**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 September 30, 2007





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





Commission
      File Number:  0-16761





**HIGHLANDS
      BANKSHARES, INC.**


(Exact
      name of registrant as specified in its charter)





West
                Virginia
            55-0650793(State
                or Other Jurisdiction of
            (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 o





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 o
            Accelerated
                Filer o
            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).   o Yesý
      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 October 31, 2007:  1,436,874
      shares of Common Stock, $5 Par Value











HIGHLANDS
                BANKSHARES, INC.Quarterly
                Report on Form 10Q For The Period Ended September
                30,2007INDEXPagePART
                I
            FINANCIAL
                INFORMATIONItem
                1.
            Financial
                StatementsUnaudited
                Consolidated Statements of IncomeNine
                Months Ended September 30, 2007 and
                2006
            2Unaudited
                Consolidated Statements of IncomeThree
                Months Ended September 30, 2007 and
                2006
            3Unaudited
                Consolidated Balance Sheet for September 30,
                2007And
                Audited Consolidated Balance Sheet for December 31,
                2006
            4Unaudited
                Consolidated Statements of Changes in
                Stockholders’Equity
                for the Nine Months Ended September 30, 2007 and
                2006
            5Unaudited
                Consolidated Statements of Cash Flows for the
                NineMonths
                Ended September 30, 2007 and 2006
            6Notes
                to Consolidated Financial Statements
            7Item
                2.
            Management’
Discussion
                and Analysis of Financial
                ConditionAnd
                Results of Operations
            10Item
                3.
            Quantitative
                and Qualitative Disclosures About Market
                Risk
            20Item
                4.
            Controls
                and Procedures
            20Item
                4T.
            Controls
                and Procedures
            21PART
                II
            OTHER
                INFORMATIONItem
                1.
            Legal
                Proceedings
            21Item
                1A.
            Risk
                Factors
            21Item
                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)Nine
                Months Ended September 30,2007
            
            
            2006(unaudited)
            
            
            (unaudited)Interest
                IncomeInterest
                and fees on loans
            
            $
            18,830
            
            
            $
            16,149Interest
                on federal funds sold
            
            
            600
            
            
            
            338Interest
                on deposits in other banks
            
            
            100
            
            
            
            39Interest
                and dividends on securities
            
            
            1,033
            
            
            
            891Total
                Interest Income
            
            
            20,563
            
            
            
            17,417Interest
                ExpenseInterest
                on deposits
            
            
            7,458
            
            
            
            5,043Interest
                on borrowed money
            
            
            447
            
            
            
            529Total
                Interest Expense
            
            
            7,905
            
            
            
            5,572Net
                Interest Income
            
            
            12,658
            
            
            
            11,845Provision
                for Loan Losses
            
            
            486
            
            
            
            508Net
                Interest Income After Provision for Loan Losses
            
            
            12,172
            
            
            
            11,337Noninterest
                IncomeService
                Charges
            
            
            979
            
            
            
            892Investment
                in insurance contracts
            
            
            173
            
            
            
            321Other
                noninterest income
            
            
            355
            
            
            
            323Total
                Noninterest Income
            
            
            1,507
            
            
            
            1,536Noninterest
                ExpenseSalaries
                and employee benefits
            
            
            4,467
            
            
            
            4,224Equipment
                and occupancy expense
            
            
            1,043
            
            
            
            984Data
                processing expense
            
            
            649
            
            
            
            580Directors
                fees
            
            
            283
            
            
            
            297Legal
                and professional fees
            
            
            430
            
            
            
            365Other
                noninterest expense
            
            
            1,445
            
            
            
            1,304Total
                Noninterest Expense
            
            
            8,317
            
            
            
            7,754Income
                Before Provision For Income Taxes
            
            
            5,362
            
            
            
            5,119Provision
                for Income Taxes
            
            
            1,985
            
            
            
            1,758Net
                Income
            
            $
            3,377
            
            
            $
            3,361Per
                Share DataNet
                Income
            
            $
            2.35
            
            
            $
            2.34Cash
                Dividends
            
            $
            .75
            
            
            $
            .69Weighted
                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 September 30,2007
            
            
            2006(unaudited)
            
            
            (unaudited)Interest
                IncomeInterest
                and fees on loans
            
            $
            6,471
            
            
            $
            5,699Interest
                on federal funds sold
            
            
            195
            
            
            
            124Interest
                on deposits in other banks
            
            
            30
            
            
            
            17Interest
                and dividends on securities
            
            
            383
            
            
            
            302Total
                Interest Income
            
            
            7,079
            
            
            
            6,142Interest
                ExpenseInterest
                on deposits
            
            
            2,652
            
            
            
            1,873Interest
                on borrowed money
            
            
            144
            
            
            
            175Total
                Interest Expense
            
            
            2,796
            
            
            
            2,048Net
                Interest Income
            
            
            4,283
            
            
            
            4,094Provision
                for Loan Losses
            
            
            145
            
            
            
            155Net
                Interest Income After Provision for Loan Losses
            
            
            4,138
            
            
            
            3,939Noninterest
                IncomeService
                Charges
            
            
            347
            
            
            
            316Investment
                in insurance contracts
            
            
            57
            
            
            
            37Other
                noninterest income
            
            
            138
            
            
            
            129Total
                Noninterest Income
            
            
            542
            
            
            
            482Noninterest
                ExpenseSalaries
                and employee benefits
            
            
            1,504
            
            
            
            1,442Equipment
                and occupancy expense
            
            
            352
            
            
            
            335Data
                processing expense
            
            
            221
            
            
            
            208Directors
                fees
            
            
            100
            
            
            
            100Legal
                and professional fees
            
            
            153
            
            
            
            127Other
                noninterest expense
            
            
            527
            
            
            
            419Total
                Noninterest Expense
            
            
            2,857
            
            
            
            2,631Income
                Before Provision For Income Taxes
            
            
            1,823
            
            
            
            1,790Provision
                for Income Taxes
            
            
            690
            
            
            
            634Net
                Income
            
            $
            1,133
            
            
            $
            1,156Per
                Share DataNet
                Income
            
            $
            .79
            
            
            $
            .80Cash
                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)September
                30, 2007
            
            
            December
                31, 2006(unaudited)
            
            
            (audited)ASSETSCash
                and due from banks—non-interest bearing
            
            
            7,825
            
            
            $
            7,111Deposits
                in other banks—interest bearing
            
            
            3,383
            
            
            
            1,624Federal
                funds sold
            
            
            12,552
            
            
            
            12,210Securities
                held to maturity
            
            
            170
            
            
            
            170Securities
                available for sale, at market value
            
            
            28,335
            
            
            
            23,729Restricted
                investments
            
            
            1,499
            
            
            
            1,570Loans
            
            
            308,035
            
            
            
            292,816Allowance
                for loan losses
            
            
            (3,711
            )
            
            
            (3,482
            )Bank
                premises and equipment, net of depreciation
            
            
            8,007
            
            
            
            8,099Interest
                receivable
            
            
            2,534
            
            
            
            2,173Investment
                in life insurance contracts
            
            
            6,239
            
            
            
            6,066Goodwill
            
            
            1,534
            
            
            
            1,534Other
                intangible assets
            
            
            1,366
            
            
            
            1,498Other
                Assets
            
            
            2,629
            
            
            
            2,198Total
                Assets
            
            $
            380,397
            
            
            $
            357,316LIABILITIESNon-interest
                bearing deposits
            
            $
            46,990
            
            
            $
            46,726Savings
                and interest bearing demand deposits
            
            
            71,972
            
            
            
            71,590Time
                deposits
            
            
            204,610
            
            
            
            182,168Total
                Deposits
            
            
            323,572
            
            
            
            300,484Long
                term debt
            
            
            12,265
            
            
            
            14,992Accrued
                expenses and other liabilities
            
            
            5,090
            
            
            
            4,764Total
                Liabilities
            
            
            340,927
            
            
            
            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
            
            
            31,115
            
            
            
            28,816Other
                accumulated comprehensive loss
            
            
            (491
            )
            
            
            (586
            )Total
                Stockholders’ Equity
            
            
            39,470
            
            
            
            37,076Total
                Liabilities and Stockholders’ Equity
            
            $
            380,397
            
            
            $
            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
            
            
            
            
            
            
            
            
            
            
            3,361
            
            
            
            
            
            
            
            3,361Net
                change in unrealized appreciation on investment securities available
                for
                sale, net of taxes
            
            
            
            
            
            
            
            
            
            
            
            
            
            
            33
            
            
            
            33Total
                Comprehensive Income
            
            
            
            
            
            
            
            
            
            
            
            
            
            
            
            
            
            
            3,394Dividends
                Paid
            
            
            
            
            
            
            
            
            
            
            (991
            )
            
            
            
            
            
            
            (991
            )Balances
                September 30, 2006
            
            $
            7,184
            
            
            $
            1,662
            
            
            $
            28,021
            
            
            $
            (472
            )
            
            $
            36,395








Common
              Stock
            
            
            Surplus
            
            
            Retained
              Earnings
            
            
            Accumulated
              Other
              Comprehensive
              Income
            
            
            TotalBalances
                at December 31, 2006
            
            $
            7,184
            
            
            $
            1,662
            
            
            $
            28,816
            
            
            $
            (586
            )
            
            $
            37,076Net
                Income
            
            
            
            
            
            
            
            
            
            
            3,377
            
            
            
            
            
            
            
            3,377Net
                change in unrealized appreciation on investment securities available
                for
                sale, net of taxes
            
            
            
            
            
            
            
            
            
            
            
            
            
            
            95
            
            
            
            95Total
                Comprehensive Income
            
            
            
            
            
            
            
            
            
            
            
            
            
            
            
            
            
            
            3,472Dividends
                Paid
            
            
            
            
            
            
            
            
            
            
            (1,078
            )
            
            
            
            
            
            
            (1,078
            )Balances
                September 30, 2007
            
            $
            7,184
            
            
            $
            1,662
            
            
            $
            31,115
            
            
            $
            (491
            )
            
            $
            39,470The
                accompanying notes are an integral part of these
                statements.




*Index*





Page
                Six





HIGHLANDS
                BANKSHARES, INC.CONSOLIDATED
                STATEMENTS OF CASH FLOWS(In
                Thousands of Dollars)Nine
                Months Ended September 30,2007
            
            
            2006(unaudited)
            
            
            (unaudited)Cash
                Flows From Operating ActivitiesNet
                Income
            
            $
            3,377
            
            
            $
            3,361Adjustments
                to reconcile net income to netcash
                provided by operating activitiesDepreciation
            
            
            519
            
            
            
            496Increase
                in cash value of life insurance contracts
            
            
            (173
            )
            
            
            (166
            )Net
                amortization of securities
            
            
            (163
            )
            
            
            (112
            )Provision
                for loan losses
            
            
            486
            
            
            
            508Amortization
                of intangibles
            
            
            132
            
            
            
            132Decrease
                (increase) in interest receivable
            
            
            (361
            )
            
            
            (226
            )Decrease
                (increase) in other assets
            
            
            (429
            )
            
            
            (582
            )Increase
                in accrued expenses
            
            
            325
            
            
            
            550Net
                Cash Provided by Operating Activities
            
            
            3,713
            
            
            
            3,961Cash
                Flows From Investing ActivitiesIncrease
                (decrease) in federal funds sold
            
            
            (342
            )
            
            
            (97
            )Proceeds
                from maturities of securities available for sale
            
            
            6,479
            
            
            
            9,234Purchase
                of securities available for sale
            
            
            (10,827
            )
            
            
            (6,410
            )Proceeds
                from maturities of securities held to maturity
            
            
            
            
            
            
            201Increase
                in restricted investments
            
            
            71
            
            
            
            (198
            )Net
                change in interest bearing deposits in other banks
            
            
            (1,759
            )
            
            
            (1,173
            )Settlement
                on insurance contract
            
            
            
            
            
            
            555Purchase
                of property and equipment
            
            
            (428
            )
            
            
            (739
            )Net
                Change in Loans
            
            
            (15,476
            )
            
            
            (13,554
            )Net
                Cash Used in Investing Activities
            
            
            (22,282
            )
            
            
            (12,181
            )Cash
                Flows From Financing ActivitiesNet
                change in deposits
            
            
            23,088
            
            
            
            8,079Additional
                long term debt
            
            
            0
            
            
            
            2,300Repayment
                of long term debt
            
            
            (2,727
            )
            
            
            (1,725
            )Dividends
                paid in cash
            
            
            (1,078
            )
            
            
            (991
            )Net
                Cash Provided by Financing Activities
            
            
            19,283
            
            
            
            7,663Net
                Increase (Decrease) in Cash and Cash Equivalents
            
            
            714
            
            
            
            (557
            )Cash
                and Cash Equivalents, Beginning of Period
            
            
            7,111
            
            
            
            8,850Cash
                and Cash Equivalents, End of Period
            
            $
            7,825
            
            
            $
            8,293Supplemental
                DisclosuresCash
                paid for income taxes
            
            $
            2,315
            
            
            $
            1,766Cash
                paid for interest
            
            $
            7,745
            
            
            $
            5,355The
                accompanying notes are an integral part of these
                statements.


*Index*


Page
                Seven





**NOTES
      TO CONSOLIDATED FINANCIAL STATEMENTS**





**NOTE
      1                      ACCOUNTING
      PRINCIPLES**





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





The
      results of operations for the three and nine-month periods ended September
      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 year’s 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 September
      30, 2007 and December 31, 2006 are as follows (in thousands of
      dollars):





September
                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
            
            $
            17,823
            
            
            $
            17,959
            
            
            $
            14,397
            
            
            $
            14,403Mortgage
                backed securities
            
            
            7,581
            
            
            
            7,605
            
            
            
            6,547
            
            
            
            6,554Obligations
                of states and municipalities
            
            
            2,755
            
            
            
            2,743
            
            
            
            2,763
            
            
            
            2,744Marketable
                equities
            
            
            28
            
            
            
            28
            
            
            
            28
            
            
            
            28Total
                Available For Sale Securities
            
            $
            28,187
            
            
            $
            28,335
            
            
            $
            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 September 30, 2007 and December 31, 2006 is shown
      in
      the table below (in thousands of dollars):





September
                30,
            
            
            December
                31,2007
            
            
            2006Loan
                TypeCommercial
            
            $
            81,837
            
            
            $
            70,408Real
                Estate construction
            
            
            15,738
            
            
            
            14,828Real
                Estate mortgage
            
            
            165,153
            
            
            
            164,243Consumer
                installment
            
            
            45,307
            
            
            
            43,337Total
                Loans
            
            $
            308,035
            
            
            $
            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 September 30, 2007, the total balance of loans in the
      portfolio secured by real estate was $234,405,000.








**NOTE
      5                     ALLOWANCE
      FOR LOAN LOSSES**





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





2007
            
            
            2006Balance,
                beginning of period
            
            $
            3,482
            
            
            $
            3,129Provisions
                charged to operations
            
            
            486
            
            
            
            508Loan
                recoveries
            
            
            283
            
            
            
            171Loan
                charge-offs
            
            
            (540
            )
            
            
            (428
            )Balance,
                end of period
            
            $
            3,711
            
            
            $
            3,380








**NOTE
      6                      DEPOSITS**





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





September
                30,
            
            
            December
                31,2007
            
            
            2006Time
                deposits over $100,000
            
            $
            66,658
            
            
            $
            54,867All
                other time deposits
            
            
            137,952
            
            
            
            127,301Total
                Time Deposits
            
            $
            204,610
            
            
            $
            182,168





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







Nine
                Months Ended September 30,
            
            
            Three
                Months Ended September 30,2007
            
            
            2006
            
            
            2007
            
            
            2006$
            2,243
            
            
            $
            1,423
            
            
            $
            818
            
            
            $
            537







*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 contributions to the plan during 2007.  The Bank has
      recognized liabilities of $692,000 at September 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 nine-month periods ended September 30, 2007
      and 2006 (in thousands of dollars):





2007
            
            
            2006Service
                cost
            
            $
            100
            
            
            $
            94Interest
                cost
            
            
            160
            
            
            
            138Expected
                return on plan assets
            
            
            (170
            )
            
            
            (152
            )Amortization
                of unrecognized prior service costs
            
            
            8
            
            
            
            8Recognized
                net actuarial loss
            
            
            48
            
            
            
            43Net
                periodic expense
            
            $
            146
            
            
            $
            131








**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 ofSeptember
      30, 2007range from 3.30% to
      6.12%.  The weighted average interest rate was 4.39% at September 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 the Company’s geographic operating
      footprint, 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. Additionally,
      consideration should be given to the cautionary language found elsewhere in
      this
      Form 10-Q and in the section on “Risk Factors” Item 1A in the Company’s Annual
      Report of Form 10-K for the year ended December 31, 2006.





**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.





*Index*








Page
                Twelve





In
      September of 2006, the Emerging Issues Task Force of the FASB (EITF) issued
      EITF
      06-04. This pronouncement affects the recording of post retirement costs of
      insurance of bank owned life insurance policies in instances where the Company
      has promised a continuation of life insurance coverage to persons post
      retirement. EITF 06-04 requires that a liability equal to the present value
      of
      the cost of post retirement insurance be recorded during the insured employees’
term of service. The terms of this pronouncement require the initial recording
      of this liability with a corresponding adjustment to retained earnings to
      reflect the implementation of the pronouncement.  This EITF becomes
      effective for fiscal years ending after December 15, 2007, and as such Highlands
      Bankshares’ financial statements for the periods shown in this Quarterly Report
      on Form 10-Q do not reflect the recording of this liability. On January 1,
      2008,
      Highlands Bankshares will record the appropriate liability and corresponding
      effect on retained earnings, and for periods after January 1, 2008 will record
      an appropriate liability and corresponding effects on current income for the
      applicable periods. At present, the exact effect of this pronouncement on
      Highlands retained earnings or current income for future periods has not been
      calculated.





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.








**Overview
      of Results**








Net
      income for the first nine months of 2007 was .48% higher than the same period
      in
      2006. A 6.86% increase in net interest income was offset by a slight decline
      in
      non-interest income and a 7.26% increase in non-interest expense.





Net
      interest income grew largely as the result of continued growth in average
      balances of earning assets compared to growth in interest bearing liabilities,
      although the effects of this relative growth were offset to some degree by
      increases in average rates on interest bearing liabilities being greater than
      the increases experienced in the average rates earned on earning
      assets.





During
      2006, the Company recorded a one-time gain of $155,000 related to an insurance
      settlement (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) This
      gain recorded in 2006 was the largest factor in contributing to the Company’s
      $29,000 decrease in other interest income for the first nine months of 2007
      as
      compared to 2006. Service charge income continued to increase largely as a
      result of the growth of Company’s deposit base.





The
      increase in non-interest expense was largely the result of increases in the
      cost
      of employee salaries and benefits, increases in legal and professional fees,
      and
      the impact of continued operational growth on both occupancy and equipment
      expense and data processing expense.





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 September 30, 2007 as compared to the same quarter
      in 2006 are substantially the same as the causes discussed for the nine months
      ended September 30, 2007 as compared to the nine months ended September 30,
      2006.








**Net
      Interest Income**





Net
      interest income, on a fully taxable equivalent basis, increased 6.83% for the
      first nine 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, which was offset in
      part
      by the increase in the average rates paid on interest bearing liabilities
      compared to the increase 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 nine 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) Nine Months Ended September 30, 2007 Compared to Nine
                Months Ended September 30, 2006Due
                to change in:Average
                Volume
            
            
            Average
                Rate
            
            
            Total
                ChangeInterest
                IncomeLoans
            
            $
            1,570
            
            
            $
            1,111
            
            
            $
            2,681Federal
                funds sold
            
            
            210
            
            
            
            52
            
            
            
            262Interest
                bearing deposits
            
            
            41
            
            
            
            20
            
            
            
            61Taxable
                investment securities
            
            
            (56
            )
            
            
            197
            
            
            
            141Nontaxable
                investment securities
            
            
            (6
            )
            
            
            6
            
            
            
            0Total
                Interest Income
            
            
            1,759
            
            
            
            1,386
            
            
            
            3,145Interest
                ExpenseDemand
                deposits
            
            
            (1
            )
            
            
            2
            
            
            
            1Savings
                deposits
            
            
            (28
            )
            
            
            133
            
            
            
            105Time
                deposits
            
            
            978
            
            
            
            1,331
            
            
            
            2,309Borrowed
                money
            
            
            (98
            )
            
            
            16
            
            
            
            (82
            )Total
                Interest Expense
            
            
            851
            
            
            
            1,482
            
            
            
            2,333Net
                Interest Income
            
            $
            908
            
            
            $
            (96
            )
            
            $
            812





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 the Fed has cut rates 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 81 basis points
      compared to a 52 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 deposit balances 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 have
      increased.





*Index*





Page
                Fourteen





As
      of
      September 30, 2007, the Company had balances of liquid funds, mostly in the
      form
      of federal funds sold, greater than seen during previous recent years. 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.





Although
      rate increases by the Fed in 2005 and 2006 have ceased, and during the third
      quarter of 2007 the Fed implemented decreases in the target rate for Federal
      Fund Sold, the Company anticipates that during the immediately upcoming
      quarters, its ability to manage its balance sheet of earning assets and interest
      bearing liabilities will have a greater impact on the Company’s net interest
      margin during these quarters than the effects of the rate decreases. Although
      the Company anticipates that the recently enacted rate decreases by the Fed
      will
      cause both the average rates paid on earning assets and interest bearing
      liabilities to decline, the current balances of liquid funds, in the form of
      federal funds sold and interest bearing deposits, will allow the Company enough
      funding flexibility such that no significant decreases in net interest margin
      are anticipated in the immediately upcoming quarters should loan demand remain
      strong.





The
      table
      below sets forth an analysis of net interest income for the nine-month periods
      ended September 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
            
            $
            300,905
            
            
            $
            18,830
            
            
            
            8.34
            %
            
            $
            274,230
            
            
            $
            16,149
            
            
            
            7.85
            %Federal
                funds sold
            
            
            15,715
            
            
            
            600
            
            
            
            5.09
            %
            
            
            9,695
            
            
            
            338
            
            
            
            4.65
            %Interest
                bearing deposits
            
            
            2,490
            
            
            
            100
            
            
            
            5.35
            %
            
            
            1,216
            
            
            
            39
            
            
            
            4.28
            %Taxable
                investment securities
            
            
            23,581
            
            
            
            948
            
            
            
            5.36
            %
            
            
            25,339
            
            
            
            807
            
            
            
            4.25
            %Nontaxable
                investment securities3
            
            
            2,927
            
            
            
            134
            
            
            
            6.10
            %
            
            
            3,076
            
            
            
            134
            
            
            
            5.81
            %Total
                Earning Assets
            
            
            345,618
            
            
            
            20,612
            
            
            
            7.95
            %
            
            
            313,556
            
            
            
            17,467
            
            
            
            7.43
            %Cash
                and cash equivalents
            
            
            8,006
            
            
            
            
            
            
            
            
            
            
            
            7,957Allowance
                for loan losses
            
            
            (3,626
            )
            
            
            
            
            
            
            
            
            
            
            (3,232
            )Insurance
                contracts
            
            
            6,151
            
            
            
            
            
            
            
            
            
            
            
            6,256Non-earning
                assets
            
            
            15,535
            
            
            
            
            
            
            
            
            
            
            
            14,615Total
                Assets
            
            $
            371,684
            
            
            
            
            
            
            
            
            
            
            $
            339,152Interest
                ExpenseInterest
                bearing demand deposits
            
            $
            25,528
            
            
            $
            168
            
            
            
            .88
            %
            
            $
            25,677
            
            
            $
            167
            
            
            
            .87
            %Savings
                and money markets
            
            
            47,744
            
            
            
            507
            
            
            
            1.42
            %
            
            
            51,288
            
            
            
            402
            
            
            
            1.05
            %Time
                deposits
            
            
            194,156
            
            
            
            6,783
            
            
            
            4.66
            %
            
            
            159,320
            
            
            
            4,474
            
            
            
            3.74
            %Long
                term debt
            
            
            12,841
            
            
            
            447
            
            
            
            4.64
            %
            
            
            15,779
            
            
            
            529
            
            
            
            4.47
            %Total
                Interest Bearing Liabilities
            
            
            280,269
            
            
            
            7,905
            
            
            
            3.76
            %
            
            
            252,064
            
            
            
            5,572
            
            
            
            2.95
            %Demand
                deposits
            
            
            48,249
            
            
            
            
            
            
            
            
            
            
            
            47,968Other
                liabilities
            
            
            4,923
            
            
            
            
            
            
            
            
            
            
            
            3,893Stockholders’
                equity
            
            
            38,243
            
            
            
            
            
            
            
            
            
            
            
            35,227Total
                liabilities and stockholders’ equity
            
            $
            371,684
            
            
            
            
            
            
            
            
            
            
            $
            339,152Net
                Interest Income
            
            
            
            
            
            $
            12,707
            
            
            
            
            
            
            
            
            
            
            $
            11,895Net
                Yield on Earning Assets3
            
            
            
            
            
            
            
            
            
            
            4.90
            %
            
            
            
            
            
            
            
            
            
            
            5.06
            %





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 September 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
            
            $
            305,542
            
            
            $
            6,471
            
            
            
            8.47
            %
            
            $
            278,888
            
            
            $
            5,698
            
            
            
            8.17
            %Federal
                funds sold
            
            
            15,449
            
            
            
            195
            
            
            
            5.05
            %
            
            
            9,636
            
            
            
            124
            
            
            
            5.15
            %Interest
                bearing deposits
            
            
            2,660
            
            
            
            30
            
            
            
            4.51
            %
            
            
            1,497
            
            
            
            16
            
            
            
            4.28
            %Taxable
                investment securities
            
            
            25,792
            
            
            
            354
            
            
            
            5.49
            %
            
            
            23,620
            
            
            
            276
            
            
            
            4.67
            %Nontaxable
                investment securities3
            
            
            2,860
            
            
            
            46
            
            
            
            6.43
            %
            
            
            2,858
            
            
            
            42
            
            
            
            5.88
            %Total
                Earning Assets
            
            
            352,303
            
            
            
            7,096
            
            
            
            8.06
            %
            
            
            316,499
            
            
            
            6,156
            
            
            
            7.78
            %Cash
                and cash equivalents
            
            
            7,950
            
            
            
            
            
            
            
            
            
            
            
            8,015Allowance
                for loan losses
            
            
            (3,693
            )
            
            
            
            
            
            
            
            
            
            
            (3,330
            )Insurance
                contracts
            
            
            6,205
            
            
            
            
            
            
            
            
            
            
            
            5,976Nonearning
                assets
            
            
            16,518
            
            
            
            
            
            
            
            
            
            
            
            15,010Total
                Assets
            
            $
            379,283
            
            
            
            
            
            
            
            
            
            
            $
            342,170Interest
                ExpenseInterest
                bearing demand deposits
            
            $
            24,358
            
            
            $
            55
            
            
            
            .90
            %
            
            $
            25,218
            
            
            $
            55
            
            
            
            .87
            %Savings
                and money markets
            
            
            49,278
            
            
            
            191
            
            
            
            1.55
            %
            
            
            48,696
            
            
            
            139
            
            
            
            1.14
            %Time
                deposits
            
            
            201,223
            
            
            
            2,406
            
            
            
            4.78
            %
            
            
            164,822
            
            
            
            1,679
            
            
            
            4.04
            %Long
                term debt
            
            
            12,416
            
            
            
            144
            
            
            
            4.61
            %
            
            
            15,781
            
            
            
            174
            
            
            
            4.41
            %Total
                Interest Bearing Liabilities
            
            
            287,275
            
            
            
            2,796
            
            
            
            3.89
            %
            
            
            254,517
            
            
            
            2,047
            
            
            
            3.22
            %Demand
                deposits
            
            
            47,435
            
            
            
            
            
            
            
            
            
            
            
            47,930Other
                liabilities
            
            
            5,550
            
            
            
            
            
            
            
            
            
            
            
            3,477Stockholders’
                equity
            
            
            39,023
            
            
            
            
            
            
            
            
            
            
            
            36,246Total
                liabilities and stockholders’ equity
            
            $
            379,283
            
            
            
            
            
            
            
            
            
            
            $
            342,170Net
                Interest Income
            
            
            
            
            
            $
            4,300
            
            
            
            
            
            
            
            
            
            
            $
            4,109Net
                Yield on Earning Assets3
            
            
            
            
            
            
            
            
            
            
            4.88
            %
            
            
            
            
            
            
            
            
            
            
            5.19
            %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 41.45% from December 31, 2006 to September 30, 2007.
      Non-performing loans represented .78% of gross loans at September 30, 2007
      and
      .58% of gross loans at December 31, 2006. The increase in non-performing loans
      was the result of the decline in quality of a few larger loans. As potential
      impairments on these loans have been considered by Management in the Company’s
      allowance for loan loss, no further loss not already allowed for is anticipated.
      In addition, because this increase is the result of a few larger loans,
      management believes that the increase in non-performing loans is not indicative
      of a growing trend of deterioration of quality in its loan
      portfolio.





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





September
                30,
            
            
            December
                31,2007
            
            
            2006Non-accrual
                loans
            
            $
            1,371
            
            
            $
            244Loans
                past due 90 days and still accruing interest
            
            
            1,035
            
            
            
            1,457Total
                non-performing loans
            
            $
            2,406
            
            
            $
            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 typically 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 September
      30, 2007 and December 31, 2006 (in thousands of dollars):





September
                30, 2007
            
            
            December
                31, 2006Percent
                of
            
            
            
            
            
            Percent
                ofAmount
            
            
            Loans
            
            
            Amount
            
            
            LoansLoan
                TypeCommercial
            
            $
            1,467
            
            
            
            26
            %
            
            $
            1,492
            
            
            
            24
            %Mortgage
                and construction
            
            
            1,010
            
            
            
            59
            %
            
            
            996
            
            
            
            61
            %Consumer
            
            
            1,135
            
            
            
            15
            %
            
            
            967
            
            
            
            15
            %Unallocated
            
            
            99
            
            
            
            
            
            
            
            27Totals
            
            $
            3,711
            
            
            
            
            
            
            $
            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
      nine-month periods ended September 30, 2007 and 2006 (in thousands of
      dollars):





2007
            
            
            2006Charge-offsCommercial
            
            $
            (141
            )
            
            $
            (27
            )Mortgage
                and construction
            
            
            (38
            )
            
            
            (1
            )Consumer
            
            
            (361
            )
            
            
            (402
            )Total
                Charge-offs
            
            
            (540
            )
            
            
            (430
            )RecoveriesCommercial
            
            
            50
            
            
            
            4Mortgage
            
            
            4
            
            
            
            0Consumer
            
            
            229
            
            
            
            169Total
                Recoveries
            
            
            283
            
            
            
            173Total
                Net Charge-offs
            
            $
            (257
            )
            
            $
            (257
            )





The
      provision for loan losses taken during the first nine months of 2007 was $22,000
      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 1.20% at September 30,
      2007.   At September 30, 2006, the ratio of the allowance for
      loan losses to gross loans was 1.19%.  The ratio of allowance for loan
      losses to non-performing loans was 1.54 at September 30, 2007 compared to 2.05
      at December 31, 2006.





**Non-interest
      Expense**





Non-interest
      expense increased 7.26% for the first nine months of 2007 as compared to the
      same period in 2006.





As
      the
      relative size of the Company’s operations continued to increase, the Company’s
      cost of equipment and also data processing expense also increased. Legal and
      professional fees increased $65,000 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 5.75% as normal annual
      increases in pay and increases in the number of full time equivalent employees
      employed by the Company and its subsidiaries were coupled with a slight increase
      in the cost of postretirement benefit plans.  The table below
      summarizes the effects of increases in average pay per employee, increases
      in
      the number of full time equivalent employees and changes in the cost of post
      retirement benefits for employees on changes in the cost of salaries and
      employee benefits from 2006 to 2007 (in thousands of dollars):





AmountIncrease
                in cost due to increases in average rate of employee salaries and
                benefits
            
            $
            82Increase
                in cost of employee salaries and benefits due to increases in full
                time
                equivalent employees
            
            
            129Increase
                in costs related to post retirement benefits
            
            
            32Total
                Increase in cost of employee salaries and benefits
            
            $
            243





*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 October 1,
      2007, the subsidiary banks could pay dividends to Highlands Bankshares, Inc.
      of
      approximately $8,032,000 without permission of the regulatory
      authorities.





*Index*








Page
                Twenty





**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 September 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 September 30, 2007 and December 31,
      2006:





September
                30, 2007
            
            
            December
                31, 2006Actual
            
            
            Regulatory
            
            
            Actual
            
            
            RegulatoryRatio
            
            
            Minimum
            
            
            Ratio
            
            
            MinimumTotal
                Risk Based Capital RatioHighlands
                Bankshares
            
            
            14.32
            %
            
            
            8.00
            %
            
            
            13.45
            %
            
            
            8.00
            %Capon
                Valley Bank
            
            
            14.51
            %
            
            
            8.00
            %
            
            
            14.56
            %
            
            
            8.00
            %The
                Grant County Bank
            
            
            13.15
            %
            
            
            8.00
            %
            
            
            12.63
            %
            
            
            8.00
            %Tier
                1 Leverage RatioHighlands
                Bankshares
            
            
            9.85
            %
            
            
            4.00
            %
            
            
            9.26
            %
            
            
            4.00
            %Capon
                Valley Bank
            
            
            9.87
            %
            
            
            4.00
            %
            
            
            9.53
            %
            
            
            4.00
            %The
                Grant County Bank
            
            
            9.06
            %
            
            
            4.00
            %
            
            
            8.85
            %
            
            
            4.00
            %Tier
                1 Risk Based Capital RatioHighlands
                Bankshares
            
            
            13.09
            %
            
            
            4.00
            %
            
            
            12.21
            %
            
            
            4.00
            %Capon
                Valley Bank
            
            
            13.26
            %
            
            
            4.00
            %
            
            
            13.30
            %
            
            
            4.00
            %The
                Grant County Bank
            
            
            11.92
            %
            
            
            4.00
            %
            
            
            11.39
            %
            
            
            4.00
            %





**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 September 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 September 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.


*Index*








Page
                Twenty One








**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.





**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**





None





**Item
      5.           OtherInformation**





None











**Item
      6.           Exhibits**





3(i)
            Restated
                Articles of Incorporation of Highlands Bankshares, Inc, as
                amended3(ii)
            Bylaws
                of Highlands Bankshares, Inc. are incorporated by reference to Exhibit
                3(ii) to Highlands Bankshares, Inc.’s Report on Form 10-Q for the quarter
                ended March 31, 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 OfficerNovember
                13, 2007