SECURITIES AND EXCHANGE COMMISSION
Washington, D. C. 20549
FORM 10-KSB
ANNUAL REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES
EXCHANGE ACT OF 1934
For fiscal year ended December 31, 1998 Commission file number: 0-16761
Highlands Bankshares, Inc.
(Exact name of registrant as specified in its charter)
West Virginia 55-0650743
(State or other jurisdiction of (I.R.S. Employer
incorporation or organization) Identification No.)
P. O. Box 929, Petersburg, West Virginia 26847
(Address of principal executive offices) (Zip Code)
Issuer's telephone number including area code: (304) 257-4111
Securities registered pursuant to Section 12(b) of the Act:
None
Securities registered pursuant to Section 12(g) of the Act:
Common Stock - $5 Par
Check whether the issuer (1) filed all reports required to be filed by
Section 13 or 15(d) of the Exchange Act 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 requirements for the past 90 days.
Yes ..X. No ....
Check if there is no disclosure of delinquent filers in response to
Item 405 of Regulation S-B contained in this form, and no disclosure will
be contained, to the best of registrant's knowledge, in definitive proxy or
information statements incorporated by reference in Part III of this Form
10-KSB or any amendment to this Form 10-KSB. [X]
Issuer's revenues for its most recent fiscal year: $16,507,000
State the aggregate market value of the voting stock held by non-affiliates
computed by reference to the price at which the stock was sold, or the average
bid and asked prices of such stock, as of a specified date within the past 60
days: As of March 9, 1999 - $28,769,808
State the number of shares outstanding of each of the issuer's classes
of common equity, as of the latest practicable date: As of March 1, 1999 -
501,898
DOCUMENTS INCORPORATED BY REFERENCE:
Proxy Statement of Highlands Bankshares, Inc. filed via Form DEF 14A on
March 24, 1999.
LOCATION OF EXHIBIT INDEX
The index of exhibits is contained in Part IV herein on pages 46-47.
TRANSITIONAL SMALL BUSINESS DISCLOSURE FORMAT YES NO X
<PAGE> 2
FORM 10-KSB INDEX
Page
Part I
Item 1. Description of Business 3
General
Services Offered by the Banks
Employees
Competition
Regulation and Supervision
Item 2. Description of Property 4
Item 3. Legal Proceedings 5
Item 4. Results of Votes of Security Holders 5
Part II
Item 5. Market for Registrant's Common Equity and
Related Stockholder Matters 5
Item 6. Management's Discussion and Analysis of Financial
Condition and Results of Operation 6
Item 7. Financial Statements 24
Item 8. Changes in and Disagreement with Accountants on
Accounting and Financial Disclosure 47
Part III
Item 9. Directors and Executive Officers 47
Item 10. Executive Compensation 47
Item 11. Security Ownership of Certain Beneficial Owners
and Management 47
Item 12. Certain Relationships and Related Transactions 47
Part IV
Item 13. Exhibits and Reports on Form 8-K 47
Signatures 49
<PAGE> 3
Part I
Item 1. Description of Business
General
Highlands Bankshares, Inc. (Highlands), incorporated under the laws of West
Virginia in 1985, is a multi-bank holding company subject to the provisions of
the Bank Holding Company Act of 1956, as amended, and owns 100% of the
outstanding stock of its subsidiary banks, The Grant County Bank and Capon
Valley Bank (hereinafter referred to as the "Banks") and its life insurance
subsidiary, HBI Life Insurance Company (HBI Life). Capon Valley Bank became a
member of Highlands effective July 1, 1987, in a combination accounted for as a
pooling of interests.
The Grant County Bank was chartered on May 20, 1902, and Capon Valley Bank
was chartered on July 1, 1918. Both are state banks chartered under the laws of
the State of West Virginia. HBI Life was chartered in April 1988 under the laws
of the State of Arizona.
Services Offered by the Banks
The banks offer all services normally offered by a full service commercial
bank, including commercial and individual demand and time deposit accounts,
commercial and individual loans, drive-in banking services and automatic teller
machine banking. No material portion of the banks' deposits have been obtained
from a single or small group of customers and the loss of the deposits of any
one customer or of a small group of customers would not have a material adverse
effect on the business of the banks. Credit life accident and health insurance
are sold to customers of the subsidiary banks through HBI Life Insurance
Company.
Employees
As of December 31, 1998, The Grant County Bank had 44 full time equivalent
employees and Capon Valley Bank had 36 full time equivalent employees. No person
is employed by Highlands or HBI Life on a full time basis.
Competition
The banks' primary trade area is generally defined as Grant County, Hardy
County, Mineral County and the northern part of Pendleton County. This area
includes the cities of Petersburg, Wardensville, Moorefield and Keyser and
several rural towns. The banks compete with three state chartered banks and two
national banks. No financial institution has been chartered in the area within
the last five years although branches of state and nationally chartered banks
have located in this area within this time period. Competition for new loans and
deposits in the banks' service area is quite intense and all competition has
been forced to pay rates on deposits which exceed the national averages.
The banks' secondary trade area includes portions of Hampshire County in
West Virginia and Frederick County in Virginia. In addition, the banks compete
with money market mutual funds and investment brokerage firms for deposits in
their service area.
Regulation and Supervision
Highlands is subject to the periodic reporting requirements of the
Securities Exchange Act of 1934. These include, but are not limited to, the
filing of annual, quarterly and other current reports with the Securities and
Exchange Commission.
<PAGE> 4
Regulation and Supervision (Continued)
Highlands, as a bank holding company, is subject to the provisions of the
Bank Holding Company Act of 1956, as amended (the "Act"). It is registered as
such and is supervised by the Federal Reserve Board. The Act requires Highlands
to secure the prior approval of the Federal Reserve Board before Highlands
acquires ownership or control of more than five percent of the voting shares, or
substantially all of the assets of any institution, including another bank.
As a bank holding company, Highlands is required to file with the Federal
Reserve Board an annual report and such additional information as it may require
pursuant to the Act. The Federal Reserve Board may also conduct examinations of
Highlands and any or all of its subsidiaries. Under Section 106 of the 1970
Amendments to the Act and the regulations of the Federal Reserve Board, a bank
holding company and its subsidiaries are prohibited from engaging in certain
tie-in arrangements in connection with an extension of credit, provision of
credit, sale, or lease of property or furnishing of services.
Federal Reserve regulations permit bank holding companies to engage in
nonbanking activities closely related to banking or to managing or controlling
banks. These activities include the making or servicing of loans, performing
certain data processing services, and certain leasing and insurance agency
activities. HBI Life acts as reinsurer of the credit life insurance coverage
sold by the Banks to bank customers. Approval of the Federal Reserve Board is
necessary to engage in any of these activities or to acquire corporations
engaging in these activities.
The operations of the Banks are subject to federal and state statutes which
apply to state chartered banks. Bank operations are also subject to the
regulations of the Federal Deposit Insurance Corporation (the "FDIC"), which
insures the banks' deposits. In addition, the Capon Valley Bank is a member of
the Federal Reserve Bank System and is subject to the regulations of the Federal
Reserve Bank Board.
The supervisory authorities regularly examine such areas as reserves, loans,
investments, management practices, and other aspects of the banks' operations.
These examinations are designed primarily for the protection of depositors. In
addition to these regular examinations, the banks must furnish the various
regulatory authorities quarterly reports containing a full and accurate
statement of its affairs.
The operations of the insurance subsidiary are subject to the oversight and
review of State of Arizona Department of Insurance.
Item 2. Description of Properties
The Grant County Bank's main office is located on Main Street in Petersburg,
West Virginia. An automatic teller machine allows customers greater flexibility
in their banking transactions. In late 1996, the Bank opened a full service
branch in Mineral County to serve the Keyser area. This facility is owned by the
Bank and features state-of-the-art drive-up facilities and an automatic teller
machine. The Bank also has a branch in Riverton, West Virginia which provides
banking services in northwest Pendleton County. The Riverton branch building has
an annual lease while the main and Keyser office facilities are owned by the
Bank.
Capon Valley Bank has its main office in Wardensville, West Virginia and
branch offices located in Moorefield and Baker, West Virginia. The Bank opened
its new Baker branch in April of 1997 to serve the customer base between
Moorefield and Wardensville. This facility includes state-of-the-art drive in
and automatic teller operations. All facilities are owned by the Bank and
considered adequate for current operations.
<PAGE> 5
Item 3. Legal Proceedings
Management is not aware of any material pending or threatened litigation in
which Highlands or its subsidiaries may be involved as a defendant. In the
normal course of business, the banks periodically must initiate suits against
borrowers as a final course of action in collecting past due loans.
Item 4. Results of Votes of Security Holders
Highlands has not submitted any matters to the vote of security holders for
the quarter ending December 31, 1998.
Part II
Item 5. Market for Registrant's Common Equity and Related Stockholder
Matters
The Company had approximately 826 stockholders of record as of March 1,
1999. The Company's stock is not traded on any national or regional stock
exchange although brokers in Cumberland, Maryland, Winchester and Harrisonburg,
Virginia may occasionally initiate or be a participant in a trade. Terms of an
exchange between individual parties may not be known to the Company. The
following outlines the dividends paid and market prices of the Company's stock
based on prices disclosed to management. Such prices may not include retail
mark-ups, mark-downs or commissions.
Dividends Market Price Range
1998 Per Share High Low
First Quarter $ .27 $ 63.00 $ 50.00
Second Quarter .27 62.75 58.25
Third Quarter .27 69.00 63.00
Fourth Quarter .27 63.25 62.25
1997
First Quarter $ .25 $ 44.25 $ 41.00
Second Quarter .25 45.00 43.00
Third Quarter .25 46.86 44.00
Fourth Quarter .25 46.50 44.75
1996
First Quarter $ .18 $ 39.88 $ 38.00
Second Quarter .18 40.50 38.00
Third Quarter .18 40.50 39.00
Fourth Quarter .40 42.00 40.50
<PAGE> 6
Item 6. Management's Discussion and Analysis of Financial Condition and
Results of Operations
Overview
The Company's 1998 net income of $2,011,882 represents a 7.01% increase in
net income and a 7.51% increase in income per share compared to 1997. This
represented a return of 9.12% on average equity for 1998 compared to 8.80% for
1997. Returns on average assets for 1998 and 1997 were 1.01% and 1.00%,
respectively. The increase in earnings was due to an increase in the volume of
earning assets in a stable interest environment.
The tax equivalent interest income increased by $676,000 in 1998 to
$15,870,000 as compared to 1997. A 5.43% increase in the level of earning assets
offset a slight decrease in the yield and resulted in the earnings improvement.
The increase in earning assets is attributable to a 9.44% increase in average
loans outstanding and was primarily in real estate loans. The funding of the
asset growth was from deposits of local customers, primarily time deposits.
Noninterest income increased 28.64% in 1998 compared to 1997 due to an
increase in service charge income and a decrease in losses on security
transactions. Noninterest expenses increased 5.11% in 1998 due mainly to the
higher cost of data processing and year 2000 compliance expenses.
Net Interest Margin
1998 Compared to 1997
The Company's net interest margin on a tax equivalent basis was $8,125,000
for 1998 compared to $7,721,000 for 1997. The increase was due to an increase in
average earning assets (5.43%) and an increased spread (the difference in rates
earned on assets and paid on liabilities) from 3.51% in 1997 to 3.59% in 1998.
Average loans outstanding grew by 9.44% 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.
Loans outstanding at December 31, 1998 increased 8.23% over amounts at
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 slight 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 5.43%. 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.
A summary of the net interest margin analysis is shown as Table II on page
21.
1997 compared to 1996
The Company's net interest income on a tax equivalent basis increased to
$7,721,000 for 1997 or 7.10% higher than the amount for 1996. Yields on loans
declined slightly (seventeen basis points) due to declines in mortgage rates.
The mortgage rate decline was the result of declines in the rate on long-term
government bonds and other market yields. Yields on investment securities
increased three basis points while yields on federal funds sold increased
eighteen basis points. The result of the above was a yield on earning assets of
8.55%, the same as the 1996 yield.
<PAGE> 7
Net Interest Margin (Continued)
1997 compared to 1996 (Continued)
The Company's overall cost of funds declined by eleven basis points in 1997
to 5.04%. The decline was primarily in the area of time deposits with a decline
of nineteen basis points. The decline was due to the maturity of higher costing
certificates that originated in 1995 and matured in the summer and fall of 1997.
Lesser reductions in the cost of demand and savings deposits were also
contributors to the decline in the cost of deposits.
A summary of the net interest margin analysis is shown as Table II on Page
21.
Provision for Loan Losses
The Company's provision for loan losses were $355,000 for 1998, $190,000 for
1997 and $135,000 for 1996. The increases in the provision were necessary to
provide an adequate allowance for loan losses for a growing loan portfolio. Net
loan losses were $370,000 in 1998 compared to $77,000 in 1997 and $197,000 in
1996. The Company's three year average charge off rate of .16% compares
favorably with industry standards and its peer group. (See the following
discussion relating to the allowance for loan losses.)
Noninterest Income
1998 Compared to 1997
Noninterest income (before losses on securities) for 1998 increased 7.07%
from 1997. Increases in service charge income of 12.08% and other operating
income of 37.19% were the result of an increase in volume. Insurance income
decreased $67,000 due to significantly higher mortality rates. Losses on
security transactions declined from $117,000 in 1997 to $2,000 in 1998. 1997
included a loss of $123,000 on a mutual fund that was not repeated in 1998. The
Company expects future growth in noninterest income to coincide with asset and
deposit growth.
1997 compared to 1996
Overall noninterest income declined in 1997 by 3.48% when compared with 1996
operations. The Company experienced a loss on the redemption of a mutual fund
investment that was redeemed in 1997. The loss of $123,000 was recognized on the
redemption though the Company may recover a portion of this loss in the
resolution of pending legal actions. Exclusive of the above, noninterest income
before security losses increased 10.77% as the result of higher service charges
on deposit accounts and the institution of minimum balance requirements on some
deposit accounts. Other types of noninterest income increased slightly in line
with asset growth.
<PAGE> 8
Noninterest Expenses
1998 Compared to 1997
Overall, noninterest expense increased 5.11% in 1998 when compared to 1997.
Personnel expenses increased 3.80% as the result of merit and inflationary
raises. Occupancy and equipment expenses increased 2.35% as the result of asset
growth and inflation. Data processing expenses increased by 4.46% as a result of
increase transaction volume and rate increases. Other noninterest expenses
increased by 9.94% due to asset growth and costs in preparing for the upcoming
year 2000. The overall increase in noninterest expenses is in line with the
increase in assets and is in line with management's expectations. Noninterest
expense as a percentage of average assets was 2.69% in 1998 compared with 2.73%
in 1997 and 2.61% in 1996. This ratio continues to compare favorably to the
Company's peer group.
1997 compared to 1996
Total noninterest expenses increased 11.94% in 1997 when compared with 1996
operations. Salaries and benefits increased 13.41% due to the increase in staff
at the new branches and merit and inflationary raises. Average full time
equivalent employees increased 9.60% in 1997 and staffing the new branches was
the major reason for this increase. The costs of occupancy and equipment
increased 11.09% due to the branch openings and the equipment costs and
depreciation associated with this expansion. Data processing expenses increased
by 12.47% due to new communication lines, general asset growth and expanded
locations. Other noninterest expenses increased 8.92% in 1997 for all of the
reasons cited above.
Financial Condition
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, Hampshire, Mineral and
northern Pendleton 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 $11,279,000 or 8.23% 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 80.39% at December 31, 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> 9
Financial Condition (Continued)
Loan Portfolio (Continued)
The following table summarizes the Company's loan portfolio, net of
unearned income:
At December 31,
1998 1997 1996
(Dollars in Thousands)
Real Estate:
Mortgage $ 83,446 $ 75,221 $ 70,829
Construction 2,969 2,189 2,158
Commercial 30,718 30,716 25,104
Installment 33,464 31,492 28,693
150,597 139,618 126,784
Less unearned discount (2,213) (2,513) (2,184)
148,384 137,105 124,600
Allowance for loan losses (1,355) (1,369) (1,257)
Loans, net $147,029 $135,736 $123,343
The following table shows the maturity of loans outstanding (in thousands
of dollars) as of December 31, 1998, 1997 and 1996.
Maturity Range 1998 1997 1996
Predetermined Rates:
0 - 12 months $ 73,878 $ 63,117 $ 45,402
13 - 60 months 53,765 54,070 68,879
More than 60 months 20,702 19,918 10,319
Nonaccrual Loans 39
Total Loans $148,384 $137,105 $124,600
The following table shows the Company's loan maturity distribution (in
thousands of dollars) as of December 31, 1998:
Maturity Range
Less Than 1-5 Over
Loan Type 1 Year Years 5 Years Total
Commercial and
Agricultural Loans $ 23,526 $ 5,223 $ 1,969 $ 30,718
Real Estate - mortgage 40,119 25,281 18,046 83,446
Real Estate - construction 2,969 2,969
Consumer - installment 7,264 23,261 726 31,251
Total $ 73,878 $ 53,765 $ 20,741 $148,384
<PAGE> 10
Financial Condition (Continued)
Loan Portfolio (Continued)
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 discontinued. Loans which reach nonaccrual status may not be
restored to accrual status until all delinquent principal and interest has been
paid or the loan becomes both well secured and in the process of collection.
Restructured loans are loans with respect to which a borrower has been granted a
concession on the interest rate or the original repayment terms because of
financial difficulties. Nonperforming loans do not represent or result from
trends or uncertainties which management reasonably expects will materially
impact future operating results, liquidity, or capital resources. Nonperforming
loans are listed in the table below.
Real estate acquired through foreclosure was $95,000 at December 31, 1998,
$174,000 at December 31, 1997 and $160,000 at December 31, 1996. All foreclosed
property held at December 31, 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.
Management has continued its efforts to reduce delinquencies through
greater efforts in the early stages of the delinquency. The increase in
delinquent real estate loans in 1998 was due to one large loan which is 75%
guaranteed by a governmental agency. Management does not anticipate any material
losses from the current level of nonperforming assets.
The following table summarizes the nonperforming loans:
At December 31,
1998 1997 1996
(Dollars in Thousands)
Loans accounted for on a nonaccrual basis $ 39 $ $
Loans contractually past due 90 days or
more as to interest or principal
payments (not included in nonaccrual
loans above)
Commercial 41 17 63
Real estate 1,339 938 208
Installments 142 292 110
Total Delinquent Loans 1,522 1,247 381
Total Nonperforming Loans $ 1,561 $1,247 $ 381
<PAGE> 11
Financial Condition (Continued)
Loan Portfolio (Continued)
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 December 31, 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.
As of December 31, 1998, the Company did not have any potential problem
loans as defined in Guide 3 that would require disclosure.
Allowance for Loan Losses
Management has analyzed the potential risk of loss on the Company's loan
portfolio given the loan balances and the value of the underlying collateral and
has recognized losses where appropriate. Nonperforming loans are closely
monitored on an ongoing basis as part of the Company's loan review process.
Management reviews the loan loss allowance at the end of each quarter. Based
primarily on the Company's loan classification system, which classifies problem
credits as substandard, doubtful or loss, additional provisions for losses are
made monthly. The ratio of the allowance for loan losses to total loans
outstanding was .91% at December 31, 1998 compared to 1.00% at December 31, 1997
and 1.01% at December 31, 1996. At December 31, 1998, the ratio of the allowance
for loan losses to nonperforming loans was 86.83% compared to 109.78% at
December 31, 1997 and 329.92% at December 31, 1996.
The unusually large amount of net charge offs in 1998 was the result of
several large bankruptcies. Some recoveries are expected from these actions but
it is too premature to estimate the amount at this time. Loan losses in 1997
were spread over all loan types with no individual loss constituting a
significant portion of the total.
Management continues to monitor the economic health of the poultry
industry. The Company has direct loans to poultry growers and the industry is a
large employer in the Company's trade area. Operating results for the industry
were poor in 1997 due to over supply of products and high grain prices. The
situation has improved during 1998, however it may take some time for borrowers
to recover financially.
<PAGE> 12
Allowance for Loan Losses (Continued)
The following table summarizes changes in the allowance for loan losses:
Year Ending December 31,
1998 1997 1996
(In Thousands of Dollars)
Balance at beginning of period $1,370 $1,257 $1,319
Loan Losses:
Commercial and agricultural 135 34 92
Real estate - mortgage 53 20 59
Installment loans to individuals 289 170 186
Total loan losses 477 224 337
Recoveries:
Commercial and agricultural 6 9 9
Real estate - mortgage 1 25 15
Installment loans to individuals 100 113 116
Total recoveries 107 147 140
Net loan losses 370 77 197
Additions charged to operations 355 190 135
Balance at end of period $1,355 $1,370 $1,257
The Company has allocated the allowance for loan losses according to the
amounts deemed to be reasonably necessary to provide for the possibility of
losses incurred within each of the above categories of loans. The allocation of
the allowance as shown in the table below should not be interpreted as an
indication that loan losses in future years will occur in the same proportions
or that the allocation indicates future loan loss trends. Furthermore, the
portion allocated to each loan category is not the total amount available for
future losses that might occur within such categories since the total allowance
is a general allowance applicable to the entire portfolio.
The following table shows the balance and percentage of the Company's
allowance for loan losses allocated to each major category of loans:
At December 31,
1998 1997 1996
Percent Percent Percent
of of of
Loans Loans Loans
Percent in Percent in Percent in
of Category of Category of Category
Allow- to Total Allow- to Total Allow- to Total
Amount ance Loans Amount ance Loans Amount ance Loans
(Dollars in Thousands)
Commercial $ 379 28% 23% $ 343 25% 22% $ 314 25% 18%
Real estate
mortgage 434 32 56 548 40 56 440 35 59
Installment 406 30 21 343 25 22 314 25 23
Unallocated 136 10 136 10 189 15
$1,355 100% 100% $1,370 100% 100% $1,257 100% 100%
<PAGE> 13
Allowance for Loan Losses (Continued)
For each period presented, the provision for loan losses charged to
operations is based on management's judgment after taking into consideration all
factors connected with the collectibility of the existing portfolio. Management
evaluates the loan portfolio in light of economic conditions, changes in the
nature and value of the portfolio, industry standards and other relevant
factors. Specific factors considered by management in determining the amounts
charged to operations include internally generated loan review reports, previous
loan loss experience with the borrower, the status of past due interest and
principal payments on the loan, the quality of financial information supplied by
the borrower and the general financial condition of the borrower.
The provision for loan losses charged to operations was $355,000 for 1998,
$190,000 for 1997 and $135,000 for 1996. In the opinion of management, the
provision charged to operations over this three year period has been sufficient
to maintain an adequate allowance for loan losses.
Securities
The Company's securities portfolio serves several purposes. Portions of the
portfolio are used to secure certain public and trust deposits. The remaining
portfolio is held as investments or used to assist the Company in liquidity and
asset liability management. During 1998, total securities decreased to $34.0
million or 16.11% of total assets at December 31, 1998. Total securities were
$37.0 million or 19.38% of total assets at December 31, 1997.
The securities portfolio consists of three components: securities held to
maturity, securities available for sale and restricted securities. 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 securities are those investments purchased
as a requirement of membership in certain loan banks and cannot be transferred
without the Bank's permission. The Company's purchases of securities have
generally been limited to securities of high credit quality with short to medium
term maturities.
The Company identifies at the time of acquisition those securities that are
available for sale. These securities are valued at their market value with any
difference in market value and amortized cost shown as an adjustment in
stockholders' equity. Changes within the year in market values are reflected as
changes in stockholders' equity, net of the deferred tax effect. As of December
31, 1998, the market value of the securities available for sale exceeded their
cost by $190,000 ($119,000 after the related tax effect).
<PAGE> 14
Securities (Continued)
The following table summarizes the carrying value of the Company's
securities at the dates indicated:
Held to Maturity Available for Sale
Carrying Value Carrying Value
December 31, December 31,
1998 1997 1996 1998 1997 1996
(Dollars in Thousands) (Dollars in Thousands)
U.S. treasuries, agencies
and corporations $ $ 751 $4,200 $22,129 $20,349 $18,304
Obligations of states and
political subdivisions 2,987 3,295 3,818 262 101
Mortgage-backed securities 517 531 541 6,821 10,665 13,807
Total Debt Securities 3,504 4,577 8,559 9,212 31,115 32,111
Other securities 546 567 946
Total $ 3,504 $ 4,577 $8,559 $29,758 $31,682 $33,057
The carrying amount and estimated market value of debt securities (in
thousands of dollars) at December 31, 1998 by contractual maturity are shown
below. Expected maturities will differ from contractual maturities because
borrowers may have the right to call or prepay obligations with or without call
or prepayment penalties.
Securities Held to Maturity Carrying Market Average
Amount Value Yield
Due in one year or less $ 155 $ 156 7.77%
Due after one year
through five years 934 949 7.25%
Due after five years
through ten years 1,403 1,478 7.87%
Due after ten years 1,012 1,038 9.09%
Total Held to Maturity $ 3,504 $ 3,621 8.02%
Securities Available for Sale Amortized Market Average
Cost Value Yield
Due in one year or less $ 10,885 $ 10,945 6.00%
Due after one year through
five years 13,556 13,736 6.19%
Due after five years through
ten years 3,320 3,326 6.95%
Due after ten years 1,188 1,205 7.01%
Total Fixed Rate Securities 28,949 29,212 6.24%
Equities 619 546
Total Available for Sale $ 29,568 $ 29,758
Yields on tax exempt securities are stated at tax equivalent yields.
Management has generally kept the maturities of investments relatively
short providing for flexibility in investing. Such a philosophy allows the
Company to better match deposit maturities with investment maturities and thus
react more quickly to interest rate changes.
<PAGE> 15
Deposits
The Company's predominant source of funds is local deposits. The Company's
deposit base is comprised of demand deposits, savings and money market accounts
and other time deposits. The Company's deposits are provided by individuals and
businesses located within the communities served.
The average balance of interest bearing deposits increased by 7.32% in 1998
over average levels in 1997. The average rate paid on deposits declined to 4.91%
in 1998 from 5.03% in 1997 and 5.15% in 1996. The majority of the Company's
deposits are higher yielding time deposits as most of its customers are
individuals who seek higher yields than savings accounts or don't wish to accept
the risks of the stock market.
The Company does not actively solicit large certificates of deposit (those
more than $100,000) due to the unstable nature of these deposits. Increases in
1998 are the result of overall deposit growth and higher than average rates
offered by the Company. A summary of the maturity of large deposits is as
follows:
December 31,
Maturity Range 1998 1997 1996
(In Thousands of Dollars)
Three months or less $ 5,883 $ 6,086 $ 4,832
Four to twelve months 11,391 8,497 11,360
One year to five years 8,449 8,744 4,667
Total $ 25,723 $ 23,327 $ 20,859
Borrowed Money
The Company will occasionally borrow funds from the Federal Home Loan Bank
to reduce market rate risks. Such borrowings have fixed repayment terms and are
amortized over a ten to twenty year life. Borrowings from this institution
allows the banks to offer long-term, fixed rate loans to their customers and
match the interest rate exposure of the receivable and the liability.
Capital Resources
The assessment of capital adequacy depends on a number of factors such as
asset quality, liquidity, earnings performance and changing competitive
conditions and economic forces. The Company seeks to maintain a strong capital
base to support its growth and expansion activities, to provide stability to
current operations and to promote public confidence.
The Company's capital position continues to exceed regulatory minimums. The
primary indicators relied on by the Federal Reserve Board and other bank
regulators in measuring strength of capital position are the Tier 1 Capital,
Total Capital and Leverage ratios. Tier 1 Capital consists of common
stockholders' equity. Total Capital consists of Tier 1 Capital and a portion of
the allowance for loan losses. Risk-based capital ratios are calculated with
reference to risk-weighted assets which consist of both on and off-balance sheet
risks.
The following table shows risk-based capital ratios and stockholders'
equity to total assets:
Regulatory December 31,
Minimum 1998 1997
Capital Ratios
Risk-based capital to risk-weighted
assets
Tier 1 4.00% 17.00% 17.35%
Total 8.00% 18.02% 18.47%
Stockholders' equity to total assets 3.00% 10.83% 11.15%
<PAGE> 16
Capital Resources (Continued)
The capital management function is an ongoing process. Central to this
process is internal equity generation accomplished by earnings retention. During
1998, 1997 and 1996, total stockholders' equity increased by $1,550,000,
$1,068,000 and $1,367,000, respectively, as a result of earnings retention and
changes in the unrealized gains (losses) on securities available for sale. The
return on average equity was 9.12% in 1998 compared to 8.80% for 1997 and 9.99%
for 1996. Total cash dividends declared represent 26.94% of net income for 1998
compared to 26.84% of net income for 1997 and 24.00% for 1996. Book value per
share was $45.52 at December 31, 1998 compared to $42.43 at December 31, 1997
and $39.35 at December 31, 1996.
In April of 1997, the Company repurchased 12,168 shares of common stock for
$499,000. The repurchased stock is being held as treasury stock and may be used
in future periods for a variety of business purposes. The stock was repurchased
from the estate of William G. VanMeter for whom the Company's chairman, John
VanMeter, is the executor.
The Company's principal source of cash income is dividend payments from the
Banks. Certain limitations exist under applicable law and regulation by
regulatory agencies regarding dividend payments to a parent by its subsidiaries.
As of January 1, 1999, the Banks had $2,365,000 of retained earnings available
for distribution to the Company as dividends without prior regulatory approval.
Liquidity and Interest Rate Sensitivity
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 liability
liquidity. 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, the Federal Reserve Bank of Richmond and
the Federal Home Loan Bank of Pittsburgh. In the past, growth in deposits and
proceeds from the maturity of investment securities have been sufficient to fund
the net increase in loans.
The investing activity saw a net increase in loans of $11,279,000, an
increase in federal funds sold of $5,479,000, an increase in investment
securities of $2,982,000 and an increase in deposits in other banks of
$2,605,000. In addition, the Company invested $2,070,000 in single premium life
insurance policies used to fund deferred compensation. New equipment and
facility additions were $337,000 in 1998 compared with $607,000 in 1997. Funding
these investments was an increase in deposits of $16,652,000, additional
long-term debt of $2,146,000 and retained operating income of $1,470,000.
In the year ending December 31, 1998, cash and due from banks increased
$1,866,000 as cash provided by operations and financing activities exceeded cash
used in investing activities. Cash provided by operations consists primarily of
earnings from operations and noncash expenses such as the provision for loan
losses, deferred income taxes and depreciation. The dividends paid of $542,000
in 1998 was an increase of 7.42 percent over 1997 amounts.
<PAGE> 17
Liquidity and Interest Rate Sensitivity (Continued)
The Company is not aware of any trends, events or uncertainties that will
have or that are reasonably likely to have a material effect on the Company's
liquidity, capital resources or operations. The Company is not aware of any
proposals from any regulatory authority which, if implemented, would have such
an effect.
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 December 31, 1998, the Company had a negative gap position through the
third year. This liability sensitive position typically produces a favorable
contribution to earnings during periods of decreasing rates and an unfavorable
contribution to earnings during a period of increasing rates. Absent any major
changes in federal reserve policy, the Company expects a slight decline in the
overall cost of money in 1998 due to the maturity of these certificates and
stability in other deposit rates.
With the largest amount of interest sensitive assets and liabilities
repricing within three years, the Company monitors these areas 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 periodically review its cumulative position of
interest sensitive assets and liabilities.
The majority of the Company's commercial and real estate loans are made
with repricing frequencies of three months to three years. For this reason, 78%
of all loans will reprice within three years of December 31, 1998. Installment
loans generally have a fixed rate of interest but have limited amortization
periods. These loans have an average life to maturity of less than two years.
Management believes that its philosophy of generally requiring loan repricing
within a three to five year period to be the most prudent approach to
asset/liability management.
In the area of investments, the Company employs a management technique
known as "laddering" to minimize interest rate exposures and provide a constant
flow of maturities subject to repricing at current market rates. To assist in
the management of investments, the Company employs an independent investment
counsel that advises it in planning and risk diversification. The Company
utilizes many forms of investment with a significant use of mortgage-backed
securities issued by federally chartered institutions. The Company does not
employ the use of derivatives in its approach to controlling market risk.
Although the majority of its investments are classified as available for sale,
the Company rarely sells securities except in unusual circumstances.
Table IV (page 23) shows the maturity of liabilities and assets in future
periods. Table III (page 22) shows the effects of rate and volume changes on the
net interest margin for the past three year period.
<PAGE> 18
Effects of Inflation
Inflation significantly affects industries having high levels of property,
plant and equipment or 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 IV, page 23) in order to minimize the
effects of inflationary trends on interest rates. Other areas of noninterest
expenses may be more directly affected by inflation.
Year 2000 Readiness Disclosure
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 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. Remediation and testing are progressing
according to plan and testing of substantially all systems is anticipated to be
complete by June 30, 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 December 31, 1998, the Company has incurred $410,000 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 $650,000 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.
<PAGE> 19
Year 2000 Readiness Disclosure (Continued)
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. The Company has identified mission critical areas and
anticipates its business resumption plan will be completed by June 30, 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.
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.
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 (including the Company) that file electronically with the
Commission. That address is (http: //www.sec.gov)
<PAGE> 20
TABLE I
SUMMARY OF OPERATIONS
(Dollar amounts in thousands)
Years Ending December 31,
(In Thousands Except for Share Amounts)
1998 1997 1996 1995 1994
Total Interest Income $15,772 $15,084 $14,182 $12,758 $11,726
Total Interest Expense (7,745) (7,474) (7,103) (6,219) (5,082)
Net Interest Income 8,027 7,610 7,079 6,539 6,644
Provision for Loan Losses 355 190 135 120 240
Net Interest Income after
Provision for Loan Losses 7,672 7,420 6,944 6,419 6,404
Other Income 735 571 592 581 467
Other Expenses 5,377 5,115 4,570 4,191 4,052
Income before Income Taxes 3,030 2,876 2,966 2,809 2,819
Income Tax Expense 1,018 996 953 956 944
Net Income $ 2,012 $ 1,880 $ 2,013 $ 1,853 $ 1,875
Net Income Per Share $ 4.01 $ 3.73 $ 3.92 $ 3.60 $ 3.65
Dividends Per Share $ 1.08 $ 1.00 $ .94 $ .83 $ .72
Total Assets at Year End $210,981 $190,770 $178,847 $167,884 $153,361
Return on Average Assets 1.01% 1.00% 1.15% 1.16% 1.22%
Return on Average Equity 9.12% 8.80% 9.99% 10.15% 11.05%
Dividend Payout Ratio 26.94% 26.80% 24.00% 23.03% 19.74%
Year End Equity to Assets Ratio 10.83% 11.16% 11.31% 11.24% 10.94%
<PAGE> 21
TABLE II
<TABLE>
NET INTEREST MARGIN AND AVERAGE BALANCE ANALYSIS
(Dollar amounts in thousands)
<CAPTION>
1998 1997 1996
Income/ Yield/ Income/ Yield/ Income/ Yield/
EARNING ASSETS Average Expense Rate Average Expense Rate Average Expense Rate
<S> <C> <C> <C> <C> <C> <C> <C> <C> <C>
Loans 3 $ 143,197 $ 13,144 9.18 $ 130,848 $ 12,230 9.35 $ 116,864 $ 11,135 9.52
Investment securities:
Taxable 4 31,402 1,952 6.22 37,032 2,315 6.25 40,270 2,491 6.19
Nontaxable 1,4 3,316 270 8.14 3,568 298 8.35 4,146 354 8.53
Total Investment
Securities 34,718 2,222 6.40 40,600 2,613 6.44 44,416 2,845 6.41
Interest bearing deposits
in banks 1,215 64 5.27 685 37 5.40 898 48 5.35
Federal funds sold 8,216 440 5.36 5,561 314 5.65 5,192 284 5.47
Total Earning Assets 187,346 15,870 8.47 177,694 15,194 8.55 167,370 14,312 8.55
Allowance for loan losses (1,319) (1,314) (1,288)
Nonearnings assets 13,636 10,860 9,280
Total Assets $ 199,663 $ 187,240 $ 175,362
INTEREST-BEARING LIABILITIES
Deposits:
Demand $ 29,187 $ 808 2.77 $ 27,823 $ 799 2.87 $ 26,701 $ 778 2.91
Savings 20,135 671 3.33 18,684 659 3.53 17,535 620 3.54
Time deposits 108,382 6,213 5.73 100,444 5,930 5.90 93,482 5,695 6.09
Total Deposits 157,704 7,692 4.88 146,951 7,388 5.03 137,718 7,093 5.15
Other borrowed money 974 53 5.44 1,443 85 5.89 148 10 6.75
Total Interest Bearing
Liabilities 158,678 7,745 4.88 148,394 7,473 5.04 137,866 7,103 5.15
Noninterest bearing
deposits 17,744 16,100 15,600
Other liabilities 1,186 1,370 1,751
Total Liabilities 177,608 165,864 155,217
Stockholders' Equity 22,055 21,376 20,145
Total Liabilities
and Equity $ 199,663 $ 187,240 $ 175,362
Net Interest Earnings $ 8,125 $ 7,721 $ 7,209
Net Yield on Interest
Earning Assets 4.34% 4.35% 4.32%
</TABLE>
1 Yields are computed on a taxable equivalent basis using a 37% income tax rate.
2 Average balances are based on daily balances. 3 Includes loans in nonaccrual
status.
4 Average balances for securities available for sale are based on amortized
carrying values and do not reflect changes in market values.
<PAGE> 22
TABLE III
<TABLE>
EFFECT OF RATE-VOLUME CHANGES ON NET INTEREST INCOME (On a fully
taxable equivalent basis)
(In thousands of dollars)
<CAPTION>
1998 Compared to 1997 1997 Compared to 1996
Increase (Decrease) Increase (Decrease)
Due to Change in: Total Due to Change in: Total
Average Average Increase Average Average Increase
Volume Rate (Decrease) Volume Rate (Decrease)
Interest Income:
<S> <C> <C> <C> <C> <C> <C>
Loans 2 $1,155 $(241) $ 914 $1,331 $(236) $1,095
Investment Securities:
Taxable (352) (11) (363) (200) 24 (176)
Nontaxable (21) (7) (28) (49) (7) (56)
Total Investment Securities (373) (18) (391) (249) 17 (232)
Interest bearing deposits
in banks 29 (2) 27 (11) (11)
Federal funds sold 144 (18) 126 20 10 30
Total Interest Income 955 (279) 676 1,091 (209) 882
Interest Expense:
Deposits:
Demand 39 (30) 9 33 (12) 21
Savings 51 (39) 12 41 (2) 39
All other time deposits 468 (185) 283 424 (189) 235
Other borrowed money (28) (4) (32) 87 (12) 75
Total Interest Expense 530 (258) 272 585 (215) 370
Net Interest Income $ 425 $ (21) $ 404 $ 506 $ 6 $ 512
</TABLE>
1 Changes in volume are calculated based on the difference in average balance
multiplied by the prior year average rate. Rate change differences are the
difference in the volume changes and the actual dollar amount of interest
income or expense changes.
2 Nonaccrual loans have been included in average asset balances.
<PAGE> 23
TABLE IV
INTEREST RATE SENSITIVITY ANALYSIS
(In thousands of dollars)
DECEMBER 31, 1998
More than
5 Years
1 - 90 91 - 365 1 to 3 3 to 5 or Without
Days Days Years Years Maturity Total
EARNINGS ASSETS
Loans $17,328 $56,550 $41,540 $12,225 $20,741 $148,384
Fed funds sold 12,374 12,374
Securities 5,390 9,875 12,445 1,748 4,535 33,993
Interest bearing time
deposits 2,832 600 3,432
Total 37,924 67,025 53,985 13,973 25,276 198,183
INTEREST BEARING LIABILITIES
Transaction accounts 18,354 18,354
Money market accounts 11,393 11,393
Savings accounts 20,849 20,849
Time deposits more
than $100,000 5,883 11,391 6,896 1,553 25,723
Time deposits less
than $100,000 16,103 40,723 23,928 5,371 100 86,225
Other borrowed money 39 121 348 384 1,428 2,320
Total 72,621 52,235 31,172 7,308 1,528 164,864
Discrete interest
sensitivity GAP (34,697) 14,790 22,813 6,665 23,748 33,319
Cumulative interest
sensitivity GAP (34,697) (19,907) 2,906 9,571 33,319
Ratio of cumulative
interest sensitive
assets to cumulative
interest sensitive
liabilities 52.22% 84.06% 101.86% 105.86% 120.21%
Assumes all transaction, money market and savings deposit accounts reprice
within 90 days.
<PAGE> 24
Item 7. Financial Statements
Index to Financial Statements
Page
Consolidated Balance Sheets as of December 31, 1998 and 1997 25
Consolidated Statements of Income for the Years Ended December 31,
1998, 1997 and 1996 26
Consolidated Statements of Changes in Stockholders' Equity for
the Years Ended December 31, 1998, 1997 and 1996 27
Consolidated Statements of Cash Flows for the Years Ended
December 31, 1998, 1997 and 1996 28
Notes to Consolidated Financial Statements 29
Independent Auditors' Report 46
<PAGE> 25
CONSOLIDATED BALANCE SHEETS
HIGHLANDS BANKSHARES, INC.
December 31,
ASSETS 1998 1997
Cash and due from banks (notes 2, 3 and 15) $ 5,111,863 $ 3,246,056
Interest bearing deposits in banks 3,431,523 826,636
Federal funds sold 12,374,283 6,895,115
Investments:
Securities held to maturity (note 4) 3,503,965 4,576,963
Securities available for sale (note 4) 29,757,841 31,682,358
Other investments 730,950 715,250
Loans (notes 5, 13, 14 and 15) 148,383,904 137,105,218
Less allowance for loan losses (note 6) (1,355,377) (1,369,566)
Net Loans 147,028,527 135,735,652
Bank premises and equipment (note 7) 4,759,710 4,772,798
Interest receivable 1,556,347 1,547,604
Deferred income tax benefits (note 10) 124,612 164,988
Investment in insurance contracts 2,122,432
Other assets 478,889 606,442
Total Assets $210,980,942 $190,769,862
LIABILITIES
Deposits:
Noninterest bearing
Demand deposits $22,043,509 $15,952,124
Interest bearing
Money market and interest checking 18,353,696 15,773,770
Money market savings 11,393,244 12,179,095
Savings accounts 20,849,433 19,389,384
Certificates of deposit over $100,000
(note 8) 25,722,913 23,327,442
All other time deposits (note 8) 86,224,570 81,313,896
Total Deposits 184,587,365 167,935,711
Accrued expenses and other liabilities 1,227,486 1,310,998
Long-term debt (note 9) 2,319,544 226,152
Total Liabilities 188,134,395 169,472,861
STOCKHOLDERS' EQUITY
Common stock, $5 par value, 1,000,000 shares
authorized, 546,764 shares issued 2,733,820 2,733,820
Surplus 1,661,987 1,661,987
Retained earnings (note 12) 19,324,019 17,854,185
Other accumulated comprehensive income 119,422 39,710
23,839,248 22,289,702
Treasury stock (at cost, 44,866 shares
in 1998 and 1997) (992,701) (992,701)
Total Stockholders' Equity 22,846,547 21,297,001
Total Liabilities and Stockholders' Equity $210,980,942 $190,769,862
The accompanying notes are an integral part of this statement.
<PAGE> 26
CONSOLIDATED STATEMENTS OF INCOME
HIGHLANDS BANKSHARES, INC.
Years Ended December 31,
1998 1997 1996
INTEREST INCOME:
Loans, including fees $13,144,542 $12,229,824 $11,134,887
Federal funds sold 440,293 314,382 284,286
Interest bearing deposits 64,230 36,915 48,357
Investment securities - taxable 1,952,454 2,314,849 2,491,490
Investment securities - nontaxable 170,115 187,667 223,795
Total Interest Income 15,771,634 15,083,637 14,182,815
INTEREST EXPENSE:
Time deposits over $100,000 1,428,100 1,374,899 1,246,000
Other deposits 6,263,489 6,013,147 5,847,251
Total Interest on Deposits 7,691,589 7,388,046 7,093,251
Borrowed money 52,937 85,224 9,921
Total Interest Expense 7,744,526 7,473,270 7,103,172
NET INTEREST INCOME 8,027,108 7,610,367 7,079,643
PROVISION FOR LOAN LOSSES (note 6) 355,000 190,000 135,000
Net Interest Income after Provision
for Loan Losses 7,672,108 7,420,367 6,944,643
NONINTEREST INCOME:
Service charges 339,289 302,726 252,689
Insurance commissions and income 107,482 174,061 162,306
Other operating income 290,221 211,546 206,398
Loss on security transactions (note 4) (2,071) (117,036) (29,503)
Total Noninterest Income 734,921 571,297 591,890
NONINTEREST EXPENSES:
Salaries and benefits (note 11) 2,916,970 2,810,116 2,477,928
Occupancy expense 269,469 241,478 270,678
Equipment expense 411,660 424,032 328,372
Data processing expense 456,740 437,232 388,753
Other operating expenses 1,321,750 1,202,271 1,103,804
Total Noninterest Expenses 5,376,589 5,115,129 4,569,535
Income before Income Tax Expense 3,030,440 2,876,535 2,966,998
INCOME TAX EXPENSE (note 10) 1,018,558 996,390 953,874
NET INCOME $2,011,882 $1,880,145 $2,013,124
Net Income Per Share $ 4.01 $ 3.73 $ 3.92
Cash Dividends Paid Per Share $ 1.08 $ 1.00 $ .94
Weighted Average Shares Outstanding 501,898 504,330 514,066
The accompanying notes are an integral part of this statement.
<PAGE> 27
<TABLE>
CONSOLIDATED STATEMENTS OF CHANGES IN STOCKHOLDERS' EQUITY
HIGHLANDS BANKSHARES, INC.
<CAPTION>
Accumulated
Other
Capital Retained Comprehensive Treasury
Stock Surplus Earnings Income (Loss) Stock Total
<S> <C> <C> <C> <C> <C> <C>
BALANCE
DECEMBER 31, 1995 2,733,820 1,661,987 14,948,757 11,280 (493,813) 18,862,031
Comprehensive Income
Net income 2,013,124 2,013,124
Change in unrealized loss
on securities available
for sale, net of tax
effect of $95,420 (162,472) (162,472)
Total Comprehensive
Income 1,850,062
Cash dividends (483,226) (483,226)
BALANCE
DECEMBER 31, 1996 2,733,820 1,661,987 16,478,655 (151,192) (493,813) 20,229,457
Comprehensive Income
Net income 1,880,145 1,880,145
Change in unrealized loss
on securities available
for sale, net of tax
effect of $112,119 190,902 190,902
Total Comprehensive
Income 2,071,047
Cash dividends (504,615) (504,615)
Purchase of treasury stock
(12,168 shares) (498,888) (498,888)
BALANCE
DECEMBER 31, 1997 $2,733,820 1,661,987 17,854,185 39,710 (992,701) 21,297,001
Comprehensive Income
Net income 2,011,882 2,011,882
Change in unrealized loss
on securities available
for sale, net of tax
effect of $46,814 79,712 79,712
Total Comprehensive
Income 2,091,594
Cash dividends (542,048) (542,048)
BALANCE
DECEMBER 31, 1998 $2,733,820 $1,661,987 $19,324,019 $ 119,422 $(992,701) $22,846,547
</TABLE>
The accompanying notes are an integral part of this statement.
<PAGE> 28
<TABLE>
CONSOLIDATED STATEMENTS OF CASH FLOWS
HIGHLANDS BANKSHARES, INC.
<CAPTION>
Years Ended December 31,
1998 1997 1996
<S> <C> <C> <C>
CASH FLOWS FROM OPERATING ACTIVITIES:
Net income $2,011,882 $1,880,145 $2,013,124
Adjustments to reconcile net income to
net cash provided by operating activities:
Loss on equipment 26,339
Loss on sale of securities 2,071 117,036 29,503
Depreciation 350,429 359,740 262,757
Net amortization of security premiums 15,062 25,000 66,023
Provision for loan losses 355,000 190,000 135,000
Deferred income taxes (6,441) (1,768) 62,065
Change in other assets and liabilities:
Interest receivable (8,743) (186,171) (58,820)
Other assets 75,118 (42,801) (49,593)
Accrued expenses (83,512) (56,201) 239,230
Net Cash Provided by Operating Activities 2,710,866 2,284,980 2,725,628
CASH FLOWS FROM INVESTING ACTIVITIES:
Proceeds from maturity of securities
held to maturity 1,068,833 3,354,000 3,736,267
Purchases of securities held to maturity (620,600)
Proceeds from maturities of securities
available for sale 12,719,231 9,291,964 12,028,403
Proceeds from sales of securities available
for sale 501,000 1,511,173
Purchases of securities available for sale (10,681,150) (7,630,000) (19,863,779)
Net change in other investments (15,700) (76,065)
Net change in deposits in other banks (2,604,887) 6,990
160,957
Net increase in loans (11,647,875)
(12,582,234) (10,712,064)
Change in federal funds sold (5,479,168)
(4,401,038) 3,522,275
Purchase of property and equipment (337,341) (607,000) (1,476,627)
Investment in insurance contracts (2,070,000)
Net Cash Used in Investing Activities (19,048,057) (12,142,383) (11,713,995)
CASH FLOWS FROM FINANCING ACTIVITIES:
Net change in time deposits 7,306,146 8,048,939 9,398,863
Net change in other deposit accounts 9,345,508 2,777,665 (2,468)
Additional long-term debt 2,145,532 2,603,924 160,000
Repayment of long-term debt (52,140) (2,519,388) (175,844)
Dividends paid in cash (542,048) (504,615) (483,226)
Purchase of treasury stock (498,888)
Net Cash Provided by Financing Activities 18,202,998 9,907,637 8,897,325
CASH AND CASH EQUIVALENTS:
Net increase (decrease) in cash and
due from banks 1,865,807 50,234 (91,042)
Cash and due from banks, beginning of year 3,246,056 3,195,822 3,286,864
Cash and Due from Banks, End of Year $5,111,863 $3,246,056 $3,195,822
Supplemental Disclosures:
Cash paid for:
Interest expense $7,798,847 $7,525,000 $6,993,122
Income taxes 1,013,250 939,000 940,000
</TABLE>
The accompanying notes are an integral part of this statement.
<PAGE> 29
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
HIGHLANDS BANKSHARES, INC.
NOTE 1 NATURE OF OPERATIONS:
Highlands Bankshares, Inc. (the "Company") is a bank holding
company and operates under a charter issued by the state of West
Virginia. The Company owns all of the outstanding stock of The
Grant County Bank, the Capon Valley Bank and HBI Life Insurance
Company, Inc. which operate under charters issued in West Virginia
and Arizona. State chartered banks are subject to regulation by
the West Virginia Division of Banking, Federal Reserve Bank and
the Federal Deposit Insurance Corporation while the insurance
company is regulated by the Arizona Department of Insurance. The
Banks provide services to customers located mainly in Grant,
Hardy, Hampshire, Mineral and Pendleton counties of West Virginia,
including the towns of Petersburg, Keyser, Moorefield and
Wardensville through six branch offices. The insurance company
sells life and accident coverage exclusively through the Company's
subsidiary banks.
NOTE 2 SUMMARY OF SIGNIFICANT ACCOUNTING POLICIES:
The accounting and reporting policies of Highlands Bankshares,
Inc. ("Company") and its subsidiaries conform to generally
accepted accounting principles and to accepted practice within the
banking industry.
(a) Principles of Consolidation
The consolidated financial statements include the accounts of
The Grant County Bank, the Capon Valley Bank and HBI Life
Insurance Company. All significant intercompany accounts and
transactions have been
eliminated.
(b) Use of Estimates in the Preparation of Financial
Statements
In preparing the financial statements, management is required
to make estimates and assumptions that affect the reported
amounts in those statements; actual results could differ
significantly from those estimates. A material estimate that
is particularly susceptible to significant changes is the
determination of the allowance for loan losses, which is
sensitive to changes in local economic conditions.
(c) Cash and Cash Equivalents
Cash and cash equivalents include cash on hand and noninterest
bearing funds at correspondent institutions.
<PAGE> 30
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
HIGHLANDS BANKSHARES, INC.
NOTE 2 SUMMARY OF SIGNIFICANT ACCOUNTING POLICIES (CONTINUED):
(d) Securities
Securities that the Company has both the positive intent and
ability to hold to maturity (at time of purchase) are
classified as held to maturity securities. All other
securities are classified as available for sale. Securities
held to maturity are carried at historical cost and adjusted
for amortization of premiums and accretion of discounts, using
the effective interest method. Securities available for sale
are carried at fair value with any valuation adjustments
reported, net of deferred taxes, as a separate component of
stockholders' equity. Also included in securities available
for sale are marketable equity securities.
Other investments consist of investments in the Federal Home
Loan Bank of Pittsburgh and the Federal Reserve Bank of
Richmond. Such investments are required as members of these
institutions and these investments cannot be sold without a
change in the members' borrowing or service
levels.
Interest and dividends on securities and amortization of
premiums and discounts on securities are reported as interest
income using the effective interest method. Gains (losses)
realized on sales and calls of securities are determined using
the specific identification method.
(e) Loans
Loans are carried on the balance sheet net of any unearned
interest and the allowance for loan losses. Interest income on
loans is determined using the effective interest method on the
daily amount of principal outstanding except where serious
doubt exists as to collectibility of the loan, in which case
the accrual of income is discontinued.
(f) Allowance For Loan Losses
The allowance for loan losses is based upon management's
knowledge and review of the loan portfolio. Estimation of an
adequate allowance for loan losses involves the exercise of
judgement, the use of assumptions with respect to present
economic conditions and knowledge of the environment in which
the Banks operate. Among the factors considered in determining
the level of the allowance are the changes in composition of
the loan portfolio, the amount of delinquent and nonaccrual
loans, past loan loss experience and the value of collateral
securing the loans.
<PAGE> 31
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
HIGHLANDS BANKSHARES, INC.
NOTE 2 SUMMARY OF SIGNIFICANT ACCOUNTING POLICIES (CONTINUED):
(g) Impaired Loans
Accounting standards require that impaired loans be presented
in the financial statements at the present value of expected
future cash flows or at the fair value of the loan's
collateral. A valuation allowance is required to the extent
that such measurement is less than the recorded investment.
Under this standard a loan is considered impaired based on
current information and events, if it is probable that the
Company will be unable to collect the scheduled payments of
principal and interest when due under the contractual terms of
the loan agreement. Charge-offs for impaired loans occur when
the loan, or portion of the loan is determined to be
uncollectible, as is the case for all loans.
(h) Bank Premises and Equipment
Bank premises and equipment are stated at cost less
accumulated depreciation. Depreciation is charged to income
over the estimated useful lives of the assets using a
combination of the straight-line and accelerated methods. The
ranges of the useful lives of bank premises and equipment are
as follows:
Buildings and Improvements 15 - 40 years
Furniture and fixtures 6 - 15 years
Maintenance, repairs, renewals, and minor improvements are
charged to operations as incurred. Gains and losses on routine
dispositions are reflected in other income or expense.
(i) Income Taxes
Amounts provided for income tax expense are based on income
reported for financial statement purposes rather than amounts
currently payable under federal and state tax laws. Deferred
taxes, which arise principally from differences between the
period in which certain income and expenses are recognized for
financial accounting purposes and the period in which they
affect taxable income, are included in the amounts provided
for income taxes.
(j) Earnings Per Share
Earnings per share are based on the weighted average number of
shares outstanding.
(k) Foreclosed Real Estate
The components of foreclosed real estate are adjusted to the
lower of cost or fair value less estimated costs of disposal.
The current year provision for a valuation allowance has been
recorded as an expense to current operations.
NOTE 3 CASH AND DUE FROM BANKS:
The Banks are required to maintain average reserve balances based
on a percentage of deposits. The Banks have generally met this
requirement through average cash on hand and balances with their
correspondent institutions.
<PAGE> 32
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
HIGHLANDS BANKSHARES, INC.
NOTE 4 SECURITIES:
The carrying amount and estimated fair value of securities are as
follows:
Carrying Unrealized Unrealized Fair
Amount Gains Losses Value
Held to Maturity
December 31, 1998
Mortgage-backed $ 516,905 $ 5,870 $ $ 522,775
State and municipals 2,987,060 111,383 3,098,443
Total Securities
Held to Maturity $3,503,965 $ 117,253 $ $3,621,218
December 31, 1997
U. S. Treasuries
and Agencies $ 750,921 $ 1,480 $ 447 $ 751,954
Mortgage-backed 530,738 4,807 535,545
State and municipals 3,295,304 97,662 2,801 3,390,165
Total Securities
Held to Maturity $4,576,963 $ 103,949 $ 3,248 $4,677,664
Available for Sale
December 31, 1998
U. S. Treasuries
and Agencies $21,428,019 $ 189,692 $ 578 $21,617,133
Mortgage-backed 6,751,620 69,812 6,821,432
State and municipals 255,000 7,319 262,319
Marketable equities 618,708 72,951 545,757
Corporate obligations 514,934 3,734 511,200
Total Securities
Available for Sale $29,568,281 $ 266,823 $ 77,263 $29,757,841
December 31, 1997
U. S. Treasuries
and Agencies $20,229,821 $ 131,837 $ 13,347 $20,348,311
Mortgage-backed 10,659,595 57,894 51,676 10,665,813
State and municipals 100,000 1,467 101,467
Marketable equities 629,908 63,141 566,767
Total Securities
Available for Sale $31,619,324 $ 191,198 $ 128,164 $31,682,358
<PAGE> 33
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
HIGHLANDS BANKSHARES, INC.
NOTE 4 SECURITIES (CONTINUED):
The carrying amount and fair value of debt securities at December 31,
1998, by contractual maturity, are shown below. Expected maturities
will differ from contractual maturities because borrowers may have the
right to call or prepay obligations with or without call or prepayment
penalties.
Securities Held to Maturity Carrying Fair
Amount Value
Due in one year or less $ 155,039 $ 156,437
Due after one year through five years 934,095 948,614
Due after five years through ten years 1,402,662 1,460,547
Due after ten years 495,264 532,845
Mortgage-backed securities 516,905 522,775
Total Held to Maturity $3,503,965 $3,621,218
Securities Available for Sale Carrying Fair
Amount Value
Due in one year or less $9,980,590 $10,033,236
Due after one year through five years 9,057,195 9,189,671
Due after five years through ten years 2,905,168 2,905,426
Due after ten years 255,000 262,319
Mortgage-backed securities 6,751,620 6,821,432
Total Fixed Rate Securities 28,949,573 29,212,084
Equities 618,708 545,757
Total Available for Sale $29,568,281 $29,757,841
The carrying amount (which approximates market value) of securities
pledged by the banks to primarily secure deposits amounted to
$8,036,529 at December 31, 1998 and $8,116,050 at December 31, 1997.
There were no holdings totaling more than 10% of stockholders' equity
with any issuer as of December 31, 1998 and 1997.
All gains or losses in 1998 and 1996 are from calls or early payoffs
of securities designated as held to maturity. Losses in 1997 include a
loss on a mutual fund investment as well as gains/losses on calls and
redemptions. Realized gains or losses for the years ending December 31
are as follows:
1998 1997 1996
Gains $ 9,438 $ 6,982 $ 2,386
Losses 11,509 (124,018) (31,889)
Total $ (2,071) $ (117,036) $ (29,503)
<PAGE> 34
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
HIGHLANDS BANKSHARES, INC.
NOTE 5 LOANS:
Loans outstanding as of December 31 are summarized as follows:
1998 1997
Commercial $30,717,977 $30,716,769
Real estate construction 2,969,000 2,189,000
Real estate mortgages 83,446,041 75,221,128
Consumer installment 33,463,853 31,491,717
Subtotal 150,596,871 139,618,614
Unearned interest (2,212,967) (2,513,396)
Total Loans $148,383,904 $137,105,218
NOTE 6 ALLOWANCE FOR LOAN LOSSES:
A summary of changes in the allowance for loan losses for the years
ended December 31 is shown in the following schedule:
1998 1997 1996
Balance at beginning of year $1,369,566 $1,257,454 $1,319,099
Provision charged to
operating expenses 355,000 190,000 135,000
Loan recoveries 107,051 146,855 140,289
Loans charged off (476,240) (224,743) (336,934)
Balance at end of year $1,355,377 $1,369,566 $1,257,454
Percentage of outstanding
loans .91% 1.00% 1.01%
<PAGE> 35
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
HIGHLANDS BANKSHARES, INC.
NOTE 7 BANK PREMISES AND EQUIPMENT:
Bank premises and equipment as of December 31 are summarized as
follows:
1998 1997
Land $ 553,652 $ 553,652
Buildings and improvements 5,176,923 4,597,205
Furniture and equipment 2,375,983 2,680,767
Total cost 8,106,558 7,831,624
Less - accumulated depreciation (3,346,848) (3,058,826)
Net Book Value $4,759,710 $4,772,798
Provisions for depreciation of $350,429 in 1998, $359,740 in 1997 and
$262,757 in 1996, were charged to operations.
NOTE 8 DEPOSITS:
At December 31, 1998, the scheduled maturities of certificates of
deposit are as follows:
1999 $ 75,304,436
2000 24,481,013
2001 5,222,373
2002 3,043,815
2003 3,895,846
Total $111,947,483
NOTE 9 LONG-TERM DEBT:
The Company has borrowed money from the Federal Home Loan Bank of
Pittsburgh (FHLB). The interest rates on the notes payable are fixed
at the time of the advance and range from 2.50% to 6.60%; the weighted
average interest rate is 5.37% at December 31, 1998. The long-term
debt is secured by the assets of The Grant County Bank.
Repayments of long-term debt are due either monthly or quarterly.
Interest expense of $52,937, $53,181, and $9,921 was incurred on these
debts in 1998, 1997, and 1996, respectively. The maturities of
long-term debt as of December 31, 1998 are as follows:
1999 $ 159,923
2000 169,042
2001 178,691
2002 188,902
2003 195,387
Thereafter 1,427,599
Total $ 2,319,544
<PAGE> 36
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
HIGHLANDS BANKSHARES, INC.
NOTE 10 INCOME TAX EXPENSE:
The components of income tax expense for the years ended December 31,
are summarized as follows:
1998 1997 1996
Current expense
Federal $ 899,787 $883,728 $829,724
State 125,212 114,430 62,085
Total current expense 1,024,999 998,158 891,809
Deferred expense
Federal (5,919) (1,625) 56,940
State (522) (143) 5,125
Total deferred expense (6,441) (1,768) 62,065
Income tax expense $1,018,558 $996,390 $953,874
Income expense (benefits) relating
to losses on security transactions
are as follows: $ (766) $ 2,040 $(10,916)
The deferred tax effects of temporary differences for the years ended
December 31 are as follows:
1998 1997 1996
Tax effect of temporary differences:
Provision for loan losses $ (24,887) $(42,793) $ 2,492
Sale of loans 32,612 (7,744) 11,105
Pension expense (18,030) (10,404) (13,587)
Depreciation 30,497 51,675 41,825
Miscellaneous (26,633) 7,498 20,230
Net (increase) decrease in
deferred income tax benefit $ (6,441) $(1,768) $ 62,065
<PAGE> 37
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
HIGHLANDS BANKSHARES, INC.
NOTE 10 INCOME TAX EXPENSE (CONTINUED):
The net deferred tax assets arising from temporary differences as of
December 31 are summarized as follows:
1998 1997
Deferred Tax Assets:
Provision for loan losses $ 305,295 $ 282,258
Insurance commissions 29,908 32,199
Sale of loans 13,773 46,385
Capital loss carryforward 45,343 45,343
Other 29,153 26,819
Less valuation allowance (45,343) (45,343)
Total Assets 378,129 387,661
Deferred Tax Liabilities:
Pension prepaids 25,039 43,070
Unrealized gain on securities
available for sale 70,138 23,322
Accretion income 23,173 47,828
Accelerated depreciation 135,167 108,453
Total Liabilities 253,517 222,673
Net Tax Asset $ 124,612 $ 164,988
The following table summarizes the difference between income tax
expense and the amount computed by applying the federal statutory
income tax rate of 34 percent for the years ended December 31:
1998 1997 1996
Amounts at federal statutory rates $1,030,351 $ 978,023 $1,008,779
Additions (reductions) resulting
from:
Tax-exempt income (76,427) (69,759) (77,900)
Partially exempt income (27,497) (39,429) (39,771)
State income taxes, net 90,004 80,113 69,538
Nondeductible capital losses 45,343
Other 2,127 2,099 (6,772)
Income tax expense $1,018,558 $ 996,390 $ 953,874
<PAGE> 38
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
HIGHLANDS BANKSHARES, INC.
NOTE 11 EMPLOYEE BENEFITS:
The Company's two subsidiary banks each have separate retirement and
profit sharing plans which cover substantially all full time employees
at each bank. The Capon Valley Bank has a defined contribution pension
plan with 401(k) features that is funded with discretionary
contributions by the Company. The Company matches on a limited basis
the contributions of the employees. Investment of employee balances is
done through the direction of each employee.
The Grant County Bank is a member of the West Virginia Bankers'
Association Retirement Plan. Benefits under the plan are based on
compensation and years of service with 100% vesting after seven years
of service. The Plan's assets are in excess of the projected benefit
obligations and thus the Bank was not able to make contributions to
the Plan in 1998, 1997 or 1996. The amounts of the prepaid expense and
the net pension expense reflected in operations are insignificant. In
addition, The Grant County Bank also maintains a profit sharing plan
covering substantially all employees to which contributions are made
at the discretion of the Board of Directors.
The Company has established an employee stock ownership plan which
will provide stock ownership to all employees of the Company. The Plan
provides total vesting upon the attainment of seven years of service.
Contributions to the plan are made at the discretion of the Board of
Directors and are allocated based on the compensation of each employee
relative to total compensation paid by the Company. All shares held by
the Plan will be considered outstanding in the computation of earnings
per share. Shares of Company stock when distributed will have
restrictions on transferability.
Deferred compensation expenses for the above benefits charged to
operations totaled $196,172 in 1998, $189,595 in 1997 and $206,893 in
1996.
NOTE 12 RESTRICTIONS ON DIVIDENDS OF SUBSIDIARY BANKS:
The principal source of funds of Highlands Bankshares, Inc. is
dividends paid by subsidiary banks. The various regulatory authorities
impose restrictions on dividends paid by a state bank. A state bank
cannot pay dividends (without the consent of state banking
authorities) in excess of the total net profits of the current year
and the combined retained profits of the previous two years. As of
January 1, 1999, the banks could pay dividends to the Company of
approximately $2,364,584 without permission of the regulatory
authorities.
NOTE 13 TRANSACTIONS WITH RELATED PARTIES:
During the year, officers and directors (and companies controlled by
them) were customers of and had transactions with the subsidiary Banks
in the normal course of business. These transactions were made on
substantially the same terms as those prevailing for other customers
and did not involve any abnormal risk. The aggregate amount of loans
to related parties of $3,248,639 at December 31, 1997, was increased
$1,717,409 by new loans and reduced $3,590,854 by payments, resulting
in an ending balance of $1,375,194 at December 31, 1998.
<PAGE> 39
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
HIGHLANDS BANKSHARES, INC.
NOTE 14 COMMITMENTS AND GUARANTEES:
The Banks make commitments to extend credit in the normal
course of business and issues standby letters of credit to meet the
financing needs of its customers. The amount of the commitments
represents the Banks' exposure to credit loss that is not included in
the balance sheet. As of the balance sheet dates, the Banks had
outstanding the following commitments:
1998 1997
Commitments to extend credit $6,516,000 $8,414,000
Standby letters of credit 541,000 645,000
The Banks use the same credit policies in making commitments and
issuing letters of credit as it does for the loans reflected in the
balance sheet.
Commitments to extend credit are agreements to lend to a customer as
long as there is no violation of any condition established in the
contract. Commitments generally have fixed expiration dates or other
termination clauses and may require payment of a fee. Since many of
the commitments are expected to expire without being drawn upon, the
total commitment amounts do not necessarily represent future cash
requirements. The Banks evaluate each customer's creditworthiness on a
case-by-case basis. The amount of collateral obtained, if deemed
necessary by the Banks upon extension of credit, is based on
management's credit evaluation of the borrower. Collateral held varies
but may include accounts receivable, inventory, property, plant and
equipment.
NOTE 15 CONCENTRATIONS OF CREDIT:
The Banks grant commercial, residential real estate and consumer loans
to customers located primarily in the eastern portion of the State of
West Virginia. Although the Banks have a diversified loan portfolio, a
substantial portion of its debtors' ability to honor their contracts
is dependent upon the agribusiness economic sector. Collateral
required by the Banks is determined on an individual basis depending
on the purpose of the loan and the financial condition of the
borrower. The ultimate collectibility of the loan portfolios is
susceptible to changes in local economic conditions. Approximately 59%
of the loan portfolio is secured by real estate. See note 5 for a
complete breakdown of loans by type.
The Bank has cash deposited in and federal funds sold to other
commercial banks totaling $15,178,758 and $7,661,626 at December 31,
1998 and 1997, respectively.
<PAGE> 40
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
HIGHLANDS BANKSHARES, INC.
NOTE 16 DISCLOSURES ABOUT FAIR VALUE OF FINANCIAL INSTRUMENTS:
The fair value of the Company's assets and liabilities is influenced
heavily by market conditions. Fair value applies to both assets and
liabilities, either on or off the balance sheet. Fair value is defined
as the amount at which a financial instrument could be exchanged in a
current transaction between willing parties, other than in a forced or
liquidation sale.
The following methods and assumptions were used to estimate the fair
value of each class of financial instruments for which it is
practicable to estimate that value:
Cash, Due from Banks and Money Market Investments
The carrying amount of cash, due from bank balances, interest bearing
deposits and federal funds sold is a reasonable estimate of fair
value.
Securities
Fair values of securities are based on quoted market prices or dealer
quotes. If a quoted market price is not available, fair value is
estimated using quoted market prices for similar securities.
Loans
The fair value of loans is estimated by discounting the future cash
flows using the current rates at which similar loans would be made to
borrowers with similar credit ratings and for the same remaining
maturities, taking into consideration the credit risk in various loan
categories.
Deposits
The fair value of demand, interest checking, regular savings and money
market deposits is the amount payable on demand at the reporting date.
The fair value of fixed maturity certificates of deposit is estimated
using the rates currently offered for deposits of similar remaining
maturities.
Interest Payable and Receivable
The carrying value of amounts of interest receivable and payable is a
reasonable estimate of fair value.
<PAGE> 41
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
HIGHLANDS BANKSHARES, INC.
NOTE 16 DISCLOSURES ABOUT FAIR VALUE OF FINANCIAL INSTRUMENTS (CONTINUED):
Off-Balance-Sheet Items
The carrying amount and estimated fair value of off-balance-sheet
items were not material at December 31, 1997.
The carrying amount and estimated fair values of financial instruments
as of December 31 are as follows:
<TABLE>
<CAPTION>
1998 1997
Estimated Estimated
Carrying Fair Carrying Fair
Amount Value Amount Value
<S> <C> <C> <C> <C>
Financial Assets:
Cash and due from banks $ 5,111,863 $ 5,111,863 $ 3,246,056 $ 3,246,056
Interest bearing deposits 3,431,523 3,431,523 826,636 826,636
Federal funds sold 12,374,283 12,374,283 6,895,115 6,895,115
Securities held to maturity 3,503,965 3,621,218 4,576,963 4,677,664
Securities available for sale 29,757,841 29,757,841 31,682,358 31,682,358
Other investments 730,950 730,950 715,250 715,250
Loans, net 147,028,527 150,145,023 135,735,652 136,215,953
Interest receivable 1,556,347 1,556,347 1,547,604 1,547,604
Financial Liabilities:
Demand and savings
deposits 72,639,882 72,639,882 63,294,373 63,294,373
Term deposits 111,947,483 112,041,093 104,641,338 104,624,538
Borrowed money 2,319,544 2,287,194 226,152 226,152
Interest payable 688,888 688,888 743,000 743,000
</TABLE>
NOTE 17 REGULATORY MATTERS:
The Company is subject to various regulatory capital requirements
administered by the federal banking agencies. Failure to meet minimum
capital requirements can initiate certain mandatory - and possibly
additional discretionary - actions by regulators that, if undertaken,
could have a direct material effect on the Company's financial
statements. Under capital adequacy guidelines and the regulatory
framework for prompt corrective action, the Company must meet specific
capital guidelines that involve quantitative measures of the Company's
assets, liabilities, and certain off-balance-sheet items as calculated
under regulatory accounting practices. The Company's capital amounts
and classification are also subject to qualitative judgments by the
regulators about components, risk weightings and other factors.
Quantitative measures established by regulation to ensure capital
adequacy require the Company to maintain minimum amounts and ratios
(set forth in the table below) of total and Tier I capital (as defined
in the regulations) to risk-weighted assets (as defined), and of Tier
I capital (as defined) to average assets (as defined). Management
believes, as of December 31, 1998, that the Company meets all capital
adequacy requirements to which it is subject.
<PAGE> 42
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
HIGHLANDS BANKSHARES, INC.
NOTE 17 REGULATORY MATTERS (CONTINUED):
To be categorized as well capitalized the Company must maintain
minimum total risk-based, Tier I risk-based, and Tier I leverage
ratios as set forth in the table. There are no conditions or events
that management believes have changed the Company's category from a
well capitalized status.
The Company's actual capital ratios are presented in the following
table:
Actual Regulatory Requirements
December Adequately Well
1998 1997 Capitalized Capitalized
Total risk-based ratio 18.02% 18.47% 8.00% 10.00%
Tier 1 risk-based ratio 17.00% 17.35% 4.00% 6.00%
Total assets leverage ratio 10.83% 11.15% 3.00% 5.00%
Capital ratios and amounts are applicable both at the individual bank
level and on a consolidated basis. At December 31, 1998, both
subsidiary banks had capital levels far in excess of minimum
requirements. As such, both banks qualified as "well capitalized
banks" for FDIC insurance purposes and thus were charged the minimum
rate for insurance coverage.
<PAGE> 43
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
HIGHLANDS BANKSHARES, INC.
NOTE 18 PARENT CORPORATION ONLY FINANCIAL STATEMENTS:
BALANCE SHEETS
Assets December 31,
1998 1997
Cash $ 15,754 $ 18,695
Investment in subsidiaries 22,681,509 21,155,702
Other investments 100,000 100,000
Other assets 1,740
Income taxes receivable 5,436
Due from subsidiaries 48,017 17,168
Total Assets $ 22,847,020 $ 21,297,001
Liabilities
Income taxes payable $ 473 $
Total Liabilities 473
Stockholders' Equity
Common stock, par value $5 per share
authorized 1,000,000 shares; 546,764
shares issued $ 2,733,820 $ 2,733,820
Surplus 1,661,987 1,661,987
Retained earnings 19,324,019 17,854,185
Other accumulated comprehensive income 119,422 39,710
23,839,248 22,289,702
Less treasury stock (at cost,
44,866 shares in 1998 and 1997) (992,701) (992,701)
Total Stockholders' Equity 22,846,547 21,297,001
Total Liabilities and Stockholders'
Equity $ 22,847,020 $ 21,297,001
<PAGE> 44
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
HIGHLANDS BANKSHARES, INC.
NOTE 18 PARENT CORPORATION ONLY FINANCIAL STATEMENTS (CONTINUED):
STATEMENTS OF INCOME AND RETAINED EARNINGS
Years Ended December 31,
1998 1997 1996
Income
Dividends from subsidiaries $ 623,525 $ 1,055,054 $ 483,226
Other dividends 735 630 630
Total 624,260 1,055,684 483,856
Expenses
Professional fees 27,032 37,980 34,478
Advertising 6,807 6,094 3,320
Other expenses 53,992 39,054 18,754
Total 87,831 83,128 56,552
Net income before income tax benefit
and undistributed income of
subsidiaries 536,429 972,556 427,304
Income tax benefit (29,360) (30,211) (18,815)
Income before undistributed income
of subsidiaries 565,789 1,002,767 446,119
Undistributed income of
subsidiaries 1,446,093 877,378 1,567,005
Net Income 2,011,882 1,880,145 2,013,124
Retained earnings,
Beginning of period 17,854,185 16,478,655 14,948,757
Dividends paid (542,048) (504,615) (483,226)
Retained Earnings,
End of Period $19,324,019 $17,854,185 $16,478,655
<PAGE> 45
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
HIGHLANDS BANKSHARES, INC.
NOTE 18 PARENT CORPORATION ONLY FINANCIAL STATEMENTS (CONTINUED):
STATEMENTS OF CASH FLOWS
Years Ended ecember 31,
1998 1997 1996
Cash Flows from Operating Activities:
Net income $2,011,882 $1,880,145 $2,013,124
Adjustments
Undistributed subsidiary income (1,446,093) (877,378)(1,567,005)
Depreciation 583 181 408
Increase (decrease) in payables 473 (41,738)
(Increase) decrease in receivables (25,413) (10,569) 19,139
(Increase) decrease in other assets (2,325)
Net Cash Provided by Operating
Activities 539,107 992,379 423,928
Cash Flows from Financing Activities:
Dividends paid (542,048) (504,615) (483,226)
Purchase of treasury stock (498,888)
Net Cash Used in Financing
Activities (542,048)(1,003,503) (483,226)
Net Decrease in Cash (2,941) (11,124) (59,298)
Cash, Beginning of Year 18,695 29,819 89,117
Cash, End of Year $ 15,754 $ 18,695 $ 29,819
<PAGE> 46
INDEPENDENT AUDITORS' REPORT
The Stockholders and Board of Directors
Highlands Bankshares, Inc.
Petersburg, West Virginia
We have audited the accompanying consolidated balance sheets of Highlands
Bankshares, Inc. and subsidiaries as of December 31, 1998 and 1997, and the
related consolidated statements of income, changes in stockholders' equity and
cash flows for each of the years in the three year period ended December 31,
1998. These financial statements are the responsibility of the Company's
management. Our responsibility is to express an opinion on these financial
statements based on our audits.
We conducted our audits in accordance with generally accepted auditing
standards. Those standards require that we plan and perform the audit to obtain
reasonable assurance about whether the financial statements are free of material
misstatement. An audit includes examining, on a test basis, evidence supporting
the amounts and disclosures in the financial statements. An audit also includes
assessing the accounting principles used and significant estimates made by
management, as well as evaluating the overall financial statement presentation.
We believe that our audits provide a reasonable basis for our opinion.
In our opinion, the financial statements referred to above present fairly, in
all material respects, the consolidated financial position of Highlands
Bankshares, Inc. and subsidiaries as of December 31, 1998 and 1997, and the
consolidated results of their operations and their cash flows for each of the
years in the three year period ended December 31, 1998, in conformity with
generally accepted accounting principles.
S. B. Hoover & Company, L.L.P.
January 25, 1999
Harrisonburg, Virginia
<PAGE> 47
Item 8. Changes in and Disagreements with Accountants on Accounting and
Financial Disclosure
None
Part III
Item 9. Directors and Executive Officers
We are incorporating the Proxy Statement of Highlands Bankshares, Inc.
via Form DEF 14A filed March 19, 1999
.
Item 10. Executive Compensation
We are incorporating the Proxy Statement of Highlands Bankshares, Inc.
via Form DEF 14A filed March 19, 1999.
Item 11. Security Ownership of Certain Beneficial Owners and Management
We are incorporating the Proxy Statement of Highlands Bankshares, Inc.
via Form DEF 14A filed March 19, 1999.
Item 12. Certain Relationships and Related Transactions
We are incorporating the Proxy Statement of Highlands Bankshares, Inc.
via Form DEF 14A filed March 19, 1999.
Most of the directors, partnerships of which they may be general partners
and corporations of which they are officers or directors, maintain normal
banking relationships with the Bank. Loans made by the Bank to such persons or
other entities were made only in the ordinary course of business, were made on
substantially the same terms, including interest rates and collateral, as those
prevailing at the time for comparable transactions with other persons, and did
not involve more than normal risk of collectibility or present other unfavorable
features. See Note 13 of the consolidated financial statements.
John VanMeter is a partner with the law firm of VanMeter and VanMeter,
which has been retained by the Company as legal counsel and it is anticipated
that the relationship will continue. Jack H. Walters is a partner with the law
firm of Walters, Krauskopf & Roth, which provides legal counsel to the Company
and it is anticipated that the relationship will continue.
Part IV
Item 13. Exhibits and Reports on Form 8-K
a) Exhibits
Exhibit No. Description
2 Not applicable
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.
Amendments to the original Articles of Incorporation
are incorporated by reference; filed as Exhibit 3(i)
with 1997 10KSB.
<PAGE> 48
Item 13. Exhibits and Reports on Form 8-K (Continued)
a) Exhibits (Continued)
Exhibit No. Description
3 (ii) Bylaws of Highlands Bankshares, Inc. are
incorporated by reference to Appendix D to
Highland Bankshares, Inc.'s Form S-4 filed
October 20, 1986.
Amendments to the original Bylaws are
incorporated by reference; filed as Exhibit
3(ii) with 1997 10KSB
4 Not applicable
9 Not applicable
10 Not applicable
11 Not applicable
12 Not applicable
16 Not applicable
18 Not applicable
21 Subsidiaries of the Small Business Issuer is
attached on Page 50
22 Not applicable
23 Consent of Certified Public Accountant attached
on Page 51
24 Not applicable
27 Financial Data Schedule attached
28 Not applicable
b) Reports on Form 8-K
No reports on Form 8-K were filed in the fourth quarter of 1998.
<PAGE> 49
SIGNATURES
Pursuant to the requirements of Section 13 or 15(d) of the Securities
Exchange Act of 1934, the registrant has duly caused this report to be signed on
its behalf by the undersigned, thereunto duly authorized.
HIGHLANDS BANKSHARES, INC.
By LESLIE A. BARR
Leslie A. Barr
President Chief Executive Officer
Date March 30, 1999
By CLARENCE E. PORTER
Clarence E. Porter
Secretary/Treasurer,
Chief Financial Officer
and Chief Accounting Officer
Date March 30, 1999
Pursuant to the requirements of the Securities Exchange Act of 1934, this
report has been signed below by the following persons on behalf of the
registrant and in the capacities and as of the date indicated.
Signature Title Date
LESLIE A. BARR March 30, 1999
Leslie A. Barr President
& Chief Executive Officer
Director
THOMAS B. MCNEIL, SR. March 30, 1999
Thomas B. McNeil, Sr. Director
George B. Moomau Director
CLARENCE E. PORTER March 30, 1999
Clarence E. Porter Secretary/Treasurer
Chief Financial
and Accounting Officer
Director
Courtney R. Tusing Director
JOHN G. VANMETER March 30, 1999
John G. VanMeter Chairman of the Board
Director
Jack H. Walters Director
L. KEITH WOLFE March 30, 1999
L. Keith Wolfe Director
<PAGE> 50
Exhibit 21 - List of Subsidiaries of the Registrant
The following is a list of subsidiaries meeting the requirements of Exhibit
21.
a) The Grant County Bank (incorporated in West Virginia), doing business as
The Grant County Bank.
b) Capon Valley Bank (incorporated in West Virginia), doing business as
the Capon Valley Bank.
c) HBI Life Insurance Company, Inc. (incorporated in the state of
Arizona), doing business as HBI Life.
Exhibit 21
<PAGE> 51
Exhibit 23 - Consent of Certified Public Accountant
Board of Directors
Highlands Bankshares, Inc.
We consent to the use of our report, dated January 25, 1999, relating to the
consolidated balance sheets of Highlands Bankshares, Inc. as of December 31,
1998 and 1997, and the related statements of income, changes in stockholders'
equity, and cash flows for each of the years in the three year period ended
December 31, 1998, which report appears on page 24 in the December 31, 1998
Annual Report to Shareholders of Highlands Bankshares, Inc. and page 46 of this
10KSB.
S. B. HOOVER & COMPANY, L.L.P.
Harrisonburg, VA
March 19, 1999
<TABLE> <S> <C>
<ARTICLE> 9
<LEGEND>
THIS SCHEDULE CONTAINS SUMMARY FINANCIAL INFORMATION EXTRACTED FROM HIGHLANDS
BANKSHARES, INC. FORM 10KSB AND IS QUALIFIED IN ITS ENTIRETY BY REFERENCE TO
SUCH FINANCIAL STATEMENTS.
</LEGEND>
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<NAME> HIGHLANDS BANKSHARES, INC.
<MULTIPLIER> 1,000
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<FISCAL-YEAR-END> DEC-31-1998
<PERIOD-START> JAN-01-1998
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