UNITED
      STATESSECURITIES
      AND EXCHANGE COMMISSIONWashington,
      DC 20549








FORM
10-Q





(Mark
One)


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


For the
quarterly period ended June 30, 2008





[  ]  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 [X] No [  ]





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 [  ]
            Accelerated
      Filer                 [  ]Non-accelerated
      filer     [  ](Do not check if
      a smaller reporting company)
            Smaller
      reporting company [X ]





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





Indicate
the number of shares outstanding of each of the issuer’s classes of common stock
as of the latest practicable date. As of July 31, 2008:  1,336,873
shares of Common Stock, $5 Par Value














HIGHLANDS
      BANKSHARES, INC.Quarterly
      Report on Form 10Q For The Period Ended June 30, 2008INDEXPagePART I
            FINANCIAL INFORMATIONItem 1.
            Financial StatementsUnaudited Consolidated Statements of Income Six Months Ended
      June 30, 2008 and 2007
            2Unaudited Consolidated Statements of Income Three Months Ended
      June 30, 2008 and 2007
            3Unaudited Consolidated Balance Sheet for June 30, 2008 and
      Audited Consolidated Balance Sheet for December 31,
    2007
            4Unaudited Consolidated Statements of Changes in Stockholders’
      Equity for the Six Months Ended June 30, 2008 and 2007
            5Unaudited Consolidated Statements of Cash Flows for the Six
      Months Ended June 30, 2008 and 2007
            6Notes to Consolidated Financial Statements
            7Item 2.
            Management’s Discussion and Analysis of Financial Condition and
      Results of Operations
            11Item 3.
            Quantitative and Qualitative Disclosures About Market
      Risk
            20Item 4.
            Controls and Procedures
            20Item 4T.
            Controls and Procedures
            20PART II
            OTHER INFORMATIONItem 1.
            Legal Proceedings
            20Item 1A.
            Risk Factors
            20Item 2.
            Unregistered Sales of Equity Securities and Use of
      Proceeds
            20Item 3.
            Defaults Upon Senior Securities
            21Item 4.
            Submission of Matters to a Vote of Security
      Holders
            21Item 5.
            Other Information
            21Item 6.
            Exhibits
            22SIGNATURES
            
            22








Index





Page
      Two


PART
      I
            FINANCIAL INFORMATION


Item
      1.
            Financial Statements





HIGHLANDS
      BANKSHARES, INC.CONSOLIDATED STATEMENTS OF INCOME(In
      Thousands of Dollars, Except Per Share Data)Six
      Months Ended June 302008
            
            
            2007(unaudited)
            
            
            (unaudited)Interest
      IncomeInterest
      and fees on loans
            
            $
            12,612
            
            
            $
            12,359Interest
      on federal funds sold
            
            
            223
            
            
            
            405Interest
      on deposits in other banks
            
            
            31
            
            
            
            70Interest
      and dividends on securities
            
            
            541
            
            
            
            650Total
      Interest Income
            
            
            13,407
            
            
            
            13,484Interest
      ExpenseInterest
      on deposits
            
            
            4,551
            
            
            
            4,806Interest
      on borrowed money
            
            
            235
            
            
            
            303Total
      Interest Expense
            
            
            4,786
            
            
            
            5,109Net
      Interest Income
            
            
            8,621
            
            
            
            8,375Provision
      for Loan Losses
            
            
            398
            
            
            
            341Net
      Interest Income After Provision for Loan Losses
            
            
            8,223
            
            
            
            8,034Non-interest
      IncomeService
      Charges
            
            
            819
            
            
            
            632Gains
      on securities
            
            
            109
            
            
            
            0Gains
      on sale of fixed assets
            
            
            25
            
            
            
            0Other
      non-interest income
            
            
            384
            
            
            
            333Total
      Non-interest Income
            
            
            1,337
            
            
            
            965Non-interest
      ExpenseSalaries
      and employee benefits
            
            
            3,141
            
            
            
            2,963Equipment
      and occupancy expense
            
            
            679
            
            
            
            691Data
      processing expense
            
            
            416
            
            
            
            428Directors
      fees
            
            
            198
            
            
            
            183Legal
      and professional fees
            
            
            265
            
            
            
            277Other
      non-interest expense
            
            
            962
            
            
            
            918Total
      Non-interest Expense
            
            
            5,661
            
            
            
            5,460Income
      Before Provision For Income Taxes
            
            
            3,899
            
            
            
            3,539Provision
      for Income Taxes
            
            
            1,440
            
            
            
            1,295Net
      Income
            
            $
            2,459
            
            
            $
            2,244Per
      Share DataNet
      Income
            
            $
            1.72
            
            
            $
            1.56Cash
      Dividends
            
            $
            .54
            
            
            $
            .50Weighted
      Average Common Shares Outstanding
            
            
            1,429,295
            
            
            
            1,436,874The
      accompanying notes are an integral part of these
    statements.


Index





Page
      Three





HIGHLANDS BANKSHARES, INC.CONSOLIDATED
      STATEMENTS OF INCOME(In
      Thousands of Dollars, Except Per Share Data)Three
      Months Ended June 302008
            
            
            2007(unaudited)
            
            
            (unaudited)Interest
      IncomeInterest
      and fees on loans
            
            $
            6,222
            
            
            $
            6,290Interest
      on federal funds sold
            
            
            75
            
            
            
            249Interest
      on deposits in other banks
            
            
            14
            
            
            
            40Interest
      and dividends on securities
            
            
            259
            
            
            
            338Total
      Interest Income
            
            
            6,570
            
            
            
            6,917Interest
      ExpenseInterest
      on deposits
            
            
            2,103
            
            
            
            2,515Interest
      on borrowed money
            
            
            101
            
            
            
            145Total
      Interest Expense
            
            
            2,204
            
            
            
            2,660Net
      Interest Income
            
            
            4,366
            
            
            
            4,257Provision
      for Loan Losses
            
            
            219
            
            
            
            168Net
      Interest Income After Provision for Loan Losses
            
            
            4,147
            
            
            
            4,089Non-interest
      IncomeService
      Charges
            
            
            440
            
            
            
            345Gains
      on securities
            
            
            22
            
            
            
            0Gain
      on sale of fixed assets
            
            
            25
            
            
            
            0Other
      non-interest income
            
            
            193
            
            
            
            150Total
      Non-interest Income
            
            
            680
            
            
            
            495Non-interest
      ExpenseSalaries
      and employee benefits
            
            
            1,581
            
            
            
            1,515Equipment
      and occupancy expense
            
            
            329
            
            
            
            336Data
      processing expense
            
            
            208
            
            
            
            219Directors
      fees
            
            
            102
            
            
            
            86Legal
      and professional fees
            
            
            128
            
            
            
            143Other
      non-interest expense
            
            
            527
            
            
            
            504Total
      Non-interest Expense
            
            
            2,875
            
            
            
            2,803Income
      Before Provision For Income Taxes
            
            
            1,952
            
            
            
            1,781Provision
      for Income Taxes
            
            
            731
            
            
            
            658Net
      Income
            
            $
            1,221
            
            
            $
            1,123Per
      Share DataNet
      Income
            
            $
            .86
            
            
            $
            .78Cash
      Dividends
            
            $
            .27
            
            
            $
            .25Weighted
      Average Common Shares Outstanding
            
            
            1,421,548
            
            
            
            1,436,874The
      accompanying notes are an integral part of these
    statements.











Index





Page
      Four








HIGHLANDS
      BANKSHARES, INC.CONSOLIDATED
      BALANCE SHEETS(In
      Thousands of Dollars)June
      30, 2008
            
            
            December
      31, 2007(unaudited)
            
            
            (audited)ASSETSCash
      and due from banks—non-interest bearing
            
            $
            8,486
            
            
            $
            7,935Deposits
      in other banks—interest bearing
            
            
            689
            
            
            
            1,853Federal
      funds sold
            
            
            5,786
            
            
            
            14,246Securities
      available for sale, at market value
            
            
            24,389
            
            
            
            26,090Restricted
      investments
            
            
            1,575
            
            
            
            1,498Loans
            
            
            313,460
            
            
            
            310,199Allowance
      for loan losses
            
            
            (3,682
            )
            
            
            (3,577
            )Bank
      premises and equipment, net of depreciation
            
            
            8,081
            
            
            
            8,104Interest
      receivable
            
            
            2,321
            
            
            
            2,273Investment
      in life insurance contracts
            
            
            6,420
            
            
            
            6,300Goodwill
            
            
            1,534
            
            
            
            1,534Other
      intangible assets
            
            
            1,473
            
            
            
            1,572Other
      Assets
            
            
            2,677
            
            
            
            2,909Total
      Assets
            
            $
            373,209
            
            
            $
            380,936LIABILITIESNon-interest
      bearing deposits
            
            $
            50,626
            
            
            $
            48,605Savings
      and interest bearing demand deposits
            
            
            74,478
            
            
            
            73,736Time
      deposits
            
            
            194,073
            
            
            
            201,397Total
      Deposits
            
            
            319,177
            
            
            
            323,738Long
      term debt
            
            
            10,083
            
            
            
            11,819Accrued
      expenses and other liabilities
            
            
            4,738
            
            
            
            4,786Total
      Liabilities
            
            
            333,998
            
            
            
            340,343STOCKHOLDERS’
      EQUITYCommon
      stock ($5 par value, 3,000,000 shares authorized, 1,436,874 shares
      issued)
            
            
            7,184
            
            
            
            7,184Surplus
            
            
            1,662
            
            
            
            1,662Retained
      earnings
            
            
            33,369
            
            
            
            32,032Other
      accumulated comprehensive loss
            
            
            (454
            )
            
            
            (285
            )Treasury
      stock (at cost, 76,441 shares at June 30, 2008)
            
            
            (2,550
            )
            
            
            0Total
      Stockholders’ Equity
            
            
            39,211
            
            
            
            40,593Total
      Liabilities and Stockholders’ Equity
            
            $
            373,209
            
            
            $
            380,936The
      accompanying notes are an integral part of these
    statements.





Index





Page
      Five





HIGHLANDS
      BANKSHARES, INCCONSOLIDATED
      STATEMENTS OF CHANGES IN STOCKHOLDERS’
    EQUITY(In
      Thousands of Dollars)Common
              Stock
            
            
            Surplus
            
            
            Treasury
              Stock
            
            
            Retained
              arnings
            
            
            Accumulated
              Other
              Comprehensive
              Income
            
            
            TotalBalances
      at December 31, 2006
            
            $
            7,184
            
            
            $
            1,662
            
            
            $
            0
            
            
            $
            28,816
            
            
            $
            (586
            )
            
            $
            37,076Net
      Income
            
            
            
            
            
            
            
            
            
            
            
            
            
            
            2,244
            
            
            
            
            
            
            
            2,244Change
      in other comprehensive income
            
            
            
            
            
            
            
            
            
            
            
            
            
            
            
            
            
            
            (33
            )
            
            
            (33
            )Total
      comprehensive income
            
            
            
            
            
            
            
            
            
            
            
            
            
            
            
            
            
            
            
            
            
            
            2,211Dividends
      Paid
            
            
            
            
            
            
            
            
            
            
            
            
            
            
            (718
            )
            
            
            
            
            
            
            (718
            )Balances
      at June 30, 2007
            
            $
            7,184
            
            
            $
            1,662
            
            
            $
            0
            
            
            $
            30,342
            
            
            $
            (619
            )
            
            $
            38,569











Common
              Stock
            
            
            Surplus
            
            
            Treasury
              Stock
            
            
            Retained
              Earnings
            
            
            Accumulated
              Other
              Comprehensive
              Income
            
            
            TotalBalances
      at December 31, 2007
            
            $
            7,184
            
            
            $
            1,662
            
            
            $
            0
            
            
            $
            32,032
            
            
            $
            (285
            )
            
            $
            40,593Net
      Income
            
            
            
            
            
            
            
            
            
            
            
            
            
            
            2,459
            
            
            
            
            
            
            
            2,459Change
      in other comprehensive income
            
            
            
            
            
            
            
            
            
            
            
            
            
            
            
            
            
            
            (169
            )
            
            
            (169
            )Cumulative
      effect adjustment to retained earnings for change in accounting
      principle
            
            
            
            
            
            
            
            
            
            
            
            
            
            
            (347
            )
            
            
            
            
            
            
            (347
            )Total
      comprehensive Income
            
            
            
            
            
            
            
            
            
            
            
            
            
            
            
            
            
            
            
            
            
            
            1,943Treasury
      stock repurchased
            
            
            
            
            
            
            
            
            
            
            (2,550
            )
            
            
            
            
            
            
            
            
            
            
            (2,550
            )Dividends
      paid
            
            
            
            
            
            
            
            
            
            
            
            
            
            
            (775
            )
            
            
            
            
            
            
            (775
            )Balances
      at June 30, 2008
            
            $
            7,184
            
            
            $
            1,662
            
            
            $
            (2,550
            )
            
            $
            33,369
            
            
            $
            (454
            )
            
            $
            39,211














Index





Page
      Six





HIGHLANDS
      BANKSHARES, INC.CONSOLIDATED
      STATEMENTS OF CASH FLOWS(In
      Thousands of Dollars)Six
      Months Ended June 30,2008
            
            
            2007(unaudited)
            
            
            (unaudited)Cash
      Flows From Operating ActivitiesNet
      Income
            
            $
            2,459
            
            
            $
            2,244Adjustments
      to reconcile net income to netcash
      provided by operating activities(Gain)
      on investment securities
            
            
            (109
            )
            
            
            0(Gain)
      on sale of fixed asset
            
            
            (25
            )
            
            
            0Depreciation
            
            
            340
            
            
            
            345Income
      from insurance contracts
            
            
            (120
            )
            
            
            (115
            )Net
      amortization of securities
            
            
            41
            
            
            
            (51
            )Provision
      for loan losses
            
            
            398
            
            
            
            341Amortization
      of intangibles
            
            
            99
            
            
            
            88Decrease
      (increase) in interest receivable
            
            
            (48
            )
            
            
            (273
            )Decrease
      (increase) in other assets
            
            
            232
            
            
            
            (154
            )Increase
      (decrease) in accrued expenses and other liabilities
            
            
            (395
            )
            
            
            76Net
      Cash Provided by Operating Activities
            
            
            2,872
            
            
            
            2,501Cash
      Flows From Investing ActivitiesIncrease
      (decrease) in federal funds sold
            
            
            8,460
            
            
            
            (3,517
            )Proceeds
      from maturities of securities available for sale
            
            
            14,138
            
            
            
            4,733Purchase
      of securities available for sale
            
            
            (12,537
            )
            
            
            (7,532
            )Decrease
      (increase) in restricted investments
            
            
            (77
            )
            
            
            67Decrease
      (increase) in interest bearing deposits in other banks
            
            
            1,164
            
            
            
            (422
            )Purchase
      of property and equipment
            
            
            (293
            )
            
            
            (303
            )Net
      Increase in Loans
            
            
            (3,554
            )
            
            
            (10,450
            )Net
      Cash Provided by (Used in) Investing Activities
            
            
            7,301
            
            
            
            (17,424
            )Cash
      Flows From Financing ActivitiesNet
      change in deposits
            
            
            (4,561
            )
            
            
            20,785Repayment
      of long term debt
            
            
            (1,736
            )
            
            
            (2,584
            )Purchase
      of treasury stock
            
            
            (2,550
            )
            
            
            0Dividends
      paid in cash
            
            
            (775
            )
            
            
            (718
            )Net
      Cash Provided (Used in) by Financing Activities
            
            
            (9,622
            )
            
            
            17,483Net
      Increase (decrease) in Cash and Cash Equivalents
            
            
            551
            
            
            
            2,560Cash
      and Cash Equivalents, Beginning of Period
            
            
            7,935
            
            
            
            7,111Cash
      and Cash Equivalents, End of Period
            
            $
            8,486
            
            
            $
            9,671Supplemental
      DisclosuresCash
      paid for income taxes
            
            $
            1,287
            
            
            $
            1,626Cash
      paid for interest
            
            $
            4,986
            
            
            $
            5,029The
      accompanying notes are an integral part of these
    statements.








Index














Page
      Seven





NOTES
TO CONSOLIDATED FINANCIAL STATEMENTS





NOTE
      1
            ACCOUNTING
      PRINCIPLES





These
consolidated financial statements conform to U. S. generally accepted accounting
principles and to general industry practices.  In the opinion of
management, the accompanying unaudited consolidated financial statements contain
all adjustments, consisting solely of normal recurring adjustments, necessary to
present fairly the financial position as of June 30, 2008 and the results of
operations for the three and six month periods ended June 30, 2008 and
2007.





The
results of operations for the three and six month periods ended June 30, 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 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 as of June 30, 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.





June
      30, 2008
            
            
            December
      31, 2007Amortized
            
            
            Market
            
            
            Amortized
            
            
            MarketCost
            
            
            Value
            
            
            Cost
            
            
            ValueAvailable For Sale
      SecuritiesU.S.
      Treasuries and Agencies
            
            $
            8,750
            
            
            $
            8,788
            
            
            $
            15,040
            
            
            $
            15,245Mortgage
      backed securities
            
            
            11,521
            
            
            
            11,487
            
            
            
            7,718
            
            
            
            7,784Obligations
      of states and municipalities
            
            
            4,087
            
            
            
            4,087
            
            
            
            3,034
            
            
            
            3,039Marketable
      equities
            
            
            28
            
            
            
            27
            
            
            
            28
            
            
            
            22Total
      Available For Sale Securities
            
            $
            24,386
            
            
            $
            24,389
            
            
            $
            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
      Eight





NOTE
      4
            LOANS





A summary
of loans outstanding as of June 30, 2008 and December 31, 2007 is shown in the
table below (in thousands of dollars):





June
      30,
            
            
            December
      31,2008
            
            
            2007Loan
      TypeCommercial
            
            $
            84,379
            
            
            $
            79,892Real
      Estate construction
            
            
            21,380
            
            
            
            15,560Real
      Estate mortgage
            
            
            161,676
            
            
            
            169,122Consumer
      installment
            
            
            46,025
            
            
            
            45,625Total
      Loans
            
            $
            313,460
            
            
            $
            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 June 30, 2008, the total balance of loans in the portfolio
secured by real estate was $244,312,000.





NOTE
      5
            ALLOWANCE
      FOR LOAN LOSSES





A summary
of the transactions in the allowance for loan losses for the six month periods
ended June 30, 2008 and 2007 is shown below (in thousands of
dollars):





2008
            
            
            2007Balance,
      beginning of period
            
            $
            3,577
            
            
            $
            3,482Provisions
      charged to operations
            
            
            398
            
            
            
            341Loan
      recoveries
            
            
            81
            
            
            
            176Loan
      charge-offs
            
            
            (374
            )
            
            
            (319
            )Balance,
      end of period
            
            $
            3,682
            
            
            $
            3,680





NOTE
      6
            DEPOSITS





Balances
of time deposits over $100,000 and of all other time deposits at June 30, 2008
and December 31, 2007 are shown below (in thousands of dollars):





June
      30,
            
            
            December
      31,2008
            
            
            2007Time
      deposits over $100,000
            
            $
            62,957
            
            
            $
            65,486All
      other time deposits
            
            
            131,116
            
            
            
            135,911Total
      Time Deposits
            
            $
            194,073
            
            
            $
            201,397





Interest
expense for time deposits over $100,000 and for all other time deposits for the
six month and three month periods ended June 30, 2008 and 2007 is shown below
(in thousands of dollars):








Six
      months ended June 30,
            
            
            Three
      months ended June 30,2008
            
            
            2007
            
            
            2008
            
            
            2007Time
      deposits over $100,000
            
            $
            1,463
            
            
            $
            1,425
            
            
            $
            683
            
            
            $
            752All
      other time deposits
            
            
            2,769
            
            
            
            2,953
            
            
            
            1,289
            
            
            
            1,539Total
      interest paid on time deposits
            
            $
            4,232
            
            
            $
            4,378
            
            
            $
            1,972
            
            
            $
            2,291














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, 2006 and
2007 and made a contribution to the plan during the first quarter of
2008.  The Bank has recognized liabilities of $160,000 at June 30,
2008 as a result of this shortfall.  The following table provides the
components of the net periodic benefit cost for the plan for the six month
periods ended June 30, 2008 and 2007 (in thousands of dollars):





2008
            
            
            2007Service
      cost
            
            $
            82
            
            
            $
            63Interest
      cost
            
            
            129
            
            
            
            100Expected
      return on plan assets
            
            
            (156
            )
            
            
            (106
            )Amortization
      of unrecognized prior service costs
            
            
            2
            
            
            
            5Recognized
      net actuarial loss
            
            
            25
            
            
            
            30Net
      periodic expense
            
            $
            82
            
            
            $
            92





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 ofJune 30,
2008range from 3.94% to
5.96%.  The weighted average interest rate was 4.61% at June 30, 2008.
The debt is secured by the general assets of the Banks.





NOTE
      9
            EARNINGS
      PER SHARE





During
the first six months of 2007, there were no changes to the outstanding shares of
common stock. During the second quarter of 2008, the Company purchased, at
varying intervals, 76,441 shares of outstanding common stock. The weighted
average shares, upon which earnings per share calculations for the three and six
month periods ended June 30, 2008, were calculated based upon the date
repurchased and the number of shares repurchased on that date, as a percentage
of the total period represented.








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
      Ten





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 June 30, 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. There were no fair value adjustments made for impaired loans at June
30, 2008.




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. There were no fair value measurements made for
the six months ended June 30, 2008.


Index





Page
      Eleven





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 13
and 14 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
      Twelve





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 June 30, 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.





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
      Thirteen





Overview of First Half
Results





Income
for the first six months of 2008 increased 9.58% as compared to the same period
in 2007. During this period, the Company recorded recurring one time gains of
$134,000, pretax, related to both calls of available for sale securities and to
the sale of a parcel of real property held by the Company. Annualized return on
average assets was 1.30% compared to 1.23% a year ago and annualized return on
average equity for the first half of 2008 was 12.09% compared to 11.96% for the
first half of 2007.





Net
interest income, on a fully taxable equivalent basis, increased 2.95% over the
first half of 2007. Average balances of both earning assets and interest bearing
liabilities increased, and, as the continued result of the effects of decreases
in the target rate for federal funds sold by the Federal Reserve Board in 2007,
average rates earned on assets and average rates paid on interest bearing
liabilities both decreased as compared to 2007.





Non-interest
income increased largely as a result of increases in income from deposit account
service charges, and the one time non recurring gains discussed
above.





Non-interest
expense increased 3.68% as decreases in data processing expense and legal and
professional fees were offset by increases in costs of employee salaries and
benefits.








Net Interest
Income





Net
interest income for the first half of 2008, on a fully taxable equivalent basis,
increased 2.95% as compared to the same period in 2007.





Average
balances of both earning assets and interest bearing liabilities increased
approximately the same amount in 2008 as compared to 2007, with average balances
of earning assets growing 3.68% and average balances of interest bearing
liabilities increasing 2.85%. The ratio of earning asset to interest bearing
liabilities, remained roughly the same for the first half of 2008 as for the
same period in 2007.





As a
result of the Federal Reserve Board’s (the “Fed”) lowering of the target rate
for federal funds sold throughout 2007 and into early 2008, average rates earned
on earning assets and paid on interest bearing liabilities both decreased. The
decrease in average rates for 2008 as compared to 2007 was approximately
equivalent, with the average rate earned on earning assets decreasing 32 basis
points and the average rate paid on interest bearing liabilities falling 33
basis points.





The
approximately parallel increase in balances of earning assets and interest
bearing liabilities, coupled with the approximately parallel decrease in rates
earned on earning assets and those paid on interest bearing liabilities resulted
in the Company’s net interest margin remaining almost flat from 2007 to 2008,
while the overall increase in average balances caused total net interest income,
on a fully taxable equivalent basis, to increase.





During
2008, the Company has experienced continued increases in demand for its loan
products, the greatest source of the Company’s interest income. However, the
increases in loan balances have been less than in recent prior years. From
December 31, 2007 to June 30, 2008, balances of gross loans increased 2.10% on
an annualized basis. As a result of slowing loan demand, coupled with large
balances of liquid funds, in the form of federal funds sold, during the early
months of 2008, the Company has been able to reduce its costs of deposits and
borrowed funds through reduction in balances of these funding sources. As a
result of the management of the balance sheet, should loan balances continue to
increase, or remain flat, throughout the remainder of 2008, Management expects
that net interest income and net interest margin will continue at current
levels.








Index





Page
      Fourteen





The table
below sets forth an analysis of net interest income for the six month periods
ended June 30, 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
            
            $
            311,756
            
            
            $
            12,612
            
            
            
            8.09
            %
            
            $
            298,548
            
            
            $
            12,359
            
            
            
            8.28
            %Federal
      funds sold
            
            
            17,603
            
            
            
            223
            
            
            
            2.53
            %
            
            
            15,851
            
            
            
            405
            
            
            
            5.11
            %Interest
      bearing deposits
            
            
            2,240
            
            
            
            31
            
            
            
            2.77
            %
            
            
            2,428
            
            
            
            70
            
            
            
            5.77
            %Taxable
      investment securities
            
            
            20,236
            
            
            
            484
            
            
            
            4.78
            %
            
            
            22,457
            
            
            
            594
            
            
            
            5.29
            %Nontaxable
      investment securities3
            
            
            2,990
            
            
            
            91
            
            
            
            6.09
            %
            
            
            2,931
            
            
            
            88
            
            
            
            6.00
            %Total
      Earning Assets
            
            
            354,825
            
            
            
            13,441
            
            
            
            7.58
            %
            
            
            342,215
            
            
            
            13,516
            
            
            
            7.90
            %Cash
      and cash equivalents
            
            
            7,349
            
            
            
            
            
            
            
            
            
            
            
            8,033Allowance
      for loan losses
            
            
            (3,595
            )
            
            
            
            
            
            
            
            
            
            
            (3,591
            )Insurance
      contracts
            
            
            6,352
            
            
            
            
            
            
            
            
            
            
            
            6,123Non-earning
      assets
            
            
            16,285
            
            
            
            
            
            
            
            
            
            
            
            15,042Total
      Assets
            
            $
            381,216
            
            
            
            
            
            
            
            
            
            
            $
            367,822Interest
      ExpenseInterest
      bearing demand deposits
            
            $
            24,116
            
            
            $
            55
            
            
            
            0.46
            %
            
            $
            26,148
            
            
            $
            113
            
            
            
            0.86
            %Savings
      and money markets
            
            
            50,571
            
            
            
            251
            
            
            
            0.99
            %
            
            
            46,964
            
            
            
            315
            
            
            
            1.34
            %Time
      deposits
            
            
            198,787
            
            
            
            4,245
            
            
            
            4.27
            %
            
            
            190,564
            
            
            
            4,378
            
            
            
            4.59
            %Long
      term debt
            
            
            11,183
            
            
            
            235
            
            
            
            4.20
            %
            
            
            13,091
            
            
            
            303
            
            
            
            4.63
            %Total
      Interest Bearing Liabilities
            
            
            284,657
            
            
            
            4,786
            
            
            
            3.36
            %
            
            
            276,767
            
            
            
            5,109
            
            
            
            3.69
            %Demand
      deposits
            
            
            50,114
            
            
            
            
            
            
            
            
            
            
            
            48,410Other
      liabilities
            
            
            5,545
            
            
            
            
            
            
            
            
            
            
            
            4,798Stockholders’
      equity
            
            
            40,900
            
            
            
            
            
            
            
            
            
            
            
            37,847Total
      liabilities and stockholders’ equity
            
            $
            381,216
            
            
            
            
            
            
            
            
            
            
            $
            367,822Net
      Interest Income
            
            
            
            
            
            $
            8,655
            
            
            
            
            
            
            
            
            
            
            $
            8,407Net
      Yield on Earning Assets3
            
            
            
            
            
            
            
            
            
            
            4.88
            %
            
            
            
            
            
            
            
            
            
            
            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





Index





Page
      Fifteen





The table
below sets forth an analysis of net interest income for the three month periods
ended June 30, 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
            
            $
            312,877
            
            
            $
            6,222
            
            
            
            7.95
            %
            
            $
            300,550
            
            
            $
            6,290
            
            
            
            8.37
            %Federal
      funds sold
            
            
            15,097
            
            
            
            75
            
            
            
            1.99
            %
            
            
            18,402
            
            
            
            249
            
            
            
            5.41
            %Interest
      bearing deposits
            
            
            2,174
            
            
            
            14
            
            
            
            2.58
            %
            
            
            2,504
            
            
            
            40
            
            
            
            6.39
            %Taxable
      investment securities
            
            
            19,950
            
            
            
            230
            
            
            
            4.61
            %
            
            
            23,056
            
            
            
            310
            
            
            
            5.38
            %Nontaxable
      investment securities3
            
            
            2,971
            
            
            
            47
            
            
            
            6.33
            %
            
            
            2,924
            
            
            
            45
            
            
            
            6.16
            %Total
      Earning Assets
            
            
            353,069
            
            
            
            6,588
            
            
            
            7.46
            %
            
            
            347,436
            
            
            
            6,934
            
            
            
            7.98
            %Cash
      and cash equivalents
            
            
            7,187
            
            
            
            
            
            
            
            
            
            
            
            8,429Allowance
      for loan losses
            
            
            (3,611
            )
            
            
            
            
            
            
            
            
            
            
            (3,638
            )Insurance
      contracts
            
            
            6,382
            
            
            
            
            
            
            
            
            
            
            
            6,152Non-earning
      assets
            
            
            16,571
            
            
            
            
            
            
            
            
            
            
            
            15,103Total
      Assets
            
            $
            379,598
            
            
            
            
            
            
            
            
            
            
            $
            373,482Interest
      ExpenseInterest
      bearing demand deposits
            
            $
            24,294
            
            
            $
            20
            
            
            
            0.33
            %
            
            $
            25,897
            
            
            $
            56
            
            
            
            0.86
            %Savings
      and money markets
            
            
            51,266
            
            
            
            105
            
            
            
            0.82
            %
            
            
            48,179
            
            
            
            168
            
            
            
            1.39
            %Time
      deposits
            
            
            196,249
            
            
            
            1,978
            
            
            
            4.03
            %
            
            
            195,040
            
            
            
            2,291
            
            
            
            4.70
            %Long
      term debt
            
            
            10,615
            
            
            
            101
            
            
            
            3.81
            %
            
            
            12,478
            
            
            
            145
            
            
            
            4.65
            %Total
      Interest Bearing Liabilities
            
            
            282,424
            
            
            
            2,204
            
            
            
            3.12
            %
            
            
            281,594
            
            
            
            2,660
            
            
            
            3.75
            %Demand
      deposits
            
            
            50,225
            
            
            
            
            
            
            
            
            
            
            
            48,923Other
      liabilities
            
            
            5,965
            
            
            
            
            
            
            
            
            
            
            
            4,734Stockholders’
      equity
            
            
            40,984
            
            
            
            
            
            
            
            
            
            
            
            38,231Total
      liabilities and stockholders’ equity
            
            $
            379,598
            
            
            
            
            
            
            
            
            
            
            $
            373,482Net
      Interest Income
            
            
            
            
            
            $
            4,384
            
            
            
            
            
            
            
            
            
            
            $
            4,274Net
      Yield on Earning Assets3
            
            
            
            
            
            
            
            
            
            
            4.97
            %
            
            
            
            
            
            
            
            
            
            
            4.92
            %





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
      Sixteen





Credit Quality and Allowance
for Loan Losses





Non-performing
loans decreased 29.78% from December 31, 2007 to June 30, 2008. Non-performing
loans represented .75% of gross loans at June 30, 2008 and 1.08% of gross loans
at December 31, 2007.





The
following table summarizes the Company’s non-performing loans at June 30, 2008
and December 31, 2007 (in thousands of dollars):





June
      30,
            
            
            December
      31,2008
            
            
            2007Non-accrual
      loans
            
            $
            1,207
            
            
            $
            916Loans
      past due 90 days and still accruing interest
            
            
            1,151
            
            
            
            2,244Restructured
      loans
            
            
            0
            
            
            
            198Total
      non-performing loans
            
            $
            2,358
            
            
            $
            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
      Seventeen





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





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





The
following table shows the allocation for loans in the loan portfolio and the
corresponding amounts of the allowance allocated by loan type as of June 30,
2008 and December 31, 2007 (in thousands of dollars):





June
      30, 2008
            
            
            December
      31, 2007Percent
      of
            
            
            
            
            
            Percent
      ofAmount
            
            
            Loans
            
            
            Amount
            
            
            LoansLoan
      TypeCommercial
            
            $
            1,227
            
            
            
            27
            %
            
            $
            1,140
            
            
            
            26
            %Mortgage
      and construction
            
            
            1,101
            
            
            
            59
            %
            
            
            1,200
            
            
            
            59
            %Consumer
            
            
            1,322
            
            
            
            14
            %
            
            
            1,172
            
            
            
            15
            %Unallocated
            
            
            32
            
            
            
            
            
            
            
            65Totals
            
            $
            3,682
            
            
            
            
            
            
            $
            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
six month periods ended June 30, 2008 and 2007 (in thousands of
dollars):





2008
            
            
            2007Charge-offsCommercial
            
            $
            (35
            )
            
            $
            (20
            )Mortgage
      and construction
            
            
            (83
            )
            
            
            (38
            )Consumer
            
            
            (256
            )
            
            
            (261
            )Total
      Charge-offs
            
            
            (374
            )
            
            
            (319
            )RecoveriesCommercial
            
            
            13
            
            
            
            49Mortgage
            
            
            2
            
            
            
            0Consumer
            
            
            66
            
            
            
            127Total
      Recoveries
            
            
            81
            
            
            
            176Total
      Net Charge-offs
            
            $
            (293
            )
            
            $
            (143
            )





The
provision for loan losses taken during the first half of 2008 was $57,000
greater than that taken during the same period in 2007. The ratio of the
allowance for loan losses to gross loans increased from 1.15% at December 31,
2007 to 1.17% at June 30, 2008.  The ratio of allowance for loan
losses to nonperforming loans was 1.56 at June 30, 2008 compared to 1.07 at
December 31, 2007.





Index





Page
      Eighteen





Non-interest
Income





Non-interest
income increased 38.55% for the half of 2008 as compared to the same period in
2007.





Income
received from customer deposit account service charges increased $187,000, due
to continued growth in deposit balances and also to 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.





Non
interest income was also impacted by $134,000 in non recurring gains. As
interest rates continued to fall from 2007 into early 2008, the Company
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 $109,000 recorded during the first half of 2008. In addition, several
years previous, the Company purchased a parcel of real property with the intent
of establishing a branch on the property. One of the branches purchased during
2005 was adjacent to this parcel held by the Company, therefore, during the
second quarter, the Company sold the parcel and recorded a gain on the
sale.





Non-interest
Expense





Non-interest
expense increased 3.68% for the first six 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 6.01% 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 July 1,
2008, the subsidiary banks could pay dividends to Highlands Bankshares, Inc. of
approximately $5,626,000 without permission of the regulatory
authorities.


Index





Page
      Nineteen





Capital





The
Company seeks to maintain a strong capital base to expand facilities, promote
public confidence, support current operations and grow at a manageable
level.  As of June 30, 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 June 30, 2008 and December 31,
2007:





June
      30, 2008
            
            
            December
      31, 2007Actual
            
            
            Regulatory
            
            
            Actual
            
            
            RegulatoryRatio
            
            
            Minimum
            
            
            Ratio
            
            
            MinimumTotal
      Risk Based Capital RatioHighlands
      Bankshares
            
            
            14.22
            %
            
            
            8.00
            %
            
            
            14.53
            %
            
            
            8.00
            %Capon
      Valley Bank
            
            
            13.20
            %
            
            
            8.00
            %
            
            
            14.78
            %
            
            
            8.00
            %The
      Grant County Bank
            
            
            13.76
            %
            
            
            8.00
            %
            
            
            13.23
            %
            
            
            8.00
            %Tier
      1 Leverage RatioHighlands
      Bankshares
            
            
            9.73
            %
            
            
            4.00
            %
            
            
            9.95
            %
            
            
            4.00
            %Capon
      Valley Bank
            
            
            9.02
            %
            
            
            4.00
            %
            
            
            10.00
            %
            
            
            4.00
            %The
      Grant County Bank
            
            
            9.39
            %
            
            
            4.00
            %
            
            
            9.09
            %
            
            
            4.00
            %Tier
      1 Risk Based Capital RatioHighlands
      Bankshares
            
            
            12.97
            %
            
            
            4.00
            %
            
            
            13.28
            %
            
            
            4.00
            %Capon
      Valley Bank
            
            
            11.95
            %
            
            
            4.00
            %
            
            
            13.53
            %
            
            
            4.00
            %The
      Grant County Bank
            
            
            12.52
            %
            
            
            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
      Twenty





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 June 30, 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 June 30, 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.





(a)  None





(b)
None





(c) On
April 8, 2008 the Company announced a share repurchase plan whereby Management
was authorized by the Board of Directors to repurchase up to 100,000 shares of
the Company’s Common Stock, $5 par value, through open market transactions. If
the maximum authorized repurchase is reached, this represents 6.96% of the
Company’s outstanding shares of Common Stock as of the announcement date. The
repurchase period will extend through December 31, 2008 unless said number of
shares are repurchased prior to this date, or the Board of Directors of the
Company elects to extend the repurchase period. The table on the following page
summarizes the shares purchased from the announcement date through June 30,
2008.








Index





Page
      Twenty One











Period
            
            Total
              Number
      of
              Shares
              Purchased
            
            
            Average
      Price
              Paid
      Per
              Share
            
            
            Total
      Number
              of
      Shares
              Purchased
      as
              Part
      of
              Publicly
              Announced
              Plan
            
            
            Maximum
              Number
      of
              Shares
      that May
              Yet
      Be
              Purchased
              Under the PlanApril
      9, 2008—April 30, 2008
            
            
            3,100
            
            
            $
            29.07
            
            
            
            3,100
            
            
            
            96,900May
      1, 2008—May 31, 2008
            
            
            4,631
            
            
            $
            31.21
            
            
            
            4,631
            
            
            
            92,269June 1, 2008—June 30,
      2008
            
            
            68,710
            
            
            $
            33.70
            
            
            
            68,710
            
            
            
            23,559Total
            
            
            76,441
            
            
            $
            33.36
            
            
            
            76,441
            
            
            
            23,559








Item
3.   Defaults Upon Senior Securities





None





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





On May
13, 2008 the Company held its annual meeting of stockholders. The following
items were approved by the shareholders by the required majority or
plurality.





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





Votes
      For
            Withhold
      AuthorityAlan
      L. Brill
            1,001,876
            10,606Morris
      M. Homan, Jr.
            1,005,126
            7,356Kathy
      G. Kimble
            983,883
            28,599John
      G. Van Meter
            1,002,429
            10,053





2)
            Ratification
      of Smith Elliott Kearns & Company, LLC as Independent Registered
      Public Accountant for 2008.





Votes
      For
            Votes
      Against
            Abstentions1,009,779
            0
            2,703








Item
5.  Other Information





None








Index





Page
      Twenty Two





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 MillerPrincipal
      Financial OfficerAugust
      13, 2008