**UNITED
      STATES**


**SECURITIES
      AND EXCHANGE COMMISSION**


**Washington,
      DC 20549**








**FORM
      10-Q**





(Mark
      One)


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


For
      the
      quarterly period ended June 30, 2007





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





Commission
      File Number:  0-16761





**HIGHLANDS
      BANKSHARES, INC.**


(Exact
      name of registrant as specified in its charter)





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


P.O.
      Box
      929


Petersburg,
      WV 26847


(Address
      of Principal Executive Offices, Including Zip Code)





304-257-4111


(Registrant’s
      Telephone Number, Including Area Code)





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





Indicate
      by check mark whether the
      registrant is a large accelerated filer, an accelerated filed, or a
      non-accelerated filer. See definition of “accelerated filer and large
      accelerated filer” in Rule 12b-2 of the Exchange Act. (Check One):





Large
                Accelerated Filer  ̈
            Accelerated
                Filer  ̈
            Non
                Accelerated filer ý





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





Indicate
      the number of shares outstanding of each of the issuer’s classes of common stock
      as of the latest practicable date. As of July 31, 2007:  1,436,874
      shares of Common Stock, $5 Par Value


*Index*





HIGHLANDS
                BANKSHARES, INC.Quarterly
                Report on Form 10Q For The Period Ended June 30,2007INDEXPagePART
                I
            FINANCIAL
                INFORMATIONItem
                1.
            Financial
                StatementsUnaudited
                Consolidated Statements of Income
              Six
                Months Ended June 30, 2007 and 2006
            2Unaudited
                Consolidated Statements of Income
              Three
                Months Ended June 30, 2007 and 2006
            3Unaudited
                Consolidated Balance Sheet for June 30,
                2007
              And
                Audited Consolidated Balance Sheet for December 31,
                2006
            4Unaudited
                Consolidated Statements of Changes in
                Stockholders’
              Equity
                for the Six Months Ended June 30, 2007 and
                2006
            5Unaudited
                Consolidated Statements of Cash Flows for the
                Six
              Months
                Ended June 30, 2007 and 2006
            6Notes
                to Consolidated Financial Statements
            7Item
                2.
            Management’
Discussion
                and Analysis of Financial
                Condition
              And
                Results of Operations
            10Item
                3.
            Quantitative
                and Qualitative Disclosures About Market
                Risk
            20Item
                4.
            Controls
                and Procedures
            20Item
                4T.
            Controls
                and Procedures
            20PART
                II
            OTHER
                INFORMATIONItem
                1.
            Legal
                Proceedings
            20Item
                1A.
            Risk
                Factors
            20Item
                2.
            Unregistered
                Sales of Equity Securities and Use of
                Proceeds
            21Item
                3.
            Defaults
                Upon Senior Securities
            21Item
                4.
            Submission
                of Matters to a Vote of Security
                Holders
            21Item
                5.
            Other
                Information
            21Item
                6.
            Exhibits
            21SIGNATURES
            
            22











*Index*


**Item
      1. Financial Statements**





Page
                Two





HIGHLANDS
                BANKSHARES, INC.CONSOLIDATED
                STATEMENTS OF INCOME(In
                Thousands of Dollars, Except Per Share Data)Six
                Months Ended June 30,2007
            
            
            2006(unaudited)
            
            
            (unaudited)Interest
                IncomeInterest
                and fees on loans
            
            $
            12,359
            
            
            $
            10,450Interest
                on federal funds sold
            
            
            405
            
            
            
            214Interest
                on deposits in other banks
            
            
            70
            
            
            
            22Interest
                and dividends on securities
            
            
            650
            
            
            
            589Total
                Interest Income
            
            
            13,484
            
            
            
            11,275Interest
                ExpenseInterest
                on deposits
            
            
            4,806
            
            
            
            3,170Interest
                on borrowed money
            
            
            303
            
            
            
            354Total
                Interest Expense
            
            
            5,109
            
            
            
            3,524Net
                Interest Income
            
            
            8,375
            
            
            
            7,751Provision
                for Loan Losses
            
            
            341
            
            
            
            353Net
                Interest Income After Provision for Loan Losses
            
            
            8,034
            
            
            
            7,398Noninterest
                IncomeService
                Charges
            
            
            632
            
            
            
            576Investment
                in insurance contracts
            
            
            116
            
            
            
            284Other
                noninterest income
            
            
            217
            
            
            
            214Total
                Noninterest Income
            
            
            965
            
            
            
            1,074Noninterest
                ExpenseSalaries
                and employee benefits
            
            
            2,963
            
            
            
            2,802Equipment
                and occupancy expense
            
            
            691
            
            
            
            649Data
                processing expense
            
            
            428
            
            
            
            372Directors
                fees
            
            
            183
            
            
            
            197Legal
                and professional fees
            
            
            277
            
            
            
            238Other
                noninterest expense
            
            
            918
            
            
            
            885Total
                Noninterest Expense
            
            
            5,460
            
            
            
            5,143Income
                Before Provision For Income Taxes
            
            
            3,539
            
            
            
            3,329Provision
                for Income Taxes
            
            
            1,295
            
            
            
            1,124Net
                Income
            
            $
            2,244
            
            
            $
            2,205Per
                Share DataNet
                Income
            
            $
            1.56
            
            
            $
            1.53Cash
                Dividends
            
            $
            .50
            
            
            $
            .46Weighted
                Average Common Shares Outstanding
            
            
            1,436,874
            
            
            
            1,436,874The
                accompanying notes are an integral part of these
                statements.





*Index*





Page
                Three





HIGHLANDS
                BANKSHARES, INC.CONSOLIDATED
                STATEMENTS OF INCOME(In
                Thousands of Dollars, Except Per Share Data)Three
                Months Ended June 30,2007
            
            
            2006(unaudited)
            
            
            (unaudited)Interest
                IncomeInterest
                and fees on loans
            
            $
            6,290
            
            
            $
            5,316Interest
                on federal funds sold
            
            
            249
            
            
            
            106Interest
                on deposits in other banks
            
            
            40
            
            
            
            10Interest
                and dividends on securities
            
            
            338
            
            
            
            303Total
                Interest Income
            
            
            6,917
            
            
            
            5,735Interest
                ExpenseInterest
                on deposits
            
            
            2,515
            
            
            
            1,650Interest
                on borrowed money
            
            
            145
            
            
            
            181Total
                Interest Expense
            
            
            2,660
            
            
            
            1,831Net
                Interest Income
            
            
            4,257
            
            
            
            3,904Provision
                for Loan Losses
            
            
            168
            
            
            
            176Net
                Interest Income After Provision for Loan Losses
            
            
            4,089
            
            
            
            3,728Noninterest
                IncomeService
                Charges
            
            
            345
            
            
            
            349Investment
                in insurance contracts
            
            
            61
            
            
            
            215Other
                noninterest income
            
            
            89
            
            
            
            77Total
                Noninterest Income
            
            
            495
            
            
            
            647Noninterest
                ExpenseSalaries
                and employee benefits
            
            
            1,515
            
            
            
            1,394Equipment
                and occupancy expense
            
            
            336
            
            
            
            325Data
                processing expense
            
            
            219
            
            
            
            194Directors
                fees
            
            
            86
            
            
            
            97Legal
                and professional fees
            
            
            143
            
            
            
            137Other
                noninterest expense
            
            
            504
            
            
            
            462Total
                Noninterest Expense
            
            
            2,803
            
            
            
            2,615Income
                Before Provision For Income Taxes
            
            
            1,781
            
            
            
            1,760Provision
                for Income Taxes
            
            
            658
            
            
            
            559Net
                Income
            
            $
            1,123
            
            
            $
            1,201Per
                Share DataNet
                Income
            
            $
            .78
            
            
            $
            .84Cash
                Dividends
            
            $
            .25
            
            
            $
            .23Weighted
                Average Common Shares Outstanding
            
            
            1,436,874
            
            
            
            1,436,874The
                accompanying notes are an integral part of these
                statements.








*Index*





Page
                Four





HIGHLANDS
                BANKSHARES, INC.CONSOLIDATED
                BALANCE SHEETS(In
                Thousands of Dollars)June
                30, 2007
            
            
            December
                31, 2006(unaudited)
            
            
            (audited)ASSETSCash
                and due from banks—non-interest bearing
            
            
            9,671
            
            
            $
            7,111Deposits
                in other banks—interest bearing
            
            
            2,046
            
            
            
            1,624Federal
                funds sold
            
            
            15,727
            
            
            
            12,210Securities
                held to maturity
            
            
            170
            
            
            
            170Securities
                available for sale, at market value
            
            
            26,546
            
            
            
            23,729Restricted
                      investments
            
            
            1,503
            
            
            
            1,570Loans
            
            
            303,123
            
            
            
            292,816Allowance
                for loan losses
            
            
            (3,680
            )
            
            
            (3,482
            )Bank
                premises and equipment, net of depreciation
            
            
            8,057
            
            
            
            8,099Interest
                receivable
            
            
            2,446
            
            
            
            2,173Investment
                in life insurance contracts
            
            
            6,181
            
            
            
            6,066Goodwill
            
            
            1,534
            
            
            
            1,534Other
                intangible assets
            
            
            1,410
            
            
            
            1,498Other
                Assets
            
            
            2,352
            
            
            
            2,198Total
                Assets
            
            $
            377,086
            
            
            $
            357,316LIABILITIESNon-interest
                bearing deposits
            
            $
            48,633
            
            
            $
            46,726Savings
                and interest bearing demand deposits
            
            
            73,980
            
            
            
            71,590Time
                deposits
            
            
            198,656
            
            
            
            182,168Total
                Deposits
            
            
            321,269
            
            
            
            300,484Long
                term debt
            
            
            12,408
            
            
            
            14,992Accrued
                expenses and other liabilities
            
            
            4,840
            
            
            
            4,764Total
                Liabilities
            
            
            338,517
            
            
            
            320,240STOCKHOLDERS’
                EQUITYCommon
                Stock, $5 par value, 3,000,000 shares authorized, 1,436,874 shares
                issued
                and outstanding
            
            
            7,184
            
            
            
            7,184Surplus
            
            
            1,662
            
            
            
            1,662Retained
                Earnings
            
            
            30,342
            
            
            
            28,816Other
                accumulated comprehensive loss
            
            
            (619
            )
            
            
            (586
            )Total
                Stockholders’ Equity
            
            
            38,569
            
            
            
            37,076Total
                Liabilities and Stockholders’ Equity
            
            $
            377,086
            
            
            $
            357,316The
                accompanying notes are an integral part of these
                statements.





*Index*





Page
                Five





HIGHLANDS
                BANKSHARES, INC.CONSOLIDATED
                STATEMENTS OF CHANGES IN STOCKHOLDERS’ EQUITY(In
                Thousands of Dollars)Common
              Stock
            
            
            Surplus
            
            
            Retained
              Earnings
            
            
            Accumulated
              Other
              Comprehensive
              Income
            
            
            TotalBalances
                at December 31, 2005
            
            $
            7,184
            
            
            $
            1,662
            
            
            $
            25,651
            
            
            $
            (505
            )
            
            $
            33,992Net
                Income
            
            
            
            
            
            
            
            
            
            
            2,205
            
            
            
            
            
            
            
            2,205Net
                change in unrealized appreciation on investment securities available
                for
                sale, net of taxes
            
            
            
            
            
            
            
            
            
            
            
            
            
            
            (82
            )
            
            
            (82
            )Total
                Comprehensive Income
            
            
            
            
            
            
            
            
            
            
            
            
            
            
            
            
            
            
            2,123Dividends
                Paid
            
            
            
            
            
            
            
            
            
            
            (660
            )
            
            
            
            
            
            
            (660
            )Balances
                June 30, 2006
            
            $
            7,184
            
            
            $
            1,662
            
            
            $
            27,196
            
            
            $
            (587
            )
            
            $
            35,455








Common
              Stock
            
            
            Surplus
            
            
            Retained
              Earnings
            
            
            Accumulated
              Other
              Comprehensive
              Income
            
            
            TotalBalances
                at December 31, 2006
            
            $
            7,184
            
            
            $
            1,662
            
            
            $
            28,816
            
            
            $
            (586
            )
            
            $
            37,076Net
                Income
            
            
            
            
            
            
            
            
            
            
            2,244
            
            
            
            
            
            
            
            2,244Net
                change in unrealized appreciation on investment securities available
                for
                sale, net of taxes
            
            
            
            
            
            
            
            
            
            
            
            
            
            
            (33
            )
            
            
            (33
            )Total
                Comprehensive Income
            
            
            
            
            
            
            
            
            
            
            
            
            
            
            
            
            
            
            2,211Dividends
                Paid
            
            
            
            
            
            
            
            
            
            
            (718
            )
            
            
            
            
            
            
            (718
            )Balances
                June 30, 2007
            
            $
            7,184
            
            
            $
            1,662
            
            
            $
            30,342
            
            
            $
            (619
            )
            
            $
            38,569The
                accompanying notes are an integral part of these
                statements.








*Index*





Page
                Six





HIGHLANDS
                BANKSHARES, INC.CONSOLIDATED
                STATEMENTS OF CASH FLOWS(In
                Thousands of Dollars)Six
                Months Ended June 30,2007
            
            
            2006(unaudited)
            
            
            (unaudited)Cash
                Flows From Operating ActivitiesNet
                Income
            
            $
            2,244
            
            
            $
            2,205Adjustments
                to reconcile net income to netcash
                provided by operating activitiesDepreciation
            
            
            345
            
            
            
            331Increase
                in cash value of life insurance contracts
            
            
            (115
            )
            
            
            (116
            )Net
                amortization of securities
            
            
            (51
            )
            
            
            (11
            )Provision
                for loan losses
            
            
            341
            
            
            
            353Amortization
                of intangibles
            
            
            88
            
            
            
            88Decrease
                (increase) in interest receivable
            
            
            (273
            )
            
            
            (126
            )Decrease
                (increase) in other assets
            
            
            (154
            )
            
            
            (185
            )Increase
                in accrued expenses
            
            
            76
            
            
            
            95Net
                Cash Provided by Operating Activities
            
            
            2,501
            
            
            
            2,634Cash
                Flows From Investing ActivitiesIncrease
                (decrease) in federal funds sold
            
            
            (3,517
            )
            
            
            4,929Proceeds
                from maturities of securities available for sale
            
            
            4,733
            
            
            
            5,714Purchase
                of securities available for sale
            
            
            (7,532
            )
            
            
            (5,406
            )Proceeds
                from maturities of securities held to maturityIncrease
                in restricted investments
            
            
            67
            
            
            
            (207
            )Net
                change in interest bearing deposits in other banks
            
            
            (422
            )
            
            
            (756
            )Settlement
                on insurance contract
            
            
            
            
            
            
            555Purchase
                of property and equipment
            
            
            (303
            )
            
            
            (373
            )Net
                Change in Loans
            
            
            (10,450
            )
            
            
            (3,519
            )Net
                Cash Used in Investing Activities
            
            
            (17,424
            )
            
            
            937Cash
                Flows From Financing ActivitiesNet
                change in deposits
            
            
            20,785
            
            
            
            (3,915Additional
                long term debt
            
            
            
            
            
            
            2,300Repayment
                of long term debt
            
            
            (2,584
            )
            
            
            (1,582
            )Dividends
                paid in cash
            
            
            (718
            )
            
            
            (660
            )Net
                Cash Provided by Financing Activities
            
            
            17,483
            
            
            
            (3,857
            )Net
                Increase (Decrease) in Cash and Cash Equivalents
            
            
            2,560
            
            
            
            (286
            )Cash
                and Cash Equivalents, Beginning of Period
            
            
            7,111
            
            
            
            8,850Cash
                and Cash Equivalents, End of Period
            
            $
            9,671
            
            
            $
            8,564Supplemental
                DisclosuresCash
                paid for income taxes
            
            $
            1,626
            
            
            $
            1,186Cash
                paid for interest
            
            $
            5,029
            
            
            $
            3,494The
                accompanying notes are an integral part of these
                statements.





*Index*





Page
                Seven





**NOTES
      TO CONSOLIDATEDFINANCIAL STATEMENTS**





**NOTE
      1                      ACCOUNTING
      PRINCIPLES**





The
      consolidated financial statements conform to U. S. generally accepted accounting
      principles and to general industry practices.  In the opinion of
      management, the accompanying unaudited consolidated financial statements contain
      all adjustments, consisting solely of normal recurring adjustments, necessary
      to
      present fairly the financial position as of June 30, 2007 and the results of
      operations for the three and six-month periods ended June 30, 2007 and
      2006.





The
      results of operations for the three and six-month periods ended June 30, 2007
      and 2006 are not necessarily indicative of the results to be expected for the
      full year.





The
      notes
      included herein should be read in conjunction with the notes to financial
      statements included in the Company’s 2006 annual report on Form
      10-K.





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





**NOTE
      2                      SECURITIES
      AND RESTRICTED INVESTMENTS**





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





The
      amortized cost and market value of securities held to maturity as of June 30,
      2007 and December 31, 2006 are as follows (in thousands of
      dollars):





June
                30, 2007
            
            
            December
                31, 2006Amortized
            
            
            Market
            
            
            Amortized
            
            
            MarketCost
            
            
            Value
            
            
            Cost
            
            
            ValueHeld
                to Maturity SecuritiesObligations
                of states and municipalities
            
            $
            170
            
            
            $
            170
            
            
            $
            170
            
            
            $
            170Total
                Held to Maturity Securities
            
            $
            170
            
            
            $
            170
            
            
            $
            170
            
            
            $
            170Available
                For Sale SecuritiesU.S.
                Treasuries and Agencies
            
            $
            18,108
            
            
            $
            18,075
            
            
            $
            14,397
            
            
            $
            14,403Mortgage
                backed securities
            
            
            5,694
            
            
            
            5,704
            
            
            
            6,547
            
            
            
            6,554Obligations
                of states and municipalities
            
            
            2,771
            
            
            
            2,738
            
            
            
            2,763
            
            
            
            2,744Marketable
                equities
            
            
            28
            
            
            
            29
            
            
            
            28
            
            
            
            28Total
                Available For Sale Securities
            
            $
            26,601
            
            
            $
            26,546
            
            
            $
            23,735
            
            
            $
            23,729





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








**NOTE
      3                      INVESTMENTS
      IN INSURANCE CONTRACTS**





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





*Index*





Page
                Eight





**NOTE
      4                      LOANS**





A
      summary
      of loans outstanding as of June 30, 2007 and December 31, 2006 is shown in
      the
      table below (in thousands of dollars):





June
                30,
            
            
            December
                31,2007
            
            
            2006Loan
                TypeCommercial
            
            $
            80,581
            
            
            $
            70,408Real
                Estate construction
            
            
            15,582
            
            
            
            14,828Real
                Estate mortgage
            
            
            162,305
            
            
            
            164,243Consumer
                installment
            
            
            44,655
            
            
            
            43,337Total
                Loans
            
            $
            303,123
            
            
            $
            292,816





In
      addition to loans to fund construction and traditional mortgage loans, portions
      of the portfolio identified as commercial are also secured by real
      estate.  At June 30, 2007, the total balance of loans in the portfolio
      secured by real estate was $229,531,000.








**NOTE
      5                     ALLOWANCE
      FOR LOAN LOSSES**





A
      summary
      of the transactions in the allowance for loan losses for the six-month periods
      ended June 30, 2007 and 2006 is shown below (in thousands of
      dollars):





2007
            
            
            2006Balance,
                beginning of period
            
            $
            3,482
            
            
            $
            3,129Provisions
                charged to operations
            
            
            341
            
            
            
            353Loan
                recoveries
            
            
            176
            
            
            
            129Loan
                charge-offs
            
            
            (319
            )
            
            
            (318
            )Balance,
                end of period
            
            $
            3,680
            
            
            $
            3,293








**NOTE
      6                      DEPOSITS**





Balances
      of time deposits over $100,000 and of all other time deposits at June 30, 2007
      and December 31, 2006 are shown below (in thousands of dollars):





June
                30,
            
            
            December
                31,2007
            
            
            2006Time
                deposits over $100,000
            
            $
            64,123
            
            
            $
            54,867All
                other time deposits
            
            
            134,533
            
            
            
            127,301Total
                Time Deposits
            
            $
            198,656
            
            
            $
            182,168





Interest
      expense for time deposits over $100,000 and for all other time deposits for
      the
      three and six month periods ended June 30, 2007 and 2006 is shown below (in
      thousands of dollars):











Six
                Months Ended June 30,
            
            
            Three
                Months Ended June 30,2007
            
            
            2006
            
            
            2007
            
            
            2006$
            1,425
            
            
            $
            886
            
            
            $
            752
            
            
            $
            450








*Index*





Page
                Nine





**NOTE
      7                      EMPLOYEE
      BENEFITS**





The
      Company's two subsidiary banks each have separate retirement and profit sharing
      plans, which cover substantially all full time employees at each
      bank.





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





The
      Grant
      County Bank is a member of the West Virginia Bankers' Association Retirement
      Plan.  Benefits under the plan are based on compensation and years of
      service with 100% vesting after seven years of service.  Prior to
      2002, the Plan's assets were in excess of the projected benefit obligations
      and
      thus the Bank was not required to make contributions to the Plan in 2003, 2002
      or 2001. The bank was required to make contributions in 2004, 2005 and 2006
      and
      has made contribution to the plan during the first half of 2007.  The
      Bank has recognized liabilities of $682,000 at June 30, 2007 as a result of
      this
      shortfall.  The following table provides the components of the net periodic
      benefit cost for the plan for the six-month periods ended June 30, 2007 and
      2006
      (in thousands of dollars):





2007
            
            
            2006Service
                cost
            
            $
            63
            
            
            $
            55Interest
                cost
            
            
            100
            
            
            
            81Expected
                return on plan assets
            
            
            (106
            )
            
            
            (90
            )Amortization
                of unrecognized prior service costs
            
            
            5
            
            
            
            5Recognized
                net actuarial loss
            
            
            30
            
            
            
            26Net
                periodic expense
            
            $
            92
            
            
            $
            77








**NOTE
      8                      DEBT
      INSTRUMENTS**





The
      Company continues to borrow money
      from the Federal Home Loan Bank of Pittsburgh (FHLB) to meet
      specificfunding
      needs.  The interest rates of the notes payable as ofJune 30,
      2007range from 3.30% to
      6.12%.  The weighted average interest rate was 4.39% at June 30, 2007.
      The debt is secured by the general assets of the Banks.











*Index*





Page
                Ten





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





**Forward
      Looking Statements**





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





**Introduction**





The
      following discussion focuses on significant results of the Company’s operations
      and significant changes in our financial condition or results of operations
      for
      the periods indicated in the discussion. This discussion should be read in
      conjunction with the preceding financial statements and related notes, as well
      as the Company’s Annual Report on Form 10-K for the period ended December 31,
      2006.





Current
      performance does not guarantee, and may not be indicative of, similar
      performance in the future.





**Critical
      Accounting Policies**





The
      Company’s financial statements are prepared in accordance with accounting
      principles generally accepted in the United States (“GAAP”). The financial
      statements contained within these statements are, to a significant extent,
      financial information that is based on measures of the financial effects of
      transactions and events that have already occurred. A variety of factors could
      affect the ultimate value that is obtained either when earning income,
      recognizing an expense, recovering an asset or relieving a liability. In
      addition, GAAP itself may change from one previously acceptable method to
      another method. Although the economics of these transactions would be the same,
      the timing of events that would impact these transactions could
      change.





Disclosure
      of the Company’s significant accounting policies is included in Note Two to the
      Consolidated Financial Statements of the Company’s Annual Report on Form 10-K
      for the period ended December 31, 2006. Some of the policies are particularly
      sensitive, requiring significant judgments, estimates and assumptions by
      management.





*Index*





Page
                Eleven





The
      allowance for loan losses is an estimate of the losses that may be sustained
      in
      the loan portfolio. The allowance is based on two basic principles of
      accounting: (i) SFAS No. 5, Accounting for Contingencies, which requires that
      losses be accrued when they are probable of occurring and estimable and (ii)
      SFAS No. 114, Accounting by Creditors for Impairment of a Loan, which requires
      that losses be accrued based on the differences between the value of collateral,
      present value of future cash flows or values that are observable in the
      secondary market and the loan balance. Additional information pertaining to
      the
      allowance for loan losses and provision for loan losses is contained on pages
      16-18 of this report.





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





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





**Recent
      Accounting Pronouncements**





In
      September 2006, the FASB issued Statement of Financial Accounting Standards
      No.
      158, “Employers Accounting for Defined Benefit Pension and Other Postretirement
      Plans—an amendment of FASB Statements No. 87, 88, 106 and 132R” (SFAS 158). SFAS
      158 requires an employer to recognize the over-funded or under-funded status
      of
      a defined benefit postretirement plan as an asset or liability in its statement
      of financial position and to recognize changes in that funded status, through
      comprehensive income, in the year in which the changes occur. The funded status
      of a benefit plan will be measured as the difference between plan assets at
      fair
      value and benefit obligation. For any other postretirement plan, the benefit
      obligation is the accumulated postretirement benefit obligation. SFAS 158 also
      requires an employer to measure the funded status of a plan as of the date
      of
      its year-end statement of financial position. The Statement also requires
      additional disclosures in the notes to financial statements about certain
      effects on net periodic benefit cost for the next fiscal year that arise from
      delayed recognition of the gains or losses, prior service costs or credits,
      and
      transition asset or obligation. Under SFAS 158 a company is required to
      initially recognize the funded status of a defined benefit postretirement plan
      to provide the required disclosures as of the end of the fiscal year ending
      after December 15, 2006. The requirement to measure plan assets and benefit
      obligations as of the date of the employer’s fiscal year end statement of
      financial position is effective for fiscal years ending after December 15,
      2008.
      The Grant County Bank is a member of the West Virginia Bankers' Association
      Retirement Plan, a defined benefit plan under SFAS 158.





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





*Index*








Page
                Twelve





**Overview
      of Results**





Net
      income for the first six months of 2007 was 1.77% higher than for the same
      period in 2006. Income during the first six months of 2006 was substantially
      impacted by a $155,000 non-recurring gain on a life insurance settlement.
      Additional information relating to this gain can be found in the Company’s 2006
      Annual Report on Form 10-K.





Return
      on
      Average Assets (ROAA) for the first six months of 2007 was 1.23% compared with
      ROAA of 1.32% during the first half of 2006. Return on Average Equity (ROAE)
      for
      the first half of 2007 was 11.96% compared to ROAE of 12.78% for the same period
      a year ago.





Interest
      income continued to increase both as the result of average rate increases and
      growth of the Company’s balance sheet. Average earning assets for the first six
      months were 9.66% greater than during the same period in 2006.  The
      increases in average rates and balances for earning assets were offset somewhat
      by similar rate and balance increases in interest bearing liabilities, resulting
      in a net increase of the Company’s net interest income of 8.05%. .





Non-interest
      income for the first half of 2007 declined, largely due to the impact of the
      non-recurring gain present during 2006. Irrespective of this gain in 2006,
      the
      Company experienced modest increases in non-interest income due mainly to
      continued increases in deposit account service charges as the Company’s deposit
      base continues to grow.





Non-interest
      expense increased 6.16%. As the Company’s operations continue to expand, costs
      of data processing, equipment and occupancy, and personnel costs have continued
      to rise accordingly.





Highlands'
      results of operations are discussed in greater detail following this overview.
      Unless otherwise specifically noted, the underlying causes for changes in the
      results for the quarter ended June 30, 2007 as compared to the same quarter
      in
      2006 are substantially the same as the causes discussed for the six months
      ended
      June 30, 2007 as compared to the six months ended June 30, 2006.








**Net
      Interest Income**





Net
      interest income, on a fully taxable equivalent basis, increased 7.99% for the
      first six months of 2007 as compared to the same period in 2006. This increase
      came primarily as the result of the relative size of increases in earning assets
      compared to increases in interest bearing liabilities. The increase in the
      average rates paid on interest bearing liabilities increased more than the
      average rate earned on earning assets.





The
      table
      on the following page illustrates the effects on net interest income, on a
      fully
      taxable equivalent basis, and for the first six months of each year, of changes
      in average volumes of interest bearing liabilities and earning assets from
      2006
      to 2007 and changes in average rates on interest bearing liabilities and earning
      assets from 2006 to 2007 (in thousands of dollars):





*Index*





Page
                Thirteen





EFFECT
                OF RATE-VOLUME CHANGES ON NET INTEREST INCOME(On
                a fully taxable equivalent basis)(In
                thousands of dollars)Increase
                (Decrease) Six Months Ended June 30, 2007 Compared to Six Months
                Ended
                June 30, 2006Due
                to change in:Average
                Volume
            
            
            Average
                Rate
            
            
            Total
                ChangeInterest
                IncomeLoans
            
            $
            1,105
            
            
            $
            804
            
            
            $
            1,909Federal
                funds sold
            
            
            157
            
            
            
            34
            
            
            
            191Interest
                bearing deposits
            
            
            38
            
            
            
            10
            
            
            
            48Taxable
                investment securities
            
            
            (99
            )
            
            
            162
            
            
            
            63Nontaxable
                investment securities
            
            
            (7
            )
            
            
            3
            
            
            
            (4
            )Total
                Interest Income
            
            
            1,194
            
            
            
            1,013
            
            
            
            2,207Interest
                ExpenseDemand
                deposits
            
            
            1
            
            
            
            1
            
            
            
            2Savings
                deposits
            
            
            (38
            )
            
            
            90
            
            
            
            52Time
                deposits
            
            
            783
            
            
            
            799
            
            
            
            1,582Borrowed
                money
            
            
            (63
            )
            
            
            12
            
            
            
            (51
            )Total
                Interest Expense
            
            
            683
            
            
            
            902
            
            
            
            1,585Net
                Interest Income
            
            $
            511
            
            
            $
            111
            
            
            $
            623





Increases
      by the Federal Reserve Board (“The Fed”) throughout 2005 and continuing into
      2006 for the target rate for federal funds sold has caused both rates earned
      on
      assets and rates paid on liabilities to increase.  Although the
      increases by The Fed slowed in late 2006 and no increases have occurred during
      2007, the Company’s balance sheet continues to be impacted by the increases
      enacted during 2005 and early 2006. As older earning assets and interest bearing
      liabilities mature and are replaced by newer earning assets and interest bearing
      liabilities, which bear higher rates of interest, the Company has experienced
      increases in both the average rates earned on assets and the average rates
      paid
      on liabilities





Due
      mainly to both the shorter maturities on deposits versus those on loans or
      securities investments, and the relative ratio of time deposits, typically
      a
      higher cost interest bearing liability, to other interest bearing liabilities,
      the average rates paid on interest bearing liabilities increased 88 basis points
      compared to a 65 basis point increase in average rates earned on
      assets.





Historically,
      the Company, in an effort to attract deposits with which to fund loan growth,
      has often paid rates on deposits higher than national averages. During the
      later
      portions of 2004 and during 2005, the Company chose to fund loan growth through
      reductions in deposits and also reductions of comparatively lower earning assets
      like federal funds sold and securities rather than compete for deposits based
      upon rate. As The Fed has continued to increase the target rate for federal
      funds sold, the average rates earned by securities, federal funds sold and
      deposits in other banks have increased more than the rates on loans. As such,
      Management has somewhat eased its strategy for funding loans through reductions
      in these lower earning assets because, in some instances, the rates paid on
      these assets are greater than the cost of interest on new deposits. In addition,
      strong loan demand throughout the later parts of 2006 and continuing into 2007
      created a need for the offering of higher rates on deposits to attract new
      deposits with which to fund this loan growth. As such, the Company’s average
      rates paid on time deposits and average balances of time deposits has
      increased.





As
      of
      June 30, 2007, the Company had balances of liquid funds, mostly in the form
      of
      federal funds sold, greater than seen during previous quarters. Because of
      the
      larger balances of liquid funds, Management anticipates that, in the immediately
      upcoming quarters, the need for offering above market rates to attract new
      deposits will continue to lessen as compared to recent years, allowing net
      interest margins to continue at or near recent levels.





*Index*





Page
                Fourteen





The
      table
      below sets forth an analysis of net interest income for the six-month periods
      ended June 30, 2007 and 2006 (Average balances and interest/expense shown in
      thousands of dollars):





2007
            
            
            2006Average
            
            
            Income/
            
            
            
            
            
            Average
            
            
            Income/Balance
            
            
            Expense
            
            
            Rate
            
            
            Balance
            
            
            Expense
            
            
            RateInterest
                IncomeLoans1,2
            
            $
            298,548
            
            
            $
            12,359
            
            
            
            8.28
            %
            
            $
            271,863
            
            
            $
            10,450
            
            
            
            7.69
            %Federal
                funds sold
            
            
            15,851
            
            
            
            405
            
            
            
            5.11
            %
            
            
            9,725
            
            
            
            214
            
            
            
            4.40
            %Interest
                bearing deposits
            
            
            2,428
            
            
            
            70
            
            
            
            5.77
            %
            
            
            1,101
            
            
            
            22
            
            
            
            4.00
            %Taxable
                investment securities
            
            
            22,457
            
            
            
            594
            
            
            
            5.29
            %
            
            
            26,213
            
            
            
            531
            
            
            
            4.05
            %Nontaxable
                investment securities3
            
            
            2,931
            
            
            
            88
            
            
            
            6.00
            %
            
            
            3,157
            
            
            
            92
            
            
            
            5.83
            %Total
                Earning Assets
            
            
            342,215
            
            
            
            13,516
            
            
            
            7.90
            %
            
            
            312,059
            
            
            
            11,309
            
            
            
            7.25
            %Cash
                and cash equivalents
            
            
            8,033
            
            
            
            
            
            
            
            
            
            
            
            7,928Allowance
                for loan losses
            
            
            (3,591
            )
            
            
            
            
            
            
            
            
            
            
            (3,182
            )Insurance
                contracts
            
            
            6,123
            
            
            
            
            
            
            
            
            
            
            
            6,398Non-earning
                assets
            
            
            15,042
            
            
            
            
            
            
            
            
            
            
            
            14,445Total
                Assets
            
            $
            367,822
            
            
            
            
            
            
            
            
            
            
            $
            337,648Interest
                ExpenseInterest
                bearing demand deposits
            
            $
            26,148
            
            
            $
            113
            
            
            
            .86
            %
            
            $
            25,995
            
            
            $
            111
            
            
            
            .85
            %Savings
                and money markets
            
            
            46,964
            
            
            
            315
            
            
            
            1.34
            %
            
            
            52,605
            
            
            
            263
            
            
            
            1.00
            %Time
                deposits
            
            
            190,564
            
            
            
            4,378
            
            
            
            4.59
            %
            
            
            156,467
            
            
            
            2,796
            
            
            
            3.57
            %Long
                term debt
            
            
            13,091
            
            
            
            303
            
            
            
            4.63
            %
            
            
            15,808
            
            
            
            354
            
            
            
            4.48
            %Total
                Interest Bearing Liabilities
            
            
            276,767
            
            
            
            5,109
            
            
            
            3.69
            %
            
            
            250,875
            
            
            
            3,524
            
            
            
            2.81
            %Demand
                deposits
            
            
            48,410
            
            
            
            
            
            
            
            
            
            
            
            47,987Other
                liabilities
            
            
            4,798
            
            
            
            
            
            
            
            
            
            
            
            3,996Stockholders’
                equity
            
            
            37,847
            
            
            
            
            
            
            
            
            
            
            
            34,790Total
                liabilities and stockholders’ equity
            
            $
            367,822
            
            
            
            
            
            
            
            
            
            
            $
            337,648Net
                Interest Income
            
            
            
            
            
            $
            8,407
            
            
            
            
            
            
            
            
            
            
            $
            7,785Net
                Yield on Earning Assets3
            
            
            
            
            
            
            
            
            
            
            4.91
            %
            
            
            
            
            
            
            
            
            
            
            4.99
            %





1Balances
      of loans
      include loans in non-accrual status


2Interest
      income on
      loans includes fees


3Yields
      are on a
      fully taxable equivalent basis





*Index*





Page
                Fifteen





The
      table
      below sets forth an analysis of net interest income for the three-month periods
      ended June 30, 2007 and 2006 (Average balances and interest/expense shown in
      thousands of dollars):





2007
            
            
            2006Average
            
            
            Income/
            
            
            
            
            
            Average
            
            
            Income/Balance
            
            
            Expense
            
            
            Rate
            
            
            Balance
            
            
            Expense
            
            
            RateInterest
                IncomeLoans1,2
            
            $
            300,550
            
            
            $
            6,290
            
            
            
            8.37
            %
            
            $
            272,374
            
            
            $
            5,316
            
            
            
            7.81
            %Federal
                funds sold
            
            
            18,402
            
            
            
            249
            
            
            
            5.41
            %
            
            
            8,658
            
            
            
            106
            
            
            
            4.90
            %Interest
                bearing deposits
            
            
            2,504
            
            
            
            40
            
            
            
            6.39
            %
            
            
            1,157
            
            
            
            10
            
            
            
            3.46
            %Taxable
                investment securities
            
            
            23,056
            
            
            
            310
            
            
            
            5.38
            %
            
            
            26,243
            
            
            
            273
            
            
            
            4.16
            %Nontaxable
                investment securities3
            
            
            2,924
            
            
            
            45
            
            
            
            6.16
            %
            
            
            3,206
            
            
            
            47
            
            
            
            5.86
            %Total
                Earning Assets
            
            
            347,436
            
            
            
            6,934
            
            
            
            7.98
            %
            
            
            311,638
            
            
            
            5,752
            
            
            
            7.38
            %Cash
                and cash equivalents
            
            
            8,429
            
            
            
            
            
            
            
            
            
            
            
            7,790Allowance
                for loan losses
            
            
            (3,638
            )
            
            
            
            
            
            
            
            
            
            
            (3,209
            )Insurance
                contracts
            
            
            6,152
            
            
            
            
            
            
            
            
            
            
            
            6,378Nonearning
                assets
            
            
            15,103
            
            
            
            
            
            
            
            
            
            
            
            14,219Total
                Assets
            
            $
            373,482
            
            
            
            
            
            
            
            
            
            
            $
            336,816Interest
                ExpenseInterest
                bearing demand deposits
            
            $
            25,897
            
            
            $
            56
            
            
            
            .86
            %
            
            $
            25,897
            
            
            $
            57
            
            
            
            .88
            %Savings
                and money markets
            
            
            48,179
            
            
            
            168
            
            
            
            1.39
            %
            
            
            51,159
            
            
            
            135
            
            
            
            1.06
            %Time
                deposits
            
            
            195,040
            
            
            
            2,291
            
            
            
            4.70
            %
            
            
            156,211
            
            
            
            1,458
            
            
            
            3.73
            %Long
                term debt
            
            
            12,478
            
            
            
            145
            
            
            
            4.65
            %
            
            
            15,859
            
            
            
            181
            
            
            
            4.57
            %Total
                Interest Bearing Liabilities
            
            
            281,594
            
            
            
            2,660
            
            
            
            3.75
            %
            
            
            249,126
            
            
            
            1,831
            
            
            
            2.94
            %Demand
                deposits
            
            
            48,923
            
            
            
            
            
            
            
            
            
            
            
            48,714Other
                liabilities
            
            
            4,734
            
            
            
            
            
            
            
            
            
            
            
            3,821Stockholders’
                equity
            
            
            38,231
            
            
            
            
            
            
            
            
            
            
            
            35,155Total
                liabilities and stockholders’ equity
            
            $
            373,482
            
            
            
            
            
            
            
            
            
            
            $
            336,816Net
                Interest Income
            
            
            
            
            
            $
            4,274
            
            
            
            
            
            
            
            
            
            
            $
            3,921Net
                Yield on Earning Assets3
            
            
            
            
            
            
            
            
            
            
            4.92
            %
            
            
            
            
            
            
            
            
            
            
            5.03
            %1Balances
                of
                loans include loans in nonaccrual status2Interest
                income on loans includes fees3Yields
                are on
                a fully taxable equivalent basis





*Index*




Page
                Sixteen





**Loan
      Portfolio**





The
      Company is an active residential mortgage and construction lender and generally
      extends commercial loans to small and medium sized businesses within its primary
      service area.  The Company's commercial lending activity extends
      across its primary service areas of Grant, Hardy, Hampshire, Mineral, Randolph,
      Tucker, and northern Pendleton counties in West Virginia, Frederick County,
      Virginia and Garrett County, Maryland.  Consistent with its focus on
      providing community-based financial services, the Company does not attempt
      to
      diversify its loan portfolio geographically by making significant amounts of
      loans to borrowers outside of its primary service area.








**Credit
      Quality and Allowance for Loan Losses**





Non-performing
      loans increased 13.87% from December 31, 2006 to June 30, 2007. Non-performing
      loans represented .64% of gross loans at June 30, 2007 and .58% of gross loans
      at December 31, 2006.





The
      following table summarizes the Company’s non-performing loans at June 30, 2007
      and December 31, 2006 (in thousands of dollars):





June
                30,
            
            
            December
                31,2007
            
            
            2006Non-accrual
                loans
            
            $
            437
            
            
            $
            244Loans
                past due 90 days and still accruing interest
            
            
            1,500
            
            
            
            1,457Total
                non-performing loans
            
            $
            1,937
            
            
            $
            1,701





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





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





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





An
      inherent risk in the lending of money is that the borrower will not be able
      to
      repay the loan under the terms of the original agreement.  The
      allowance for loan losses provides for this risk and is reviewed periodically
      for adequacy.  This review also considers concentrations of loans in
      terms of geography, business type or level of risk.  While lending is
      geographically diversified within the service area, the Company does have some
      concentration of loans in the area of agriculture (primarily poultry farming),
      timber and related industries. Management recognizes these concentrations and
      considers them when structuring its loan portfolio.









*Index*







Page
                Seventeen







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




based
      on
      historical loss rates adjusted for current economic conditions.  The
      final step is to calculate a loss for the remainder of the portfolio using
      historical loss information for each type of loan classification. The
      determination of specific allowances and weighting is somewhat subjective and
      actual losses may be greater or less than the amount of the
      allowance.  However, Management believes that the allowance represents
      a fair assessment of the losses that exist in the current loan
      portfolio.





The
      required level of the allowance for loan losses is computed quarterly and the
      allowance adjusted prior to the issuance of the quarterly financial
      statements.  All loan losses charged to the allowance are approved by
      the boards of directors of each bank at their regular meetings.  The
      allowance is reviewed for adequacy after considering historical loss rates,
      current economic conditions (both locally and nationally) and any known credit
      problems that have not been considered under the above formula.





Management
      has analyzed the potential risk of loss on the Company's loan portfolio given
      the loan balances and the value of the underlying collateral and has recognized
      losses where appropriate. Non-performing loans are closely monitored on an
      ongoing basis as part of the Company's loan review process.





The
      following table shows the allocation for loans in the loan portfolio and the
      corresponding amounts of the allowance allocated by loan type as of June 30,
      2007 and December 31, 2006 (in thousands of dollars):





June
                30, 2007
            
            
            December
                31, 2006Percent
                of
            
            
            
            
            
            Percent
                ofAmount
            
            
            Loans
            
            
            Amount
            
            
            LoansLoan
                TypeCommercial
            
            $
            1,502
            
            
            
            27
            %
            
            $
            1,492
            
            
            
            24
            %Mortgage
                and construction
            
            
            1,083
            
            
            
            58
            %
            
            
            996
            
            
            
            61
            %Consumer
            
            
            1,068
            
            
            
            15
            %
            
            
            967
            
            
            
            15
            %Unallocated
            
            
            27
            
            
            
            
            
            
            
            27Totals
            
            $
            3,680
            
            
            
            
            
            
            $
            3,482








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





*Index*





Page
                Eighteen





The
      following table summarizes the Company’s net charge-offs by loan type for the
      six-month periods ended June 30, 2007 and 2006 (in thousands of
      dollars):





2007
            
            
            2006Charge-offsCommercial
            
            $
            (20
            )
            
            $
            (3
            )Mortgage
                and construction
            
            
            (38
            )
            
            
            (1
            )Consumer
            
            
            (261
            )
            
            
            (314
            )Total
                Charge-offs
            
            
            (319
            )
            
            
            (318
            )RecoveriesCommercial
            
            
            49
            
            
            
            3Mortgage
            
            
            0
            
            
            
            0Consumer
            
            
            127
            
            
            
            125Total
                Recoveries
            
            
            176
            
            
            
            128Total
                Net Charge-offs
            
            $
            (143
            )
            
            $
            (190
            )





The
      provision for loan losses taken during the first half of 2007 was $12,000 less
      than that taken during the same period in 2006. In spite of the decrease in
      the
      provision, the ratio of the allowance for loan losses to gross loans increased
      from 1.19% at December 31, 2006 to 1.21% at June 30, 2007.   At
      June 30, 2006, the ratio of the allowance for loan losses to gross loans was
      1.20%.  The ratio of allowance for loan losses to non-performing loans
      was 1.90 at June 30, 2007 compared to 2.05 at December 31, 2006.





**Non-interest
      Income**





Non-interest
      income decreased 10.15% for the first half of 2007 as compared to the same
      period in 2006.





During
      the second quarter of 2006, the Company recorded a one-time, non-recurring
      gain
      of $155,000 related to the settlement of a life insurance contract. This gain
      greatly impacted the amount of non-interest income recorded during 2006, and
      contributed significantly to the year over year decline in non-interest income.
      In addition to the impact of the gain recorded in 2006, income from investments
      in life insurance contracts fell as the result of there being fewer policies
      present during the first quarter of 2007 as compared to the same period in
      2006.
      (See Note Twenty of the Financial Statements included in the Company’s Annual
      Report on Form 10-K for the Year Ended December 31, 2006)





Account
      service charges continue to increase, largely due to increases in non-sufficient
      funds fees charged to customers.








**Non-interest
      Expense**





Non-interest
      expense increased 6.16% for the first six months of 2007 as compared to
      2006.





As
      the
      relative size of the Company’s operations continues to increase, the Company’s
      cost of equipment and also data processing expense also increased. Legal and
      professional fees increased $39,000 as compared to 2006 largely as a result
      of
      increased on-site engagements of consultants assisting the Company with Sarbanes
      Oxley Rule 404 compliance.





The
      cost
      of employee salaries and related benefits increased slightly as normal annual
      increases in pay were offset in part by declines in the cost of postretirement
      benefit plans.


*Index*





Page
                Nineteen





**Borrowed
      Funds**





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





**Liquidity**





Operating
      liquidity is the ability to meet present and future financial obligations.
      Short-term liquidity is provided primarily through cash balances, deposits
      with
      other financial institutions, federal funds sold, non-pledged securities and
      loans maturing within one year. Additional sources of liquidity available to
      the
      Company include, but are not limited to, loan repayments, the ability to obtain
      deposits through the adjustment of interest rates and the purchasing of federal
      funds.  To further meet its liquidity needs, the Company also
      maintains lines of credit with correspondent financial institutions, the Federal
      Reserve Bank of Richmond and the Federal Home Loan Bank of
      Pittsburgh.





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





The
      parent Company’s operating funds, funds with which to pay shareholder dividends
      and funds for the exploration of new business ventures, have been supplied
      primarily through dividends paid by the Company’s subsidiary banks Capon Valley
      Bank (CVB) and The Grant County Bank (GCB).  The various regulatory
      authorities impose restrictions on dividends paid by a state bank.  A
      state bank cannot pay dividends without the consent of the relevant banking
      authorities in excess of the total net profits of the current year and the
      combined retained profits of the previous two years.  As of July 1,
      2007, the subsidiary banks could pay dividends to Highlands Bankshares, Inc.
      of
      approximately $7,212,000 without permission of the regulatory
      authorities.





**Capital**





The
      Company seeks to maintain a strong capital base to expand facilities, promote
      public confidence, support current operations and grow at a manageable
      level.  As of June 30, 2007, the Company was above the regulatory
      minimum levels of capital. The table below summarizes the capital ratios for
      the
      Company and its subsidiary banks as of June 30, 2007 and December 31,
      2006:





June
                30, 2007
            
            
            December
                31, 2006Actual
            
            
            Regulatory
            
            
            Actual
            
            
            RegulatoryRatio
            
            
            Minimum
            
            
            Ratio
            
            
            MinimumTotal
                Risk Based Capital RatioHighlands
                Bankshares
            
            
            14.24
            %
            
            
            8.00
            %
            
            
            13.45
            %
            
            
            8.00
            %Capon
                Valley Bank
            
            
            14.55
            %
            
            
            8.00
            %
            
            
            14.56
            %
            
            
            8.00
            %The
                Grant County Bank
            
            
            12.94
            %
            
            
            8.00
            %
            
            
            12.63
            %
            
            
            8.00
            %Tier
                1 Leverage RatioHighlands
                Bankshares
            
            
            9.79
            %
            
            
            4.00
            %
            
            
            9.26
            %
            
            
            4.00
            %Capon
                Valley Bank
            
            
            9.61
            %
            
            
            4.00
            %
            
            
            9.53
            %
            
            
            4.00
            %The
                Grant County Bank
            
            
            9.02
            %
            
            
            4.00
            %
            
            
            8.85
            %
            
            
            4.00
            %Tier
                1 Risk Based Capital RatioHighlands
                Bankshares
            
            
            12.99
            %
            
            
            4.00
            %
            
            
            12.21
            %
            
            
            4.00
            %Capon
                Valley Bank
            
            
            13.30
            %
            
            
            4.00
            %
            
            
            13.30
            %
            
            
            4.00
            %The
                Grant County Bank
            
            
            11.69
            %
            
            
            4.00
            %
            
            
            11.39
            %
            
            
            4.00
            %





*Index*





Page
                Twenty





**Effects
      of Inflation**





Inflation
      primarily affects industries having high levels of property, plant and equipment
      or inventories. Although the Company is not significantly affected in these
      areas, inflation does have an impact on the growth of assets.  As
      assets grow rapidly, it becomes necessary to increase equity capital at
      proportionate levels to maintain the appropriate equity to asset
      ratios.  Traditionally, the Company's earnings and high capital
      retention levels have enabled the Company to meet these needs. The Company's
      reported earnings results have been minimally affected by
      inflation.  The different types of income and expense are affected in
      various ways.  Interest rates are affected by inflation, but the
      timing and magnitude of the changes may not coincide with changes in the
      consumer price index.  Management actively monitors interest rate
      sensitivity in order to minimize the effects of inflationary trends on interest
      rates. Other areas of non-interest expenses may be more directly affected by
      inflation.








**Item
      3.Quantitative and Qualitative Disclosures About Market
      Risk**





There
      have been no material changes in Quantitative and Qualitative Disclosures about
      Market Risk as reported in the Company’s Annual Report on Form 10-K for the
      period ended December 31, 2006.





**Item
      4.Controls and Procedures**





The
      Company’s management, with the participation of the Company’s Chief Executive
      Officer and Chief Financial Officer, has evaluated the effectiveness of the
      Company’s disclosure controls and procedures as of June 30, 2007. Based on this
      evaluation, the Company’s Chief Executive Officer and Chief Financial Officer
      concluded that the Company’s disclosure controls and procedures are effective as
      of June 30, 2007. The company has established procedures undertaken during
      the
      normal course of business in an effort to reasonably ensure that fraudulent
      activity of either an amount material to these results or in any amount is
      not
      occurring.





Changes
      in Internal Controls





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








**Item
      4T.Controls and Procedures**





Not
      applicable.










**PART
      II OTHER INFORMATION**





**Item
      1. Legal Proceedings**





Management
      is not aware of any material pending or threatened litigation in which the
      Company or its subsidiaries may be involved as a defendant.  In the
      normal course of business, the banks periodically must initiate suits against
      borrowers as a final course of action in collecting past due loans. In addition,
      to management’s knowledge, no governmental authorities have initiated or
      contemplated legal action against the Company.





**Item
      1A. Risk Factors**





There
      have been no material changes to the Company’s risk factors since these factors
      were previously disclosed in the Company’s Annual Report on Form 10-K for the
      period ended December 31, 2006.





*Index*





Page
                Twenty One





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





None





**Item
      3.     Defaults Upon Senior
      Securities**





None





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





On
      May 8,
      2007 the Company held its annual meeting of stockholders. The following items
      were approved by the shareholders by the required majority or
      plurality.





1)
            Election
                of the Board of Directors as proposed in the Proxy material, without
                any
                additions or exceptions





**Votes
                For**
            **With-hold
                Authority**Steven
                C. Judy
            977,823
            100Jack
                H. Walters
            971,800
            6,123Leslie
                A Barr
            969,075
            8,848





2)
            Ratification
                of Smith Elliott Kearns & Company, LLC as Independent Registered
                Public Accountant for 2007.








**Item
      5.     Other
      Information**





None











**Item
      6.    Exhibits**





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, 1986.3(ii)
            Bylaws
                of Highlands Bankshares, Inc. are incorporated by reference to Exhibit
                3(ii) to Highlands Bankshares, Inc.’s Form 10-Q filed May 15,
                2003.31.1
            Certification
                of Chief Executive Officer Pursuant to section 302 of the Sarbanes-Oxley
                Act of 2002 Chapter 63, Title 18 U.S.C. Section 1350 (A) and
                (B).31.2
            Certification
                of Chief Financial Officer Pursuant to section 302 of the Sarbanes-Oxley
                Act of 2002 Chapter 63, Title 18 U.S.C. Section 1350 (A) and
                (B).32.1
            Statement
                of Chief Executive Officer Pursuant to 18  U.S.C. §
                1350.32.2
            Statement
                of Chief Financial Officer Pursuant to 18  U.S.C. §
                1350.





*Index*





Page
                Twenty Two





Signatures





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





HIGHLANDS
                BANKSHARES, INC./s/
                C.E. PorterC.E.
                PorterPresident
                & Chief Executive Officer/s/
                R. Alan MillerR.
                Alan MillerChief
                Financial OfficerAugust
                10, 2007