Highlands Bankshares Inc /WV/ - Quarterly Report (10-Q)

UNITED STATES

SECURITIES AND EXCHANGE COMMISSION

Washington, DC 20549

FORM 10-Q

(Mark One)

ý QUARTERLY REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES EXCHANGE ACT OF 1934

For the quarterly period ended March 31, 2008

o TRANSITION REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES EXCHANGE ACT OF 1934

Commission File Number: 0-16761

HIGHLANDS BANKSHARES, INC.

(Exact name of registrant as specified in its charter)

West Virginia	55-0650793
(State or Other Jurisdiction of Incorporation or Organization)	(IRS Employer Identification No.)

P.O. Box 929

Petersburg, WV 26847

(Address of Principal Executive Offices, Including Zip Code)

304-257-4111

(Registrant’s Telephone Number, Including Area Code)

Indicate by check mark whether the registrant (1) has filed all reports required to be filed by Section 13 or 15(d) of the Securities Exchange Act of 1934 during the preceding 12 months (or for such shorter period that the registrant was required to file such reports), and (2) has been subject to such filing requirements for the past 90 days. Yes ý No o

Indicate by check mark whether the registrant is a large accelerated filer, an accelerated filed, a non-accelerated filer, or a smaller reporting company. See the definitions of “large accelerated filer,” “accelerated filer” and “smaller reporting company” in Rule 12b-2 of the Exchange Act.

Large Accelerated Filer o	Accelerated Filer o
Non-accelerated filer o (Do not check if a smaller reporting company)	Smaller reporting company ý

Indicate by check mark whether the registrant is a shell company (as defined in Rule 12b-2 of the Exchange Act). o Yes ý No

Indicate the number of shares outstanding of each of the issuer’s classes of common stock as of the latest practicable date. As of April 30, 2007: 1,436,874 shares of Common Stock, $5 Par Value

HIGHLANDS BANKSHARES, INC.
Quarterly Report on Form 10Q For The Period Ended March 31, 2008

	IN D EX
		Page
PART I	FINANCIAL INFORMATION

Item 1.	Financial Statements

	Unaudited Consolidated Statements of Income Three Months Ended March 31, 2008 and 2007	2

	Unaudited Consolidated Balance Sheet for March 31, 2008 and Audited Consolidated Balance Sheet for December 31, 2007	3

	Unaudited Consolidated Statements of Changes in Stockholders’ Equity for the Three Months Ended March 31, 2008 and 2007	4

	Unaudited Consolidated Statements of Cash Flows for the Three Months Ended March 31, 2008 and 2007	5

	Notes to Consolidated Financial Statements	6

Item 2.	Management’ Discussion and Analysis of Financial Condition and Results of Operations	10

Item 3.	Quantitative and Qualitative Disclosures About Market Risk	18

Item 4.	Controls and Procedures	18

Item 4T.	Controls and Procedures	18

PART II	OTHER INFORMATION

Item 1.	Legal Proceedings	18

Item 1A.	Risk Factors	18

Item 2.	Unregistered Sales of Equity Securities and Use of Proceeds	18

Item 3.	Defaults Upon Senior Securities	18

Item 4.	Submission of Matters to a Vote of Security Holders	18

Item 5.	Other Information	18

Item 6.	Exhibits	19

SIGNATURES		19

Index

Page Two

PA R T I FINANCIAL INFORMATION

Ite m 1. Financial Statements

HIGHLANDS BANKSHARES, INC.
CONSOLIDATED STATEMENTS OF INCOME
(In Thousands of Dollars, Except Per Share Data)

	Three Months Ended March, 31
	2008		2007
	(unaudited)		(unaudited)
Interest Income
Interest and fees on loans	$	6,390	$	6,069
Interest on federal funds sold		148		157
Interest on deposits in other banks		17		30
Interest and dividends on securities		282		310
Total Interest Income		6,837		6,566

Interest Expense
Interest on deposits		2,448		2,290
Interest on borrowed money		134		158
Total Interest Expense		2,582		2,448

Net Interest Income		4,255		4,118

Provision for Loan Losses		179		173

Net Interest Income After Provision for Loan Losses		4,076		3,945

Non-interest Income
Service Charges		379		288
Gains on securities		87		0
Other non-interest income		191		183
Total Non-interest Income		657		471

Non-interest Expense
Salaries and employee benefits		1,560		1,448
Equipment and occupancy expense		350		355
Data processing expense		208		210
Directors fees		96		97
Legal and professional fees		137		134
Other non-interest expense		435		414
Total Non-interest Expense		2,786		2,658

Income Before Provision For Income Taxes		1,947		1,758

Provision for Income Taxes		709		637

Net Income	$	1,238	$	1,121

Per Share Data
Net Income	$	.86	$	.78
Cash Dividends	$	.27	$	.25
Weighted Average Common Shares Outstanding		1,436,874		1,436,874
The accompanying notes are an integral part of these statements.

Index

Page Three

HIGHLANDS BANKSHARES, INC.
CONSOLIDATE D BALANCE SHEETS
(In Thousands of Dollars)

	March 31, 2008			December 31, 2007
	(unaudited)			(audited)
ASSETS
Cash and due from banks—non-interest bearing	$	8,637		$	7,935
Deposits in other banks—interest bearing		2,669			1,853
Federal funds sold		21,714			14,246
Securities available for sale, at market value		19,626			26,090
Restricted investments		1,519			1,498
Loans		311,287			310,199
Allowance for loan losses		(3,574	)		(3,577	)
Bank premises and equipment, net of depreciation		8,175			8,104
Interest receivable		2,152			2,273
Investment in life insurance contracts		6,360			6,300
Goodwill		1,534			1,534
Other intangible assets		1,523			1,572
Other Assets		2,832			2,909

Total Assets	$	384,454		$	380,936

LIABILITIES
Non-interest bearing deposits	$	51,952		$	48,605
Savings and interest bearing demand deposits		74,317			73,736
Time deposits		199,647			201,397
Total Deposits		325,916			323,738

Long term debt		11,665			11,819
Accrued expenses and other liabilities		5,678			4,786

Total Liabilities		343,259			340,343

STOCKHOLDERS’ EQUITY
Common Stock, $5 par value, 3,000,000 shares authorized, 1,436,874 shares issued and outstanding		7,184			7,184
Surplus		1,662			1,662
Retained Earnings		32,535			32,032
Other accumulated comprehensive loss		(186	)		(285	)
Total Stockholders’ Equity		41,195			40,593

Total Liabilities and Stockholders’ Equity	$	384,454		$	380,936


The accompanying notes are an integral part of these statements.

Index

Page Four

HIGHLANDS BANKSHARES, INC.
CONSOLIDATED STATEMENTS OF C HANGES IN STOCKHOLDERS’ EQUITY
(In Thousands of Dollars)

	Common Stock		Surplus		Retained Earnings			Accumulated Other Comprehensive Income			Total
Balances at December 31, 2006	$	7,184	$	1,662	$	28,816		$	(586	)	$	37,076

Net Income						1,121						1,121
Change in other comprehensive income									27			27

Total Comprehensive Income												1,148

Dividends Paid						(359	)					(359	)

Balances March 31, 2007	$	7,184	$	1,662	$	29,578		$	(559	)	$	37,865

	Common Stock		Surplus		Retained Earnings			Accumulated Other Comprehensive Income			Total
Balances at December 31, 2007	$	7,184	$	1,662	$	32,032		$	(285	)	$	40,593

Net Income						1,238						1,238
Cumulative effect adjustment to retained earnings for change in accounting principle						(347	)					(347	)
Change in other comprehensive income									99			99

Total Comprehensive Income												990

Dividends Paid						(388	)					(388	)

Balances March 31, 2008	$	7,184	$	1,662	$	32,535		$	(186	)	$	41,195
The accompanying notes are an integral part of these statements.

Index

Page Five

HIGHLANDS BANKSHARES, INC.
CONSOLIDATED STATE M ENTS OF CASH FLOWS
(In Thousands of Dollars)
	Three Months Ended March 31,
	2008			2007
	(unaudited)			(unaudited)
Cash Flows From Operating Activities
Net Income	$	1,238		$	1,121
Adjustments to reconcile net income to net
cash provided by operating activities
(Gain) on investment securities		(87	)		0
Depreciation		170			172
Income from insurance contracts		(60	)		(55	)
Net amortization of securities		(116	)		(52	)
Provision for loan losses		179			173
Amortization of intangibles		49			44
Decrease in interest receivable		121			45
Decrease (increase) in other assets		77			(7	)
Increase in accrued expenses and other liabilities		544			687
Net Cash Provided by Operating Activities		2,115			2,128

Cash Flows From Investing Activities
Increase in federal funds sold		(7,468	)		(7,444	)
Proceeds from maturities of securities available for sale		10,117			2,258
Purchase of securities available for sale		(3,350	)		(772	)
Decrease (increase) in restricted investments		(21	)		76
(Increase) in interest bearing deposits in other banks		(816	)		(1,511	)
Purchase of property and equipment		(241	)		(46	)
Net Increase in Loans		(1,270	)		(5,257	)
Net Cash Used in Investing Activities		(3,049	)		(12,696	)

Cash Flows From Financing Activities
Net increase in deposits		2,178			14,422
Repayment of long term debt		(154	)		(2,442	)
Dividends paid in cash		(388	)		(359	)
Net Cash Provided by Financing Activities		1,636			11,621

Net Increase in Cash and Cash Equivalents		702			1,053

Cash and Cash Equivalents, Beginning of Period		7,935			7,111

Cash and Cash Equivalents, End of Period	$	8,637		$	8,164

Supplemental Disclosures
Cash paid for income taxes	$	0		$	140
Cash paid for interest	$	2,685		$	2,366
The accompanying notes are an integral part of these statements.

Index

Page Six

NOTES TO CONSOLIDAT E D FINANCIAL STATEMENTS

NOTE 1

ACCOUNTING PRINCIPLES

The consolidated financial statements conform to U. S. generally accepted accounting principles and to general industry practices. In the opinion of management, the accompanying unaudited consolidated financial statements contain all adjustments, consisting solely of normal recurring adjustments, necessary to present fairly the financial position as of March 31, 2008 and the results of operations for the three month periods ended March 31, 2008 and 2007.

The results of operations for the three month periods ended March 31, 2008 and 2007 are not necessarily indicative of the results to be expected for the full year.

The notes included herein should be read in conjunction with the notes to financial statements included in the Company’s 2007 annual report on Form 10-K.

Certain reclassifications have been made to prior period balances to conform with the current years’ presentation format.

NOTE 2

SECURITIES AND RESTRICTED INVESTMENTS

The Company’s securities portfolio serves several purposes. Portions of the portfolio secure certain public and trust deposits while the remaining portions are held as investments or used to assist the Company in liquidity and asset/liability management.

The amortized cost and market value of securities as of March 31, 2008 and December 31, 2007 is shown in the table below (in thousands of dollars). All of the securities on the Company’s balance sheet are classified as available for sale.

	March 31, 2008				December 31, 2007
	Amortized		Market		Amortized		Market
	Cost		Value		Cost		Value
Available For Sale Securities
U.S. Treasuries and Agencies	$	8,588	$	8,801	$	15,040	$	15,245
Mortgage backed securities		7,823		8,005		7,718		7,784
Obligations of states and municipalities		2,759		2,794		3,034		3,039
Marketable equities		28		26		28		22
Total Available For Sale Securities	$	19,198	$	19,626	$	25,820	$	26,090

Restricted investments consist of investments in the Federal Home Loan Bank, the Federal Reserve Bank and West Virginia Bankers’ Title Insurance Company. Investments are carried at face value and the level of investment is dictated by the level of participation with each institution. Amounts are restricted as to transferability. Investments in the Federal Home Loan Bank act as a collateral against the outstanding borrowings from that institution.

NOTE 3

INVESTMENT IN INSURANCE CONTRACTS

Investment in insurance contracts consist of single premium insurance contracts which have the dual purposes of providing a rate of return to the Company which approximately equals the Company’s average cost of funds and of providing life insurance and retirement benefits to certain executives.

Index

Page Seven

NOTE 4

LOANS

A summary of loans outstanding as of March 31, 2008 and December 31, 2007 is shown in the table below (in thousands of dollars):

	March 31,		December 31,
	2008		2007
Loan Type
Commercial	$	81,871	$	79,892
Real Estate construction		16,757		15,560
Real Estate mortgage		167,629		169,122
Consumer installment		45,030		45,625
Total Loans	$	311,287	$	310,199

In addition to loans to fund construction and traditional mortgage loans, portions of the portfolio identified as commercial are also secured by real estate. At March 31, 2008, the total balance of loans in the portfolio secured by real estate was $242,103,000.

NOTE 5

ALLOWANCE FOR LOAN LOSSES

A summary of the transactions in the allowance for loan losses for the three month periods ended March 31, 2008 and 2007 is shown below (in thousands of dollars):

	2008			2007
Balance, beginning of period	$	3,577		$	3,482
Provisions charged to operations		179			173
Loan recoveries		39			94
Loan charge-offs		(221	)		(162	)
Balance, end of period	$	3,574		$	3,587

NOTE 6

DEPOSITS

Balances of time deposits over $100,000 and of all other time deposits at March 31, 2008 and December 31, 2007 are shown below (in thousands of dollars):

	March 31,		December 31,
	2008		2007
Time deposits over $100,000	$	65,160	$	65,486
All other time deposits		134,487		135,911
Total Time Deposits	$	199,647	$	201,397

Interest expense for time deposits over $100,000 and for all other time deposits for the three month periods ended March 31, 2008 and 2007 is shown below (in thousands of dollars):

	2008		2007
Time deposits over $100,000	$	780	$	673
All other time deposits		1,480		1,617
Total interest paid on time deposits	$	2,260	$	2,290

Index

Page Eight

NOTE 7

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.

Capon Valley Bank has a defined contribution pension plan with 401(k) features that is funded with discretionary contributions by the Bank. The bank matches on a limited basis the contributions of the employees. Investment of employee balances is done through the direction of each employee. Employer contributions are vested over a six year period.

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 2003, 2002 or 2001. The bank was required to make contributions in 2005, 2006 and 2007 and made a contribution to the plan during the first quarter of 2008. The Bank has recognized liabilities of $117,000 at March 31, 2008 as a result of this shortfall. The following table provides the components of the net periodic benefit cost for the plan for the three month periods ended March 31, 2008 and 2007 (in thousands of dollars):

	2008			2007
Service cost	$	31		$	34
Interest cost		50			49
Expected return on plan assets		(53	)		(50	)
Amortization of unrecognized prior service costs		2			2
Recognized net actuarial loss		16			7

Net periodic expense	$	46		$	42

NOTE 8

DEBT INSTRUMENTS

As it becomes necessary, the Company borrows money from the Federal Home Loan Bank of Pittsburgh (FHLB) to meet specific funding needs. The interest rates of the notes payable as of March 31, 2008 range from 3.80% to 6.12%. The weighted average interest rate was 4.54% at March 31, 2008. The debt is secured by the general assets of the Banks.

NOTE 9

EARNINGS PER SHARE

There have been no changes in the Company’s outstanding shares of common stock since the third quarter of 2002. In April 2008, the Company announced a share repurchase program authorizing repurchase of up to 100,000 shares of the Company’s common stock. Should shares be repurchased under this plan, it will affect the Company’s outstanding shares and the number of weighted average shares outstanding for the purpose of earnings per share calculations in future periods.

NOTE 10

ADJUSTMENT TO RETAINED EARNINGS FOR CHANGE IN ACCOUNTING PRINCIPLE

Index

Page Nine

These EITF pronouncements provided an option for affected companies to record the resulting liability as a cumulative effect adjustment to retained earnings at the beginning of the period in which recorded or to record through retrospective application to prior periods. Highlands Bankshares opted to record the liability as a cumulative effect adjustment to prior period retained earnings and as such recorded a liability and corresponding reduction of prior period retained earnings of $347,000. There is no corresponding deferred tax consequence relating to this liability. The recording of the cumulative effect adjustment to prior period retained earnings is reflected in the March 31, 2008 balance of retained earnings and is shown as an adjustment to retained earnings in the Consolidated Statement of Changes in Stockholders’ Equity.

NOTE 11

FAIR VALUE MEASUREMENTS

SFAS No. 157, Fair Value Measurements , defines fair value, establishes a framework for measuring fair value, establishes a three-level valuation hierarchy for disclosure of fair value measurement and enhances disclosure requirements for fair value measurements. The valuation hierarchy is based upon the transparency of inputs to the valuation of an asset or liability as of the measurement date. The three levels are defined as follow:

Level One: Inputs to the valuation methodology are quoted prices (unadjusted) for identical assets or liabilities in active markets.

Level Two: I nputs to the valuation methodology include quoted prices for similar assets and liabilities in active markets, and inputs that are observable for the asset or liability, either directly or indirectly, for substantially the full term of the financial instrument.

	·	Level Three : Inputs to the valuation methodology are unobservable and significant to the fair value measurement.

Following is a description of the valuation methodologies used for instruments measured at fair value on the Company’s balance sheet, as well as the general classification of such instruments pursuant to the valuation hierarchy:

Securities

Where quoted prices are available in an active market, securities are classified within level 1 of the valuation hierarchy. Level 1 securities would include highly liquid government bonds, mortgage products and exchange traded equities. If quoted market prices are not available, then fair values are estimated by using pricing models, quoted prices of securities with similar characteristics, or discounted cash flow. Level 2 securities would include U.S. agency securities, mortgage-backed agency securities, obligations of states and political subdivisions and certain corporate, asset backed and other securities. In certain cases where there is limited activity or less transparency around inputs to the valuation, securities are classified within level 3 of the valuation hierarchy. Currently, all of the Company’s securities are considered to be Level 2 securities.

Impaired loans

SFAS No. 157 applies to loans measured for impairment using the practical expedients permitted by SFAS No. 114, Accounting by Creditors for Impairment of a Loan , including impaired loans measured at an observable market price (if available), or at the fair value of the loan’s collateral (if the loan is collateral dependent). Fair value of the loan’s collateral, when the loan is dependent on collateral, is determined by appraisals or independent valuation which is then adjusted for the cost related to liquidation of the collateral.

Other Real Estate Owned

Certain assets such as other real estate owned (OREO) are measured at fair value less cost to sell. We believe that the fair value component in its valuation follows the provisions of SFAS No. 157.

Index

Page Ten

Item 2.

Management’s Discussion a nd Analysis of Financial Condition and Results of Operations

Introduction

The following discussion focuses on significant results of the Company’s operations and significant changes in our financial condition or results of operations for the periods indicated in the discussion. This discussion should be read in conjunction with the preceding financial statements and related notes, as well as the Company’s Annual Report on Form 10-K for the period ended December 31, 2007. Current performance does not guarantee, and may not be indicative of, similar performance in the future.

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 are, 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.

Disclosure of the Company’s significant accounting policies is included in Note Two to the Consolidated Financial Statements of the Company’s Annual Report on Form 10-K for the period ended December 31, 2007. Some of the policies are particularly sensitive, requiring significant judgments, estimates and assumptions by management.

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. Additional information pertaining to the allowance for loan losses and provision for loan losses is contained on pages 14 and 15 of this report.

The Company has invested in and owns life insurance policies on certain officers. The policies are designed so that the company recovers the interest expenses associated with carrying the policies and the officer will, at the time of retirement, receive any earnings in excess of the amounts earned by the Company. The Company recognizes as an asset the net amount that could be realized under the insurance contract as of the balance sheet date. This amount represents the cash surrender value of the policies less applicable surrender charges. The portion of the benefits which will be received by the executives at the time of their retirement is considered, when taken collectively, to constitute a retirement plan. Therefore the Company accounts for these policies using guidance found in Statement of Financial Accounting Standards No. 106, "Employers' Accounting for Post Retirement Benefits Other Than Pensions.” SFAS No. 106 requires that an employers' obligation under a deferred compensation agreement be accrued over the expected service life of the employee through their normal retirement date. Assumptions are used in estimating the present value of amounts due officers after their normal retirement date. These assumptions include the estimated income to be derived from the investments and an estimate of the Company’s cost of funds in these future periods. In addition, the discount rate used in the present value calculation will change in future years based on market conditions.

During 2005, the Company purchased all the outstanding shares of the National Bank of Davis. The net assets of this purchase were recorded at fair value, including goodwill. Goodwill represents the cost in excess of the fair value of net assets acquired (including identifiable intangibles) in transactions accounted for as purchases. In accordance with provisions of SFAS No. 142, " Goodwill and Other Intangible Assets ", goodwill is not amortized over an estimated useful life, but rather will be tested at least annually for impairment. Core deposit and other intangible assets include premiums paid for acquisitions of core deposits (core deposit intangibles) and other identifiable intangible assets. Intangible assets other than goodwill, which are determined to have finite lives, are amortized based upon the estimated economic benefits received .

Index

Page Eleven

Recent Accounting Pronouncements

In September 2006, the Financial Accounting Standards Board (FASB) issued Statement of Financial Accounting Standards No. 157, “Fair Value Measurements” (SFAS 157). SFAS 157 defines fair value, establishes a framework for measuring fair value in generally accepted accounting principles, and expands disclosures about fair value measurements. SFAS 157 does not require any new fair value measurements, but provides enhanced guidance to other pronouncements that require or permit assets or liabilities to be measured at fair value. This Statement is effective for financial statements issued for fiscal years beginning after November 15, 2007 and interim periods within those years. As of December 1, 2007, the FASB has proposed a one-year deferral for the implementation of the Statement for nonfinancial assets and nonfinancial liabilities that are recognized or disclosed at fair value in the financial statements on a nonrecurring basis. SFAS 157 had no material impact on the Company’s March 31, 2008 financial statements. Additional disclosure information required by this pronouncement is included as a footnote to the financial statements .

In 2006, the FASB issued EITF 06-04 and 06-10. These EITF pronouncements require that companies which own life insurance policies insuring employees and for which the employees receive a portion of the death benefits of the policies (commonly referred to as “split dollar” policies) and for which these death benefits to the employee continue post retirement record a liability for the present value of the cost of these post retirement death benefits. These EITF pronouncements became effective for Highlands Bankshares on January 1, 2008. These EITF pronouncements provided an option for affected companies to record the resulting liability as a cumulative effect adjustment to retained earnings at the beginning of the period in which recorded or to record through retrospective application to prior periods. Highlands Bankshares opted to record the liability as a cumulative effect adjustment to prior period retained earnings and as such recorded a liability and corresponding reduction of prior period retained earnings of $347,000. There is no corresponding deferred tax consequence relating to this liability.

No other recent accounting pronouncements had a material impact on the Company’s consolidated financial statements, and it is believed that none will have a material impact on the Company’s operations in future years.

Forward Looking Statements

Certain statements in this report may constitute “forward-looking statements” within the meaning of the Private Securities Litigation Reform Act of 1995. Forward-looking statements are statements that include projections, predictions, expectations or beliefs about future events or results or otherwise are not statements of historical fact. Such statements are often characterized by the use of qualified words (and their derivatives) such as “expect,” “believe,” “estimate,” “plan,” “project,” “anticipate” or other similar words. Although the Company believes that its expectations with respect to certain forward-looking statements are based upon reasonable assumptions within the bounds of its existing knowledge of its business and operations, there can be no assurance that actual results, performance or achievements of the Company will not differ materially from any future results, performance or achievements expressed or implied by such forward-looking statements. Actual future results and trends may differ materially from historical results or those anticipated depending on a variety of factors, including, but not limited to, the effects of and changes in: general economic conditions, the interest rate environment, legislative and regulatory requirements, competitive pressures, new products and delivery systems, inflation, changes in the stock and bond markets, technology, downturns in the trucking and timber industries, effects of mergers and/or downsizing in the poultry industry in Hardy County, and consumer spending and savings habits. Additionally, actual future results and trends may differ from historical or anticipated results to the extent: (1) any significant downturn in certain industries, particularly the trucking and timber industries are experienced; (2) loan demand decreases from prior periods; (3) the Company may make additional loan loss provisions due to negative credit quality trends in the future that may lead to a deterioration of asset quality; (4) the Company may not continue to experience significant recoveries of previously charged-off loans or loans resulting in foreclosure; and (5) the Company is unable to control costs and expenses as anticipated. The Company does not update any forward-looking statements that may be made from time to time by or on behalf of the Company.

Index

Page Twelve

Overview of First Quarter Results

Income for the quarter increased 10.44% as compared to the first quarter of 2007. Annualized return on average assets was 1.30% compared to 1.24% a year ago and annualized return on average equity for the quarter was 12.20% compared to 12.00% for the first quarter of 2007.

Net interest income, on a fully taxable equivalent basis increased 3.26% over the first quarter of 2007 as earning assets continued to increase. Although total net interest income, on a fully taxable equivalent basis increased, the Company’s net interest margin decreased twelve basis points as declines in average rates earned on earning assets outpaced declines in average rates paid on interest bearing liabilities.

Non-interest income increased largely as a result of increases in income from deposit account service charges. Also, the Company recorded non-recurring income of $87,000 during the first quarter of 2008 relating to the recording of gains on called debt securities.

Non-interest expense increased in large part due to an increase in employee costs.

Net Interest Income

Net interest income, on a fully taxable equivalent basis, increased 3.26% from the first quarter of 2007 to the first quarter of 2008.

Although total net interest income increased, the Company has experienced a slight decline in its net interest margin. The ratio of balances of average earning assets to average balances of interest bearing liabilities was unchanged from 2007 to 2008 at 1.24, however, average rates on earning assets decreased 12 basis points from the first quarter of 2007 to the same period in 2008 while average rates paid on interest bearing liabilities was substantially unchanged. The larger decrease in average rates earned on earning assets occurred because of a decrease in the percentage of loans, which typically earn a higher rate of return as compared to the Company’s other earning assets, of total earning assets and because as the Federal Reserve Board (the “Fed”) lowered interest rates throughout 2007, other earning assets, which typically have shorter maturities than loans or time deposits, repriced downward quickly.

In addition, the Company’s largest portion of interest expense is comprised of time deposits. Although time deposits, due to maturities, are expected by the Company to reprice downward in the coming periods, this repricing has lagged behind the decrease in rates earned on earning assets other than loans. As of March 31, 2008, the Company had balances of liquid funds, mostly in the form of federal funds sold, greater than seen during previous quarters. Because of larger balances of liquid funds, Management anticipates that, in the immediately upcoming quarters, the need for offering above market rates to attract new deposits will lessen. Therefore, although management expects a continued slight decline in net interest margins, the expectation is that the decrease will not be significant, and that net interest income will continue to increase.

Index

Page Thirteen

The table below sets forth an analysis of net interest income for the three month periods ended March 31, 2008 and 2007 (Average balances and interest/expense shown in thousands of dollars):

	2008								2007
	Average			Income/					Average			Income/
	Balance			Expense		Rate			Balance			Expense		Rate
Interest Income
Loans 1,2	$	310,635		$	6,390		8.23	%	$	296,342		$	6,069		8.19	%
Federal funds sold		20,110			148		2.94	%		13,418			157		4.68	%
Interest bearing deposits		2,306			17		2.95	%		2,383			30		5.04	%
Taxable investment securities		20,522			255		4.97	%		21,994			283		5.15	%
Nontaxable investment securities 3		3,009			42		5.58	%		2,879			44		6.11	%
Total Earning Assets		356,582			6,852		7.69	%		337,016			6,583		7.81	%

Cash and cash equivalents		7,510								7,661
Allowance for loan losses		(3,580	)							(3,533	)
Insurance contracts		6,323								6,086
Non-earning assets		15,999								15,384
Total Assets	$	382,834							$	362,614

Interest Expense
Interest bearing demand deposits	$	23,939		$	35		.58	%	$	26,450		$	58		.88	%
Savings and money markets		49,876			146		1.17	%		44,627			147		1.32	%
Time deposits		201,324			2,267		4.50	%		187,028			2,085		4.41	%
Long term debt		11,751			134		4.56	%		13,724			158		4.61	%
Total Interest Bearing Liabilities		286,890			2,582		3.60	%		271,829			2,448		3.60	%

Demand deposits		50,003								48,200
Other liabilities		5,124								5,126
Stockholders’ equity		40,817								37,459
Total liabilities and stockholders’ equity	$	382,834							$	362,614

Net Interest Income				$	4,270							$	4,135

Net Yield on Earning Assets 3							4.79	%							4.91	%

1 Balances of loans include loans in non accrual status

2 Interest income on loans includes fees

3 Yields are on a fully taxable equivalent basis

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, Tucker, and northern Pendleton counties in West Virginia, Frederick County, Virginia and Garrett County, Maryland. 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.

Index

Page Fourteen

Credit Quality and Allowance for Loan Losses

Non-performing loans decreased 28.32% from December 31, 2007 to March 31, 2008. Non-performing loans represented .77% of gross loans at March 31, 2008 and 1.08% of gross loans at December 31, 2007.

The following table summarizes the Company’s non-performing loans at March 31, 2008 and December 31, 2007 (in thousands of dollars):

	March 31,		December 31,
	2008		2007
Non-accrual loans	$	1,151	$	916
Loans past due 90 days and still accruing interest		1,256		2,244
Restructured loans		0		198
Total non-performing loans	$	2,407	$	3,358

Non-performing loans include non-accrual loans, loans 90 days or more past due and restructured loans. Non accrual loans are loans on which interest accruals have been suspended or discontinued permanently. Restructured loans are loans on which the original interest rate or repayment terms have been changed due to financial hardship of the borrower.

Loans are typically placed on non-accrual status once they have reached certain levels of delinquency, depending on loan type, and it is no longer reasonable to expect collection of principal and interest because collateral is insufficient to cover both the principal and interest due. After loans are placed on non-accrual status, they are returned to accrual status if the obligation is brought current by the borrower, or they are charged off if payment is not made and Management believes that collection of the amounts due is doubtful. Charged-off loans are charged against the allowance for loan losses. Any subsequent collection or sale of repossessed collateral is added to the allowance as a recovery.

Because of its large impact on the local economy, Management continuously monitors 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. In recent periods, the Company’s loan portfolio has begun to reflect a concentration in loans collateralized by heavy equipment, particularly in the trucking, timber and coal extraction industries. In part because of rising fuel costs, and because of continued slow economic growth, the trucking sector experienced a recent downturn, and profitability growth within this sector still appears to be sluggish. While close monitoring of this sector is necessary, management expects no significant losses in the foreseeable future.

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 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.

Each of the Company's banking subsidiaries, Capon Valley Bank and The Grant County Bank, determines the adequacy of its allowance for loan losses independently. Although the loan portfolios of the two banks are similar to each other, some differences exist which result in divergent risk patterns and different charge-off rates amongst the functional areas of the banks’ portfolios. Each bank pays particular attention to individual loan performance, collateral values, borrower financial condition and economic conditions. The determination of an adequate allowance at each bank is done in a three step process. The first step is to identify impaired loans. Impaired loans are problem loans above a certain threshold which have estimated losses 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 borrower’s 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 weighting is somewhat 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 current loan portfolio.

Index

Page Fifteen

The required level 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 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. Non-performing loans are closely monitored on an ongoing basis as part of the Company's loan review process.

The following table shows the allocation for loans in the loan portfolio and the corresponding amounts of the allowance allocated by loan type as of March 31, 2008 and December 31, 2007 (in thousands of dollars):

	March 31, 2008					December 31, 2007
			Percent of					Percent of
	Amount		Loans			Amount		Loans
Loan Type
Commercial	$	1,153		26	%	$	1,140		26	%
Mortgage and construction		1,074		60	%		1,200		59	%
Consumer		1,220		14	%		1,172		15	%
Unallocated		127					65
Totals	$	3,574				$	3,577

As certain loans identified as impaired are paid current, collateral values increase or loans are removed from watch lists for other reasons, and as other loans become identified as impaired, and because delinquency levels within each of the portfolios change, the allocation of the allowance among the loan types may change. Management feels that the allowance is a fair representation of the losses present in the portfolio given historical loss trends, economic conditions and any known credit problems as of a given date. Management believes that the allowance is to be taken as a whole, and allocation between loan types is an estimation of potential losses within each type given information known at the time.

The following table summarizes the Company’s net charge-offs by loan type for the three month periods ended March 31, 2008 and 2007 (in thousands of dollars):

	2008			2007
Charge-offs
Commercial	$	(14	)	$	(12	)
Mortgage and construction		(78	)		(5	)
Consumer		(129	)		(145	)
Total Charge-offs		(221	)		(162	)

Recoveries
Commercial		13			30
Mortgage		0			0
Consumer		26			64
Total Recoveries		39			94

Total Net Charge-offs	$	(182	)	$	(68	)

The provision for loan losses taken during the first quarter of 2008 was $6,000 greater than that taken during the same quarter in 2007. The ratio of the allowance for loan losses to gross loans remained steady from December 31, 2007 to March 31, 2008 at 1.15%. The ratio of allowance for loan losses to nonperforming loans was 1.48 at March 31, 2008 compared to 1.07 at December 31, 2007.

Index

Page Sixteen

Non-interest Income

Non-interest income increased 39.49% for the first quarter of 2008 as compared to the same period in 2007. This increase was impacted most by an increase in income received from customer deposit account service charges, due to continued growth in deposit balances and the implementation by The Grant County Bank during the last quarter of 2007 of a courtesy overdraft program, which resulted in an increase in non-sufficient funds fees collected by that bank.

In addition, as interest rates continue to fall, the Company has experienced an increase in debt securities with call features in its portfolio being called before the expected maturity dates, which resulted in realized gains of $87,000 recorded during the first quarter of 2008 as compared to no similar recorded gains during the first three months of 2007.

Non-interest Expense

Non-interest expense increased 4.82% for the first three months of 2008 as compared to 2007.

Equipment and occupancy and data processing expense declined slightly from 2007 to 2008, as did legal and professional fees. This decrease was offset by a 7.73% increase in the costs of employee salaries and benefits which arose largely as a result of customary employee salary increases and inflationary effects on the cost of employee benefit insurance.

Borrowed Funds

The Company borrows funds from the Federal Home Loan Bank (“FHLB”) to reduce market rate risks, provide liquidity, and to fund capital additions. These borrowings may have fixed or variable interest rates and are amortized over a period of one to twenty years, or may be comprised of single payment borrowings with periodic interest payments and principal amounts due at maturity. In an attempt to manage interest expense and interest rate risk and as competition for deposits have increased, the Company has, during recent periods, used these available debt vehicles to fund loan growth more frequently than was utilized in the past.

Liquidity

Operating liquidity is the ability to meet present and future financial obligations. Short term liquidity is provided primarily through cash balances, deposits with other financial institutions, federal funds sold, non-pledged securities and loans maturing within one year. 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.

Historically, the Company’s primary need for additional levels of operational liquidity has been to fund increases in loan balances. The Company has normally funded increases in loans by increasing deposits and decreases in secondary liquidity sources such as balances of federal funds sold and balances of securities. In recent periods, the Company has substantially maintained or increased levels of these secondary liquidity resources and does not anticipate that an unexpectedly high level of loan demand in coming periods would impact liquidity to the extent that the Company would be required to pay above market rates to obtain deposits.

The parent Company’s operating funds, funds with which to pay shareholder dividends and funds for the exploration of new business ventures have been supplied primarily through dividends paid by the Company’s subsidiary banks Capon Valley Bank (CVB) and The Grant County Bank (GCB). The various regulatory authorities impose restrictions on dividends paid by a state bank. A state bank cannot pay dividends without the consent of the relevant 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 April 1, 2008, the subsidiary banks could pay dividends to Highlands Bankshares, Inc. of approximately $7,235,000 without permission of the regulatory authorities.

Index

Page Seventeen

Capital

The Company seeks to maintain a strong capital base to expand facilities, promote public confidence, support current operations and grow at a manageable level. As of March 31, 2008, the Company was above the regulatory minimum levels of capital. The table below summarizes the capital ratios for the Company and its subsidiary banks as of March 31, 2008 and December 31, 2007:

	March 31, 2008						December 31, 2007
	Actual			Regulatory			Actual			Regulatory
	Ratio			Minimum			Ratio			Minimum
Total Risk Based Capital Ratio
Highlands Bankshares		14.69	%		8.00	%		14.53	%		8.00	%
Capon Valley Bank		14.48	%		8.00	%		14.78	%		8.00	%
The Grant County Bank		13.63	%		8.00	%		13.23	%		8.00	%

Tier 1 Leverage Ratio
Highlands Bankshares		10.09	%		4.00	%		9.95	%		4.00	%
Capon Valley Bank		9.90	%		4.00	%		10.00	%		4.00	%
The Grant County Bank		9.36	%		4.00	%		9.09	%		4.00	%

Tier 1 Risk Based Capital Ratio
Highlands Bankshares		13.44	%		4.00	%		13.28	%		4.00	%
Capon Valley Bank		13.23	%		4.00	%		13.53	%		4.00	%
The Grant County Bank		12.48	%		4.00	%		12.09	%		4.00	%

In April of 2008, Highlands Bankshares announced that its Board of Directors had authorized the Company’s management to repurchase up to 100,000 shares of the Company’s outstanding common stock. Repurchase of the Company’s common stock outstanding will have the effect of lowering capital. The relative size of the reduction in capital will depend upon the actual number of shares repurchased under the announced repurchase plan. Management and the board of directors feels that the Company and both subsidiary banks current levels of capitalization as compared to regulatory minimums are such that the effects on capital of this repurchase program will not reduce capital to an extent that any type of regulatory action will occur as a result of lowered capital levels.

Effects of Inflation

Inflation primarily 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. 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 in order to minimize the effects of inflationary trends on interest rates. Other areas of non-interest expenses may be more directly affected by inflation.

Index

Page Eighteen

I t em 3. Quantitative and Qualitative Disclosures About Market Risk

There have been no material changes in Quantitative and Qualitative Disclosures about Market Risk as reported in the Company’s Annual Report on Form 10-K for the period ended December 31, 2007.

It e m 4. Controls and Procedures

The Company’s management, with the participation of the Company’s Chief Executive Officer and Chief Financial Officer, has evaluated the effectiveness of the Company’s disclosure controls and procedures as of March 31, 2008. Based on this evaluation, the Company’s Chief Executive Officer and Chief Financial Officer concluded that the Company’s disclosure controls and procedures are effective as of March 31, 2008. The company has established procedures undertaken during the normal course of business in an effort to reasonably ensure that fraudulent activity of either an amount material to these results or in any amount is not occurring.

Changes in Internal Controls

During the period reported upon, there were no significant changes in internal controls of Highlands Bankshares, Inc. pertaining to its financial reporting and control of its assets or in other factors that materially affected or are reasonably likely to materially affect such control.

Ite m 4T. Controls and Procedures

Not applicable.

PART II OTH E R INFORMATION

Item 1. Legal Pro c eedings

Management is not aware of any material pending or threatened litigation in which the Company 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. In addition, to management’s knowledge, no governmental authorities have initiated or contemplated legal action against the Company.

Item 1A. Risk Fac t ors

There have been no material changes to the Company’s risk factors since these factors were previously disclosed in the Company’s Annual Report on Form 10-K for the period ended December 31, 2007.

Item 2. Unregistered Sal e s of Equity Securities and Use of Proceeds.

None

Item 3. Defaults Upon Sen i or Securities

None

Item 4. Submission of Mat t ers to a Vote of Security Holders

None

Item 5. Other Informati o n

None

Index

Page Nineteen

Item 6. Exh i bits

EXHIBIT INDEX
Exhibit Number	Description
3(i)	Articles of Incorporation of Highlands Bankshares, Inc., as restated, are hereby incorporated by reference to Exhibit 3(i) to Highlands Bankshares Inc.’s Form 10-Q filed November 13, 2007 .
3(ii)	Amended Bylaws of Highlands Bankshares, Inc. are incorporated by reference to Exhibit 3(ii) to Highlands Bankshares Inc.’s Report on Form 8-K filed January 9, 2008.
31.1	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).
31.2	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).
32.1	Statement of Chief Executive Officer Pursuant to 18 U.S.C. §1350.
32.2	Statement of Chief Financial Officer Pursuant to 18 U.S.C. §1350.

Sign a tures

Pursuant to the requirements of the Securities Exchange Act of 1934, the Registrant has duly caused this report to be signed on its behalf by the undersigned thereunto duly authorized.

	HIGHLANDS BANKSHARES, INC.

	/s/ C.E. Porter
	C.E. Porter
	President & Chief Executive Officer

	/s/ R. Alan Miller
	R. Alan Miller
	Chief Financial Officer
May 13, 2008