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 Quarter Ended Commission File No. 0-16761
June 30, 1999
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 June 30, 1999
Common Stock, par value - $5 501,898 shares
HIGHLANDS BANKSHARES, INC.
HIGHLANDS BANKSHARES, INC.
INDEX
Page
PART I FINANCIAL INFORMATION 2
Item 1. Financial Statements
Consolidated Statements of Income - Six Months
Ended June 30, 1999 and 1998 2
Consolidated Statements of Income - Three Months
Ended June 30, 1999 and 1998 3
Consolidated Balance Sheets - June 30, 1999 and
December 31, 1998 4
Consolidated Statements of Changes in Stockholders'
Equity - Six Months Ended June 30, 1999 and 1998 5
Consolidated Statements of Cash Flows - Six Months
Ended June 30, 1999 and 1998 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. Exhibits 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)
Six Months Ended
June 30,
1999 1998
Interest Income
Interest and fees on loans $ 6,625 $ 6,417
Interest on federal funds sold 269 195
Interest on time deposits 110 17
Interest and dividends on investment securities
Taxable 904 1,041
Nontaxable 86 87
Total Interest Income 7,994 7,757
Interest Expense
Interest on time deposits over $100,000 740 707
Interest on other deposits 3,026 3,097
Interest on borrowed money 68 12
Total Interest Expense 3,834 3,816
Net Interest Income 4,160 3,941
Provision for Loan Losses 135 120
Net Interest Income After Provision for Loan Losses 4,025 3,821
Noninterest Income
Service charges 171 161
Other 201 145
Gain (loss) on security transactions 3 (3)
Total Noninterest Income 375 303
Noninterest Expense
Salaries and employee benefits 1,539 1,456
Occupancy expense 137 128
Equipment expense 215 220
Data processing 221 227
Other 691 625
Total Noninterest Expense 2,803 2,656
Income Before Income Taxes 1,597 1,468
Provision for Income Taxes 556 506
Net Income $ 1,041 $ 962
Per Share Data
Net Income $ 2.07 $ 1.92
Cash Dividends $ .58 $ .54
Weighted Average Common Shares Outstanding 501,898 501,898
The accompanying notes are an integral part of these statements.
<PAGE> 3
HIGHLANDS BANKSHARES, INC.
CONSOLIDATED STATEMENTS OF INCOME
(In Thousands of Dollars Except Per Share Amounts)
Three Months Ended
June 30,
1999 1998
Interest Income
Interest and fees on loans $ 3,341 $ 3,260
Interest on federal funds sold 140 105
Interest on time deposits 65 7
Interest and dividends on investment securities
Taxable 456 512
Nontaxable 44 43
Total Interest Income 4,046 3,927
Interest Expense
Interest on time deposits over $100,000 368 356
Interest on other deposits 1,527 1,566
Interest on borrowed money 33 9
Total Interest Expense 1,928 1,931
Net Interest Income 2,118 1,996
Provision for Loan Losses 75 60
Net Interest Income After Provision for Loan Losses 2,043 1,936
Noninterest Income
Service charges 90 87
Other income 120 55
Investment security gains (losses) 3 (3)
Total Noninterest Income 213 139
Noninterest Expense
Salaries and employee benefits 782 738
Occupancy expense 70 61
Equipment expense 106 110
Data processing expense 110 117
Other 357 313
Total Noninterest Expense 1,425 1,339
Income Before Income Taxes 831 736
Provision for Income Taxes 295 271
Net Income $ 536 $ 465
Per Share Data
Net Income $ 1.07 $ .93
Cash Dividends $ .29 $ .27
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)
June 30, December 31,
1999 1998
ASSETS
Cash and due from banks - noninterest bearing $ 4,284 $ 5,112
Time deposits in other banks 5,117 3,432
Federal funds sold 7,944 12,374
Securities held to maturity (note 2) 3,456 3,504
Securities available for sale (note 3) 31,067 29,758
Other investments 746 731
Loans, net of unearned interest (note 4) 153,725 148,384
Less allowance for loan losses (note 5) (1,326) (1,356)
Net Loans 152,399 147,028
Bank premises and equipment 5,178 4,760
Interest receivable 1,686 1,556
Investment in insurance contracts 4,573 2,122
Deferred income tax benefits 277 125
Other assets 474 479
Total Assets $217,201 $210,981
LIABILITIES
Deposits:
Noninterest bearing
Demand deposits $ 19,583 $ 22,043
Interest bearing
Money market and checking 19,497 18,353
Money market savings 14,641 11,394
Savings 22,409 20,849
Time deposits over $100,000 26,142 25,723
All other time deposits 87,742 86,225
Total Deposits 190,014 184,587
Borrowed money 2,544 2,320
Accrued expenses and other liabilities 1,305 1,228
Total Liabilities 193,863 188,135
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 20,075 19,324
Accumulated other comprehensive income (loss) (140) 119
24,331 23,839
Treasury stock (at cost, 44,866 shares in
1999 and 1998) (993) (993)
Total Stockholders' Equity 23,338 22,846
Total Liabilities and Stockholders' Equity $217,201 $210,981
The accompanying notes are an integral part of these statements.
<PAGE> 5
HIGHLANDS BANKSHARES, INC.
CONSOLIDATED STATEMENTS OF CHANGES IN STOCKHOLDERS' EQUITY
(In Thousands of Dollars)
<TABLE>
<CAPTION>
Accumulated
Other
Common Treasury Retained Comprehensive
Stock Surplus Stock Earnings Income(Loss) Total
<S> <C> <C> <C> <C> <C> <C>
Balance, December 31, 1998 $2,734 $ 1,662 $ (993) $ 19,324 $ 119 $22,846
Comprehensive Income
Net Income 1,041 1,041
Net change in unrealized
depreciation on investment
securities available for sale,
net of taxes (259) (259)
Total Comprehensive Income 1,041 (259) 782
Dividends paid (290) (290)
Balances, June 30, 1999 $2,734 $ 1,662 $ (993) $ 20,075 $(140) $23,338
Accumulated
Other
Common Treasury Retained Comprehensive
Stock Surplus Stock Earnings Income (Loss) Total
Balance, December 31, 1997 $2,734 $ 1,662 $ (993) $ 17,854 $ 40 $21,297
Comprehensive Income
Net Income 962 962
Net change in unrealized
depreciation on investment
securities available for sale,
net of taxes (2) (2)
Total Comprehensive Income 962 (2) 960
Dividends paid (271) (271)
Balances, June 30, 1998 $2,734 $ 1,662 $ (993) $ 18,545 $ 38 $21,986
</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)
Six Months Ended
June 30,
1999 1998
Cash Flows from Operating Activities:
Net income $ 1,041 $ 962
Adjustments to reconcile net income to net
cash provided by operating activities:
(Gain) loss on securities transactions (3) 3
Depreciation 178 184
Net securities amortization (accretion) 92 (1)
Provision for loan losses 135 120
Income from insurance investments (53) (31)
Increase in interest receivable (130) (77)
Decrease in other assets 5 115
Increase in accrued expenses 77 85
Net Cash Provided by Operating Activities 1,342 1,360
Cash Flows from Investing Activities:
Net change in federal funds sold 4,430 35
Proceeds from maturities of securities
available for sale 7,034 5,061
Proceeds from maturities of securities
held to maturity 50 819
Purchase of other investments (15) (16)
Net change in time deposits in other banks (1,685) (21)
Purchase of securities available for sale (8,846) (4,352)
Net change in loans (5,506) (5,898)
Purchase of property and equipment (596) (33)
Investment in insurance contracts (2,397) (2,101)
Net Cash Consumed by Investing Activities (7,531) (6,506)
Cash Flows from Financing Activities:
Net increase in deposits 5,427 6,373
Dividends paid in cash (290) (271)
Repayment of other borrowed money (83)
Other borrowed money 307 517
Net Cash Provided by Financing Activities 5,361 6,619
Net Increase (Decrease) in Cash and Cash Equivalents (828) 1,473
Cash and Cash Equivalents, Beginning of Period 5,112 3,246
Cash and Cash Equivalents, End of Period $ 4,284 $ 4,719
Supplemental Disclosures:
Cash Paid For:
Income taxes $ 622 $ 454
Interest 3,834 3,836
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 June 30, 1999, and the results of operations for the
six month periods ended June 30, 1999 and 1998. The notes included
herein should be read in conjunction with the notes to financial
statements included in the 1998 annual report to stockholders of
Highlands Bankshares, Inc.
The Company does not expect the anticipated adoption of any newly
issued accounting standards to have a material impact on future
operations or financial position.
NOTE 2 SECURITIES HELD TO MATURITY:
The amortized cost and fair value of securities held to maturity as
of June 30, 1999 and December 31, 1998, are as follows:
1999 1998
Amortized Fair Amortized Fair
Cost Value Cost Value
US Treasury securities and
obligations of US Government
corporations and agencies $ 468 $ 472 $ 517 $ 523
Obligations of states and
political subdivisions 2,988 3,024 2,987 3,098
Total $ 3,456 $3,496 $3,504 $3,621
NOTE 3 SECURITIES AVAILABLE FOR SALE:
The amortized cost and fair value of securities available for sale
as of June 30, 1999 and December 31, 1998, are as follows:
1999 1998
Amortized Fair Amortized Fair
Cost Value Cost Value
US Treasury securities and
obligations of US Government
corporations and agencies $29,909 $29,785 $28,179 $28,439
Obligations of states and
political subdivisions 255 250 255 262
Other investments 1,125 1,032 1,134 1,057
Total $31,289 $31,067 $29,568 $29,758
<PAGE> 8
HIGHLANDS BANKSHARES, INC.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
NOTE 4 LOANS OUTSTANDING:
A summary of loans outstanding as of June 30, 1999 and December 31,
1998, is as follows:
1999 1998
Commercial $ 29,937 $ 30,718
Real estate - construction 2,560 2,969
- mortgages 87,027 83,446
Consumer installment 36,113 33,464
Total 155,637 150,597
Unearned interest (1,912) (2,213)
Net loans outstanding $153,725 $148,384
NOTE 5 ALLOWANCE FOR LOAN LOSSES:
A summary of transactions in the allowance for loan losses for the
six months ended June 30, 1999 and 1998, follows:
1999 1998
Balance, beginning of period $ 1,356 $ 1,370
Provisions charged to operating expenses 135 120
Loan recoveries 50 38
Loan charge-offs (215) (170)
Balance, end of period $ 1,326 $ 1,358
NOTE 6 INVESTMENT IN INSURANCE CONTRACTS:
Investment in insurance contracts consist of single premium
insurance contracts which have the dual purposes of providing a rate
of return to the Company which approximately equals the rate of return
on one year Treasury obligations and providing life insurance and
retirement benefits to employees. The carrying value of these
investments is $4,573,000 at June 30, 1999.
<PAGE> 9
Item 2 Management's Discussion and Analysis of Financial Condition and
Results of Operations
Overview
Year to Date Operations
The Company's six month income of $1,041,000 was an increase of $79,000 over
1998 amounts and represents an 8.21% increase in net income and earnings per
share compared to 1998 operations. Earnings represented an annualized return on
equity of 9.02% for the first six months of 1999 compared to 8.89% for the same
period in 1998. The annualized return on average assets was .97% in the first
six months of 1999 compared with .99% in the first six months of 1998.
The tax equivalent net interest income increased by $219,000 in 1999 as the
result of an increased level of income earning assets. Returns on loans declined
thirty basis points, yields on fed funds and cash equivalents fell 75 basis
points and yields on investments declined by 29 basis points. A decline of 41
basis points in the overall cost of funds was the result of lowers costs on all
types of deposits. The net interest margin was 4.24% for the first six months of
1999 compared to 4.34% for the same period in 1998.
Noninterest income increased 23.76% in 1999 compared to 1998 due mainly to
an increase in income from insurance operations and returns earned on
investments in insurance contracts. Noninterest expenses increased 5.53% in 1999
due to average earning asset growth of 8.15% and costs relating to the year 2000
readiness and compliance.
Quarter Ending June 30 Operations
Overall net income and earnings per share for the quarter ending June 30,
1999 increased 15.27% when compared to 1998 operations. Increases in the net
interest margin and noninterest income far exceeded increases in operating
expenses during the period.
Net Interest Income
Year to Date Operations
The Company's net interest margin on a tax equivalent basis was $4,211,000
in the first six months of 1999 compared to $3,992,000 for 1998. The 5.49%
increase was due to a decline in the costs of deposits that equaled the decline
in the yields on assets and an 8.15% increase in average earning assets. Average
loans outstanding grew by 6.69% from 1998 to 1999. This growth reflects good
local 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 areas which have traditionally paid higher
rates on deposits than larger statewide financial institutions. The deposit
increase represents growth in all types of accounts and has been obtained from
customers in the immediate service areas.
Loans outstanding at June 30, 1999 increased 7.60% over amounts at June 30,
1998 and 7.20% on annualized basis since December 31, 1998. The increase in
loans has been the result of opening branches in new market areas and a
concerted effort to increase lending in existing markets. Loan growth has been
funded primarily by deposit growth with a slight decline in the level of
security investments as compared with prior years. The 3.72% increase in the tax
equivalent net interest margin for the second quarter of 1999 over the first
quarter of 1999 is the result of growth in earning assets. Barring any dramatic
increases in interest rates by the Federal Reserve Bank, the Company anticipates
its net interest margin remaining stable or increasing slightly as rates paid on
deposits are expected to decline slightly over the next twelve months and
returns on and the levels of earning assets are expected to remain stable during
this period.
<PAGE> 10
Item 2 Management's Discussion and Analysis of Financial Condition and
Results of Operations (Continued)
Net Interest Income (Continued)
Quarter Ending June 30 Operations
The Company's net interest income on a tax equivalent basis of $2,144,000
was 4.26% of average earning assets for the quarter ending June 30, 1999
compared to net interest income of $2,021,000 (4.35% of average earning assets)
for the same period in 1998. Increased income from loans was the result of
increases in volume as the level of average loans outstanding rose in the period
and market rates declined slightly. Yields on investment securities and short
term investments declined rather significantly from 1998 operations. Helping
improve the net interest margin was a decrease in rates paid on interest bearing
liabilities from 4.88% in 1998 to 4.39% in 1999. The decline was the result of
declining costs on all types of deposit accounts. The Company expects future
deposit rates to remain stable or decline slightly in the second half of 1999 as
local rates move closer to those of state and national competition.
A complete yield analysis is shown as Table I on page 18.
Noninterest Income
Year to Date Operations
Noninterest income for the period ending June 30, 1999 increased 23.76% from
amounts at June 30, 1998. An increase in insurance income of $37,000 was the
result of a decline in the amount of claims in 1999. Income from investments in
insurance contracts entered into in 1998 and early 1999 increased by $22,000 in
1999 compared to 1998 operations. All other noninterest income increased 5.10%
in the first six months of 1999 as the result of asset growth and small changes
in the gain (loss) on security transactions.
Quarter Ending June 30 Operations
Noninterest interest income for the quarter ending June 30, 1999 increased
53.24% as the result of items discussed in the preceding paragraph.
Noninterest Expenses
Year to Date Operations
Overall, noninterest expense increased 5.53% in the first six months of 1999
when compared to the same period in 1998. Personnel expenses increased 5.70% as
the result of inflation and staffing changes. Occupancy and equipment expenses
increased 1.15% as the result of slightly higher depreciation on recent
acquisitions. Data processing expenses declined by 2.64% as a result of changes
in the data processing contract. Other noninterest expenses increased by 10.56%
due to asset growth and expenses relating to Y2K readiness. The overall increase
in noninterest expenses of 5.53% is lower than the increase in assets and is in
line with management's expectations.
<PAGE> 11
Item 2 Management's Discussion and Analysis of Financial Condition and
Results of Operations (Continued)
Noninterest Expenses (Continued)
Quarter Ending June 30 Operations
Overall, noninterest expenses increased 6.42% for the quarter ending June
30, 1999 compared to the quarter ending June 30, 1998. The reasons for the
quarterly increase are the same as for the year-to-date increases and the
percentage increases for the quarters are relatively the same as the
year-to-date increases.
Loan Portfolio
The Company is an active residential mortgage and construction lender and
generally extends commercial loans to small and medium sized businesses within
its primary service area. The Company's commercial lending activity extends
across its primary service areas of Grant, Hardy, 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 $5,341,000 or 3.60% in the first six months in
1999. The bulk of this increase was in real estate mortgage loans and consumer
installment loans. The loan to deposit ratio was 80.90% at June 30, 1999
compared to 80.39% at December 31, 1998. 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.
Asset Quality
Nonperforming loans include nonaccrual loans, loans 90 days or more past due
and restructured loans. Nonaccrual loans are loans on which interest accruals
have been suspended or discontinued permanently. Restructured loans are loans on
which the original interest rate or repayment terms have been changed due to
financial hardship of the borrower. The Company had no material restructured
loans at June 30, 1999, March 31, 1999 or December 31, 1998.
<PAGE> 12
Item 2 Management's Discussion and Analysis of Financial Condition and
Results of Operations (Continued)
Asset Quality (Continued)
Real estate acquired through foreclosure was $54,000 at June 30, 1999
compared to $95,000 at December 31, 1998. All foreclosed property held at June
30, 1999 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 June 30, 1999,
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.
The provision for credit losses and changes in the allowance for credit
losses are shown below (in thousands of dollars).
Quarter Ended Six Months Ended
June 30, June 30,
Allowance for credit losses 1999 1998 1999 1998
Balance, beginning of period $ 1,303 $ 1,320 $ 1,356 $ 1,370
Net charge-offs (recoveries)
Charge-offs 71 37 215 170
Recoveries (19) (15) (50) (38)
Total net charge-offs * 52 22 165 132
Provision for credit losses 75 60 135 120
Balance, End of Period $ 1,326 $ 1,358 $ 1,326 $ 1,358
<PAGE> 13
Item 2 Management's Discussion and Analysis of Financial Condition and
Results of Operations (Continued)
Allowance for Loan Losses (Continued)
Quarter Ended Six Months Ended
June 30, June 30,
1999 1998 1999 1998
* Components of net charge-offs:
Commercial $ 3 $ 2 $ 75 $105
Installment 49 20 90 27
Total $ 52 $ 22 $165 $132
The allowance for credit losses of $1,326,000 at June 30, 1999, was up
$23,000 from its level at March 31, 1999, and down $30,000 from December 31,
1998 levels. The allowance was equal to .86%, .87% and .91% of total loans at
June 30, 1999, March 31, 1999 and December 31, 1998, respectively. 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.
Securities
The Company's securities portfolio serves numerous purposes. Portions of
the portfolio may secure certain public and trust deposits. The remaining
portions are held as investments or used to assist the Company in liquidity and
asset/liability management. Total securities at June 30, 1999 were $35,269,000
compared to $33,993,000 at December 31, 1998. Securities as a percentage of
total assets were 16.24% at June 30, 1999 compared to 16.11% at December 31,
1998. The level of securities relative to total assets has remained steady
throughout 1999.
The securities portfolio consists of three components, specifically,
securities held to maturity, securities available for sale and other
investments. Securities are classified as held to maturity when management has
the intent and the Company has the ability at the time of purchase to hold the
securities to maturity. Held to maturity securities are carried at cost,
adjusted for amortization of premiums and accretion of discounts. Securities to
be held for indefinite periods of time are classified as available for sale and
accounted for at market value. Securities available for sale include securities
that may be sold in response to changes in market interest rates, changes in the
security's prepayment risk, increases in loan demand, general liquidity needs
and other similar factors. Other investments consist of investments in insurance
products which are designed to provide a rate of return similar to one year
Treasury obligations. These products may provide additional employee benefits
based on their annualized performance. Other investments also include restricted
securities whose ownership is required to participate in certain governmental
programs. The Company's recent purchases of all securities have generally been
limited to securities of high credit quality with short to medium term
maturities. Changes in the market values of securities available for sale are
reflected as changes in stockholders' equity, net of the deferred tax effect. As
of June 30, 1999, the cost of the securities available for sale exceeded their
market value by $222,000 ($140,000 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.
<PAGE> 14
Item 2 Management's Discussion and Analysis of Financial Condition and
Results of Operations (Continued)
Deposits (Continued)
Total deposits increased 2.94% between December 31, 1998 and June 30, 1999,
in all deposit areas except noninterest bearing accounts. The cost of funds for
the first six months of 1999 was 4.48% compared to 4.89% for the same period in
1998. The yields on all deposits declined within the period. 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 half of 1999.
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 June 30, 1999, the Company's total risk based capital ratio was
17.71% which is far above the regulatory minimum of 8.0%. The ratio of total
capital to total assets was 10.74% at June 30, 1999.
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.
<PAGE> 15
Item 2 Management's Discussion and Analysis of Financial Condition and
Results of Operations (Continued)
Interest Rate Sensitivity (Continued)
At June 30, 1999 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.
Disclosure of Year 2000 Issues
The following statements are being designated as Year 2000 Readiness
Disclosures under the Year 2000 Information and Readiness Disclosure Act,
enacted by the 105th Congress on October 19, 1998.
Each of the subsidiary banks and the insurance company have appointed a
group of individuals from within the Organization 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, wire transfers,
internal computer readiness, transaction processing, security, liquidity
planning and correspondent banking. The Company has ascertained its compliance
internally through the help of computer and data processing consultants and
through the upgrade of computer and information processing hardware.
Noncompliant items and systems have been identified. Remediation and testing
have progressed according to plan. Testing of substantially all mission critical
systems was completed by June 30, 1999. Certain enhancements to systems will be
installed and tested during the third quarter of 1999. Continuing discussions
with third party vendors who perform dataprocessing functions and with
correspondent banking institutions do not indicate any critical shortcomings in
their compliance at this time.
As of June 30, 1999, the Company has incurred $730,000 for services and
equipment costs in its efforts to become Year 2000 compliant. Most of these
expenditures are amounts for normal and scheduled equipment upgrades. The
Company has budgeted $850,000 in total expenditures through December 31, 1999,
for its Year 2000 compliance efforts. Roughly 60 to 70% of this amount is 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 capacity 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.
<PAGE> 16
Item 2 Management's Discussion and Analysis of Financial Condition and
Results of Operations (Continued)
Disclosure of Year 2000 Issues (Continued)
The Company has developed 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 processing strategies. The Company is also
enhancing its existing business resumption contingency 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
before or after December 31, 1999. The Company has identified mission critical
areas and has met the June 30, 1999, regulatory deadline for drafting its Y2K
business resumption contingency plans. Further plan testing is to occur during
the third quarter of 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 telecommunications
companies, where alternative arrangements or sources are limited or unavailable.
To the extent that borrowers fail to adequately address Year 2000 issues,
problem loans and credit losses may increase in future years. It is the opinion
of the Company and its Board that Year 2000 risk constitutes only a small
portion of the overall risk inherent in its loan portfolio. It is not, however,
possible at this time to quantify the potential impact of borrowers' Year 2000
risk on their ability to repay loans as agreed.
The Company is addressing possible liquidity risks associated with Year
2000 by identifying alternative funding sources, by monitoring and communicating
with large depositors, and by planning investment maturities. Plans are in place
to acquire extra cash as needed in cooperation with the Federal Reserve Bank
System. The Company and its Board believe that its Year 2000 liquidity planning
addresses any potential Year 2000 cash flow disruption reasonably anticipated at
this time. If Year 2000 liquidity issues are not adequately addressed by the
Company and third parties, the Company's business, results of operations, and
financial position could be materially and adversely affected.
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.
<PAGE> 17
Item 2 Management's Discussion and Analysis of Financial Condition and
Results of Operations (Continued)
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 1
HIGHLANDS BANKSHARES, INC.
NET INTEREST MARGIN ANALYSIS
(Dollar Amounts in Thousands)
<TABLE>
<CAPTION>
Six Months Ended Six Months Ended
June 30, 1999 June 30, 1998
Average Income/ Average Income/
Balance Expense Rates Balance Expense Rates
<S> <C> <C> <C> <C> <C> <C>
Interest Income
Loans
Commercial $29,866 $1,274 8.53% $ 31,569 $1,382 8.76%
Consumer 32,262 1,731 10.73% 29,512 1,637 11.09%
Real estate 87,694 3,620 8.26% 79,341 3,398 8.57%
Total 149,822 6,625 8.84% 140,422 6,417 9.14%
Federal funds sold 11,604 269 4.64% 6,875 195 5.67%
Interest bearing deposits 4,467 110 4.93% 874 17 3.89%
Investments
Taxable 29,689 904 6.09% 32,314 1,041 6.44%
Tax exempt 1 3,242 137 8.45% 3,358 138 8.22%
Total Earning Assets 1 198,824 8,045 8.09% 183,843 7,808 8.49%
Interest Expense
Demand deposits 32,828 395 2.41% 29,023 412 2.84%
Savings 21,085 285 2.70% 19,780 341 3.44%
Time deposits 114,572 3,086 5.39% 106,805 3,051 5.71%
Other borrowed money 2,568 68 5.30% 468 12 5.13%
Total Interest Bearing
Liabilities 171,053 3,834 4.48% 156,076 3,816 4.89%
Net Interest Margin $4,211 $3,992
Net Yield on Interest Earning
Assets 1 4.24% 4.34%
1 On a taxable equivalent basis based on a tax rate of 37%.
</TABLE>
<PAGE> 18
TABLE 1 (Continued)
HIGHLANDS BANKSHARES, INC.
NET INTEREST MARGIN ANALYSIS
(Dollar Amounts in Thousands)
<TABLE>
<CAPTION>
Three Months Ended Three Months Ended
June 30, 1999 June 30, 1998
Average Income/ Average Income/
Balance Expense Rates Balance Expense Rates
<S> <C> <C> <C> <C> <C> <C>
Interest Income
Loans
Commercial $ 29,743 $ 644 8.66% $ 32,095 $ 707 8.81%
Consumer 32,910 872 10.60% 29,926 831 11.11%
Real estate 88,491 1,825 8.25% 80,402 1,722 8.57%
Total 151,144 3,341 8.84% 142,423 3,260 9.16%
Federal funds sold 11,650 140 4.81% 7,321 105 5.74%
Interest bearing deposits 5,285 65 4.92% 929 7 3.01%
Investments
Taxable 30,151 456 6.05% 31,870 512 6.43%
Tax exempt 1 3,242 70 8.64% 3,368 68 8.08%
Total Earning Assets 1 201,472 4,072 8.08% 185,911 3,952 8.50%
Interest Expense
Demand deposits 35,521 214 2.41% 29,885 211 2.82%
Savings 21,425 147 2.74% 20,096 173 3.44%
Time deposits 116,184 1,534 5.28% 107,643 1,538 5.72%
Other borrowed money 2,559 33 5.16% 698 9 5.16%
Total Interest Bearing
Liabilities 175,689 1,928 4.39% 158,322 1,931 4.88%
Net Interest Margin $ 2,144 $ 2,021
Net Yield on Interest Earning
Assets 1 4.26% 4.35%
1 On a taxable equivalent basis based on a tax rate of 37%.
</TABLE>
<PAGE> 19
TABLE II
HIGHLANDS BANKSHARES, INC.
INTEREST RATE SENSITIVITY ANALYSIS
JUNE 30, 1999
(In Thousands of Dollars)
More than
5 Years
1 - 90 91 - 365 1 to 3 3 to 5 or no
Days Days Years Years Maturity Total
EARNINGS ASSETS
Loans $27,281 $58,045 $37,728 $17,541 $13,130 $153,725
Fed funds sold 7,944 7,944
Securities 5,026 4,585 14,070 4,912 6,676 35,269
Time deposits in other
banks 3,491 600 1,026 5,117
Total 43,742 63,230 52,824 22,453 19,806 202,055
INTEREST BEARING LIABILITIES
Transaction accounts 19,497 19,497
Money market savings 14,641 14,641
Savings accounts 22,409 22,409
Time deposits more
than $100,000 4,970 13,803 4,854 2,515 26,142
Time deposits less
than $100,000 15,929 44,774 21,353 5,586 100 87,742
Other borrowed money 42 131 376 403 1,592 2,544
Total 77,488 58,708 26,583 8,504 1,692 172,975
Rate sensitivity GAP (33,746) 4,522 26,241 13,949 18,114
Cumulative GAP (33,746) (29,224) (2,983) 10,966 29,080
Ratio of cumulative
interest sensitive assets to
cumulative interest
sensitive liabilities 56.45% 78.54% 98.17% 106.40% 116.81%
Assumes all transaction, money market and savings 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 - On April 13, 1999, the
stockholders held their annual meeting. The
following item was approved by the
shareholders by the required majority:
1) Election of the Board of Directors as
proposed in the proxy material without
any additions or exceptions.
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
Bank- shares, Inc. are
incorporated by reference to
Appendix D to Highland
Bankshares, Inc.'s Form S-4
filed October 20, 1986.
27 Financial Data Schedule
attached
(b) Reports on Form 8-K filed during the
six months ended June 30, 1999.
None
<PAGE> 21
EXHIBIT INDEX
Exhibit
Index Page Number
27 Financial Data Schedule for the quarter ending
June 30, 1999 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 G. VANMETER
John G. VanMeter
Chairman
August 10, 1999
<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> 6-MOS
<FISCAL-YEAR-END> DEC-31-1999
<PERIOD-START> JAN-01-1999
<PERIOD-END> JUN-30-1999
<CASH> 4,284
<INT-BEARING-DEPOSITS> 5,117
<FED-FUNDS-SOLD> 7,944
<TRADING-ASSETS> 0
<INVESTMENTS-HELD-FOR-SALE> 31,067
<INVESTMENTS-CARRYING> 3,456
<INVESTMENTS-MARKET> 3,496
<LOANS> 153,725
<ALLOWANCE> (1,326)
<TOTAL-ASSETS> 217,201
<DEPOSITS> 190,014
<SHORT-TERM> 173
<LIABILITIES-OTHER> 1,305
<LONG-TERM> 2,371
0
0
<COMMON> 2,734
<OTHER-SE> 20,604
<TOTAL-LIABILITIES-AND-EQUITY> 217,201
<INTEREST-LOAN> 6,625
<INTEREST-INVEST> 990
<INTEREST-OTHER> 379
<INTEREST-TOTAL> 7,994
<INTEREST-DEPOSIT> 3,766
<INTEREST-EXPENSE> 3,834
<INTEREST-INCOME-NET> 4,160
<LOAN-LOSSES> 135
<SECURITIES-GAINS> 3
<EXPENSE-OTHER> 2,803
<INCOME-PRETAX> 1,597
<INCOME-PRE-EXTRAORDINARY> 1,597
<EXTRAORDINARY> 0
<CHANGES> 0
<NET-INCOME> 1,041
<EPS-BASIC> 2.07
<EPS-DILUTED> 2.07
<YIELD-ACTUAL> 4.24
<LOANS-NON> 35
<LOANS-PAST> 1,550
<LOANS-TROUBLED> 0
<LOANS-PROBLEM> 0
<ALLOWANCE-OPEN> 1,355
<CHARGE-OFFS> 214
<RECOVERIES> 50
<ALLOWANCE-CLOSE> 1,326
<ALLOWANCE-DOMESTIC> 1,326
<ALLOWANCE-FOREIGN> 0
<ALLOWANCE-UNALLOCATED> 0
</TABLE>
