Item 1. Description of Business
General
Highlands Bankshares, Inc. (hereinafter referred to as "Highlands"), incorporated under the laws of West Virginia in 1985, is a multi-bank holding company subject to the provisions of the Bank Holding Company Act of 1956, as amended, and owns 100% of the outstanding stock of its subsidiary banks, The Grant County Bank and Capon Valley Bank (hereinafter referred to as the "Banks"), its life insurance subsidiary, HBI Life Insurance Company (hereinafter referred to as "HBI Life") and its trust subsidiary, Highlands Bankshares Trust Company (hereinafter referred to as "HBTC").
The Grant County Bank was chartered on August 6, 1902, and Capon Valley Bank was chartered on July 1, 1918. Both are state banks chartered under the laws of the State of West Virginia. HBI Life was chartered in April 1988 under the laws of the State of Arizona. HBTC was chartered in December 2000 under the laws of the state of West Virginia.
Services Offered by the Banks
The Banks offer all services normally offered by a full service commercial bank, including commercial and individual demand and time deposit accounts, commercial and individual loans, drive-in banking services and automated teller machines. No material portion of the banks' deposits have been obtained from a single or small group of customers and the loss of the deposits of any one customer or of a small group of customers would not have a material adverse effect on the business of the banks. Credit life accident and health insurance are sold to customers of the subsidiary banks through HBI Life. Trust services are offered through HBTC.
Employees
As of December 31, 2001, The Grant County Bank had 58 full time equivalent employees and Capon Valley Bank had 42 full time equivalent employees. Highlands employs two persons as full time equivalents. No person is employed by HBI Life on a full time basis. HBTC had two full time equivalent employees at year-end.
Competition
The banks' primary trade area is generally defined as Grant County, Hardy County, Mineral County, Randolph County, Frederick County, portions of Western Maryland and the northern part of Pendleton County. This area includes the cities of Petersburg, Wardensville, Moorefield and Keyser and several rural towns. The banks' secondary trade area includes portions of Hampshire County in West Virginia. The banks compete with four state chartered banks and six national banks. In addition, the banks compete with money market mutual funds and investment brokerage firms for deposits in their service area. No financial institution has been chartered in the area within the last five years although branches of state and nationally chartered banks have located in this area within this time period. Competition for new loans and deposits in the banks' service area is quite intense and all banks have been forced to pay rates on deposits which exceed the national averages.
Regulation and Supervision
Highlands is subject to the periodic reporting requirements of the Securities Exchange Act of 1934. These include, but are not limited to, the filing of annual, quarterly and other current reports with the Securities and Exchange Commission.
Regulation and Supervision (Continued)
Highlands, as a bank holding company, is subject to the provisions of the Bank Holding Company Act of 1956, as amended (the "Act"). It is registered as such and is supervised by the Federal Reserve Board. The Act requires Highlands to secure the prior approval of the Federal Reserve Board before Highlands acquires ownership or control of more than five percent of the voting shares, or substantially all of the assets of any institution, including another bank.
As a bank holding company, Highlands is required to file with the Federal Reserve Board an annual report and such additional information as it may require pursuant to the Act. The Federal Reserve Board may also conduct examinations of Highlands and any or all of its subsidiaries. Under Section 106 of the 1970 Amendments to the Act and the regulations of the Federal Reserve Board, a bank holding company and its subsidiaries are prohibited from engaging in certain tie-in arrangements in connection with an extension of credit, provision of credit, sale, or lease of property or furnishing of services.
Federal Reserve Bank regulations permit bank holding companies to engage in nonbanking activities closely related to banking or to managing or controlling banks. These activities include the making or servicing of loans, trust services, performing certain data processing services, and certain leasing and insurance agency activities. HBI Life acts as reinsurer of the credit life insurance coverage sold by the Banks to bank customers. HBTC provides trust services to customers of the Banks. Approval of the Federal Reserve Board is necessary to engage in any of these activities or to acquire corporations engaging in these activities.
The operations of the Banks are subject to federal and state statutes which apply to state chartered banks. Bank operations are also subject to the regulations of the Federal Deposit Insurance Corporation (the "FDIC"), which insures the banks' deposits. In addition, the Capon Valley Bank is a member of the Federal Reserve Bank System and is subject to the regulations of the Federal Reserve Bank Board.
The supervisory authorities regularly examine such areas as reserves, loans, investments, management practices, and other aspects of the banks' operations. These examinations are designed primarily for the protection of depositors. In addition to these regular examinations, the banks must furnish the various regulatory authorities quarterly reports containing a full and accurate statement of its affairs.
The operations of the insurance subsidiary are subject to the oversight and review of State of Arizona Department of Insurance.
The operations of the trust company are subject to the oversight and review of the State of West Virginia and the Federal Reserve Bank.
Item 2.
Item 2. Description of Properties
The Grant County Bank's main office is located on Main Street in Petersburg, West Virginia. In July 2000, the Bank acquired a full service branch in Harman through the purchase of the Stockmans' Bank of Harman. This location primarily serves Randolph County. The Bank also has branch facilities in Moorefield, Keyser and Riverton, West Virginia which provide banking services in Hardy County, Mineral County, and northwest Pendleton County, respectively. The Riverton branch building is leased while all other locations are owned by the Bank.
Capon Valley Bank has its main office in Wardensville, West Virginia and branch offices located in Moorefield and Baker, West Virginia and Gore, Virginia. The Wardensville location was substantially renovated and expanded in 2000 to enhance customer service. Capon's offices serve mainly Hardy County and Hampshire County, West Virginia, with the Gore branch servicing Frederick County, Virginia. All facilities include state-of-the-art drive in and automated teller operations. All facilities are owned by the Bank and considered adequate for current operations.
Item 3.
Item 3. Legal Proceedings
Management is not aware of any material pending or threatened litigation in which Highlands or its subsidiaries may be involved as a defendant. In the normal course of business, the banks periodically must initiate suits against borrowers as a final course of action in collecting past due loans.
Item 4.
Item 4. Submission of Matters to a Vote of Security Holders
Highlands has not submitted any matters to the vote of security holders for the quarter ending December 31, 2001.
Part II
Item 5.
Item 5. Market for Common Equity and Related Stockholder Matters
The Company had approximately 825 stockholders of record as of March 1, 2002. This amount includes all shareholders, whether titled individually or held by a brokerage firm or custodian in street name. The Company's stock is not traded on any national or regional stock exchange although brokers in Cumberland, Maryland or Winchester and Harrisonburg, Virginia may occasionally initiate or be a participant in a trade. Terms of an exchange between individual parties may not be known to the Company. The following outlines the dividends paid and market prices of the Company's stock based on prices disclosed to management. Prices have been provided by a broker in Winchester who is making a market in the Company's stock. Such prices may not include retail mark-ups, mark-downs or commissions.
Dividends Market Price Range 2001 Per Share High Low ---- --------- ---- ---
First Quarter $.34 $51.00 $47.00 Second Quarter .34 50.00 47.13 Third Quarter .34 50.25 47.75 Fourth Quarter .34 50.00 46.60
First Quarter $.31 $59.00 $57.00 Second Quarter .31 58.50 50.13 Third Quarter .31 55.00 51.00 Fourth Quarter .31 51.00 48.00
Item 6.
Item 6. Management's Discussion and Analysis of Financial Condition and Results of Operations
Overview
The Company's 2001 net income of $2,480,785 represents a 4.19% increase in net income and earnings per share compared to 2000. This represented a return on average equity of 9.08% for 2001 compared to 9.40% for 2000. Returns on average assets for 2001 and 2000 were .94% and 1.03%, respectively. The increase in earnings was due to an increase in the volume of earning assets and was achieved in spite of a declining interest margin.
The tax equivalent interest income increased by $2,001,000 in 2001 to $20,306,000 as compared to 2000. A 14.16% increase in the level of earning assets, nearly double the previous year's increase, more than offset the decrease in yields for 2001, creating the earnings improvement. A 12.49% increase in average loans outstanding was the result of a good local economy and was spread across all types of loans. The increase was also partly attributable to the acquisition of the branch at Harman. The funding of the asset growth was from deposits of local customers (primarily time deposits) and declines in securities available for sale.
Noninterest income decreased 5.47% in 2001 compared to 2000 due to an absence of security gains, a slight reduction in service charge income and an increase in the claims experience in the insurance company over year 2000. Noninterest expenses increased 8.74% in 2001 due mainly to the higher personnel and occupancy expenses.
Net Interest Margin
2001 compared to 2000
The Company's net interest margin on a tax equivalent basis was $10,257,000 for 2001 compared to $9,515,000 for 2000. The increase was due to an increase in average earning assets (14.16%) while maintaining deposit and borrowings liability costs at 4.84% for both years. Average loans outstanding grew by 12.49% from 2000 to 2001. This growth reflected good local economic conditions, even in a declining interest rate environment. The overall cost of funds reflected the high level of competition for deposits in the Company's service area which has traditionally paid higher rates on deposits than larger, statewide financial institutions. Efforts to reduce this discrepancy have been moderately successful and are expected to show future benefits in the form of lower interest expenses. The deposit increase was the result of growth in the area of time deposit accounts and was obtained primarily from customers in the immediate service areas.
Loans outstanding at December 31, 2001 increased 8.56% over amounts at December 31, 2000. The loan increase was the result of continued efforts to increase lending in existing markets. Loan growth was funded primarily by deposit growth, with a small amount of additional borrowings from the Federal Home Loan Bank. The increase in the dollar amount of tax equivalent net interest margin for 2001 over the 2000 amounts is the result of an annualized growth in average earning assets of 14.16%. The Company anticipates its net interest margin to remain stable or rise slightly in the first six months of 2002 due to the maturing of higher rate liabilities. This improvement in the net interest margin should continue as long as interest rates remain stable or increase gradually. Rates paid on deposits are expected to stabilize over the next twelve months as the Federal Reserve Bank's rate cuts have been less frequent and the economy shows signs of recovery. Returns on most loans have repricing opportunities within the next twelve months and the Company should be able to slightly improve its net interest margin in this anticipated rate environment.
A summary of the net interest margin analysis is shown as Table II on page 22.
Net Interest Margin (Continued)
2000 Compared to 1999
The Company's net interest margin on a tax equivalent basis was $9,515,000 for 2000 compared to $8,716,000 for 1999. The increase was due to an increase in average earning assets (7.11%) and a consistent spread (the difference in rates earned on assets and paid on liabilities) of 3.70% in 1999 to 3.69% in 2000. Average loans outstanding grew by 13.48% from 1999 to 2000. This growth reflected good local and national economic conditions, slightly increasing interest rates and acquiring an additional banking facility. The deposit increase represented growth in savings and time deposit accounts and was obtained primarily from customers in the immediate service areas.
Loans outstanding at December 31, 2000 increased 13.60% over amounts at December 31, 1999. The loan increase was the result of acquiring a branch in a new market area and continued efforts to increase lending in existing markets. Loan growth was funded primarily by deposit growth with declines in the level of security investments. The net interest margin for 2000 was 4.43% and for 1999 was 4.35%, reflecting the results of increasing rates on all types of earning assets and all types of deposit accounts.
A summary of the net interest margin analysis is shown as Table II on Page 22.
Provision for Loan Losses
The Company's provisions for loan losses were $600,000 for 2001, $500,000 for 2000, and $320,000 for 1999. Net loan losses were $490,000 in 2001 compared to $412,000 in 2000 and $357,000 in 1999. The Company's three year charge off rate of .24% of average loans outstanding compares closely with its peer group. The 2001 charge off percentage of .25% of average loans was slightly above the peer group average for the year 2001 and reflects some charged off loans acquired in the prior year acquisition of the Harman Branch. (See the following discussion relating to the allowance for loan losses.)
Noninterest Income
2001 Compared to 2000
Noninterest income for 2001 decreased 5.47% from 2000. Decreases in service charge income of 1.76% were largely due to the loss of one large corporate customer which was bought and financially managed from outside the local area. Decreases in insurance commissions of 23.70% were the result of above average claims experienced during the year. Offsetting these declines was greater income from investments in insurance contracts which showed improved profitability in 2001. There were no gains or losses on security transactions in 2001 as no securities were sold. The $104,000 gain on security transactions in 2000 was due to unusual circumstances involving securities involved in the acquisition of the Stockmans Bank and were not repeated in 2001.
2000 Compared to 1999
Overall noninterest income increased in 2000 by 23.03% when compared with 1999 operations. Increases in service charge income were the result of volume increases and increased rates for non sufficient funds (NSF) checks. Other operating income declined due to a $165,000 gain from the demutualization of an insurance company in 1999 which was not repeated in 2000. The Company did recognize greater income from investments in insurance contracts due to a complete year of investing in these assets. Gains of $104,000 from the sale of investments in 2000 compared to losses from the sale of investments in 1999 of $65,000 added $169,000 to total noninterest income.
Noninterest Expenses
2001 Compared to 2000
Total noninterest expenses increased 8.74% in 2001 when compared with 2000 operations. Salaries and benefits increased 8.49% due to the increase in staff at the new branches, merit raises and higher benefit costs. Average full time equivalent employees increased 9.89% in 2001 due mainly to staffing the new branches in Gore, VA and Harman. The costs of occupancy and equipment increased 18.82% due to depreciation associated with the new and renovated facilities and equipment upgrades. Data processing expenses increased by 8.03% due to general asset growth and expanded locations. Other operating expenses increased 4.30% for all of the reasons cited above. Noninterest expense as a percentage of average assets was 2.73% in 2001 compared to 2.86% in 2000 and 2.74% in 1999. These ratios compare favorably to the Company's peer group. The overall increase in noninterest expenses is a reflection of additional locations which generally take one to three years to become profitable.
2000 Compared to 1999
Overall, noninterest expense increased 12.15% in 2000 when compared to 1999. Personnel expenses increased 12.34% as the result of additional locations, higher benefit costs and merit raises. Occupancy and equipment expenses increased 14.78% as the result of a full year of costs, including depreciation, for the Moorefield branch and equipment upgrades. Data processing expenses increased by 3.45% as a result of volume growth and expanded locations. Other noninterest expenses increased by 13.22% due to asset growth and new locations costs.
Financial Condition
Loan Portfolio
The Company is an active residential mortgage and construction lender and generally extends commercial loans to small and medium sized businesses within its primary service area. The Company's commercial lending activity extends across its primary service areas of Grant, Hardy, Hampshire, Mineral, Randolph, northern Pendleton counties and Frederick County, VA. Consistent with its focus on providing community-based financial services, the Company does not attempt to diversify its loan portfolio geographically by making significant amounts of loans to borrowers outside of its primary service area.
The principal economic risk associated with each of the categories of loans in the Company's portfolio is the creditworthiness of its borrowers. Within each category, such risk is increased or decreased depending on prevailing economic conditions. The risk associated with the real estate mortgage loans and installment loans to individuals varies based upon employment levels, consumer confidence, fluctuations in value of residential real estate and other conditions that affect the ability of consumers to repay indebtedness. The risk associated with commercial, financial and agricultural loans varies based upon the strength and activity of the local economies of the Company's market areas. The risk associated with real estate construction loans varies based upon the supply of and demand for the type of real estate under construction.
Loans outstanding increased $16,201,000 or 8.56% in 2001. All loan types recognized significant growth with the exception of real estate construction. The loan to deposit ratio was 84.89% at December 31, 2001 compared to 87.39% at December 31, 2000. Management believes this level of lending activity is satisfactory to generate adequate earnings without undue credit risk. Loan demand is expected to remain satisfactory in the near future with any growth a function of local and national economic conditions.
Financial Condition (Continued)
Loan Portfolio (Continued)
The following table presents the year-end balances of loans, classified by type (in thousands):
2001 2000 1999 1998 1997 ---- ---- ---- ---- ---- Real estate loans: Construction and land development $ 4,105 $ 4,096 $ 3,296 $ 2,969 $ 2,189 Secured by farmland 9,464 10,059 9,219 9,586 9,436 Secured by 1-4 family residential properties 75,771 72,408 67,775 64,372 59,126 Secured by multi- Family (5 or more) residential properties Secured by nonfarm, non-residential properties 48,282 39,122 33,064 28,142 26,076
Loans to farmers 1,238 567 391 449 541 Commercial and industrial loans 9,652 8,029 6,568 4,498 3,101 Consumer loans 56,366 54,691 46,266 38,353 35,414 Loans for nonrated industrial development obligations 458 275 All other loans 133 21 35 15 1,222 ------- ------ ------- ------ -------
Loans - net of unearned income $205,469 $189,268 $166,614 $148,384 $137,105 ======= ======= ======= ======= =======
There were no foreign loans outstanding during any of the above periods.
The following table summarizes the Company's loan portfolio, net of unearned income:
At December 31, ---------------------------------------------- 2001 2000 1999 ---- ---- ---- (In Thousands of Dollars) Real Estate: Mortgage $111,668 $101,890 $ 93,391 Construction 3,868 4,061 3,296 Commercial 42,204 37,681 31,567 Installment 47,927 46,191 39,994 ------- ------- -------
205,667 189,823 168,248 Less unearned discount (198) (555) (1,634) -------- ------- -------
205,469 189,268 166,614 Allowance for loan losses (1,603) (1,493) (1,318) -------- ------- -------
Loans, net $203,867 $187,775 $165,296 ======= ======= =======
Financial Condition (Continued)
Loan Portfolio (Continued) The following table shows the maturity of loans outstanding (in thousands of dollars) as of December 31, 2001, 2000 and 1999.
Maturity Range 2001 2000 1999 -------------- ---- ---- ----
Predetermined Rates: 0 - 12 months $ 99,049 $105,054 $ 91,080 13 - 60 months 68,106 75,918 61,193 More than 60 months 37,429 8,264 14,147 Nonaccrual Loans 885 32 194 ------- ------- -------
Total Loans $205,469 $189,268 $166,614 ======= ======= =======
The following table shows the Company's loan maturity distribution (in thousands of dollars) as of December 31, 2001: Maturity Range Less Than 1-5 Over Loan Type 1 Year Years 5 Years Total --------- ------- ----- ------- -----
Commercial and Agricultural Loans $ 29,425 $ 6,280 $ 6,499 $ 42,204 Real Estate - mortgage 53,274 27,376 31,018 111,668 Real Estate - construction 3,868 3,868 Consumer - installment 12,482 34,450 797 47,729 ------- ------- ------- -------
Total $ 99,049 $ 68,106 $ 38,314 $205,469 ======= ======= ======= =======
Nonperforming loans include nonaccrual loans, loans 90 days or more past due and restructured loans. Nonaccrual loans are loans on which interest accruals have been discontinued. Loans are placed in nonaccrual status when the collection of principal or interest is 120 days past due and collection is uncertain based on the net realizable value of the collateral and/or the financial strength of the borrower. Also, the existence of any guaranties by federal or state agencies is given consideration in this decision. The policy is the same for all types of loans. Restructured loans are loans which a borrower has been granted a concession on the interest rate or the original repayment terms because of financial difficulties. Nonperforming loans do not represent or result from trends or uncertainties which management reasonably expects will materially impact future operating results, liquidity, or capital resources. Nonperforming loans are listed in the table below.
Real estate acquired through foreclosure was $58,250 at December 31, 2001, $110,000 at December 31, 2000 and $121,000 at December 31, 1999. All foreclosed property held at December 31, 2001 was in the Company's primary service area. The Company's practice is to value real estate acquired through foreclosure at the lower of (i) an independent current appraisal or market analysis less anticipated costs of disposal, or (ii) the existing loan balance. The Company is actively marketing all foreclosed real estate and does not anticipate material write-downs in value before disposition.
Nonperforming loans increased 16.69% at December 31, 2001 compared to 2000. Nonaccrual loans dramatically increased as the result of two bankruptcies. Loans 90 and more days past due decreased 1.96% in spite of an 8.56% increase in total loans outstanding. The decrease in delinquent loans is a net result of the reclassification of the two bankruptcies and a corresponding increase in commercial loans due to one failed business, one bankruptcy and one workout. In addition, a substantial portion of the delinquent real estate loans have been guaranteed by state or federal agencies. Management does not anticipate any significant losses from the current level of nonperforming assets.
Financial Condition (Continued)
Loan Portfolio (Continued)
The following table summarizes the nonperforming loans:
At December 31, ------------------------------- 2001 2000 1999 ---- ---- ---- (Dollars in Thousands)
Loans accounted for on a nonaccrual basis Real estate $ 474 $ 32 $ 194 ------ ----- ------
Loans contractually past due 90 days or more as to interest or principal payments (not included in nonaccrual loans above) Commercial 607 60 89 Real estate 1,352 1,984 1,465 Installments 336 297 140 ------ ----- ------
Total Delinquent Loans 2,295 2,341 1,694 ------ ----- ------
Total Nonperforming Loans $ 2,769 $2,373 $ 1,888 ====== ===== ======
An inherent risk in the lending of money is that the borrower will not be able to repay the loan under the terms of the original agreement. The allowance for loan losses (see subsequent section) provides for this risk and is reviewed periodically for adequacy. This review also considers concentrations of loans in terms of geography, business type or level of risk. While lending is geographically diversified within the service area, the Company does have some concentration of loans in the area of agriculture (primarily poultry farming), timber and related industries. Management recognizes these concentrations and considers them when structuring its loan portfolio. As of December 31, 2001, management is not aware of any significant potential problem loans for which the debtor is currently meeting their obligations as stated in the loan agreement but which may change in future periods.
As of December 31, 2001, the Company did not have any potential problem loans as defined in Guide 3 that would require disclosure.
Allowance for Loan Losses
Management has analyzed the potential risk of loss on the Company's loan portfolio given the loan balances and the value of the underlying collateral and has recognized losses where appropriate. Nonperforming loans are closely monitored on an ongoing basis as part of the Company's loan review process. Management reviews the loan loss allowance at the end of each quarter. Based primarily on the Company's loan classification system, which classifies problem credits as substandard, doubtful or loss, additional provisions for losses are made monthly. The ratio of the allowance for loan losses to total loans outstanding was .78% at December 31, 2001 and .79% at both December 31, 2000 and December 31, 1999. At December 31, 2001, the ratio of the allowance for loan losses to nonperforming loans was 57.89% compared to 62.92% at December 31, 2000 and 69.83% at December 31, 1999.
Allowance for Loan Losses (Continued)
The computation of the allowance for loan losses is based on guidelines established in FFIEC interagency statement SAB 102. This is a change in methodology from their previous computation. Both banks continue to classify loans into categories and assign a loss rate as follows to be used later in the calculation:
Loss 100% Doubtful 50% Substandard 15% Special mention 5%
All loans 90 days or more past due and nonaccrual loans are included in one of the four categories above. Generally, all loans in excess of $250,000 are evaluated individually as well as any loan regardless of size that is classified as loss, doubtful, substandard or special mention. This detailed review identifies each applicable loan for specific impairment and a specific allocation for that impaired amount is set aside as the first element in the calculation. In all sections of the calculation, the amounts are classified into "Installment," "Real Estate" or "Commercial".
After reducing the loan portfolio by the impaired loans, the above less ratios are applied to each category. For "Doubtful" collectibility, all loan balances receive a 50% allocation for loss; for "Substandard", a 15% allocation, for "Special Mention", a 5% allocation is added to the required reserve.
Additionally, all loans past due 90 days or more, not included in any of the above four loss categories, receive a 15% allocation. All other loans in the portfolio are evaluated as a group.
The remaining portfolio balances are assigned a loss factor based on the average net loss after recoveries over the last five years. Loss experience per classification varies significantly based on risk and collateral. Installment loans and Commercial loans, generally, have higher loss volumes than real estate secured loans. These actual loss experience factors are weighed by the average life of the loan category. Installments have a two to three year carrying life, real estate loans a five to six year life; and commercial loans a three to four year life. The net result creates a low and high range of allocated reserve. The Company's actual reserve balance is compared to this range and adjusted as deemed necessary.
The allowance for loan losses is computed quarterly and adjusted prior to the issuance of the quarterly financial statements. All loan losses charged to the allowance are approved by the boards of directors at their regular meetings. The allowance is reviewed for adequacy after considering historical loss rates, current economic conditions (both locally and nationally) and any known credit problems that have not been considered under the above formula.
Management continues to monitor the economic health of the poultry industry. The Company has direct loans to poultry growers and the industry is a large employer in the Company's trade area. Operating results for the industry have improved due to moderating grain prices and better turkey pricing but profitability in this industry is still quite volatile. Since Pilgrim's Pride purchase of WLR Foods, Inc. there has been no noticeable impact to the local economy, either positively or negatively. Loan requests for poultry house loans or expansion continue to be presented for approval.
Allowance for Loan Losses (Continued)
An analysis of the loan loss allowance is set forth in the following table (in thousands):
2001 2000 1999 1998 1997 ---- ---- ---- ---- ----
Balance at beginning of period $ 1,493 $ 1,318 $ 1,355 $ 1,370 $ 1,257
Charge-offs: Commercial loans 239 172 107 135 34 Real estate loans 92 128 87 53 20 Consumer loans 369 215 254 289 170 ------ ------- ------ ------- ------
700 515 448 477 224 ------ ------- ------ ------- ------
Recoveries: Commercial loans 57 2 16 6 9 Real estate loans 12 30 1 1 25 Consumer loans 141 71 74 100 113 ------ ------- ------ ------- ------
210 103 91 107 147 ------ ------- ------ ------- ------
Net charge-offs 490 412 357 370 77 Provision for loan losses 600 500 320 355 190 Other 87 ------ ------- ------ ------- ------ Balance at end of period $ 1,603 $ 1,493 $ 1,318 $ 1,355 $ 1,370 ====== ======= ====== ======= ======
Percent of net charge-offs to average net loans outstanding during the period .25% .23% .23% .26% .06% ======== ========= ======== ========= ========
Allowance for Loan Losses (Continued)
Cumulative net loan losses, after recoveries, for the five year period ending December 31, 2001 are as follows:
Commercial $ 597 34.99% Real estate 311 18.23% Consumer 798 46.78% ------ -----------
Total $ 1,706 100.00%
The above acts as the basis for allocating the overall allowances. Additional changes have been made in the allocation of the allowance to address unknowns, loan commitments, etc. The unallocated portion is not computed using a specific formula and is management's best estimate of what should be allocated for contingencies in the current portfolio. Without an unallocated reserve, the allocation would have been made along the lines of the five year average losses by loan type. In 2001, a greater portion was allocated to the real estate allowance and a lesser amount to the consumer allowance as changes in the calculation of the allowance placed more weight on the significantly higher proportion of balances and estimated longer loan life in real estate. A single loss involving the bankruptcy of one commercial loan was responsible for about 63% of the gross commercial charge-offs in 2001.
While 2001 losses were slightly above peer group amounts, they are considered reasonable in the eyes of management. The allowance as of December 31, 2001 was .78% of loans outstanding which is below peer group levels. However, management believes the present allowance, which is 3.82 times the average annual net charge-off rate over the last three years, is adequate based on its knowledge of the loan portfolio and historical performance.
Securities
The Company's securities portfolio serves several purposes. Portions of the portfolio are used to secure certain public and trust deposits. The remaining portfolio is held as investments or used to assist the Company in liquidity and asset liability management. During 2001, total securities increased to $31.9 million or 11.51% of total assets at December 31, 2001. Total securities were $25.8 million or 10.39% of total assets at December 31, 2000.
The securities portfolio consists of three components: securities held to maturity, securities available for sale and restricted securities. Securities are classified as held to maturity when management has the intent and the Company has the ability at the time of purchase to hold the securities to maturity. Held to maturity securities are carried at cost, adjusted for amortization of premiums and accretion of discounts. Securities to be held for indefinite periods of time are classified as available for sale and accounted for at market value. Securities available for sale include securities that may be sold in response to changes in market interest rates, changes in the security's prepayment risk, increases in loan demand, general liquidity needs and other similar factors. Restricted securities are those investments purchased as a requirement of membership in certain loan banks and cannot be transferred without the issuer's permission. The Company's purchases of securities have generally been limited to securities of high credit quality with short to medium term maturities.
Securities (Continued)
The Company identifies at the time of acquisition those securities that are available for sale. These securities are valued at their market value with any difference in market value and amortized cost shown as an adjustment in stockholders' equity. Changes within the year in market values are reflected as changes in stockholders' equity, net of the deferred tax effect. As of December 31, 2001, the fair value of the securities available for sale exceeded their cost basis by $449,000 ($283,000 after the related tax effect).
The following table summarizes the carrying value of the Company's securities at the dates indicated: Held to Maturity Available for Sale Carrying Value Carrying Value ---------------------------------------------------------- December 31, December 31, 2001 2000 1999 2001 2000 1999 ---- ---- ---- ---- ---- ---- (In Thousands of Dollars) (In Thousands of Dollars)
U.S. treasuries, agencies and corporations $ $ 88 $ $16,432 $18,719 $21,160 Obligations of states and political subdivisions 1,597 2,131 2,837 6,380 789 243 Mortgage-backed securities 6 9 340 6,609 3,275 4,339 ------ ------ ----- ------ ------ ------
Total Debt Securities 1,603 2,228 3,177 29,421 22,783 25,742
Other securities 39 52 151 ------ ------ ----- ------ ------ ------
Total $ 1,603 $ 2,228 $3,177 $29,460 $22,835 $25,893 ====== ====== ===== ====== ====== ======
The carrying amount and estimated market value of debt securities (in thousands of dollars) at December 31, 2001 by contractual maturity are shown below. Expected maturities will differ from contractual maturities because borrowers may have the right to call or prepay obligations with or without call or prepayment penalties.
Securities Held to Maturity Amortized Fair Average --------------------------- Cost Value Yield ------------ ----------- ---------
Due in one year or less $ 231 $ 233 6.84% Due after one year through five years 1,202 1,229 7.12% Due after five years through ten years 171 177 7.41% -------- --------- -----
Total Held to Maturity $ 1,603 $ 1,639 7.11% ======== ========= =====
Securities Available for Sale Amortized Fair Average ----------------------------- Cost Value Yield ------------ ----------- ---------
Due in one year or less $ 7,035 $ 7,133 5.22% Due after one year through five years 13,292 13,521 4.78% Due after five years through ten years 3,836 3,918 5.92% Due after ten years 4,806 4,848 5.98% -------- --------- -----
Total Fixed Rate Securities 28,969 29,421 5.24%
Equities 42 39 6.07% -------- --------- -----
Total Available for Sale $ 29,011 $ 29,460 5.24% ======== ========= =====
Yields on tax exempt securities are stated at tax equivalent yields.
Management has generally kept the maturities of investments relatively short providing for flexibility in investing. Such a philosophy allows the Company to better match deposit maturities with investment maturities and thus react more quickly to interest rate changes.
Deposits
The Company's predominant source of funds is local deposits. The Company's deposit base is comprised of demand deposits, savings and money market accounts and other time deposits. The Company's deposits are provided by individuals and businesses located within the communities served.
The average balance of interest bearing deposits increased by 14.32% in 2001 over average levels in 2000. The average rate paid on deposits increased to 4.84% in 2001 from 4.82% in 2000 and 4.46% in 1999. The majority of the Company's deposits are higher yielding time deposits as most of its customers are individuals who seek higher yields than savings accounts or don't wish to accept the risks of the stock market.
The Company does not actively solicit large certificates of deposit (those more than $100,000) due to the unstable nature of these deposits. Increases in 2001 are the result of overall deposit growth and higher than average rates offered by the Company. A summary of the maturity of large deposits is as follows: December 31, ---------------------------- Maturity Range 2001 2000 1999 -------------- ---- ---- ---- (In Thousands of Dollars)
Three months or less $ 8,980 $ 4,172 $ 6,341 Four to twelve months 21,965 14,336 12,342 One year to three years 10,018 13,753 7,100 Four years to five years 4,219 2,623 2,746 ------- ------- --------
Total $ 45,182 $ 34,884 $ 28,529 ======== ======= ========
Borrowed Money
The Company occasionally borrows funds from the Federal Home Loan Bank to reduce market rate risks and to fund capital additions. Such borrowings may have fixed repay or variable interest rates and are amortized over a period of ten to twenty years. Borrowings from this institution allow the banks to offer long-term, fixed rate loans to their customers and match the interest rate exposure of the receivable and the liability. The Company had additional borrowings in 2001 of $1,395,000 and repayments within the year of $881,000.
Capital Resources
The assessment of capital adequacy depends on a number of factors such as asset quality, liquidity, earnings performance and changing competitive conditions and economic forces. The Company seeks to maintain a strong capital base to support its growth and expansion activities, to provide stability to current operations and to promote public confidence.
The Company's capital position continues to exceed regulatory minimums. The primary indicators relied on by the Federal Reserve Board and other bank regulators in measuring strength of capital position are the Tier 1 Capital, Total Capital and Leverage ratios. Tier 1 Capital consists of common stockholders' equity. Total Capital consists of Tier 1 Capital and a portion of the allowance for loan losses. Risk-based capital ratios are calculated with reference to risk-weighted assets which consist of both on and off-balance sheet risks.
Capital Resources (Continued)
The following table shows risk-based capital ratios and stockholders' equity to total assets:
Regulatory December 31, Minimum 2001 2000 ----------- ---- ----
Capital Ratios -------------- Risk-based capital to risk- weighted assets Tier 1 8.00% 13.66% 15.17% Total 4.00% 14.46% 16.03% Stockholders' equity to total assets 5.00% 10.06% 10.57%
The capital management function is an ongoing process. Central to this process is internal equity generation accomplished by earnings retention. During 2001, 2000, and 1999, total stockholders' equity increased by $2,042,000, $2,044,000 and $1,378,000, respectively, as a result of earnings retention and changes in the unrealized gains (losses) on securities available for sale. The return on average equity was 9.08% in 2001 compared to 9.40% for 2000 and 9.94% for 1999. Total cash dividends declared represent 27.51% of net income for 2001 compared to 26.14% of net income for 2000 and 25.04% for 1999. Book value per share was $56.41 at December 31, 2001 compared to $52.34 at December 31, 2000 and $48.26 at December 31, 1999.
The Company's principal source of cash income is dividend payments from the Banks and insurance subsidiary. Certain limitations exist under applicable law and regulation by regulatory agencies regarding dividend payments to a parent by its subsidiaries. As of January 1, 2002, the Banks had $1,223,000 of retained earnings available for distribution to the Company as dividends without prior regulatory approval.
Liquidity and Interest Rate Sensitivity
Liquidity. Liquidity is the ability to meet present and future financial obligations through either the sale or maturity of existing assets or the acquisition of additional funds through liability management. Liquid assets include cash, interest bearing deposits with banks, federal funds sold, investments and loans maturing within one year. The Company's ability to obtain deposits and purchase funds at favorable rates determines its liability liquidity. As a result of the Company's management of liquid assets and the ability to generate liquidity through liability funding, management believes that the Company maintains overall liquidity sufficient to satisfy its depositors' requirements and meet its customers' credit needs.
Additional sources of liquidity available to the Company include, but are not limited to, loan repayments, the ability to obtain deposits through the adjustment of interest rates and the purchasing of federal funds. To further meet its liquidity needs, the Company also maintains lines of credit with correspondent financial institutions, the Federal Reserve Bank of Richmond and the Federal Home Loan Bank of Pittsburgh. In the past, growth in deposits and proceeds from the maturity of investment securities have been sufficient to fund the net increase in loans.
The investing activity saw a net increase in loans of $16,692,000, an increase in investments of $5,763,000 and an increase in fed funds sold of $6,245,000. New equipment and facility additions were $776,000 in 2001 compared with $1,288,000 in 2000. Funding these investments was an increase in deposits of $25,470,000 and retained operating income of $1,798,000.
Liquidity and Interest Rate Sensitivity (Continued)
In the year ending December 31, 2001, cash and due from banks decreased $570,000 as cash provided by operations and financing activities was less than cash used in investing activities. Cash provided by operations consists primarily of earnings from operations and noncash expenses such as the provision for loan losses, deferred income taxes and depreciation. The dividends paid of $683,000 in 2001 were an increase of 9.68 percent over 2000 amounts.
The Company is not aware of any trends, events or uncertainties that will have or that are reasonably likely to have a material effect on the Company's liquidity, capital resources or operations. The Company is not aware of any proposals from any regulatory authority which, if implemented, would have such an effect.
Interest Rate Sensitivity. In conjunction with maintaining a satisfactory level of liquidity, management must also control the degree of interest rate risk assumed on the balance sheet. Managing this risk involves regular monitoring of the interest sensitive assets relative to interest sensitive liabilities over specific time intervals.
At December 31, 2001, the Company had a negative gap position as of twelve months into the future. This position causes a squeeze on income in the short term in reaction to rate changes by the Federal Reserve Bank. With assets repricing at a level of 89% of the volume of interest bearing liabilities during the first year, the impact to earnings should be minimal due to the history of asset growth to absorb some of the effect. The Company expects a decrease in the overall cost of money in the first half of 2001 due to the maturity of certificates issued at higher rates and a gradual increase in all deposit rates for the rest of the year.
With the largest amount of interest sensitive assets and liabilities repricing within one year, the Company monitors this position closely. Early withdrawal of deposits, prepayments of loans and loan delinquencies are some of the factors that could affect actual versus expected cash flows. In addition, changes in rates on interest sensitive assets and liabilities may not be equal, which could result in a change in the net interest margin. While the Company does not match each of its interest sensitive assets against specific interest sensitive liabilities, it does periodically review its cumulative position of interest sensitive assets and liabilities.
The majority of the Company's commercial and real estate loans are made with repricing frequencies of three months to three years. For this reason, 82% of all loans will reprice within three years of December 31, 2001. Installment loans generally have a fixed rate of interest but have limited amortization periods. These loans have an average life to maturity of less than two years. Management believes that its philosophy of requiring loan repricing within a three to five year period to be the most prudent approach to asset/liability management.
In the area of investments, the Company employs a management technique known as "laddering" to minimize interest rate exposures and provide a constant flow of maturities subject to repricing at current market rates. To assist in the management of investments, the Company employs an independent investment counsel that advises it in planning and risk diversification. The Company utilizes many forms of investments with a significant use of mortgage-backed securities issued by federally chartered institutions. The Company does not employ the use of derivatives in its approach to controlling market risk. Although the majority of its investments are classified as available for sale, the Company rarely sells securities except in unusual circumstances.
Table IV (page 24) shows the maturity of liabilities and assets in future periods. Table III (page 23) shows the effects of rate and volume changes on the net interest margin for the past three year period.
Effects of Inflation
Inflation significantly affects industries having high levels of property, plant and equipment or inventories. Although the Company is not significantly affected in these areas, inflation does have an impact on the growth of assets. As assets grow rapidly, it becomes necessary to increase equity capital at proportionate levels to maintain the appropriate equity to asset ratios. Traditionally, the Company's earnings and high capital retention levels have enabled the Company to meet these needs.
The Company's reported earnings results have been affected by inflation, but isolating the effect is difficult. The different types of income and expense are affected in various ways. Interest rates are affected by inflation, but the timing and magnitude of the changes may not coincide with changes in the consumer price index. Management actively monitors interest rate sensitivity, as illustrated by the Gap Analysis (Table IV, page 24) in order to minimize the effects of inflationary trends on interest rates. Other areas of noninterest expenses may be more directly affected by inflation.
Securities and Exchange Commission WEB Site
The Securities and Exchange Commission maintains a WEB site that contains reports, proxy and information statements and other information regarding registrants (including the Company) that file electronically with the Commission. That address is (http: //www.sec.gov)
TABLE I
SUMMARY OF OPERATIONS
---------- Years Ending December 31,-------------- (In Thousands Except for Share Amounts) 2001 2000 1999 1998 1997
Total Interest Income $20,207 $18,207 $16,243 $15,772 $15,084 Total Interest Expense (10,049) (8,790) (7,663) (7,745) (7,474) ------ ------ ------ ------ ------
Net Interest Income 10,158 9,417 8,580 8,027 7,610 Provision for Loan Losses 600 500 320 355 190 ------ ------ ------ ------ ------
Net Interest Income after Provision for Loan Losses 9,558 8,917 8,260 7,672 7,420 Other Income 1,194 1,263 1,026 735 571 Other Expenses 7,210 6,631 5,912 5,377 5,115 ------ ------ ------ ------ ------
Income before Income Taxes 3,542 3,549 3,374 3,030 2,876 Income Tax Expense 1,061 1,168 1,049 1,018 996 ------ ------ ------ ------ ------
Net Income $ 2,481 $ 2,381 $ 2,325 $ 2,012 $ 1,880 ====== ====== ====== ====== ======
Net Income Per Share $ 4.94 $ 4.74 $ 4.63 $ 4.01 $ 3.73 Dividends Per Share $ 1.36 $ 1.24 $ 1.16 $ 1.08 $ 1.00
Total Assets at Year End $276,778 $248,600 $220,481 $210,981 $190,770 ======= ======= ======= ======= =======
Return on Average Assets .94% 1.03% 1.08% 1.01% 1.00% Return on Average Equity 9.08% 9.40% 9.94% 9.12% 8.80% Dividend Payout Ratio 27.51% 26.14% 25.04% 26.94% 26.80% Year End Equity to Assets Ratio 10.23% 10.57% 10.99% 10.83% 11.16%
1 Yields are computed on a taxable equivalent basis using a 37% income tax rate. 2 Average balances are based on daily balances. 3 Includes loans in nonaccrual status. 4 Average balances for securities available for sale are based on amortized carrying values and do not reflect changes in market values.
TABLE III
EFFECT OF RATE-VOLUME CHANGES ON NET INTEREST INCOME (On a fully taxable equivalent basis) (In thousands of dollars)
2001 Compared to 2000 2000 Compared to 1999 ------------------------- ------------------------- Increase (Decrease) Increase (Decrease)
Due to Change in: Total Due to Change in: Total Average Average Increase Average Average Increase Volume Rate (Decrease) Volume Rate (Decrease) -------- -------- --------- ------ ------ -------
Interest Income:
Loans 2 $1,985 $ 17 $2,002 $1,841 $ 353 $2,194
Investment Securities: Taxable (117) (79) (196) (159) 45 (114) Nontaxable 17 (12) 5 8 (17) (9) ----- ---- ---- ---- ----- -----
Total Investment Securities (100) (91) (191) (151) 28 (123)
Interest bearing deposits in banks 121 (52) 69 (37) (6) (43) Federal funds sold 484 (363) 121 (169) 67 (102) ----- ----- ---- ----- ---- ----
Total Interest Income 2,490 (489) 2,001 1,484 442 1,926 ----- ----- ----- ----- ---- -----
Interest Expense:
Deposits: Demand (49) (298) (347) (72) 130 58 Savings 99 (203) (104) 15 52 67 All other time deposits 1,334 376 1,710 610 318 928 Other borrowed money 21 (21) 0 65 9 74 ----- ----- ---- ---- ---- ----
Total Interest Expense 1,405 (146) 1,259 618 509 1,127 ----- ----- ----- ---- ---- -----
Net Interest Income $1,085 $(343) $ 742 $ 866 $ (67) $ 799 ===== ==== ==== ==== ===== ====
1 Changes in volume are calculated based on the difference in average balance multiplied by the prior year average rate. Rate change differences are the difference in the volume changes and the actual dollar amount of interest income or expense changes.
2 Nonaccrual loans have been included in average asset balances.
TABLE IV
INTEREST RATE SENSITIVITY ANALYSIS (In thousands of dollars) DECEMBER 31, 2001
More than 5 Years 1 - 90 91 - 365 1 to 3 3 to 5 or Without Days Days Years Years Maturity Total EARNINGS ASSETS
Loans $26,953 $87,763 $54,024 $24,919 $11,810 $205,469 Fed funds sold 13,284 13,284 Securities 5,880 7,914 11,136 3,103 3,822 31,855 Interest bearing time deposits 5,934 300 100 6,334 ------ ------ ------ ------ ----- ------
Total 52,051 95,977 65,260 28,022 15,632 256,942 ------ ------ ------ ------ ------ -------
INTEREST BEARING LIABILITIES
Transaction accounts 17,936 17,936 Money market accounts 11,407 11,407 Savings accounts 26,782 26,782 Time deposits more than $100,000 8,980 21,965 10,018 4,219 45,182 Time deposits less than $100,000 27,345 51,312 24,479 8,220 100 111,456 Other borrowed money 337 163 1,320 725 1,978 4,523 ------ ------ ------ ------ ----- ------
Total 92,787 73,440 35,817 13,164 2,078 217,286 ------ ------ ------ ------ ----- -------
Discrete interest sensitivity GAP (40,736) 22,537 29,443 14,858 13,544
Cumulative interest sensitivity GAP (40,736) (18,199) 11,244 26,102 39,656
Ratio of cumulative Interest sensitive assets to cumulative interest sensitive liabilities 56.10% 89.05% 105.57% 112.13% 118.25%
Assumes all transaction, money market and savings deposit accounts reprice within 90 days.
TABLE V
QUARTERLY FINANCIAL RESULTS (In thousands, except per share amounts)
Fourth Third Second First Quarter Quarter Quarter Quarter
Interest income $ 4,964 $ 5,126 $ 5,161 $ 4,956 Interest expense 2,451 2,562 2,537 2,499 -------- -------- -------- --------
Net interest income 2,513 2,564 2,624 2,457 Provision for loan losses 210 135 135 120 -------- -------- -------- -------- Net interest income after provision 2,303 2,429 2,489 2,337
Non-interest income 370 281 269 274 Non-interest expense 1,894 1,828 1,768 1,720 -------- -------- -------- --------
Income before income tax provision 779 882 990 891 Income tax provision 119 302 343 297 -------- -------- -------- --------
Net Income $ 660 $ 580 $ 647 $ 594 ======== ======== ======== ========
Per common share: Net income (basic) $ 1.31 $ 1.16 $ 1.29 $ 1.18 Net income (diluted) 1.31 1.16 1.29 1.18 Cash dividends .34 .34 .34 .34
Interest income $ 4,922 $ 4,737 $ 4,368 $ 4,180 Interest expense 2,441 2,306 2,083 1,960 -------- -------- -------- --------
Net interest income 2,481 2,431 2,285 2,220 Provision for loan losses 190 90 100 120 -------- -------- -------- -------- Net interest income after provision 2,291 2,341 2,185 2,100
Non-interest income 432 284 268 279 Non-interest expense 1,767 1,654 1,639 1,571 -------- -------- -------- --------
Income before income tax provision 956 971 814 808 Income tax provision 229 356 313 270 -------- -------- -------- --------
Net Income $ 727 $ 615 $ 501 $ 538 ======== ======== ======== ========
Per common share: Net income (basic) $ 1.45 $ 1.22 $ 1.00 $ 1.07 Net income (diluted) 1.45 1.22 1.00 1.07 Cash dividends .31 .31 .31 .31
Item 7.
Item 7. Financial Statements
Page
Consolidated Balance Sheets as of December 31, 2001 and 2000 27
Consolidated Statements of Income for the Years Ended December 31, 2001, 2000 and 1999 28
Consolidated Statements of Changes in Stockholders' Equity for the Years Ended December 31, 2001, 2000 and 1999 29
Consolidated Statements of Cash Flows for the Years Ended December 31, 2001, 2000 and 1999 30
Notes to Consolidated Financial Statements 31
Independent Auditors' Report 49
CONSOLIDATED BALANCE SHEETS
HIGHLANDS BANKSHARES, INC. December 31, ASSETS 2001 2000 ----------------------------
Cash and due from banks (notes 2, 3 and 16) $ 6,492,361 $ 7,061,961 Interest bearing deposits in banks 6,333,551 6,360,931 Federal funds sold 13,284,408 7,039,508 Investments: Securities held to maturity (note 4) 1,603,393 2,228,390 (fair value of $1,638,968 and $2,233,856 at December 31, 2001 and 2000, respectively) Securities available for sale (note 4) 29,460,117 22,835,324 Other investments 791,650 763,050
Loans (notes 5, 14, 15 and 16) 205,469,148 189,267,688 Less allowance for loan losses (note 6) (1,602,536) (1,492,936) ----------- -----------
Net Loans 203,866,612 187,774,752
Bank premises and equipment (note 7) 7,055,640 6,809,453 Interest receivable 1,817,884 1,901,296 Investment in insurance contracts 5,100,262 4,854,304 Other assets 971,993 971,124 ----------- -----------
Total Assets $276,777,871 $248,600,093 =========== ===========
LIABILITIES
Deposits: Noninterest bearing $ 29,278,596 $ 26,369,759 Interest bearing Money market and interest checking 17,935,755 17,678,521 Money market savings 11,407,235 12,281,053 Savings accounts 26,782,334 23,333,958 Certificates of deposit over $100,000 (note 8) 45,181,560 34,884,029 All other time deposits (note 8) 111,456,188 102,023,919 ----------- -----------
Total Deposits 242,041,668 216,571,239
Accrued expenses and other liabilities 1,902,794 1,751,921 Long-term debt (note 9) 4,523,442 4,009,319 ----------- -----------
Total Liabilities 248,467,904 222,332,479 ----------- -----------
STOCKHOLDERS' EQUITY
Common stock, $5 par value, 3,000,000 shares authorized, 546,764 shares issued 2,733,820 2,733,820 Surplus 1,661,987 1,661,987 Retained earnings (note 12) 24,623,951 22,825,747 Other accumulated comprehensive income 282,910 38,761 ----------- -----------
29,302,668 27,260,315 Treasury stock (at cost, 44,866 shares in 2001 and 2000) (992,701) (992,701) ------------ -----------
Total Stockholders' Equity 28,309,967 26,267,614 ----------- -----------
Total Liabilities and Stockholders' Equity $276,777,871 $248,600,093 =========== ===========
The accompanying notes are an integral part of this statement.
CONSOLIDATED STATEMENTS OF INCOME
HIGHLANDS BANKSHARES, INC.
Years Ended December 31, ---------------------------------- 2001 2000 1999 INTEREST INCOME: Loans, including fees $17,894,665 $15,891,868 $13,663,857 Federal funds sold 450,657 330,761 431,670 Interest bearing deposits 248,442 179,100 221,724 Investment securities - taxable 1,445,327 1,641,057 1,754,509 Investment securities - nontaxable 167,930 164,486 171,192 ---------- --------- ---------
Total Interest Income 20,207,021 18,207,272 16,242,952 ---------- ---------- ----------
INTEREST EXPENSE: Time deposits over $100,000 2,623,584 1,865,498 1,524,334 Other deposits 7,213,321 6,712,478 6,000,044 ---------- --------- ---------
Total Interest on Deposits 9,836,905 8,577,976 7,524,378
Borrowed money 211,827 212,054 138,313 ---------- --------- ---------
Total Interest Expense 10,048,732 8,790,030 7,662,691 ---------- ---------- ---------
NET INTEREST INCOME 10,158,289 9,417,242 8,580,261
PROVISION FOR LOAN LOSSES (note 6) 600,000 500,000 320,000 ---------- --------- ---------
Net Interest Income after Provision for Loan Losses 9,558,289 8,917,242 8,260,261 ---------- --------- ---------
NONINTEREST INCOME: Service charges 581,224 591,614 409,052 Insurance commissions and income 100,801 132,105 112,339 Insurance investment income 245,958 192,642 139,230 Other operating income 266,061 242,892 429,673 Gain (loss) on security transactions (note 4) 103,870 (63,590) ---------- --------- ---------
Total Noninterest Income 1,194,044 1,263,123 1,026,704 ---------- --------- ---------
NONINTEREST EXPENSES: Salaries and benefits (note 11) 3,937,908 3,629,664 3,230,973 Occupancy expense 381,029 302,738 269,483 Equipment expense 630,840 548,850 472,441 Data processing expense 529,054 489,744 473,392 Other operating expenses 1,731,258 1,659,834 1,466,016 ---------- --------- ---------
Total Noninterest Expenses 7,210,089 6,630,830 5,912,305 ---------- --------- ---------
Income before Income Tax Expense 3,542,244 3,549,535 3,374,660
INCOME TAX EXPENSE (note 10) 1,061,459 1,168,624 1,049,291 ---------- --------- ---------
NET INCOME $ 2,480,785 $2,380,911 $2,325,369 ========== ========= =========
Earnings Per Share $ 4.94 $ 4.74 $ 4.63 ========= ======= ======
Cash Dividends Paid Per Share $ 1.36 $ 1.24 $ 1.16 ========= ====== =======
Weighted Average Shares Outstanding 501,898 501,898 501,898 ========== ========= =========
The accompanying notes are an integral part of this statement.
CONSOLIDATED STATEMENTS OF CHANGES IN STOCKHOLDERS' EQUITY
HIGHLANDS BANKSHARES, INC.
The accompanying notes are an integral part of this statement.
CONSOLIDATED STATEMENTS OF CASH FLOWS
HIGHLANDS BANKSHARES, INC. Years Ended December 31, 2001 2000 1999 ------------------------------- CASH FLOWS FROM OPERATING ACTIVITIES: Net income $ 2,480,785 $ 2,380,911 $ 2,325,369 Adjustments to reconcile net income to net cash provided by operating activities: (Gain) loss on security transactions (103,870) 63,590 Gain on sale of property and equipment (237) Depreciation 523,626 447,697 407,147 Increase in insurance contracts (245,958) (192,642) (139,230) Net amortization of security premiums 122,343 2,171 151,150 Provision for loan losses 600,000 500,000 320,000 Deferred income tax expense (benefit) (17,061) 18,010 (15,192) Change in other assets and liabilities: Interest receivable 83,412 (158,422) (71,527) Other assets (127,198) 86,378 (105,451) Accrued expenses 150,873 315,869 116,566 --------- --------- ----------
Net Cash Provided by Operating Activities 3,570,822 3,295,865 3,052,422 --------- --------- ----------
CASH FLOWS FROM INVESTING ACTIVITIES: Purchase of branch, net of cash acquired (1,220,000) Proceeds from maturity of securities held to maturity 621,481 952,376 332,027 Proceeds from maturities of securities available for sale 17,116,010 7,590,970 15,000,285 Proceeds from sales of securities available for sale 2,115,255 377,499 Purchases of securities available for sale (23,472,091) (3,978,886) (12,312,504) Net change in other investments (28,600) (17,500) (14,600) Net change in deposits in other banks 27,380 (3,924,660) 995,252 Net increase in loans (16,691,860) (17,279,029) (18,587,196) Change in federal funds sold (6,244,900) (2,736,875) 9,671,650 Purchase of property and equipment (776,171) (1,287,893) (1,338,297) Proceeds from sale of property and equipment 6,358 2,840 Investment in insurance contracts (2,400,000) ---------- --------- ----------
Net Cash Used in Investing Activities (29,442,393) (19,783,402) (8,275,884) ------------ ----------- ----------
CASH FLOWS FROM FINANCING ACTIVITIES: Net change in time deposits 19,729,800 14,050,142 6,489,323 Net change in other deposit accounts 5,740,629 1,368,109 1,268,300 Additional long-term debt 1,395,300 1,731,532 394,922 Repayment of long-term debt (881,177) (290,171) (146,508) Dividends paid in cash (682,581) (622,355) (582,197) --------- --------- ----------
Net Cash Provided by Financing Activities 25,301,971 16,237,257 7,423,840 ---------- ---------- ----------
CASH AND CASH EQUIVALENTS: Net (decrease) increase in cash and due from banks (569,600) (250,280) 2,200,378 Cash and due from banks, beginning of year 7,061,961 7,312,241 5,111,863 --------- --------- ----------
Cash and Due from Banks, End of Year $ 6,492,361 $7,061,961 $ 7,312,241 ========== ========= ==========
Supplemental Disclosures: Cash paid for: Interest expense $10,042,704 $8,610,571 $ 7,688,056 Income taxes 1,367,143 1,203,000 1,152,533
The accompanying notes are an integral part of this statement.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
HIGHLANDS BANKSHARES, INC.
NOTE 1 NATURE OF OPERATIONS:
Highlands Bankshares, Inc. (the "Company") is a bank holding company and operates under a charter issued by the state of West Virginia. The Company owns all of the outstanding stock of The Grant County Bank, Capon Valley Bank, HBI Life Insurance Company, Inc. and Highlands Bankshares Trust Company, which operate under charters issued in Arizona and West Virginia, respectively. State chartered banks are subject to regulation by the West Virginia Division of Banking, The Federal Reserve Bank and the Federal Deposit Insurance Corporation while the insurance company is regulated by the Arizona Department of Insurance. The Banks provide services to customers located mainly in Grant, Hardy, Hampshire, Mineral, Pendleton and Randolph counties of West Virginia, including the towns of Petersburg, Keyser, Moorefield and Wardensville through eight locations and the county of Frederick in Virginia through a single location. The insurance company sells life and accident coverage exclusively through the Company's subsidiary banks. The Trust Company utilizes the subsidiary banks to facilitate the sales of trust services to its customers and citizens in those locales.
NOTE 2 SUMMARY OF SIGNIFICANT ACCOUNTING POLICIES:
The accounting and reporting policies of Highlands Bankshares, Inc. ("Company") and its subsidiaries conform to accounting principles generally accepted in the United States of America and to accepted practice within the banking industry.
(a) Principles of Consolidation
The consolidated financial statements include the accounts of The Grant County Bank, the Capon Valley Bank, HBI Life Insurance Company and Highlands Bankshares Trust Company. All significant intercompany accounts and transactions have been eliminated.
(b) Use of Estimates in the Preparation of Financial Statements
In preparing the financial statements, management is required to make estimates and assumptions that affect the reported amounts in those statements; actual results could differ significantly from those estimates. A material estimate that is particularly susceptible to significant changes is the determination of the allowance for loan losses, which is sensitive to changes in local economic conditions.
(c) Cash and Cash Equivalents
Cash and cash equivalents include cash on hand and noninterest bearing funds at correspondent institutions.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
HIGHLANDS BANKSHARES, INC.
NOTE 2 SUMMARY OF SIGNIFICANT ACCOUNTING POLICIES (CONTINUED):
(d) Securities
Securities that the Company has both the positive intent and ability to hold to maturity (at time of purchase) are classified as held to maturity securities. All other securities are classified as available for sale. Securities held to maturity are carried at historical cost and adjusted for amortization of premiums and accretion of discounts, using the effective interest method. Securities available for sale are carried at fair value with any valuation adjustments reported, net of deferred taxes, as other accumulated comprehensive income.
Other investments consist of investments in the Federal Home Loan Bank of Pittsburgh and the Federal Reserve Bank of Richmond. Such investments are required as members of these institutions and these investments cannot be sold without a change in the members' borrowing or service levels.
Interest and dividends on securities and amortization of premiums and discounts on securities are reported as interest income using the effective interest method. Gains (losses) realized on sales and calls of securities are determined using the specific identification method.
(e) Loans
Loans are carried on the balance sheet net of any unearned interest and the allowance for loan losses. Interest income on loans is determined using the effective interest method on the daily amount of principal outstanding except where serious doubt exists as to collectibility of the loan, in which case the accrual of income is discontinued.
(f) Allowance For Loan Losses
The allowance for loan losses is based upon management's knowledge and review of the loan portfolio. Estimation of an adequate allowance for loan losses involves the exercise of judgement, the use of assumptions with respect to present economic conditions and knowledge of the environment in which the Banks operate. Among the factors considered in determining the level of the allowance are the changes in composition of the loan portfolio, the amount of delinquent and nonaccrual loans, past loan loss experience and the value of collateral securing the loans.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
HIGHLANDS BANKSHARES, INC.
NOTE 2 SUMMARY OF SIGNIFICANT ACCOUNTING POLICIES (CONTINUED):
(g) Bank Premises and Equipment
Bank premises and equipment are stated at cost less accumulated depreciation. Depreciation is charged to income over the estimated useful lives of the assets using a combination of the straight-line and accelerated methods. The ranges of the useful lives of bank premises and equipment are as follows:
Buildings and Improvements 15 - 40 years Furniture and fixtures 5 - 15 years
Maintenance, repairs, renewals, and minor improvements are charged to operations as incurred. Gains and losses on routine dispositions are reflected in other income or expense.
(h) Income Taxes
Amounts provided for income tax expense are based on income reported for financial statement purposes rather than amounts currently payable under federal and state tax laws. Deferred taxes, which arise principally from differences between the period in which certain income and expenses are recognized for financial accounting purposes and the period in which they affect taxable income, are included in the amounts provided for income taxes.
(i) Earnings Per Share
Earnings per share are based on the weighted average number of shares outstanding.
(j) Foreclosed Real Estate
The components of foreclosed real estate are adjusted to the lower of cost or fair value less estimated costs of disposal. The current year provision for a valuation allowance has been recorded as an expense to current operations.
(k) Comprehensive Income
Accounting principles generally require that recognized revenue, expenses, gains and losses be included in net income. Certain changes in assets and liabilities, such as unrealized gains and losses on available-for-sale securities, are reported as a separate component of the equity section of the balance sheet. Such items, along with net income, are components of comprehensive income.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
HIGHLANDS BANKSHARES, INC.
NOTE 2 SUMMARY OF SIGNIFICANT ACCOUNTING POLICIES (CONTINUED):
(k) Comprehensive Income (Continued)
The components of other comprehensive income and related tax effects are as follows:
Years Ended December 31, ------------------------ 2001 2000 1999 ---- ---- ---- (In thousands)
Unrealized holding gains (losses) on available- for-sale securities $ 387,537 $ 556,267 $(644,019)
Reclassification adjustment for (gains) losses realized in income (103,870) 63,590 -------- -------- --------
Net Unrealized Gains (Losses) 387,537 452,397 (580,429) Tax effect (143,388) (167,386) 214,757 -------- -------- --------
Net Change $ 244,149 $ 285,011 $(365,672) ======== ======== ========
NOTE 3 CASH AND DUE FROM BANKS:
The Banks are required to maintain average reserve balances based on a percentage of deposits. The Banks have generally met this requirement through average cash on hand and balances with their correspondent institutions.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
HIGHLANDS BANKSHARES, INC.
NOTE 4 SECURITIES:
The carrying amount and estimated fair value of securities are as follows:
Carrying Unrealized Unrealized Fair Amount Gains Losses Value ------------------------------------------------
Held to Maturity
December 31, 2001
Mortgage-backed $ 6,022 $ 422 $ $ 6,444 State and municipals 1,597,371 35,153 1,632,524 --------- -------- -------- ---------
Total Securities Held to Maturity $1,603,393 $ 35,575 $ $1,638,968 ========= ======== ======== =========
December 31, 2000
U.S. Agencies $ 88,609 $ $ 319 $ 88,290 Mortgage-backed 8,893 298 9,191 State and municipals 2,130,888 13,042 7,555 2,136,375 --------- -------- -------- ---------
Total Securities Held to Maturity $2,228,390 $ 13,340 $ 7,874 $2,233,856 ========= ======== ======== =========
Available for Sale
December 31, 2001
U. S. Treasuries and Agencies $10,562,796 $ 197,676 $ $10,760,472 Mortgage-backed 6,527,396 81,347 6,608,743 State and municipals 6,318,613 65,393 3,505 6,380,501 Marketable equities 42,206 3,106 39,100 Corporate obligations 5,560,038 111,263 5,671,301 --------- --------- --------- ---------
Total Securities Available for Sale $29,011,049 $ 455,679 $ 6,611 $29,460,117 ========== ========= ========= ==========
December 31, 2000
U. S. Treasuries and Agencies $18,178,632 $ 79,250 $ 38,211 $18,219,671 Mortgage-backed 3,257,381 24,107 6,402 3,275,086 State and municipals 771,710 19,146 1,539 789,317 Marketable equities 58,274 6,574 51,700 Corporate obligations 507,796 8,246 499,550 --------- --------- --------- ---------
Total Securities Available for Sale $22,773,793 $ 122,503 $ 60,972 $22,835,324 ========== ========= ========= ==========
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
HIGHLANDS BANKSHARES, INC.
NOTE 4 SECURITIES (CONTINUED):
The carrying amount and fair value of debt securities at December 31, 2001, by contractual maturity, are shown below. Expected maturities will differ from contractual maturities because borrowers may have the right to call or prepay obligations with or without call or prepayment penalties.
Securities Held to Maturity Fair --------------------------- Cost Value -------------- ------------
Due in one year or less $ 230,741 $ 233,068 Due after one year through five years 1,196,015 1,222,517 Due after five years through ten years 170,615 176,939 Mortgage-backed securities 6,022 6,444 --------- ---------
Total Held to Maturity $1,603,393 $1,638,968 ========= =========
Securities Available for Sale Fair ----------------------------- Cost Value -------------- ------------
Due in one year or less $7,034,575 $ 7,133,409 Due after one year through five years 13,203,631 13,432,279 Due after five years through ten years 992,472 1,000,180 Due after ten years 1,210,769 1,246,406 Mortgage-backed securities 6,527,396 6,608,743 --------- ----------
Total Fixed Rate Securities 28,968,843 29,421,017 Equities 42,206 39,100 --------- ----------
Total Available for Sale $29,011,049 $29,460,117 ========== ==========
The carrying amount (which approximates market value) of securities pledged by the banks to primarily secure deposits amounted to $4,963,000 at December 31, 2001 and $10,786,000 at December 31, 2000.
There were no holdings totaling more than 10% of stockholders' equity with any issuer as of December 31, 2001 and 2000.
All gains and losses arose from the sale of securities available for sale. There were no sales of securities in 2001. Realized gains or losses for the years ending December 31 are as follows:
2001 2000 1999 ------------ ------------ ------------
Gains $ 0 $ 103,870 $ 4,259 Losses 0 (67,849) -------- --------- ---------
Total $ 0 $ 103,870 $ (63,590) ======== ========= =========
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
HIGHLANDS BANKSHARES, INC.
NOTE 5 LOANS:
Loans outstanding as of December 31 are summarized as follows:
2001 2000 -------------- -----------
Commercial $ 42,204,159 $ 37,681,492 Real estate construction 3,868,000 4,061,000 Real estate mortgages 111,668,376 101,889,826 Consumer installment 47,926,399 46,191,314 ----------- -----------
Subtotal 205,666,934 189,823,632 Unearned interest (197,786) (555,944) ----------- -----------
Total Loans $205,469,148 $189,267,688 ========== ==========
NOTE 6 ALLOWANCE FOR LOAN LOSSES:
A summary of changes in the allowance for loan losses for the years ended December 31 is shown in the following schedule:
2001 2000 1999 ------------- ------------- -----------
Balance at beginning of year $1,492,936 $1,318,332 $ 1,355,377 Allowance relating to loans acquired in purchase 86,873 Provision charged to operating expenses 600,000 500,000 320,000 Loan recoveries 209,552 102,873 90,544 Loans charged off (699,952) (515,142) (447,589) --------- --------- ----------
Balance at end of year $1,602,536 $1,492,936 $ 1,318,332 ========= ========= ==========
Percentage of outstanding loans .78% .79% .79%
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
HIGHLANDS BANKSHARES, INC.
NOTE 7 BANK PREMISES AND EQUIPMENT:
Bank premises and equipment as of December 31 are summarized as follows:
2001 2000 --------------------------
Land $ 1,137,485 $ 1,017,103 Buildings and improvements 6,400,610 6,087,509 Furniture and equipment 3,644,925 3,322,481 ---------- ----------
Total cost 11,183,020 10,427,093 Less - accumulated depreciation (4,127,380) (3,617,640) ---------- -----------
Net Book Value $ 7,055,640 $ 6,809,453 ========== ==========
Provisions for depreciation of $523,626 in 2001, $447,697 in 2000 and $407,147 in 1999 were charged to operations.
NOTE 8 DEPOSITS:
At December 31, 2001, the scheduled maturities of certificates of deposit are as follows:
2002 107,511,843 2003 26,462,399 2004 8,043,528 2005 7,258,612 2006 7,361,366 ------------
Total $ 156,637,748 ============
NOTE 9 LONG-TERM DEBT:
The Company has borrowed money from the Federal Home Loan Bank of Pittsburgh (FHLB). The interest rates on most of the notes payable were fixed at the time of the advance and fixed rates range from 2.50% to 6.85%; the largest borrowing is a variable rate loan whose rate is tied to LIBOR and was 1.42% at December 31, 2001. The weighted average interest rate is 5.68% at December 31, 2001. The debt is secured by the general assets of the Banks.
Repayments of long-term debt are due either monthly or quarterly. Interest expense of $211,827, $212,054, and $138,313 was incurred on these debts in 2001, 2000, and 1999, respectively. The maturities of long-term debt as of December 31, 2001 are as follows:
2002 $ 499,911 2003 475,322 2004 617,581 2005 342,037 2006 356,667 Thereafter 2,231,924 -----------
Total $ 4,523,442 ===========
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
HIGHLANDS BANKSHARES, INC.
NOTE 10 INCOME TAX EXPENSE:
The components of income tax expense for the years ended December 31, are summarized as follows:
2001 2000 1999 ------------ ----------------------
Current Expense Federal $ 968,401 $ 953,961 $ 930,223 State 110,119 196,653 134,260 --------- -------- ---------
Total Current Expense 1,078,520 1,150,614 1,064,483 --------- --------- ---------
Deferred Expense (Benefit) Federal (15,690) 16,431 (13,961) State (1,371) 1,579 (1,231) ---------- -------- ---------
Total Deferred Expense (Benefit) (17,061) 18,010 (15,192) --------- -------- ---------
Income Tax Expense $1,061,459 $1,168,624 $1,049,291 ========= ========= =========
Income expense (benefits) relating to security transactions are as follows: $ $ 38,432 $ (23,528)
The deferred tax effects of temporary differences for the years ended December 31 as follows:
2001 2000 1999 ------------ ---------------------
Tax effect of temporary differences: Provision for loan losses $ 37,802 $(12,874) $(10,937) Sale of loans (28,271) 3,693 7,192 Pension expense (31,690) (24,694) (26,626) Depreciation 47,406 52,928 23,945 Deferred compensation (57,251) (38,471) (24,797) Basis of securities sold 75,369 Miscellaneous 14,943 (37,941) 16,031 -------- ------- -------
Net (increase) decrease in deferred income tax benefit $ (17,061) $ 18,010 $(15,192) ======== ======= =======
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
HIGHLANDS BANKSHARES, INC.
NOTE 10 INCOME TAX EXPENSE (CONTINUED):
The net deferred tax assets arising from temporary differences as of December 31 are summarized as follows:
2001 2000 ------------------------
Deferred Tax Assets: Provision for loan losses $ 419,951 $ 382,072 Insurance commissions 32,130 32,181 Sale of Loans 31,183 2,935 Deferred compensation 146,232 89,319 Accrued pension expense 23,965 Other 12,228 22,375 -------- --------
Total Assets 641,724 552,847 -------- --------
Deferred Tax Liabilities: ------------------------- Unrealized gain on securities available for sale 166,157 22,769 Accretion income 19,571 22,914 Other liabilities 28,471 Property basis differences 346,166 299,745 -------- --------
Total Liabilities 560,365 345,428 -------- --------
Net Tax Asset $ 81,359 $ 207,419 ======== ========
The following table summarizes the difference between income tax expense and the amount computed by applying the federal statutory income tax rate for the years ended December 31:
2001 2000 1999 --------------------------------------
Amounts at federal statutory rates $1,205,199 $1,206,848 $1,147,384 Additions (reductions) resulting from: Tax-exempt income (102,365) (82,259) (71,484) Partially exempt income (28,142) (36,606) (30,125) State income taxes, net 105,278 115,964 100,227 Income from life insurance contracts (97,014) (71,798) (51,515) Capital losses utilized (53,346) State income tax adjustment (30,000) 30,000 Other 8,503 6,475 8,150 --------- --------- ---------
Income tax expense $1,061,459 $1,168,624 $1,049,291 ========= ========= =========
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
HIGHLANDS BANKSHARES, INC.
NOTE 11 EMPLOYEE BENEFITS:
The Company's two subsidiary banks each have separate retirement and profit sharing plans which cover substantially all full time employees at each bank. The Capon Valley Bank has a defined contribution pension plan with 401(k) features that is funded with discretionary contributions by the Company. The Company matches on a limited basis the contributions of the employees. Investment of employee balances is done through the direction of each employee.
The Grant County Bank is a member of the West Virginia Bankers' Association Retirement Plan. Benefits under the plan are based on compensation and years of service with 100% vesting after seven years of service. The Plan's assets are in excess of the projected benefit obligations and thus the Bank was not required to make contributions to the Plan in 2001, 2000 or 1999. The amounts of the accrued liability and the net pension expense reflected in operations are insignificant. In addition, The Grant County Bank also maintains a profit sharing plan covering substantially all employees to which contributions are made at the discretion of the Board of Directors.
The Company has established an employee stock ownership plan which will provide stock ownership to all employees of the Company. The Plan provides total vesting upon the attainment of seven years of service. Contributions to the plan are made at the discretion of the Board of Directors and are allocated based on the compensation of each employee relative to total compensation paid by the Company. All shares held by the Plan are considered outstanding in the computation of earnings per share. Shares of Company stock, when distributed, will have restrictions on transferability.
Employer contributions related to the above benefit plans charged to operations totaled $234,455 in 2001, $266,601 in 2000 and $266,704 in 1999.
NOTE 12 RESTRICTIONS ON DIVIDENDS OF SUBSIDIARY BANKS:
The principal source of funds of Highlands Bankshares, Inc. is dividends paid by subsidiary banks. The various regulatory authorities impose restrictions on dividends paid by a state bank. A state bank cannot pay dividends (without the consent of state banking authorities) in excess of the total net profits of the current year and the combined retained profits of the previous two years. As of January 1, 2002, the banks could pay dividends to the Company of approximately $1,223,000 without permission of the regulatory authorities.
NOTE 13 ACQUISITION OF THE STOCKMANS BANK OF HARMAN:
On July 27, 2000, The Grant County Bank acquired the remaining stock not already owned by Highlands Bankshares from the stockholders of the Stockmans Bank of Harman (hereinafter referred to as "Harman"). Harman was a single branch bank serving Randolph County in West Virginia. The acquisition was accounted for as purchase under generally accepted accounting principles and operations subsequent to July 26, 2000 are included as part of the operations of the Company for the year 2000. Grant purchased the 229 shares not already owned by Highlands from unrelated shareholders and Highlands contributed the 21 shares it owned to Grant as a capital contribution. Unrelated shareholders were paid $7,850 per share in cash for their shares at closing. The total acquisition cost, including shares acquired in previous years, was $1,878,000 plus expenses. The total purchase price was allocated as follows:
Cash and Due From Banks $ .7 million Loans Receivable 5.7 million Securities 2.2 million Fed Funds Sold 1.6 million Other Assets .7 million Deposits Assumed (8.7) million Other Liabilities (.3) million Cash Paid and Expenses of Purchase (1.9) million
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
HIGHLANDS BANKSHARES, INC.
NOTE 13 ACQUISITION OF THE STOCKMANS BANK OF HARMAN (CONTINUED):
As part of the accounting for this transaction, the Company acquired goodwill totaling $108,122 which is being amortized on a straight line basis over a period of ten years.
NOTE 14 TRANSACTIONS WITH RELATED PARTIES:
During the year, officers and directors (and companies controlled by them) were customers of and had transactions with the subsidiary Banks in the normal course of business. These transactions were made on substantially the same terms as those prevailing for other customers and did not involve any abnormal risk. The aggregate amount of loans to related parties of $2,699,825 at December 31, 2000 was increased $661,577 by new loans and reduced $717,417 by payments resulting in an ending balance of $2,643,985 at December 31, 2001.
NOTE 15 COMMITMENTS AND GUARANTEES:
The Banks make commitments to extend credit in the normal course of business and issued standby letters of credit to meet the financing needs of their customers. The amount of the commitments represents the Banks' exposure to credit loss that is not included in the balance sheet. As of the balance sheet dates, the Banks had outstanding the following commitments: 2001 2000
Commitments to extend credit $ 8,991,000 $11,517,000 Standby letters of credit 252,000 438,000
The Banks use the same credit policies in making commitments and issuing letters of credit as it does for the loans reflected in the balance sheet.
Commitments to extend credit are agreements to lend to a customer as long as there is no violation of any condition established in the contract. Commitments generally have fixed expiration dates or other termination clauses and may require payment of a fee. Since many of the commitments are expected to expire without being drawn upon, the total commitment amounts do not necessarily represent future cash requirements. The Banks evaluate each customer's creditworthiness on a case-by-case basis. The amount of collateral obtained, if deemed necessary by the Banks upon extension of credit, is based on management's credit evaluation of the borrower. Collateral held varies but may include accounts receivable, inventory, property, plant and equipment.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
HIGHLANDS BANKSHARES, INC.
NOTE 16 CONCENTRATIONS:
The Banks grant commercial, residential real estate and consumer loans to customers located primarily in the eastern portion of the State of West Virginia. Although the Banks have a diversified loan portfolio, a substantial portion of the debtors' ability to honor their contracts is dependent upon the agribusiness economic sector. Collateral required by the Banks is determined on an individual basis depending on the purpose of the loan and the financial condition of the borrower. The ultimate collectibility of the loan portfolios is susceptible to changes in local economic conditions. Approximately 56% of the loan portfolio is secured by real estate. See note 5 for a complete breakdown of loans by type.
The Bank has cash deposited in and federal funds sold to other commercial banks totaling $22,772,450 and $17,082,837 at December 31, 2001 and 2000, respectively.
NOTE 17 DISCLOSURES ABOUT FAIR VALUE OF FINANCIAL INSTRUMENTS:
The fair value of the Company's assets and liabilities is influenced heavily by market conditions. Fair value applies to both assets and liabilities, either on or off the balance sheet. Fair value is defined as the amount at which a financial instrument could be exchanged in a current transaction between willing parties, other than in a forced or liquidation sale.
The following methods and assumptions were used to estimate the fair value of each class of financial instruments for which it is practicable to estimate that value:
Cash, Due from Banks and Money Market Investments
The carrying amount of cash, due from bank balances, interest bearing deposits and federal funds sold is a reasonable estimate of fair value.
Securities
Fair values of securities are based on quoted market prices or dealer quotes. If a quoted market price is not available, fair value is estimated using quoted market prices for similar securities.
Loans
The fair value of loans is estimated by discounting the future cash flows using the current rates at which similar loans would be made to borrowers with similar credit ratings and for the same remaining maturities, taking into consideration the credit risk in various loan categories.
Deposits
The fair value of demand, interest checking, regular savings and money market deposits is the amount payable on demand at the reporting date. The fair value of fixed maturity certificates of deposit is estimated using the rates currently offered for deposits of similar remaining maturities.
Long Term Debt
The fair value of fixed rate loans is estimated using the rates currently offered by the Federal Intermediate Credit Bank for indebtedness with similar maturities.
Interest Payable and Receivable
The carrying value of amounts of interest receivable and payable is a reasonable estimate of fair value.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
HIGHLANDS BANKSHARES, INC.
NOTE 17 DISCLOSURES ABOUT FAIR VALUE OF FINANCIAL INSTRUMENTS (CONTINUED):
Off-Balance-Sheet Items
The carrying amount and estimated fair value of off-balance-sheet items were not material at December 31, 2001.
The carrying amount and estimated fair values of financial instruments as of December 31 are as follows:
2001 2000 Estimated Estimated Carrying Fair Carrying Fair Amount Value Amount Value ------------ -----------------------------------
Financial Assets: Cash and due from banks $ 6,492,361 $ 6,492,361 $ 7,061,961 $ 7,061,961 Interest bearing deposits 6,333,551 6,333,551 6,360,931 6,360,931 Federal funds sold 13,284,408 13,284,408 7,039,508 7,039,508 Securities held to maturity 1,603,393 1,638,968 2,228,390 2,233,856 Securities available for sale 29,460,117 29,460,117 22,835,324 22,835,324 Other investments 791,650 791,650 763,050 763,050 Loans, net 203,866,612 204,748,161 187,774,752 187,498,412 Interest receivable 1,817,884 1,817,884 1,901,296 1,901,296
Financial Liabilities: Demand and savings deposits 85,403,920 85,403,920 79,663,291 79,663,291 Term deposits 156,637,748 158,647,902 136,907,948 137,101,109 Borrowed money 4,523,442 4,477,891 4,009,319 3,964,810 Interest payable 848,606 848,606 842,979 842,979
NOTE 18 REGULATORY MATTERS:
The Company is subject to various regulatory capital requirements administered by the federal banking agencies. Failure to meet minimum capital requirements can initiate certain mandatory - and possibly additional discretionary - actions by regulators that, if undertaken, could have a direct material effect on the Company's financial statements. Under capital adequacy guidelines and the regulatory framework for prompt corrective action, the Company must meet specific capital guidelines that involve quantitative measures of the Company's assets, liabilities, and certain off-balance-sheet items as calculated under regulatory accounting practices. The Company's capital amounts and classification are also subject to qualitative judgments by the regulators about components, risk weightings and other factors.
Quantitative measures established by regulation to ensure capital adequacy require the Company to maintain minimum amounts and ratios (set forth in the table below) of total and Tier I capital (as defined in the regulations) to risk-weighted assets (as defined), and of Tier I capital (as defined) to average assets (as defined). The Company meets all capital adequacy requirements to which it is subject and as of the most recent examination, the Company was classified as well capitalized.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
HIGHLANDS BANKSHARES, INC.
NOTE 18 REGULATORY MATTERS (CONTINUED):
To be categorized as well capitalized the Company must maintain minimum total risk-based, Tier I risk-based, and Tier I leverage ratios as set forth in the table. There are no conditions or events that management believes have changed the Company's category from a well capitalized status.
The Company's actual capital ratios are presented in the following table:
Actual Regulatory Requirements ------------------------------------------- December Adequately Well 2001 2000 Capitalized Capitalized
Total risk-based ratio 14.46% 16.03% 8.00% 10.00% Tier 1 risk-based ratio 13.66% 15.17% 4.00% 6.00% Total assets leverage ratio 10.06% 10.57% 4.00% 5.00%
Capital ratios and amounts are applicable both at the individual bank level and on a consolidated basis. At December 31, 2001, both subsidiary banks had capital levels in excess of minimum requirements. As such, both banks qualified as "well capitalized banks" for FDIC insurance purposes and thus were charged the minimum rate for insurance coverage.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
HIGHLANDS BANKSHARES, INC.
NOTE 19 PARENT CORPORATION ONLY FINANCIAL STATEMENTS:
BALANCE SHEETS
Assets December 31, ---------------------- 2001 2000 ---------- ----------
Cash $ 102,141 $ 81,062 Investment in subsidiaries 28,128,103 26,121,840 Other investments 15,304 10,304 Other assets 26,965 22,951 Income taxes receivable 208,372 237,959 ---------- -----------
Total Assets $28,480,885 $ 26,474,116 ========== ===========
Liabilities
Accrued Expenses 2,315 Due to subsidiaries $ 168,603 $ 206,502 ---------- -----------
Total Liabilities 170,918 206,502 ---------- -----------
Stockholders' Equity
Common stock, par value $5 per share 3,000,000 shares authorized, 546,764 shares issued $ 2,733,820 $ 2,733,820 Surplus 1,661,987 1,661,987 Retained earnings 24,623,951 22,825,747 Other accumulated comprehensive income 282,910 38,761 ---------- -----------
29,302,668 27,260,315 Less treasury stock (at cost, 44,866 shares in 2001 and 2000) (992,701) (992,701) ---------- -----------
Total Stockholders' Equity 28,309,967 26,267,614 ---------- -----------
Total Liabilities and Stockholders' Equity $28,480,885 $ 26,474,116 ========== ===========
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
HIGHLANDS BANKSHARES, INC.
NOTE 19 PARENT CORPORATION ONLY FINANCIAL STATEMENTS (CONTINUED):
STATEMENTS OF INCOME AND RETAINED EARNINGS
Years Ended December 31, ---------------------------------- 2001 2000 1999 ------------------------ ----------
Income
Dividends from subsidiaries $ 3,063,877 $ 722,354 $ 666,652 Other dividends 1,680 ---------- --------- ----------
Total 3,063,877 722,354 668,332 ---------- --------- ----------
Expenses
Salary and benefits expense 169,325 Professional fees 34,413 48,988 34,056 Directors' fees 40,550 32,650 25,500 Other expenses 70,120 31,172 33,905 ---------- --------- ----------
Total 314,408 112,810 93,461 ---------- --------- ----------
Net income before income tax benefit and undistributed income (deficit) of subsidiaries 2,749,469 609,544 574,871
Income tax benefit 112,779 43,006 37,866 ---------- --------- ----------
Income before undistributed income (deficit) of subsidiaries 2,862,248 652,550 612,737
Undistributed income (deficit) of subsidiaries (381,463) 1,728,361 1,712,632 ---------- --------- ----------
Net Income 2,480,785 2,380,911 2,325,369
Retained earnings, Beginning of period 22,825,747 21,067,191 19,324,019 Dividends paid (682,581) (622,355) (582,197) ---------- --------- ----------
Retained Earnings, End of Period $24,623,951 $22,825,747 $21,067,191 ========== ========== ==========
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
HIGHLANDS BANKSHARES, INC.
NOTE 19 PARENT CORPORATION ONLY FINANCIAL STATEMENTS (CONTINUED):
STATEMENTS OF CASH FLOWS
Years Ended December 31, ------------------------------ 2001 2000 1999 ---------------------------------
Cash Flows from Operating Activities: Net income $ 2,480,785 $2,380,911 $2,325,369 Adjustments Undistributed subsidiary (income) deficit 381,463 (1,728,361) (1,712,632) Depreciation 397 446 624 Increase (decrease) in payables (35,584) 153,220 52,809 (Increase) decrease in receivables 29,587 (124,691) (65,251) Increase in other assets (4,411) ---------- ------- -----
Net Cash Provided by Operating Activities 2,852,237 681,525 600,919 ---------- --------- ---------
Cash Flows from Investing Activities: Investment in subsidiaries (2,143,577) Other investments (5,000) (12,584) ---------- -------- -------
Net Cash Used in Investing Activities (2,148,577) (12,584)
Cash Flows from Financing Activities: Dividends paid (682,581) (622,355) (582,197) --------- ----- -----
Net Cash Used in Financing Activities (682,581) (622,355) (582,197) -------- ------ -----
Net Increase in Cash 21,079 46,586 18,722
Cash, Beginning of Year 81,062 34,476 15,754 ---------- --------- ---------
Cash, End of Year $ 102,141 $ 81,062 $ 34,476 ========== ========= =========
INDEPENDENT AUDITORS' REPORT
The Stockholders and Board of Directors Highlands Bankshares, Inc. Petersburg, West Virginia
We have audited the accompanying consolidated balance sheets of Highlands Bankshares, Inc. and subsidiaries as of December 31, 2001 and 2000, and the related consolidated statements of income, changes in stockholders' equity and cash flows for each of the years in the three year period ended December 31, 2001. These financial statements are the responsibility of the Company's management. Our responsibility is to express an opinion on these financial statements based on our audits.
We conducted our audits in accordance with U.S. generally accepted auditing standards. Those standards require that we plan and perform the audit to obtain reasonable assurance about whether the financial statements are free of material misstatement. An audit includes examining, on a test basis, evidence supporting the amounts and disclosures in the financial statements. An audit also includes assessing the accounting principles used and significant estimates made by management, as well as evaluating the overall financial statement presentation. We believe that our audits provide a reasonable basis for our opinion.
In our opinion, the financial statements referred to above present fairly, in all material respects, the consolidated financial position of Highlands Bankshares, Inc. and subsidiaries as of December 31, 2001 and 2000, and the consolidated results of their operations and their cash flows for each of the years in the three year period ended December 31, 2001, in conformity with U.S. generally accepted accounting principles.
/s/ S. B. Hoover & Company, L.L.P.
January 24, 2002 Harrisonburg, Virginia
Item 8.
Item 8. Changes in and Disagreements with Accountants on Accounting and - -------- --------------------------------------------------------------------- Financial Disclosure ---------------------
None
Part III
Item 9.
Item 9. Directors, Executive Officers, Promoters and Control Persons; Compliance with Section 16(a) of the Exchange Act
We are incorporating the Proxy Statement of Highlands Bankshares, Inc. via Form DEF 14A filed March 13, 2002.
Item 10.
Item 10. Executive Compensation
We are incorporating the Proxy Statement of Highlands Bankshares, Inc. via Form DEF 14A filed March 13, 2002.
Item 11.
Item 11. Security Ownership of Certain Beneficial Owners and Management
We are incorporating the Proxy Statement of Highlands Bankshares, Inc. via Form DEF 14A filed March 13, 2002.
Item 12.
Item 12. Certain Relationships and Related Transactions
We are incorporating the Proxy Statement of Highlands Bankshares, Inc. via Form DEF 14A filed March 13, 2002.
Most of the directors, partnerships of which they may be general partners and corporations of which they are officers or directors, maintain normal banking relationships with the Bank. Loans made by the Bank to such persons or other entities were made only in the ordinary course of business, were made on substantially the same terms, including interest rates and collateral, as those prevailing at the time for comparable transactions with other persons, and did not involve more than normal risk of collectibility or present other unfavorable features. See Note 14 of the consolidated financial statements.
John VanMeter is a partner with the law firm of VanMeter and VanMeter, which has been retained by the Company as legal counsel and it is anticipated that the relationship will continue. Jack H. Walters is a partner with the law firm of Walters & Krauskopf, which provides legal counsel to the Company and it is anticipated that the relationship will continue.
Part IV
Item 13.
Item 13. Exhibits and Reports on Form 8-K
a) Exhibits
Exhibit No. Description
2 Not applicable
3 (i) Articles of Incorporation of Highlands Bankshares, Inc. are incorporated by reference to Appendix C to Highlands Bankshares, Inc.'s Form S-4 filed October 20, 1986.
Amendments to the original Articles of Incorporation are incorporated by reference; filed as Exhibit 3(i) with 1997 10-KSB.
Item 13. Exhibits and Reports on Form 8-K (Continued)
a) Exhibits (Continued) --------------------
Exhibit No. Description
3 (ii) Bylaws of Highlands Bankshares, Inc. are incorporated by reference to Appendix D to Highland Bankshares, Inc.'s Form S-4 filed October 20, 1986.
Amendments to the original Bylaws are incorporated by reference; filed as Exhibit 3(ii) with 1997 10-KSB
4 Not applicable
9 Not applicable
10 Not applicable
11 Not applicable
12 Not applicable
16 Not applicable
18 Not applicable
21 Subsidiary listing of the Registrant
22 Not applicable
23 Consent of Certified Public Accountant
24 Not applicable
28 Not applicable
b) Reports on Form 8-K
No reports on Form 8-K were filed in the fourth quarter of 2001.
SIGNATURES
Pursuant to the requirements of Section 13 or 15(d) of the Securities Exchange Act of 1934, the registrant has duly caused this report to be signed on its behalf by the undersigned, thereunto duly authorized.
HIGHLANDS BANKSHARES, INC.
By /s/ LESLIE A. BARR ------------------------------- Leslie A. Barr President, Chief Executive Officer
Date MARCH 27, 2002 -------------------------
By /s/ CLARENCE E. PORTER ------------------------------ Clarence E. Porter Treasurer
Date MARCH 27, 2002 -------------------------
Pursuant to the requirements of the Securities Exchange Act of 1934, this report has been signed below by the following persons on behalf of the registrant and in the capacities and as of the date indicated.
Signature Title Date
/s/ LESLIE A. BARR MARCH 27, 2002 - -------------- ------------- Leslie A. Barr President & Chief Executive Officer Director /s/ ALAN L. BRILL MARCH 27, 2002 - -------------------- ------------ Alan L. Brill Secretary
/s/ KATHY G. KIMBLE MARCH 27, 2002 - ---------------------- -------------- Kathy G. Kimble Director
George B. Moomau Director ------------
/s/ THOMAS B. MCNEIL, SR. MARCH 27, 2002 - ---------------------- -------------- Thomas B. McNeil, Sr. Director
/s/ CLARENCE E. PORTER MARCH 27, 2002 - ---------------------- -------------- Clarence E. Porter Treasurer
/s/ COURTNEY R. TUSING MARCH 27, 2002 - ---------------------- -------------- Courtney R. Tusing Director
/s/ JOHN G. VANMETER MARCH 27, 2002 - ---------------------- -------------- John G. VanMeter Chairman of the Board Director
/s/ JACK H. WALTERS MARCH 27, 2002 - ---------------------- -------------- Jack H. Walters Director
/s/ L. KEITH WOLFE MARCH 27, 2002 - ---------------------- ------------- L. Keith Wolfe Director