UNITED STATES
SECURITIES AND EXCHANGE COMMISSION
Washington, D. C. 20549
FORM 10-QSB
Quarterly Report Under Section 13 or 15(d)
of the Securities Exchange Act of 1934
For the quarter ended Commission File No. 0-16761
September 30, 1998
HIGHLANDS BANKSHARES, INC.
West Virginia 55-0650793
(State or Other Jurisdiction of (I.R.S. Employer
Incorporation or Organization) Identification No.)
P. O. Box 929
Petersburg, West Virginia 26847
(304) 257-4111
(Registrant's Telephone Number, Including Area Code)
Indicate by check mark whether the registrant (1) filed all reports required
to be filed by Section 13 or 15(d) of the Securities Exchange Act of 1934 during
the past 12 months (or for such shorter period that the registrant was required
to file such reports), and (2) has been subject to such filing requirement for
the past 90 days. Yes ..X. No ....
State the number of shares outstanding of each of the issuer's classes of
common equity, as of the latest practicable date.
Class Outstanding at September 30, 1998
Common Stock, par value - $5 501,898 shares
<PAGE> 1
HIGHLANDS BANKSHARES, INC.
INDEX
Page
PART I FINANCIAL INFORMATION 2
Item 1. Financial Statements
Consolidated Statements of Income - Nine Months Ended
September 30, 1998 and 1997 2
Consolidated Statements of Income - Three Months Ended
September 30, 1998 and 1997 3
Consolidated Balance Sheets - September 30, 1998 and
December 31, 1997 4
Consolidated Statements of Changes in Stockholders' Equity -
Nine Months Ended September 30, 1998 and 1997 5
Consolidated Statements of Cash Flows - Nine Months Ended
September 30, 1998 and 1997 6
Notes to Consolidated Financial Statements 7
Item 2. Management's Discussion and Analysis of
Financial Condition and Results of Operations 9
PART II OTHER INFORMATION 20
Item 1. Legal Proceedings 20
Item 2. Changes in Securities 20
Item 3. Defaults upon Senior Securities 20
Item 4. Submission of Matters to a Vote of Security Holders 20
Item 5. Other Information 20
Item 6. Exhibit and Reports on Form 8K 20
SIGNATURES 22
<PAGE> 2
Part I Financial Information
Item 1 Financial Statements
HIGHLANDS BANKSHARES, INC.
CONSOLIDATED STATEMENTS OF INCOME
(In Thousands of Dollars)
Nine Months Ended
September 30,
1998 1997
Interest Income
Interest and fees on loans $ 9,771 $ 9,071
Interest on federal funds sold 284 206
Interest on time deposits 35 26
Interest and dividends on investment securities
Taxable 1500 1,771
Nontaxable 128 142
------ ------
Total Interest Income 11,718 11,216
------ ------
Interest Expense
Interest on time deposits over $100,000 1,083 1,010
Interest on other deposits 4,674 4,473
Interest on borrowed money 23 68
------ ------
Total Interest Expense 5,780 5,551
------ ------
Net Interest Income 5,938 5,665
Provision for Loan Losses 200 135
------ ------
Net Interest Income after Loan Losses 5,738 5,530
------ ------
Noninterest Income
Service charges 250 217
Other 278 288
Investment security gains (losses) (3) 6
------ ------
Total Noninterest Income 525 511
------ ------
Noninterest Expense
Salaries and employee benefits 2,172 2,141
Occupancy expense 199 181
Equipment expense 326 330
Data processing expense 344 326
Other 974 874
------ ------
Total Noninterest Expense 4,015 3,852
------ ------
Income before Income Taxes 2,248 2,189
Provision for Income Taxes 769 742
------ ------
Net Income $ 1,479 $ 1,447
====== ======
Per Share Data
Net Income $ 2.95 $ 2.86
====== ======
Cash Dividends $ .81 $ .75
====== ======
Weighted Average Common Shares Outstanding 501,898 505,143
======= =======
The accompanying notes are an integral part of these statements.
<PAGE> 3
HIGHLANDS BANKSHARES, INC.
CONSOLIDATED STATEMENTS OF INCOME
(In Thousands of Dollars)
Three Months Ended
September 30,
1998 1997
Interest Income
Interest and fees on loans $ 3,354 $ 3,103
Interest on federal funds sold 96 84
Interest on deposits in other institutions 11 7
Interest and dividends on investment securities
Taxable 490 585
Nontaxable 41 47
------ ------
Total Interest Income 3,992 3,826
------ ------
Interest Expense
Interest on time deposits over $100,000 376 349
Interest on other deposits 1,577 1,537
Interest on borrowed money 11 31
------ ------
Total Interest Expense 1,964 1,917
------ ------
Net Interest Income 2,028 1,909
Provision for Loan Losses 80 45
------ ------
Net Interest Income after Loan Losses 1,948 1,864
------ ------
Noninterest Income
Service charges 89 77
Other income 102 108
Investment security losses (1)
------ ------
Total Noninterest Income 191 184
------ ------
Noninterest Expense
Salaries and employee benefits 716 726
Occupancy expense 71 62
Equipment expense 106 111
Data processing 117 109
Other 349 295
------ ------
Total Noninterest Expense 1,359 1,303
------ ------
Income before Income Taxes 780 745
Provision for Income Taxes 263 261
------ ------
Net Income $ 517 $ 484
====== ======
Per Share Data
Net Income $ 1.03 $ .96
======= =======
Cash Dividends $ .27 $ .25
======= =======
Weighted Average Common Shares Outstanding 501,898 501,898
======= =======
The accompanying notes are an integral part of these statements.
<PAGE> 4
HIGHLANDS BANKSHARES, INC.
CONSOLIDATED BALANCE SHEETS
(In Thousands of Dollars)
September 30,December 31,
1998 1997
ASSETS
Cash and due from banks $ 4,593 $ 3,246
Time deposits in other banks 837 827
Federal funds sold 11,725 6,895
Securities held to maturity (note 2) 3,506 4,577
Securities available for sale (note 3) 28,535 31,683
Other investments 731 715
Loans, net of unearned interest (note 4) 145,282 137,105
Less allowance for loan losses (note 5) (1,193) (1,370)
------- -------
Net Loans 144,089 135,735
Bank premises and equipment 4,570 4,773
Interest receivable 1,544 1,548
Investment in insurance contracts 2,116
Other assets 632 771
------- -------
Total Assets $202,878 $190,770
======= =======
LIABILITIES
Deposits:
Noninterest bearing
Demand deposits $ 17,605 $ 15,952
Interest bearing
Money market and checking 18,113 15,774
Money market savings 11,538 12,179
Savings 21,283 19,389
Time deposits over $100,000 25,051 23,328
All other time deposits 84,658 81,314
------- -------
Total Deposits 178,248 167,936
Borrowed money 729 226
Accrued expenses and other liabilities 1,412 1,311
------- -------
Total Liabilities 180,389 169,473
------- -------
STOCKHOLDERS' EQUITY
Common stock ($5 par value, 1,000,000 shares
authorized, 546,764 shares issued) 2,734 2,734
Surplus 1,662 1,662
Retained earnings 18,927 17,854
Net unrealized gain on securities available for sale 159 40
------- -------
23,482 22,290
Treasury stock (at cost, 44,866 shares in
1998 and 1997) (993) (993)
---- ----
Total Stockholders' Equity 22,489 21,297
------- -------
Total Liabilities and Stockholders' Equity $202,878 $190,770
======= =======
The accompanying notes are an integral part of these statements.
<PAGE> 5
<TABLE>
HIGHLANDS BANKSHARES, INC.
CONSOLIDATED STATEMENTS OF CHANGES IN STOCKHOLDERS' EQUITY
(In Thousands of Dollars)
<CAPTION>
Accumulated
Other
Common Retained Treasury Comprehensive
Stock Surplus Earnings Stock Income (Loss) Total
<S> <C> <C> <C> <C> <C> <C>
Balance, December 31, 1996 $ 2,734 $ 1,662 $ 16,478 $ (494) $ (151) $ 20,229
Comprehensive Income
Net Income 1,447 1,447
Net change in unrealized
depreciation on investment
securities available for sale,
net of taxes 73 73
----- ----- ----- ---- ----- -----
Total Comprehensive Income 1,447 73 1,520
Purchase of treasury stock (499) (499)
Dividends paid (380) (380)
----- ----- ----- ---- ----- -----
Balances, September 30, 1997 $ 2,734 $ 1,662 $ 17,545 $ (993) $ (78) $ 20,870
===== ===== ====== ===== ===== =======
Accumulated
Other
Common Retained Treasury Comprehensive
Stock Surplus Earnings Stock Income (Loss) Total
Balance, December 31, 1997 $ 2,734 $ 1,662 $ 17,854 $ (993) $ 40 $21,297
Comprehensive Income
Net Income 1,479 1,479
Net change in unrealized
appreciation on investment
securities available for sale,
net of taxes 119 119
----- ----- ----- ----- ----- -----
Total Comprehensive Income 1,479 119 1,598
Dividends paid (406) (406)
----- ----- ----- ----- ----- -----
Balances, September 30, 1998 $ 2,734 $ 1,662 $ 18,927 $ (993) $ 159 $ 22,489
====== ====== ======= ===== ==== ======
</TABLE>
The accompanying notes are an integral part of these statements.
<PAGE> 6
HIGHLANDS BANKSHARES, INC.
CONSOLIDATED STATEMENTS OF CASH FLOWS
(In Thousands of Dollars)
Nine Months Ended
September 30,
1998 1997
Cash Flows from Operating Activities:
Net income $ 1,479 $ 1,447
Adjustments to reconcile net income to net
cash provided by operating activities:
Investment securities gains (3) (6)
Depreciation 278 284
Increase in insurance contracts (46)
Net accretion (3) (6)
Provision for loan losses 200 135
(Increase) decrease in interest receivable 4 (184)
Decrease in other assets 68 11
Increase in accrued expenses 101 320
------ ------
Net Cash Provided by Operating Activities 2,078 2,001
------ ------
Cash Flows from Investing Activities:
Net change in federal funds sold (4,830) (4,576)
Proceeds from maturities of securities
available for sale 8,714 6,539
Proceeds from maturities of securities
held to maturity 1,071 1,002
Purchase of other investments (16) (76)
Net change in time deposits in other banks (10) 181
Purchase of securities available for sale (5,370) (5,130)
Net change in loans to customers (8,554) (8,834)
Purchase of property and equipment (75) (587)
Investment in insurance contracts (2,070)
------ ------
Net Cash Consumed by Investing Activities (11,140) (11,481)
------- -------
Cash Flows from Financing Activities:
Net increase in deposits 10,312 9,636
Increase in other borrowed money 503 1,021
Payment of dividends (406) (380)
Purchase of treasury stock (498)
------ ------
Net Cash Provided by Financing Activities 10,409 9,779
------ ------
Net Increase in Cash and Cash Equivalents 1,347 299
Cash and Cash Equivalents, Beginning of Period 3,246 3,196
------ ------
Cash and Cash Equivalents, End of Period $ 4,593 $ 3,495
====== ======
Supplementary Disclosures:
Cash paid for:
Income taxes $ 749 $ 679
Interest expense 5,801 5,452
The accompanying notes are an integral part of these statements.
<PAGE> 7
HIGHLANDS BANKSHARES, INC.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
NOTE 1 ACCOUNTING PRINCIPLES:
The consolidated financial statements conform to generally accepted
accounting principles and to general industry practices. In the
opinion of management, the accompanying unaudited consolidated
financial statements contain all adjustments (consisting of only
normal recurring accruals) necessary to present fairly the financial
position as of September 30, 1998, and the results of operations for
the nine and three month periods ended September 30, 1998 and 1997.
The notes included herein should be read in conjunction with the notes
to financial statements included in the 1997 annual report to
stockholders of Highlands Bankshares, Inc.
NOTE 2 SECURITIES HELD TO MATURITY:
The amortized cost and market value of securities held to maturity
as of September 30, 1998 and December 31, 1997, are as follows:
1998 1997
------------------------------------
Amortized Market Amortized Market
Cost Value Cost Value
US Treasury securities and
obligations of US government
corporations and agencies $ 518 $ 525 $1,282 $ 1,287
Obligations of states and
political subdivisions 2,988 3,119 3,295 3,390
------ ------ ----- ------
Total $ 3,506 $ 3,644 $4,577 $ 4,677
====== ====== ===== ======
NOTE 3 SECURITIES AVAILABLE FOR SALE:
The amortized cost and market value of securities available for
sale as of September 30, 1998 and December 31, 1997, are as follows:
1998 1997
-------------------------------------
Amortized Market Amortized Market
Cost Value Cost Value
US Treasury securities and
obligations of US government
corporations and agencies $27,409 $27,718 $30,889 $31,014
Obligations of states and
political subdivisions 255 261 100 101
Other investments 618 556 630 568
------ ------ ----- ------
Total $28,282 $28,535 $31,619 $31,683
====== ====== ====== ======
<PAGE> 8
HIGHLANDS BANKSHARES, INC.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
NOTE 4 LOANS OUTSTANDING:
A summary of loans outstanding as of September 30, 1998 and
December 31, 1997, is as follows:
1998 1997
Commercial $ 30,406 $ 30,717
Real estate - construction 2,795 2,189
- mortgages 80,731 75,221
Consumer installment 33,588 31,492
------ -------
Total 147,520 139,619
Unearned interest (2,238) (2,514)
------ -------
Net loans outstanding $145,282 $137,105
======= =======
NOTE 5 ALLOWANCE FOR LOAN LOSSES:
A summary of transactions in the allowance for loan losses for the
nine months ended September 30, 1998 and 1997, follows:
1998 1997
Balance, beginning of period $ 1,370 $ 1,257
Provisions charged to operating expenses 200 135
Loan recoveries 59 121
Loan charge-offs (436) (182)
------ -------
Balance, end of period $ 1,193 $ 1,331
====== =======
<PAGE> 9
Item 2. Management's Discussion and Analysis of Financial Condition and
Results of Operations
Overview
Year to Date Operations
The Company's nine month income of $1,479,000 represents a 2.21% increase in
total earnings and an increase of 3.15% in earnings per share compared to 1997.
Earnings represented a return of 9.08% on average equity for the first nine
months of 1998 compared to 9.38% for the same period in 1997. Returns on average
assets for the nine month period ending September 30, 1998 and 1997 were 1.00%
and 1.04%, respectively. The increase in earnings was due to an increasing
volume of earning assets and stability in noninterest expenses.
The tax equivalent interest income increased by $494,000 in 1998 to
$11,793,000 as compared to 1997. A 5.07% increase in the level of earning assets
and a slight increase in the net interest spread was responsible for the
improvement. The increase in earning assets is attributable to a 9.64% increase
in average loans outstanding. The increase was primarily in real estate loans.
The funding of the asset growth was from deposits of local customers, primarily
time deposits.
Noninterest income increased 2.74% in 1998 compared to 1997 due to an
increase in service charge income. Noninterest expenses increased 4.23% in 1998
due mainly to the higher cost of data processing and year 2000 compliance
expenses.
Quarter Ending September 30 Operations
Net income for the quarter ending September 30, 1998 increased 6.82% when
compared to 1997 operations. Increases in other noninterest expenses were more
than offset by an increase in the net interest margin and an increase in service
charge income. An increased provision for loan losses was the result of a
limited number of unforeseen bankruptcies.
Net Interest Income
Year to Date Operations
The Company's net interest margin on a tax equivalent basis was $6,013,000
in the first nine months of 1998 compared to $5,748,000 for 1997. The increase
was due to an increase in average earning assets (5.07%) and an increased spread
(the difference in rates earned on assets and paid on liabilities) from 3.53% in
1997 to 3.59% in 1998. Average loans outstanding grew by 9.64% from 1997 to
1998. This growth reflects good local and national economic conditions, moderate
interest rates and expanded banking facilities. The overall costs of funds
reflects the high level of competition for deposits in the Company's service
area which has traditionally paid higher rates on deposits than larger statewide
financial institutions. The deposit increase represents growth in all types of
accounts (particularly time deposits) and has been obtained primarily from
customers in the immediate service areas.
<PAGE> 10
Item 2. Management's Discussion and Analysis of Financial Condition and Results
of Operations (Continued)
Net Interest Income (Continued)
Year to Date Operations (Continued)
Loans outstanding at September 30, 1998 increased 8.93% over amounts at
September 30, 1997 and 7.95% on annualized basis since December 31, 1997. The
loan increase has been the result of opening branches in new market areas and a
continued effort to increase lending in existing markets. Loan growth has been
funded primarily by deposit growth with a moderate decline in the level of
security investments since December 31, 1997. The increase in the tax equivalent
net interest margin for 1998 over the 1997 amounts is the result of slight
declines in the costs of funds on all types of deposit accounts and an
annualized growth in earning assets of 5.07%. Barring any future increases in
interest rates by the Federal Reserve Bank, the Company anticipates its net
interest margin remaining stable or increasing slightly. Rates paid on deposits
are expected to remain stable or decline slightly over the next twelve months
and returns on and the levels of earning assets are expected to remain at
current levels during this period.
Quarter Ending September 30 Operations
The Company's net interest income on a tax equivalent basis of $2,052,000
was 4.39% of earning assets for the quarter ending September 30, 1998 compared
to $1,936,000 (4.31% of earning assets) for the same period in 1997. Increased
income from loans was the result of increases in volume as the level of average
loans outstanding rose in the period and rates of return declined. Yields on
investment securities and short term investments declined slightly from 1997
operations. A decline in rates paid on interest bearing liabilities was offset
by a decline in the yields on loans. The overall result was an increase in the
net interest margin percentage from 4.31% to 4.39%. The Company expects future
deposit rates to remain stable or decline slightly in the last quarter of 1998
as local rates on deposits move towards those of state and national competition.
Rates on loans will be heavily influenced by the local economy and to a lesser
degree by national policy changes.
A complete yield analysis is shown as Table I on page 18.
Noninterest Income
Year to Date Operations
Noninterest income for the year to date ending September 30, 1998 increased
2.74% from year to date amounts at September 30, 1997. An increase in service
charge income of 15.21% was the result of an increased number of accounts
subject to service charges. A decline in other income due to lower earnings from
the insurance subsidiary and a slight security loss in 1998 compared to a slight
gain in 1997 tempered overall noninterest income increases.
Quarter Ending September 30 Operations
Noninterest income for the quarter ending September 30, 1998 increased 3.80%
compared to 1997 operations as the result of higher service charges for the same
reasons as cited above.
<PAGE> 11
Item 2. Management's Discussion and Analysis of Financial Condition and Results
of Operations (Continued)
Noninterest Expenses
Year to Date Operations
Overall, noninterest expense increased 4.23% in the first nine months of
1998 when compared to the same period in 1997. Personnel expenses increased
1.45% as the result of merit raises. Occupancy and equipment expenses increased
2.74% as the result of asset growth and inflation. Data processing expenses
increased by 5.52% as a result of increase transaction volume and rate
increases. Other noninterest expenses increased by 11.44% due to asset growth
and costs in preparing for the upcoming year 2000. The overall increase in
noninterest expenses of 4.23% is in line with the increase in assets and is in
line with management's expectations.
Quarter Ending September 30 Operations
Overall, noninterest expenses increased 4.30% for the quarter ending
September 30, 1998 compared to the quarter ending September 30, 1997. The
reasons for the quarterly increase include the cost of year 2000 preparedness
and higher data processing costs.
Loan Portfolio
The Company is an active residential mortgage and construction lender and
generally extends commercial loans to small and medium sized businesses within
its primary service area (Grant, Hardy, Mineral, northern Pendleton and
southeastern Hampshire counties). Consistent with its focus on providing
community-based financial services, the Company does not attempt to diversify
its loan portfolio geographically by making significant amounts of loans to
borrowers outside of its primary service area.
The principal economic risk associated with each of the categories of loans
in the Company's portfolio is the creditworthiness of its borrowers. Within each
category, such risk is increased or decreased depending on prevailing economic
conditions. The risk associated with the real estate mortgage loans and
installment loans to individuals varies based upon employment levels, consumer
confidence, fluctuations in value of residential real estate and other
conditions that affect the ability of consumers to repay indebtedness. The risk
associated with commercial, financial and agricultural loans varies based upon
the strength and activity of the local economies of the Company's market areas.
The risk associated with real estate construction loans varies based upon the
supply of and demand for the type of real estate under construction.
Loans outstanding increased $8,177,000 or 5.96% in the first nine months in
1998. The bulk of this increase was in real estate loans with smaller increases
in other types of loans. The loan to deposit ratio was 81.51% at September 30,
1998 compared to 81.64% at December 31, 1997. Management believes this level of
lending activity is satisfactory to generate adequate earnings without undue
credit risk. Loan demand is expected to remain satisfactory in the near future
with any growth a function of local and national economic conditions.
<PAGE> 12
Item 2. Management's Discussion and Analysis of Financial Condition and Results
of Operations (Continued)
Asset Quality
Nonperforming loans include nonaccrual loans, loans 90 days or more past due
and restructured loans. Under the Company's criteria for classification of
nonperforming loans, loans that are both (a) past due 90 days or more and (b)
not deemed nonaccrual due to an assessment of collectibility are specifically
excluded from the definition of nonperforming assets. Nonaccrual loans are loans
on which interest accruals have been suspended or discontinued permanently.
Restructured loans are loans on which the original interest rate or repayment
terms have been changed due to financial hardship of the borrower. The Company
had $88,000 of nonperforming loans at September 30, 1998 compared to $27,000 at
June 30, 1998 and zero at December 31, 1997. Accruing loans past due 90 days or
more, and excluded from classification as nonperforming assets, totaled
$1,584,000 at September 30, 1998, $1,037,000 at June 30, 1998 and $1,247,000 at
December 31, 1997.
Real estate acquired through foreclosure was $140,000 at September 30, 1998
compared to $174,000 at December 31, 1997. All foreclosed property held at
September 30, 1998 was in the Company's primary service area. The Company's
practice is to value real estate acquired through foreclosure at the lower of
(i) an independent current appraisal or market analysis less anticipated costs
of disposal, or (ii) the existing loan balance. The Company is actively
marketing all foreclosed real estate and does not anticipate material
write-downs in value before disposition.
An inherent risk in the lending of money is that the borrower will not be
able to repay the loan under the terms of the original agreement. The allowance
for loan losses (see subsequent section) provides for this risk and is reviewed
periodically for adequacy. This review also considers concentrations of loans in
terms of geography, business type or level of risk. While lending is
geographically diversified within the service area, the Company does have some
concentration of loans in the area of agriculture (primarily poultry farming),
timber and related industries. Management recognizes these concentrations and
considers them when structuring its loan portfolio. As of September 30, 1998,
management is not aware of any significant potential problem loans in which the
debtor is currently meeting their obligations as stated in the loan agreement
but which may change in future periods.
Allowance for Loan Losses
Management evaluates the loan portfolio in light of national and local
economic changes, changes in the nature and value of the portfolio and industry
standards. The Company's loan classification system, which rates existing loans,
provides the basis for adjusting the allowance for loan losses. Management
reviews these classification totals, along with internally generated loan review
reports, past due reports, historical loan loss experience and individual
borrower's financial health to determine the necessary amount to be provided in
the allowance for loan losses. Management evaluates nonperforming loans relative
to their collateral value and makes the appropriate adjustments to the allowance
when needed.
<PAGE> 13
Item 2. Management's Discussion and Analysis of Financial Condition and Results
of Operations (Continued)
Allowance for Loan Losses (Continued)
The provision for credit losses and changes in the allowance for credit
losses are shown below (in thousands of dollars).
Quarter Ended Nine Months Ended
September 30, September 30,
1998 1997 1998 1997
Balance, beginning of period $ 1,358 $ 1,290 $ 1,370 $ 1,257
Net charge-offs (recoveries)
Charge-offs 267 32 436 182
Recoveries (22) (28) (59) (121)
------ ------ ------ ------
Total net charge-offs * 245 4 377 61
Provision for credit losses 80 45 200 135
------ ------ ------ ------
Balance, End of Period $ 1,193 $ 1,331 $ 1,193 $ 1,331
====== ====== ====== ======
* Components of net charge-offs:
Real estate mortgages 53 1 53 8
Commercial 27 (3) 132 13
Installment 165 6 192 40
----- ----- ----- ----
Total $ 245 $ 4 $ 377 $ 61
====== ====== ====== ======
The allowance for credit losses, of $1,193,000 at September 30, 1998, was
down $165,000 from its level at June 30, 1998, and down $177,000 from December
31, 1997 levels. The allowance was equal to .82%, .95% and .94% of total loans
at September 30, 1998, June 30, 1998 and December 31, 1997, respectively. The
unusually large amount of net charge offs in the third quarter of 1998 was the
result of a couple of large bankruptcies. Some recoveries are expected from
these actions but it is too premature to estimate the amount at this time. The
Company believes that its allowance must be viewed in its entirety and,
therefore, is available for potential credit losses in its entire portfolio,
including loans, credit-related commitments and other financial instruments. In
the opinion of management, the allowance, when taken as a whole, is adequate to
absorb reasonably estimated credit losses inherent in the Company's portfolio.
<PAGE> 14
Item 2. Management's Discussion and Analysis of Financial Condition and Results
of Operations (Continued)
Securities
The Company's securities portfolio serves numerous purposes. Portions of
the portfolio may secure certain public deposits. The remaining portions are
held as investments or used to assist the Company in liquidity and
asset/liability management. Total securities at September 30, 1998 were
$32,772,000 compared to $36,975,000 at December 31, 1997. Securities as percent
of total assets were 16.15% at September 30, 1998 compared to 19.38% at December
31, 1997. The decline in securities is a result of controlled loan growth, a
flattened yield curve and increases in federal funds sold.
The securities portfolio consists of three components: securities held to
maturity, securities available for sale and restricted investments. Securities
are classified as held to maturity when management has the intent and the
Company has the ability at the time of purchase to hold the securities to
maturity. Held to maturity securities are carried at cost, adjusted for
amortization of premiums and accretion of discounts. Securities to be held for
indefinite periods of time are classified as available for sale and accounted
for at market value. Securities available for sale include securities that may
be sold in response to changes in market interest rates, changes in the
security's prepayment risk, increases in loan demand, general liquidity needs
and other similar factors. Restricted investments include investments in federal
agencies such as the Federal Reserve Bank and the Federal Home Loan Bank. The
Company's recent purchases of all securities have generally been limited to
securities of high credit quality with short to medium term maturities. Changes
within the year in market values are reflected as changes in stockholders'
equity, net of the deferred tax effect. As of September 30, 1998, the cost of
the securities available for sale exceeded their market value by $253,000
($159,000 after tax considerations).
Deposits
The Company's main source of funds remains deposits received from
individuals, governmental entities and businesses located within the Company's
service area. Deposit accounts include demand deposits, savings, money market
and certificates of deposit.
Total deposits increased 6.14% between December 31, 1997 and September 30,
1998, in all deposit areas except money market savings accounts. The cost of
funds for the first nine months of 1998 was 4.91% compared to 5.02% for the same
period in 1997. The yields on all deposits declined slightly within the period
except demand deposits. The majority of the Company's deposits are time deposits
which are attractive to persons seeking high yields on their deposits but
without the need for liquidity. The Company has not actively pursued deposits in
excess of $100,000 due to the volatile nature of these relationships and saw
only moderate increases in these deposits in the first nine months of 1998.
Borrowed Money
The Company will occasionally borrow funds from the Federal Home Loan Bank
to reduce market rate risks. Such borrowings are on a relatively small scale and
are not a significant source of funding to the Company.
<PAGE> 15
Item 2. Management's Discussion and Analysis of Financial Condition and Results
of Operations (Continued)
Capital
The Company seeks to maintain a strong capital base to expand facilities,
promote public confidence, support current operations and grow at a manageable
level. As of September 30, 1998, the Company's total risk based capital ratio
was 18.11% which is far above the regulatory minimum of 8.0%. The ratio of total
capital to total assets was 11.08% at September 30, 1998.
Management believes this level of capital is adequate to meet current
requirements and allow for future growth.
Liquidity
Liquidity is the ability to meet present and future financial obligations
through either the sale or maturity of existing assets or the acquisition of
additional funds through liability management. Liquid assets include cash,
interest bearing deposits with banks, federal funds sold, investments and loans
maturing within one year. The Company's ability to obtain deposits and purchase
funds at favorable rates determines its liquidity exposure. As a result of the
Company's management of liquid assets and the ability to generate liquidity
through liability funding, management believes that the Company maintains
overall liquidity sufficient to satisfy its depositors' requirements and meet
its customers' credit needs.
Additional sources of liquidity available to the Company include, but are
not limited to, loan repayments, the ability to obtain deposits through the
adjustment of interest rates and the purchasing of federal funds. To further
meet its liquidity needs, the Company also maintains lines of credit with
correspondent financial institutions and the Federal Reserve Bank of Richmond.
Both subsidiary banks have lines of credit with the Federal Home Loan Bank of
Pittsburgh although utilization has been insignificant. In the past, growth in
deposits and proceeds from the maturity of investment securities have been
sufficient to fund the net increase in loans and investment securities.
Interest Rate Sensitivity
In conjunction with maintaining a satisfactory level of liquidity,
management must also control the degree of interest rate risk assumed on the
balance sheet. Managing this risk involves regular monitoring of the interest
sensitive assets relative to interest sensitive liabilities over specific time
intervals.
At September 30, 1998 the Company had a negative gap position. This
liability sensitive position typically produces an unfavorable contribution to
earnings during a period of increasing rates. With the largest amount of
interest sensitive assets and liabilities repricing within three years, the
Company monitors these areas very closely. Early withdrawal of deposits,
prepayments of loans and loan delinquencies are some of the factors that could
affect actual versus expected cash flows. In addition, changes in rates on
interest sensitive assets and liabilities may not be equal, which could result
in a change in net interest margin. While the Company does not match each of its
interest sensitive assets against specific interest sensitive liabilities, it
does review its positions regularly and takes actions to reposition itself when
necessary.
<PAGE> 16
Item 2. Management's Discussion and Analysis of Financial Condition and Results
of Operations (Continued)
Year 2000 Project
Each of the subsidiary banks has appointed a group of individuals from
within the Bank to identify critical areas for year 2000 compliance and to
determine if that area will be year 2000 compliant. Critical compliance areas
include third party data processing, internal computer readiness, check and
deposit transaction processing, security, liquidity planning and correspondent
banking. The Company has begun to ascertain its compliance internally through
the help of computer and information consultants and the upgrade of computer and
information processing hardware. Noncompliance items and systems have been
identified. Most remediation is complete and testing of remediation results is
under way. Testing of substantially all systems is anticipated to be complete by
December 31, 1998. Testing of external interfaces is scheduled for the first
quarter of 1999. Continuing discussions with third party vendors who perform
data processing functions and with correspondent banking institutions do not
indicate any critical shortcomings in their compliance at this time.
As of September 30, 1998, the Company has incurred $370,000 in services and
equipment costs in its efforts to become year 2000 compliant. Most of these
expenditures include amounts for normal and scheduled equipment upgrades. The
Company has budgeted $625,000 in total expenditures through December 31, 1999
for its compliance effort. Roughly 60 to 70% of this amount will be for
equipment replacements and upgrades. Some of the costs of the year 2000 project
include the cost of Company personnel who will spend significant time on the
project. The Company does not anticipate that these costs when aggregated will
have a materially negative impact on the Company operations in any one period.
The impact of year 2000 issues on the Company will depend not only on
corrective actions that the Company takes, but also on the way in which year
2000 issues are addressed by governmental agencies, businesses and other third
parties that provide services or data to, or receive services or data from, the
Company, or whose financial condition or operational capability is important to
the Company. To reduce this exposure, the Company has an ongoing process of
identifying and contacting mission critical third party vendors and other
significant third parties to determine their year 2000 plans and target dates.
Notwithstanding the Company's efforts, there can be no assurance that mission
critical third party vendors or other significant third parties will adequately
address their year 2000 issues.
The Company is developing contingency plans for implementation in the event
that mission critical third party vendors or other significant third parties
fail to adequately address year 2000 issues. Such plans principally involve
identifying alternate vendors or internal remediation. The Company is also
enhancing its existing business resumption plans to reflect year 2000 issues and
is developing plans designed to coordinate the efforts of its personnel and
resources in addressing any year 2000 problems that become evident after
December 31, 1999. There can be no assurance that any such plans will fully
mitigate any such failure or problems. Furthermore, there may be certain mission
critical third parties, such as utilities or telecommunication companies, where
alternative arrangements or sources are limited or unavailable.
The Company's credit risk associated with borrowers may increase to the
extent borrowers fail to adequately address year 2000 issues. As a result, there
may be increases in the Company's problem loans and credit losses in future
years. It is not, however, possible to quantify the potential impact of such
losses at this time.
If year 2000 issues are not adequately addressed by the Company and third
parties, the Company's business, results of operations and financial position
could be materially adversely affected.
<PAGE> 17
Item 2. Management's Discussion and Analysis of Financial Condition and Results
of Operations (Continued)
Year 2000 Project (Continued)
The foregoing year 2000 discussion contains "forward-looking statements"
within the meaning of the Private Securities Litigation Reform Act of 1995. Such
statements, including without limitation, anticipated costs, the dates by which
the Company expects to substantially complete programming changes, remediation
and testing of systems and the impact of the redeployment of existing staff, are
based on management's best current estimates, which were derived utilizing
numerous assumptions about future events, including the continued availability
of certain resources, representations received from third party service
providers and other factors. However, there can be no guarantee that these
estimates will be achieved and actual results could differ materially from those
anticipated. Specific factors that might cause such material differences
include, but are not limited to, the availability and cost of personnel trained
in this area, the ability to identify and convert all relevant computer systems,
results of year 2000 testing, adequate resolution of year 2000 issues by
governmental agencies, businesses or other third parties who are service
providers, suppliers, borrowers or customers of the Company, unanticipated
system costs, the need to replace hardware, the adequacy of and ability to
implement contingency plans and similar uncertainties. The "forward-looking
statements" made in the foregoing year 2000 discussion speak only as of the date
on which such statements are made, and the Company undertakes no obligation to
update any forward-looking statement to reflect events or circumstances after
the date on which such statement is made or to reflect the occurrence of
unanticipated events.
Effects of Inflation
Inflation significantly affects industries having high proportions of
property, plant and equipment or high levels of inventories. Although the
Company is not significantly affected in these areas, inflation does have an
impact on the growth of assets. As assets grow rapidly, it becomes necessary to
increase equity capital at proportionate levels to maintain the appropriate
equity to asset ratios. Traditionally, the Company's earnings and high capital
retention levels have enabled the Company to meet these needs.
The Company's reported earnings results have been affected by inflation,
but isolating the effect is difficult. The different types of income and expense
are affected in various ways. Interest rates are affected by inflation, but the
timing and magnitude of the changes may not coincide with changes in the
consumer price index. Management actively monitors interest rate sensitivity, as
illustrated by the Gap Analysis (Table II, page 19) in order to minimize the
effects of inflationary trends on interest rates. Other areas of noninterest
expenses may be more directly affected by inflation.
Securities and Exchange Commission Web Site
The Securities and Exchange Commission maintains a Web site that contains
reports, proxy and information statements and other information regarding
registrants that file electronically with the Commission, including Highlands
Bankshares, Inc., and the address is (http://www.sec.gov).
<PAGE> 18
Table I
HIGHLANDS BANKSHARES, INC.
NET INTEREST MARGIN ANALYSIS
(Dollar Amounts in Thousands)
Nine Months Ended Nine Months Ended
September 30, 1998 September 30, 1997
Average Income/ Average Income/
Balance Expense Rates Balance Expense Rates
Rate Related Income
Loans
Commercial $31,422 $2,080 8.83% $26,549 $1,781 8.94%
Consumer 30,045 2,509 11.13% 27,035 2,314 11.41%
Real Estate 80,418 5,182 8.59% 75,822 4,976 8.75%
------ ----- ---- ------ ----- ----
Total 141,885 9,771 9.18% 129,406 9,071 9.35%
Federal funds sold 6,935 284 5.46% 4,906 206 5.60%
Interest bearing deposits 853 35 5.47% 715 26 4.85%
Investments
Taxable 31,918 1,500 6.27% 37,372 1,771 6.32%
Tax exempt (1) 3,314 203 8.17% 3,592 225 8.35%
----- --- ---- ----- ---- ----
Total Earning Assets (1) 184,905 11,793 8.50% 175,991 11,299 8.55%
------- ------ ------ -------- ------ -----
Interest Expense
Demand deposits 28,830 615 2.84% 27,706 587 2.82%
Savings 19,944 519 3.47% 18,541 489 3.52%
Time deposits 107,494 4,623 5.73% 99,722 4,407 5.89%
Other borrowed money 557 23 5.51% 1,517 68 5.98%
------ ------ ----- ------- ---- -----
Total Interest Bearing
Liabilities 156,825 5,780 4.91% 147,486 5,551 5.02%
------- ------ ---- ------- ----- -----
Net Interest Margin $ 6,013 $ 5,748
====== =====
Net Yield on Interest
Earning Assets (1) 4.34% 4.35%
===== =====
(1) Yields are on a taxable equivalent basis using an assumed tax rate of 37%.
<PAGE> 18 (Continued)
Table I (Continued)
HIGHLANDS BANKSHARES, INC.
NET INTEREST MARGIN ANALYSIS
(Dollar Amounts in Thousands)
Three Months Ended Three Months Ended
September 30, 1998 September 30, 1997
Average Income/ Average Income/
Balance Expense Rates Balance Expense Rates
Rate Related Income
Loans
Commercial $31,127 $ 698 8.96% $26,739 $ 602 9.00%
Consumer 31,110 872 11.21% 27,843 793 11.39%
Real Estate 82,571 1,784 8.64% 77,980 1,708 8.76%
------ ----- ---- ------ ----- ----
Total 144,808 3,354 9.26% 132,562 3,103 9.36%
Federal funds sold 7,054 96 5.44% 5,854 84 5.74%
Interest bearing deposits 811 11 5.43% 529 7 5.29%
Investments
Taxable 31,126 490 6.30% 36,974 585 6.33%
Tax exempt (1) 3,225 65 8.06% 3,560 74 8.31%
----- --- ---- ----- ---- ----
Total Earning Assets (1) 187,024 4,016 8.59% 179,479 3,853 8.59%
------- ----- ------ ------- ----- ----
Interest Expense
Demand deposits 28,445 203 2.85% 27,874 210 3.01%
Savings 20,271 178 3.51% 18,883 167 3.54%
Time deposits 108,871 1,572 5.78% 102,850 1,509 5.87%
Other borrowed money 734 11 5.99% 2,003 31 6.19%
------ ------ ----- ------- ---- ----
Total Interest Bearing
Liabilities 158,321 1,964 4.96% 151,610 1,917 5.06%
------- ----- ----- ------- ----- ----
Net Interest Margin $ 2,052 $ 1,936
====== =====
Net Yield on Interest
Earning Assets (1) 4.39% 4.31%
===== =====
(1) Yields are on a taxable equivalent basis using an assumed tax rate of 37%.
<PAGE> 19
TABLE II
HIGHLANDS BANKSHARES, INC.
INTEREST RATE SENSITIVITY ANALYSIS
SEPTEMBER 30, 1998
(In Thousands of Dollars)
1 - 90 91 - 365 1 to 3 3 to 5 More than
Days Days Years Years 5 Years Total
EARNINGS ASSETS
Loans $ 20,994 $ 53,365 $ 49,000 $ 12,842 $ 9,081 $145,282
Fed funds sold 11,725 11,725
Securities 3,172 8,387 12,467 3,174 5,572 32,772
Time deposits in
other banks 237 600 837
------ ------- ------- ------- ------ ------
Total 36,128 62,352 61,467 16,016 14,653 190,616
------- ------- ------- ------- ------- -------
INTEREST BEARING LIABILITIES
Transaction accounts 18,113 18,113
Money market accounts 11,538 11,538
Savings accounts 21,283 21,283
Time deposits more
than $100,000 2,953 14,387 6,269 1,442 25,051
Time deposits less
than $100,000 12,078 42,393 24,542 5,545 100 84,658
Other borrowed money 15 47 138 156 373 729
------ ------- ------- ------- ------ ------
Total 65,980 56,827 30,949 7,143 473 161,372
------- ------- ------- ------ ----- -------
Rate sensitivity GAP (29,852) 5,525 30,518 8,873 14,180 29,244
Cumulative GAP (29,852) (24,327) 6,191 15,064 29,244
Ratio of cumulative
interest sensitive assets
to cumulative interest
sensitive liabilities 54.76% 80.19% 104.03% 109.36% 118.12%
Assumes all transaction and money market deposit accounts reprice within 90
days.
<PAGE> 20
Part II Other Information
Item 1. Legal Proceedings - Not Applicable
Item 2. Changes in Securities - Not Applicable
Item 3. Defaults Upon Senior
Securities - Not Applicable
Item 4. Submission of Matters to a
Vote of Security Holders - Not Applicable
Item 5. Other Information - Not Applicable
Item 6. Exhibits and Reports on 8-K - (a) Exhibits
3(i) Articles of Incorporation of
Highlands Bankshares, Inc. are
incorporated by reference to
Appendix C to Highlands
Bankshares, Inc.'s Form S-4
filed October 20, 1986.
3(ii) Bylaws of Highlands Bankshares,
Inc. are incorporated by
reference to Appendix D to
Highlands Bankshares, Inc.'s
Form S-4 filed October 20,
1986.
27 Financial Data Schedule
attached
(b) Reports on Form 8-K filed during the
nine months ended September 30, 1998.
None
<PAGE> 21
EXHIBIT INDEX
Exhibit
Index Page Number
27 Financial Data Schedule for the quarter ending
September 30, 1998 23
<PAGE> 22
Signature
Pursuant to the requirements of the Securities Exchange Act of 1934, the
Registrant has duly caused this report to be signed on its behalf by the
undersigned thereunto duly authorized.
HIGHLANDS BANKSHARES, INC.
LESLIE A. BARR
Leslie A. Barr
President
JOHN A. VANMETER
John A. VanMeter
Chairman
Date November 10, 1998
<TABLE> <S> <C>
<ARTICLE> 9
<LEGEND>
This schedule contains summary financial information extracted from
Highlands Bankshares, Inc. Form 10QSB and is qualified in its entirety by
reference to such financial statements.
</LEGEND>
<MULTIPLIER> 1,000
<S> <C>
<PERIOD-TYPE> 9-MOS
<FISCAL-YEAR-END> DEC-31-1998
<PERIOD-START> JUL-01-1998
<PERIOD-END> SEP-30-1998
<CASH> 4,593
<INT-BEARING-DEPOSITS> 837
<FED-FUNDS-SOLD> 11,725
<TRADING-ASSETS> 0
<INVESTMENTS-HELD-FOR-SALE> 28,535
<INVESTMENTS-CARRYING> 3,506
<INVESTMENTS-MARKET> 3,644
<LOANS> 145,282
<ALLOWANCE> (1,193)
<TOTAL-ASSETS> 202,878
<DEPOSITS> 178,248
<SHORT-TERM> 62
<LIABILITIES-OTHER> 1,412
<LONG-TERM> 667
0
0
<COMMON> 2,734
<OTHER-SE> 19,755
<TOTAL-LIABILITIES-AND-EQUITY> 202,878
<INTEREST-LOAN> 9,771
<INTEREST-INVEST> 1,628
<INTEREST-OTHER> 319
<INTEREST-TOTAL> 11,718
<INTEREST-DEPOSIT> 5,757
<INTEREST-EXPENSE> 5,780
<INTEREST-INCOME-NET> 5,938
<LOAN-LOSSES> 200
<SECURITIES-GAINS> (3)
<EXPENSE-OTHER> 4,015
<INCOME-PRETAX> 2,248
<INCOME-PRE-EXTRAORDINARY> 2,248
<EXTRAORDINARY> 0
<CHANGES> 0
<NET-INCOME> 1,479
<EPS-PRIMARY> 2.95
<EPS-DILUTED> 2.95
<YIELD-ACTUAL> 4.34
<LOANS-NON> 88
<LOANS-PAST> 1,390
<LOANS-TROUBLED> 0
<LOANS-PROBLEM> 0
<ALLOWANCE-OPEN> 1,370
<CHARGE-OFFS> 436
<RECOVERIES> 59
<ALLOWANCE-CLOSE> 1,193
<ALLOWANCE-DOMESTIC> 1,193
<ALLOWANCE-FOREIGN> 0
<ALLOWANCE-UNALLOCATED> 0
</TABLE>
