Edgar Filing: HIGHLANDS BANKSHARES INC /VA/

f10q06302010.htm

UNITED STATES

SECURITIES AND EXCHANGE COMMISSION

WASHINGTON, D.C. 20549

FORM 10-Q

[X] Quarterly Report Pursuant to Section 13 or 15(d)

of the Securities Exchange Act of 1934

For the quarterly period ended June 30, 2010

[ ] Transition Report Pursuant to Section 13 or 15(d)

of the Securities Exchange Act of 1934

For the transition period from ____________ to _____________

Commission File Number: 0-27622

HIGHLANDS BANKSHARES, INC.

(Exact name of registrant as specified in its charter)

Virginia (State or other jurisdiction of incorporation or organization)	54-1796693 (I.R.S. Employer Identification No.)
P.O. Box 1128 Abingdon, Virginia (Address of principal executive offices)	24212-1128 (Zip Code)

276-628-9181

(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 [X] No [ ]

Indicate by check mark whether the registrant has submitted electronically and posted on its corporate Web site, if any, every Interactive Data File required to be submitted and posted pursuant to Rule 405 of Regulation S-T (§232.405 of this chapter) during the preceding 12 months (or for such shorter period that the registrant was required to submit and post such files). Yes [ ] No [ ]

Indicate by check mark whether the registrant is a large accelerated filer, an accelerated filer, a non-accelerated filer or smaller reporting company (See definition of “large accelerated filer, accelerated filer and smaller reporting company” in Rule 12b-2 of the Act). Large Accelerated Filer [ ] Accelerated Filer [ ] Non-Accelerated Filer [ ] Smaller Reporting Company [X]

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

Indicate the number of shares outstanding of each of the issuer’s classes of common stock, as of the latest practicable date.

5,011,152 shares of common stock, par value $0.625 per share, outstanding as of August 11, 2010

Highlands Bankshares, Inc.

FORM 10-Q

For the Quarter Ended March 31, 2010

INDEX


PART I. FINANCIAL INFORMATION	PAGE

Item 1. Financial Statements

Consolidated Balance Sheets at June 30, 2010 (Unaudited) and December 31, 2009	3

Consolidated Statements of Income (Unaudited) for the Three Months and Six Months Ended June 30, 2010 and 2009	4

Consolidated Statements of Cash Flows (Unaudited) for the Six Months Ended June 30, 2010 and 2009	5

Consolidated Statements of Changes in Stockholders’ Equity (Unaudited) for the Three Months and Six Months Ended June 30 , 2010 and 2009	6-7

Notes to Consolidated Financial Statements (Unaudited)	8-20

Item 2. Management’s Discussion and Analysis of Financial Condition and Results of Operations	20-26

Item 3. Quantitative and Qualitative Disclosures About Market Risk	26

Item 4. Controls and Procedures	26

PART II. OTHER INFORMATION

Item 1. Legal Proceedings	26

Item 1A. Risk Factors	27

Item 2. Unregistered Sales of Equity Securities and Use of Proceeds	27

Item 3. Defaults Upon Senior Securities	27

Item 4. Removed and Reserved	27

Item 5. Other Information	27

Item 6. Exhibits	27

SIGNATURES AND CERTIFICATIONS	28

PART I.

FINANCIAL INFORMATION

ITEM 1. Financial Statements

Consolidated Balance Sheets

(Amounts in thousands)

ASSETS		(Unaudited) June 30, 2010		(Note 1) December 31, 2009

Cash and due from banks	$	14,121	$	14,300
Federal funds sold		26,320		15,037

Total Cash and Cash Equivalents		40,441		29,337

Investment securities available for sale (amortized cost $66,861 at June 30, 2010, $76,326 at December 31, 2009)		62,360		70,948
Other investments, at cost		6,383		8,417
Loans, net of allowance for loan losses of $11,005 at June 30, 2010, $11,681 at December 31, 2009		471,008		474,438
Premises and equipment, net		24,033		24,613
Interest receivable		3,027		3,147
Bank Owned Life Insurance		12,549		12,324
Other Real Estate Owned		12,427		6,847
Other assets		16,550		15,236

Total Assets	$	648,778	$	645,307

LIABILITIES AND STOCKHOLDERS’ EQUITY

LIABILITIES

Deposits:
Non-interest bearing	$	83,418	$	84,073
Interest bearing		442,227		435,831

Total Deposits		525,645		519,904

Interest, taxes and other liabilities		2,836		1,950
Other short-term borrowings		65,939		74,039
Long-term debt		15,195		10,836
Capital securities		3,150		3,150

Total Other Liabilities		87,120		89,975

Total Liabilities		612,765		609,879

STOCKHOLDERS’ EQUITY

Common stock (5,011 shares issued and outstanding)		3,132		3,132
Additional paid-in capital		7,783		7,783
Retained earnings		28,069		28,063
Accumulated other comprehensive income		(2,971)		(3,550)

Total Stockholders’ Equity		36,013		35,428

Total Liabilities and Stockholders’ Equity	$	648,778	$	645,307

See accompanying Notes to Consolidated Financial Statements

Consolidated Statements of Income

(Amounts in thousands, except per share data)

(Unaudited)

		Six Months Ended June 30, 2010		Six Months Ended June 30, 2009		Three Months Ended June 30, 2010		Three Months Ended June 30, 2009
INTEREST INCOME
Loans receivable and fees on loans	$	14,442	$	15,588	$	7,223	$	7,696
Securities available for sale:
Taxable		365		1,268		157		558
Exempt from taxable income		1,057		1,137		512		532
Other investment income		55		25		34		19
Federal funds sold		12		6		7		5

Total Interest Income		15,931		18,024		7,933		8,810

INTEREST EXPENSE
Deposits		4,581		6,151		2,259		2,982
Federal funds purchased		1		1		-		-
Other borrowed funds		1,829		2,288		932		1,174

Total Interest Expense		6,411		8,440		3,191		4,156

Net Interest Income		9,520		9,584		4,742		4,654

Provision for Loan Losses		1,891		742		679		353

Net Interest Income after Provision for Loan Losses		7,629		8,842		4,063		4,301

NON-INTEREST INCOME
Securities gains, losses, net		171		33		172		(68)
Service charges on deposit accounts		972		1,062		515		562
Other service charges, commissions and fees		723		630		385		328
Life Insurance benefits		-		656		-		-
Other operating income		320		606		164		454
Other than temporary impairment		(724)		-		(724)		-
Total Non-Interest Income		1,462		2,987		512		1,276

NON-INTEREST EXPENSE
Salaries and employee benefits		5,235		5,372		2,599		2,647
Occupancy expense of bank premises		579		565		277		274
Furniture and equipment expense		834		843		434		417
Other operating expense		3,070		3,014		1,637		1,348

Total Non-Interest Expense		9,718		9,794		4,947		4,686

Income Before Income Taxes		(627)		2,035		(372)		891

Income Tax Expense		(633)		(104)		(334)		(33)

Net Income	$	6	$	2,139	$	(38)	$	924

Basic Earnings Per Common Share – Weighted Average	$	-	$	0.43	$	(0.01)	$	0.19

Earnings Per Common Share – Assuming Dilution	$	-	$	0.43	$	(0.01)	$	0.19

See accompanying Notes to Consolidated Financial Statements

Consolidated Statements of Cash Flows

(Amounts in thousands)

(Unaudited)

		Six Months Ended		Six Months Ended
		June 30, 2010		June 30, 2009

CASH FLOWS FROM OPERATING ACTIVITIES:
Net income	$	6	$	2,139
Adjustments to reconcile net income to net cash provided by operating
activities
Provision for loan losses		1,891		742
Depreciation and amortization		666		681
Net realized (gains) losses on available for sale securities		(171)		(33)
Net amortization on securities		93		194
Other than temporary impairment charge		724		-
Amortization of Capital issue costs		3		3
(Increase) decrease in interest receivable		120		(3)
Valuation adjustment of other real estate owned		365		78
(Increase) decrease in other assets		(1,772)		(2,131)
Increase in interest, taxes and other liabilities		886		(58)

Net cash provided by operating activities		2,811		1,612

CASH FLOWS FROM INVESTING ACTIVITIES:
Securities available for sale:
Proceeds from sale of securities		19,156		14,214
Proceeds from maturities of debt and equity securities		2,081		17,802
Purchase of debt and equity securities		(12,418)		(17,684)
(Purchase) redemptions of other investments, net		2,034		(2,093)
Net (increase) decrease in loans		(5,434)		(604)
Proceeds of sales of other real estate owned		927		209
Proceeds from cash surrender value of life insurance		-		604
Premises and equipment expenditures		(53)		(1,357)

Net cash provided by (used in) investing activities		6,293		11,091

CASH FLOWS FROM FINANCING ACTIVITIES:
Net increase (decrease) in time deposits		304		(14,968)
Net increase in demand, savings and other deposits		5,437		11,852
Increase (decrease) in short-term borrowings		(8,100)		15,432
Increase (decrease) in long-term debt		4,359		(13,557)
Proceeds from exercise of stock options		-		26

Net cash provided by financing activities		2,000		(1,215)

Net increase (decrease) in cash and cash equivalents		11,104		11,488

CASH AND CASH EQUIVALENTS AT BEGINNING OF YEAR		29,337		16,582

CASH AND CASH EQUIVALENTS AT END OF PERIOD	$	40,441	$	28,070

SUPPLEMENTAL DISCLOSURES OF CASH FLOW INFORMATION
Cash paid during the year for:
Interest	$	6,031	$	8,286
Income taxes	$	-	$	250

SUPPLEMENTAL DISCLOSURE OF NONCASH TRANSACTIONS
Transfer of loans to other real estate owned	$	6,873	$	2,337

See accompanying Notes to Consolidated Financial Statements

Consolidated Statements of Changes in Stockholders’ Equity

(Amounts in thousands)

(Unaudited)

				Accumulated
		Additional		Other	Total
Common Stock		Paid-in	Retained	Comprehensive	Stockholders’
Shares	Par Value	Capital	Earnings	Income	Equity

Balance, March 31, 2009	5,003	$	3,127	$	7,713	$	36,209	$	(8,446)	$	$ 38,603

Comprehensive income:
Net income	-		-		-		924		-		924
Change in unrealized loss on securities available for sale, net of deferred income tax benefit of $340	-		-		-				683		683
Less: reclassification adjustment net of deferred tax expense of $23	-		-		-				45		45
Total comprehensive income	-		-		-		-		-		$1,652


Balance, June 30, 2009	5,003	$	3,127	$	7,713	$	37,133	$	(7,718)	$	40,255


Balance, March 31, 2010	5,011	$	3,132	$	7,783	$	28,107	$	(3,462)	$	35,560

Comprehensive income:
Net income / (loss)	-		-		-		(38)		-		(38)
Change in unrealized loss on securities available for sale, net of deferred income tax expense of $311	-		-		-		-		604		604
Less: reclassification adjustment net of deferred tax expense of $58	-		-		-		-		(113)		(113)
Total comprehensive income	-		-		-		-		-		453


Balance, June 30, 2010	5,011	$	3,132	$	7,783	$	28,069	$	(2,971)	$	36,013

See accompanying Notes to Consolidated Financial Statements

Consolidated Statements of Changes in Stockholders’ Equity

(Amounts in thousands)

(Unaudited)

				Accumulated
		Additional		Other	Total
Common Stock		Paid-in	Retained	Comprehensive	Stockholders’
Shares	Par Value	Capital	Earnings	Income	Equity


Balance, December 31, 2008	5,001	$ 3,126	$ 7,688	$ 34,994	$ (6,760)	$ 39,048

Comprehensive income:
Net income	-	-	-	2,139	-	2,139
Change in unrealized (loss) on securities available for sale, net of deferred income tax benefit of $482	-	-	-	-	(936)	(936)
Less: reclassification adjustment net of deferred tax expense of $11	-	-	-	-	(22)	(22)
Total comprehensive income	-	-	-	-	-	1,181

Common stock issued for stock options exercised, net	2	1	25	-	-	26

Balance, June 30, 2009	5,003	$ 3,127	$ 7,713	$ 37,133	$ (7,718)	$ 40,255


Balance, December 31, 2009	5,011	$ 3,132	$ 7,783	$ 28,063	$ (3,550)	$ 35,428

Comprehensive income:
Net income	-	-	-	6	-	6
Change in unrealized (loss) on securities available for sale, net of deferred income tax expense of $356	-	-	-	-	692	692
Less: reclassification adjustment net of deferred tax expense of $58	-	-	-	-	(113)	(113)
Total comprehensive income	-	-	-	-	-	585


Balance, June 30, 2009	5,011	$ 3,132	$ 7,783	$ 28,069	$ (2,971)	$ 36,013

See accompanying Notes to Consolidated Financial Statements

Notes to Consolidated Financial Statements

(Unaudited)

(in thousands, except share, per share and percentage data)

Note 1 - General

The consolidated financial statements of Highlands Bankshares, Inc. (the “Company”) conform to United States generally accepted accounting principles and to banking industry practices. The accompanying consolidated interim financial statements are unaudited. In the opinion of management, all adjustments necessary for a fair presentation of the consolidated financial statements have been included. All such adjustments are of a normal and recurring nature. The consolidated balance sheet as of December 31, 2009 has been extracted from the audited financial statements included in the Company’s Annual Report on Form 10-K for the year ended December 31, 2009 (the “2009 Form 10-K”). The notes included herein should be read in conjunction with the notes to consolidated financial statements included in the 2009 Form 10-K. The results of operations for the three-month and six-month periods ended June 30, 2010 and 2009 are not necessarily indicative of the results to be expected for the full year.

The preparation of financial statements requires management to make estimates and assumptions that affect the reported amounts of assets and liabilities and disclosure of contingent assets and liabilities at the date of the financial statements and the reported amounts of revenues and expenses during the reporting period. Actual results could differ from those estimates.

Note 2 - Allowance for Loan Losses

A summary of transactions in the consolidated allowance for loan losses for the six months ended June 30 is as follows:

		2010		2009

Balance, January 1	$	11,681	$	5,171
Provision		1,891		742
Recoveries		43		61
Charge-offs		(2,610)		(741)

Balance, June 30	$	11,005	$	5,233

Note 3 - Income Taxes

Income tax expense (benefit) for the six months ended June 30 is different than the amount computed by applying the statutory corporate federal income tax rate of 34% to income before taxes. The reasons for these differences are as follows:

		2010		2009

Tax expense (benefit) at statutory rate	$	(214)	$	692
Reduction in taxes from:
Tax-exempt interest		(360)		(407)
Life Insurance proceeds		-		(223)
Other, net		(59)		(166)

Provision for income taxes	$	(633)	$	(104)

Notes to Consolidated Financial Statements

(Unaudited)

(in thousands, except share, per share and percentage data)

Note 4 - Capital Requirements

Regulators of the Company and its subsidiaries, including Highlands Union Bank (the “Bank”), have implemented risk-based capital guidelines which require compliance with certain minimum capital ratios as a percent of assets and other certain off-balance sheet items that are adjusted for predefined credit risk factors. The regulatory minimum for Tier 1 and combined Tier 1 and Tier 2 capital ratios are 4.0% and 8.0%, respectively. Tier 1 capital includes tangible equity reduced by goodwill and certain other intangibles. Tier 2 capital includes portions of the allowance for loan losses, not to exceed Tier 1 capital. In addition to the risk-based guidelines, a minimum leverage ratio (Tier 1 capital as a percentage of average total consolidated assets) of 4.0% is required. The following table contains the capital ratios for the Company and the Bank at June 30, 2010.

Entity	Tier 1	Combined Capital	Leverage

Highlands Bankshares, Inc.	8.58%	9.84%	6.48%

Highlands Union Bank	9.00%	10.26%	6.79%

Note 5 - Capital Securities

The Company completed a $7.5 million capital issue of $2.3125 Preferred Securities (the “Trust Preferred Securities”) on January 23, 1998. These Trust Preferred Securities were issued by Highlands Capital Trust I, a wholly owned subsidiary of the Company

Subject to certain exceptions and limitations, the Company may elect from time to time to defer interest payments on the debt securities, which would result in a deferral of distribution payments on the related Capital Securities. Due to the economic environment, the Board determined that, effective April 15th, 2010, the Company will defer interest payments on the debt securities held by Highlands Capital Trust I. As a result, distribution payments to holders of the Highlands Capital Trust I 9.25% Capital Securities will also be deferred.

Note 6 – Earnings Per Share

The following table contains information regarding the Company’s computation of basic earnings per share and diluted earnings per share for the six and three months ended June 30, 2010 and 2009.

	Six Months Ended June 30,		Three Months Ended June 30,
	2010	2009	2010	2009

Basic Earnings Per Share	$ 0.00	$ 0.43	$ (0.01)	$ 0.19

Basic Number of Shares	5,011,152	5,002,463	5,011,152	5,003,237

Diluted Earnings Per Share	$ 0.00	$ 0.43	$ (0.01)	$ 0.19

Diluted Number of Shares	5,011,152	5,002,463	5,011,152	5,003,237

Notes to Consolidated Financial Statements

(Unaudited)

(in thousands, except share, per share and percentage data)

Note 7 – Commitments and Contingencies

The Bank is a party to various financial instruments with off-balance sheet risk arising in the normal course of business to meet the financing needs of its customers. Those financial instruments include commitments to extend credit and standby letters of credit. At June 30, 2010, these commitments included: standby letters of credit of $1.92 million; equity lines of credit of $9.87 million; credit card lines of credit of $5.19 million; commercial real estate, construction and land development commitments of $3.82 million; and other unused commitments to fund interest earning assets of $26.28 million.

Note 8 – Summary of Significant Accounting Policy Update For Certain Required Disclosures

In January 2010, fair value guidance was amended to require disclosures for significant amounts transferred in and out of Levels 1 and 2 and the reasons for such transfers and to require that gross amounts of purchases, sales, issuances and settlements be provided in the Level 3 reconciliation. The new disclosures are effective for the Company for the current quarter and have been reflected in the Fair Value footnote.

Guidance related to subsequent events was amended in February 2010 to remove the requirement for an SEC filer to disclose the date through which subsequent events were evaluated. The amendments were effective upon issuance and had no significant impact on the Company’s financial statements.

Other accounting standards that have been issued or proposed by the FASB or other standards-setting bodies are not expected to have a material impact on the Company’s financial position, results of operations or cash flows.

Notes to Consolidated Financial Statements

(Unaudited)

(in thousands, except share, per share and percentage data)

Note 9 – Fair Value

The Company utilizes fair value measurements to record fair value adjustments to certain assets and to determine fair value disclosures. Securities available-for-sale are recorded at fair value on a recurring basis. Additionally, from time to time, the Company may be required to record at fair value other assets on a nonrecurring basis. These nonrecurring fair value adjustments typically involve application of lower of cost or market accounting or write-downs of individual assets.

Fair Value Hierarchy

Under ASC Topic 820 on Fair Value Measurements and Disclosures, the Company groups assets and liabilities at fair value in three levels, based on the markets in which the assets and liabilities are traded and the reliability of the assumptions used to determine fair value. These levels are:

	Level 1		Valuation is based upon quoted prices for identical instruments traded in active markets.

	Level 2		Valuation is based upon quoted prices for similar instruments in active markets, quoted prices for identical or similar instruments in markets that are not active, and model-based valuation techniques for which all significant assumptions are observable in the market.

	Level 3		Valuation is generated from model-based techniques that use at least one significant assumption not observable in the market. These unobservable assumptions reflect estimates of assumptions that market participants would use in pricing the asset or liability. Valuation techniques include use of option pricing models, discounted cash flow models and similar techniques.

A description of valuation methodologies used for instruments measured at fair value, as well as the general classification of such instruments pursuant to the valuation hierarchy, is set forth below.

In general, fair value is based upon quoted market prices, where available. If such quoted market prices are not available, fair value is based upon third party models that primarily use, as inputs, observable market-based parameters. Valuation adjustments may be made to ensure that financial instruments are recorded at fair value. These adjustments may include amounts to reflect counterparty credit quality, the Company’s creditworthiness, among other things, as well as unobservable parameters. Any such valuation adjustments are applied consistently over time. The Company’s valuation methodologies may produce a fair value calculation that may not be indicative of net realizable value or reflective of future fair values. While management believes the Company’s valuation methodologies are appropriate and consistent with other market participants, the use of different methodologies or assumptions to determine the fair value of certain financial instruments could result in a different estimate of fair value at the reporting date.

Notes to Consolidated Financial Statements

(Unaudited)

(in thousands, except share, per share and percentage data)

Investment Securities Available for Sale

Securities classified as available for sale are reported at fair value utilizing Level 1, Level 2 and Level 3 inputs. For Level 1 securities, the Company obtains fair value measurements from active exchanges. For Level 2 securities, the Company obtains fair value measurements from an independent pricing service. The fair value measurements consider observable data that may include dealer quotes, market spreads, cash flows, the U.S. Treasury yield curve, live trading levels, trade execution data, market consensus prepayment speeds, credit information, and the bond’s terms and conditions, among other things.

As of June 30, 2010 we own approximately $4.92 million (amortized cost) in collateralized debt obligation securities that are backed by trust preferred securities issued by banks, thrifts, and insurance companies (TRUP CDOs). The market for these securities at June 30, 2010 is not active and markets for similar securities are also not active. The TRUP CDOs have been classified within Level 3 of the fair value hierarchy because we determined that significant adjustments are required to fair value at the measurement date.

The remaining securities in the Company’s available for sale securities portfolio are classified within the Level 2 heirarchy using inputs from independent pricing models.

The following table summarizes the Company’s available for sale securities portfolio measured at fair value on a recurring basis as of June 30, 2010, segregated by the level of the valuation inputs within the fair value hierarchy.

June 30, 2010

	Level 1	Level 2	Level 3	Total Fair Value
Available for Sale Securities
TRUP CDO’s	--	--	$ 912	$ 912
State and Political Subdivisions		$ 32,667		$ 32,667
Mortgage Backed Securities	--	$ 22,446	--	$ 22,446
Other		$ 6,335		$ 6,335
Total AFS Securities	--	$ 61,448	$ 912	$ 62,360

December 31, 2009

Available for Sale Securities
TRUP CDO’s	--	--	$ 1,197	$ 1,197
State and Political Subdivisions		$ 47,347		$ 47,347
Mortgage Backed Securities	--	$ 18,752	--	$18,752
Other		$ 3,652		$ 3,652
Total AFS Securities	--	$ 69,751	$ 1,197	$ 70,948

Notes to Consolidated Financial Statements

(Unaudited)

(in thousands, except share, per share and percentage data)

Pursuant to ASC Topic 820, the following table shows a reconciliation of the beginning and ending balance at June 30, 2010 for Level 3 assets measured on a recurring basis using significant unobservable inputs. Level 3 assets represent the Company’s TRUP CDOs.

Investment Securities Available for Sale

Beginning balance, January 1, 2010	$ 1,197
Total gains, losses included in net income	(724)
Included in Other comprehensive Income	439
Transfers in or out of Level 3	--
Ending Balance June 30, 2010	$ 912

Loans

The Company does not record loans at fair value on a recurring basis. However, from time to time, a loan is considered impaired and an allowance for loan losses is established. Loans for which it is probable that payment of interest and principal will not be made in accordance with the contractual terms of the loan agreement are considered impaired. Once a loan is identified as individually impaired, management

measures impairment using one of several methods, including collateral value, recent appraisal value and /or tax assessed value, liquidation value and discounted cash flows. Those impaired loans not requiring an allowance represent loans for which the fair value of the expected repayments or collateral exceed the recorded investments in such loans. At June 30, 2010 all of the total impaired loans were evaluated based on the fair value of the collateral. Fair value is based upon independent market prices or appraised values of the collateral which the Company considers as nonrecurring Level 2.

The following table summarizes the Company’s impaired loans by loan category at fair value on a non - recurring basis as of June 30, 2010, segregated by the level of the valuation inputs within the fair value hierarchy.

June 30, 2010

	Level 1	Level 2	Level 3	Total Fair Value
Impaired Loans
Residential 1-4 family		$ 6,911		$ 6,911
Commercial, Construction and Land Development		$ 18,714		$ 18,714
Farmland		$ 798		$ 798
Multifamily		$ 6,400		$ 6,400
Other-non real estate		$ 1,090		$ 1,090
Total Impaired Loans		$ 33,913		$ 33,913

December 31, 2009

	Level 1	Level 2	Level 3	Total Fair Value
Impaired Loans
Residential 1-4 family		$ 7,548		$ 7,548
Commercial, Construction and Land Development		$ 2,552		$ 2,552
Farmland		$ --		$ --
Multifamily		$ 84		$ 84
Other-non real estate		$ 159		$ 159
Total Impaired Loans		$ 10,343		$ 10,343

Notes to Consolidated Financial Statements

(Unaudited)

(in thousands, except share, per share and percentage data)

Foreclosed Assets / Repossessions

Foreclosed assets and repossessions are adjusted to fair value upon transfer of the loans to foreclosed assets and repossessions. Subsequently, foreclosed assets and repossessions are carried at the lower of carrying value or fair value. Fair value is based upon independent market prices or appraised values of the

collateral which the Company considers as nonrecurring Level 2. If additional write-downs have occurred due to the recessionary economic environment, then the foreclosed asset balances are reclassified as non-recurring Level 3.

June 30, 2010

Level 1 Level 2 Level 3 Total Fair Value

Repossessions/OREO

$ 10,213

2,239

$ 12,452

December 31, 2009

Level 1 Level 2 Level 3 Total Fair Value

Repossessions/OREO

$ 4,221

2,713

$ 6,934

Pursuant to ASC Topic 820, the following table shows a reconciliation of the beginning and ending balance at June 30, 2010 for Level 3 assets measured on a non-recurring basis using significant unobservable inputs.

Other Real Estate Owned

Beginning balance, January 1, 2010	$ 2,713
Total gains, losses included in net income	(95)
Transfers in or out of Level 3	(379)
Ending Balance June 30, 2010	$ 2,239

Transfers out of Level 3 reflect the OREO properties classified as Level 3 that were sold during the six months ended June 30, 2010.

General

The Company has no liabilities carried at fair value or measured at fair value on a non-recurring basis.

Fair Value of Financial Instruments

Fair value is the price that would be received to sell an asset or paid to transfer a liability in an orderly transaction between market participants at the measurement date. Fair value is best determined based upon quoted market prices. However, in many instances, there are no quoted market prices for the Company’s various financial instruments. In cases where quoted market prices are not available, fair values are based on estimates using present value or other valuation techniques. Those techniques are significantly affected by the assumptions used, including the discount rate and estimates of future cash flows. Accordingly, the fair value estimates may not be realized in an immediate settlement of the instrument. Accordingly, the aggregate fair value amounts presented may not necessarily represent the underlying fair value of the Company

Cash and Cash Equivalents

The carrying amount reported in the balance sheets for cash, short-term investments and federal funds sold approximates fair value.

Notes to Consolidated Financial Statements

(Unaudited)

(in thousands, except share, per share and percentage data)

Securities Available for Sale

Fair values are determined in the manner as described above.

Other Investmensts

Other investments include Federal Home Loan Bank stock, Federal Reserve Bank stock, Community Bankers Bank stock, and Pacific Coast Bankers Bank. The carrying value of those securities approximates fair value based on the redemption provisions of those Banks. Also included in other investments are certificates of deposit purchased from other banks in which the carrying amount approximates fair value.

Loans

The fair value of loans represent the amount at which the loans of the Bank could be exchanged on the open market, based upon the current lending rate for similar types of lending arrangements discounted over the remaining life of the loans. For fixed rate loans and for variable rate loans with infrequent re-pricing or re-pricing limits, fair value is based on discounted cash flows using current market rates applied to the cash flow analysis.

Deposits

The fair value of time deposits is based on discounted cash flows using current market rates applied to the cash flow analysis for each time deposit. Other non-maturity deposits are reported that their carrying values.

Other Short-Term Borrowings

Fair values of other short-term borrowings are estimated using discounted cash flow analyses based on the Company’s current incremental borrowing rates for similar types of borrowing arrangements. Estimated maturity dates are also included in the calculation of fair value for these borrowings.

Long-term Debt and Capital Securities

Rates currently available to the Company for debt with similar terms and remaining maturities or established call prices are used to estimate fair value of existing debt.

Off-Balance Sheet Instruments

The amount of off-balance sheet commitments to extend credit, standby letters of credit, and financial guarantees, is considered equal to fair value. Because of the uncertainty involved in attempting to assess the likelihood and timing of commitments being drawn upon, coupled with the lack of an established market and the wide diversity of fee structures, the Company does not believe it is meaningful to provide an estimate of fair value that differs from the given value of the commitment.

Notes to Consolidated Financial Statements

(Unaudited)

(in thousands, except share, per share and percentage data)

The carrying amounts and fair values of the Company's financial instruments at June 30, 2010 and December 31, 2009 were as follows:

	June 30, 2010		December 31, 2009
	Carrying Amount	Fair Value	Carrying Amount	Fair Value
	Carrying Amount	Fair Value	Carrying Amount	Fair Value

Cash and cash equivalents	$ 40,441	$ 40,441	$ 29,337	$ 29,337
Securities available for sale	62,360	62,360	70,948	70,948
Other investments	6,383	6,383	8,417	8,417
Loans, net	471,008	464,110	474,438	467,790
Deposits	(525,645)	(528,471)	(519,904)	(522,563)
Other short-term borrowings	(65,939)	(73,365)	(74,039)	(80,047)
Long-term debt	(15,195)	(16,068)	(10,836)	(10,875)
Capital Securities	(3,150)	(2,588)	(3,150)	(2,588)

Notes to Consolidated Financial Statements

(Unaudited)

(in thousands, except share, per share and percentage data)

Note 10 – Life Insurance Proceeds

During the first quarter of 2009, the Company received life insurance proceeds as a result of the death of one of the Company’s executive officers. Total death benefit proceeds received totaled $1.26 million. Of this amount, $656 was tax free income and $604 represented the accumulated cash value of the various policies.

Note 11 -Investment Securities Available For Sale

The amortized cost and market value of securities available for sale are as follows:

		June 30, 2010
		Amortized Cost		Gross Unrealized Gains		Gross Unrealized Losses		Fair Value

U.S Government agencies and corporations	$	4,023	$	21	$	-	$	4,044
State and political subdivisions		33,201		247		780		32,668
Mortgage backed securities		22,029		458		41		22,446
Other securities		7,608		--		4,406		3,202


	$	66,861	$	726	$	5,227	$	62,360

		December 31, 2009
		Amortized Cost		Gross Unrealized Gains		Gross Unrealized Losses		Fair Value

U.S Government agencies and corporations	$	1,498	$	9	$	--	$	1,507
State and political subdivisions		48,002		399		1,053		47,348
Mortgage backed securities		18,445		314		7		18,752
Other securities		8,381		--		5,040		3,341


	$	76,326	$	722	$	6,100	$	70,948

Investment securities available for sale with a carrying value of $44,202 and $47,988 at June 30, 2010 and December 31, 2009, respectively, and a market value of $44,505 and $48,309 at June 30, 2010 and December 31, 2009, respectively, were pledged as collateral on public deposits, FHLB advances and for other purposes as required or permitted by law.

Notes to Consolidated Financial Statements

(Unaudited)

(in thousands, except share, per share and percentage data)

The following table presents the age of gross unrealized losses and fair value by investment category:

	---------------------------------------June 30, 2010----------------------------
	Less Than 12 months		12 Months or More		Total
	Fair Value	Unrealized Losses	Fair Value	Unrealized Losses	Fair Value	Unrealized Losses

Mortgage-backed securities	$ 7,636	$ 40	$ 128	$ 1	$ 7,764	$ 41
States and pol. subdivisions	6,874	207	5,893	573	12,767	780
Other securities	62	39	2,642	4,366	2,704	4,406

Total	$ 14,572	$ 286	$ 8,663	$ 4,940	$23,235	$ 5,227

	---------------------------------------December 31, 2009----------------------------
	Less Than 12 months		12 Months or More		Total
	Fair Value	Unrealized Losses	Fair Value	Unrealized Losses	Fair Value	Unrealized Losses

Mortgage-backed securities	$ 1,465	$ 4	$ 224	$ 3	$ 1,689	$ 7
States and pol. subdivisions	12,363	216	7,975	838	20,338	1,053
Other securities	86	15	3,256	5024	3,342	5,040

Total	$ 13,914	$ 235	$ 11,455	$ 5,865	$ 25,369	$ 6,100

The segment of our portfolio that contains the largest unrealized loss is our pooled trust preferred securities (TRUP CDOs) which represent trust preferred securities issued primarily by banks and a limited number of insurance companies and real estate investment trusts.

The Company reviews its investment portfolio on a quarterly basis for indications of other-than-temporary impairment (“OTTI”).

Notes to Consolidated Financial Statements

(Unaudited)

(in thousands, except share, per share and percentage data)

During the first quarter of 2009, the FASB ASC Topic 320, Investments-Debt and Equity Securities, amended the assessment criteria for recognizing and measuring OTTI related to debt securities. For analysis of the TRUP CDOs securities, the Company prepares cash flow analyses on each applicable security to determine if an adverse change in cash flows expected to be collected has occurred. An adverse change in cash flows expected to be collected has occurred if the present value of cash flows previously projected is greater than the present value of cash flows projected at the current reporting date and less than the current book value. If an adverse change in cash flows is deemed to have occurred, then OTTI has occurred. The Company then compares the present value of cash flows using the current yield for the current reporting period and compare it to the reference amount, or current net book value, to determine the credit-related OTTI. The credit-related OTTI is then recorded through earnings and the non-credit related OTTI is accounted for in Other Comprehensive Income (OCI). The Company uses a third party to provide the quarterly cash flow projections to assist us in determining OTTI.

The cash flow projections for the pooled trust preferred securities utilize a discounted cash flow test that uses variables such as the estimate of future cash flows, creditworthiness of the underlying banks and determination of probability of default of the underlying collateral. Cash flows are constructed in an INTEX cash flow model. INTEX is a proprietary cash flow model recognized as the industry standard for analyzing all types of collateralized debt obligations. It includes each individual deal’s structural features updated with trustee information, including asset-by-asset detail, as it becomes available. The modeled cash flows are then used to determine if all the scheduled principal and interest payments of our investments will be returned.

The expected future default assumptions for the pooled trust preferred securities are based upon the Company’s best estimate of future bank deferrrals. Banks currently in default or deferring interest payments are assigned a 100% probability of default. In all cases, a 15% projected recovery rate is applied to current deferrals and projected defaults. During the second quarter of 2010, the Company incurred $724 in OTTI charges on its TRUP CDOs.

In addition, the risk of future OTTI may be influenced by additional bank failures, prolonged recession in the U.S. economy, changes in real estate values, interest deferrals, and whether the federal government provides assistance to certain financial institutions.

Notes to Consolidated Financial Statements

(Unaudited)

(in thousands, except share, per share and percentage data)

The amortized cost and estimated fair value of securities available for sale at June 30, 2010 by contractual maturity are shown below. Expected maturities may differ from contractual maturities because borrowers may have the right to call or prepay obligations with or without call or prepayment penalties.

	Amortized Cost	Approximate Market Value
	Amortized Cost	Approximate Market Value
Due in one year or less	$ -	$ -
Due after one year through five years	559	578
Due after five years through ten years	747	767
Due after ten years	35,918	35,366
	37,224	36,711

Mortgage-backed securities	22,029	22,446
Other securities	7,608	3,203
	$ 66,861	$ 62,360

Note 12 - Holding Company Note and Line of Credit

On April 27th, 2009, the Company announced that it entered into a Loan Agreement with Community Bankers Bank (“CBB”), pursuant to which CBB agreed to extend to the Company a Revolving Line of Credit and a Closed-End Term Loan (collectively, the “Loans”). The Company pledged the stock of the Bank as collateral for the Loans. As of June 30, 2010, the Company had borrowed $4,021,000 under Loan B and $1,000,000 under Loan A. Proceeds of the loans of $3,000,000 were down-streamed into the Bank as additional Tier 1 capital with the balance retained as cash reserves at the Company.

ITEM 2. Management’s Discussion and Analysis of Financial Condition and Results of Operations

The following discussion and analysis is provided to address information about the Company’s financial condition and results of operations that is not otherwise apparent from the Consolidated Financial Statements and the notes thereto or included in this report. Reference should be made to those statements and the notes thereto for an understanding of the following discussion and analysis.

The Company generates a significant amount of its income from the net interest income earned by the Bank. Net interest income is the difference between interest income and interest expense. Interest income depends on the amount of interest-earning assets outstanding during the period and the interest rates earned thereon. The Company’s cost of money is a function of the average amount of deposits and borrowed money outstanding during the period and the interest rates paid thereon. The quality of the assets further influences the amount of interest income lost on non-accrual loans and the amount of additions to the allowance for loan losses. Highlands Union Insurance Services and Highlands Union Financial Services, which are subsidiaries of Highlands Union Bank, generate fee income by providing insurance and financial service products to its clients.

Critical Accounting Policy

The financial condition and results of operations presented in the Consolidated Financial Statements, accompanying Notes to Consolidated Financial Statements and management’s discussion and analysis are, to a large degree, dependent upon the accounting policies of the Company. The selection and application of these accounting policies involve judgments, estimates, and uncertainties that are susceptible to change. For a discussion of the Company’s critical accounting policies related to its allowance for loan losses and other than temporary impairment, see the Company’s Annual Report on Form 10-K for the year ended December 31, 2009.

Regulatory Economic Environment

Many emergency government programs enacted in 2008 in response to the financial crisis and global regulatory and legislative focus has generally moved to a second phase of broader reform and a restructuring of financial institution regulation. On July 21, 2010, the Dodd-Frank Wall Street Reform and Consumer Protection Act (the “Dodd-Frank Act”) was signed into law. The Dodd-Frank Act contains significant modifications to the current bank regulatory structure and requires various federal agencies to adopt a broad range of new implementing rules and regulations. While not determinable at this time, the impact of the Dodd-Frank Act and the rules and regulations that will be promulgated there-under could significantly affect our operations, increase our operating costs and divert management resources.

Results of Operations

Results of operations for the three-month and six-month periods ended June 30, 2010 reflected a net loss of $38 thousand for the three months and net income of $6 thousand for the six month period, respectively. In the second quarter of 2010, the Company experienced in a decrease in earnings of $962 thousand from the second quarter of 2009. For the six month period ended June 30, 2010, the Company earned $2.13 million less than the corresponding period in 2009. Tax exempt life insurance proceeds in the amount of $656 thousand were received in the first quarter of 2009 due to the untimely death of one of the Company’s executive officers. For the first six months of 2010, provisions for loan loss reserves increased $1.15 million over the corresponding period in 2009. Also, other than temporary impairment charges (“OTTI”) in the amount of $724 were incurred in June of 2010.

Net interest income for the three-month period ended June 30, 2010 increased $88 thousand or 1.88% . For the six-month period ended June 30, 2010 net interest income decreased $64 thousand or 0.67% as compared to the six month period ended June 30, 2009. Average interest-earning assets decreased $38.84 million from the six-month period ended June 30, 2009 to the current six-month period, while average interest-bearing liabilities decreased $23.75 million over the same period. The tax-equivalent yield on average interest-earning assets was 5.69% for the six-month period ended June 30, 2010 representing a decrease of 34 basis points from the yield of 6.03% for the same period in 2009. The yield on average interest-bearing liabilities decreased 63 basis points to 2.45% for the six month period ended June 30, 2010 as compared to 3.08% for the same period in 2009.

Total interest income for the three and six months ended June 30, 2010 was $877 thousand and $2.09 million less than the comparable 2009 periods due to new loan and investment securities volume being booked at lower rates and existing adjustable rate loans and investment securities re-pricing at lower rates. In addition, the Company’s average investment securities portfolio balance for the six months ended June 30, 2010 has also decreased by approximately $43.19 million over the six months ended June 30, 2009 due to the Company choosing not to replace what has matured or been paid down during the last several months as well as investment write-downs that have occurred over the last 12 months. Yields on typical investment securities during the current economic cycle have decreased significantly; therefore, management has intentionally decreased its security portfolio and maintained a significant amount of cash and cash equivalents during the last several months. The majority of what has paid off during the last year has been callable agency securities and agency mortgage backed securities. The Company has also reduced its municipal bond holdings by approximately $14.05 million during 2010 in an effort to reduce its exposure to municipality debt. The Company’s total interest expense decreased by $965 thousand for the three months and $2.03 million for the six months over the same periods in 2009 due primarily to new interest-bearing deposits recorded at lower rates and existing interest-bearing deposits re-pricing lower as they mature or re-price. The Company continues to face considerable competition in all of its market areas as it pertains to rates on deposits and loans.

During the first six months of 2010, the Company’s non-interest income decreased by $1.53 million from the corresponding period for 2009. Tax exempt life insurance proceeds in the amount of $656 thousand were received in the first quarter of 2009. During the second quarter of 2009, the Company also had a $292 thousand gain on the sale of a parcel of land adjacent to one of its branch locations. Additionally during the second quarter of 2010, the Company incurred $724 thousand of OTTI losses.

Service charges on deposit accounts decreased by $47 thousand for the three-month period and $90 thousand for the six-month period ended June 30, 2010 as compared to June 30, 2009.

Non-interest expense for the three month period ended June 30, 2010 increased $261 thousand and decreased $76 thousand for the six month period ended June 30, 2010, respectively, over the comparable periods in 2009. OREO write-downs and losses on the sale of OREO and repossessions in the amount of $678 thousand increased $316 thousand for the six month period ended June 30, 2010 as compared to the prior period. OREO write-downs and losses on the sale of OREO and repossessions totaled $415 thousand for the three month period ended June 30, 2010.

In addition to OREO losses and write-downs, for the six months ended June 30, 2010, other operating expenses that exceeded 1% of total interest income and other operating income were charges for FDIC insurance totaling $468 thousand, other contracted services totaling $270 thousand, software licensing and maintenance totaling $363 thousand and telephone / data costs totaling $235 thousand.

For the three month period ended June 30, 2010, other operating expenses that exceeded 1% of total interest income and other operating income were charges for FDIC insurance totaling $234 thousand, other contracted services totaling $139 thousand, software licensing and maintenance totaling $179 thousand and telephone / data costs totaling $128 thousand.

Operating results of the Company when measured as a percentage of average equity reveals a decrease in return on average equity to 0.03% for the six-month period ended June 30, 2010 from 10.88% for the corresponding period in 2009. Return on average assets for the six months ended June 30, 2010 was 0.00% compared to 0.63% for the six months ended June 30, 2009.The provision for loan losses for the three-month and six-month periods ended June 30, 2010 totaled $679 thousand and $1.89 million, respectively, a $326 thousand and $1.15 million increase as compared to the corresponding periods in 2009. This increased provision was due to the continued recession resulting in increased charge-offs and past dues loans. The Company continually monitors the loan portfolio for signs of credit weaknesses or developing collection problems. Loan loss provisions for each period are determined after evaluating the loan portfolio and determining the level necessary to absorb current charge-offs and maintain the reserve at adequate levels. Net charge-offs for the first half of 2010 were $2.57 million compared with $680 thousand for the first half of 2009. Year–to–date net charge-offs were 0.53% and 0.14% of total loans for the periods ended June 30, 2010 and June 30, 2009, respectively. Loan loss reserves increased 110% to $11.01 million at June 30, 2010 from the amount at June 30, 2009. The Company’s allowance for loan loss reserves at June 30, 2010 increased to 2.28% of total loans versus 1.07% at June 30, 2009. At December 31, 2009, the allowance for loan loss reserve as a percentage of total loans was 2.40%.

Financial Position

Total loans decreased from $490.06 million at June 30, 2009 to $482.01 million at June 30, 2010. Total loans at December 31, 2009 were $486.11 million. During the six-month period ended June 30, 2010 2010, total loans decreased by $4.10 million.. Over the last few months, the Company has significantly decreased its construction portfolio as a result of the recent economic downturn. Since June 30, 2009 the Company has reduced its construction loan and other land loan balances from $49.38 million down to $34.72 million. The Company has also begun reducing its overall commercial real estate loan portfolio in an effort to increase its risk based capital ratios. The loan to deposit ratio decreased from 94.31% at June 30, 2009 to 91.70% at June 30, 2010. The loan to deposit ratio at December 31, 2009 was 93.50%. Deposits at June 30, 2010 have increased $6.03 million since June 30, 2009 and have increased $5.74 million since December 31, 2009. During the last 12 months, the Company has continued to lower the interest rates paid on time deposits in a continuing effort to reduce its cost of funds.

The Company’s average investment securities portfolio balance for the six months ended June 30, 2010 has decreased by approximately $43.19 million over the six months ended June 30, 2009 due to the Company’s decision not to replace what has matured or paid down during the last several months. Yields on typical investment securities during the current economic cycle have decreased significantly; therefore, management has intentionally decreased its security portfolio and maintained a significant amount of cash and cash equivalents during the last several months. The Company has also reduced its municipal bond holdings by approximately $14.05 million during the first six months of 2010.

The Company also owns approximately $4.92 million (carrying value) in collateralized debt obligation securities that are backed by trust preferred securities issued by banks, thrifts, and insurance companies (TRUP CDOs). The market for these securities at June 30, 2010 is not active and markets for similar securities are also not active. These securities are currently in non-accrual status. As of June 30, 2010, the unrealized loss in these securities totaled $4.01 million. Management feels that these losses are temporary and primarily a result of the current inactive market. The market discounts reflect the current illiquidity and the negative credit events within the banking sector. Continuing deterioration of profits of banks nationally and the possibility of increased bank failures could result in changes in the Company’s outlook for these securities and cause the Company to consider recording additional OTTI charges on these securities. During the six months ended June 30, 2010, the Company recorded OTTI credit related charges on its TRUPS CDOs in the amount of $724 thousand.

The Company has also paid off several other borrowings with pay-downs from the securities portfolio. The Company has utilized the Federal Home Loan Bank and other alternative funding sources to fund loan and asset growth. The Company currently has approximately $76.03 million in outstanding FHLB advances. No new advances were originated during the last 12 months. The Company has reduced its borrowings with the FHLB by $23 million dollars over the last year as interest rates have continued to decline and these higher rate borrowings were replaced with lower cost deposits. The Company secures all of its existing and future advances from the FHLB with a selected group of in-house residential and commercial real estate secured loans and a selected group of securities that are held in safekeeping by the FHLB.

Non-performing assets are comprised of loans on non-accrual status, loans contractually past due 90 days or more and still accruing interest, other real estate owned and repossessions. In addition, the market value of any securities available for sale placed in non accrual status are included. Non-performing assets were $33.43 million or 5.15% of total assets at June 30, 2010, compared with $23.95 million or 3.71% of total assets at December 31, 2009 and $10.33 million or 2.02% of total assets at June 30, 2009.

Non-performing assets at June 30, 2010 totaling $33.43 million are made up of the following:

Category	Amount included in non-performing total
Construction and other land loans	$ 4.69 million
Farmland	$ 905 thousand
1-4 family residential	$ 3.88 million
Second Mortgages	$ 102 thousand
Multifamily and commercial real estate	$ 9.69 million
Non-real estate secured	$ 798 thousand
Fair value of Debt securities	$ 912 thousand
OREO /repossessions	$ 12.45 million

The internal credit review department performs pre-approval analyses of large credits and also conducts credit review activities that provide management with an early warning of loan deterioration. The internal credit review department also prepares regular analyses of the adequacy of the allowance for loans losses. These analyses include calculations based upon a mathematical formula that considers identified potential losses on specific loans and makes pool allocations for historical losses for various loan types. In recent years, the Company has used a rolling three year history by loan category in determining pool allocation factors. However, due to the severe economic recession, the Company based its pool allocations beginning in March, 2010 to more closely match 2009 losses. In addition, an amount is allocated based upon such factors as changing trends in the loan mix, the effects of changes in business conditions and market area, unemployment trends, the effects of any changes in loan policies, the effects of competition, regulatory factors, and environmental factors on the loan portfolio. As a result of the continued recession, the Company has increased its reserve for loan losses by $5.77 million over June 30, 2009 due to the significant increase in non-performing and past due loans. The reserve for loan losses decreased $676 thousand since December 31, 2009 due to transferring a significant amount of non-performing loans into OREO. Total outstanding loan balances also decreased $4.12 million since December 31, 2009.

Loans for which it is probable that payment of interest and principal will not be made in accordance with the contractual terms of the loan agreement are considered impaired. Once a loan is identified as individually impaired, management measures impairment using one of several methods, including collateral value, recent appraisal value and /or tax assessed value, liquidation value and discounted cash flows. Management has allocated approximately $5.06 million of its $11.01 million total loan loss reserve for these identified impaired loans. The remaining allowance for loan loss reserve is allocated to the different pool segments as well as other internal and external factors related to the current economic environment.

The Company’s OREO balance is currently $12.45 million and has increased $6.69 million since June 30, 2009. Of this total, $5.22 million is residential property and $7.23 is commercial real estate / vacant land. The Company’s OREO balance at December 31, 2009 was $6.85 million. The ability to sell OREO has been negatively affected by the current economic climate. The Company has recently formed a special assets committee to focus directly on selling OREO properties and reducing other non-performing assets. The committee is comprised of lending officers from all three market areas. The Company has seen increased deterioration in the Tennessee commercial real estate market. The reduction in non-performing assets will to a large degree depend on how quickly the Company’s specific market areas rebound from the current recession.

Investment securities and other investments totaled $68.74 million (market value) at June 30, 2010, which reflects a decrease of $10.62 million or 13.38% from the December 31, 2009 total of $79.36 million. Investment securities available for sale and other investments at June 30, 2010 were comprised of mortgage backed securities (31.47% of the total securities portfolio), municipal issues (47.52%), collateralized mortgage obligations (1.17%), corporate bonds (4.52%), U. S. government agencies (5.88%), and equity securities (0.16%). The Company’s entire securities portfolio was classified as available for sale at both June 30, 2010 and December 31, 2009.

Other investments include the Bank’s holdings of Federal Reserve, Federal Home Loan Bank, Pacific Coast Bankers Bank and Community Bankers Bank stock. These investments (carrying value of $6.38 million and 9.29% of the total) are considered to be restricted as the Company is required to hold these investments and the only market for these investments is the issuing agency.

Liquidity and Capital Resources

Total stockholders’ equity of the Company was $36.01 million at June 30, 2010, representing a decrease of $4.24 million or 10.54% from June 30, 2009. Total stockholders’ equity at December 31, 2009 was $35.43 million. The decrease in stockholders’ equity from June 30, 2009 to June 30, 2010 is primarily due to the reduction in earnings due to the additional loan loss provision recorded over the last 12 months. The Company’s other than temporary impairment losses recorded over the last 12 months did not negatively impact stockholders equity since these losses were already included in stockholders equity directly through Accumulated Other Comprehensive income.

Quantitative measures established by regulation to ensure capital adequacy require the Company and the Bank to maintain minimum amounts and ratios of total risk-based capital and Tier I capital to risk-weighted assets (as defined in the regulations), and Tier I capital to adjusted total assets (as defined). Management believes, as of June 30, 2010 and December 31, 2009, that the Company and the Bank met all the capital adequacy requirements to be classified as well capitalized to which they are subject.

The Company plans to aggressively reduce it higher risk weighted assets (primarily commercial real estate loans) as well as the overall asset size of the Banks over the next 12-18 months in an effort to improve its regulatory capital ratios. Management also plans to focus on reducing its non-performing assets.

Liquidity is the ability to provide sufficient cash levels to meet financial commitments and to fund loan demand and deposit withdrawals. The Company and subsidiary Bank maintain a significant level of liquidity in the form of cash and cash equivalents ($40.44 million as of June 30, 2010) and unrestricted investment securities available for sale ($17.14 million). Cash and cash equivalents are immediately available for satisfaction of deposit withdrawals, customer credit needs, and operations of the Company. The Bank also maintains a significant amount of available credit with both the Federal Home Loan Bank and two correspondent financial institutions. The Bank also has the ability to attract certificates of deposit outside its market area by posting rates on the internet. The primary investors utilizing this network are credit unions. Unencumbered investment securities available for sale represent a secondary level of liquidity available for conversion to liquid funds in the event of extraordinary needs. The Company believes that it maintains sufficient liquidity to meet its requirements and needs.

Forward-Looking Information

Certain information in this report may include “forward-looking statements” within the meaning of Section 27A of the Securities Act of 1933, as amended, and Section 21E of the Securities Exchange Act of 1934, as amended (the “Exchange Act”). These forward-looking statements are generally identified by phrases such as “the Company expects,” “the Company believes” or words of similar import. These statements speak only as of the date of this report. The statements are based on current expectations, are inherently uncertain, are subject to risks, and should be viewed with caution. Such forward-looking statements involve known and unknown risks including, but not limited to, the following factors:

·	Changes in general economic and business conditions in the Company’s market area;

·	Further deterioration in the housing market;

·	Continued problems related to the national credit crisis;

·	Changes in banking and other laws and regulations applicable to the Company;

·	The inability to timely liquidate non-performing assets, including loans and other real estate owned through foreclosure at prices that will prevent future losses;

·	Additional unforeseen loan losses and / or investment securities write-downs;

·	The ability to successfully manage the Company’s growth or implement its growth strategies if it is unable to identify attractive markets, locations or opportunities to expand in the future;

·	The ability to continue to attract low cost core deposits;

·	Maintaining adequate capital levels (below well capitalized);

·	Maintaining cost controls and asset qualities ;

·	Reliance on the Company’s management team, including its ability to attract and retain key personnel;

·	The successful management of interest rate risk;

·	Changes in interest rates and interest rate policies;

·	Risks inherent in making loans such as repayment risks and fluctuating collateral values;

·	Competition with other banks and financial institutions, and companies outside of the banking industry, including those companies that have substantially greater access to capital and other resources;

·	Demand, development and acceptance of new products and services;

·	Problems with technology utilized by the Company;

·	Changing trends in customer profiles and behavior; and

·	Other factors described in our current and periodic reports filed with the SEC from time to time.

Although the Company believes that its expectations with respect to the forward-looking statements are based upon reliable assumptions within the bounds of its 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.

ITEM 3. Quantitative and Qualitative Disclosures About Market Risk

N/A

ITEM 4. Controls and Procedures

We have carried out an evaluation, under the supervision and the participation of our management, including our Chief Executive Officer, Chief Financial Officer and Vice President of Accounting, of the effectiveness of the design and operation of our disclosure controls and procedures (as defined in Rule 13a-15(e) under the Exchange Act) as of the end of the period covered by this report. Based upon that evaluation, our Chief Executive Officer, Chief Financial Officer and Vice President of Accounting concluded that our disclosure controls and procedures are effective in providing reasonable assurance that (a) the information required to be disclosed by us in the reports that we file or submit under the Exchange Act is recorded, processed, summarized and reported within the time periods specified in the SEC’s rules and forms, and (b) such information is accumulated and communicated to our management, including our Chief Executive Officer, Chief Financial Officer and Vice President of Accounting, as appropriate to allow timely decisions regarding required disclosure.

There have not been any changes in the Company’s internal controls over financial reporting during the second quarter of 2010 that have materially affected, or are reasonably likely to materially affect, our internal control over financial reporting.

PART II. OTHER INFORMATION

Item 1. Legal Proceedings

None.

Item 1A. Risk Factors

Not applicable

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

The Company had no repurchases of common stock during the three months ended June 30 2010. The Company does not anticipate any significant repurchases during 2010 in an effort to retain regulatory capital during the economic downturn. The Company currently has 5,011,152 shares of common stock outstanding.

Item 3. Defaults Upon Senior Securities

None

Item 4. Removed and Reserved

Item 5. Other Information

None

Item 6. Exhibits

31.1

Rule 13a-14(a) Certification of Executive Vice President and Chief Executive Officer

31.2

Rule 13a-14(a) Certification of Chief Financial Officer

31.3

Rule 13a-14(a) Certification of Vice President of Accounting

32.1

Certification Statement of Executive Vice President and Chief Executive Officer pursuant to 18 U.S.C. Section 1350.

32.2

Certification Statement of Chief Financial Officer pursuant to 18 U.S.C. Section 1350.

32.3

Certification Statement of Vice President of Accounting pursuant to 18 U.S.C. Section 1350.

SIGNATURES

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

	HIGHLANDS BANKSHARES, INC. (Registrant)

Date: August 12, 2010	By:	/s/Samuel L. Neese
		Executive Vice President and
		Chief Executive Officer



Date: August 12, 2010	By:	/s/Robert M. Little, Jr.
		Robert M.Little, Jr.
		Chief Financial Officer



Date: August 12, 2010	By:	/s/James R. Edmondson
		James R. Edmondson
		Vice President-Accounting

Exhibits Index

31.1

Rule 13a-14(a) Certification of Executive Vice President and Chief Executive Officer

31.2

Rule 13a-14(a) Certification of Chief Financial Officer

31.3

Rule 13a-14(a) Certification of Vice President of Accounting

32.1

Certification Statement of Executive Vice President and Chief Executive Officer pursuant to 18 U.S.C. Section 1350.

32.2

Certification Statement of Chief Financial Officer pursuant to 18 U.S.C. Section 1350.

32.3

Certification Statement of Vice President of Accounting pursuant to 18 U.S.C. Section 1350.