SECURITIES AND EXCHANGE COMMISSION
Washington, D. C. 20549
FORM 10-K
ANNUAL REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES
EXCHANGE ACT OF 1934
For fiscal year ended December 31, 2002 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
Indicate by check mark 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.
[ X ]
Indicate by check mark whether the issuer is an accelerated filer (as
defined in Rule 12b-2 of the Act). [ ___ ]
Indicate by check mark 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-K
or any amendment to this Form 10-K. [ X ]
Issuer's revenues for its most recent fiscal year: $20,273,574
The aggregate market value of the 1,323,687 shares of Common Stock of the
registrant issued and outstanding held by nonaffiliates on March 1, 2003 was
approximately $ 33,092,175 based on the closing sales price of $ 25.00 per share
on March 1, 2003. For purposes of this calculation, the term "affiliate"
refers to all directors and executive officers of the registrant.
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, 2003 -
1,436,874
DOCUMENTS INCORPORATED BY REFERENCE:
Proxy Statement of Highlands Bankshares, Inc. filed via Form DEF 14A on
March 5, 2003.
TRANSITIONAL SMALL BUSINESS DISCLOSURE FORMAT YES [ ] NO [ X ]
2
FORM 10-K INDEX
Page
Part I
Item 1. Description of Business 3
Item 2. Description of Properties 4
Item 3. Legal Proceedings 5
Item 4. Submission of Matters to a Vote of Security Holders 5
Part II
Item 5. Market for Common Equity and
Related Stockholder Matters 5
Item 6. Selected Financial Data 6
Item 7. Management's Discussion and Analysis of Financial
Condition and Results of Operation 6
Item 7A. Quantitative and Qualitative Disclosures About Market Risk 28
Item 8. Financial Statements 29
Item 9. Changes in and Disagreement with Accountants on
Accounting and Financial Disclosure 58
Part III
Item 10. Directors and Executive Officers of the Registrant 58
Item 11. Executive Compensation 58
Item 12. Security Ownership of Certain Beneficial Owners and
Management 58
Item 13. Certain Relationships and Related Transactions 58
Item 14. Controls and Procedures 58
Part IV
Item 15. Exhibits and Reports on Form 8-K 59
Signatures 61
Certification of Chief Executive Officer 62
Certification of Executive Officer(s) 63
Certification of Chief Financial Officer 65
Section 906 of the Sarbanes-Oxley Act of 2002 (18 U.S.C.ss.1350) 66
3
Part I
Item 1. Description of Business
General
Highlands Bankshares, Inc. (hereinafter referred to as "Highlands," or the
"Company"), 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"), its life insurance subsidiary, HBI
Life Insurance Company (hereinafter referred to as "HBI Life") and its trust
subsidiary, Highlands Bankshares Trust Company (hereinafter referred to as
"HBTC").
The Grant County Bank was chartered on August 6, 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. HBTC was chartered in December 2000 under the laws of
the state of West Virginia.
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
automated teller machines. 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. Trust
services are offered through HBTC.
Employees
As of December 31, 2002, The Grant County Bank had 60 full time equivalent
employees and Capon Valley Bank had 44 full time equivalent employees. Highlands
employs two persons and HBTC had one full time equivalent employee at year-end.
No person is employed by HBI Life on a full time basis.
Competition
The banks' primary trade area is generally defined as Grant, Hardy, Mineral,
Randolph, and the northern portion of Pendleton County in West Virginia,
Frederick County, Virginia and portions of Western Maryland. This area includes
the cities of Petersburg, Wardensville, Moorefield and Keyser and several rural
towns. The banks' secondary trade area includes portions of Hampshire County in
West Virginia. The banks compete with four state chartered banks and six
national banks. In addition, the banks compete with money market mutual funds
and investment brokerage firms for deposits in their service area. 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 banks have been forced to pay rates on
deposits which exceed the national averages.
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.
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 Bank regulations permit bank holding companies to engage in
non-banking activities closely related to banking or to managing or controlling
banks. These activities include the making or servicing of loans, trust
services, 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. HBTC provides trust
services to customers of the Banks. 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.
The operations of the trust company are subject to the oversight and review
of the State of West Virginia and the Federal Reserve Bank.
Item 2. Description of Properties
The Grant County Bank's main office is located on Main Street in Petersburg,
West Virginia. In July 2000, the Bank acquired a full service branch in Harman,
West Virginia through the purchase of the Stockmans' Bank of Harman. This
location primarily serves Randolph County. The Bank also has branch facilities
in Moorefield, Keyser and Riverton, West Virginia which provide banking services
in Hardy County, Mineral County, and northwest Pendleton County, respectively.
The Riverton branch building is leased while all other locations 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 and Gore,
Virginia. The Wardensville location was substantially renovated and expanded in
2000 to enhance customer service. Capon's offices serve mainly Hardy County and
Hampshire County, West Virginia, with the Gore branch servicing Frederick
County, Virginia. All facilities include state-of-the-art drive in and automated
teller operations. All facilities are owned by the Bank and considered adequate
for current operations.
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. Submission of Matters to a Vote of Security Holders
Highlands has not submitted any matters to the vote of security holders for
the quarter ending December 31, 2002.
Part II
Item 5. Market for Common Equity and Related Stockholder Matters
The Company had approximately 855 stockholders of record as of March 1,
2003. This amount includes all shareholders, whether titled individually or held
by a brokerage firm or custodian in street name. The Company's stock is not
traded on any national or regional stock exchange although brokers in
Cumberland, Maryland or 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. Prices have been provided using a
nationally recognized online stock quote system. Such prices may not include
retail mark-ups, mark-downs or commissions. During the third quarter of 2002,
the Company declared a 200% stock dividend. Share prices for the first and
second quarters of 2002 and for 2001 have been adjusted to account for this
stock split effected in the form of dividend.
Dividends Market Price Range
2002 Per Share High Low
---- --------- ---- ---
First Quarter .1233 18.46 15.92
Second Quarter .1233 18.67 16.75
Third Quarter .1300 18.50 17.03
Fourth Quarter .1300 21.51 18.50
Dividends Market Price Range
2001 Per Share High Low
---- --------- ---- ---
First Quarter .1133 17.00 15.67
Second Quarter .1133 16.67 15.71
Third Quarter .1133 16.75 15.92
Fourth Quarter .1133 16.67 15.53
6
Item 6. Selected Financial Data
- - - - - Years Ending December 31, - - - - -
(In Thousands Except
for Share Amounts)
2002 2001 2000 1999 1998
Total Interest Income $18,970 $20,207 $18,207 $16,243 $15,772
Total Interest Expense 7,705 10,049 8,790 7,663 7,745
------ ------ ------ ------ ------
Net Interest Income 11,265 10,158 9,417 8,580 8,027
Provision for Loan Losses 820 600 500 320 355
------ ------ ------ ------ ------
Net Interest Income after
Provision for Loan Losses 10,445 9,558 8,917 8,260 7,672
Other Income 1,304 1,194 1,263 1,026 735
Other Expenses 7,885 7,210 6,631 5,912 5,377
------ ------ ------ ------ ------
Income before Income Taxes 3,864 3,542 3,549 3,374 3,030
Income Tax Expense 1,240 1,061 1,168 1,049 1,018
------ ------ ------ ------ ------
Net Income $ 2,624 $ 2,481 $ 2,381 $ 2,325 $ 2,012
====== ====== ====== ====== ======
Net Income Per Share* $ 1.80 $ 1.65 $ 1.58 $ 1.54 $ 1.34
Dividends Per Share* $ .51 $ .45 $ .41 $ .39 $ .36
Total Assets at Year End $292,348 $276,778 $248,600 $220,481 $210,981
======= ======= ======= ======= =======
Return on Average Assets .93% .94% 1.03% 1.08% 1.01%
Return on Average Equity 9.23% 9.08% 9.40% 9.94% 9.12%
Dividend Payout Ratio 28.12% 27.51% 26.14% 25.04% 26.94%
Year End Equity to Assets Ratio 9.89% 10.23% 10.57% 10.99% 10.83%
*--Prior years' per share figures restated to reflect stock split effected in
form of dividend in 2002.
Item 7. Management's Discussion and Analysis of Financial Condition and
Results of Operations
Critical Accounting Policies
The Company's financial statements are prepared in accordance with
accounting principles generally accepted in the United States ("GAAP"). The
financial statements contained within these statements is, to a significant
extent, financial information that is based on measures of the financial effects
of transactions and events that have already occurred. A variety of factors
could affect the ultimate value that is obtained either when earning income,
recognizing an expense, recovering an asset or relieving a liability. In
addition, GAAP itself may change from one previously acceptable method to
another method. Although the economics of these transactions would be the same,
the timing of events that would impact these transactions could change.
The allowance for loan losses is an estimate of the losses that may be
sustained in the loan portfolio. The allowance is based on two basic principles
of accounting: (i) SFAS No. 5, Accounting for Contingencies, which requires that
losses be accrued when they are probable of occurring and estimable and (ii)
SFAS No. 114, Accounting by Creditors for Impairment of a Loan, which requires
that losses be accrued based on the differences between the value of collateral,
present value of future cash flows or values that are observable in the
secondary market and the loan balance.
7
Recent Accounting Pronouncements
In December 2001, the American Institute of Certified Public Accountants
("AICPA") issued Statement of Position ("SOP") no. 01-6, Accounting by Certain
Entities (Including Entities with Trade Receivables) That Lend to or Finance the
Activities of Others, to reconcile and conform the accounting and financial
reporting provisions established by carious AICPA industry audit guides. SOP No.
01-6 is effective for annual and interim financial statements issued for fiscal
years beginning December 15, 2001 and did not have a material impact on the
Company's consolidated financial statements.
All other recent accounting pronouncements had no material impact on the
Company's consolidated financial statements.
Overview
The Company's 2002 net income of $2,624,000 is a 5.78% increase in net
income compared to 2001. This represents a return on average equity of 9.23% for
2002 compared to 9.08% for 2001. Returns on average assets for 2002 and 2001
were .93% and .94%, respectively. Earnings per share increased 9.09% from 2001
to 2002 due to the increase in net income and the repurchase of 22,940 common
shares by the Company.
Taxable equivalent interest income decreased by $1,218,000 in 2002 to
$19,088,000. A 7.27% increase in the level of average earning assets was offset
by a decrease in rates for 2002. Decreases in interest rates, coupled with a
continued good local economy, drove a 9.30% increase in average loans
outstanding.
Noninterest income increased 9.21% in 2002 compared to 2001. Increases in
service charge income, trust fees and other bank fees were offset in part by
reductions in income from investments in life insurance contracts and reductions
in income realized by the insurance company in 2002. Noninterest expenses
increased 9.36% in 2002 due mainly to higher personnel and equipment expenses,
and higher operating expenses consistent with loan and deposit growth.
Net Interest Margin
2002 compared to 2001
The Company's net interest margin on a tax equivalent basis was
$11,383,000 for 2002 compared to $10,257,000 for 2001. A 7.27% increase in
average earning assets was offset by a reduction in yield on these assets of 102
basis points to cause a $1,218,000 reduction in interest income. However, the
reduction in yields on earning assets was offset by a reduction of 134 basis
points on rates paid on interest bearing liabilities to result in an increase in
taxable equivalent net interest margin of $1,126,000.
Average loans outstanding grew by 9.30% from 2001 to 2002 as falling interest
rates throughout 2002, coupled with stable local economic conditions
propelled loan demand. Loans outstanding at December 31, 2002 increased
$20,285,000 compared to December 31, 2001. Increases in loan growth have been
primarily funded through increases in deposit growth and reductions in balances
of fed funds sold, securities and interest bearing deposits in other banks.
Levels of competition for deposits in the Company's service area have caused the
Company's subsidiary banks to traditionally pay higher rates on deposits than
larger, statewide financial institutions. Recent efforts to reduce this
discrepancy have been moderately successful and the companies cost of funds on
deposits fell 136 basis points from 2001 to 2002 after having risen slightly
from 2000 to 2001. Average deposit balances increased 7.73% in 2002 as compared
to 2001. The depressed interest rate environment appears to have made customers
reluctant to place deposits in long term time deposits, and time deposit
balances increased only slightly in 2002 while average balances of noninterest
bearing demand deposits, interest bearing demand deposits and savings deposits
increased 19.74% in 2002 as compared to 2001.
8
Net Interest Margin (Continued)
2002 compared to 2001 (Continued)
The Company anticipates its net interest margin to remain stable or rise
slightly in the first six months of 2003 due to the maturing of higher rate
liabilities. Current net interest margin should continue as long as interest
rates remain stable or increase gradually and loan and deposit trends remain
consistent. Rates paid on deposits are expected to stabilize over the next
twelve months as the Federal Reserve Bank's rate cuts have been less frequent
and the economy shows signs of recovery. Most loans have repricing opportunities
within the next twelve months and the Company should be able to slightly improve
its net interest margin in this anticipated rate environment.
2001 compared to 2000
The Company's net interest margin on a tax equivalent basis was
$10,257,000 for 2001 compared to $9,515,000 for 2000. The increase was due to an
increase in average earning assets (14.16%) while maintaining deposit and
borrowings liability costs at 4.84% for both years. Average loans outstanding
grew by 12.49% from 2000 to 2001. This growth reflected good local economic
conditions, even in a declining interest rate environment. The overall cost of
funds reflected 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.
Loans outstanding at December 31, 2001 increased 8.56% over amounts at
December 31, 2000. The loan increase was the result of continued efforts to
increase lending in existing markets. Loan growth was funded primarily by
deposit growth, with a small amount of additional borrowings from the Federal
Home Loan Bank.
A summary of the net interest margin analysis is shown as Table II on Page 23.
Provision for Loan Losses
The Company's provisions for loan losses were $820,000 for 2002, $600,000
for 2001, and $500,000 for 2000. Net loan charge-offs were $630,000 in 2002
compared to $490,000 in 2001 and $412,000 in 2000. The Company's 2002 net charge
off rate of .29% of average loans is approximately equal to its peer group. The
Company's three year charge off rate of .26% of average loans outstanding is
slightly above peer group.
The increase in the provision for loan losses from 2001 to 2002 was
necessitated by the 9.87% increase in loan balances from December 31, 2001 to
December 31, 2002. This increase in loan balances, coupled with the increase in
net loan charge-offs, required a greater provision in order to maintain adequate
ratios between the allowance and a larger loan portfolio. Greater net
charge-offs were observed in 2002 as compared to 2001. Net charge-offs on
consumer loans increased 54.39% as recoveries on these loans fell from $141,000
in 2001 to $72,000 in 2002. Gross charge-offs on consumer loans increased 14.91%
compared to a 5.06% increase in the overall consumer loan portfolio. Net
charge-offs on commercial loans increased 29.67% from 2001 to 2002 due in large
part to the default of one large commercial customer.
Noninterest Income
2002 Compared to 2001
Noninterest income for 2002 increased $110,000 from 2001, an increase of
9.21%. Service charge income increased by .96% as deposit and loan volume
increased. This increase in service charge income came in spite of a decrease in
service charges related to a single large customer who paid large amounts of
overdraft and other service charges fees in 2001 and 2000. Because of an
infusion of cash from an investor this customer paid significantly less
overdraft fees in 2002. Due to decreases in interest rates and changes in
economic conditions, income from investments in life insurance contracts fell
3.33%. Trust fees increased 65.98% from 2001 due to a higher volume of
customers. Gains on sales of other real estate owned were $40,550 during 2002
compared to no gains recorded in 2001.
9
Noninterest Income (Continued)
2001 Compared to 2000
Noninterest income for 2001 decreased 5.47% from 2000. Decreases in service
charge income of 1.76% were largely due to the loss of one large corporate
customer which was bought and financially managed from outside the local area.
Decreases in insurance commissions of 23.70% were the result of above average
claims experienced during the year. Offsetting these declines was greater income
from investments in insurance contracts which showed improved profitability in
2001. There were no gains or losses on security transactions in 2001 as no
securities were sold. The $104,000 gain on security transactions in 2000 was due
to unusual circumstances involving securities involved in the acquisition of the
Stockmans Bank and were not repeated in 2001.
Noninterest Expenses
2002 Compared to 2001
Total noninterest expenses increased 9.36% in 2002 compared with 2001.
Salaries and benefits increased 7.41% due to an increase in full time equivalent
employees of 2.88%, merit increases and higher benefit costs. Occupancy expense
remained substantially unchanged and equipment expense increased 4.98% as
expanded operations required new equipment purchases resulting in increased
depreciation and maintenance costs. Data processing expenses increased by 8.57%
due to general asset growth and expanded operations. Other changes contributing
to the increase in noninterest expenses were increases in marketing expenditure
due to expanded advertising campaigns and The Grant County Bank's 100th
Anniversary celebration, continuing costs associated with the start-up and
expansion of Highlands Bankshares Trust Company and increases in nonincome
taxes. Noninterest expense as a percentage of average assets was 2.79% in 2002
compared to 2.73% in 2001 and 2.86% in 2000. These ratios compare favorably to
the Company's peer group. The Company's overall increase in noninterest
expense is consistent with increases in loan and deposit volumes.
2001 Compared to 2000
Total noninterest expenses increased 8.74% in 2001 when compared with 2000
operations. Salaries and benefits increased 8.49% due to the increase in staff
at the new branches, merit raises and higher benefit costs. Average full time
equivalent employees increased 9.89% in 2001 due mainly to staffing the new
branches in Gore, VA and Harman. The costs of occupancy and equipment increased
18.82% due to depreciation associated with the new and renovated facilities and
equipment upgrades. Data processing expenses increased by 8.03% due to
general asset growth and expanded locations. Other operating expenses increased
4.30% for all of the reasons cited above. The overall increase in noninterest
expenses is a reflection of additional locations which generally take one to
three years to become profitable.
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, Randolph,
and northern Pendleton counties in WV and Frederick County, VA. 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.
10
Financial Condition (Continued)
Loan Portfolio (Continued)
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 $20,285,000, or 9.87% in 2002. Mortgage and real
estate construction loans grew 11.11%, consumer loans 5.06% and
commercial loans 11.57%. The loan to deposit ratio was 87.67% at December 31,
2002 compared to 84.89% at December 31, 2001. 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.
The following table presents the year-end balances of loans, classified by
type (in thousands):
2002 2001 2000 1999 1998
---- ---- ---- ---- ----
Real estate loans:
Construction and
land
development $ 6,813 $ 4,105 $ 4,096 $ 3,296 $ 2,969
Secured by
farmland 11,220 9,464 10,059 9,219 9,586
Secured by 1-4
family
residential
properties 86,748 75,771 72,408 67,775 64,372
Secured by
nonfarm, non-
residential
properties 51,152 48,282 39,122 33,064 28,142
Loans to farmers 593 1,238 567 391 449
Commercial and
industrial
loans 10,676 9,652 8,029 6,568 4,498
Consumer loans 55,642 56,366 54,691 46,266 38,353
Loans for nonrated
industrial
development
obligations 458 275
All other loans 2,910 133 21 35 15
------- ------ ------- ------ -------
Total Loans $225,754 $205,469 $189,268 $166,614 $148,384
======= ======= ======= ======= =======
There were no foreign loans outstanding during any of the above periods.
11
Financial Condition (Continued)
Loan Portfolio (Continued)
The following table summarizes the Company's loan portfolio, net of
unearned income:
At December 31,
-----------------------------------------------
2002 2001 2000
---- ---- ----
(In Thousands of Dollars)
Real Estate:
Mortgage $ 121,558 $ 111,668 $ 101,890
Construction 6,813 3,868 4,061
Commercial 47,089 42,204 37,681
Installment 50,351 47,927 46,191
-------- -------- --------
Subtotal 225,811 205,667 189,823
Less unearned discount (57) (197) (555)
--------- --------- --------
Total Loans 225,754 205,470 189,268
Allowance for loan losses (1,793) (1,603) (1,493)
-------- --------- --------
Loans, net $ 223,961 $ 203,867 $ 187,775
======== ======== ========
The following table shows the maturity of loans outstanding (in
thousands of dollars) as of December 31, 2002, 2001 and 2000.
Maturity Range 2002 2001 2000
-------------- ---- ---- ----
Predetermined Rates:
0 - 12 months $145,473 $ 99,049 $105,054
13 - 60 months 68,699 68,106 75,918
More than 60 months 11,353 37,840 8,264
Nonaccrual Loans 229 474 32
------- ------- -------
Total Loans $225,754 $205,469 $189,268
======= ======= =======
The following table shows the Company's loan maturity distribution (in
thousands of dollars) as of December 31, 2002:
Maturity Range
Less Than 1-5 Over
Loan Type 1 Year Years 5 Years Total
--------- ------- ----- ------- -----
Commercial and
Agricultural Loans $ 35,569 $ 4,193 $ 7,327 $ 47,089
Real Estate - mortgage 82,030 35,570 3,958 121,558
Real Estate - construction 6,813 6,813
Consumer - installment 21,061 28,936 297 50,294
-------- ------- ------- --------
Total $ 145,473 $ 68,699 $ 11,582 $ 225,754
======== ======= ======= ========
12
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 are placed in nonaccrual status when the
collection of principal or interest is 120 days past due and collection is
uncertain based on the net realizable value of the collateral and/or the
financial strength of the borrower. Also, the existence of any guaranties by
federal or state agencies is given consideration in this decision. The policy is
the same for all types of loans. Restructured loans are loans 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 $517,050 at December 31, 2002,
$58,250 at December 31, 2001 and $110,000 at December 31, 2000. Of the
foreclosed property held at December 31, 2002, one property, valued at $278,000,
was in the Company's secondary service area and all remaining properties were
located 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 or at the time of disposition.
Nonperforming loans increased 3.97% at December 31, 2002 compared to 2001.
Nonaccrual loans decreased as the result of two bankruptcies present in 2001
which were resolved in 2002. Loans 90 and more days past due decreased 16.43% as
compared to a 9.87% increase in total loans. Restructured loans also
increased in 2002 due to the refinancing of two troubled commercial loans
necessary to recoup timely payment of principal. In neither case were any
principal amounts forgiven. Management does not anticipate any significant
losses from the current level of nonperforming assets.
The following table summarizes the nonperforming loans:
At December 31,
-------------------------------
2002 2001 2000
---- ---- ----
(Dollars in Thousands)
Loans accounted for on a
nonaccrual basis
Consumer $ 9 $ $
Real estate 290 474 32
------ ----- ------
Total nonaccrual loans 299 474 32
------ ----- ------
Restructured loans 662 0 0
------ ----- ------
Loans contractually past due 90 days
or more as to interest or principal
payments (not included in
nonaccrual loans above)
Commercial 161 607 60
Real estate 1,312 1,352 1,984
Installments 445 336 297
------ ----- ------
Total Delinquent Loans 1,918 2,295 2,341
------- ----- ------
Total Nonperforming Loans $ 2,879 $2,769 $ 2,373
====== ===== ======
13
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, 2002, management is not aware of any significant potential
problem loans for 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, 2002, the Company did not have any potential problem
loans as defined in Guide 3 that would require disclosure.
Allowance for Loan Losses
The allowance for loan loss at December 31, 2002 was $1,793,000, an 11.91%
increase over the balance at December 31, 2001, while net loans grew 9.87%
during the same period. The Company's provision for loan losses in 2002 was
36.67% greater than that provided for in 2001. The increase in the provision for
loan losses from 2001 to 2002 was necessitated by the 9.87% increase in loan
balances from December 31, 2001 to December 31, 2002. This increase in loan
balances, coupled with the increase in net loan charge-offs, required a greater
provision in order to maintain adequate ratios between the allowance and a
larger loan portfolio. Greater net charge-offs were observed in 2002 as compared
to 2001. Net charge-offs on consumer loans increased 54.39% as recoveries on
these loans fell from $141,000 in 2001 to $72,000 in 2002 as gross charge-offs
on consumer loans increased 14.91% compared to a 5.06% increase in the overall
consumer loan portfolio. Net charge-offs on commercial loans increased 29.67%
from 2001 to 2002 due in large part to the default of one large commercial
customer.
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 .79% at December 31, 2002, .78% at December 31, 2001 and .79% at
December 31, 2000. At December 31, 2002, the ratio of the allowance for loan
losses to nonperforming loans was 62.28% compared to 57.89% at December 31, 2001
and 62.92% at December 31, 2000.
The allowance for loan losses is an estimate of the losses in the current
loan portfolio. The allowance is based on two principles of accounting: (i) SFAS
5, Accounting for Contingencies which requires that losses be accrued when they
are probable of occurring and estimatable and (ii) SFAS 114, Accounting by
Creditors for Impairment of a Loan, which requires that loans be identified
which have characteristics of impairment as individual risks, (e.g. the
collateral, present value of cash flows or observable market values are less
than the loan balance).
14
Allowance for Loan Losses (Continued)
Each of Company's banking subsidiaries, Capon Valley Bank and The Grant
County Bank, determines its allowance for loan losses independently. Each bank
pays particular attention to individual loan performance, collateral values,
borrower financial condition and overall national and local economic conditions.
The determination of adequate allowance at each bank is done in a three step
process. The first step is to identify problem loans above a certain threshold
and estimated losses are calculated based on collateral values and projected
cash flows. The second step is to identify loans above a certain threshold which
are problem loans due to the borrowers' payment history or deteriorating
financial condition. Losses in this category are determined based on historical
loss rates adjusted for current economic conditions. The final step is to
calculate a loss for the remainder of the portfolio using historical
loss information for each type of loan classification. The determination
of specific allowances and weights is in some part subjective and actual losses
may be greater or less than the amount of the allowance. However, management
believes that the allowance represents a fair assessment of the losses that
exist in the loan portfolio.
Both banks classify loans into the following categories, impaired,
doubtful, substandard, special mention and other loans past due 90+ days and
assign loss rate to each. Within these categories, Real Estate, Installment
Loans, Commercial Loans and Lines of Credit are assigned a specific loss rate
based on historical losses and management's estimate of losses. The allowance
associated with loans classed as impaired is calculated at 100% of the
identified impairment.
Loans 90 days or more past due and nonaccrual loans are included in one of
the five categories above. Credit card balances 90 days or more past due are
categorized as substandard and are assigned a loss rate of 50%. Generally, all
loans in excess of $250,000 are evaluated individually as well as any loan
regardless of size that is classified as loss, doubtful, substandard or special
mention. This detailed review identifies each applicable loan for
specific impairment and a specific allocation for that impaired amount is set
aside as the first element in the calculation. Rates assigned each category may
vary over time and between the banks as historical loss rates, loan structure
and economic conditions change.
The remaining portfolio balances are assigned a loss factor based on the
historical net loss after recoveries over the last five years. Loss
experience per classification varies significantly based on risk and
collateral. Installment and commercial loans generally have higher loss volumes
than secured real estate loans. These actual loss experience factors are weighed
by the average life of the loan category. Installments have a two to three year
carrying life, real estate loans a five to six year life; and commercial loans a
three to four year life. The net result creates a low and high range of
allocated allowance. The Company's actual allowance balance is compared to this
range and adjusted as deemed necessary.
The adequacy of the allowance for loan losses is computed quarterly and the
allowance adjusted prior to the issuance of the quarterly financial statements.
All loan losses charged to the allowance are approved by the boards of directors
of each bank at their regular meetings. The allowance is reviewed for adequacy
after considering historical loss rates, current economic conditions (both
locally and nationally) and any known credit problems that have not been
considered under the above formula.
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
have improved due to moderating grain prices and better turkey pricing but
profitability in this industry is still quite volatile. Since Pilgrim's Pride's
purchase of WLR Foods, Inc. in January of 2001 there has been little noticeable
impact to the local economy, either positively or negatively. Loan requests for
poultry house loans or expansion continue to be presented for approval.
15
Allowance for Loan Losses (Continued)
An analysis of the loan loss allowance is set forth in the following table
(in thousands):
2002 2001 2000 1999 1998
---- ---- ---- ---- ----
Balance at beginning of
period $ 1,603 $ 1,493 $ 1,318 $ 1,355 $ 1,370
Charge-offs:
Commercial loans 246 239 172 107 135
Real estate loans 110 92 128 87 53
Consumer loans 424 369 215 254 289
------- ------- ------ ------- ------
780 700 515 448 477
------- -------- ------ ------- ------
Recoveries:
Commercial loans 10 57 2 16 6
Real estate loans 68 12 30 1 1
Consumer loans 72 141 71 74 100
------- ------- ------ ------- ------
150 210 103 91 107
------ ------- ------ ------- ------
Net charge-offs 630 490 412 357 370
Provision for
loan losses 820 600 500 320 355
Other 87
------ ------- ------ ------- ------
Balance at end
of period $ 1,793 $ 1,603 $ 1,493 $ 1,318 $ 1,355
====== ======= ====== ======= ======
Percent of net charge-offs
to average net loans
outstanding during the
period .29% .25% .23% .23% .26%
======= ========= ======== ========= ========
16
The following table shows the amount and percentage of the Company's
allowance for loan losses allocated to each major category of loans:
At December 31,
-------------------------------------------------------------------------------------------------------------------
2002 2001 2000 1999 1998
-------------------- --------------------- --------------------- -------------------- ----------------------
Percent Percent Percent Percent Percent
of of of of of
Loans Loans Loans Loans Loans
Percent in Percent in Percent in Percent in Percent in
of Category of Category of Category of Category of Category
Allow- to Total Allow- to Total Allow- to Total Allow- to Total Allow- to Total
Amount ance Loans Amount ance Loans Amount ance Loans Amount ance Loans Amount ance Loans
------ ---- ----- ------ ---- ----- ------ ---- ----- ------ ---- ----- ------ ---- -----
(Dollars in Thousands)
Commercial $ 543 30% 21% $ 487 30% 21% $507 34% 20% $ 395 30% 19% $ 379 28% 23%
Real estate
Mortgage 504 28 57 576 36 56 239 16 56 211 16 58 434 32 56
Installment 652 37 22 450 28 23 598 40 24 580 44 23 406 30 21
Unallocated 94 5 90 06 149 10 132 10 136 10
---- ---- ---- ---- -- --- --- ---- --- ------ ------- --- ----- ----- ---
$1,793 100% 100% $1,603 100% 100% $1,493 100% 100% $1,318 100% 100% $1,355 100 % 100%
===== === === ===== === === ===== ==== === ======== ===== ===== ===== ===== ====
17
Allowance for Loan Losses (Continued)
Cumulative net loan losses, after recoveries, for the five year period
ending December 31, 2002 are as follows:
Commercial $ 808 35.70%
Real estate 358 15.85%
Consumer 1,093 48.45%
------ -----
Total $ 2,259 100.00%
The above will act as a basis for allocating the overall allowances.
Additional changes have been made in the allocation of the allowance to address
unknowns and contingent items. The unallocated portion is not computed using a
specific formula and is management's best estimate of what should be allocated
for contingencies in the current portfolio.
2002 losses were approximately equal to peer group amounts, and are
considered reasonable in the eyes of management. The allowance as of December
31, 2002 was .79% of loans outstanding which is below peer group levels.
Management believes the present allowance, which is 3.16 times the average
annual net charge-off rate over the last three years, is adequate based on its
knowledge of the loan portfolio and historical performance.
During the course of routine examination of the Company's two subsidiary
banks, The Grant County Bank and Capon Valley Bank, under the normal examination
cycle by regulatory agencies, examiners have identified certain supervisory
issues. Results of these regulatory examinations are not published or publicly
available.
Requirements of regulatory agencies in regards to certain calculated
amounts such as the allowance for loan losses will at times differ from GAAP
requirements. One of the regulatory agencies which exerts supervisory control on
the Company's subsidiary banks has indicated that a requirement for an increased
allowance for loan losses will be directed to one of the subsidiary banks. The
final report is not expected to be received until mid April.
The Company believes that the allowance for loan losses shown in these
statements is adequate to cover potential losses in the current loan portfolio
using guidance set forth in SFAS Nos. 5 and 114. As such, the current
methodology for calculating the allowance for loan loss will be continued until
such time as GAAP requirements change. If one or more of the regulatory agencies
require differing amounts of allowance for loan losses, the subsidiary bank or
banks to which this requirement might apply will calculate its allowance for
loan losses for regulatory filings based on the regulatory guidance, while the
Company will continue to report in its 10-Q, 10-K, Annual Report and other
filings with the Securities and Exchange Commission an allowance for loan losses
based on generally accepted accounting principles as promulgated by the FASB,
the SEC and other accounting authorities.
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. Total securities decreased to $25,537,000 or 8.74%
of total assets at December 31, 2002. Total securities were $31,855,000 or
11.51% of total assets at December 31, 2001.
18
Securities (Continued)
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 issuer'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, 2002, the fair value of the securities available for sale exceeded their
cost basis by $464,000 ($292,000 after the related tax effect).
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,
2002 2001 2000 2002 2001 2000
---- ---- ---- ---- ---- ----
(In Thousands of Dollars) (In Thousands of Dollars)
U.S. treasuries,
agencies
and corporations $ $ $ 88 $13,534 $16,432 $18,719
Obligations of
states and
political
subdivisions 1,365 1,597 2,131 4,350 6,380 789
Mortgage-backed
securities 4 6 9 5,582 6,609 3,275
------ ------ ----- ------ ------ ------
Total Debt
Securities 1,369 1,603 2,228 23,466 29,421 22,783
Other securities 30 39 52
------ ------ ----- ------ ------ ------
Total $ 1,369 $ 1,603 $2,228 $23,496 $29,460 $22,835
====== ====== ===== ====== ====== ======
19
Securities (Continued)
The carrying amount and estimated market value of debt securities (in thousands
of dollars) at December 31, 2002 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.
Equivalent
Securities Held to Maturity Amortized Fair Average
Cost Value Yield
------------ ----------- ---------
Due in one year or less $ 4 $ 4 8.51%
Due after one year through
five years 1,365 1,448 7.15%
--------- ---------- -------
Total Held to Maturity $ 1,369 $ 1,452 7.11%
======== ========= =====
Equivalent
Securities Available for Sale Amortized Fair Average
-----------------------------
Cost Value Yield
------------ ----------- ---------
Due in one year or less $ 12,843 $ 12,990 4.38%
Due after one year through
five years 8,318 8,597 4.37%
Due after five years
through ten years 732 768 5.82%
Due after ten years 1,105 1,111 4.47%
-------- --------- -----
Total Fixed Rate Securities 22,998 23,466 5.24%
Equities 34 30 8.92%
-------- --------- -----
Total Available for Sale $ 23,032 $ 23,496 4.51%
======== ========= =====
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.
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 6.04% in 2002
over average levels in 2001. The average balance of noninterest bearing deposits
increased 20.54% over average 2001 balances. The average rate paid on deposits
decreased to 3.48% in 2002 from 4.84% in 2001 and 4.82% in 2000. 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.
20
Deposits (Continued)
The Company does not actively solicit large certificates of deposit (those
more than $100,000) due to the unstable nature of these deposits. Any increase
in balances of these large deposits in 2002 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 2002 2001 2000
-------------- ---- ---- ----
(In Thousands of Dollars)
Three months or less $ 7,570 $ 8,980 $ 4,172
Four to twelve months 22,030 21,965 14,336
One year to three years 8,598 10,018 13,753
Four years to five years 7,195 4,219 2,623
-------- -------- --------
Total $ 45,393 $ 45,182 $ 34,884
======= ======= ========
Borrowed Money
The Company occasionally borrows funds from the Federal Home Loan Bank to
reduce market rate risks and to fund capital additions. Such borrowings may have
fixed or variable interest rates and are amortized over a period of ten to
twenty years. Borrowings from this institution allow the banks to offer
long-term, fixed rate loans to their customers and match the interest rate
exposure of the receivable and the liability. The Company had no additional
borrowings in 2002 and repayments within the year of $493,860.
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.
21
Capital Resources (Continued)
The following table shows risk-based capital ratios and stockholders'
equity to total assets:
Regulatory December 31,
Minimum 2002 2001
----------- ---- ----
Capital Ratios
--------------
Risk-based capital to
risk-weighted assets
Tier 1 8.00% 13.66% 13.66%
Total 4.00% 14.03% 14.46%
Stockholders' equity to
total assets 5.00% 9.89% 10.06%
The capital management function is an ongoing process. Central to this
process is internal equity generation accomplished by earnings retention. During
2002, 2001, and 2000, total stockholders' equity increased by $606,000,
$2,042,000 and $2,044,000, respectively, as a result of earnings retention and
changes in the unrealized gains (losses) on securities available for sale.
The repurchase of outstanding stock totaling $1,217,000 was the major reason
that equity growth was less than previous years. The return on average equity
was 9.23% in 2002 compared to 9.08% for 2001 and 9.40% for 2000. Total cash
dividends declared represent 28.12% of net income for 2002 compared to 27.51% of
net income for 2001 and 26.14% for 2000. Book value per share was $20.12 at
December 31, 2002 compared to $18.80 at December 31, 2001 and $17.45 at December
31, 2000. Book value calculations have been adjusted for the stock split
effected in form of dividend distributed during the third quarter of 2002.
The Company's principal source of cash income is dividend payments from the
Banks and insurance subsidiary. Certain limitations exist under
applicable law and regulation by regulatory agencies regarding dividend payments
to a parent by its subsidiaries. As of January 1, 2003, the Banks had
approximately $411,000 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.
Investing activity saw an increase in net loans of $20,094,000, an increase
in deposits at other institutions of $1,834,000 and an increase in fed funds
sold of $1,341,000. New equipment and facility additions were $314,000 in 2002
compared with $776,000 in 2001. Funding these investments was an increase in
deposits of $15,471,000, a decrease in investments of $6,318,000 and retained
operating income of $1,886,000.
22
Liquidity and Interest Rate Sensitivity (Continued)
In the year ending December 31, 2002, cash and due from banks increased
$1,734,000 as cash provided by operations and financing activities was greater
than 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
$738,000 in 2002 were an increase of 8.10% over 2001 amounts.
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, 2002, the Company had a negative gap position as of 90 days
into the future. This position causes a squeeze on income in the short term in
reaction to rate changes by the Federal Reserve Bank. This gap becomes slightly
positive by one year into the future. With assets repricing at a level of
102.99% of the volume of interest bearing liabilities during the first year, the
impact to earnings of interest rate changes should be minimal due to the ability
to match increases in assets and liabilities. Even with gradual rises in
interest rates, the Company expects its cost of funds should remain stable
throughout the early part of 2003 as any effects of rising rates are offset by
the maturity of older time deposits paying at a higher rate of interest than the
current prevailing rates.
With the largest amount of interest sensitive assets and liabilities
repricing within one year, the Company monitors this position 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 the 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, 95%
of all loans will reprice within three years of December 31, 2002. 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 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 investments 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 25) shows the maturity of liabilities and assets in future
periods. Table III (page 24) shows the effects of rate and volume changes on the
net interest margin for the past three year period.
23
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 minimally 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 25) in order to
minimize the effects of inflationary trends on interest rates. Other areas of
noninterest expenses may be more directly affected by inflation.
Securities and Exchange Commission WEB Site
The Securities and Exchange Commission maintains a WEB site that contains
reports, proxy and information statements and other information regarding
registrants (including the Company) that file electronically with the
Commission. That address is (http: //www.sec.gov)
24
TABLE I
NET INTEREST MARGIN AND AVERAGE BALANCE ANALYSIS
(Dollar amounts in thousands)
2002 2001 2000
------------------------------ ------------------------------ --------------------------------
Income/ Yield/ Income/ Yield/ Income/ Yield/
EARNING ASSETS Average Expense Rate Average Expense Rate Average Expense Rate
- -------------- ------- ----------- --------- -------- --------- ------ ------- ------ ------
Loans 1,3 $ 216,408 $ 17,324 8.01 $ 197,989 $ 17,895 9.04 $ 176,010 $ 15,893 9.03
Investment securities:
Taxable 4 25,247 1,165 4.61 24,686 1,445 5.85 26,583 1,641 6.17
Nontaxable 1,4 5,451 318 5.83 3,501 267 7.63 3,285 262 7.98
-------- ----- ----- ------ ----- ----- ------ ----- -------
Total Investment
Securities 30,698 1,483 4.83 28,187 1,712 6.07 29,868 1,903 6.37
Interest bearing
deposits
in banks 4,271 104 2.44 5,813 248 4.27 3,464 179 5.17
Federal funds sold 11,431 177 1.55 13,019 451 3.46 5,276 330 6.25
------ ----- ----- ------ ----- ----- ----- ----- -----
Total Earning Assets 262,808 19,088 7.26 245,008 20,306 8.29 214,618 18,305 8.53
------- ------ ------ --------- ------ ------ --------- ----- -------
Allowance for loan
losses (1,793) (1,613) (1,474)
Nonearnings assets 21,840 20,550 18,608
------- ------ ------
Total Assets $ 282,855 $ 263,945 $231,752
======= ========= =======
INTEREST-BEARING LIABILITIES
Deposits:
Demand $ 34,502 $ 451 1.31 $ 28,330 $ 520 1.84 $ 30,015 $ 867 2.89
Savings 29,276 425 1.45 25,109 546 2.17 21,784 650 2.98
Time deposits 151,813 6,619 4.36 149,867 8,771 5.85 126,041 7,061 5.60
------- ------- ------- --------- ------- ----- -------- ------- -------
Total Deposits 215,591 7,495 3.48 203,306 9,837 4.84 177,840 8,578 4.82
Other borrowed money 4,280 210 4.91 4,149 212 5.11 3,762 212 5.64
----- ----- ----- ----- ----- ----- ------- ------ -----
Total Interest Bearing
Liabilities 219,871 7,705 3.50 207,455 10,049 4.84 181,602 8,790 4.84
------- ----- ----- ------ ----- ----- ------ -------
Noninterest bearing
deposits 32,226 26,735 23,035
Other liabilities 2,320 2,436 1,793
----- ----- ------
Total Liabilities 254,417 236,626 206,430
Stockholders' Equity 28,438 27,319 25,322
------ ------ ------
Total Liabilities
and Equity $282,855 $ 263,945 $231,752
======= ========= =========
Net Interest Earnings $ 11,383 $ 10,257 $ 9,515
======== ========= =======
Net Yield on Interest
Earning Assets 4.33% 4.19% 4.43%
==== ===== =====
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.
25
TABLE II
EFFECT OF RATE-VOLUME CHANGES ON NET INTEREST INCOME
(On a fully taxable equivalent basis)
(In thousands of dollars)
2002 Compared to 2001 2001 Compared to 2000
------------------- ----------------------
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:
Loans 2 $1,665 $(2,237) $(572) $1,985 $ 17 $2,002
Investment Securities:
Taxable 33 (313) (280) (117) (79) (196)
Nontaxable 149 (97) 52 17 (12) 5
----- ----- ---- ----- ---- ----
Total Investment
Securities 182 (410) (228) (100) (91) (191)
Interest bearing deposits
in banks (66) (78) (144) 121 (52) 69
Federal funds sold (55) (219) (274) 484 (363) 121
------ ----- ----- ---- ----- ----
Total Interest Income 1,726 (2,944) (1,218) 2,490 (489) 2,001
----- ------- ------- ----- ----- -----
Interest Expense:
Deposits:
Demand 113 (182) (69) (49) (298) (347)
Savings 91 (212) (121) 99 (203) (104)
All other time
deposits 115 (2,267) (2,152) 1,334 376 1,710
Other borrowed money 7 (9) (2) 21 (21) 0
----- ----- ----- ---- ----- ----
Total Interest Expense 326 (2,670) (2,344) 1,405 (146) 1,259
---- ------- ------ ----- ----- -----
Net Interest Income $1,400 $ (274) $1,126 $1,085 $ (343) $ 742
===== ==== ===== ===== ==== ====
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.
26
TABLE III
INTEREST RATE SENSITIVITY ANALYSIS
(In thousands of dollars)
DECEMBER 31, 2001
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 $39,347 $106,126 $61,137 $ 7,562 $11,582 $225,754
Fed funds sold 14,625 14,625
Securities 4,751 8,945 6,855 3,107 1,879 25,537
Interest bearing time
deposits 4,300 200 4,500
------ ------ ------ ------ ----- ------
Total 63,023 115,271 67,992 10,669 13,461 270,416
------ ------- ------ ------ ------ -------
INTEREST BEARING LIABILITIES
Transaction accounts 20,936 20,936
Money market accounts 16,996 16,996
Savings accounts 29,503 29,503
Time deposits more than
$100,000 7,570 22,030 8,598 7,195 45,393
Time deposits less than
$100,000 22,806 52,792 26,160 11,009 131 112,898
Other borrowed money 132 347 978 762 1,811 4,030
------ ------ ------ ------ ----- ------
Total 97,943 75,169 35,736 18,966 1,942 229,756
-------- -------- -------- -------- ------- ------
Discrete interest
sensitivity GAP (34,920) 40,102 32,256 (8,297) 11,519
Cumulative interest
sensitivity GAP (34,920) 5,182 37,438 29,141 40,660
Ratio of cumulative
interest
sensitive assets to
cumulative
interest sensitive
liabilities 64.35% 102.99% 117.93% 112.79% 117.70%
Assumes all transaction, money market and savings deposit accounts reprice
within 90 days.
27
TABLE IV
QUARTERLY FINANCIAL RESULTS
(In thousands, except per share amounts)
Fourth Third Second First
Quarter Quarter Quarter Quarter
2002
Interest income $ 4,718 $ 4,809 $ 4,706 $ 4,737
Interest expense 1,817 1,801 1,931 2,156
-------- -------- -------- --------
Net interest income 2,901 3,008 2,775 2,581
Provision for loan losses 350 210 140 120
-------- -------- -------- --------
Net interest income
after provision 2,551 2,798 2,635 2,461
Non-interest income 412 328 285 279
Non-interest expense 2,068 2,000 1,937 1,880
-------- -------- -------- --------
Income before income
tax provision 895 1,126 983 860
Income tax provision 284 375 321 260
-------- -------- -------- --------
Net Income $ 611 $ 751 $ 662 $ 600
======== ======== ======== ========
Per common share:*
Net income (basic) $ .42 $ .52 $ .46 $ .40
Net income (diluted) .42 .52 .46 .40
Cash dividends .13 .13 .13 .12
2001
Interest income $ 4,964 $ 5,126 $ 5,161 $ 4,956
Interest expense 2,451 2,562 2,537 2,499
-------- -------- -------- --------
Net interest income 2,513 2,564 2,624 2,457
Provision for loan losses 210 135 135 120
-------- -------- -------- --------
Net interest income
after provision 2,303 2,429 2,489 2,337
Non-interest income 370 281 269 274
Non-interest expense 1,894 1,828 1,768 1,720
-------- -------- -------- --------
Income before income
tax provision 779 882 990 891
Income tax provision 119 302 343 297
-------- -------- -------- --------
Net Income $ 660 $ 580 $ 647 $ 594
======== ======== ======== ========
Per common share:*
Net income (basic) $ .44 $ .39 $ .43 $ .39
Net income (diluted) .44 .39 .43 .39
Cash dividends .12 .11 .11 .11
*--Prior period per share figures restated to reflect stock split effected in
form of dividend in 2002.
28
Item 7A. Quantitative and Qualitative Disclosures About Market Risk
This information is incorporated herein by reference from Item 7,
Management's Discussion and Analysis of Financial Condition and Results of
Operations, on Pages 6 through 27 of this Form 10-K.
29
Item 8. Financial Statements
Index to Financial Statements
Financial Highlights...................................... 30
Consolidated Balance Sheets
as of December 31, 2002 and 2001.......................... 31
Consolidated Statements of Income
for the Years Ended December 31, 2002,
2001 and 2000............................................. 32
Consolidated Statements of Changes in
Stockholders' Equity for the Years Ended
December 31, 2002, 2001 and 2000.......................... 33
Consolidated Statements of Cash Flows
for the Years Ended December 31, 2002,
2001 and 2000............................................. 35
Notes to Consolidated Financial
Statements................................................ 36
Independent Auditors' Report.............................. 54
Management's Discussion and Analysis...................... 55
30
FINANCIAL HIGHLIGHTS
HIGHLANDS BANKSHARES, INC.
Years Ended December 31,
2002 2001 2000 1999 1998
---- ---- ---- ---- ----
(Dollars in Thousands except per share data)
RESULTS OF
OPERATIONS
Interest income $18,970 $ 20,207 $18,207 $ 16,243 $15,772
Interest expense (7,705) (10,049) (8,790) (7,663) (7,745)
------ -------- ------ ------- ------
Net Interest Income 11,265 10,158 9,417 8,580 8,027
Provision for loan losses (820) (600) (500) (320) (355)
Noninterest income 1,304 1,194 1,263 1,026 735
Noninterest expenses (7,885) (7,210) (6,631) (5,912) (5,377)
Income taxes (1,240) (1,061) (1,168) (1,049) (1,018)
------- ------- ------ ------- ------
Net Income $ 2,624 $ 2,481 $ 2,381 $ 2,325 $ 2,012
====== ======= ====== ======= ======
PROFITABILITY RATIOS
Return on Average Assets .93% .94% 1.03% 1.08% 1.01%
Return on Average Equity 9.23% 9.08% 9.40% 9.94% 9.12%
PER COMMON SHARE *
Net Income $ 1.80 $ 1.65 $ 1.58 $ 1.54 $ 1.34
Cash Dividends Declared .51 .45 .41 .39 .36
Book Value 20.12 18.80 17.45 16.09 15.17
Last Reported Market
Price 21.51 16.33 16.67 20.00 21.08
AT YEAR END
Assets $292,348 $276,778 $248,600 $220,481 $210,981
Deposits 257,512 242,042 216,571 192,345 184,587
Loans 225,754 205,469 189,268 166,614 148,384
Stockholders' Equity 28,916 28,310 26,268 24,224 22,847
*--Prior years' per share figures restated to reflect stock split effected in
form of dividend in 2002.
31
CONSOLIDATED BALANCE SHEETS
HIGHLANDS BANKSHARES, INC.
December 31,
ASSETS 2002 2001
---- -----
Cash and due from banks (notes 2, 3 and 16) $ 8,226,301 $ 6,492,361
Interest bearing deposits in banks (note 16) 4,499,666 6,333,551
Federal funds sold (note 16) 14,625,342 13,284,408
Investments:
Securities held to maturity (note 4) 1,369,112 1,603,393
(fair value of $1,451,553 and $1,638,968
at December 31, 2002 and 2001, respectively)
Securities available for sale (note 4) 23,496,039 29,460,117
Restricted investments (note 2d) 671,811 791,650
Loans (notes 5, 14, 15 and 16) 225,754,224 205,469,148
Less allowance for loan losses (note 6) (1,793,345) (1,602,536)
---------- ------------
Net Loans 223,960,879 203,866,612
Bank premises and equipment (note 7) 6,873,307 7,055,640
Interest receivable 1,821,476 1,817,884
Investment in life insurance contracts
(note 12) 5,338,036 5,100,262
Other assets 1,466,306 971,993
----------- -----------
Total Assets $292,348,275 $276,777,871
=========== ===========
LIABILITIES
Deposits:
Noninterest bearing $ 31,785,317 $ 29,278,596
Interest bearing
Money market and interest checking 20,935,592 17,935,755
Money market savings 16,996,289 11,407,235
Savings accounts 29,503,487 26,782,334
Time deposits over $100,000 (note 8) 45,392,941 45,181,560
All other time deposits (note 8) 112,898,645 111,456,188
----------- -----------
Total Deposits 257,512,271 242,041,668
Accrued expenses and other liabilities 1,890,096 1,902,794
Long term debt (note 9) 4,029,582 4,523,442
----------- -----------
Total Liabilities 263,431,949 248,467,904
----------- ------------
STOCKHOLDERS' EQUITY (note 18)
Common stock, $5 par value, 3,000,000
shares authorized, 1,436,874 shares
issued in 2002, 7,184,370 2,733,820
546,764 shares issued in 2001
Surplus 1,661,987 1,661,987
Retained earnings (note 12) 19,849,947 24,623,951
Other accumulated comprehensive income 220,022 282,910
----------- -----------
28,916,326 29,302,668
Treasury stock (at cost, 44,866 shares in 2001) (992,701)
------------ -----------
Total Stockholders' Equity 28,916,326 28,309,967
----------- -----------
Total Liabilities and Stockholders' Equity $292,348,275 $276,777,871
=========== ============
The accompanying notes are an integral part of this statement.
32
CONSOLIDATED STATEMENTS OF INCOME
HIGHLANDS BANKSHARES, INC.
Years Ended December 31,
2002 2001 2000
----- ----- -----
INTEREST INCOME:
Loans, including fees $17,323,503 $17,894,665 $15,891,868
Federal funds sold 176,787 450,657 330,761
Interest bearing deposits 103,982 248,442 179,100
Investment securities - taxable 1,164,634 1,445,327 1,641,057
Investment securities - nontaxable 201,184 167,930 164,486
---------- --------- ---------
Total Interest Income 18,970,090 20,207,021 18,207,272
---------- ---------- ----------
INTEREST EXPENSE:
Time deposits over $100,000 2,072,384 2,623,584 1,865,498
Other deposits 5,422,116 7,213,321 6,712,478
---------- --------- ---------
Total Interest on Deposits 7,494,500 9,836,905 8,577,976
Interest on Long Term Debt 210,232 211,827 212,054
---------- --------- ---------
Total Interest Expense 7,704,732 10,048,732 8,790,030
---------- ---------- ----------
NET INTEREST INCOME 11,265,358 10,158,289 9,417,242
PROVISION FOR LOAN LOSSES (note 6) 820,000 600,000 500,000
----------- --------- ---------
Net Interest Income after Provision
for Loan Losses 10,445,358 9,558,289 8,917,242
---------- --------- ---------
NONINTEREST INCOME:
Service charges 586,821 581,224 591,614
Insurance commissions and income 86,658 100,801 132,105
Life insurance investment income 237,774 245,958 192,642
Other operating income 392,231 266,061 242,892
Gain on security transactions (note 4) 103,870
----------- --------- ---------
Total Noninterest Income 1,303,484 1,194,044 1,263,123
---------- --------- ---------
NONINTEREST EXPENSES:
Salaries and benefits (note 11) 4,229,618 3,937,908 3,629,664
Occupancy expense 380,021 381,029 302,738
Equipment expense 662,266 630,840 548,850
Data processing expense 574,400 529,054 489,744
Other operating expenses 2,038,621 1,731,258 1,659,834
---------- --------- ---------
Total Noninterest Expenses 7,884,926 7,210,089 6,630,830
---------- --------- ---------
Income before Income Tax Expense 3,863,916 3,542,244 3,549,535
INCOME TAX EXPENSE (note 10) 1,239,778 1,061,459 1,168,624
---------- --------- ---------
NET INCOME $ 2,624,138 $2,480,785 $2,380,911
========== ========= =========
Earnings Per Share* $ 1.80 $ 1.65 $ 1.58
========== ========= =========
Cash Dividends Paid Per Share* $ .51 $ .45 $ .41
========= ========= =========
Weighted Average Shares Outstanding* 1,455,511 1,505,694 1,505,694
*--Prior years' per share figures restated to reflect stock split in form of
dividend in 2002.
The accompanying notes are an integral part of this statement.
33
CONSOLIDATED STATEMENTS OF CHANGES IN STOCKHOLDERS' EQUITY
HIGHLANDS BANKSHARES, INC.
Accumulated
Other
Common Retained Comprehensive Treasury
Stock Surplus Earnings Income (Loss) Stock Total
-------- ------- -------- ------------ -------- ----------
BALANCE
DECEMBER 31, 1999 $2,733,820 $1,661,987 $ 21,067,191 $(246,250) $(992,701) $ 24,224,047
Comprehensive Income
Net income 2,380,911 2,380,911
Change in other
comprehensive
income
(note 19) 285,011 285,011
--------
Total Comprehensive
Income 2,665,922
Cash dividends (622,355) (622,355)
-------- -------- -------- -------- -------- --------
BALANCE
DECEMBER 31, 2000 2,733,820 1,661,987 22,825,747 38,761 (992,701) 26,267,614
Comprehensive Income
Net income 2,480,785 2,480,785
Change in other
comprehensive income
(note 19) 244,149 244,149
--------
Total Comprehensive
Income 2,724,934
Cash dividends (682,581) (682,581)
-------- -------- --------- -------- -------- ---------
BALANCE
DECEMBER 31, 2001 $ 2,733,820 $ 1,661,987 $24,623,951 $ 282,910 $(992,701) $ 28,309,967
========== ========== ========== ========= ========= ===========
The accompanying notes are an integral part of this statement.
34
CONSOLIDATED STATEMENTS OF CHANGES IN STOCKHOLDERS' EQUITY
(continued)
HIGHLANDS BANKSHARES, INC.
Accumulated
Other
Common Retained Comprehensive Treasury
Stock Surplus Earnings Income (Loss) Stock Total
BALANCE
DECEMBER 31, 2001 2,733,820 1,661,987 24,623,951 282,910 (992,701) 28,309,967
Comprehensive Income
Net income 2,624,138 2,624,138
Change in other
comprehensive income
(note 19) (62,888) (62,888)
--------
Total Comprehensive
Income 2,561,250
Treasury stock repurchased (1,217,055) (1,217,055)
Treasury stock
retired (339,030) (1,870,726) 2,209,756
Stock split effected
in form of dividend 4,789,580 (4,789,580)
Cash dividends (737,836) (737,836)
-------- -------- ---------- -------- -------- ------------
BALANCE
DECEMBER 31, 2002 $ 7,184,370 $ 1,661,987 $19,849,947 $ 220,022 $ 0 $28,916,326
========== =========== ========== ======= ========== ==========
The accompanying notes are an integral part of this statement.
35
CONSOLIDATED STATEMENTS OF CASH FLOWS
HIGHLANDS BANKSHARES, INC.
Years Ended December 31,
2002 2001 2000
---- ---- ----
CASH FLOWS FROM OPERATING ACTIVITIES:
Net income $2,624,138 $2,480,785 $2,380,911
Adjustments to reconcile net income to
net cash provided by operating
activities:
Gain on security transactions (103,870)
Gain on sale of property and
equipment (237)
Depreciation 525,685 523,626 447,697
Income from life insurance contracts (237,774) (245,958) (192,642)
Net amortization of security premiums 294,266 122,343 2,171
Provision for loan losses 820,000 600,000 500,000
Deferred income tax expense (benefit) (103,570) (17,061) 18,010
Change in other assets and liabilities:
Interest receivable (3,592) 83,412 (158,422)
Other assets (494,313) (127,198) 86,378
Accrued expenses (12,698) 150,873 315,869
---------- --------- --------
Net Cash Provided by Operating
Activities 3,412,142 3,570,822 3,295,865
--------- --------- ---------
CASH FLOWS FROM INVESTING ACTIVITIES:
Purchase of branch, net of cash
acquired (1,220,000)
Proceeds from maturity of securities
held to maturity 232,337 621,481 952,376
Proceeds from maturity of
securities available
for sale 12,406,125 17,116,010 7,590,970
Proceeds from sales of securities
available for sale 484,797 2,115,255
Purchase of securities
available for sale (7,207,357)(23,472,091) (3,978,886)
Net change in restricted investments 119,839 (28,600) (17,500)
Net change in deposits in other banks 1,833,885 27,380 (3,924,660)
Net increase in loans (20,914,267)(16,691,860) (17,279,029)
Change in federal funds sold (1,340,934) (6,244,900) (2,736,875)
Purchase of property and equipment (314,479) (776,171) (1,287,893)
Proceeds from sale of property
and equipment 6,358 2,840
------- --------- ---------
Net Cash Used in Investing
Activities (14,700,054)(29,442,393) (19,783,402)
-------- ---------- -----------
CASH FLOWS FROM FINANCING ACTIVITIES:
Net change in time deposits 1,653,838 19,729,800 14,050,142
Net change in other deposit accounts 13,816,765 5,740,629 1,368,109
Additional long term debt 1,395,300 1,731,532
Repayment of long term debt (493,860) (881,177) (290,171)
Repurchase of treasury stock (1,217,055)
Dividends paid in cash (737,836) (682,581) (622,355)
--------- ---------- ----------
Net Cash Provided by Financing
Activities 13,021,852 25,301,971 16,237,257
----------- ----------- ----------
CASH AND CASH EQUIVALENTS:
Net (decrease) increase in cash and
due from banks 1,733,940 (569,600) (250,280)
Cash and due from banks, beginning of
year 6,492,361 7,061,961 7,312,241
--------- --------- ---------
Cash and due from banks, end of year $ 8,226,301 $6,492,361 $ 7,061,961
========== ============ =========
Supplemental Disclosures:
Cash paid for:
Interest expense $7,920,454 $10,042,704 $8,610,571
Income taxes 1,421,272 1,367,143 1,203,000
The accompanying notes are an integral part of this statement.
36
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
HIGHLANDS BANKSHARES, INC.
NOTE 1 SUMMARY 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, Capon Valley Bank, HBI Life Insurance Company,
Inc. and Highlands Bankshares Trust Company, which operate under
charters issued in Arizona and West Virginia, respectively. State
chartered banks are subject to regulation by the West Virginia
Division of Banking, The 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, Pendleton and Randolph counties of West
Virginia, including the towns of Petersburg, Keyser, Moorefield
and Wardensville through eight locations and the county of
Frederick in Virginia through a single location. The insurance
company sells life and accident coverage exclusively through the
Company's subsidiary banks. The Trust Company utilizes the
subsidiary banks to facilitate the sales of trust services to its
customers and citizens in those locales.
NOTE 2 SUMMARY OF SIGNIFICANT ACCOUNTING POLICIES:
The accounting and reporting policies of Highlands Bankshares,
Inc. and its subsidiaries conform to accounting principles
generally accepted in the United States of America and to accepted
practice within the banking industry.
(a) Principles of Consolidation
The consolidated financial statements include the accounts of
The Grant County Bank, Capon Valley Bank, HBI Life Insurance
Company and Highlands Bankshares Trust 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.
37
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
other accumulated comprehensive income.
Restricted 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 unearned
interest and 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. Loans are placed on
nonaccrual or charged off if collection of principal or
interest becomes doubtful. The interest on these loans is
accounted for on cash-basis or cost-recovery method until
qualifying for return to accrual. Loans are returned to
accrual when all the principal and interest amounts
contractually due are brought current and future payments are
reasonably assured.
(f) Allowance For Loan Losses
The allowance for loan losses is based upon management's
knowledge and review of the loan portfolio. Estimation of the
adequacy of the allowance involves exercise of
judgement, 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 changes in composition of the loan
portfolio, amounts of delinquent and nonaccrual loans, past
loan loss experience and the value of collateral securing the
loans.
(g) 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.
38
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
HIGHLANDS BANKSHARES, INC.
NOTE 2 SUMMARY OF SIGNIFICANT ACCOUNTING POLICIES (CONTINUED):
(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 Equipment 5 - 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) Per Share Calculations
Earnings per share are based on the weighted average number of
shares outstanding. In the third quarter of 2002, the Company
declared a stock split in the form of dividend. Prior period
per share amounts, including earnings per share, dividends per
share, book value per share, and market price have been
adjusted to reflect this split.
(k) Comprehensive Income
Accounting principles generally require that recognized
revenue, expenses, gains and losses be included in net income.
Certain changes in assets and liabilities, such as unrealized
gains and losses on available-for-sale
securities and accrued pension liabilities, are reported along
with net income as the components of comprehensive income.
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.
39
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, 2002
Mortgage-backed $ 4,285 $ $ $ 4,285
State and
municipals 1,364,827 82,441 1,447,268
--------- -------- -------- ---------
Total Securities
Held to Maturity $1,369,112 $ 82,441 $ $1,451,553
========= ======== ======== =========
December 31, 2001
Mortgage-backed $ 6,022 $ 422 $ $ 6,444
State and municipals 1,597,371 35,153 1,632,524
--------- -------- -------- ---------
Total Securities
Held to Maturity $1,603,393 $ 35,575 $ $1,638,968
========= ======== ======== =========
Available for Sale
December 31, 2002
U. S. Treasuries
and Agencies $8,844,027 $ 116,835 $ $8,960,862
Mortgage-backed 5,410,267 171,891 5,582,158
State and municipals 4,238,055 111,515 4,349,570
Marketable equities 33,585 3,471 30,114
Corporate
obligations 4,506,319 67,016 4,573,335
----------- -------- ------------ --------
Total Securities
Available for
Sale $23,032,253 $ 467,257 $ 3,471 $23,496,039
========== ======== ======== ==========
December 31, 2001
U. S. Treasuries
and Agencies $10,562,796 $ 197,676 $ $10,760,472
Mortgage-backed 6,527,396 81,347 6,608,743
State and municipals 6,318,613 65,393 3,505 6,380,501
Marketable equities 42,206 3,106 39,100
Corporate
obligations 5,560,038 111,263 5,671,301
--------- -------- -------- ---------
Total Securities
Available for
Sale $29,011,049 $ 455,679 $ 6,611 $29,460,117
========== ======== ======== ==========
40
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
HIGHLANDS BANKSHARES, INC.
NOTE 4 SECURITIES (CONTINUED):
The carrying amount and fair value of debt securities at December 31,
2002, 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 Fair
Cost Value
---- -----------
Due in one year or less $ 0 $ 0
Due after one year through five years 1,364,827 1,447,268
Due after five years through ten years 0 0
Mortgage-backed securities 4,285 4,285
--------- ---------
Total Held to Maturity $1,369,112 $1,451,553
========= =========
Securities Available for Sale Fair
Cost Value
---- -----------
Due in one year or less $12,809,523 $ 12,954,848
Due after one year through five years 4,378,878 4,503,513
Due after five years through ten years 255,000 274,781
Due after ten years 145,000 150,625
Mortgage-backed securities 5,410,267 5,582,158
---------- -----------
Total Fixed Rate Securities 22,998,668 23,465,925
Equities 33,585 30,114
---------- -----------
Total Available for Sale $23,032,253 $ 23,496,039
========== ===========
The carrying amounts (which approximate market value) of securities
pledged by the banks to primarily secure deposits amounted to
$6,035,000 at December 31, 2002 and $4,963,000 at December 31, 2001.
There were no holdings totaling more than 10% of stockholders' equity
with any issuer as of December 31, 2002 and 2001.
All gains and losses arose from the sale of securities available for
sale. There were no sales of securities in 2001 or 2002. In 2000, the
company experienced a gain of $103,870 on sales of securities.
41
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
HIGHLANDS BANKSHARES, INC.
NOTE 5 LOANS:
Loans outstanding as of December 31 are summarized as follows:
2002 2001
Commercial $ 47,089,188 $ 42,204,159
Real estate construction 6,813,000 3,868,000
Real estate mortgages 121,557,830 111,668,376
Consumer installment 50,350,956 47,926,399
----------- -----------
Subtotal 225,810,974 205,666,934
Unearned interest (56,750) (197,786)
----------- -----------
Total Loans $225,754,224 $205,469,148
=========== ===========
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:
2002 2001 2000
---- ---- ----
Balance at beginning
of year $ 1,602,536 $1,492,936 $ 1,318,332
Allowance relating to loans
acquired in purchase 86,873
Provision charged to
operating expenses 820,000 600,000 500,000
Loan recoveries 151,227 209,552 102,873
Loans charged off (780,418) (699,952) (515,142)
---------- --------- ----------
Balance at end of year $1,793,345 $1,602,536 $ 1,492,936
========= ========= ==========
Percentage of outstanding
loans .79% .78% .79%
42
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:
2002 2001
---- ----
Land $ 1,137,485 $ 1,137,485
Buildings and improvements 6,165,529 6,400,610
Furniture and equipment 3,670,567 3,644,925
---------- ----------
Total cost 10,973,581 11,183,020
Less - accumulated depreciation (4,100,274) (4,127,380)
----------- ----------
Net Book Value $ 6,873,307 $ 7,055,640
========== ==========
Provisions for depreciation of $ 525,685 in 2002, $523,626 in 2001 and
$447,697 in 2000 were charged to operations.
NOTE 8 DEPOSITS:
At December 31, 2002, the scheduled time deposit maturities are as
follows:
2003 $106,197,392
2004 21,875,679
2005 11,538,659
2006 5,860,508
2007 12,819,348
-----------
Total $158,291,586
===========
NOTE 9 LONG TERM DEBT:
The Company has borrowed money from the Federal Home Loan Bank of
Pittsburgh (FHLB). The interest rates on all of the notes payable as
of December 31, 2002 were fixed at the time of the advance and fixed
rates range from 3.94% to 6.85%. The weighted average interest rate is
5.16% at December 31, 2002. The company has total borrowing capacity
from the FHLB of $89,360,000. The debt is secured by the general
assets of the Banks.
Repayments of long term debt are due either monthly or quarterly.
Interest expense of $210,231, $211,827, and $212,054 was incurred on
these debts in 2002, 2001, and 2000, respectively. The
maturities of long term debt as of December 31, 2002 are as follows:
2003 $ 459,510
2004 618,715
2005 341,450
2006 354,257
2007 367,790
Thereafter 1,887,860
-----------
Total $ 4,029,582
===========
43
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:
2002 2001 2000
------------------------------------
Current Expense
Federal $ 1,104,987 $ 968,401 $ 953,961
State 238,361 110,119 196,653
---------- --------- --------
Total Current Expense 1,343,348 1,078,520 1,150,614
---------- --------- --------
Deferred Expense (Benefit)
Federal (93,744) (15,690) 16,431
State (9,826) (1,371) 1,579
----------- --------- --------
Total Deferred Expense (Benefit) (103,570) (17,061) 18,010
---------- --------- ----------
Income Tax Expense $ 1,239,778 $1,061,459 $1,168,624
========== ========= =========
Income expense (benefits) relating
to security transactions are as
follows: $ 0 $ 0 $ 38,432
The deferred tax effects of temporary differences for the years ended
December 31are as follows:
2002 2001 2000
---- ---- ----
Tax effect of temporary differences:
Provision for loan losses $ (57,117) $ 37,802 $(12,874)
Sale of loans 14,346 (28,271) 3,693
Pension expense (16,584) (31,690) (24,694)
Depreciation 41,065 47,406 52,928
Deferred compensation (59,090) (57,251) (38,471)
Basis of securities sold 75,369
Miscellaneous (26,190) 14,943 (37,941)
-------- --------- ---------
Net (increase) decrease
in deferred
income tax benefit $(103,570) $(17,061) $ 18,010
======== ======= =======
44
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:
2002 2001
Deferred Tax Assets:
Provision for loan losses $ 484,928 $ 419,951
Insurance commissions 40,820 32,130
Sale of loans 16,070 31,183
Deferred compensation 216,386 146,232
Pension obligation 42,558
Other 19,481 12,228
-------- --------
Total Assets 820,243 641,724
-------- --------
Deferred Tax Liabilities:
-------------------------
Unrealized gain on securities
available for sale 171,921 166,157
Accretion income 17,217 19,571
Other liabilities 10,530 28,471
Property basis differences 398,862 346,166
-------- --------
Total Liabilities 598,530 560,365
-------- --------
Net Deferred Tax Asset $ 221,713 $ 81,359
======== ========
The following table summarizes the difference between income tax
expense and the amount computed by applying the federal statutory
income tax rate for the years ended December 31:
2002 2001 2000
---- ---- ----
Amounts at federal statutory
rates $ 1,313,660 $ $1,205,199
$1,206,848
Additions (reductions) resulting
from:
Tax-exempt income (115,818) (102,365) (82,259)
Partially exempt income (30,158) (28,142) (36,606)
State income taxes, net 132,934 105,278 115,964
Income from life insurance
contracts (89,317) (97,014) (71,798)
State income tax adjustment (30,000) 30,000
Other 28,477 8,503 6,475
---------- --------- ---------
Income tax expense $ 1,239,778 $1,061,459 $1,168,624
========== ========== ===========
45
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 bank 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. Prior to 2002, the Plan's assets were in excess of the
projected benefit obligations and thus the Bank was not required to
make contributions to the Plan in 2002, 2001 or 2000. Due to the
inability of the investment portfolio to achieve its expected return,
the Bank has accrued additional liabilities of $163,000 at December
31, 2002. This has resulted in a decline in other comprehensive income
of $72,000 (which is net of an income tax effect of $43,000) and an
intangible asset of $48,000. The amounts of the accrued liability and
the net pension expense reflected in operations are not significant.
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 are considered outstanding in the computation of earnings per
share. Shares of Company stock, when distributed, will have
restrictions on transferability.
Employer contributions related to the above benefit plans charged to
operations totaled $231,607 in 2002, $234,455 in 2001 and $266,601 in
2000.
NOTE 12 INVESTMENT IN LIFE INSURANCE CONTRACTS:
The Company has invested in and owns life insurance polices on key
officers. The policies are designed so that the company recovers the
interest expenses associated with carrying the polices and the officer
will, at the time of retirement, receive any earnings in excess of the
amounts earned by the Company. The following is a summary of the
activity relating to this investment:
2002 2001 2000
---- ---- ----
Gross policy income $ 256,071 $ 262,413 $ 209,107
Insurance expense (18,297) (16,454) (16,465)
-------- -------- ---------
Net 237,774 245,959 192,642
Amounts earned by the company (113,413) (166,646) (121,068)
--------- -------- ----
Deferred compensation for
officers $ 124,361 $ 79,313 $ 71,574
======== ======== ========
NOTE 13 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, 2003, the banks could pay dividends to Highlands
Bankshares, Inc. of approximately $411,000 without permission
of the regulatory authorities.
46
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
HIGHLANDS BANKSHARES, INC.
NOTE 14 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 payoff amount of
loans to related parties of $2,240,150 at December 31, 2001 was
increased during 2002 $1,084,663 as a result of new loans and reduced
$950,553 by payments. The ending balance of loans to related parties
was $2,374,260 at December 31, 2002.
NOTE 15 COMMITMENTS AND GUARANTEES:
The Banks make commitments to extend credit in the normal
course of business and issued standby letters of credit to meet the
financing needs of their 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:
2002 2001
Commitments to extend credit $12,029,000 $ 8,991,000
Standby letters of credit 204,000 252,000
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.
47
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
HIGHLANDS BANKSHARES, INC.
NOTE 16 CONCENTRATIONS:
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 the 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 57%
of the loan portfolio is secured by real estate. See note 5 for a
complete breakdown of loans by type.
The Banks had cash deposited in and federal funds sold to other
commercial banks totaling $24,166,439 and $22,772,450 at December 31,
2002 and 2001, respectively.
NOTE 17 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.
Long Term Debt
The fair value of fixed rate loans is estimated using the rates
currently offered by the Federal Intermediate Credit Bank for
indebtedness with similar maturities.
Interest Payable and Receivable
The carrying value of amounts of interest receivable and payable is a
reasonable estimate of fair value.
48
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
HIGHLANDS BANKSHARES, INC.
NOTE 17 DISCLOSURES ABOUT FAIR VALUE OF FINANCIAL INSTRUMENTS (CONTINUED):
Life Insurance Contracts
The carrying amount of life insurance contracts is assumed to be a
reasonable fair value. Life insurance contracts are carried on the
balance sheet at their redeemable value as of December 31, 2002. This
redeemable value is based on existing market conditions and therefore
represents the fair value of the contract.
Off-Balance-Sheet Items
The carrying amount and estimated fair value of off-balance-sheet
items were not material at December 31, 2002.
The carrying amount and estimated fair values of financial
instruments as of December 31 are as follows:
2002 2001
---- ----
Estimated Estimated
Carrying Fair Carrying Fair
Amount Value Amount Value
------------ -----------------------------------
Financial Assets:
Cash and due from
banks $ 8,226,301 $ 8,226,301 $6,492,361 $6,492,361
Interest bearing
deposits 4,499,666 4,499,666 6,333,551 6,333,551
Federal funds sold 14,625,342 14,625,342 13,284,408 13,284,408
Securities held to
maturity 1,369,112 1,451,553 1,603,393 1,638,968
Securities available
for sale 23,496,039 23,496,039 29,460,117 29,460,117
Other investments 671,811 671,811 791,650 791,650
Loans, net 223,960,879 223,471,173 203,866,612 204,748,161
Interest receivable 1,821,476 1,821,476 1,817,884 1,817,884
Life insurance
contracts 5,338,036 5,338,036 5,100,262 5,100,262
Financial Liabilities:
Demand and savings
deposits 99,220,685 99,220,685 85,403,920 85,403,920
Term deposits 158,291,586 159,022,847 156,637,748 158,647,902
Long term debt 4,029,582 4,117,444 4,523,442 4,477,891
Interest payable 849,472 849,472 848,606 848,606
49
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
HIGHLANDS BANKSHARES, INC.
NOTE 18 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). The Company
meets all capital adequacy requirements to which it is subject and as
of the most recent examination, the Company was classified as well
capitalized.
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
2002 2001 Capitalized Capitalized
Total risk-based ratio 14.03% 14.46% 8.00% 10.00%
Tier 1 risk-based ratio 13.20% 13.66% 4.00% 6.00%
Total assets leverage
ratio 9.75% 10.06% 4.00% 5.00%
Capital ratios and amounts are applicable both at the individual bank
level and on a consolidated basis. At December 31, 2002, both
subsidiary banks had capital levels 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.
In addition, Highlands Bankshares Trust Company and HBI Life Insurance
Company are subject to certain capital requirements. At present, both
companies are well within any capital limitations and no conditions or
events have occurred to change this capital status, nor does
management except any such occurrence in the foreseeable future.
50
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
HIGHLANDS BANKSHARES, INC.
NOTE 19 CHANGES IN OTHER COMPREHENSIVE INCOME
The components of change in other comprehensive income and related tax
effects are as follows:
Years Ended December 31,
2002 2001 2000
---- ---- ----
Beginning balance January 1 $ 282,910 $ 38,761 $ (246,250)
Unrealized holding gains
on available-for-sale
securities net of income
taxes of $205,819 350,449
Unrealized holding gains
on available-for-sale
securities net of income
taxes of $143,388 244,149
Unrealized holding gains
on available-for-sale
securities net of income
taxes of $5,143 9,575
Reclassification adjustment
for gains on securities
transactions, net of income
taxes of $38,432 (65,438)
Accrued pension obligation
net of income taxes of
$42,558 (72,463)
-------- -------- --------
Net change for the year (62,888) 244,149 285,011
-------- -------- --------
Ending balance December 31 $ 220,022 $ 282,910 $ 38,761
========== ========== ==========
51
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
HIGHLANDS BANKSHARES, INC.
NOTE 20 PARENT CORPORATION ONLY FINANCIAL STATEMENTS:
BALANCE SHEETS
Assets December 31,
2002 2001
Cash $ 122,102 $ 102,141
Investment in subsidiaries 28,759,210 28,128,103
Other investments 15,304
Other assets 39,554 26,965
Income taxes receivable 251,826 208,372
--------- ---------
Total Assets $29,172,692 $28,480,885
========== ==========
Liabilities
Accrued expenses $ 8,735 $ 2,315
Due to subsidiaries 247,631 168,603
--------- ---------
Total Liabilities 256,366 170,918
--------- ---------
Stockholders' Equity
Common stock, par value $5 per share
3,000,000 shares authorized,
1,436,874 shares issued in 2002
and 546,764
shares issued in 2001 $7,184,370 $2,733,820
Surplus 1,661,987 1,661,987
Retained earnings 19,849,947 24,623,951
Other accumulated comprehensive income 220,022 282,910
--------- ---------
28,916,326 29,302,668
Less treasury stock (at cost,
44,866 shares
in 2001) (992,701)
--------- ---------
Total Stockholders' Equity 28,916,326 28,309,967
---------- ----------
Total Liabilities and Stockholders'
Equity $29,172,692 $28,480,885
========== ==========
52
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
HIGHLANDS BANKSHARES, INC.
NOTE 20 PARENT CORPORATION ONLY FINANCIAL STATEMENTS (CONTINUED):
STATEMENTS OF INCOME AND RETAINED EARNINGS
Years Ended December 31,
2002 2001 2000
---- ---- ----
Income
Dividends from subsidiaries $2,137,042 $3,063,877 $ 722,354
Other income 480
-------- -------- --------
Total $2,137,522 $3,063,877 $ 722,354
---------- ---------- ---------
Expenses
Salary and benefits expense $ 190,239 $ 169,325 $
Professional fees 36,330 34,413 48,988
Directors' fees 43,051 40,550 32,650
Other expenses 70,296 70,120 31,172
-------- -------- --------
Total $ 339,916 $ 314,408 $ 112,810
---------- ---------- ---------
Net income before income
tax benefit
and undistributed
income (deficit)
of subsidiaries $1,797,606 $2,749,469 $ 609,544
Income tax benefit 132,536 112,779 43,006
-------- --------- --------
Income before undistributed income
(deficit) of subsidiaries 1,930,142 2,862,248 652,550
Undistributed income (deficit) of
Subsidiaries 693,996 (381,463) 1,728,361
-------- -------- ---------
Net Income $2,624,138 $2,480,785 $2,380,911
--------- --------- ---------
Retained earnings,
Beginning of period 24,623,951 22,825,747 21,067,191
Dividends paid in cash (737,836) (682,581) (622,355)
Stock split paid in stock (4,789,580)
Treasury stock retired (1,870,726)
Net Income 2,624,138 2,480,785 2,380,911
--------- ----------- --------
Retained Earnings,
End of Period $19,849,947 $24,623,951 $22,825,747
========== ========== =======
53
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
HIGHLANDS BANKSHARES, INC.
NOTE 20 PARENT CORPORATION ONLY FINANCIAL STATEMENTS (CONTINUED):
STATEMENTS OF CASH FLOWS
Years Ended December 31,
2002 2001 2000
Cash Flows from Operating Activities:
Net income $2,624,138 $2,480,785 $2,380,911
Adjustments
Undistributed subsidiary
(income) deficit (693,996) 381,463 (1,728,361)
Depreciation 1,609 397 446
Loss on investment 15,304
Increase (decrease) in payables 85,448 (35,584) 153,220
(Increase) decrease in
receivables (43,454) 29,587 (124,691)
Increase in other assets (14,197) (4,411)
--------- -------- ------
Net Cash Provided by Operating
Activities 1,974,852 2,852,237 681,525
--------- --------- --------
Cash Flows from Investing Activities:
Investment in subsidiaries (2,143,577)
Other investments (5,000) (12,584)
-------- ---------- -------
Net Cash Used in Investing Activities (2,148,577) (12,584)
Cash Flows from Financing Activities:
Purchase of treasury stock (1,217,055)
Dividends paid (737,836) (682,581) (622,355)
--------- -------- -------
Net Cash Used in Financing
Activities (1,954,891) (682,581) (622,355)
---------- --------- -------
Net Increase in Cash 19,961 21,079 46,586
Cash, Beginning of Year 102,141 81,062 34,476
-------- -------- --------
Cash, End of Year $ 122,102 $ 102,141 $ 81,062
======== ======== ========
54
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, 2002 and 2001, 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,
2002. 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 U.S. 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, 2002 and 2001, and the
consolidated results of their operations and their cash flows for each of the
years in the three year period ended December 31, 2002, in conformity with U.S.
generally accepted accounting principles.
/s/ S. B. Hoover & Company, L.L.P.
January 31, 2003
Harrisonburg, Virginia
Members of the American Institute of Certified Public Accountants and
Virginia Society of Certified Public Accountants
55
MANAGEMENT'S DISCUSSION AND ANALYSIS
HIGHLANDS BANKSHARES, INC.
Results of Operations
The Company produced another year of increased earnings in 2002. Despite
decreases in loan interest rates, net interest margin increased from 2001, more
than offsetting the costs of expanded operations. Net income increased 5.77%
from $2.48 million in 2001 to $2.62 million in 2002. Total assets grew $15.57
million, a 5.63% increase. Loan demand remained strong with net loans increasing
9.86%. Loan growth was primarily funded through deposit growth and reductions in
securities balances. Deposits increased $15.47 million from December 31, 2001 to
December 31, 2002, with the largest increases being in transaction and savings
accounts. A low interest rate environment appears to have made customers
reluctant to place money in longer term time deposits and as a result time
deposit balances grew at a modest 1.06%, while transaction and saving deposits
increasing 16.18%. Deposit amounts increased at a greater rate during the second
half of 2002, with the funds from deposits being placed by Highlands subsidiary
banks in highly liquid cash and Federal Funds Sold balances in anticipation of
continued strong loan demand. An increased provision for loan losses reflects a
higher level of loans outstanding and management's belief that a slowing economy
could result in some credit deterioration. Holdings of Other Real Estate Owned
increased $458,800 due primarily to foreclosures on two properties. It is
management's belief that these properties can be disposed of at or near their
carrying value with no adverse effect on the Company's capital.
Net interest income after the provision for loan loss rose $887,000 to $10.45
Million--an increase of 9.28%. Non interest income also rose 9.17% from 2001 to
2002. The growth in assets and deposits drove an increase in non-interest
operational expenditures of 9.36%, with employee expense increasing 7.41% and
data processing expense increasing 8.58%.
Over recent years, Highlands Bankshares has taken steps to position itself for
future earnings potential. Changes in West Virginia's state laws were revised in
2000 to allow trust operations within the subsidiary banks to be consolidated
into one trust operation within Highlands Bankshares Trust Company. Highlands
Bankshares Trust Company finished its second year of operations in 2002 with a
66% increase in trust fee revenue over 2001. Highlands' subsidiary banks, Capon
Valley Bank and The Grant County Bank have over the last 5 years added branches
in Baker, Harman and Moorefield, West Virginia and in Gore, Virginia. As of
December 31, 2002, deposits in these branches comprised 12.18% of total
deposits, and 43% of the growth in deposits from December 31, 1997 to December
31, 2002 came from these branches. As growth continues, we expect further
operational economies of scale to be obtained, resulting in an increased return
to shareholders.
During 2002, there were changes to the management of Highlands Bankshares and
The Grant County Bank. In May, D. Richardson II resigned his position as
internal auditor of the holding company and became Chief Financial Officer of
The Grant County Bank. In August, Alan Miller joined the holding company as
Finance Officer. On December 31, 2002, Edgel Liller retired as Vice President &
Cashier of The Grant County Bank after 18 years of service.
Highlands Bankshares experienced record profitability during 2002 and we
anticipate 2003 being another successful year. A slowing economy and a depressed
interest rate environment leave us with many challenges. We are keeping a close
eye on the Federal Reserve Bank regarding interest rate changes and feel that
since most of our loans and many of our securities have adjustable rates, we are
positioned favorably in an environment of changing interest rates. Certain
localities within our primary area of operations have experienced recent
economic downturns. However, with banking locations in six counties we feel that
a level of diversity is achieved to minimize the impact of adverse changes in
local economies.
56
MANAGEMENT'S DISCUSSION AND ANALYSIS
HIGHLANDS BANKSHARES, INC.
Results of Operations (Continued)
Capital Adequacy
Total stockholders' equity increased by 2.14% at December 3, 2002 compared to
levels at December 31, 2001. This increase was not as high as recent years as we
repurchased over $1.2 Million worth of shares on the open market and
subsequently retired all shares of treasury stock in an effort to increase
shareholder value. Recent rate declines have caused increases in the value of
the available for sale portfolio and this has increased stockholder's equity by
$9,574. Conversely, market fluctuations contributed to declines in asset values
in the portfolio of the pension plan in which The Grant County Bank participates
resulting in a decrease in stockholders' equity of $72,463. Our primary capital
to asset ratio remains an excellent 9.89% and this compares favorably with our
peers. The increased earnings for 2002 and our excellent capital position
allowed us to increase dividends paid to stockholders by 11.82%, which
represents the eleventh consecutive year of dividend increases.
The retention of earnings from profitable operations allows the company to meet
the needs of growing communities without the sale of additional stock. The
company's Tier I capital to risk based asset ratio at December 31, 2002 was
13.20% compared to a regulatory minimum of 8.00%. The company has never
experienced a problem with capital adequacy and does not anticipate any in the
foreseeable future.
Liquidity
The company provides liquidity through the management of cash, federal funds
sold, interest bearing bank deposits and short term investment securities. In
addition, lines of credit with correspondent banks, the Federal Reserve Bank and
the Federal Home Loan Bank of Pittsburgh exist to help manage short term
liquidity needs although such lines are rarely utilized. The company's core
deposits are very large and thus it has not had to aggressively pursue large
deposits, which can be unstable. In the judgment of management, liquidity has
not been a problem in prior periods and should not be one in the foreseeable
future.
57
MANAGEMENT'S DISCUSSION AND ANALYSIS
HIGHLANDS BANKSHARES, INC.
Common Stock Performance and Dividends
The Company 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 table
shows the market prices of the Company's stock based on prices disclosed to
management. During the third quarter of 2002, the Company initiated a 200% stock
dividend. Share prices for the first and second quarters of 2002 and for 2001
have been adjusted to account for this stock split effected in the form of
dividend.
Dividends Market Price Range
2002 Per Share High Low
---- --------- ---- ---
First Quarter .12 18.46 15.92
Second Quarter .12 18.67 16.75
Third Quarter .1300 18.50 17.03
Fourth Quarter .1300 21.51 18.50
Dividends Market Price Range
2001 Per Share High Low
---- --------- ---- ---
First Quarter .1133 17.00 15.67
Second Quarter .1133 16.67 15.71
Third Quarter .1133 16.75 15.92
Fourth Quarter .1133 16.67 15.53
General Information
Stock transfers and inquiries should be addressed to our transfer agent at:
Registrar and Transfer Company
10 Commerce Drive
Cranford, New Jersey 07016-3572
Telephone: 1-800-368-5948
A copy of the Company's annual Form 10-K which is filed with the Securities and
Exchange Commission may be obtained, without charge, upon written request to
Treasurer of the Company at its headquarters. Such information will be available
after March 31, 2003. Requests should be directed to:
R. Alan Miller
Finance Officer
Highlands Bankshares, Inc.
P. O. Box 929
Petersburg, WV 26847
58
Item 9. Changes in and Disagreements with Accountants on Accounting and
- ------- ---------------------------------------------------------------------
Financial Disclosure
None
Part III
Item 10. Directors, Executive Officers, Promoters and Control Persons;
Compliance with Section 16(a) of the Exchange Act
We are incorporating the Proxy Statement of Highlands Bankshares, Inc.
via Form DEF 14A filed March 5, 2003.
Item 11. Executive Compensation
We are incorporating the Proxy Statement of Highlands Bankshares, Inc.
via Form DEF 14A filed March 5, 2003.
Item 12. Security Ownership of Certain Beneficial Owners and Management
We are incorporating the Proxy Statement of Highlands Bankshares, Inc.
via Form DEF 14A filed March 5, 2003.
Item 13. Certain Relationships and Related Transactions
We are incorporating the Proxy Statement of Highlands Bankshares, Inc.
via Form DEF 14A filed March 5, 2003.
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 14 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, which provides legal counsel to the Company and it
is anticipated that the relationship will continue.
Item 14. Controls and Procedures
Evaluation of Disclosure Controls and Procedures
- ------------------------------------------------
.
As a result of the enactment of the Sarbanes-Oxley Act of 2002, issuers
such as Highlands Bankshares, Inc. that file periodic reports under the
Securities Exchange Act of 1934 (the "Act") are now required to include in those
reports certain information concerning the issuer's controls and procedures for
complying with the disclosure requirements of the federal securities laws. Under
rules adopted by the Securities and Exchange Commission effective August 29,
2002, these disclosure controls and procedures include, without limitation,
controls and procedures designed to ensure that information required to be
disclosed by an issuer in the reports it files or submits under the Act, is
communicated to the issuer's management, including its principal executive
officer or officers and principal financial officer or officers, or persons
performing similar functions, as appropriate to allow timely decisions regarding
required disclosure.
We have established our disclosure controls and procedures to ensure that
material information related to Highlands Bankshares, Inc. is made known to our
principal executive officers and principal finance officer on a regular basis,
in particular during the periods in which our quarterly and annual reports are
being prepared. These disclosure controls and procedures consist principally of
59
Evaluation of Disclosure Controls and Procedures (Continued)
communications between and among the President and the Finance Officer, and the
other executive officers of Highlands Bankshares, Inc. and its subsidiaries to
identify any new transactions, events, trends, contingencies or other matters
that may be material to the Company's operations. As required, we will evaluate
the effectiveness of these disclosure controls and procedures on a quarterly
basis, and most recently did so as of January 31, 2003, a date within 90 days
prior to the filing of this quarterly report. Based on this evaluation, the
management of Highlands Bankshares, Inc., including the Finance Officer,
concluded that such disclosure controls and procedures were operating
effectively as designed as of the date of such evaluation.
Changes in Internal Controls
During the period reported upon, there were no significant changes in the
internal controls of Highlands Bankshares, Inc. pertaining to its financial
reporting and control of its assets or in other factors that could significantly
affect these controls
Part IV
Item 15. 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 10-KSB.
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 10-KSB
4 Not applicable
9 Not applicable
10 Not applicable
11 Not applicable
60
Item 15. Exhibits and Reports on Form 8-K (Continued)
a) Exhibits (Continued)
--------------------
Exhibit No. Description
12 Not applicable
16 Not applicable
18 Not applicable
21 Subsidiary listing of the Registrant is attached
on Page 67
22 Not applicable
23 Consent of Certified Public Accountant attached
on Page 68
24 Not applicable
28 Not applicable
b) Reports on Form 8-K
No reports on Form 8-K were filed in the fourth quarter of 2002.
61
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 /s/ LESLIE A. BARR
---------------------------------
Leslie A. Barr
President, Chief Executive Officer
Date March 26, 2003
-------------------------
By /s/ R. ALAN MILLER
------------------------------
R. Alan Miller
Finance Officer
Date March 26, 2003
-------------------------
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
/s/ LESLIE A. BARR March 26, 2003
- --------------------------- --------------
Leslie A. Barr President
& Chief Executive Officer
Director
/s/ ALAN L. BRILL March 26, 2003
- --------------------------- --------------
Alan L. Brill Secretary
Kathy G. Kimble Director
Steven C. Judy Director
/s/ THOMAS B. MCNEIL, SR. March 26, 2003
- --------------------------- --------------
Thomas B. McNeil, Sr. Director
/s/ CLARENCE E. PORTER March 26, 2003
- --------------------------- --------------
Clarence E. Porter Treasurer
/s/ COURTNEY R. TUSING March 26, 2003
- --------------------------- --------------
Courtney R. Tusing Director
/s/ JOHN G. VANMETER March 26, 2003
- --------------------------- --------------
John G. VanMeter Chairman of the Board
Director
/s/ JACK H. WALTERS March 26, 2003
- --------------------------- --------------
Jack H. Walters Director
L. Keith Wolfe Director
62
CERTIFICATION
OF CHIEF EXECUTIVE OFFICER
Pursuant to section 302 of the Sarbanes-Oxley Act of 2002
Chapter 63, Title 18 USC Section 1350 (A) and (B)
I, Leslie A. Barr, certify that:
1. I have reviewed this annual report on Form 10-K of Highlands Bankshares,
Inc.;
2. Based on my knowledge, this annual report does not contain any untrue
statement of a material fact or omit to state a material fact necessary to
make the statements made, in light of the circumstances under which such
statements were made, not misleading with respect to the period covered by
this annual report;
3. Based on my knowledge, the financial statements, and other financial
information included in this annual report, fairly present in all material
respects the financial condition, results of operations and cash flows of the
registrant as of, and for, the periods presented in this annual report;
4. The registrant's other certifying officers and I are responsible for
establishing and maintaining disclosure controls and procedures (as
defined in Exchange Act Rules 13a-14 and 15d-14) for the registrant and we
have:
a).designed such disclosure controls and procedures to ensure that material
information relating to the registrant, including its consolidated
subsidiaries, is made known to us by others within those entities,
particularly during the period in which this annual report is being
prepared;
b) evaluated the effectiveness of the registrant's disclosure controls and
procedures as of a date within 90 days prior to the filing date of this
annual report (the "Evaluation Date"); and
c) presented in this annual report our conclusions
about the effectiveness of the disclosure controls and procedures
based on our evaluation as of the Evaluation Date;
5. The registrant's other certifying officers and I have disclosed, based on our
most recent evaluation, to the registrant's auditors and the audit committee
of registrant's board of directors (or persons performing the equivalent
function):
a) all significant deficiencies in the design or operation of internal
controls which could adversely affect the registrant's ability to record,
process, summarize and report financial data and have identified
for the registrant's auditors any material weaknesses in internal
controls; and
b) any fraud, whether or not material, that involves management or other
employees who have a significant role in the registrant's internal
controls; and
6. The registrant's other certifying officers and I have indicated in this
annual report whether or not there were significant changes in internal
controls or in other factors that could significantly affect internal
controls subsequent to the date of our most recent evaluation, including any
corrective actions with regard to significant deficiencies and material
weaknesses.
Date: March 26, 2003
----------------------
/s/ LESLIE A. BARR
----------------------------------
Leslie A. Barr
President
63
CERTIFICATION
OF EXECUTIVE OFFICER
Pursuant to section 302 of the Sarbanes-Oxley Act of 2002
Chapter 63, Title 18 USC Section 1350 (A) and (B)
I, Clarence E. Porter, certify that:
1. I have reviewed this annual report on Form 10-K of Highlands Bankshares,
Inc.;
2. Based on my knowledge, this annual report does not contain any untrue
statement of a material fact or omit to state a material fact necessary to
make the statements made, in light of the circumstances under which such
statements were made, not misleading with respect to the period covered by
this annual report;
3. Based on my knowledge, the financial statements, and other financial
information included in this annual report, fairly present in all material
respects the financial condition, results of operations and cash flows of the
registrant as of, and for, the periods presented in this annual report;
4. The registrant's other certifying officers and I are responsible for
establishing and maintaining disclosure controls and procedures (as
defined in Exchange Act Rules 13a-14 and 15d-14) for the registrant and we
have:
a).designed such disclosure controls and procedures to ensure that material
information relating to the registrant, including its consolidated
subsidiaries, is made known to us by others within those entities,
particularly during the period in which this annual report is being
prepared;
b) evaluated the effectiveness of the registrant's disclosure controls and
procedures as of a date within 90 days prior to the filing date of this
annual report (the "Evaluation Date"); and
c) presented in this annual report our conclusions
about the effectiveness of the disclosure controls and procedures
based on our evaluation as of the Evaluation Date;
5. The registrant's other certifying officers and I have disclosed, based on our
most recent evaluation, to the registrant's auditors and the audit committee
of registrant's board of directors (or persons performing the equivalent
function):
a) all significant deficiencies in the design or operation of internal
controls which could adversely affect the registrant's ability to record,
process, summarize and report financial data and have identified
for the registrant's auditors any material weaknesses in internal
controls; and
b) any fraud, whether or not material, that involves management or other
employees who have a significant role in the registrant's internal
controls; and
6. The registrant's other certifying officers and I have indicated in this
annual report whether or not there were significant changes in internal
controls or in other factors that could significantly affect internal
controls subsequent to the date of our most recent evaluation, including any
corrective actions with regard to significant deficiencies and material
weaknesses.
Date: March 26, 2003
-------------------------
/s/ CLARENCE E. PORTER
----------------------------------
Clarence E. Porter
Treasurer
64
CERTIFICATION
OF EXECUTIVE OFFICER
Pursuant to section 302 of the Sarbanes-Oxley Act of 2002
Chapter 63, Title 18 USC Section 1350 (A) and (B)
I, Alan L. Brill, certify that:
1. I have reviewed this annual report on Form 10-K of Highlands Bankshares,
Inc.;
2. Based on my knowledge, this annual report does not contain any untrue
statement of a material fact or omit to state a material fact necessary to
make the statements made, in light of the circumstances under which such
statements were made, not misleading with respect to the period covered by
this annual report;
3. Based on my knowledge, the financial statements, and other financial
information included in this annual report, fairly present in all material
respects the financial condition, results of operations and cash flows of the
registrant as of, and for, the periods presented in this annual report;
4. The registrant's other certifying officers and I are responsible for
establishing and maintaining disclosure controls and procedures (as
defined in Exchange Act Rules 13a-14 and 15d-14) for the registrant and we
have:
a).designed such disclosure controls and procedures to ensure that material
information relating to the registrant, including its consolidated
subsidiaries, is made known to us by others within those entities,
particularly during the period in which this annual report is being
prepared;
b) evaluated the effectiveness of the registrant's disclosure controls and
procedures as of a date within 90 days prior to the filing date of this
annual report (the "Evaluation Date"); and
c) presented in this annual report our conclusions
about the effectiveness of the disclosure controls and procedures
based on our evaluation as of the Evaluation Date;
5. The registrant's other certifying officers and I have disclosed, based on our
most recent evaluation, to the registrant's auditors and the audit committee
of registrant's board of directors (or persons performing the equivalent
function):
a) all significant deficiencies in the design or operation of internal
controls which could adversely affect the registrant's ability to record,
process, summarize and report financial data and have identified
for the registrant's auditors any material weaknesses in internal
controls; and
b) any fraud, whether or not material, that involves management or other
employees who have a significant role in the registrant's internal
controls; and
6. The registrant's other certifying officers and I have indicated in this
annual report whether or not there were significant changes in internal
controls or in other factors that could significantly affect internal
controls subsequent to the date of our most recent evaluation, including any
corrective actions with regard to significant deficiencies and material
weaknesses.
..
Date: March 26, 2003
-----------------------
/s/ ALAN L. BRILL
----------------------------------
Alan L. Brill
Secretary
65
CERTIFICATION
OF CHIEF FINANCIAL OFFICER
Pursuant to section 302 of the Sarbanes-Oxley Act of 2002
Chapter 63, Title 18 USC Section 1350 (A) and (B)
I, R. Alan Miller, certify that:
1. I have reviewed this annual report on Form 10-K of Highlands Bankshares,
Inc.;
2. Based on my knowledge, this annual report does not contain any untrue
statement of a material fact or omit to state a material fact necessary to
make the statements made, in light of the circumstances under which such
statements were made, not misleading with respect to the period covered by
this annual report;
3. Based on my knowledge, the financial statements, and other financial
information included in this annual report, fairly present in all material
respects the financial condition, results of operations and cash flows of the
registrant as of, and for, the periods presented in this annual report;
4. The registrant's other certifying officers and I are responsible for
establishing and maintaining disclosure controls and procedures (as
defined in Exchange Act Rules 13a-14 and 15d-14) for the registrant and we
have:
a).designed such disclosure controls and procedures to ensure that material
information relating to the registrant, including its consolidated
subsidiaries, is made known to us by others within those entities,
particularly during the period in which this annual report is being
prepared;
b) evaluated the effectiveness of the registrant's disclosure controls and
procedures as of a date within 90 days prior to the filing date of this
annual report (the "Evaluation Date"); and
c) presented in this annual report our conclusions
about the effectiveness of the disclosure controls and procedures
based on our evaluation as of the Evaluation Date;
5. The registrant's other certifying officers and I have disclosed, based on our
most recent evaluation, to the registrant's auditors and the audit committee
of registrant's board of directors (or persons performing the equivalent
function):
a) all significant deficiencies in the design or operation of internal
controls which could adversely affect the registrant's ability to record,
process, summarize and report financial data and have identified
for the registrant's auditors any material weaknesses in internal
controls; and
b) any fraud, whether or not material, that involves management or other
employees who have a significant role in the registrant's internal
controls; and
6. The registrant's other certifying officers and I have indicated in this
annual report whether or not there were significant changes in internal
controls or in other factors that could significantly affect internal
controls subsequent to the date of our most recent evaluation, including any
corrective actions with regard to significant deficiencies and material
weaknesses.
Date: March 26, 2003
-------------------------
/s/ R. ALAN MILLER
----------------------------------
R. Alan Miller
Finance Officer
66
Pursuant toss.906 of the Sarbanes-Oxley Act of 2002 (18 U.S.C.ss.1350)
The undersigned, as the Chief Executive Officer and Chief Financial
Officer, respectively, of Highlands Bankshares Inc., certify that the Annual
Report on Form 10-K for the period ended December 31, 2002, which accompanies
this certification fully complies with the requirements of Section 13(a) or
15(d), as applicable, of the Securities Exchange Act of 1934 and the information
contained in the periodic report fairly presents, in all material respects, the
financial condition and results of operations of Highlands Bankshares Inc. at
the dates and for the periods indicated. The foregoing certification is made
pursuant to ss. 906 of the Sarbanes-Oxley Act of 2002 (18 U.S.C. ss. 1350) and
no purchaser or seller of securities or any other person shall be entitled to
rely upon the foregoing certification for any purpose. The undersigned expressly
disclaim any obligation to update the foregoing certification except as required
by law.
/s/ LESLIE A. BARR
-------------------------
Leslie A. Barr
Chief Executive Officer
/s/ R. ALAN MILLER
-------------------------
R. Alan Miller
Finance Officer