASU No. 2016-01 Financial Instruments--Overall (Subtopic 825-10) was issued by the FASB.  The amendments address certain aspects of recognition, measurement, presentation, and disclosure of financial instruments.  The amendments will be effective for fiscal years beginning after December 15, 2017, including interim periods within those fiscal years. The Company is currently evaluating the impact of these amendments on its financial statements
 
 
13

 

 

HIGHLANDS BANKSHARES, INC. AND SUBSIDIARY

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
December 31, 2015
(Amounts in thousands)

Note 2. Formal Written Agreement

On October 13, 2010, the Company and Bank entered into a written agreement (“Written Agreement”) with the Federal Reserve Bank of Richmond (the “Reserve Bank”).  Under the terms of the Written Agreement, the Bank has agreed to develop and submit to the Reserve Bank for approval within the time periods specified therein written plans or programs to:

·  
strengthen board oversight of the management and operations of the Bank;
·  
strengthen credit risk management and administration;
·  
provide for the effective grading of the Bank’s loan portfolio;
·  
summarize the findings of its review of the adequacy of the staffing of its loan review function;
·  
improve the Bank’s position with respect to loans, relationships, or other assets in excess of $500,000 that currently are, or in the future become past due more than 90 days, on the Bank’s problem loan list, or adversely classified in any report of examination of the Bank;
·  
review and revise the Bank’s methodology for determining the allowance for loan and lease losses (“ALLL”) and maintain an adequate ALLL;
·  
maintain sufficient capital at the Company and the Bank;
·  
establish a revised written contingency funding plan;
·  
establish a revised written strategic and capital plan;
·  
establish a revised investment policy;
·  
improve the Bank’s earnings and overall condition;
·  
revise the Bank’s information technology program;
·  
establish a disaster recovery and business continuity program; and,
·  
establish a committee to monitor compliance with all aspects of the written agreement.

Further, both the Company and the Bank have agreed to refrain from declaring or paying dividends without prior regulatory approval.  The Company has agreed that it will not take any other form of payment representing a reduction in Bank’s capital or make any distributions of interest, principal or other sums on subordinated debentures or trust preferred securities without prior regulatory approval.  The Company also has agreed not to incur, increase or guarantee any debt or not to purchase or redeem any shares of its stock without prior regulatory approval.



 
14

 

 
HIGHLANDS BANKSHARES, INC. AND SUBSIDIARY

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
December 31, 2015
(Amounts in thousands)

Note  3.                      Investment Securities Available-For-Sale

The amortized cost and market value of securities available-for-sale are as follows:

 
2015
 
Amortized Cost
 
Gross Unrealized Gains
 
Gross Unrealized Losses
 
Fair Value
 
               
State and political subdivisions
$     6,834
 
$       124
 
$           -
 
$      6,958
Mortgage backed securities
62,911
 
160
 
478
 
62,593
SBA Pools
10,494
 
9
 
194
 
10,309
 
$    80,239
 
$       293
 
$     672
 
$    79,860


 
2014
 
Amortized Cost
 
Gross Unrealized Gains
 
Gross Unrealized Losses
 
Fair Value
 
               
State and political subdivisions
$   9,546
 
$       163
 
$         8
 
$      9,701
Mortgage backed securities
61,476
 
395
 
148
 
61,723
Single Issue Trust Preferred
500
 
-
 
12
 
488
SBA Pools
12,669
 
29
 
275
 
12,423
 
$   84,191
 
$       587
 
$     443
 
$    84,335

The following tables presents the age of gross unrealized losses and fair value by investment category:

 
December 31, 2015
 
Less Than 12 months
12 Months or More
Total
 
Fair Value
Unrealized Losses
Fair Value
Unrealized Losses
Fair Value
Unrealized Losses
             
State and political subdivisions
$           -
$         -
$          -
$          -
$        -
$          -
Mortgage-backed securities
45,790
363
4,589
115
50,379
478
Single Issue Trust Preferred
-
-
-
-
-
-
SBA Pools
157
3
9,110
191
9,267
194
             
  Total
$  45,947
$     366
$  13,699
 $    306
$59,646
$     672

The total number of investment securities in a loss position at December 31, 2015 was 34.



 
15

 


 
HIGHLANDS BANKSHARES, INC. AND SUBSIDIARY

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
December 31, 2015
(Amounts in thousands)

Note  3.                      Investment Securities Available-For-Sale (Continued)

 
December 31, 2014
 
Less Than 12 months
12 Months or More
Total
 
Fair Value
Unrealized Losses
Fair Value
Unrealized Losses
Fair Value
Unrealized Losses
             
State and political subdivisions
$        -
$     -
$   1,002
$      8
$   1,002     
$      8
Mortgage-backed securities
5,244
19
7,586
129
12,830
148
Single Issue Trust Preferred
-
-
488
12
488
12
SBA Pools
-
-
11,239
275
11,239
275
             
  Total
$ 5,244
$     19
$  20,315
 $    424
$25,559
$  443
             

The total number of investment securities in a loss position at December 31, 2014 was 83.

The Company assesses securities for OTTI quarterly by reviewing credit ratings, financial and regulatory reports as well as other pertinent financial indicators published. As of December 31, 2015 and 2014, the Company's assessment revealed no impairment other than that deemed temporary.

Investment securities available-for-sale with a book value (amortized cost) of $31,422 and $39,298 at December 31, 2015 and 2014 respectively, and a market value of $31,355 and $39,325 at December 31, 2015 and 2014, respectively, were pledged as collateral on public deposits, FHLB advances, secured correspondent credit lines and for other purposes as required or permitted by law.


 
16

 

HIGHLANDS BANKSHARES, INC. AND SUBSIDIARY

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
December 31, 2015
(Amounts in thousands)

Note  3. Investment Securities Available-For-Sale (Continued)

The amortized cost and estimated fair value of securities available-for-sale at December 31, 2015 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.

 
Amortized Cost
 
Fair Value
   
Due in one year or less
$               -
 
$                 -
Due after one year through five years
2,631
 
2,664
Due after five years through ten years
7
 
7
Due after ten years
14,690
 
14,596
 
17,328
 
17,267
       
Mortgage-backed securities
62,911
 
62,593
 
$     80,239
 
$     79,860

For the years ended December 31, 2015 and 2014, proceeds from sales of securities were $1,025 and $4,367 respectively.  Gross realized gains and losses on investment securities available for sale were as follows:

   
2015
 
2014
 
           
Realized gains from sales and calls of securities
 
$       16
 
$       1
 
Realized losses
 
       -
 
       -
 
Net gains
 
    $       16
 
    $    1
 

Note 4.  Other Investments

Federal Home Loan Bank (FHLB) stock, Federal Reserve Bank (FRB) stock, Pacific Coast Bankers’ Bank and Community Bankers’ Bank  stock with a carrying value of $4,350 and $4,525 at December 31, 2015 and 2014, respectively are stated at cost and included as “ Other Investments” on the Company’s Balance Sheets. These investments are considered to be restricted as the Company is required by these entities to hold these investments, and the only market for this stock is the issuing agency.  Also included in “Other Investments” are Certificates of Deposit purchased from other FDIC - insured institutions.  The balances of these CDs were $2,242 and $2,242 at December 31, 2015 and 2014, respectively.


 
17

 



HIGHLANDS BANKSHARES, INC. AND SUBSIDIARY

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
December 31, 2015
(Amounts in thousands)

Note 5.  Loans and Allowance for Loan Losses

The composition of net loans is as follows:

 
2015
 
2014
 
Real Estate Secured:
       
Residential 1-4 family
$   194,287
 
$   186,829
 
Multifamily
23,895
 
21,131
 
Construction and Land Loans
19,163
 
18,518
 
Commercial, Owner Occupied
73,031
 
70,748
 
Commercial, Non-owner occupied
38,025
 
32,173
 
Second mortgages
8,169
 
8,075
 
Equity lines of credit
6,000
 
6,499
 
Farmland
11,283
 
8,246
 
 
373,853
 
352,219
 
         
Secured (other) and unsecured
       
Personal
20,775
 
20,901
 
Commercial
35,144
 
31,586
 
Agricultural
2,959
 
2,683
 
 
58,878
 
55,170
 
         
Overdrafts
139
 
285
 
         
 
432,870
 
407,674
 
Less:
       
  Allowance for loan losses
          5,654
 
          5,477
 
  Net deferred fees
             787
 
             677
 
 
6,441
 
6,154
 
         
Loans, net
$    426,429
 
$    401,520
 


Loans are considered delinquent when payments have not been made according to the terms of the contract. The accrual of interest on loans is discontinued at the time the loan is 90 days delinquent unless the credit is well-secured and in process of collection.  Credit card loans and other personal loans are typically charged off no later than 180 days past due.  In all cases, loans are placed on non-accrual or charged-off at an earlier date if collection of principal or interest is considered doubtful.

The following is a summary of residential real estate currently in the process of foreclosure as well as foreclosed residential real estate as of December 31, 2015.
 

          Number         Balance
Residential real estate in the process of foreclosure
 
                       -
 
                 $         -
 
Foreclosed residential real estate
 
                    10
 
                 $     1,295


 
18

 

 
HIGHLANDS BANKSHARES, INC. AND SUBSIDIARY

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
December 31, 2015
(Amounts in thousands)

Note 5.  Loans and Allowance for Loan Losses (Continued)

The following table is an analysis of past due loans as of December 31, 2015:

   
30-59 Days Past Due
 
60-89 Days Past Due
 
Greater Than 90 Days
 
Total Past Due
 
Current
 
Total Financing Receivables
 
Recorded
 Investment > 90 Days and Accruing
                             
Real Estate Secured
                           
Residential 1-4 family
 
 $    4,193
 
 $    1,580
 
 $    2,545
 
 $    8,318
 
 $  185,969
 
 $  194,287
 
 $          -
Equity lines of credit
 
 24
 
 -
 
 17
 
 41
 
 5,959
 
 6,000
 
-
Multifamily
 
 -
 
-
 
 -
 
 -
 
 23,895
 
 23,895
 
-
Farmland
 
 56
 
 7
 
 303
 
 366
 
 10,917
 
 11,283
 
-
Construction,  Land Development, Other Land Loans
 
 49
 
 61
 
 37
 
 147
 
 19,016
 
 19,163
 
 -
Commercial Real Estate- Owner Occupied
 
 514
 
 485
 
 5,014
 
 6,013
 
 67,018
 
 73,031
 
 -
Commercial Real Estate- Non Owner Occupied
 
 -
 
 -
 
 -
 
 -
 
 38,025
 
 38,025
 
 -
Second Mortgages
 
 88
 
 37
 
 5
 
 130
 
 8,039
 
 8,169
 
 -
Non Real Estate Secured
                           
Personal
 
 264
 
 141
 
163
 
 568
 
 20,346
 
 20,914
 
 -
Commercial
 
 590
 
 217
 
 366
 
 1,173
 
 33,971
 
 35,144
 
 -
Agricultural
 
 45
 
 -
 
 -
 
 45
 
 2,914
 
 2,959
 
 -
                             
          Total
 
 $    5,823
 
 $    2,528
 
 $   8,450
 
 $   16,801
 
 $  416,069
 
 $  432,870
 
 $          -
                             


The following is a summary of non-accrual loans at December 31, 2015:
 
 
 
   
Amount
 
Real Estate Secured
     
Residential 1-4 Family
 
 $       2,675
 
Multifamily
 
-
 
Construction and Land Loans
 
71
 
Commercial-Owner Occupied
 
5,856
 
Commercial- Non Owner Occupied
 
-
 
Second Mortgages
 
5
 
Equity Lines of Credit
 
17
 
Farmland
 
303
 
Secured (other) and Unsecured
     
Personal
 
163
 
Commercial
 
366
 
Agricultural
 
-
 
Total
 
$     9,456
 

 
 
19

 
 

 
HIGHLANDS BANKSHARES, INC. AND SUBSIDIARY

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
December 31, 2015
(Amounts in thousands)

Note 5.  Loans and Allowance for Loan Losses (Continued)

The following table is an analysis of past due loans as of December 31, 2014:
   
30-59 Days Past Due
 
60-89 Days Past Due
 
Greater Than 90 Days
 
Total Past Due
 
Current
 
Total Financing Receivables
 
Recorded Investment > 90 Days and Accruing
                             
Real Estate Secured
                           
Residential 1-4 family
 
 $    4,521
 
 $    3,001
 
 $    2,884
 
 $    10,406
 
 $  176,423
 
 $  186,829
 
 $          -
Equity lines of credit
 
45
 
 -
 
 -
 
 45
 
 6,454
 
 6,499
 
-
Multifamily
 
 1,252
 
-
 
 -
 
 1,252
 
 19,879
 
 21,131
 
-
Farmland
 
 208
 
 -
 
 477
 
 685
 
 7,561
 
 8,246
 
-
Construction,  Land Development, Other Land Loans
 
 417
 
 31
 
 168
 
 616
 
 17,902
 
 18,518
 
 -
Commercial Real Estate- Owner Occupied
 
 2,193
 
 790
 
 2,344
 
 5,327
 
 65,421
 
 70,748
 
 -
Commercial Real Estate- Non Owner Occupied
 
 225
 
 85
 
 1,547
 
 1,857
 
 30,316
 
 32,173
 
 -
Second Mortgages
 
 107
 
 51
 
 134
 
 292
 
 7,783
 
 8,075
 
 -
Non Real Estate Secured
                           
Personal
 
 404
 
 105
 
233
 
 742
 
 20,444
 
 21,186
 
 22
Commercial
 
 720
 
 49
 
 447
 
 1,216
 
 30,370
 
 31,586
 
 -
Agricultural
 
 3
 
 -
 
 -
 
 3
 
2,680
 
 2,683
 
 -
                             
          Total
 
 $    10,095
 
 $    4,112
 
 $   8,234
 
 $   22,441
 
 $  385,233
 
 $  407,674
 
 $          22
                             
 
The following is a summary of non-accrual loans at December 31, 2014:

   
Amount
Real Estate Secured
   
Residential 1-4 Family
 
 $       3,401
Multifamily
 
-
Construction and Land Loans
 
168
Commercial-Owner Occupied
 
5,259
Commercial- Non Owner Occupied
 
1,547
Second Mortgages
 
134
Equity Lines of Credit
 
-
Farmland
 
477
Secured (other) and Unsecured
   
Personal
 
211
Commercial
 
447
Agricultural
 
             -
     
Total
 
$     11,644


 
20

 


HIGHLANDS BANKSHARES, INC. AND SUBSIDIARY
 
 
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
December 31, 2015
(Amounts in thousands)

Note 5.  Loans and Allowance for Loan Losses (Continued)

The following tables represent a summary of credit quality indicators of the Bank’s loan portfolio at December 31, 2015 and December 31, 2014. The grades are assigned and or modified by the Company’s credit review and credit analysis departments based on the creditworthiness of the borrower and the overall strength of the loan.

Credit Risk Profile by Internally Assigned Grade –December 31, 2015
Grade (1)
 
Residential 1-4 Family
 
Multifamily
 
Farmland
 
Construction, Land Loans
 
Commercial Real Estate- Owner Occupied
 
Commercial Real Estate Non-Owner Occupied
                         
Quality
 
$      25,939
 
$                -
 
$            25
 
$            3,036
 
$        2,870
 
$         1,481
Satisfactory
 
 109,993
 
 20,271
 
 6,323
 
 7,406
 
 38,926
 
 19,979
Acceptable
 
 46,639
 
 1,811
 
 3,922
 
 6,420
 
 21,671
 
 12,157
Special Mention
 
 3,133
 
792
 
 195
 
 397
 
 2,552
 
 2,523
Substandard
 
 8,583
 
 1,021
 
 818
 
1,904
 
 7,012
 
 1,885
Doubtful
 
 -
 
 -
 
 -
 
 -
 
 -
 
 -
                         
     Total
 
$   194,287
 
$     23,895
 
$     11,283
 
$        19,163
 
$     73,031
 
$      38,025


Credit Risk Profile by Internally Assigned Grade –December 31, 2014
Grade (1)
 
Residential 1-4 Family
 
Multifamily
 
Farmland
 
Construction, Land Loans
 
Commercial Real Estate- Owner Occupied
 
Commercial Real Estate Non-Owner Occupied
                         
Quality
 
$      29,494
 
$              6
 
$          37
 
$           3,278
 
$        4,159
 
$            874
Satisfactory
 
 100,767
 
 16,326
 
 3,090
 
 8,091
 
 31,018
 
 15,052
Acceptable
 
 44,021
 
 2,719
 
 4,080
 
 4,745
 
 20,987
 
 12,223
Special Mention
 
 2,640
 
828
 
 198
 
 2,231
 
 3,994
 
 2,108
Substandard
 
 9,907
 
 1,252
 
 841
 
 173
 
 10,590
 
 1,916
Doubtful
 
 -
 
 -
 
 -
 
 -
 
 -
 
 -
                         
     Total
 
$   186,829
 
$     21,131
 
$     8,246
 
$        18,518
 
$     70,748
 
$      32,173

 
(1)  Quality--This grade is reserved for the Bank’s top quality loans. These loans have excellent sources of repayment, with no significant identifiable risk of collection.  Generally, loans assigned this rating will demonstrate the following characteristics:
 
 
·  
Conformity in all respects with Bank policy, guidelines, underwriting standards, and Federal and State regulations (no exceptions of any kind).
 
 
·  
Documented historical cash flow that meets or exceeds required minimum Bank guidelines, or that can be supplemented with verifiable cash flow from other sources.
 
 
·  
Adequate secondary sources to liquidate the debt, including combinations of liquidity, liquidation of collateral, or liquidation value to the net worth of the borrower or guarantor.
 
 
 
21

 
 
HIGHLANDS BANKSHARES, INC. AND SUBSIDIARY

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
December 31, 2015
(Amounts in thousands)

Note 5.  Loans and Allowance for Loan Losses (Continued)
 
For existing loans, all of the requirements above apply plus all payments have been made as agreed, current financial information on all borrowers and guarantors has been obtained and analyzed, and overall business operating trends are either stable or improving.
 
      Satisfactory-This grade is given to acceptable loans. These loans have adequate sources of repayment, with little identifiable risk of collection. Loans assigned this rating will demonstrate the following characteristics:
 
·  
General conformity to the Bank's policy requirements, product guidelines and underwriting standards.  Any exceptions that are identified during the underwriting and approval process have been adequately mitigated by other factors.
 
 
·  
Documented historical cash flow that meets or exceeds required minimum Bank guidelines, or that can be supplemented with verifiable cash flow from other sources.  
 
 
·  
Adequate secondary sources to liquidate the debt, including combinations of liquidity, liquidation of collateral, or liquidation value to the net worth of the borrower or guarantor.
 
 
For existing loans, all of the requirements outlined above will apply, plus all payments have been made as agreed, current financial information on all borrowers and guarantors has been obtained and analyzed, and overall business operating trends are stable with any declines considered minor and temporary.
 
 
Acceptable-This grade is given to loans that show signs of weakness in either adequate sources of repayment or collateral, but have demonstrated mitigating factors that minimize the risk of delinquency or loss.  Loans assigned this rating may demonstrate some or all of the following characteristics:
 
 
·  
Additional exceptions to the Bank's policy requirements, product guidelines or underwriting standards that present a higher degree of risk to the Bank.  Although the combination and/or severity of identified exceptions is greater, all exceptions have been properly mitigated by other factors.
 
 
·  
Unproved, insufficient or marginal primary sources of repayment that appear sufficient to service the debt at this time.  Repayment weaknesses may be due to minor operational issues, financial trends, or reliance on projected (not historical) performance.
 
 
·  
Marginal or unproven secondary sources to liquidate the debt, including combinations of liquidation of collateral and liquidation value to the net worth of the borrower or guarantor.
 
 
For existing loans, payments have generally been made as agreed with only minor and isolated delinquencies.
 
 
22

 
 
Special Mention -This grade is given to Watch List loans that include the following characteristics:
 
 
·  
Loans with underwriting guideline tolerances and/or exceptions with no identifiable mitigating factors.
 
 
·  
Extending loans that are currently performing satisfactorily but with potential weaknesses that may, if not corrected, weaken the asset or inadequately protect the Bank's position at some future date. Potential weaknesses are the result of deviations from prudent lending practices.
 
 
·  
Loans where adverse economic conditions that develop subsequent to the loan origination do not jeopardize liquidation of the debt, but do substantially increase the level of risk, may also warrant this rating.
 
 
     Substandard-Loans in this category are characterized by deterioration in quality exhibited by any number of well-defined weaknesses requiring corrective action. A substandard loan is inadequately protected by the current sound net worth and paying capacity of the obligor or of the collateral pledged, if any. Loans classified as substandard must have a well-defined weakness or weaknesses that jeopardize the liquidation of the debt; they are characterized by the distinct possibility that the Bank will sustain some loss if the deficiencies are not corrected.
 
 
 
23

 

HIGHLANDS BANKSHARES, INC. AND SUBSIDIARY

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
December 31, 2015
(Amounts in thousands)

Note 5.  Loans and Allowance for Loan Losses (Continued)
 
 The weaknesses may include, but are not limited to:
 
 
·  
High debt to worth ratios and / or declining or negative earnings trends
 
 
·  
Declining or inadequate liquidity
 
 
·  
Improper loan structure  or questionable repayment sources
 
 
·  
Lack of well-defined secondary repayment source
 
 
·  
Unfavorable competitive comparisons
 
 
Such loans are no longer considered to be adequately protected due to the borrower's declining net worth, lack of earnings capacity, declining collateral margins and/or unperfected collateral positions. A possibility of loss of a portion of the loan balance cannot be ruled out. The repayment ability of the borrower is marginal or weak and the loan may have exhibited excessive overdue status or extensions and/or renewals.
 
 
Doubtful -Loans classified Doubtful have all the weaknesses inherent in loans classified Substandard, plus the added characteristic that the weaknesses make collection or liquidation in full on the basis of currently existing facts, conditions, and values highly questionable and improbable. The ability of the borrower to service the debt is extremely weak, overdue status is constant, the debt has been placed on non-accrual status, and no definite repayment schedule exists.
 
 
However, these loans are not yet rated as loss because certain events may occur which would salvage the debt. Among these events are:
 
 
·  
Injection of capital
 
 
·  
Alternative financing
 
 
·  
Liquidation of assets or the pledging of additional collateral
 
 
The following tables provide a summary of loans whose risk profile is based on payment activity.
 
Credit Risk Profile based on payment activity – December 31, 2015
   
Consumer - Non Real Estate
 
Equity Line of Credit /Second Mortgages
 
Commercial - Non Real Estate
 
Agricultural - Non Real Estate
                 
Performing
 
$        20,751
 
$          14,147
 
$              34,778
 
$            2,959
Nonperforming (>90 days past due)
 
 163
 
 22
 
 366
 
 -
                 
     Total
 
$       20,914
 
$         14,169
 
$              35,144
 
$           2,959
                 
 

 
 
24

 
 
Credit Risk Profile based on payment activity - December 31, 2014
   
Consumer - Non Real Estate
 
Equity Line of Credit / Second Mortgages
 
Commercial - Non Real Estate
 
Agricultural - Non Real Estate
                 
Performing
 
$       20,953
 
$          14,440
 
$               31,339
 
$            2,683
Nonperforming (>90 days past due)
 
 233
 
 134
 
 447
 
 -
                 
     Total
 
$       21,186
 
$         14,574
 
$              31,586
 
$           2,683
                 
 
 
 
25

 
 
HIGHLANDS BANKSHARES, INC. AND SUBSIDIARY

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
December 31, 2015
(Amounts in thousands)

Note 5.  Loans and Allowance for Loan Losses  (Continued)

The following tables reflect the Bank’s impaired loans at December 31, 2015 and December 31, 2014:

 
 
December 31, 2015
 
Recorded Investment
 
Unpaid Principal Balance
 
Related Allowance
 
Average Recorded Investment
 
Interest Income Recognized
With no Related Allowance
                   
Real Estate Secured
                   
Residential 1-4 family
 
$     7,078
 
$     7,078
 
$          -
 
$     7,533
 
$      247
Equity lines of credit
 
51
 
51
 
-
 
38
 
2
Multifamily
 
1,021
 
1,021
 
-
 
1,137
 
60
Farmland
 
816
 
816
 
-
 
829
 
38
Construction, Land Development, Other Land Loans
 
1,547
 
1,547
 
-
 
1,643
 
92
Commercial Real Estate- Owner Occupied
 
5,569
 
5,569
 
-
 
7,379
 
132
Commercial Real Estate- Non Owner Occupied
 
-
 
-
 
-
 
-
 
-
Second Mortgages
 
398
 
398
 
-
 
508
 
14
Non Real Estate Secured
                   
Personal
 
68
 
68
 
-
 
61
 
4
Commercial
 
315
 
315
 
-
 
338
 
13
Agricultural
 
-
 
-
 
-
 
-
 
-
                     
          Total
 
$    16,863
 
$    16,863
 
$          -
 
$   19,466
 
$       602

 
 
December 31, 2015
 
Recorded Investment
 
Unpaid Principal Balance
 
Related Allowance
 
Average Recorded Investment
 
Interest Income Recognized
With an Allowance Recorded
                   
Real Estate Secured
                   
Residential 1-4 family
 
$     1,846
 
$     1,846
 
$       249
 
$     2,497
 
$       93
Equity lines of credit
 
-
 
-
 
-
 
-
 
-
Multifamily
 
-
 
-
 
-
 
-
 
-
Farmland
 
-
 
-
 
-
 
-
 
-
Construction, Land Development, Other Land Loans
 
446
 
446
 
32
 
406
 
25
Commercial Real Estate- Owner Occupied
 
2,119
 
2,119
 
799
 
1,761
 
9
Commercial Real Estate- Non Owner Occupied
 
1,885
 
1,885
 
290
 
1,901
 
56
Second Mortgages
 
18
 
18
 
10
 
9
 
1
Non Real Estate Secured
                   
Personal
 
114
 
114
 
45
 
184
 
4
Commercial
 
670
 
670
 
512
 
736
 
28
Agricultural
 
-
     
-
 
4
 
-
                     
          Total
 
$    7,098
 
$    7,098
 
$     1,937
 
$    7,498
 
$       216



 
26

 


HIGHLANDS BANKSHARES, INC. AND SUBSIDIARY

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
December 31, 2015
(Amounts in thousands)

Note 5.  Loans and Allowance for Loan Losses  (Continued)

 
 
December 31, 2014
 
Recorded Investment
 
Unpaid Principal Balance
 
Related Allowance
 
Average Recorded Investment
 
Interest Income Recognized
With no Related Allowance
                   
Real Estate Secured
                   
Residential 1-4 family
 
$     7,988
 
$     7,988
 
$          -
 
$     7,015
 
$       256
Equity lines of credit
 
24
 
24
 
-
 
194
 
1
Multifamily
 
1,252
 
1,252
 
-
 
626
 
21
Farmland
 
842
 
842
 
-
 
663
 
32
Construction, Land Development, Other Land Loans
 
1,738
 
1,738
 
-
 
1,716
 
64
Commercial Real Estate- Owner Occupied
 
9,188
 
9,392
 
-
 
7,291
 
262
Commercial Real Estate- Non Owner Occupied
 
-
 
-
 
-
 
3,227
 
-
Second Mortgages
 
618
 
618
 
-
 
340
 
20
Non Real Estate Secured
                   
Personal
 
54
 
54
 
-
 
53
 
3
Commercial
 
361
 
361
 
-
 
229
 
20
Agricultural
 
-
 
-
 
-
 
-
 
-
                     
          Total
 
$    22,065
 
$    22,269
 
$          -
 
$   21,354
 
$       679



 
 
December 31, 2014
 
Recorded Investment
 
Unpaid Principal Balance
 
Related Allowance
 
Average Recorded Investment
 
Interest Income Recognized
With an Allowance Recorded
                   
Real Estate Secured
                   
Residential 1-4 family
 
$     3,148
 
$     3,148
 
$       586
 
$     3,087
 
$       125
Equity lines of credit
 
-
 
-
 
-
 
19
 
-
Multifamily
 
-
 
-
 
-
 
-
 
-
Farmland
 
-
 
-
 
-
 
100
 
-
Construction, Land Development, Other Land Loans
 
366
 
366
 
20
 
183
 
13
Commercial Real Estate- Owner Occupied
 
1,403
 
1,403
 
143
 
2,466
 
56
Commercial Real Estate- Non Owner Occupied
 
1,916
 
1,916
 
322
 
3,249
 
31
Second Mortgages
 
-
 
-
 
-
 
28
 
-
Non Real Estate Secured
                   
Personal
 
253
 
253
 
188
 
193
 
7
Commercial
 
802
 
802
 
540
 
863
 
28
Agricultural
 
7
 
7
 
7
 
94
 
1
                     
          Total
 
$    7,895
 
$    7,895
 
$     1,806
 
$    10,282
 
$       261



 
27

 

HIGHLANDS BANKSHARES, INC. AND SUBSIDIARY

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
December 31, 2015
(Amounts in thousands)

Note 5.  Loans and Allowance for Loan Losses  (Continued)

 A loan is considered impaired and an allowance for loan losses is established on loans for which it is probable that the full collection of principal and interest is in doubt. Once a loan is identified as individually impaired, management measures impairment using one of several methods, including collateral value based on recent appraisal  and /or tax assessment value, liquidation value and/or discounted cash flows. Those impaired loans not requiring an allowance represent loans for which the fair value of the expected repayments or collateral exceed the recorded investments in such loans. At December 31, 2015 and 2014, all of the total impaired loans were evaluated based on the fair value of the collateral. On a quarterly basis, the ALLL methodology begins with the determination of individually impaired loans. All loans that are rated “7” (Doubtful) are assessed as impaired based on the expectation that the full collection of principal and interest is in doubt. All loans that are rated “6” (Substandard) or are expected to be downgraded to “6”, require additional analysis to determine whether they may be impaired. All loans that are rated “5” (Special Mention) are presumed not to be impaired. However, “5” rated loans with the following characteristics warrant further analysis before completing an assessment of impairment:

•  
A loan is 60 days or more delinquent on scheduled principal or interest;
•  
A loan is presently in an unapproved over advanced position;
•  
A loan is newly modified; or,
•  
A loan is expected to be modified.


The Company’s credit administration personnel and senior financial officers are responsible for tracking, coding, and monitoring loans that become troubled debt restructurings. Concessions are made to existing borrowers in the form of modified interest rates and / or payment terms. The loans are segregated for regulatory and external reporting. Each specific troubled debt restructuring is reviewed to determine if the accrual of interest should be discontinued and also reviewed for impairment. The Company’s senior credit administration officer performs this analysis on a quarterly basis in addition to determining any other loans that are impaired within the loan portfolio. The Company had a total of $10,064 and $12,060 of loans categorized as troubled debt restructurings as of December 31, 2015 and 2014, respectively. Interest is accrued on troubled debt restructurings if the loan is otherwise not impaired and the full collection of principal and interest under the modified terms is still deemed probable.

In the determination of the allowance for loan losses, management considers troubled debt restructurings and subsequent defaults in these restructurings by adjusting the loan grades of such loans. Defaults resulting in charge-offs affect the historical loss experience ratios which are a component of the allowance calculation. Additionally, specific reserves may be established on restructured loans evaluated individually.



 
28

 


HIGHLANDS BANKSHARES, INC. AND SUBSIDIARY

NOTES TO CONSOLIDATED FINANCIAL STATEMENT
 December 31, 2015
(Amounts in thousands)

Note 5.  Loans and Allowance for Loan Losses  (Continued)

The following is a summary of troubled debt restructurings occurring during the twelve months ended December 31, 2015.
Troubled Debt Restructurings
Interest only
Number of Contracts
Pre- Modification  Outstanding Recorded Investment
Post- Modification Oustanding Recorded Investment
       
Residential 1-4 family
1
$                    188   
$                           188   
Equity lines of credit
     
Multifamily
     
Farmland
     
Construction, Land Development,
Other Land Loans
     
Commercial Real Estate-  Owner Occupied
2
2,203   
2,203   
Commercial Real Estate-  Non Owner Occupied
     
Second Mortgages
1
68   
68   
Non Real Estate Secured
     
Personal / Consumer
     
Business Commercial
     
Agricultural
     
       
Total
4
$                    2,459   
$                      2,459   

Troubled Debt Restructurings
Below Market Rate
Number of Contracts
Pre- Modification  Outstanding Recorded Investment
Post- Modification Outstanding Recorded Investment
       
Residential 1-4 family
1
$                      863   
$                        863   
Equity lines of credit
     
Multifamily
     
Farmland
     
Construction, Land Development,
Other Land Loans
     
Commercial Real Estate-  Owner Occupied
1
1,547   
1,547   
Commercial Real Estate-  Non Owner Occupied
     
Second Mortgages
     
Non Real Estate Secured
     
Personal / Consumer
     
Business Commercial
     
Agricultural
     
       
Total
2
$                    2,410   
$                     2,410   
 
 
 
29

 
 
HIGHLANDS BANKSHARES, INC. AND SUBSIDIARY

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
December 31, 2015
(Amounts in thousands)

Note 5.  Loans and Allowance for Loan Losses  (Continued)



Troubled Debt Restructurings
Loan term extension
Number of Contracts
Pre- Modification  Outstanding Recorded Investment
Post- Modification Outstanding Recorded Investment
       
Residential 1-4 family
1
$                      131   
$                     131   
Equity lines of credit
     
Multifamily
     
Farmland
     
Construction, Land Development,
Other Land Loans
1
35   
35   
Commercial Real Estate-  Owner Occupied
1
847   
847   
Commercial Real Estate-  Non Owner Occupied
     
Second Mortgages
     
Non Real Estate Secured
     
Personal / Consumer
     
Business Commercial
     
Agricultural
     
       
Total
 
3
$                1,013   
$                    1,013   
Troubled Debt Restructurings
All
Number of Contracts
Pre- Modification  Outstanding Recorded Investment
Post- Modification Outstaniding Recorded Investment
Total Restructurings
9
$                 5,882   
$                     5,882   


Troubled Debt Restructurings that subsequently defaulted during the twelve months ended December 31, 2015
Number of Contracts
 
Pre- Modification  Outstanding Recorded Investment
Post- Modification Outstanding Recorded Investment
       
Residential 1-4 family
     
Equity lines of credit
     
Multifamily
     
Farmland
     
Construction, Land Development,
Other Land Loans
     
Commercial Real Estate-  Owner Occupied
     
Commercial Real Estate-  Non Owner Occupied
     
Second Mortgages
     
Non Real Estate Secured
     
Personal / Consumer
     
Business Commercial
     
Agricultural
     
       
Total
     
 
 
 
30

 
HIGHLANDS BANKSHARES, INC. AND SUBSIDIARY

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
 December 31, 2015
(Amounts in thousands)

Note 5.  Loans and Allowance for Loan Losses  (Continued)

The following is a summary of troubled debt restructurings occurring during the twelve months ended December 31, 2014.
Troubled Debt Restructurings
Interest only
Number of Contracts
Pre- Modification  Outstanding Recorded Investment
Post- Modification Outstanding Recorded Investment
       
Residential 1-4 family
     
Equity lines of credit
     
Multifamily
1
$                   1,252   
$                      1,252   
Farmland
     
Construction, Land Development,
Other Land Loans
     
Commercial Real Estate-  Owner Occupied
1
1,395   
1,395   
Commercial Real Estate-  Non Owner Occupied
     
Second Mortgages
     
Non Real Estate Secured
     
Personal / Consumer
     
Business Commercial
     
Agricultural
     
       

Total
2
$                     2,647   
$                        2,647   

 
Troubled Debt Restructurings
Below Market Rate
Number of Contracts
Pre- Modification  Outstanding Recorded Investment
Post- Modification Outstanding Recorded Investment
       
Residential 1-4 family
1
$                       879   
$                        879   
Equity lines of credit
     
Multifamily
     
Farmland
     
Construction, Land Development,
Other Land Loans
     
Commercial Real Estate-  Owner Occupied
     
Commercial Real Estate-  Non Owner Occupied
1
707   
707   
Second Mortgages
     
Non Real Estate Secured
     
Personal / Consumer
     
Business Commercial
     
Agricultural
     
       
Total
2
$                         1,586   
$                        1,586   
 
 
 
31

 
 
HIGHLANDS BANKSHARES, INC. AND SUBSIDIARY

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
December 31, 2015
(Amounts in thousands)

Note 5.  Loans and Allowance for Loan Losses  (Continued)



Troubled Debt Restructurings
Loan term extension
Number of Contracts
Pre- Modification  Outstanding Recorded Investment
Post- Modification Outstanding Recorded Investment
       
Residential 1-4 family
6
$                   1,217   
$                        1,217   
Equity lines of credit
     
Multifamily
     
Farmland
     
Construction, Land Development,
Other Land Loans
     
Commercial Real Estate-  Owner Occupied
1
2,114   
2,114   
Commercial Real Estate-  Non Owner Occupied
     
Second Mortgages
     
Non Real Estate Secured
     
Personal / Consumer
     
Business Commercial
     
Agricultural
1
129   
129   
       
Total
 
8
3,460   
3,460   
Troubled Debt Restructurings
All
Number of Contracts
Pre- Modification  Outstanding Recorded Investment
Post- Modification Outstanding Recorded Investment
Total Restructurings
12
$                     7,693   
$                       7,693   


Troubled Debt Restructurings that subsequently defaulted during the twelve months ended December 31, 2014
Number of Contracts
 
Pre- Modification  Outstanding Recorded Investment
Post- Modification Outstanding Recorded Investment
       
Residential 1-4 family
     
Equity lines of credit
     
Multifamily
     
Farmland
     
Construction, Land Development,
Other Land Loans
     
Commercial Real Estate-  Owner Occupied
     
Commercial Real Estate-  Non Owner Occupied
     
Second Mortgages
     
Non Real Estate Secured
     
Personal / Consumer
     
Business Commercial
     
Agricultural
     
       
Total
     
 
 
 
32

 
 
 
HIGHLANDS BANKSHARES, INC. AND SUBSIDIARY

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
December 31, 2015
          (Amounts in thousands)

Note 5.  Loans and Allowance for Loan Losses  (Continued)

The following tables present the balance in the allowance for loan losses and the recorded investment in loans by loan category and is segregated by impairment evaluation method as of December 31, 2015 and December 31, 2014.



Twelve months ended December 31, 2015
Residential
1-4 Family
Multifamily
Construction and Land Loans
Commercial Owner Occupied
Commercial Non-Owner Occupied
Second Mortgages
Equity Line of Credit
Farmland
Personal and  Overdrafts
Commercial and Agricultural
Unallocated
Total
Allowance for Credit Losses:
                       
Beginning Balance December 31,  2014
$     995
$       20
$       87
$      409
$     1,063
$      67
$     74
$      12
$     665
$      982
$     1,103
$      5,477
Provision for Credit Losses
16
(20)
(79)
634
(309)
(21)
(95)
(8)
759
152
440
1,469
Charge-offs
360
-
12
407
12
3
-
-
796
257
-
1,847
Recoveries
(3)
-
(41)
(376)
(6)
-
(41)
(3)
(76)
(9)
-
(555)
Net Charge-offs
357
-
(29)
31
6
3
(41)
(3)
720
248
-
1,292
Ending Balance
 December 31, 2015
654
-
37
1,012
748
43
20
7
704
886
1,543
5,654
Ending Balance: Individually evaluated for impairment
249
-
32
799
290
10
-
-
45
512
 
1,937
Ending Balance:  Collectively Evaluated for Impairment
405
-
5
213
458
33
20
7
659
374
1,543
3,717
Loans:
                       
Ending Balance: Individually Evaluated for Impairment
8,924
1,021
1,993
7,688
1,885
416
51
816
182
985
-
23,961
Ending Balance: Collectively Evaluated for Impairment
185,363
22,874
17,170
65,343
36,140
7,753
5,949
10,467
20,732
37,118
-
408,909
Ending Balance: December 31, 2015
$194,287
$23,895
$19,163
$73,031
$38,025
$8,169
$6,000
$11,283
$20,914
$38,103
-
$432,870
                                    
 
 
 
33

 
 
    HIGHLANDS BANKSHARES, INC. AND SUBSIDIARY

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
December 31, 2015
(Amounts in thousands)

Note 5.  Loans and Allowance for Loan Losses  (Continued)


Twelve months ended December 31, 2014
Residential
1-4 Family
Multifamily
Construction and Land Loans
Commercial Owner Occupied
Commercial Non-Owner Occupied
Second Mortgages
Equity Line of Credit
Farmland
Personal and  Overdrafts
Commercial and Agricultural
Unallocated
Total
Allowance for Credit Losses:
                       
Beginning Balance December 31,  2013
$   975
$     143
$      230
$    1,029
$     1,415
$     153
$      50
$       65
$      483
$      1,264
$     1,018
 
  $      6,825
Provision for Credit Losses
277
(123)
(142)
(407)
886
(61)
140
(53)
636
86
85
1,324
Charge-offs
258
-
18
345
1,239
25
116
-
544
407
-
2,952
Recoveries
(1)
-
(17)
(132)
(1)
-
-
-
(90)
(39)
-
(280)
Net Charge-offs
257
-
1
213
1,238
25
116
-
454
368
-
2,672
Ending Balance
 December 31, 2014
995
20
87
409
1,063
67
74
12
665
982
1,103
5,477
Ending Balance: Individually evaluated for impairment
586
-
20
143
322
-
-
-
188
547
-
1,806
Ending Balance:  Collectively Evaluated for Impairment
409
            20
67
266
741
67
74
12
477
435
1,103
3,671
Loans:
                       
Ending Balance: Individually Evaluated for Impairment
11,136
1,252
2,104
10,591
1,916
618
24
842
592
1,170
-
30,245
Ending Balance: Collectively Evaluated for Impairment
175,693
19,879
16,414
60,157
30,257
7,457
6,475
7,404
20,594
33,099
-
377,429
Ending Balance: December 31, 2014
$186,829
$21,131
$18,518
$70,748
$32,173
$8,075
$6,499
$8,246
$21,186
$34,269
-
$407,674



 
34

 


HIGHLANDS BANKSHARES, INC. AND SUBSIDIARY

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
December 31, 2015
(Amounts in thousands)

Note 5.  Loans and Allowance for Loan Losses  (Continued)

 Overview of Loan Review and ALLL Processes

The loan review function performs various tasks that are utilized to discover weaknesses within the loan portfolio.  These include annual reviews on loan relationships that are greater than $500.  The relationship review includes a discussion on the collateral, repayment history, guarantor(s) financial position, and debt service coverage on an individual and global level.  These reviews are based primarily upon federal tax returns for cash flow determination, internally prepared interim statements and personal financial statements.  Debt service coverage (DSC) is calculated on each individual customer, or guarantor, as well as the aggregate or global DSC.  The DSC is discounted to determine a “stressed” DSC.  Collateral evaluation includes an inspection of the collateral file to determine if the Bank is indeed properly securitized.  Collateral is discounted, when appropriate, to determine a “stressed” loan to value ratio (LTV).   In addition to annual loan relationship reviews, quarterly reviews on all loan relationships over $100 that are graded Substandard, Doubtful and Loss are also completed.  This quarterly review process is comprised of a shortened version of the full relationship review.  These quarterly reviews include a discussion on personal credit management, DSC and LTV.  In addition to these quarterly reviews of all non-pass watch list relationships, a semi-annual review is conducted on all Special Mention loan relationships that are on the watch list.  These reviews are prepared in the same manner as the quarterly non-pass relationship reviews.  The appropriateness of the risk rating of each relationship is assessed, with changes to the risk rating being made by the Senior Credit Review Officer, when deemed appropriate. Other measures taken to determine potential problem relationships include the monthly preparation of the watch list.  During that process, past due loan reports are reviewed, as well as any other information that might be presented by loan officers, regarding a particular loan relationship that is exhibiting stress.  To be considered as a watch list relationship, distinct characteristics must be exhibited.  These include, but are not limited to late payments greater than 60 days, a low DSC calculation, bankruptcy filings, casualty losses, or other issues that would cause a perceived increase in the risk of loss to the Bank. The final segment of the loan review process involves special reviews.  These reviews target specific segments of the loan portfolio, i.e. credit cards, equity lines, consumer loans, construction loans, and other specific segments of the loan portfolio that management wishes to have reviewed.  However, currently, the primary emphasis of the loan review function is loan relationship review work, and watch list management.

The segments of the Company’s loan portfolio are disaggregated to a level that allows management to monitor risk and performance. In reviewing risk, management has determined there to be several different risk categories within the loan portfolio. The allowance for loan losses consists of amounts applicable to: (i) the commercial loan portfolio; (ii) the commercial real estate loan portfolio; (iii) the construction loan portfolio; (iv) the consumer loan portfolio; and, (v) the residential loan portfolio. The commercial real estate (“CRE”) loan segment is further disaggregated into two classes. Non-owner occupied CRE loans, which include loans secured by non-owner occupied nonfarm nonresidential properties, generally have a greater risk profile than all other CRE loans, which include multifamily structures and owner-occupied commercial structures. The construction loan segment is further disaggregated into two classes. One-to-four family residential construction loans are generally made to individuals for the acquisition of and/or construction on a lot or lots on which a residential dwelling is to be built. Commercial construction loans are generally made to developers or investors for the purpose of acquiring, developing and constructing residential or commercial structures. Construction lending is generally considered to involve a higher degree of credit risk than long-term permanent financing.

The following describes the Company’s basic methodology for computing its ALLL for the twelve months ending December 31, 2015 and 2014.

On a quarterly basis, the ALLL methodology begins with the identification of loans subject to ASC 310.  All loans that are rated “7” (Doubtful) are assessed as impaired based on the expectation that the full collection of principal and interest is in doubt. All loans that are rated “6” (Substandard) or are expected to be downgraded to “6”, require additional analysis to determine whether they may be impaired under ASC 310. All loans that are rated “5” (Special Mention) are presumed not to be impaired. However, “5” rated loans, together with any troubled debt restructured loans, may warrant further analysis before completing an assessment of impairment.  For ASC 310 loans that are individually evaluated and found to be impaired (primarily those designated as Substandard and Doubtful), the associated ALLL will be based upon one of the three impairment measurement methods specified within ASC 310:

(1)  
Present value of expected future cash flows discounted at the loan’s effective interest rate;
(2)  
Loan’s observable market price; or,
(3)  
Fair value of the collateral.
 
 
 
35

 
 
HIGHLANDS BANKSHARES, INC. AND SUBSIDIARY

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
December 31, 2015
(Amounts in thousands)