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
DECEMBER 31, 1998 Number: 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, 1998, there were 1,246,548 shares of Common Stock
outstanding.
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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, 1998.
(2) Part III incorporates by reference from the registrant's proxy statement for
its Annual Meeting of Stockholders scheduled for May 12, 1999.
(3) Part IV incorporates by reference from: (i) the registrant's Annual Report
to Stockholders for the fiscal year ended December 31, 1998, and (ii) the
registrant's proxy statement for its Annual Meeting of Stockholders
scheduled for May 12, 1999.
The exhibit index is located on page 26.
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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, 1998, the Corporation had total assets of $307,764,000,
deposits of $272,341,000, and net worth of $18,279,000.
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 opened an indirect lending department in 1997.
The majority of indirect lending originates through new and used car
dealerships. The indirect lending portfolio comprises a significant portion of
the total consumer loan portfolio. 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 its 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 has two direct subsidiaries as of December 31, 1998. The
Bank which was formed in 1985 and Highlands Capital Trust I, a statutory
business trust (the "Trust") which was created by the Corporation on January 21,
1998. The Corporation's material assets as of December 31, 1998 include:
building and land, approximately $1.4 million; investment securities,
approximately $4.2 million; and its investment in subsidiaries, approximately
$19.8 million. The Corporation's only material liability is the note payable on
the trust preferred debentures issued in January of 1998, $7.5 million.
The Corporation operates six full service and one express facility
throughout Washington County, Virginia, the City of Bristol, Virginia, Marion,
Virginia., and Glade Spring, Virginia. The Corporation also operates fifteen
off-site ATM's throughout the service areas listed above as well as Russell
County and Wythe County, Virginia.
The results of operations for the fiscal years ended December 31, 1998,
1997, and 1996 ("fiscal year 1998", "fiscal year 1997" and "fiscal year 1996",
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.
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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 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 2% per
annum applies to the one year adjustable product. A 4% lifetime cap 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
customer 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 1998 the Corporation's primary lending
area was Washington County, Virginia , the City of Bristol, Virginia, and Smyth
County, 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 are 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, including equity lines of credit, made up
approximately 36.99% of the loan portfolio as of December 31, 1998.
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, 1998 outstanding construction loans (net of
undisbursed funds) totaled $2,156,000. These loans are generally made at 80% or
less of appraised value at
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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 $46,097,000 or 19.75% of total loans held for investment at December 31,
1998.
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, 1998 were
$70,137,000.
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
$24,240,000 at December 31, 1998 and the outstanding balance of non-real estate
agriculture loans was $2,821,000 at December 31, 1998.
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, 1998 the Corporation's mortgage-backed securities portfolio had a
carrying value of $37,918,000 or 12.32% of total assets compared to $36,424,000
or 14.10% of total assets at December 31, 1997. Amortized costs of
mortgage-backed securities were $38,077,000 at December 31, 1998 and $36,299,000
for the comparable 1997 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, 1998 of $7,873,000 and amortized cost of $7,886,000 compared to a
market value of $480,000 and amortized cost of $476,000 at December 31, 1997.
The Corporation had $0 and $1,503,000 invested in United States Treasury
Notes at December 31, 1998 and 1997 respectively. These investments represented
approximately 0.00% and 0.58% of total assets at those dates.
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The Corporation had $2,765,000 and $1,486,000 in United States
Government-sponsored Agency Obligations at December 31, 1998 and 1997
respectively. These investments represent approximately 0.90% and 0.57% of total
assets at those dates.
The Corporation holds the following equity investments: Federal Reserve
Bank Stock of $295,400 and $248,150 as of December 31, 1998 and 1997
respectively; Federal Home Loan Bank Stock of $950,900 and $781,000 for the same
dates as above; and Community Bankers' Bank Stock of $54,750 and $54,750 for the
same dates as above.
The Corporation also holds investments in municipal bonds of $759,000
and $972,000 as of December 31, 1998 and 1997 respectively. These investments
represented approximately 0.25% and 0.38% 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,
repayments from securities, 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, statement 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.
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The following table sets forth the various types of accounts offered by the
Corporation at December 31, 1998:
<TABLE>
<CAPTION>
Weighted
Average Minimum Amount
Interest Balance In % of
Type of Account Rate Term Deposit Thousands Total
- --------------- ---- ---- ------- --------- -----
<S> <C> <C> <C> <C> <C>
Checking Account 0.00% none $ 100.00 $ 36,187 13.29%
Interest Checking 3.51 none 100.00 14,888 5.47
Passbook Accounts 4.00 none 25.00 35,640 13.09
Money Market
Deposit Accounts 3.78 none 500.00 7,048 2.59
Christmas Club Accts 4.04 none 5.00 36 0.00
Individual Retirement
Accounts 6.53 various 500.00 25,217 9.26
Certificates of Deposit
Accounts 5.82 various 500.00 153,325 56.30
--------- -------
Totals $272,341 100.00%
-------- -------
</TABLE>
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.
<TABLE>
<CAPTION>
Years Ended December 31
(In Thousands) 1998 1997 1996
- -------------- ----- ---- ----
<S> <C> <C> <C>
Increase (decrease) in deposits before
interest credited back to accounts $ 28,880 $ 41,924 $ 38,054
Interest credited back to accounts 6,815 5,251 4,090
-------- -------- --------
Net increase in deposits 35,695 47,175 42,144
-------- -------- --------
Total deposits at year end $272,341 $236,646 $189,471
-------- -------- --------
</TABLE>
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
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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 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, 1998 the Bank had approximately $52,592,000
of unused lines of credit, including FHLB unused lines of credit, to fund any
necessary cash requirements.
The following table sets forth certain information as to the
Corporation's advances and other borrowings at the dates indicated. See Notes 8,
9 and 14 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.
<TABLE>
<CAPTION>
December 31
(In Thousands) 1998 1997 1996
- -------------- ---- ---- ----
<S> <C> <C> <C>
Advances from FHLB $ 6,643 $ 1,786 $ 1,929
Guaranteed preferred beneficial
interests in corporation's junior
subordinated debt securities 7,500 -0- -0-
Other borrowings 120 828 -0-
------- ------- -------
Total borrowings $14,263 $ 2,614 $ 1,929
</TABLE>
EMPLOYEES
The Corporation at December 31, 1998, had 143 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. The Corporation formed a statutory business
trust, Highlands Capital Trust I, in January of 1998 to issue trust preferred
securities in order to raise additional capital.
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.
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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.
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 its 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
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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.
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, 1998 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.
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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 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 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
11
<PAGE>
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).
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 generally
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 6 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
<TABLE>
<CAPTION>
Year Ended December 31,
1998 1997 1996
(Dollars in Thousands)
AVERAGE YEILD/ AVERAGE YIELD/ AVERAGE YIELD/
BALANCE INTEREST RATE BALANCE INTEREST RATE BALANCE INTEREST RATE
------- -------- ---- ------- -------- ---- ------- -------- ----
<S> <C> <C> <C> <C> <C> <C> <C> <C> <C>
ASSETS
Interest earning assets
(taxable-equivalent
basis (1) :
Loans (net of un-
earned discount) (2) $213,069 $ 19,618 9.21% $175,542 $16,249 9.26% $131,449 $ 12,326 9.38%
Securities (3) 56,757 3,057 5.39 38,158 2,363 6.19 34,350 2,082 6.06
Federal funds sold 4,250 222 5.22 3,244 169 5.20 3,822 204 5.33
-------- -------- ------ -------- -------- ------ -------- -------- ------
Total interest-earning
assets $274,076 $ 22,897 8.35% $216,944 $ 18,781 8.66% $169,621 $ 14,612 8.61%
-------- -------- ------ -------- -------- ------ -------- -------- ------
LIABILITIES
Interest-bearing
liabilities :
Savings & time dep. $226,142 $ 12,336 5.46% $181,846 $ 10,099 5.55% $142,331 $ 7,714 5.42%
Other interest-bearing
liabilities 13,933 1,065 7.64 3,366 222 6.59 1,803 108 5.99
-------- -------- ------ -------- -------- ------ -------- -------- ------
Total interest-bearing
liabilities $240,075 $ 13,401 5.58% $185,212 $ 10,321 5.57% $144,134 $ 7,822 5.43%
-------- -------- ------ -------- -------- ------ -------- -------- ------
Net interest income $ 9,496 $ 8,460 $ 6,790
Net margin on int.
earning assets on a
tax equivalent basis 3.46% 3.90% 4.00%
Average interest
spread 2.77% 3.09% 3.18%
</TABLE>
12
<PAGE>
(1) 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.
(2) For the purposes of these computations, non-accruing loans are included in
the daily average loan amounts outstanding.
(3) 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 FAS115
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 changes in interest
due to both rate and volume has been allocated to volume and rate changes in
proportion to the relationship of the absolute dollar amounts of the change in
each.
<TABLE>
<CAPTION>
1998 Compared to 1997 1997 Compared to 1996
INCREASE INCREASE INCREASE INCREASE
(DECREASE) DUE (DECREASE) DUE (DECREASE) DUE (DECREASE) DUE
TO CHANGE IN TO CHANGE IN NET INCREASE TO CHANGE IN TO CHANGE IN NET INCREASE
Increase (Decrease) in VOLUME RATE (DECREASE) VOLUME RATE (DECREASE)
- ---------------------- ------ ---- ---------- ------ ---- ----------
<S> <C> <C> <C> <C> <C> <C>
INTEREST INCOME
Securities ......................... $ 1,148 $ (454) $ 694 $ 278 $ 3 $ 281
Federal funds sold ................. 52 1 53 (36) 1 (35)
Loans .............................. 3,474 (105) 3,369 4,135 (212) 3,923
------- ------- ------- ------- ------- -------
Total Income Change ................ $ 4,674 $ (558) $ 4,116 $ 4,377 $ (208) $ 4,169
------- ------- ------- ------- ------- -------
INTEREST EXPENSE
Savings and time
deposits ........................ $ 2,441 $ (204) $ 2,237 $ 2,377 $ 8 $ 2,385
Other interest-bearing
liabilities ..................... 697 146 843 113 1 114
------- ------- ------- ------- ------- -------
Total Expense Change ............... $ 3,138 $ (58) $ 3,080 $ 2,490 $ 9 $ 2,499
------- ------- ------- ------- ------- -------
Increase (Decrease) in
Net Interest Income ............. $ 1,536 $ (500) $ 1,036 $ 1,887 $ (217) $ 1,670
------- ------- ------- ------- ------- -------
</TABLE>
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, 1998.
(Dollars in Thousands)
<TABLE>
<CAPTION>
One Year Five Years
Within One Through Through After Ten Total Book Market
Year Five Years Ten Years Years Yield Value Value
---- ---------- --------- ----- ----- ----- -----
<S> <C> <C> <C> <C> <C> <C> <C>
U.S.T.N.'s ........ $ 0 $ 0 $ 0 $ 0 0% $ 0 $ 0
U.S. Gov Agency ... 282 4,665 4,513 39,809 5.37 49,425 49,269
State & Muni's .... 0 0 305 454 6.85 754 759
Other ............. 0 0 0 1,327 6.44 1,327 1,327
------- ------- ------- ------- ---- ------- -------
TOTAL ........... $ 282 $ 4,665 $ 4,818 $41,590 5.39 $51,506 $51,355
------- ------- ------- ------- ---- ------- -------
</TABLE>
13
<PAGE>
LOAN PORTFOLIO
The table below classifies loans, net of unearned income, by major
category and percentage distribution at December 31, 1998 for each of the past
three years:
December 31,
(Dollars in thousands)
<TABLE>
<CAPTION>
1998 1997 1996
Description Amount Percentage Amount Percentage Amount Percentage
----------- ------ ---------- ------ ---------- ------ ----------
<S> <C> <C> <C> <C> <C> <C>
Commercial $ 24,235 10.38% $ 24,395 12.71% $ 20,365 13.14%
Real Estate 136,184 58.37 104,818 54.59 101,491 65.50
Consumer 70,132 30.05 59,653 31.07 30,128 19.44
Other 2,821 1.20 3,139 1.63 2,967 1.92
-------- ------ -------- ------ -------- ------
Total $233,372 100.00% $192,005 100.00% $154,951 100.00%
-------- ------ -------- ------ -------- ------
</TABLE>
The following table shows the maturity of loans outstanding, inclusive
of contractual amortization as of December 31, 1998. Loans are classified based
upon the period in which the final payment is due.
December 31, 1998
(Dollars in Thousands)
<TABLE>
<CAPTION>
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
---- ---- ---- ---- ---- ---- -----
<S> <C> <C> <C> <C> <C> <C> <C>
Commercial $ 6,054 $ 5,418 $ 10,917 $ 804 $ 1,006 $ 36 $ 24,235
Real Estate 16,884 4,101 45,953 6,856 17,395 44,995 136,184
Consumer 20,911 797 46,617 18 1,739 50 70,132
Other 1,227 973 503 118 0 0 2,821
-------- -------- -------- -------- -------- -------- --------
Total $ 45,076 $ 11,289 $103,990 $ 7,796 $ 20,140 $ 45,081 $233,372
-------- -------- -------- -------- -------- -------- --------
</TABLE>
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, 1998, 1997 and 1996, non-accrual loans amounted
to $1,396,000, $888,000 and $96,000, respectively. Interest income lost on
non-accruing loans was approximately $146,000, $71,000, and $6,000 for December
31, 1998, 1997, and 1996 respectively.
14
<PAGE>
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)
<TABLE>
<CAPTION>
1998 1997 1996
---- ---- ----
<S> <C> <C> <C>
Allowance for loan losses at
beginning of year $ 1,636 $ 1,072 $ 908
Loans charged off:
Commercial 270 42 170
Real Estate 0 0 0
Consumer 786 470 85
Other 0 0 0
-------- -------- --------
Total $ 1,056 $ 512 $ 255
-------- -------- --------
Recoveries of loans previously charged off:
Commercial $ 41 6 32
Real Estate 0 0 0
Consumer 157 68 13
Other 0 0 0
-------- -------- --------
Total $ 198 $ 74 $ 45
-------- -------- --------
Net loans charged off $ 858 $ 438 $ 210
Provision for loan losses 1,230 1,002 374
-------- -------- --------
Allowance for loan losses end of year $ 2,008 $ 1,636 $ 1,072
-------- -------- --------
Average total loans (net of unearned income) $213,069 $175,542 $131,449
Total loans (net of unearned
income) at year-end $233,372 $192,005 $154,951
Ratio of net charge-offs to average loans 0.403% 0.249% 0.160%
Ratio of provision for loan losses to
average loans 0.577% 0.571% 0.285%
Ratio of provision for loan
losses to net charge-off 143.357% 228.770% 178.100%
Allowance for loan losses to
year-end loans 0.860% 0.852% 0.690%
</TABLE>
15
<PAGE>
ALLOCATION OF THE ALLOWANCE FOR LOAN LOSSES
The following table provides an allocation of the allowance for loan
losses as of December 31, 1998
Year Ended December 31, 1998
Percent of Loans on each category
(Dollars in Thousands)
<TABLE>
<CAPTION>
Allowance for Percentage of Percentage of
Loan Loss Total Loan Loss Total Loans
--------- --------------- -----------
<S> <C> <C> <C>
Commercial $ 503 25.05% 10.38%
Real Estate 118 5.88 58.37%
Consumer 1,384 68.92 30.05
Other 3 0.15 1.20
------ ------ ------
Total $2,008 100.00% 100.00%
------ ------ ------
</TABLE>
DEPOSITS
The following table provides a breakdown of deposits at December 31 for
the years indicated is as follows:
<TABLE>
<CAPTION>
December 31,
(Dollars in Thousands)
1998 1997 1996
---- ---- ----
<S> <C> <C> <C>
Non-interest bearing demand deposits $36,187 $30,930 $26,003
Interest bearing demand deposits 21,936 15,065 13,378
Savings deposits 35,640 26,808 21,930
Time deposits 178,578 163,843 128,160
------- ------- -------
Total Deposits $272,341 $236,646 $189,471
-------- -------- --------
</TABLE>
The average daily amount of deposits and rates paid on such deposits is
summarized for the periods indicated in the following table:
<TABLE>
<CAPTION>
Year Ended December 31,
(Dollars in Thousands)
1998 1997 1996
---- ---- ----
Amount Rate Amount Rate Amount Rate
------ ---- ------ ---- ------ ----
<S> <C> <C> <C> <C> <C> <C>
Non-interest bearing
demand deposits $ 33,671 0.00% $ 28,177 0.00% $ 22,566 0.00%
Interest-bearing demand
deposits 18,239 3.60 14,029 3.58 12,566 3.60
Savings deposits 32,681 4.00 24,600 4.00 20,516 4.01
Time deposits 175,222 5.92 143,217 6.01 109,249 5.89
-------- ----- -------- ---- -------- ----
Total $259,813 $210,023 $164,897
-------- -------- --------
</TABLE>
16
<PAGE>
The remaining maturities of time deposits at December 31, 1998 are as
follows (in thousands) :
<TABLE>
<CAPTION>
Maturity
<S> <C>
3 months or less....................................$ 37,373
Over 3 through 12 months............................ 87,916
Over 12 months...................................... 53,289
--------
Total $178,578
========
</TABLE>
INTEREST RATE SENSITIVITY ANALYSIS
The following table provides the maturities of investment securities,
loans, and deposits as of December 31, 1998, and measures the interest rate
sensitivity gap for each range of maturity indicated: The amounts below also
reflect various prepayment assumptions.
December 31, 1998
(Dollars in Thousands)
Maturing
<TABLE>
<CAPTION>
Within One After One But After Five
Year Within Five Years Years Total
---- ----------------- ----- -----
<S> <C> <C> <C> <C>
ASSETS
Interest-bearing
Investment Securities $ 28,882 $ 13,004 $ 9,469 $ 51,355
Fed Funds Sold 1,670 1,670
Loans 97,629 123,250 10,484 231,363
Noninterest-bearing
Other Assets 10,819 0 12,557 23,376
--------- --------- --------- ---------
Total Assets $ 139,000 $ 136,254 $ 32,510 $ 307,764
--------- --------- --------- ---------
LIABILITIES AND SHARE-
HOLDERS' EQUITY
Interest-bearing
All Interest-bearing Deposits $ 149,519 $ 81,606 $ 5,029 $ 236,154
Other Interest-bearing Liab. 666 600 13,500 14,766
Noninterest-bearing
Demand Deposit Non-Interest 24,754 11,433 0 36,187
Other Liabilities 2,015 0 363 2,378
Shareholders' Equity 0 0 18,279 18,279
--------- --------- --------- ---------
Total Liabilities and Shareholders'
Equity $ 176,954 $ 93,639 $ 37,171 $ 307,764
--------- --------- --------- ---------
Interest Rate Sensitivity GAP $ (37,954) $ 42,615 $ (4,661) $ 0
</TABLE>
17
<PAGE>
RETURN ON EQUITY AND ASSETS
The following table highlights certain ratios for the periods indicated:
<TABLE>
<CAPTION>
Year Ended December 31,
(Percentage)
1998 1997 1996
---- ---- ----
<S> <C> <C> <C>
Net income to:
Average total assets 0.61 0.84 0.97
Average shareholders' equity 10.06 12.53 13.01
Dividend payout ratio (dividends declared per
share divided by net income per share) 6.93 0.00 0.00
Average shareholders' equity to average total
assets ratio 6.02 6.73 7.46
</TABLE>
ITEM 2. PROPERTIES
The Corporation's and the Bank's main offices are located at 340 W. Main
Street, Abingdon, Virginia. The main office is a two story brick structure owned
by the Bank. The Bank utilizes the entire structure for its day to day
operations. Attached to the main office is a four lane drive thru facility
constructed in 1998. The new drive thru replaced an older unit which was
detached from the main office's structure. The main office opened for operations
in 1985. In addition, the Bank has three other 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 branch.
The branch was completed and opened for operation in 1993. The West Abingdon
location operates as an "express facility." This location contains four drive
thru 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. During 1998, the
Bank constructed and placed in service a two-story brick building located at 506
Maple Avenue, Glade Spring, Virginia. The Glade Spring Office is a full service
location with four drive thru lanes. 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
building with interior customer loan and deposit areas as well as a four lane
drive thru unit. The 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 full service customer service areas and
a four lane drive thru facility. The Bank also operates its dealer finance
division out of the Commonwealth office. This office was completed and opened
for operations in 1995. The Bank also has a full service branch at 1425 North
Main Street , Marion, Virginia. The branch was placed in service in December of
1997. It is a two story brick building and operates as a full service branch.
The Marion office has two drive thru lanes. There is also an ATM located
approximately 1/2 mile from the branch on North Main Street. The ATM resides on
property purchased by the Bank in 1997. All of the Bank's branch locations
except Marion have an on premises ATM. All branch properties are owned by the
Bank and are free of liens. In September 1998, the Bank acquired the adjacent
building to its Commonwealth office to facilitate future expansion. This is a
one story brick structure, located at 801-805 Commonwealth Avenue, Bristol,
Virginia and is currently leased. A note payable to the sellers was executed and
is secured by a first deed of trust. The balance on the note as of December 31,
1998 was approximately $120,000. Also during 1998, the Bank initiated an off
premises ATM program. Throughout 1998, 15 offsite ATMs were purchased and
installed throughout the Bank's market areas. Three machines were placed in
Bristol, Virginia; five were installed in Washington County, Virginia; one in
Russell County, Virginia; five in Smyth County, Virginia, and one in Wythe
County, Virginia. All machines 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
18
<PAGE>
by another bank for use as an operations center. The Corporation assumed
the lease 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 its subsidiary to lease the first floor to be used for its
operations center. Currently, the bookkeeping, proof, accounting, shareholder
services, human resources, internal audit and training departments are located
there. The West Plumb Alley property is free of liens. Also during 1998, the
Corporation purchased the adjacent property to the operations center. The
property purchased is a one story brick structure which is currently leased. It
is management's intention to utilize the property as growth continues. The
property is owned free and clear 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.
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, 1998.
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, 1998 the Corporation has approximately 994
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 1998. It is
the opinion of management that this range accurately reflects the market value
of the Corporations common stock at the present time.
Common Stock Performance-December 31 1998
High Low Quarterly Average
---- --- -----------------
First Quarter $32.00 $29.00 $30.53
Second Quarter $31.67 $30.00 $30.56
Third Quarter $30.00 $30.00 $30.00
Fourth Quarter $32.00 $30.00 $31.00
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 declared and paid cash dividends of $123,000 or
$0.10 per share during 1998.
At December 31, 1998, there were approximately 994 holders of the
Corporation's common stock (based on the number of record holders as of that
date).
19
<PAGE>
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)
<TABLE>
<CAPTION>
1998 1997 1996 1995 1994
---- ---- ---- ---- ----
<S> <C> <C> <C> <C> <C>
Income Statement Amounts:
Gross interest income $ 22,897 $ 18,781 $ 14,612 $ 11,585 $ 8,425
Gross interest expense 13,401 10,321 7,822 6,161 3,985
Net interest income 9,496 8,460 6,790 5,424 4,440
Provision for possible loan
Losses 1,230 1,002 374 143 120
Net interest income after
provision 8,266 7,458 6,416 5,281 4,320
Other operating income 1,367 842 644 488 425
Other operating expense 6,962 5,382 4,439 3,541 3,004
Income before income taxes
and other items 2,671 2,918 2,621 2,228 1,741
Income taxes 896 966 857 779 581
Income before cumulative
effect of change in
accounting principles 1,775 1,952 1,764 1,449 1,160
Cumulative effect of change
in accounting principles -0- -0- -0- -0- -0-
Net income $ 1,775 $ 1,952 $ 1,764 $ 1,449 1,160
Per Share Data (1):
Net income per share $ 1.44 $ 1.59 $ 1.45 $ 1.19 $ 0.96
Cash dividends per share .10 -0- -0- -0- -0-
Book value (at year end) 14.66 13.64 11.97 10.52 8.43
Balance Sheet Amounts (at year-end):
Total assets $307,764 $258,236 $ 207,739 $ 162,543 $128,749
Total loans (net of unearned
income) 233,371 192,005 154,951 113,743 93,738
Total deposits 272,341 236,646 189,471 147,327 117,314
Long-term debt 6,763 2,614 1,929 -0- -0-
Guaranteed preferred
beneficial interests in
junior subordinated debt
securities 7,500
Total equity 18,279 16,802 14,617 12,812 10,243
</TABLE>
(1) 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 Company's plan for addressing Year 2000 is discussed in the 1998
Annual Report to stockholders. The Company has budgeted $100,000 to implement
its plan relating to Year 2000. Other information required herein is
incorporated by reference from pages 8 to 12 of the Annual Report to
Stockholders for the fiscal year ended December 31, 1998.
ITEM 8. FINANCIAL STATEMENTS AND SUPPLEMENTARY DATA
The financial statements and supplementary data required herein are
incorporated by reference from pages 20 to 40 of the Annual Report to
Stockholders for the fiscal year ended December 31,1998.
20
<PAGE>
ITEM 9. CHANGES IN ACCOUNTANTS AND DISAGREEMENTS WITH ACCOUNTANTS ON ACCOUNTING
AND FINANCIAL DISCLOSURE
None.
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 1998 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
1998 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 1998
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 1998 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, 1998 and 1997
Consolidated Statements of Operations for each of the years in
the three year period ended December 31, 1998
Consolidated Statements of Stockholder's Equity for each of the
years in the three year period ended December 31, 1998
Consolidated Statements of Cash Flows for each of the years in
the three year period ended December 31, 1998
Notes to Consolidated Financial Statements for December 31,
1998, 1997 and 1996
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
<PAGE>
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
<PAGE>
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, 1999 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, 1999.
Signature Title
/S/ James D Morefield 03-26-99
- ------------------------------------
James D. Morefield Date Chairman of the Board, and Director
/S/ James D. Morre, Jr. 03-26-99
- ------------------------------------
Dr. James D. Moore, Jr. Date President
/S/ J. Carter Lambert 03-26-99
- ------------------------------------
J. Carter Lambert Date Vice Chairman
/S/ Samuel L. Neese 03-26-99
- ------------------------------------
Samuel L. Neese Date Executive Vice President, and Chief
Executive Officer
/S/ James T. Riffe 03-26-99
- ------------------------------------
James T. Riffe Date Executive Vice President and Cashier
/S/ William E. Chaffin 03-26-99
- ------------------------------------
William E. Chaffin Date Director
/S/ V. D. Kendrick 03-26-99
- ------------------------------------
V.D. Kendrick Date Director
/S/ Clydes B. Kiser 03-26-99
- ------------------------------------
Clydes B. Kiser Date Director
/S/ Charles P. Olinger 03-26-99
- ------------------------------------
Charles P. Olinger Date Director
/S/ William J. Singleton 03-26-99
- ------------------------------------
William J. Singleton Date Director
/S/ H. Ramsey White, Jr. 03-26-99
- ------------------------------------
Dr. H. Ramsey White, Jr. Date Director
23
<PAGE>
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., DDS
<PAGE>
HIGHLANDS BANKSHARES, INC.
&
HIGHLANDS UNION BANK
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 & EXECUTIVE VICE PRESIDENT
CHIEF EXECUTIVE OFFICER CHIEF OPERATING OFFICER
W. CLARK HUTTON ROBERT M. LITTLE, JR. JAMES R. EDMONDSON
SENIOR VICE PRESIDENT, CONTROLLER ASSISTANT CONTROLLER
SENIOR LOAN OFFICER
MELINDA S. BISHOP MONICA M. ANDERSON
SENIOR INTERNAL AUDITOR INTERNAL AUDITOR
<PAGE>
HIGHLANDS UNION BANK
OFFICERS
JAMES D. MOORE, JR., M.D.
President
SAMUEL L. NEESE JAMES T. RIFFE
Executive Vice President, Executive Vice President,
Chief Executive Officer Chief Operations Officer
<TABLE>
<S> <C>
C. B. HALE Business Development Officer, CRA Outreach Officer
W. CLARK HUTTON Senior Vice President, Senior Loan Officer
GARY L. DUTTON Vice President, Senior Loan Officer Washington and Smyth Counties
C. WAYNE PERRY Vice President, Credit Review, Compliance Officer, Branch Administration
TIM L. ROBINSON Vice President, Senior Loan Officer City of Bristol
ROBERT M. LITTLE, JR. Controller, Stock Registrar
JAMES R. EDMONDSON Vice President, Accounting
CHRISTINE S. ELDRETH Vice President, Manager of Commercial Loan Operations
EDWARD T. FARMER Vice President, Operations Officer, P. C. Coordinator
CURTIS B. FLEENOR Vice President, Manager of Main Office Consumer Lending
LYNDA S. HAYS Vice President, Financial Services Manager
CHARLES E. HOLMES Vice President, Commercial Loan Officer
BETH A. MOREFIELD Vice President, Dealer Finance Manager
M. SULEEN REEDER Vice President, Mortgage Loan Officer, Manager of Mortgage Loan Operations
DAVID O. RHEA Vice President, Commercial Loan Officer
DARLENE M. ROSE Vice President, Manager of Consumer Loan Operations
MARIE F. SHY Vice President, Branch Manager
JOHN W. SNODGRASS Vice President, Branch Manager
MONICA M. ANDERSON Internal Auditor
MELINDA S. BISHOP Senior Internal Auditor
JANICE M. ELDRETH Assistant Vice President, Computer Operations Officer
MARK W. FARRIS Assistant Vice President, Loan Officer
ROBIN G. FROST Assistant Vice President, Branch Manager
ROBERT M. HOWARD Human Resource Officer, Training Officer
WAYNE M. LARGEN Assistant Vice President, Loan Officer
EDNA M. MOORE Assistant Vice President, Mortgage Loan Officer, Manager Secondary Market Mortgages
MALINDA W. PICKETT Assistant Vice President, Branch Manager
MARK B. REDMAN Assistant Vice President, Branch Manager, Bank Security Officer
MARY JANE ROBINSON Assistant Vice President, Student Loan Officer, Consumer Loan Officer
BEVERLY A. SHARRETT Assistant Vice President, Assistant Branch Manager, Consumer Loan Officer
BRENDA D. WILLIAMS Assistant Vice President, Dealer Loan Officer
C. BRYAN LAWSON Financial Services Officer
JO ANN VINCILL Business Development Officer
</TABLE>
<PAGE>
Dear Shareholders:
1998 was a very important and exciting year for Highlands Bankshares, Inc. and
Highlands Union Bank. It was a year of continued remarkable growth and
significant investment in the future of your company. Assets increased by $49
million, or 19.1 percent, net loans increased by $41 million, or 21.5 percent,
and deposits increased by $35 million, or 15.1 percent. Net income was
$1,775,000. Return on equity was 10.06 percent and return on assets was .61
percent. This is a decrease in earnings from 1997 of $177,000. Due to many
factors, most of this decrease in earnings was expected. The year brought us a
national trend of declining interest rates, declining interest margins, a record
number of mortgage refinancings to a lower interest rate, a record year for
prepayments in mortgage backed securities due to the home refinancings, and a
record year of filings for personal bankruptcy. The large growth in the bank's
loan portfolio continued in 1998. Due to this outstanding growth, large
contributions to the allowance for the loan loss reserve account continued to be
necessary. A contribution of over $1.2 million was made during 1998 to support
the growth and to cover 1998 loan losses. A primary factor in the reduced
earnings in 1998 was costs and expenses associated with the raising of $7.5
million in capital to support future growth and expansion.
As previously stated, the growth of Highlands Bankshares, Inc. and Highlands
Union Bank continues to be far greater than the banking industry in general. In
its brief 14-year history, Highlands Union Bank has grown to be one of the
larger banks headquartered in the State of Virginia with a significant market
share in the communities we serve. As a result of this sustained and unusual
growth, and in order to keep the company in a well-capitalized position, it
became necessary in 1998 to raise additional capital. This is the third such
recapitalization since the bank opened in 1985. After much research, it was
determined by the Board of Directors and management that it was in the best
interest of the existing shareholders to issue trust preferred securities in
lieu of another issuance of common stock. In January 1998, Highlands Bankshares,
Inc. issued $7.5 million in trust preferred capital securities with a rate of
9.25% and a maturity of 30 years. Trust preferred capital securities have three
primary benefits: the interest payments are tax deductible, the debt can be
included in tier one capital ratio up to 25% of the total capital after the
issue, and future earnings per share are not diluted by having additional shares
of common stock outstanding.
With this growth and increased market share in the communities we serve comes
the continued need to upgrade and expand our infrastructure, technology,
delivery systems, and facilities in order to properly serve our existing and
future customer base. To facilitate this, several other significant investments
in the future were made during the past few months. As previously reported, a
new branch location was added in Marion, Virginia in December of 1997. In
December of 1998 a new branch location was also added in Glade Spring, Virginia.
These branches represent a strong investment over the previous twelve-month
period. In order to provide the most convenient and modern services possible to
our customers, Highlands Union Bank has installed 17 in-store ATM facilities in
locations in the City of Bristol, Virginia, and the counties of Washington,
Smyth, Wythe, and Russell in Virginia during 1998. We believe that the addition
of the two branch locations and the in-store ATM's combined with the services
and service locations already available, provides our present and future
customers with the best and most convenient banking services available in our
area, and offers the bank opportunities for future growth and expansion.
Other investments made in preparation for future growth includes the
construction of a new drive thru facility at the main office. The previously
existing drive thru had become worn and outdated due to many
<PAGE>
years of very heavy use. We continue to invest in technologies that help keep
our operating costs very low by industry standards, and provide our customers
with the most modern services possible. Recently, the bank purchased an in-house
check printing system. This system should provide future cost savings in the
printing of loan coupon books and allow us to print customer checks at a cost
savings to the bank, as well as to our customers.
1998 was also a year that your Corporation continued to work on the Y2K issue.
As of this date, management has identified all business and operational
functions that will be impacted by the date change and is aggressively testing
and/or converting its application systems for Y2K date recognition. Conversion
and testing of all in-house systems is expected to be completed by June 1999.
Throughout 1999, the Company will be conducting testing with external entities,
such as the Federal Reserve Bank, as they become Y2K "ready". Management
estimates the Company's costs related to the Y2K fix will not have a material
impact on future earnings. However, the impact of Y2K noncompliance by all
outside parties cannot be estimated fully at this time.
We were especially excited during 1998 to declare the first cash dividend in the
history of your company. A $0.10 per share cash dividend was paid to
shareholders on April 13, 1998.
We were very proud and honored that Highlands Union Bank was selected by a
national banking news publication (INDEPENDENT BANKER) to be the featured cover
story for their August issue. The bank was selected because of its extraordinary
growth and success during its brief 13-year history. This cover story gave your
bank significant national exposure and recognition.
As you can tell, 1998 was a very challenging but exciting year. It was a year of
continued extraordinary growth and investment in the future of your company. We
believe with the addition of new capital, two new branch locations, improved
delivery systems, improved infrastructure, and a dedicated and professional
staff of officers and employees, Highlands Bankshares, Inc. and Highlands Union
Bank are positioned to move into the future with confidence. We will look at
ways to continually improve upon and expand the range of services we offer our
customers. We further believe that your company is positioned to explore and
take advantage of many opportunities that may arise in the future. We will
continue to explore these opportunities for the enhancement of future earnings
and the continued success of your company.
We continue to be humbled by and appreciative of the support that we receive
from our customers, friends, and shareholders. We look ahead with great
anticipation and excitement as we move into a new millennium. 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
<PAGE>
FINANCIAL HIGHLIGHTS
<TABLE>
<CAPTION>
RESULTS OF OPERATIONS 1998 1997 1996 1998/1997 1997/1996
(IN THOUSANDS EXCEPT SHARE AND PER SHARE DATA) PERCENTAGE CHANGE
<S> <C> <C> <C> <C> <C>
Net Interest Income $ 9,496 $ 8,460 $ 6,790 12.25% 24.59%
Net Income <Loss> 1,775 1,952 1,764 <9.07> 10.66
FINANCIAL CONDITION AT YEAR-END
Assets $307,764 $258,236 $207,739 19.18% 24.31%
Loans 233,371 192,005 154,951 21.54 23.91
Securities 51,355 41,963 31,345 22.38 33.87
Deposits 272,341 236,646 189,471 15.08 24.90
Stockholders' Equity 18,279 16,802 14,617 8.79 14.95
Shares Outstanding 1,247 1,232 1,222 1.22 0.82
SIGNIFICANT RATIOS
Return on average assets 0.61% 0.84% 0.97% <27.38%> <13.40%>
Return on average equity 10.06 12.53 13.01 <19.71> <3.69>
Average stockholders' equity to
average assets 6.02 6.73 7.46 <10.55> <9.79>
Allowance for loan losses as a
percentage of total loans 0.86 0.85 0.69 1.18 23.19
Non-performing loans to total loans 0.87 0.99 0.43 <12.12> 130.23
PER SHARE DATA
Based on weighted-average shares outstanding
Net Income $ 1.44 $ 1.59 $ 1.45 < 9.43%> 9.66%
Stockholders' equity (book value)
per shares outstanding at
year-end 14.66 13.64 11.97 7.51 13.95
</TABLE>
<PAGE>
COMPARISON OF RESULTS OF OPERATIONS FOR
THE YEARS ENDED DECEMBER 31, 1998 AND 1997
Net interest income for the year-ended December 31, 1998 increased 12.25%,
approximately $1.04 million over 1997. Average interest earning assets increased
$57.1 million from 1997 to 1998 while average interest-bearing liabilities
increased $54.8 million. The yield on average interest-earning assets for the
year ended December 31, 1998 was 8.35% compared with 8.66% for the comparable
1997 period. The 1998 yield on average loans decreased by 5 basis points to
9.21% as compared to the 1997 period yield of 9.26%. The 1998 yield on average
investments, including federal funds sold, decreased 0.74% to 5.37% from
December 31, 1997 to 1998. The yield on average interest-bearing liabilities
increased 1 basis point during 1998 to 5.58% as compared to 5.57% during 1997.
Net income for the year-ended December 31, 1998 was $1.78 million, a decrease of
9.07% over the 1997 period. Income tax expense for 1998 decreased 7.25% to $896
thousand as compared to $966 thousand for the 1997 period.
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.
<PAGE>
COMPARISON OF FINANCIAL CONDITION
AT DECEMBER 31, 1998 AND 1997
Total assets at December 31, 1998 totaled $307.8 million compared to
$258.2 million at December 31, 1997. This 19.18% growth in assets was primarily
due to the large volume of loans originated. Total loans increased 21.54%, or
$41.3 million over the comparable 1997 period. The security portfolio increased
22.38% to $51.3 million during 1998 as contrasted to the 1997 period. Total
deposits increased to $272.3 million or 15.08% from 1997's level of $236.6
million. Stockholder's equity increased 8.79% during 1998. 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, 1997 of $104
thousand, net of the related deferred tax. As of December 31, 1998 the
Corporation's security portfolio had $100 thousand in paper losses. The
Corporation notes that it does have the ability and intent to carry to maturity
the existing $51.3 million of the "Available-for-Sale" securities.
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 24.98% from 1996's level of $189.5
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 a 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 unrealized gains, net of
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.
<PAGE>
COMPARISON OF SIGNIFICANT RATIOS AT
DECEMBER 31, 1998 AND 1997
Return on average assets dropped to 0.61% for the year-ended December
31, 1998 as compared to 0.84% for the comparable 1996 period. The continued
growth in assets, the absorption of the operational costs from the new branch
openings, the costs and interest expense related to the trust preferred
securities, and the addition of over $1.2 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 from 12.53% at December 31, 1997 to
10.06% at year-end 1998. Average stockholders' equity to average assets declined
to 6.02% at December 31, 1998 from 6.73% at December 31, 1997. Non-performing
loans to total loans decreased to 0.87% as of December 31, 1998 as compared to
0.99% for the comparable 1997 period. Allowance for loan losses as a percentage
of total loans increased 1.18% to 0.86% at December 31, 1998. The decrease in
average stockholders' equity to average assets is primarily attributable to the
enormous amount of growth which the Corporation sustained during 1998.
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 from 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.
<PAGE>
COMPARISON OF PER SHARE DATA FOR THE
YEARS ENDED DECEMBER 31, 1998 AND 1997
Net income per share, on a weighted average basis, decreased 9.43% to $1.44 at
December 31, 1998 as compared to $1.59 for the comparable 1997 period. Book
value per share of common stock increased by 7.51% to $14.66 per share as
compared to $13.64 at December 31, 1997. The Corporation had approximately $100
thousand in unrealized losses as of December 31, 1998, 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, 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 has 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.
<PAGE>
YEAR 2000
Like most financial service providers, the Company and its operations may be
significantly affected by the Y2K issue due to its dependence on technology and
date-sensitive data. Computer software and hardware and other equipment, both
within and outside the Company's direct control, and third parties with whom the
Company electronically or operationally interfaces (including without limitation
its customers and third party vendors) are likely to be affected. If computer
systems are not modified in order to be able to identify the year 2000, many
computer applications could fail or create erroneous results. Likewise, under
certain circumstances, at failure to adequately address the Y2K issue could
adversely affect the viability of the Company's suppliers and creditors and the
creditworthiness of its borrowers. Thus, if not adequately addressed, the Y2K
issue could result in a significant adverse impact on the Company's operations
and, in turn, its financial condition and results of operations.
The Company has formulated its plan to address the Y2K issue. Following are the
primary phases of the Company's Y2K plan:
1. Awareness phase
2. Assessment phase
3. Renovation phase
4. Validation or testing phase
5. Implementation phase
The Company is expensing all costs associated with required system changes as
those costs are incurred and such costs are being funded through operating cash
flows.
During the assessment phase, the Company began to develop back-up or contingency
plans for each of its mission critical systems. Virtually all of the Company's
mission critical systems are dependent upon third party vendors or service
providers, therefore, contingency plans include selecting a new vendor or
service provider and converting to their system. In the event a current vendor's
system fails during the validation phase and it is determined the vendor is
unable or unwilling to correct the failure, the Company will convert to a new
system from a pre-selected list of prospective vendors. In each case, realistic
trigger dates have been established to allow for orderly and successful
conversions. For some systems, contingency plans consist of reverting to manual
systems until problems can be corrected.
The majority of the Company's mission critical systems fall into the categories
of its core-banking system, its proof of deposit system and its automatic teller
machine network. The Company has received warranties from vendors to the effect
that the core-banking system and its automatic teller machine network software
is Y2K compliant. Further, the Company has received warranties that its proof of
deposit system will be Y2K ready subject to specific changes which the Company
is currently implementing. Additionally, the core-banking system, used by a
number of banking institutions, has been reviewed by the Federal Reserve Bank of
Richmond.
With respect to each third party with whom the Company interfaces electronically
or from whom it obtains significant services or supplies, the Company has
requested information regarding that party's preparations and state of
preparedness with respect to Y2K issues. Interruptions in the services provided
by such third parties have been taken into account in the Company's contingency
plans (which, for example, provide for increased inventories of business forms
and supplies, increased levels of cash on hand, use of a generator to operate
the Company's main computer system and operations function, manual processing of
branch transactions, direct clearing of checks through the Federal Reserve
rather than through a correspondent bank, and, where possible, a change to a
different third party supplier.)
<PAGE>
HIGHLANDS BANKSHARES, INC. AND SUBSIDIARIES
CONSOLIDATED FINANCIAL REPORT
DECEMBER 31, 1998
<PAGE>
C O N T E N T S
<TABLE>
<CAPTION>
Page
----
<S> <C>
INDEPENDENT AUDITOR'S REPORT F1
FINANCIAL STATEMENTS
Consolidated Balance Sheets F2
Consolidated Statements of Income F3
Consolidated Statements of Comprehensive Income F4
Consolidated Statements of Stockholders' Equity F5
Consolidated Statements of Cash Flows F6
Notes to Consolidated Financial Statements F7 - F26
</TABLE>
<PAGE>
Brown,
Edwards & Page F1
Company, L.L.P.
Certified Public Accountants
INDEPENDENT AUDITOR'S REPORT
Board of Directors and Stockholders
Highlands Bankshares, Inc. and Subsidiaries
Abingdon, Virginia
We have audited the accompanying consolidated balance sheets of Highlands
Bankshares, Inc. and Subsidiaries as of December 31, 1998, 1997, and 1996 and
the related consolidated statements of income, comprehensive income,
stockholders' equity, and cash flows for the years then ended. These
consolidated financial statements are the responsibility of the Bank's
management. Our responsibility is to express an opinion on these consolidated
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 consolidated financial statements are
free of material misstatement. An audit includes examining, on a test basis,
evidence supporting the amounts and disclosures in the consolidated financial
statements. An audit also includes 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 Subsidiaries as of December 31, 1998, 1997 and 1996 and the
results of their operations and their 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 1, 1999
<PAGE>
HIGHLANDS BANKSHARES, INC. AND SUBSIDIARIES
Page F2
CONSOLIDATED BALANCE SHEETS
December 31, 1998, 1997 and 1996
(In thousands)
<TABLE>
<CAPTION>
ASSETS 1998 1997 1996
---------- --------- ---------
<S> <C> <C> <C>
Cash and due from banks (Note 17) $ 9,324 $ 7,712 $ 8,008
Federal funds sold 1,670 7,213 7,948
--------- --------- ---------
Total Cash and Cash Equivalents 10,994 14,925 15,956
Investment securities available for sale (Note 2) 51,355 41,963 31,345
Loans, net of allowance for loan losses of $2,008,
$1,636 and $1,072 1998, 1997 and 1996,
respectively (Notes 3 and 4) 231,363 190,369 153,879
Premises and equipment (Note 5) 8,270 7,062 4,583
Interest receivable 1,875 1,495 1,271
Other assets (Note 6) 3,907 2,422 705
--------- --------- ---------
Total Assets $ 307,764 $ 258,236 $ 207,739
========= ========= =========
LIABILITIES AND STOCKHOLDERS' EQUITY
Deposits (Note 7)
Noninterest bearing $ 36,187 $ 30,930 $ 26,003
Interest bearing 236,154 205,716 163,468
--------- --------- ---------
Total Deposits 272,341 236,646 189,471
--------- --------- ---------
Federal funds purchased 503 -- --
Interest, taxes and other liabilities 2,378 2,174 1,722
Long-term debt (Note 8) 6,763 2,614 1,929
Capital securities (Note 9) 7,500 -- --
--------- --------- ---------
17,144 4,788 3,651
--------- --------- ---------
Total Liabilities 289,485 241,434 193,122
--------- --------- ---------
STOCKHOLDERS' EQUITY
Common stock (Notes 11 and 13) 3,116 3,081 3,054
Surplus 5,265 5,271 5,187
Undivided profits 9,998 8,346 6,394
Net unrealized gains (losses) on securities available
for sale, net of taxes of $(51), $54 and $(9) in 1998,
1997 and 1996, respectively (100) 104 (18)
--------- --------- ---------
Total Stockholders' Equity 18,279 16,802 14,617
--------- --------- ---------
Total Liabilities and Stockholders' Equity $ 307,764 $ 258,236 $ 207,739
========= ========= =========
</TABLE>
The Notes to Consolidated Financial Statements are an integral part of these
statements.
<PAGE>
HIGHLANDS BANKSHARES, INC. AND SUBSIDIARIES
Page F3
CONSOLIDATED STATEMENTS OF INCOME
Years Ended December 31, 1998, 1997 and 1996
(In thousands)
<TABLE>
<CAPTION>
INTEREST INCOME 1998 1997 1996
-------- ------- --------
<S> <C> <C> <C>
Loans receivable and fees on loans $19,618 $16,249 $12,326
Securities available for sale 3,057 2,363 2,082
Federal funds sold 222 169 204
------- ------- -------
Total Interest Income 22,897 18,781 14,612
------- ------- -------
INTEREST EXPENSE
Deposits 12,336 10,099 7,714
Federal funds purchased 58 29 9
Other borrowed funds 342 176 99
Long-term debt 665 17 --
------- ------- -------
Total interest expense 13,401 10,321 7,822
------- ------- -------
Net interest income 9,496 8,460 6,790
PROVISION FOR LOAN LOSSES 1,230 1,002 374
------- ------- -------
Net interest income after provision for loan losses 8,266 7,458 6,416
------- ------- -------
NON-INTEREST INCOME
Securities gains (losses), net 359 10 23
Service charges on deposit accounts 545 514 474
Other service charges, commissions and fees 324 186 104
Other operating income, rents 139 132 43
------- ------- -------
Total Non-Interest Income 1,367 842 644
------- ------- -------
NON-INTEREST EXPENSES
Salaries and employee benefits (Note 12) 3,785 3,004 2,534
Occupancy expense of bank premises 615 441 298
Furniture and equipment expense 729 596 564
Other operating expenses (Note 19) 1,833 1,341 1,043
------- ------- -------
Total Non-Interest Expenses 6,962 5,382 4,439
------- ------- -------
Income Before Income Taxes 2,671 2,918 2,621
Income Tax Expense (Note 6) 896 966 857
------- ------- -------
Net Income $ 1,775 $ 1,952 $ 1,764
======= ======= =======
Earnings Per Common Share (Note 11) $ 1.44 $ 1.59 $ 1.45
======= ======= =======
Earnings Per Common Share - assuming dilution $ 1.38 $ 1.53 $ 1.38
======= ======= =======
</TABLE>
The Notes to Consolidated Financial Statements are an integral part of these
statements.
<PAGE>
HIGHLANDS BANKSHARES, INC. AND SUBSIDIARIES
Page F4
CONSOLIDATED STATEMENTS OF COMPREHENSIVE INCOME
Years Ended December 31, 1998, 1997 and 1996
(In thousands)
<TABLE>
<CAPTION>
1998 1997 1996
-------- ------- --------
<S> <C> <C> <C>
Net income $ 1,775 $ 1,952 $ 1,764
------- ------- -------
Other comprehensive income(loss), before tax
Unrealized gain(loss) on securities available-for-sale (309) 185 (55)
Less: reclassification adjustment for (gain)loss
included in net income (24) -- --
------- ------- -------
Other comprehensive income(loss) (333) 185 (55)
Federal income tax (expense) benefit related to
other comprehensive income(loss) 113 (63) 19
------- ------- -------
Other comprehensive income(loss), net of tax (220) 122 (36)
------- ------- -------
Total comprehensive income $ 1,555 $ 2,074 $ 1,728
======= ======= =======
</TABLE>
The Notes to Consolidated Financial Statements are an integral part of these
statements.
<PAGE>
HIGHLANDS BANKSHARES, INC. AND SUBSIDIARIES
Page F5
CONSOLIDATED STATEMENTS OF STOCKHOLDERS' EQUITY
Years Ended December 31, 1998, 1997 and 1996
(In thousands)
<TABLE>
<CAPTION>
Gain (loss) on
Common Stock Securities Total
--------------------- Undivided Available Stockholders'
Shares Par Value Surplus Profits for sale Equity
------ --------- ------- ------- -------- ------
<S> <C> <C> <C> <C> <C> <C>
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 -- -- 53 -- -- 53
(Note 13)
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 84 -- -- 111
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
Net income -- -- -- 1,775 -- 1,775
Common stock issued for
stock options exercised 14 35 (6) -- -- 29
Net changes in unrealized
gains (losses) on available
for sale securities, net of
taxes of $(105) -- -- -- -- (204) (204)
Cash dividend -- -- -- (123) -- (123)
------ -------- -------- -------- -------- --------
Balance, December 31, 1998 1,246 $ 3,116 $ 5,265 $ 9,998 $ (100) $ 18,279
====== ======== ======== ======== ======== ========
</TABLE>
The Notes to Consolidated Financial Statements are an integral part of these
statements.
<PAGE>
HIGHLANDS BANKSHARES, INC. AND SUBSIDIARIES
Page F6
CONSOLIDATED STATEMENTS OF CASH FLOWS
Years Ended December 31, 1998, 1997 and 1996
(In thousands)
<TABLE>
<CAPTION>
1998 1997 1996
--------- --------- --------
<S> <C> <C> <C>
CASH FLOWS FROM OPERATING ACTIVITIES:
Net income $ 1,775 $ 1,952 $ 1,764
Adjustments to reconcile net income to net cash
provided by operating activities:
Provision for loan losses 1,230 1,002 374
Provision for deferred income taxes (15) (124) (67)
Deferred compensation expense -- -- 53
Depreciation and amortization 529 328 214
Net realized gains on available for sale securities (359) (10) (23)
Net amortization on securities 540 190 125
(Increase) decrease in interest receivable (380) (224) (203)
(Increase) decrease in other assets (1,076) (1,593) 227
Increase (decrease) in interest, taxes and other
liabilities 204 452 318
-------- -------- --------
Net Cash Provided by Operating Activities 2,448 1,973 2,782
-------- -------- --------
CASH FLOWS FROM INVESTING ACTIVITIES:
Securities available for sale:
Proceeds from sale of securities 45,339 14,560 12,779
Proceeds from maturities of debt securities 500 565 2,125
Purchase of securities (55,706) (25,740) (14,128)
Net increase in loans (42,224) (37,492) (41,418)
Premises and equipment expenditures (1,722) (2,800) (446)
-------- -------- --------
Net Cash Used in Investing Activities (53,813) (50,907) (41,088)
-------- -------- --------
CASH FLOWS FROM FINANCING ACTIVITIES:
Net increase in certificates of deposit 12,397 35,683 29,811
Net increase in demand, savings and other deposits 23,298 11,492 12,333
Increase (decrease) in federal funds purchased 503 -- --
Proceeds from issuance of long-term debt 6,125 840 --
Repayment of long-term debt (1,976) (12) --
Proceeds from issuance of junior subordinated
debt securities 7,500 -- --
Repayment of short-term borrowings -- (143) 929
Capital securities issuance cost (319) (68) --
Cash dividends paid (123) -- --
Proceeds from issuance of common stock 29 111 36
-------- -------- --------
Net cash provided by financing activities 47,434 47,903 43,109
-------- -------- --------
Net increase (decrease) in cash and cash equivalents (3,931) (1,031) 4,803
CASH AND CASH EQUIVALENTS AT BEGINNING OF YEAR 14,925 15,956 11,153
-------- -------- --------
CASH AND CASH EQUIVALENTS AT END OF YEAR $ 10,994 $ 14,925 $ 15,956
======== ======== ========
SUPPLEMENTAL DISCLOSURE OF NON-CASH
TRANSACTIONS:
Unrealized gain (loss) in value of securities available for
sale (net of tax effects of $(105), $63, and $(19), at
December 31, 1998, 1997 and 1996, respectively $ (204) $ 122 $ (36)
======== ======== ========
SUPPLEMENTAL DISCLOSURES OF CASH FLOW
INFORMATION:
Cash paid during the year for:
Interest $ 13,280 $ 9,802 $ 7,595
======== ======== ========
Income taxes $ 952 $ 1,011 $ 901
======== ======== ========
</TABLE>
The Notes to Consolidated Financial Statements are an integral part of these
statements.
<PAGE>
HIGHLANDS BANKSHARES, INC. AND SUBSIDIARIES
Page F7
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
December 31, 1998
(In thousands)
Note 1. Summary of Significant Accounting Policies
Basis of Presentation:
The accounting and reporting policies of Highlands Bankshares,
Inc. and Subsidiaries 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. (the "Parent Company") and
its wholly-owned subsidiaries, Highlands Union Bank (the "Bank"),
and Highlands Capital Trust I (the "Trust"). All significant
intercompany balances and transactions have been eliminated in
consolidation.
Nature of Operations:
Highlands Bankshares, Inc. and Subsidiaries (the "Company")
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. Highlands
Capital Trust I, its wholly-owned subsidiary became effective on
January 14, 1998. The nature of the trust is described more fully
in Note 7.
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.
(Continued)
<PAGE>
HIGHLANDS BANKSHARES, INC. AND SUBSIDIARIES
Page F8
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
December 31, 1998
(In thousands)
Note 1. Summary of Significant Accounting Policies (Continued)
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.
Intangible Assets:
Organizational costs are stated at cost less accumulated
amortization. Amortization is computed on the straight-line
method over 60 months. Capital issue costs relating to the junior
subordinated debt securities are stated at cost less accumulated
amortization. Amortization is computed on the straight-line
method over the life of the securities - 30 years.
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 and consumer
single-payment loans are computed using 365 days per year.
Interest accruals on mortgage loans is computed using 360 days
per year. 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 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.
Loan origination fees that exceed the direct costs of
underwriting and closing loans are deferred. The deferred fees
received are amortized to income over the estimated lives of the
loans using a straight line method. 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.
(Continued)
<PAGE>
HIGHLANDS BANKSHARES, INC. AND SUBSIDIARIES
Page F9
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
December 31, 1998
(In thousands)
Note 1. Summary of Significant Accounting Policies (Continued)
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.
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.
Reclassification of Financial Statement Presentation:
Certain reclassifications have been made to the 1997 and 1996
financial statements to conform with the 1998 financial statement
presentation. Such reclassifications had no effect on net income
as previously reported.
Note 2. 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:
<TABLE>
<CAPTION>
1998
------------------------------------------------
Gross Gross
Amortized Unrealized Unrealized Fair
Cost Gains Losses Value
--------- ---------- ---------- -------
<S> <C> <C> <C> <C>
U.S. Government agencies and
corporations $ 3,250 $ 14 $ -- $ 3,264
State and political subdivisions 754 5 -- 759
Collateralized Mortgage Obligations 7,886 -- 13 7,873
Mortgage Backed securities 38,288 -- 157 38,131
Other securities 1,328 -- -- 1,328
------- ------- ------- -------
$51,506 $ 19 $ 170 $51,355
======= ======= ======= =======
</TABLE>
<TABLE>
<CAPTION>
1997
------------------------------------------------
Gross Gross
Amortized Unrealized Unrealized Fair
Cost Gains Losses Value
--------- ---------- ---------- -------
<S> <C> <C> <C> <C>
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
Collateralized Mortgage Obligations 3,987 -- 12 3,975
Mortgage Backed securities 32,788 141 -- 32,929
Other securities 1,098 -- -- 1,098
------- ------- ------- -------
$41,805 $ 184 $ 26 $41,963
======= ======= ======= =======
</TABLE>
(Continued)
<PAGE>
HIGHLANDS BANKSHARES, INC. AND SUBSIDIARIES
Page F10
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
December 31, 1998
(In thousands)
Note 2. Investment Securities (Continued)
<TABLE>
<CAPTION>
1996
------------------------------------------------
Gross Gross
Amortized Unrealized Unrealized Fair
Cost Gains Losses Value
--------- ---------- ---------- -------
<S> <C> <C> <C> <C>
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
Collateralized Mortgage Obligations 2,372 -- 25 2,347
Mortgage Backed securities 22,633 12 -- 22,645
Other securities 861 -- -- 861
------- ------- ------- -------
$31,373 $ 39 $ 67 $31,345
======= ======= ======= =======
</TABLE>
Investment securities available for sale with a carrying value of
$4,787, $3,571, and $1,003 at December 31, 1998, 1997 and 1996
respectively, and a market value of $4,783, $3,595, and $998 at
December 31, 1998, 1997 and 1996 were pledged as collateral on
public deposits and for other purposes as required or permitted
by law.
Federal Home Loan Bank (FHLB) and Federal Reserve Bank (FRB)
stock with a carrying value of $1,246, $1,029 and $806 at
December 31, 1998, 1997 and 1996, respectively are included in
the caption "Other Securities". These investments are considered
to be restricted as the Company is required by FHLB and FRB to
hold these investments, and the only market for this stock is the
issuing agency.
The amortized cost and estimated fair value of securities
available for sale at December 31, 1998 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.
<TABLE>
<CAPTION>
Approximate
Amortized Market
Cost Value
---- -----
<S> <C> <C>
Due in one year or less $ - $ -
Due after one year through five years 2,000 2,010
Due after five years through ten years 1,049 1,059
Due after ten years 955 954
----------- ----------
4,004 4,023
---------- ---------
Mortgage-backed securities 46,174 46,004
Other securities 1,328 1,328
---------- ---------
47,502 47,332
---------- ---------
$ 51,506 $ 51,355
======== ========
</TABLE>
Gross realized gains and on investment securities
available for sale are as follows:
<TABLE>
<CAPTION>
1998 1997 1996
---- ---- ----
<S> <C> <C> <C>
Realized gains $ 369 $ 34 $ 50
Realized losses $ ( 10) $ ( 24) $( 27)
</TABLE>
<PAGE>
HIGHLANDS BANKSHARES, INC. AND SUBSIDIARIES
Page F11
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
December 31, 1998
(In thousands)
Note 3. Loans
The composition of the net loans is as follows:
<TABLE>
<CAPTION>
1998 1997 1996
---- ---- ----
<S> <C> <C> <C>
Commercial $ 24,240 $ 24,404 $ 20,370
Real estate 136,339 104,899 101,570
Installment 70,137 59,798 30,656
Other 2,821 3,139 2,967
---------- ------------- -----------
233,537 192,240 155,563
---------- ----------- ---------
Deduct:
Unearned discount 31 127 455
Allowance for loan losses 2,008 1,636 1,072
Net deferred loan fees 135 108 157
---------- ------------- -------------
2,174 1,871 1,684
---------- ------------ ------------
$ 231,363 $ 190,369 $ 153,879
========= =========== =========
</TABLE>
Nonaccruing loans totaling $1,396, $888, and $99 at December 31,
1998, 1997 and 1996 are included in the above loans. Interest
income lost on these nonaccruing loans was approximately $146,
$71, and $6, for December 31, 1998, 1997 and 1996, respectively.
Loans have been pledged as part of the floating blanket lien to
secure Federal Home Loan Bank advances. (Note 14)
Note 4. Allowance for Loan Losses
Activity in the allowance for loan losses is as follows:
<TABLE>
<CAPTION>
1998 1997 1996
---- ---- ----
<S> <C> <C> <C>
Balance, beginning $ 1,636 $ 1,072 $ 908
Provisions charged to
operations 1,230 1,002 374
Loans charged to reserve ( 1,057) ( 512) ( 255)
Recoveries 199 74 45
---------- --------- ---------
Balance, ending $ 2,008 $ 1,636 $ 1,072
========= ========= =======
</TABLE>
<PAGE>
HIGHLANDS BANKSHARES, INC. AND SUBSIDIARIES
Page F12
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
December 31, 1998
(In thousands)
Note 5. Premises and Equipment
Premises and equipment, stated at cost, are comprised of the
following:
<TABLE>
<CAPTION>
1998 1997 1996
---- ---- ----
<S> <C> <C> <C>
Land $ 1,870 $ 1,847 $ 1,451
Bank premises 5,374 4,445 2,909
Equipment 2,954 2,184 1,316
--------- -------- --------
10,198 8,476 5,676
Less accumulated
depreciation 1,928 1,414 1,093
--------- -------- ---------
$ 8,270 $ 7,062 $ 4,583
======== -======= =======
</TABLE>
Depreciation expense is $514, $321, and $209 for 1998,
1997, and 1996, respectively.
Note 6 Income Taxes
The components of the net deferred tax asset are as follows:
<TABLE>
<CAPTION>
1998 1997 1996
----- ---- ----
<S> <C> <C> <C>
Deferred tax assets:
Allowance for loan loss $ 532 $ 471 $ 323
Deferred compensation 73 84 90
Loss on securities available for sale 51 - 9
---------- ------------ -----------
656 555 422
--------- --------- ---------
Deferred tax liability:
Depreciation (195) (160) (128)
Gain on securities available for sale - (54) (-)
--------- ----------- -----------
(195) (214) (128)
--------- --------- --------
Net deferred tax asset $ 461 $ 341 $ 294
========= ========= ========
</TABLE>
The net deferred tax asset is included in the balance sheet under
the caption "Other Assets".
The components of income tax expense (benefit) related to
continuing operations are as follows:
<TABLE>
<CAPTION>
1998 1997 1996
----- ---- ----
<S> <C> <C> <C>
Federal:
Current $ 911 $ 1,090 $ 924
Deferred (15) (124) (67)
--------- -------- ---------
Total $ 896 $ 966 $ 857
======== ======== =======
</TABLE>
(Continued)
<PAGE>
HIGHLANDS BANKSHARES, INC. AND SUBSIDIARIES
Page F13
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
December 31, 1998
(In thousands)
Note 6 Income Taxes (Continued)
The Bank's income tax expense differs from the statutory federal
rate of 34% as follows:
<TABLE>
<CAPTION>
1998 1997 1996
---- ---- ----
<S> <C> <C> <C>
Statutory rate applied to
earnings before income taxes $ 908 $ 992 $ 891
Tax exempt interest (53) (10) (15)
Other, net 41 (16) (19)
-------- --------- ---------
$ 896 $ 966 $ 857
======= ======== =======
</TABLE>
Note 7. Deposits
The composition of deposits is as follows:
<TABLE>
1998 1997 1996
---- ---- ----
<S> <C> <C> <C>
Noninterest bearing demand $ 36,187 $ 30,930 $ 26,003
Interest bearing demand 21,936 15,065 13,378
Savings deposits 35,640 26,808 21,930
Time deposits, in amounts of
$100,000 or more 41,302 37,890 31,007
Other time deposits 137,276 125,953 97,153
---------- ---------- --------
$ 272,341 $ 236,646 $ 189,471
========= ========= ========
</TABLE>
The remaining maturities of time deposits at December 31, 1998
are as follows:
<TABLE>
<S> <C>
Three months or less $ 37,370
Three through twelve months 87,882
Over twelve months 53,326
-----------
$ 178,578
==========
</TABLE>
<PAGE>
HIGHLANDS BANKSHARES, INC. AND SUBSIDIARIES
Page F14
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
December 31, 1998
(In thousands)
Note 8. Long-Term Debt
At December 31, Highlands Bankshares Inc. and Subsidiaries
had the following long-term debt agreements:
<TABLE>
<CAPTION>
1998 1997 1996
---- ---- ----
<S> <C> <C> <C>
Note payable Federal Home Loan Bank dated June 6, 1996 for $1,000
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
with an annual interest rate of 7.02%, due June 6, 2003. The note
requires semi-annual installments of $71 plus interest. The loan
is secured by a floating blanket lien on assets of the Bank, including loans 643 786 929
Note payable Federal Home Loan Bank dated March 26, 1998 for
$6,000 with an annual interest rate of 5.51%, due March 26, 2008
The note requires quarterly interest payments and has an early
conversion option at March 26, 2003. The loan is secured by a
floating blanket lien on assets of the Bank, including loans 6,000 -- --
Note payable resulting from a seller-financing transaction dated
September 10, 1998 for $125 with an annual interest rate of
8.50%, due September 10, 2003. The note requires monthly
installments of principal and interest of $3. The loan is secured
by a first deed of trust on real estate 120 -- --
Note payable to Company's Subsidiary (amount participated with
other financial institutions only) dated March 4, 1997 for $900
with an annual interest rate of 8.25%, due March 4, 2002. The
note requires monthly installments of $8 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 $6,763 $2,614 $1,929
====== ====== ======
</TABLE>
(Continued)
<PAGE>
HIGHLANDS BANKSHARES, INC. AND SUBSIDIARIES
Page F15
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
December 31, 1998
(In thousands)
Note 8. Long-Term Debt (Continued)
Principal maturities of notes payable at December 31, 1998 are as
follows:
1999 $ 164
2000 166
2001 168
2002 171
2003 94
Thereafter 6,000
-----
$ 6,763
=======
Note 9. Capital Securities
On January 21, 1998, Highlands Capital Trust I, a statutory
business trust (the "Trust") created by the Parent Company,
issued $7,500 of 9.25% Capital Securities which will mature on
January 15, 2028. The principal asset of the Trust is $7,500 of
the Parent Company's junior subordinated debt securities with
like maturities and like interest rates to the Capital
Securities. Additionally, the Trust has issued 9,000 shares of
common securities to the Parent Company. The 9.25% Capital
Securities had $7,500 outstanding at December 31, 1998 and an
estimated fair value of $7,923. The related junior subordinated
debt securities had an estimated fair value of $7,923.
The Capital Securities, the assets of the Trust and the common
securities issued by the Trust are redeemable in whole or in part
on or after January 15, 2008, or at any time in whole but not in
part from the date of issuance on the occurrence of certain
events.
The Capital Securities may be included in Tier I capital up to
25% of capital before inclusion for regulatory capital adequacy
determination purposes. The remaining 75% of the Capital
Securities may be included in Tier II capital. Distributions to
the holders of the Capital Securities are included in interest
expense.
The obligations of the Parent Company with respect to the
issuance of the Capital Securities constitute a full and
unconditional guarantee by the Parent Company of the Trust's
obligations with respect to the Capital Securities.
Subject to certain exceptions and limitations, the Parent Company
may elect from time to time to defer junior subordinated debt
securities interest payments, which would result in a deferral of
distribution payments on the related Capital Securities.
Amortization of capital issue costs and interest expense related
to the Trust is $10 and $662, respectively for 1998.
<PAGE>
HIGHLANDS BANKSHARES, INC. AND SUBSIDIARIES
Page F16
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
December 31, 1998
(In thousands)
Note 10. 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:
1999 199
2000 111
---------
Total minimum payments required $ 310
========
Total operating lease expense was $342, $330, and $359 for
December 31, 1998, 1997 and 1996 respectively.
The Company owns several buildings for use by its' subsidiaries,
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:
1999 $ 92
2000 42
2001 14
2002 1
--------
Total minimum payments required $ 149
========
Total operating lease income was $90, $90 and $0 for December 31, 1998,
1997 and 1996, respectively.
Note 11. Common Stock, Stock Split, and Earnings Per Common Share
On April 15, 1995, the Board authorized a 2 for 1 stock split to
be distributed to all shareholders of record as of April 12,
1995. 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.
Earnings per common share is computed using the weighted average
outstanding shares as of December 31. The stock options (Note 13)
have a dilutive effect on earnings per share.
(Continued)
<PAGE>
HIGHLANDS BANKSHARES, INC. AND SUBSIDIARIES
Page F17
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
December 31, 1998
(In thousands)
Note 11. Common Stock, Stock Split, and Earnings Per Common Share
(Continued)
The following is a reconciliation of the numerators and the
denominators of the basic and diluted earnings per common share
computation:
<TABLE>
<CAPTION>
1998
-------------------------------------
Income Shares Per-Share
(Numerator) (Denominator) Amount
----------- ------------- ------
<S> <C> <C> <C>
Net income $1,775
======
Basic Earnings per Common Share
Income available to common
stockholders 1,775 1,236 $1.44
=====
Effect of Dilutive Stock options
outstanding -- 46
------ ------
Diluted Earnings per Common Share
Income available to common
stockholders + assumed conversions $1,775 1,282 $1.38
====== ====== =====
</TABLE>
<TABLE>
<CAPTION>
1997
-------------------------------------
Income Shares Per-Share
(Numerator) (Denominator) Amount
----------- ------------- ------
<S> <C> <C> <C>
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 -- 51
------ ------
Diluted Earnings per Common Share
Income available to common
stockholders + assumed conversions $1,952 1,279 $1.53
====== ====== =====
</TABLE>
<TABLE>
<CAPTION>
1996
---------------------------------------
Income Shares Per-Share
(Numerator) (Denominator) Amount
----------- ------------- ------
<S> <C> <C> <C>
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 -- 54
------ -----
Diluted Earnings per Common Share
Income available to common
stockholders + assumed conversions $1,764 1,274 $1.38
====== ====== =====
</TABLE>
<PAGE>
HIGHLANDS BANKSHARES, INC. AND SUBSIDIARIES
Page F18
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
December 31, 1998
(In thousands)
Note 12. Profit Sharing and Retirement Savings Plan
From January 1, 1986 to June 30, 1997, the Bank provided a profit
sharing plan covering substantially all employees with over one
year of service. The plan provided for contributions in such
amounts as the Board of Directors determined annually, but not in
excess of the amount permitted under the Internal Revenue Code as
a deductible expense. The Bank accrued to the plan $120 for the
year ended December 31, 1996, which represents approximately 6%
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 makes a 2% contribution to all employees
exclusive of employee contributions and employer matching.
Employees may elect to make voluntary contributions to the plan
up to 15% of their base pay. The Bank matches 50% of the
employee's initial 6% contribution; therefore, the maximum
employer contribution per employee could be 5% of base pay. The
cost of Bank contributions under the savings plan was $115 and
$34, in 1998 and 1997 respectively.
Note 13. 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 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.
Options outstanding at weighted-average exercise price for the
years ended December 31, are as follows:
<TABLE>
<CAPTION>
1998 1997 1996
---------------------- --------------------- ----------------------
Dollars Number of Dollars Number of Dollars Number of
(Per Share) Shares (Per Share) Shares (Per Share) Shares
----------- --------- ----------- ------ ----------- ---------
<S> <C> <C> <C> <C> <C> <C>
Options outstanding January 1 $ 9.20 83,856 $ 7.02 82,668 $ 5.56 73,962
Granted 29.65 23,750 23.00 11,650 15.00 12,900
Exercised 4.80 (14,401) 7.38 (10,462) 5.84 (4,194)
-------- ------- -------
Options outstanding December 31 $ 15.28 93,205 $ 9.20 83,856 $ 7.02 82,668
======== ======= =======
</TABLE>
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 1996 $53
thousand was recorded as compensation as a result of options
granted. The 1998 and 1997 stock options were granted at the
current market value of the stock. The grant date fair value of
options is determined by the difference between market value and
option price on the grant date. The weighted-average grant-date
fair value of options granted during 1998, 1997 and 1996 was $0,
$0 and $3.50, respectively.
As of December 31, 1998, exercise prices of options outstanding
range from $4.14 to $31.00 per share, and carry a
weighted-average remaining contractual life of 6.77 years.
<PAGE>
HIGHLANDS BANKSHARES, INC. AND SUBSIDIARIES
Page F19
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
December 31, 1998
(In thousands)
Note 14. 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 $859, $2,408, and $2,026 and unused
portions of credit lines of $16,655, $12,297 and 10,335 for the
years ended December 31, 1998, 1997 and 1996, 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 $52,592 of unused lines of
credit to fund any necessary cash requirements. The Bank has
$6,643 of Federal Home Loan Bank advances outstanding as of
December 31, 1998. Specific mortgage loans with a balance of
$81,180 at December 31, 1998 were pledged to the FHLB as
collateral.
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.
The Bank has committed to enter a lease agreement for the use of
a new main frame computer. The final agreement is expected to
close by the end of the first quarter in 1999. The lease will be
for five years with a fixed rate of interest requiring annual
installments. The principal amount will be approximately $930
including approximately $140 on an existing lease that will be
rolled into the new agreement. As a part of this transaction, the
Bank made a downpayment on the main frame of $794 which is
included in the balance sheet under the caption "Other Assets".
This amount will be refunded to the Bank when the lease agreement
becomes effective.
Note 15. Fair Values of Financial Instruments
The carrying amounts and fair values of the Company's financial
instruments at December 31 were as follows:
<TABLE>
<CAPTION>
1998 1997 1996
------------------- --------------------- ---------------------
Carrying Fair Carrying Fair Carrying Fair
Amount Value Amount Value Amount Value
------ ------- ------ ------- -------- -------
<S> <C> <C> <C> <C> <C> <C>
Cash and cash equivalents $ 10,994 $ 10,994 $ 14,925 $ 14,925 $ 15,956 $ 15,956
Securities available for sale 51,355 51,355 41,963 41,963 31,345 31,345
Loans, net 231,363 234,290 190,369 195,020 153,879 156,977
Deposits (272,341) (273,551) (236,646) (237,429) (189,471) (190,071)
Federal funds purchased (503) (503) -- -- -- --
Long-term debt (6,763) (6,767) (2,614) (2,448) (1,929) (1,837)
Capital securities (7,500) (7,923) -- -- -- --
</TABLE>
(Continued)
<PAGE>
HIGHLANDS BANKSHARES, INC. AND SUBSIDIARIES
Page F20
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
December 31, 1998
(In thousands)
Note 15. Fair Values of Financial Instruments (Continued)
Cash and Cash Equivalents
The carrying amount reported in the balance sheets for cash and
short-term investments approximates fair value.
Securities Available for Sale
The carrying amount reported in the balance sheets for securities
available for sale 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.
Federal Funds Purchased
The carrying amount reported in the balance sheets for federal
funds purchased approximates fair value.
Long-Term Debt and Capital Securities
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.
<PAGE>
HIGHLANDS BANKSHARES, INC. AND SUBSIDIARIES
Page F21
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
December 31, 1998
(In thousands)
Note 16. Related Party Transactions
In the normal course of business, the Bank has made loans to
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, in
the opinion of management, involve more than normal credit risk
or present other unfavorable features. The activity of such loans
are approximately as follows:
<TABLE>
<CAPTION>
1998 1997 1996
------- ------- -------
<S> <C> <C> <C>
Balance, beginning $ 5,766 $ 5,541 $ 6,317
Loan additions 3,652 3,889 2,712
Amounts collected ( 2,761) ( 3,664) ( 3,488)
-------- -------- --------
Balance, ending $ 6,657 $ 5,766 $ 5,541
======= ======= ========
Unused Commitments $ 410 $ 216 $ 107
======== ======== =========
</TABLE>
Note 17. 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, 1998, 1997 and 1996 were $1,239, $1,034 and $789,
respectively.
Note 18. 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 Company could have declared
dividends of $2,939 $3,534 and $3,686 in 1998, 1997 and 1996
respectively. The Company paid dividends of $123 or $.10 per
share in 1998. The Company declined to pay cash dividends for
1997 and 1996, in order to maintain the capital necessary to
support the present rate of growth.
The Company 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 effect on the Company and the consolidated financial
statements. Under the regulatory capital adequacy guidelines and
the regulatory framework for prompt corrective action, the
Company must meet specific capital guidelines involving
quantitative measures of the Company's assets, liabilities, and
certain off-balance-sheet items as calculated under regulatory
accounting practices. The Company'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.
(Continued)
<PAGE>
HIGHLANDS BANKSHARES, INC. AND SUBSIDIARIES
Page F22
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
December 31, 1998
(In thousands)
Note 18. Undivided Profits and Capital (Continued)
Quantitative measures established by regulation to ensure capital
adequacy require the Company 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, 1998, that the Company meets all the
capital adequacy requirements to which it is subject.
The Company received notification from the Virginia State
Corporation Commission dated February 10, 1999 that as of October
5, 1998 the Company was categorized as well capitalized under the
regulatory framework for prompt corrective action. To remain
categorized as well capitalized, the Company 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 Company's prompt corrective
action category.
The Parent company's actual and required capital amounts and
ratios are as follows:
<TABLE>
<CAPTION>
To Be Well Capitalized
under the Prompt
For Capital Corrective Action
Actual Adequacy Purposes Provisions
------------------ ------------------ ------------------
Amount Ratio Amount Ratio Amount Ratio
------ ----- ------ ----- ------ -----
<S> <C> <C> <C> <C> <C> <C>
As of December 31, 1998:
Total Risk-Based Capital
(to Risk-Weighted Assets) $27,887 12.79% $17,447 >=8.0% $21,808 >=10.0%
Tier I Capital
(to Risk-Weighted Assets) 24,505 11.24% 8,723 >=4.0% 13,085 >=6.0%
Tier I Capital
(to Adjusted Total Assets) 24,505 8.09% 12,112 >=4.0% 15,140 >=5.0%
As of December 31, 1997:
Total Risk-Based Capital
(to Risk-Weighted Assets) $18,334 9.91% $14,800 >=8.0% $18,500 >=10.0%
Tier I Capital
(to Risk-Weighted Assets) 16,698 9.03% 7,400 >=4.0% 11,100 >=6.0%
Tier I Capital
(to Adjusted Total Assets) 16,698 6.68% 9,994 >=4.0% 12,492 >=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%
</TABLE>
(Continued)
<PAGE>
HIGHLANDS BANKSHARES, INC. AND SUBSIDIARIES
Page F23
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
December 31, 1998
(In thousands)
Note 18. Undivided Profits and Capital (Continued)
The Bank's actual and required capital amounts and ratios are as
follows:
<TABLE>
<CAPTION>
To Be Well Capitalized
under the Prompt
For Capital Corrective Action
Actual Adequacy Purposes Provisions
------------------- ------------------ ------------------
Amount Ratio Amount Ratio Amount Ratio
------ ----- ------ ----- ------ -----
<S> <C> <C> <C> <C> <C> <C>
As of December 31, 1998:
Total Risk-Based Capital
(to Risk-Weighted Assets) $21,241 10.15% $17,232 >=8.0% $21,054 >=10.0%
Tier I Capital
(to Risk-Weighted Assets) 19,865 9.22% 8,616 >=4.0% 12,924 >=6.0%
Tier I Capital
(to Adjusted Total Assets) 19,865 6.69% 11,875 >=4.0% 14,844 >=5.0%
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%
</TABLE>
Note 19. Other Operating Expenses
Other operating expenses consist of the following:
<TABLE>
<CAPTION>
1998 1997 1996
------- ------- -------
<S> <C> <C> <C>
Data processing $ 14 $ 9 $ 9
FDIC insurance 67 24 2
Postage and freight 251 197 161
Regulatory agency assessments 45 40 33
Supplies 216 183 146
Bank stock tax 146 151 122
Other 1,094 737 570
------- -------- --------
$ 1,833 $ 1,341 $ 1,043
======= ======= =======
</TABLE>
<PAGE>
HIGHLANDS BANKSHARES, INC. AND SUBSIDIARIES
Page F24
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
December 31, 1998
(In thousands)
Note 20. Subsequent Events
In January 1999, the Company committed to purchase real estate in
Abingdon, VA for $485,000. The property will be used as a future
expansion site of the Company.
Note 21. Condensed Parent Company Financial Statements
The condensed financial statements below relate to Highlands
Bankshares, Inc. as of December 31, 1998, 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.
<TABLE>
<CAPTION>
CONDENSED BALANCE SHEETS
1998 1997 1996
------- ------- -------
<S> <C> <C> <C>
ASSETS
Cash $ 202 $ 1 $ 331
Investment securities available
for sale (Note 2) 2,480 -- --
Federal funds sold 1,670 -- --
Investments in subsidiaries 19,772 16,343 14,122
Premises and equipment, net 1,402 1,276 141
Other assets 406 86 24
-------- -------- --------
Total Assets $ 25,932 $ 17,706 $ 14,618
======== ======== ========
LIABILITIES AND STOCKHOLDERS' EQUITY
Interest, taxes and other
liabilities $ 153 $ 23 $ --
Long-term debt -- 886 --
Capital securities 7,500 -- --
-------- -------- --------
Total Liabilities 7,653 909 --
-------- -------- --------
STOCKHOLDERS' EQUITY
Common stock 3,116 3,081 3,055
Surplus 5,265 5,271 5,187
Undivided profits 9,998 8,341 6,394
Net unrealized gains (losses) on securities (100) 104 (18)
-------- -------- --------
Total Stockholders' Equity 18,279 16,797 14,618
-------- -------- --------
Total Liabilities and
Stockholders' Equity $ 25,932 $ 17,706 $ 14,618
======== ======== ========
</TABLE>
(Continued)
<PAGE>
HIGHLANDS BANKSHARES, INC. AND SUBSIDIARIES
Page F25
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
December 31, 1998
(In thousands)
Note 21. Condensed Parent Company Financial Statements (Continued)
<TABLE>
<CAPTION>
CONDENSED STATEMENTS OF INCOME
1998 1997 1996
--------- ---------- ----------
<S> <C> <C> <C>
Cash dividends received from subsidiary $ -- $ -- $ 500
Revenues 373 102 --
Long-term debt interest expense (9) (61) --
Capital securities expense (672) -- --
Operating expense (68) (57) (5)
------- ------- -------
(376) (16) 495
Income tax (expense) benefit 128 5 (2)
Equity in undistributed earnings of subsidiary 2,023 1,963 1,271
------- ------- -------
Net income $ 1,775 $ 1,952 $ 1,764
======= ======= =======
</TABLE>
(Continued)
<PAGE>
HIGHLANDS BANKSHARES, INC. AND SUBSIDIARIES
Page F26
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
December 31, 1998
(In thousands)
Note 21.Condensed Parent Company Financial Statements (Continued)
<TABLE>
<CAPTION>
CONDENSED STATEMENTS OF CASH FLOWS
1998 1997 1996
---- ---- ----
<S> <C> <C> <C>
CASH FLOWS FROM OPERATING ACTIVITIES:
Net income $ 1,775 $ 1,952 $ 1,764
Adjustments to reconcile net income to
net cash provided by operating activities:
Depreciation and amortization 42 25 5
Provision for deferred income taxes (3) -- --
Equity in undistributed earnings of
subsidiary (2,023) (1,963) (1,271)
Net amortization on securities 25 -- --
(Increase) decrease in other assets (110) (69) (24)
Increase (decrease) in other liabilities 130 25 (2)
------- ------- -------
Net cash provided by operating activities (164) (30) 472
------- ------- -------
CASH FLOWS FROM INVESTING ACTIVITIES:
Securities available for sale:
Proceeds from sale of securities 1,072 -- --
Purchase of securities (3,586) -- --
Net (increase) in federal funds sold (1,670) -- --
Premises and equipment expenditures (152) (1,154) (141)
------- ------- -------
Net cash provided by investing activities (4,336) (1,154) (141)
------- ------- -------
CASH FLOWS FROM FINANCING ACTIVITIES:
Proceeds from issuance of long-term debt -- 900 --
Repayment of long-term debt (886) (14) --
Proceeds from issuance of junior subordinated
debt securities 7,500 -- --
Capital securities issuance cost (319) (68) --
Cash dividends paid (123) -- --
Proceeds from issuance of common stock 29 111 --
Purchase of subsidiary stock (1,500) (75) --
------- ------- -------
Net cash provided by financing activities 4,701 854 --
------- ------- -------
Net increase (decrease) in cash and cash equivalents 201 (330) 331
CASH AND CASH EQUIVALENTS
AT BEGINNING OF YEAR 1 331 --
------- ------- -------
CASH AND CASH EQUIVALENTS
AT END OF YEAR $ 202 $ 1 $ 331
======= ======= =======
</TABLE>
<TABLE> <S> <C>
<ARTICLE> 9
<LEGEND>
THIS SCHEDULE CONTAINS SUMMARY FINANCIAL INFORMATION EXTRACTED FROM THE
HIGHLANDS UNION BANKSHARES AND SUBSIDIARIES CONSOLIDATED BALANCE SHEET AT
DECEMBER 30, 1998 AND THE CONSOLIDATED STATEMENT OF OPERATIONS FOR THE YEAR
ENDED DECEMBER 31, 1998 AND IS QUALIFIED IN ITS ENTIRETY BY REFERENCE TO SUCH
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