UNITED
      STATESSECURITIES
      AND EXCHANGE COMMISSIONWashington,
      DC 20549








FORM
10-Q





(Mark
One)


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


For the
quarterly period ended March 31, 2008





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





Commission
File Number:  0-16761





HIGHLANDS
BANKSHARES, INC.


(Exact
name of registrant as specified in its charter)





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





P.O. Box
929


Petersburg,
WV 26847


(Address
of Principal Executive Offices, Including Zip Code)





304-257-4111


(Registrant’s
Telephone Number, Including Area Code)





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





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





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





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





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

















HIGHLANDS
      BANKSHARES, INC.Quarterly
      Report on Form 10Q For The Period Ended March 31, 2008INDEXPagePART I
            FINANCIAL INFORMATIONItem 1.
            Financial StatementsUnaudited Consolidated Statements of Income Three Months Ended
      March 31, 2008 and 2007
            2Unaudited Consolidated Balance Sheet for March 31, 2008 and
      Audited Consolidated Balance Sheet for December 31,
    2007
            3Unaudited Consolidated Statements of Changes in Stockholders’
      Equity for the Three Months Ended March 31, 2008 and
    2007
            4Unaudited Consolidated Statements of Cash Flows for the Three
      Months Ended March 31, 2008 and 2007
            5Notes to Consolidated Financial Statements
            6Item 2.
            Management’ Discussion and Analysis of Financial Condition and
      Results of Operations
            10Item 3.
            Quantitative and Qualitative Disclosures About Market
      Risk
            18Item 4.
            Controls and Procedures
            18Item 4T.
            Controls and Procedures
            18PART II
            OTHER INFORMATIONItem 1.
            Legal Proceedings
            18Item 1A.
            Risk Factors
            18Item 2.
            Unregistered Sales of Equity Securities and Use of
      Proceeds
            18Item 3.
            Defaults Upon Senior Securities
            18Item 4.
            Submission of Matters to a Vote of Security
      Holders
            18Item 5.
            Other Information
            18Item 6.
            Exhibits
            19SIGNATURES
            
            19


Index





Page
      Two




PART
I                           FINANCIAL
INFORMATION


Item
1.                 Financial
Statements





HIGHLANDS
      BANKSHARES, INC.CONSOLIDATED
      STATEMENTS OF INCOME(In
      Thousands ofDollars, Except Per Share
Data)Three
      Months Ended March, 312008
            
            
            2007(unaudited)
            
            
            (unaudited)Interest
      IncomeInterest
      and fees on loans
            
            $
            6,390
            
            
            $
            6,069Interest
      on federal funds sold
            
            
            148
            
            
            
            157Interest
      on deposits in other banks
            
            
            17
            
            
            
            30Interest
      and dividends on securities
            
            
            282
            
            
            
            310Total
      Interest Income
            
            
            6,837
            
            
            
            6,566Interest
      ExpenseInterest
      on deposits
            
            
            2,448
            
            
            
            2,290Interest
      on borrowed money
            
            
            134
            
            
            
            158Total
      Interest Expense
            
            
            2,582
            
            
            
            2,448Net
      Interest Income
            
            
            4,255
            
            
            
            4,118Provision
      for Loan Losses
            
            
            179
            
            
            
            173Net
      Interest Income After Provision for Loan Losses
            
            
            4,076
            
            
            
            3,945Non-interest
      IncomeService
      Charges
            
            
            379
            
            
            
            288Gains
      on securities
            
            
            87
            
            
            
            0Other
      non-interest income
            
            
            191
            
            
            
            183Total
      Non-interest Income
            
            
            657
            
            
            
            471Non-interest
      ExpenseSalaries
      and employee benefits
            
            
            1,560
            
            
            
            1,448Equipment
      and occupancy expense
            
            
            350
            
            
            
            355Data
      processing expense
            
            
            208
            
            
            
            210Directors
      fees
            
            
            96
            
            
            
            97Legal
      and professional fees
            
            
            137
            
            
            
            134Other
      non-interest expense
            
            
            435
            
            
            
            414Total
      Non-interest Expense
            
            
            2,786
            
            
            
            2,658Income
      Before Provision For Income Taxes
            
            
            1,947
            
            
            
            1,758Provision
      for Income Taxes
            
            
            709
            
            
            
            637Net
      Income
            
            $
            1,238
            
            
            $
            1,121Per
      Share DataNet
      Income
            
            $
            .86
            
            
            $
            .78Cash
      Dividends
            
            $
            .27
            
            
            $
            .25Weighted
      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 BALANCE SHEETS(In
      Thousands of Dollars)March
      31, 2008
            
            
            December
      31, 2007(unaudited)
            
            
            (audited)ASSETSCash
      and due from banks—non-interest bearing
            
            $
            8,637
            
            
            $
            7,935Deposits
      in other banks—interest bearing
            
            
            2,669
            
            
            
            1,853Federal
      funds sold
            
            
            21,714
            
            
            
            14,246Securities
      available for sale, at market value
            
            
            19,626
            
            
            
            26,090Restricted
      investments
            
            
            1,519
            
            
            
            1,498Loans
            
            
            311,287
            
            
            
            310,199Allowance
      for loan losses
            
            
            (3,574
            )
            
            
            (3,577
            )Bank
      premises and equipment, net of depreciation
            
            
            8,175
            
            
            
            8,104Interest
      receivable
            
            
            2,152
            
            
            
            2,273Investment
      in life insurance contracts
            
            
            6,360
            
            
            
            6,300Goodwill
            
            
            1,534
            
            
            
            1,534Other
      intangible assets
            
            
            1,523
            
            
            
            1,572Other
      Assets
            
            
            2,832
            
            
            
            2,909Total
      Assets
            
            $
            384,454
            
            
            $
            380,936LIABILITIESNon-interest
      bearing deposits
            
            $
            51,952
            
            
            $
            48,605Savings
      and interest bearing demand deposits
            
            
            74,317
            
            
            
            73,736Time
      deposits
            
            
            199,647
            
            
            
            201,397Total
      Deposits
            
            
            325,916
            
            
            
            323,738Long
      term debt
            
            
            11,665
            
            
            
            11,819Accrued
      expenses and other liabilities
            
            
            5,678
            
            
            
            4,786Total
      Liabilities
            
            
            343,259
            
            
            
            340,343STOCKHOLDERS’
      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
            
            
            32,535
            
            
            
            32,032Other
      accumulated comprehensive loss
            
            
            (186
            )
            
            
            (285
            )Total
      Stockholders’ Equity
            
            
            41,195
            
            
            
            40,593Total
      Liabilities and Stockholders’ Equity
            
            $
            384,454
            
            
            $
            380,936The
      accompanying notes are an integral part of these
    statements.





Index





Page
      Four





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, 2006
            
            $
            7,184
            
            
            $
            1,662
            
            
            $
            28,816
            
            
            $
            (586
            )
            
            $
            37,076Net
      Income
            
            
            
            
            
            
            
            
            
            
            1,121
            
            
            
            
            
            
            
            1,121Change
      in other comprehensive income
            
            
            
            
            
            
            
            
            
            
            
            
            
            
            27
            
            
            
            27Total
      Comprehensive Income
            
            
            
            
            
            
            
            
            
            
            
            
            
            
            
            
            
            
            1,148Dividends
      Paid
            
            
            
            
            
            
            
            
            
            
            (359
            )
            
            
            
            
            
            
            (359
            )Balances
      March 31, 2007
            
            $
            7,184
            
            
            $
            1,662
            
            
            $
            29,578
            
            
            $
            (559
            )
            
            $
            37,865








Common
              Stock
            
            
            Surplus
            
            
            Retained
              Earnings
            
            
            Accumulated
              Other
              Comprehensive
              Income
            
            
            TotalBalances
      at December 31, 2007
            
            $
            7,184
            
            
            $
            1,662
            
            
            $
            32,032
            
            
            $
            (285
            )
            
            $
            40,593Net
      Income
            
            
            
            
            
            
            
            
            
            
            1,238
            
            
            
            
            
            
            
            1,238Cumulative
      effect adjustment to retained earnings for change in accounting
      principle
            
            
            
            
            
            
            
            
            
            
            (347
            )
            
            
            
            
            
            
            (347
            )Change
      in other comprehensive income
            
            
            
            
            
            
            
            
            
            
            
            
            
            
            99
            
            
            
            99Total
      Comprehensive Income
            
            
            
            
            
            
            
            
            
            
            
            
            
            
            
            
            
            
            990Dividends
      Paid
            
            
            
            
            
            
            
            
            
            
            (388
            )
            
            
            
            
            
            
            (388
            )Balances
      March 31, 2008
            
            $
            7,184
            
            
            $
            1,662
            
            
            $
            32,535
            
            
            $
            (186
            )
            
            $
            41,195The
      accompanying notes are an integral part of these
    statements.







Index





Page
      Five





HIGHLANDS
      BANKSHARES, INC.CONSOLIDATED
      STATEMENTS OF CASH FLOWS(In
      Thousands of Dollars)Three
      Months Ended March 31,2008
            
            
            2007(unaudited)
            
            
            (unaudited)Cash
      Flows From Operating ActivitiesNet
      Income
            
            $
            1,238
            
            
            $
            1,121Adjustments
      to reconcile net income to netcash
      provided by operating activities(Gain)
      on investment securities
            
            
            (87
            )
            
            
            0Depreciation
            
            
            170
            
            
            
            172Income
      from insurance contracts
            
            
            (60
            )
            
            
            (55
            )Net
      amortization of securities
            
            
            (116
            )
            
            
            (52
            )Provision
      for loan losses
            
            
            179
            
            
            
            173Amortization
      of intangibles
            
            
            49
            
            
            
            44Decrease
      in interest receivable
            
            
            121
            
            
            
            45Decrease
      (increase) in other assets
            
            
            77
            
            
            
            (7
            )Increase
      in accrued expenses and other liabilities
            
            
            544
            
            
            
            687Net
      Cash Provided by Operating Activities
            
            
            2,115
            
            
            
            2,128Cash
      Flows From Investing ActivitiesIncrease
      in federal funds sold
            
            
            (7,468
            )
            
            
            (7,444
            )Proceeds
      from maturities of securities available for sale
            
            
            10,117
            
            
            
            2,258Purchase
      of securities available for sale
            
            
            (3,350
            )
            
            
            (772
            )Decrease
      (increase) in restricted investments
            
            
            (21
            )
            
            
            76(Increase)
      in interest bearing deposits in other banks
            
            
            (816
            )
            
            
            (1,511
            )Purchase
      of property and equipment
            
            
            (241
            )
            
            
            (46
            )Net
      Increase in Loans
            
            
            (1,270
            )
            
            
            (5,257
            )Net
      Cash Used in Investing Activities
            
            
            (3,049
            )
            
            
            (12,696
            )Cash
      Flows From Financing ActivitiesNet
      increase in deposits
            
            
            2,178
            
            
            
            14,422Repayment
      of long term debt
            
            
            (154
            )
            
            
            (2,442
            )Dividends
      paid in cash
            
            
            (388
            )
            
            
            (359
            )Net
      Cash Provided by Financing Activities
            
            
            1,636
            
            
            
            11,621Net
      Increase in Cash and Cash Equivalents
            
            
            702
            
            
            
            1,053Cash
      and Cash Equivalents, Beginning of Period
            
            
            7,935
            
            
            
            7,111Cash
      and Cash Equivalents, End of Period
            
            $
            8,637
            
            
            $
            8,164Supplemental
      DisclosuresCash
      paid for income taxes
            
            $
            0
            
            
            $
            140Cash
      paid for interest
            
            $
            2,685
            
            
            $
            2,366The
      accompanying notes are an integral part of these
    statements.











Index





Page
      Six





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 March 31, 2008 and the results of
operations for the three month periods ended March 31, 2008 and
2007.





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





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





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





NOTE
      2
            SECURITIES
      AND RESTRICTED INVESTMENTS





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





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





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





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





NOTE
      3
            INVESTMENT
      IN INSURANCE CONTRACTS





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


Index











Page
      Seven





NOTE
      4
            LOANS





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





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





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





NOTE
      5
            ALLOWANCE
      FOR LOAN LOSSES





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





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





NOTE
      6
            DEPOSITS





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





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





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





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








Index











Page
      Eight





NOTE
      7
            EMPLOYEE
      BENEFITS





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





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





The Grant
County Bank is a member of the West Virginia Bankers' Association Retirement
Plan.  Benefits under the plan are based on compensation and years of
service with 100% vesting after seven years of service.  Prior to
2002, the Plan's assets were in excess of the projected benefit obligations and
thus the Bank was not required to make contributions to the Plan in 2003, 2002
or 2001. The bank was required to make contributions in 2005, 2006 and 2007 and
made a contribution to the plan during the first quarter of 2008.  The
Bank has recognized liabilities of $117,000 at March 31, 2008 as a result of
this shortfall.  The following table provides the components of the net
periodic benefit cost for the plan for the three month periods ended March 31,
2008 and 2007 (in thousands of dollars):





2008
            
            
            2007Service
      cost
            
            $
            31
            
            
            $
            34Interest
      cost
            
            
            50
            
            
            
            49Expected
      return on plan assets
            
            
            (53
            )
            
            
            (50
            )Amortization
      of unrecognized prior service costs
            
            
            2
            
            
            
            2Recognized
      net actuarial loss
            
            
            16
            
            
            
            7Net
      periodic expense
            
            $
            46
            
            
            $
            42





NOTE
      8
            DEBT
      INSTRUMENTS





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





NOTE
      9
            EARNINGS
      PER SHARE





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




NOTE
      10
            ADJUSTMENT
      TO RETAINED EARNINGS FOR CHANGE IN ACCOUNTING
  PRINCIPLE





In 2006,
the FASB issued EITF 06-04 and 06-10. These EITF pronouncements require that
companies which own life insurance policies insuring employees and for which the
employees receive a portion of the death benefits of the policies (commonly
referred to as “split dollar” policies) and for which these death benefits to
the employee continue post retirement record a liability for the present value
of the cost of these post retirement death benefits. These EITF pronouncements
became effective for Highlands Bankshares on January 1, 2008.


Index





Page
      Nine





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








NOTE
      11
            FAIR
      VALUE MEASUREMENTS





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





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


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


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


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





Securities




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




Impaired
loans




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




Other Real Estate
Owned




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


Index





Page
      Ten





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





Introduction





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





Critical Accounting
Policies





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





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





The
allowance for loan losses is an estimate of the losses that may be sustained in
the loan portfolio. The allowance is based on two basic principles of
accounting: (i) SFAS No. 5, Accounting for Contingencies, which requires that
losses be accrued when they are probable of occurring and estimable and (ii)
SFAS No. 114, Accounting by Creditors for Impairment of a Loan, which requires
that losses be accrued based on the differences between the value of collateral,
present value of future cash flows or values that are observable in the
secondary market and the loan balance. Additional information pertaining to the
allowance for loan losses and provision for loan losses is contained on pages 14
and 15 of this report.





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





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


Index








Page
      Eleven





Recent Accounting
Pronouncements





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





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





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





Forward Looking
Statements





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


Index





Page
      Twelve





Overview of First Quarter
Results





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





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





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





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








Net Interest
Income





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





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





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








Index





Page
      Thirteen





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





2008
            
            
            2007Average
            
            
            Income/
            
            
            
            
            
            Average
            
            
            Income/Balance
            
            
            Expense
            
            
            Rate
            
            
            Balance
            
            
            Expense
            
            
            RateInterest
      IncomeLoans1,2
            
            $
            310,635
            
            
            $
            6,390
            
            
            
            8.23
            %
            
            $
            296,342
            
            
            $
            6,069
            
            
            
            8.19
            %Federal
      funds sold
            
            
            20,110
            
            
            
            148
            
            
            
            2.94
            %
            
            
            13,418
            
            
            
            157
            
            
            
            4.68
            %Interest
      bearing deposits
            
            
            2,306
            
            
            
            17
            
            
            
            2.95
            %
            
            
            2,383
            
            
            
            30
            
            
            
            5.04
            %Taxable
      investment securities
            
            
            20,522
            
            
            
            255
            
            
            
            4.97
            %
            
            
            21,994
            
            
            
            283
            
            
            
            5.15
            %Nontaxable
      investment securities3
            
            
            3,009
            
            
            
            42
            
            
            
            5.58
            %
            
            
            2,879
            
            
            
            44
            
            
            
            6.11
            %Total
      Earning Assets
            
            
            356,582
            
            
            
            6,852
            
            
            
            7.69
            %
            
            
            337,016
            
            
            
            6,583
            
            
            
            7.81
            %Cash
      and cash equivalents
            
            
            7,510
            
            
            
            
            
            
            
            
            
            
            
            7,661Allowance
      for loan losses
            
            
            (3,580
            )
            
            
            
            
            
            
            
            
            
            
            (3,533
            )Insurance
      contracts
            
            
            6,323
            
            
            
            
            
            
            
            
            
            
            
            6,086Non-earning
      assets
            
            
            15,999
            
            
            
            
            
            
            
            
            
            
            
            15,384Total
      Assets
            
            $
            382,834
            
            
            
            
            
            
            
            
            
            
            $
            362,614Interest
      ExpenseInterest
      bearing demand deposits
            
            $
            23,939
            
            
            $
            35
            
            
            
            .58
            %
            
            $
            26,450
            
            
            $
            58
            
            
            
            .88
            %Savings
      and money markets
            
            
            49,876
            
            
            
            146
            
            
            
            1.17
            %
            
            
            44,627
            
            
            
            147
            
            
            
            1.32
            %Time
      deposits
            
            
            201,324
            
            
            
            2,267
            
            
            
            4.50
            %
            
            
            187,028
            
            
            
            2,085
            
            
            
            4.41
            %Long
      term debt
            
            
            11,751
            
            
            
            134
            
            
            
            4.56
            %
            
            
            13,724
            
            
            
            158
            
            
            
            4.61
            %Total
      Interest Bearing Liabilities
            
            
            286,890
            
            
            
            2,582
            
            
            
            3.60
            %
            
            
            271,829
            
            
            
            2,448
            
            
            
            3.60
            %Demand
      deposits
            
            
            50,003
            
            
            
            
            
            
            
            
            
            
            
            48,200Other
      liabilities
            
            
            5,124
            
            
            
            
            
            
            
            
            
            
            
            5,126Stockholders’
      equity
            
            
            40,817
            
            
            
            
            
            
            
            
            
            
            
            37,459Total
      liabilities and stockholders’ equity
            
            $
            382,834
            
            
            
            
            
            
            
            
            
            
            $
            362,614Net
      Interest Income
            
            
            
            
            
            $
            4,270
            
            
            
            
            
            
            
            
            
            
            $
            4,135Net
      Yield on Earning Assets3
            
            
            
            
            
            
            
            
            
            
            4.79
            %
            
            
            
            
            
            
            
            
            
            
            4.91
            %





1Balances
of loans include loans in non accrual status


2Interest
income on loans includes fees


3Yields
are on a fully taxable equivalent basis








Loan
Portfolio





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


Index





Page
      Fourteen





Credit Quality and Allowance
for Loan Losses





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





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





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





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





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





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





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




Each of
the Company's banking subsidiaries, Capon Valley Bank and The Grant County Bank,
determines the adequacy of its allowance for loan losses independently. Although
the loan portfolios of the two banks are similar to each other, some differences
exist which result in divergent risk patterns and different charge-off rates
amongst the functional areas of the banks’ portfolios.  Each bank pays
particular attention to individual loan performance, collateral values, borrower
financial condition and economic conditions.  The determination of an
adequate allowance at each bank is done in a three step process.  The
first step is to identify impaired loans. Impaired loans are problem loans above
a certain threshold which have estimated losses calculated based on collateral
values and projected cash flows.  The second step is to identify loans
above a certain threshold which are problem loans due to the borrower’s payment
history or deteriorating financial condition.  Losses in this category
are determined based on historical loss rates adjusted for current economic
conditions.  The final step is to calculate a loss for the remainder
of the portfolio using historical loss information for each type of loan
classification. The determination of specific allowances and weighting is
somewhat subjective and actual losses may be greater or less than the amount of
the allowance.  However, Management believes that the allowance
represents a fair assessment of the losses that exist in the current loan
portfolio.





Index





Page
      Fifteen





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





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





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





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








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





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





2008
            
            
            2007Charge-offsCommercial
            
            $
            (14
            )
            
            $
            (12
            )Mortgage
      and construction
            
            
            (78
            )
            
            
            (5
            )Consumer
            
            
            (129
            )
            
            
            (145
            )Total
      Charge-offs
            
            
            (221
            )
            
            
            (162
            )RecoveriesCommercial
            
            
            13
            
            
            
            30Mortgage
            
            
            0
            
            
            
            0Consumer
            
            
            26
            
            
            
            64Total
      Recoveries
            
            
            39
            
            
            
            94Total
      Net Charge-offs
            
            $
            (182
            )
            
            $
            (68
            )





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





Index








Page
      Sixteen





Non-interest
Income





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





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





Non-interest
Expense





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





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


.


Borrowed
Funds





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





Liquidity





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





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





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








Index








Page
      Seventeen





Capital





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





March
      31, 2008
            
            
            December
      31, 2007Actual
            
            
            Regulatory
            
            
            Actual
            
            
            RegulatoryRatio
            
            
            Minimum
            
            
            Ratio
            
            
            MinimumTotal
      Risk Based Capital RatioHighlands
      Bankshares
            
            
            14.69
            %
            
            
            8.00
            %
            
            
            14.53
            %
            
            
            8.00
            %Capon
      Valley Bank
            
            
            14.48
            %
            
            
            8.00
            %
            
            
            14.78
            %
            
            
            8.00
            %The
      Grant County Bank
            
            
            13.63
            %
            
            
            8.00
            %
            
            
            13.23
            %
            
            
            8.00
            %Tier
      1 Leverage RatioHighlands
      Bankshares
            
            
            10.09
            %
            
            
            4.00
            %
            
            
            9.95
            %
            
            
            4.00
            %Capon
      Valley Bank
            
            
            9.90
            %
            
            
            4.00
            %
            
            
            10.00
            %
            
            
            4.00
            %The
      Grant County Bank
            
            
            9.36
            %
            
            
            4.00
            %
            
            
            9.09
            %
            
            
            4.00
            %Tier
      1 Risk Based Capital RatioHighlands
      Bankshares
            
            
            13.44
            %
            
            
            4.00
            %
            
            
            13.28
            %
            
            
            4.00
            %Capon
      Valley Bank
            
            
            13.23
            %
            
            
            4.00
            %
            
            
            13.53
            %
            
            
            4.00
            %The
      Grant County Bank
            
            
            12.48
            %
            
            
            4.00
            %
            
            
            12.09
            %
            
            
            4.00
            %








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








Effects of
Inflation





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





Index





Page
      Eighteen





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, 2007.





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





Changes in Internal
Controls





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








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, 2007.








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.    Other Information





None








Index





Page
      Nineteen





Item
6.     Exhibits





EXHIBIT
      INDEXExhibit
              Number
            Description3(i)
            Articles
      of Incorporation of Highlands Bankshares, Inc., as restated, are hereby
      incorporated by reference to Exhibit 3(i) to Highlands Bankshares Inc.’s
      Form 10-Q filed November 13, 2007 .3(ii)
            Amended
      Bylaws of Highlands Bankshares, Inc. are incorporated by reference to
      Exhibit 3(ii) to Highlands Bankshares Inc.’s Report on Form 8-K filed
      January 9, 2008.31.1
            Certification
      of Chief Executive Officer Pursuant to section 302 of the
      Sarbanes-Oxley  Act  of
              2002
      Chapter 63, Title 18 USC Section 1350 (A) and (B).31.2
            Certification
      of Chief Financial Officer  Pursuant to section 302 of the
      Sarbanes-Oxley  Act of
              2002
      Chapter 63, Title 18 USC Section 1350 (A) and (B).32.1
            Statement
      of Chief Executive Officer Pursuant to 18  U.S.C.
      §1350.32.2
            Statement
      of Chief Financial Officer Pursuant to 18 U.S.C.
  §1350.























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 OfficerMay
      13, 2008