Exhibit 13.1

                 [EXCERPTS FROM ANNUAL REPORT TO SHAREHOLDERS]


                      Management's Discussion and Analysis

                                    2003-2002


         For the year ended  December 31,  2003,  total assets grew from $485.60
million on  December  31,  2002 to $543.42  million at December  31,  2003.  The
increase  totaling  11.91% was due to several  factors  including  the continued
growth in our  North  Carolina  and  Tennessee  markets.  During  2003,  we also
expanded our West Abingdon  branch to full service and we opened a new branch in
Blountville,  Tennessee.  As of December  31,  2003,  we had also  substantially
completed  construction  of our  latest  branch  located  in Banner  Elk,  North
Carolina. Outstanding loans in our North Carolina market exceeded $40 million as
of December 31, 2003.  The  Rogersville,  Tennessee  office has  quadrupled  its
deposit size since the acquisition date in September of 2000.  Combined deposits
at our newly constructed Blountville, Tennessee and our West Abingdon exceeded 8
million as of December  31,  2003.  The growth of assets  during 2003 was funded
primarily by the increase in customer deposits as individuals continued to place
their  dollars in banks as a result of the  market's  uncertainty.  Our deposits
grew from $410.30 million at the end of last year to $450.01 million on December
31, 2003. Even as interest rates continued to decline,  we were able to increase
the  percentage of adjustable  rate loans  compared to fixed rate over the prior
year.  We feel that the Bank's asset  liability  mix is now much more  favorably
positioned  when  interest  rates rise as  opposed  to 2 to 3 years  ago.  As of
December  31, 2003 our deposit  portfolio  consisted of 54% time  deposits,  18%
savings deposits and 27% transaction  accounts.  During 2003,  outstanding loans
grew  11.28% or $38.29  million.  The loan  growth was  helped by the  continued
refinancing  of mortgages  nationwide  due to the low interest rate  environment
during the year. Our "collateral mix"of loans again strengthened with 73% of our
loan portfolio secured by real estate, 21% secured by collateral other than real
estate and only 6% unsecured. Our loan to deposit ratio increased from 82.75% at
December  31, 2002 to 83.96% at December  31, 2003.  The  investment  securities
portfolio of the company  increased a moderate  19.10% or $20.04  million during
the year. Our securities  purchases were primarily tax - free municipal  isssues
and mortgage-backed securities.
         Our net  income for the year 2003  increased  $416  thousand  over 2002
which  resulted in another  record year of earnings for your Company.  We had an
increase in net income of 10.14% from $4.10  million in 2002 to $4.52 million in
2003. Our growth in outstanding loans and securities helped offset the declining
yields related to our loan and securities  portfolios.  Our net interest  income
slightly  decreased  .55% from $16.68 million in 2002 to $16.59 million in 2003.
Interest  income  declined  $1.48  million  from the prior year as  compared  to
interest  expense which  decreased  $1.39 million from 2002. The  tax-equivalent
yield on our  average  interest-earning  assets for 2003 was 6.34%  compared  to
7.18%  for the  year  ended  December  31st,  2002.  The  yield  on our  average
interest-bearing liabilities for 2003 declined to 3.06% from 3.73% for the prior
year.
         During the second  quarter of 2003,  the  Company  received  regulatory
approval  to  re-purchase  16% of the  $7.5  million  of  trust  preferred  debt
securities.  The shares were re-purchased in April 2003 at a price of $26.15 per
share which is equal to the 2008 call
<PAGE>

price. For future regulatory purposes, this $1.2 million will not be eligible to
be  included  in Tier 1 or Tier 2 capital;  however  the  reduction  in interest
expense will enhance the Company's net interest margin.
         Non-interest  income  increased 1.01 million over 2002.  Security gains
totaled  $589  thousand  for 2003 as  compared  to $17  thousand  in  2002.  The
remaining  increase  in  non-interest  income  was  primarily   attributable  to
increased debit card / credit card fee income,  earnings related to our purchase
of Bank Owned Life  Insurance  and  dividends  received  from our  investment in
Virginia Title Center.  Earnings related to our investment in Bankers Insurance,
LLC. also  increased  over 2002.  Non-interest  expenses  increased  from $13.05
million  in 2002 to $13.47  million  in 2003.  Salaries  and  employee  benefits
increased 8.08% in 2003 due to our continued growth and branch expansion.
         Our  allowance  for loan  losses  as a  percentage  of  total  loans at
December  31,  2003  slightly  decreased  to 1.13% of total loans as compared to
1.14% for the prior  year.  Management  is  especially  pleased to mention  that
earnings  per common share  increased  from $1.55 in 2002 to $1.70 in 2003 which
represents  an  increase  of 9.68% for the  year.  Book  value  per  share  also
increased  from $12.16 at December  31,  2002 to $13.33 at  December  31,  2003.
Return on  Average  Equity  decreased  from  13.82% to 13.27%  Return on Average
Assets remained the same at .87% at December 31, 2003.
         We are  also  pleased  to  report  that we paid our  sixth  consecutive
dividend in 2003.
Participation  in our both our Dividend  Reinvestment  Plan and  Optional  Stock
Purchase plan has continued to grow.

                                   2002 - 2001


           For the year ended December 31, 2002,  total assets grew from $453.75
million on  December  31,  2001 to $485.60  million at December  31,  2002.  The
increase  totaling  7.02% was due to several  factors  including  the  continued
growth of our Boone N. C. and Rogersville TN. branch offices.  Outstanding loans
at  the  Boone  office  exceeded  $27  million  as of  December  31,  2002.  The
Rogersville  office has tripled is deposit  size since the  acquisition  date in
September of 2000. The growth of assets during 2002 was funded  primarily by the
increase in savings and  checking  accounts as  individuals  continued  to place
their  dollars in banks as a result of the market's  decline.  Our deposits grew
from $392.10  million at the end of last year to $410.30 million on December 31,
2002. The continued  reduction of interest rates during 2002 allowed  management
of the company another year of opportunity to shift the overall  position of our
interest bearing liabilities to longer-term maturities.  We feel that the Bank's
asset  liability mix is now much more favorably  positioned  when interest rates
rise.  As of  December  31,  2002 our deposit  portfolio  consisted  of 57% time
deposits,  17% savings deposits and 26% transaction  accounts. We also were able
to increase the percentage of adjustable rate assets compared to fixed rate over
the prior year.  This too has  strengthened  our position in the event of rising
interest rates. During 2002, outstanding loans grew 4.32% or $14.06 million. The
loan growth was helped by the continued  refinancing of mortgages nationwide due
to the low interest rate  environment  during the year. Our  "collateral  mix"of
loans  strengthened with 71% of our loan portfolio  secured by real estate,  23%
secured by  collateral  other  than real  estate  and only 6%  unsecured.  . The
investment
<PAGE>


securities  portfolio of the company increased a moderate 4.64% or $4.66 million
during the year. During the second quarter of 2002, we purchased $7.8 million of
Bank Owned Life Insurance. The earnings related to this purchase will be used to
offset future employee  benefit costs.  Also during 2002, we purchased an equity
owner's  interest in Virginia  Title  Center,  LLC.  which is  headquartered  in
Roanoke, Virginia.
         Our net income for the year 2002 increased $803 thousand over 2001which
resulted in a record year of earnings  for your  Company.  We had an increase in
net income of 24.33% from $3.30  million in 2001 to $4.10  million in 2002.  Our
growth in outstanding  loans and securities  helped offset the declining  yields
related to our loan and securities portfolios. Our net interest income increased
18.19%  from  $14.11  million  in 2001 to $16.68  million  in 2002.  We  greatly
benefited this past year by our interest bearing liabilities re-pricing downward
more rapidly than our interest  earning  assets.  Interest income declined $2.05
million  from the prior year as  compared to interest  expense  which  decreased
$4.62   million   from   2001.   The   tax-equivalent   yield  on  our   average
interest-earning  assets for 2002 was 7.18% compared to 8.24% for the year ended
December 31st, 2001. The yield on our average  interest-bearing  liabilities for
2002  declined to 3.73% from 5.34% for the prior year. We also had a significant
increase in our non-interest bearing checking accounts which helped to lower our
cost of funds.
         Non-interest   income   increased  282  thousand  over  2001.  This  is
especially  encouraging  since net  securities  gains for 2002  totaled only $17
thousand as compared to $494  thousand  in 2001.  The  increase in  non-interest
income was primarily  attributable to an increase in overdraft  fees,  increased
debit card / credit card fee income,  earnings  related to our  purchase of Bank
Owned Life  Insurance  and dividends  received  from our  investment in Virginia
Title Center.  Non-interest  expenses  increased  from $11.62 million in 2001 to
$13.05 million in 2002. A portion of this increase was due to the opening of the
Boone,  N. C. branch  office in January of 2001 and the addition of personnel in
the Abingdon market area.
         Our  allowance  for loan  losses  as a  percentage  of  total  loans at
December  31, 2002  increased  8.57% to 1.14% as compared to 1.05% for the prior
year. Management is especially pleased to mention that earnings per common share
increased  from $1.25 in 2001 to $1.55 in 2002 which  represents  an increase of
24% for the year.  Book value per share also  increased  from $10.38 at December
31, 2001 to $12.16 at December  31,  2002.  Return on Average  Equity  increased
8.14% in 2002 to 13.82%.  Return on Average Assets  increased  12.99% to .87% at
December 31, 2002.
         During  the  first  quarter  of  2002,  we  implemented   our  Dividend
Reinvestment  and Optional Stock Purchase Plan and we are happy to report to you
that the response from our shareholders has been very positive.

                  In  summary,  as always we are very  excited  to report to our
valued  shareholders  what has  occurred  during  the past three  years.  We are
especially  pleased with not only the improved earnings of your Company but also
the program  initiatives  that have been put in place. We feel optimistic  about
the continued  opportunity  for growth in not only our current  market areas but
new locations as well.  Our Banner Elk,  North  Carolina  branch is scheduled to
open in February,  2004.  We truly  believe  that the  products,  services,  and
delivery  systems that have been  implemented in our tri-state  market area will
certainly add value to your Company in the years to come.



<PAGE>




                   HIGHLANDS BANKSHARES, INC. AND SUBSIDIARIES

                          CONSOLIDATED FINANCIAL REPORT

                                DECEMBER 31, 2003




<PAGE>

                                 C O N T E N T S


                                                                          Page
                                                                          ----

INDEPENDENT AUDITOR'S REPORT                                                 3

FINANCIAL STATEMENTS
  Consolidated Balance Sheets                                                 4
  Consolidated Statements of Income                                           5
  Consolidated Statements of Stockholders' Equity                             6
  Consolidated Statements of Cash Flows                                       7
  Notes to Consolidated Financial Statements                             8 - 33


<PAGE>

                          INDEPENDENT AUDITOR'S REPORT


Board of Directors and Stockholders
Highlands Bankshares, Inc. and Subsidiaries
Abingdon, Virginia

         We  have  audited  the  accompanying  consolidated  balance  sheets  of
Highlands Bankshares,  Inc. and Subsidiaries,  as of December 31, 2003, 2002 and
2001 and the related consolidated  statements of income,  stockholders'  equity,
and cash flows for the years then  ended.  These  financial  statements  are the
responsibility of Highlands Bankshares, Inc.'s management. Our responsibility is
to express an opinion on these  consolidated  financial  statements based on our
audits.

         We conducted our audits in accordance with auditing standards generally
accepted in the United States of America.  Those standards  require that we plan
and perform the audit to obtain reasonable assurance about whether the financial
statements are free of material misstatement.  An audit includes examining, on a
test basis,  evidence supporting the amounts and disclosures in the consolidated
financial statements. An audit also includes assessing the accounting principles
used and  significant  estimates made by  management,  as well as evaluating the
overall financial statement  presentation.  We believe that our audits provide a
reasonable basis for our opinion.

         In our opinion, the consolidated financial statements referred to above
present fairly, in all material  respects,  the financial  position of Highlands
Bankshares,  Inc. and Subsidiaries,  as of December 31, 2003, 2002 and 2001, and
the results of their operations and their cash flows for the years then ended in
conformity with accounting principles generally accepted in the United States of
America.


                                             CERTIFIED PUBLIC ACCOUNTANTS

1969 Lee Highway
Bristol, VA 24201
January 24, 2003

<PAGE>


                   HIGHLANDS BANKSHARES, INC. AND SUBSIDIARIES

                           CONSOLIDATED BALANCE SHEETS
                        December 31, 2003, 2002 and 2001
                             (Amounts in thousands)

<TABLE>
<CAPTION>
                ASSETS                                            2003          2002            2001
                                                               -----------    -----------   -----------
<S>                                                            <C>            <C>           <C>
 Cash and due from banks                                       $    14,473    $    13,369   $    10,921

 Federal funds sold                                                    389          5,132         1,320
                                                               -----------    -----------   -----------

                Total Cash and Cash Equivalents                     14,862         18,501        12,241

 Investment securities available-for-sale (Note 2)                 122,064        102,743        98,299
 Other Investments, at cost (Note 3)                                 2,900          2,182         1,971
 Loans, net of allowance for loan losses of $4,274, $3,877
    and $3,418 in 2003, 2002, and 2001 respectively (Note 4)       373,534        335,644       322,042
 Premises and equipment, net (Note 5)                               15,465         13,157        12,900
 Interest receivable                                                 2,749          2,708         2,904
 Other assets (Note 6)                                              11,841         10,668         3,388
                                                               -----------    -----------   -----------
                Total Assets                                   $   543,416    $   485,603   $   453,745
                                                               ===========    ===========   ===========

              LIABILITIES AND STOCKHOLDERS' EQUITY

 Deposits (Note 8)
      Noninterest bearing                                      $    59,057    $    55,597   $    50,248
      Interest bearing                                             390,952        354,704       341,845
                                                               -----------    -----------   -----------

                Total Deposits                                     450,009        410,301       392,093
                                                               -----------    -----------   -----------

 Interest, taxes and other liabilities                               2,244          2,309         3,217
 Other short term borrowings (Note 9)                               33,000         19,094        13,000
 Long-term debt (Note 10)                                           16,429         14,200        10,483
 Capital securities (Note 11)                                        6,300          7,500         7,500
                                                               -----------    -----------   -----------
                                                                    57,973         43,103        34,200
                                                               -----------    -----------   -----------

                Total Liabilities                                  507,982        453,404       426,293
                                                               -----------    -----------   -----------

 STOCKHOLDERS' EQUITY

      Common stock, 2,659, 2,648, and 2,644 shares
          issued and outstanding as of December 31, 2003,
          2002, and 2001, respectively. Authorized 20,000,000
          shares, par value $1.25 per share (Notes 13 and 15)        3,324          3,309         3,304
      Additional paid-in capital                                     6,305          6,150         6,063
      Retained Earnings                                             25,984         21,729        17,863
      Accumulated other comprehensive income (loss)                   (179)         1,011           222
                                                               -----------    -----------   -----------

                Total Stockholders' Equity                          35,434         32,199        27,452
                                                               -----------    -----------   -----------

                Total Liabilities and Stockholders' Equity     $   543,416    $   485,603   $   453,745
                                                               ===========    ===========   ===========
</TABLE>

The  Notes to Consolidated  Financial  Statements are an  integral part of these
statements.

<PAGE>



                   HIGHLANDS BANKSHARES, INC. AND SUBSIDIARIES

                        CONSOLIDATED STATEMENTS OF INCOME
                  Years Ended December 31, 2003, 2002 and 2001
                  (Amounts in thousands, except per share data)

<TABLE>
<CAPTION>

INTEREST INCOME                                                    2003        2002       2001
                                                                   ----        ----       ----

<S>                                                               <C>         <C>         <C>
     Loans receivable and fees on loans                           $24,893     $26,095     $27,574
     Securities available for sale:
        Taxable                                                     2,214       3,185       3,997
        Tax-exempt                                                  2,183       1,459         972
        Other Investment Income                                        98         114         138
     Federal funds sold                                                75          91         317
                                                                  -------     -------     -------
           Total Interest Income                                   29,463      30,944      32,998
                                                                  -------     -------     -------

INTEREST EXPENSE

    Deposits                                                       10,335      11,768      16,740
    Federal funds purchased                                            13           3        --
    Other borrowed funds                                            2,529       2,495       2,147
                                                                  -------     -------     -------
          Total interest expense                                   12,877      14,266      18,887
                                                                  -------     -------     -------

          Net interest income                                      16,586      16,678      14,111

PROVISION FOR LOAN LOSSES (Note 4)                                  2,053       1,825       1,448
                                                                  -------     -------     -------

          Net interest income after provision for loan losses      14,533      14,853      12,663
                                                                  -------     -------     -------

NON-INTEREST INCOME
     Securities gains                                                 589          17         494
     Service charges on deposit accounts                            2,665       2,620       2,181
     Other service charges, commissions and fees                      778         634         586
     Other operating income                                           620         375         103
                                                                  -------     -------     -------
            Total Non-Interest Income                               4,652       3,646       3,364
                                                                  -------     -------     -------

NON-INTEREST EXPENSE
     Salaries and employee benefits (Note 14)                       7,746       7,167       6,456
     Occupancy expense of bank premises                               582         568         565
     Furniture and equipment expense                                1,607       1,718       1,570
     Other operating expenses (Note 23)                             3,535       3,593       3,028
                                                                  -------     -------     -------
            Total Non-Interest Expenses                            13,470      13,046      11,619
                                                                  -------     -------     -------

            Income Before Income Taxes                              5,715       5,453       4,408

     Income Tax Expense (Note 7)                                    1,195       1,349       1,107
                                                                  -------     -------     -------

            Net Income                                            $ 4,520     $ 4,104     $ 3,301
                                                                  =======     =======     =======

Earnings Per Common Share (Note 13)                               $  1.70     $  1.55     $  1.25
                                                                  =======     =======     =======

Earnings Per Common Share - assuming dilution (Note 13)           $  1.69     $  1.54     $  1.24
                                                                  =======     =======     =======

</TABLE>

The Notes to  Consolidated  Financial  Statements  are an integral part of these
statements.
<PAGE>


                   HIGHLANDS BANKSHARES, INC. AND SUBSIDIARIES

                 CONSOLIDATED STATEMENTS OF STOCKHOLDERS' EQUITY
                  Years Ended December 31, 2003, 20021 and 2001
                             (Amounts in thousands)

<TABLE>
<CAPTION>

                                                                                                           Accumulated
                                                                                   Additional                Other         Total
                                                                   Common Stock     Paid-in    Retained Comprenhensive Stockholders'
                                                                Shares   Par Value  Capital    Earnings      Income        Equity
                                                               --------   --------  --------   --------     --------      --------


<S>                                                            <C>        <C>       <C>      <C>            <C>           <C>
Balance, December 31, 2000                                     $  2,637   $  3,296  $  5,952 $   14,773     $    162      $ 24,183
                                                                                                                          --------

 Comprehensive income:
Net income                                                          -          -         -        3,301          -           3,301
Change in unrealized gain (loss) on securities available-for-
sale, net of deferred income tax expense of $199                    -          -         -          -            386           386
Less: reclassification adjustment, net of income tax expense of
$168                                                                -          -         -          -           (326)         (326)
                                                                                                                          --------

Total comprehensive income                                          -          -         -          -            -           3,361
                                                                                                                          --------

Common stock issued for stock options exercised                       7          8       111        -            -             119
Cash dividend                                                       -          -         -         (211)         -            (211)
                                                               --------   --------  --------   --------     --------      --------


Balance, December 31, 2001                                        2,644      3,304     6,063     17,863          222        27,452
                                                                                                                          --------
 Comprehensive income:
Net income                                                          -          -         -        4,104          -           4,104
Change in unrealized gain (loss) on securities  available-for-
sale, net of deferred income tax expense of $412                    -          -         -          -            800           800
Less: reclassification adjustment, net of income tax expense of
$6                                                                  -          -         -          -            (11)          (11)
                                                                                                                          --------

 Total comprehensive income                                         -          -         -          -            -           4,893
                                                                                                                          --------

Common stock issued for stock options exercised                       3          4        74        -            -              78

Common stock issued for  dividend reinvestment and optional
 cash purchase plan                                                   1          1        13        -            -              14
Cash dividend                                                       -          -         -         (238)         -            (238)
                                                               --------   --------  --------   --------     --------      --------
 Balance, December 31, 2002                                       2,648      3,309  $  6,150   $ 21,729     $  1,011      $ 32,199

 Comprehensive income:
Net income                                                          -          -         -        4,520          -           4,520
Change in unrealized gain (loss) on securities available-for-
sale, net of deferred income tax benefit of  $413                   -          -         -          -           (801)         (801)
Less: reclassification adjustment, net of income tax expense of
$200                                                                -          -         -          -           (389)         (389)
                                                                                                                          --------

 Total comprehensive income                                         -          -         -          -            -           3,330
                                                                                                                          --------

Common stock issued for stock options exercised                      10         14       140        -            -             154
Common stock issued for  dividend reinvestment and optional
cash purchase plan                                                    1          1        15        -            -              16
Cash dividend                                                       -          -         -         (265)         -            (265)
                                                               --------   --------  --------   --------     --------      --------

 Balance, December 31, 200                                     $  2,659   $  3,324  $  6,305   $ 25,984     $   (179)     $ 35,434
                                                               ========   ========  ========   ========     ========      ========
</TABLE>

The Notes to  Consolidated  Financial Statements  are an  integral part of these
statements

<PAGE>



                   HIGHLANDS BANKSHARES, INC. AND SUBSIDIARIES

                      CONSOLIDATED STATEMENTS OF CASH FLOWS
                  Years Ended December 31, 2003, 2002, and 2001
                              (Amount in thousands)
<TABLE>
<CAPTION>

                                                                                        2003                2002           2001
                                                                                        ----                ----           ----
 CASH FLOWS FROM OPERATING ACTIVITIES:

<S>                                                                                    <C>                <C>           <C>
      Net income                                                                       $  4,520           $  4,104      $  3,301
      Adjustments to reconcile net income to net cash
        provided by operating activities:
           Provision for loan losses                                                      2,053              1,825         1,448
           Provision for deferred income taxes                                              (27)               (96)         (129)
           Depreciation and amortization                                                    882                957           906
           Net realized gains on available-for-sale securities                             (589)               (17)
           Net amortization on securities                                                   302                160           (11)
           Amortization of Capital Issue costs                                               12                 11            11
           (Increase) decrease  in interest receivable                                      (41)               196            61
           Increase in other assets                                                        (565)            (7,215)         (626)
           Decrease in interest, taxes and other
             liabilities                                                                    (65)              (908)         (328)
                                                                                       --------           --------      --------
                Net Cash provided by (used in) operating activities                       6,482               (983)        4,139
                                                                                       --------           --------      --------

 CASH FLOWS FROM INVESTING ACTIVITIES:
      Securities available for sale:
          Proceeds from sale of debt and equity securities                                7,178              9,394        11,455
          Proceeds from maturities of debt and equity securities                         25,435             20,922        26,500
          Purchase of debt and equity securities                                        (53,451)           (34,114)      (54,683)
      Purchase of other investments                                                        (718)              (212)          (87)
      Net increase in loans                                                             (39,943)           (15,426)      (34,543)
      Premises and equipment expenditures                                                (2,920)            (1,194)       (1,332)
                                                                                       --------           --------      --------
                Net Cash used in investing activities                                   (64,419)           (20,630)      (52,690)
                                                                                       --------           --------      --------

 CASH FLOWS FROM FINANCING ACTIVITIES:

      Net increase (decrease) in certificates of deposit                                 11,186             (9,367)        9,712
      Net increase in demand, savings and other deposits                                 28,522             27,575        36,066
      Net increase in short term borrowings                                              13,906              6,094         7,806
      Net increase (decrease) in Long-Term Debt                                           1,979              3,717        (7,992)
      Repurchase of Capital Securities                                                   (1,200)
      Cash dividends paid                                                                  (265)              (238)         (211)
      Proceeds from exercise of common stock options                                        154                 78           119
      Proceeds from issuance of common stock                                                 16                 14           -
                                                                                       --------           --------      --------
                Net Cash provided by financing activities                                54,298             27,873        45,500
                                                                                       --------           --------      --------
                Net increase (decrease) in cash and cash equivalents                     (3,639)             6,260        (3,051)

 CASH AND CASH EQUIVALENTS AT BEGINNING OF YEAR                                          18,501             12,241        15,292
                                                                                       --------           --------      --------

 CASH AND CASH EQUIVALENTS AT END OF YEAR                                              $ 14,862           $ 18,501      $ 12,241
                                                                                       ========           ========      ========

 SUPPLEMENTAL DISCLOSURE OF NON-CASH TRANSACTIONS

 Land, premises and equipment purchased through seller financed
   transactions                                                                        $    250           $   -         $   -
                                                                                       ========           ========      ========
SUPPLEMENTAL DISCLOSURES OF CASH FLOW INFORMATION:
 Cash paid during the year for:
      Interest                                                                         $ 13,090           $ 15,194      $ 19,411
                                                                                       ========           ========      ========
                                                                                       $  1,150           $  1,619      $  1,111
                                                                                       ========           ========      ========
</TABLE>

The  Notes to  Consolidated Financial  Statements  are an integral part of these
statements

<PAGE>


                   HIGHLANDS BANKSHARES, INC. AND SUBSIDIARIES

                   NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
                                December 31, 2003
                             (Amounts in thousands)


     Note 1. Summary of Significant Accounting Policies

     Basis of Presentation and Consolidation

     The accompanying  consolidated financial statements include the accounts of
     Highlands  Bankshares,  Inc., (the "Parent  Company") and its  wholly-owned
     subsidiaries, Highlands Union Bank (the "Bank") and Highlands Capital Trust
     I (the "Trust").  The statements  also include  Highlands  Union  Insurance
     Services,  Inc., (the "Insurance Services"),  and Highlands Union Financial
     Services,  Inc., (the  "Financial  Services")  which are both  wholly-owned
     subsidiaries  of  the  Bank.  All  significant  intercompany  balances  and
     transactions  have been  eliminated in  consolidation.  The  accounting and
     reporting  policies of Highlands  Bankshares,  Inc. and Subsidiaries,  (the
     "Company") conform to U.S. generally accepted accounting  principals and to
     predominate practices within the banking industry.

     Nature of Operations

     The Company  operates in  Abingdon,  Virginia,  and  surrounding  southwest
     Virginia,  eastern Tennessee,  and western North Carolina under the laws of
     the  Commonwealth  of Virginia.  The Company was  organized on December 29,
     1995.  The Parent  Company is supervised by the Federal  Reserve Bank under
     the Bank Holding  Company Act of 1956,  as amended.  The Bank began banking
     operations on April 27, 1985 under a state bank charter and provides a full
     line of  financial  services  to  individuals  and  businesses.  The Bank's
     primary lending products include  mortgage,  consumer and commercial loans,
     and their primary deposit products are checking,  savings, and certificates
     of  deposit.  As a state bank and a member of the Federal  Reserve  Bank of
     Richmond, the Bank is subject to regulation by the Virginia State Bureau of
     Financial Institutions,  the Federal Deposit Insurance Corporation, and the
     Federal Reserve Bank.  Highlands  Capital Trust I became effective  January
     14,  1998.  The  nature of the trust is  described  more  fully in Note 11.
     Highlands Union Insurance  Services,  Inc. became effective October 8, 1999
     for the purpose of selling  insurance  through  Bankers  Insurance LLC. The
     bank operated a financial services  department for the purpose of brokering
     various investment vehicles until January 2, 2001. At that time,  Highlands
     Union Financial Services,  Inc. was created to convert that department into
     a separate legal entity.

     Cash and Cash Equivalents

     For purposes of the  consolidated  statements of cash flows,  cash and cash
     equivalents  include cash and due from banks and federal funds sold, all of
     which mature  within  ninety days.  The Company  maintains its cash in bank
     deposit accounts which, at times, may exceed federally insured limits.  The
     Company  has not  experienced  any  losses in such  accounts.  The  Company
     believes it is not exposed to any significant  credit risk on cash and cash
     equivalents.

     Securities Available-for-Sale

     Securities  classified  as  available-for-sale  are those  debt and  equity
     securities  that the Company  intends to hold for an  indefinite  period of
     time,  but not  necessarily  to  maturity.  Any decision to sell a security
     classified  as  available-for-sale  would  be  based  on  various  factors,
     including  significant movements in interest rates, changes in the maturity
     mix of the Company's  assets and liabilities,  liquidity needs,  regulatory
     capital considerations, and other similar factors.

     Securities  available-for-sale are carried at fair value.  Unrealized gains
     or losses are reported as  increases  or  decreases in other  comprehensive
     income, net of the related deferred income tax

<PAGE>


                   HIGHLANDS BANKSHARES, INC. AND SUBSIDIARIES

                   NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
                                December 31, 2003
                             (Amounts in thousands)

     Note 1. Summary of Significant Accounting Policies (Continued)

     Securities Available-for-Sale (Continued)

     effect.  Realized  gains or losses are  recorded  on the trade date and are
     determined on the basis of the amortized cost of specific  securities sold.
     Realized  gains or losses are included in earnings.  Premiums and discounts
     are recognized in interest income using the interest method over the period
     to maturity.

     Loans

     The Company grants mortgage,  commercial and consumer loans to customers. A
     substantial  portion of the loan portfolio is represented by mortgage loans
     throughout  southwest  Virginia.  The ability of the  Company's  debtors to
     honor  their  contracts  is  dependent  upon the real  estate  and  general
     economic conditions in this area.

     Loans  that  management  has  the  intent  and  ability  to  hold  for  the
     foreseeable  future or until maturity or pay-off  generally are reported at
     their outstanding unpaid principal  balances adjusted for charge-offs,  the
     allowance  for loan losses,  and any deferred  fees or costs on  originated
     loans.  Interest income is accrued on the unpaid balance.  Loan origination
     fees, net of certain direct  origination  costs, are deferred and amortized
     to income over the  estimated  lives of the loans  using the  straight-line
     method.  The  aforementioned  method is not  materially  different from the
     interest method.

     The accrual of interest on loans is discontinued at the time the loan is 90
     days  delinquent  unless  the  credit is  well-secured  and in  process  of
     collection.  Credit  card  loans and  other  personal  loans are  typically
     charged off no later than 180 days past due. In all cases, loans are placed
     on nonaccrual or  charged-off at an earlier date if collection of principal
     or interest is considered doubtful.

     All  interest  accrued  but not  collected  for  loans  that are  placed on
     nonaccrual or charged off is reversed against interest income. The interest
     on these loans is accounted for on the cash-basis or cost-recovery  method,
     until  qualifying  for return to  accrual.  Loans are  returned  to accrual
     status when all the principal and interest  amounts  contractually  due are
     brought current and future payments are reasonably assured.

     Allowance for Loan Losses

     The allowance for loan losses is  established  through a provision for loan
     losses charged to earnings as losses are estimated to have  occurred.  Loan
     losses are charged  against the  allowance  when  management  believes  the
     uncollectibility of a loan balance is confirmed.  Subsequent recoveries, if
     any, are credited to the allowance.

     The allowance for loan losses is evaluated on a regular basis by management
     and is based upon  management's  periodic review of the  collectibility  of
     loans in light of historical experience,  the nature and volume of the loan
     portfolio,  adverse  situations  that may affect the borrower's  ability to
     repay, estimated value of any underlying collateral and prevailing economic
     conditions.  This  evaluation  is  inherently  subjective  as  it  requires
     estimates that are susceptible to significant  revision as more information
     becomes available.

     A loan is  considered  impaired  when,  based on  current  information  and
     events,  it is  probable  that the  Company  will be unable to collect  the
     scheduled payments of principal or interest when due

<PAGE>


                   HIGHLANDS BANKSHARES, INC. AND SUBSIDIARIES

                   NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
                                December 31, 2003
                             (Amounts in thousands)

     Note 1. Summary of Significant Accounting Policies (Continued)

     Allowance for Loan Losses (Continued)

     according  to  the  contractual  terms  of  the  loan  agreement.   Factors
     considered by management in determining  impairment include payment status,
     collateral value, and the probability of collecting scheduled principal and
     interest  payments when due. Loans that  experience  insignificant  payment
     delays and payment  shortfalls  generally  are not  classified as impaired.
     Management  determines  the  significance  of payment  delays  and  payment
     shortfalls on a case-by-case  basis,  taking into  consideration all of the
     circumstances  surrounding the loan and the borrower,  including the length
     of the delay,  the  reasons for the delay,  the  borrower's  prior  payment
     record,  and the amount of the  shortfall in relation to the  principal and
     interest owed. Impairment is measured on a loan by loan basis by either the
     present  value of  expected  future  cash  flows  discounted  at the loan's
     effective  interest rate, the loan's  obtainable  market price, or the fair
     value of the  collateral  if the  loan is  collateral  dependent.  Interest
     income is not recognized on impaired loans.

     Premises and Equipment

     Land is carried at cost.  Premises  and  equipment  are stated at cost less
     accumulated  depreciation.  Depreciation  is computed on the  straight-line
     method over estimated useful lives.  Maintenance and repairs are charged to
     current  operations while  improvements are capitalized.  Disposition gains
     and losses are reflected in current operations.

     Intangible Assets

     Capital issue costs relating to the junior subordinated debt securities are
     stated at cost less accumulated  amortization.  Amortization is computed on
     the straight-line method over the life of the securities - 30 years.

     Foreclosed Assets

     Assets acquired  through,  or in lieu of, loan  foreclosure or repossession
     are held for sale and are  initially  recorded at fair value at the date of
     foreclosure or repossession,  establishing a new cost basis.  Subsequent to
     foreclosure  or  repossession,  valuations  are  periodically  performed by
     management  and the assets are carried at the lower of  carrying  amount or
     fair value less cost to sell.  Revenue and  expenses  from  operations  and
     changes in the  valuation  allowance  are  included  in net  expenses  from
     foreclosed and repossessed  assets.  Foreclosed and  repossessed  assets at
     December 31, 2003, 2002 and 2001 were $439, $511 and $288, respectively.

     Income Taxes

     Under the asset and liability method,  deferred income taxes are recognized
     for the tax  consequences of "temporary  differences"  by applying  enacted
     statutory  tax rates to the  differences  between the  financial  statement
     carrying  amounts  and the tax bases of  existing  assets and  liabilities.
     Under SFAS No. 109,  the effect on deferred  taxes of a change in tax rates
     is recognized in income in the period that includes the enactment date.

     Earnings Per Common Share

     Earnings per common  share are  calculated  based on the  weighted  average
     outstanding  shares  during the year.  Earnings per common  share  assuming
     dilution are calculated  based on the weighted average  outstanding  shares
     during the year plus common stock equivalents at year end.

<PAGE>


                   HIGHLANDS BANKSHARES, INC. AND SUBSIDIARIES

                   NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
                                December 31, 2003
                             (Amounts in thousands)


     Note 1. Summary of Significant Accounting Policies (Continued)

     Stock Compensation Plans

     Statement of Financial  Accounting Standards (SFAS) No. 123, Accounting for
     Stock-Based  Compensation,  encourages  all  entities to adopt a fair value
     based method of accounting for employee stock compensation  plans,  whereby
     compensation  cost is  measured at the grant date based on the value of the
     award and is  recognized  over the  service  period,  which his usually the
     vesting  period.  However,  it also allows an entity to continue to measure
     compensation cost for those plans using the intrinsic value based method of
     accounting  prescribed  by  Accounting  Principles  Board  Opinion  No. 25,
     Accounting for Stock Issued to Employees,  whereby compensation cost is the
     excess,  if any, of the quoted  market price of the stock at the grant date
     (or other measurement date) over the amount an employee must pay to acquire
     the stock.  Stock options issued under the Corporation's  stock option plan
     have no  intrinsic  value at the grant  date,  and under  Opinion No. 25 no
     compensation  cost is recognized for them. The  Corporation  has elected to
     continue  with the  accounting  methodology  in  Opinion  No. 25 and,  as a
     result,  has provided pro forma  disclosures of net income and earnings per
     share  and  other  disclosures,  as if  the  fair  value  based  method  of
     accounting been applied.  The pro forma disclosures  include the effects of
     all awards granted on or after January 1, 1995. (See Note 15.)

     Use of Estimates

     In preparing  consolidated  financial  statements in  conformity  with U.S.
     generally accepted  accounting  principles,  management is required to make
     estimates and  assumptions  that affect the reported  amounts of assets and
     liabilities  as of the date of the balance  sheet and  reported  amounts of
     revenue and expenses  during the  reporting  period.  Actual  results could
     differ  from those  estimates.  Material  estimates  that are  particularly
     susceptible  to  significant   change  in  the  near  term  relate  to  the
     determination  of the  allowance  for loan  losses,  and the  valuation  of
     foreclosed  real  estate,  deferred  tax assets and  investment  securities
     activities.

     Business Segments

     The  Company  reports  its  activities  as a single  business  segment.  In
     determining  the  appropriateness  of  segment   definition,   the  Company
     considers  components of the business about which financial  information is
     available  and  regularly  evaluated  relative to resource  allocation  and
     performance assessment.

     Reclassification of Financial Statement Presentation

     Certain  reclassifications  have been  made to the 2002 and 2001  financial
     statements to conform with the 2003 financial statement presentation.  Such
     reclassifications had no effect on net income as previously reported.

     Recent Accounting  Pronouncements

     In October 2002,  the Financial  Accounting  Standards  Board (FASB) issued
     Statement of  Financial  Accounting  Standards  No. 147,  "Acquisitions  of
     Certain Financial Institutions - an amendment of FASB Statements No. 72 and
     144 and  FASB  Interpretation  No.  9",  effective  October  1,  2002.  The
     Statement removes acquisitions of financial  institutions from the scope of
     both Statement 72 and Interpretation 9 and requires that those transactions
     be accounted  for in  accordance  with FASB  Statement  No. 141,  "Business
     Combinations",  and No. 142, "Goodwill and Other Intangible  Assets".  Thus
     the  requirement in Statement 72 to recognize (and  subsequently  amortize)
     any


<PAGE>


                   HIGHLANDS BANKSHARES, INC. AND SUBSIDIARIES

                   NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
                                December 31, 2003
                             (Amounts in thousands)

     Note 1. Summary of Significant Accounting Policies (Continued)

     Recent Accounting Pronouncements (Continued)

     excess of the fair  value of  liabilities  assumed  over the fair  value of
     tangible and identifiable  assets acquired as an unidentifiable  intangible
     asset no longer  applies to business  combinations.  The Company has had no
     branch acquisitions since the issuance of this Statement.


     Note 2. Investment Securities Available-For-Sale

     The amortized cost and market value of securities available-for-sale are as
     follows:
<TABLE>
<CAPTION>

                                                           2003
                                     -------------------------------------------------
                                                 Amortized      Gross
                                                 Unrealized   Unrealized
                                       Cost        Gains        Losses      Fair Value
                                     --------    ----------   ----------    ----------
<S>                                  <C>          <C>          <C>          <C>
U.S Government agencies and
 corporations                        $  3,247     $     15     $    -       $  3,262
State and political subdivisions       48,275        1,035          679       48,631
Mortgage backed securities             53,583          220          329       53,474
Other securities                       17,231           98          632       16,697
                                     --------     --------     --------     --------
                                     $122,336     $  1,368     $  1,640     $122,064
                                     ========     ========     ========     ========
</TABLE>

<TABLE>
<CAPTION>


                                                           2002
                                     -------------------------------------------------
                                                 Amortized      Gross
                                                 Unrealized   Unrealized
                                       Cost        Gains        Losses      Fair Value
                                     --------    ----------   ----------    ----------
<S>                                  <C>          <C>          <C>          <C>
State and political subdivisions     $ 29,824     $    972     $     77     $ 30,719
Mortgage backed securities             57,052          720           42       57,730
Other securities                       14,335          174          215       14,294
                                     --------     --------     --------     --------
                                     $101,211     $  1,866     $    334     $102,743
                                     ========     ========     ========     ========
</TABLE>

<TABLE>
<CAPTION>

                                                           2001
                                     -------------------------------------------------
                                                 Amortized      Gross
                                                 Unrealized   Unrealized
                                       Cost        Gains        Losses      Fair Value
                                     --------    ----------   ----------    ----------

<S>                                  <C>          <C>          <C>           <C>
U.S Government agencies and
corporations                         $   501      $     1      $    -        $   502
State and political subdivisions      24,378           45           118       24,305
Mortgage backed securities            62,309          594           136       62,767
Other securities                      10,775           61           111       10,725
                                     -------      -------       -------      -------
                                     $97,963      $   701       $   365      $98,299
                                     =======      =======       =======      =======

</TABLE>

<PAGE>

                   HIGHLANDS BANKSHARES, INC. AND SUBSIDIARIES

                   NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
                                December 31, 2003
                             (Amounts in thousands)


Note 2. Investment Securities Available-For-Sale (Continued)

     The following  table presents the age of gross  unrealized  losses and fair
     value by investment category.
<TABLE>
<CAPTION>

                                          -----------------------------December 31, 2003------------------------
                                           Less Than   12 months       12 Months or More               Total
                                                       Unrealized     Fair   Unrealized     Fair     Unrealized
                                          Fair Value     Losses      Value      Losses      Value      Losses
                                          ----------- ----------- ---------- ----------- ---------- ------------

<S>                                       <C>         <C>         <C>        <C>         <C>         <C>
         Mortgage-backed securities           32,023         328         63           1     32,086          329
         States and pol. subdivisions         22,209         679          -           -     22,209          679
         Other securities                      7,793         502        870         130      8,663          632
                                          ----------- ----------- ---------- ----------- ---------- ------------
           Total                          $   62,025  $    1,509  $     933  $      131  $  62,958   $    1,640
                                          =========== =========== ========== =========== ========== ============
</TABLE>

     Management  does not believe any individual  unrealized loss as of December
     31, 2003  represents an  other-than-temporary  impairment.  The  unrealized
     losses are primarily attributable to changes in interest rates. The Company
     has the both the intent and ability to hold the securities contained in the
     previous table for a time necessary to recover the amortized cost.

     Investment securities  available-for-sale with a carrying value of $10,316,
     $8,432, and $6,713 at December 31, 2003, 2002 and 2001 respectively,  and a
     market value of $10,614,  $8,675, and $6,686 at December 31, 2003, 2002 and
     2001,  respectively  were pledged as collateral on public  deposits and for
     other purposes as required or permitted by law.

     The   amortized    cost   and   estimated    fair   value   of   securities
     available-for-sale  at December 31, 2003 by contractual  maturity are shown
     below.  Expected maturities may differ from contractual  maturities because
     borrowers may have the right to call or prepay  obligations with or without
     call or prepayment penalties.

                                                             Approximate
                                         Amortized Cost      Market Value
                                         --------------      ------------
Due in one year or less                    $    986           $  1,010
Due after one year through five years           970                988
Due after five years through ten years        1,735              1,772
Due after ten years                          47,831             48,122
                                           --------           --------
                                             51,522             51,892

Mortgage-backed securities                   53,583             53,474
Other securities                             17,231             16,698
                                           --------           --------
                                           $122,336           $122,064
                                           ========           ========


     For the years ended December 31, 2003,  2002, and 2001,  proceeds from sale
     of securities were $7,178, $9,394 and $11,455, respectively. Gross realized
     gains  and  losses  on  investment  securities  available  for sale were as
     follows:
<TABLE>
<CAPTION>
                                            2003                  2002                  2001
                                      ------------------    ------------------    -----------------
<S>                                   <C>                   <C>                   <C>
         Realized gains               $           589       $              67     $           494
         Realized losses              $             -       $              50     $             -
         Tax (benefit) provision      $           200       $               6     $           168

</TABLE>

<PAGE>


                   HIGHLANDS BANKSHARES, INC. AND SUBSIDIARIES

                   NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
                                December 31, 2003
                             (Amounts in thousands)


Note 3. Other Investments

     Federal Home Loan Bank (FHLB) stock,  Federal  Reserve Bank (FRB) stock and
     Community  Bankers' Bank Stock with a carrying value of $2,900,  $2,182 and
     $1,971 at December 31, 2003,  2002 and 2001,  respectively  are listed as "
     Other Investments" on the Company's financial statements. These investments
     are  considered  to be  restricted  as the  Company  is  required  by these
     agencies to hold these  investments,  and the only market for this stock is
     the issuing agency.

Note 4. Loans

     The composition of net loans is as follows:

<TABLE>
<CAPTION>
                                                         2003              2002              2001
                                                         ----              ----              ----

<S>                                                    <C>               <C>               <C>
Real Estate Secured:
Residential 1-4 family                                 $141,693          $128,462          $114,556
Multifamily                                               2,651             3,383             3,011
Commercial, Construction and Land Development           113,146            85,468            80,673
Second mortgages                                          6,976            11,676             7,737
Equity lines of credit                                    7,430             5,253             4,166
Farmland                                                  4,843             5,589             5,065
                                                       --------          --------          --------
                                                        276,739           239,831           215,208

Secured, Other:
Personal                                                 48,637            49,483            60,532
Commercial                                               27,247            26,043            26,002
Agricultural                                              4,506             4,209             3,274
                                                       --------          --------          --------

Unsecured                                                20,448            19,894            20,478
Overdrafts                                                  420               241               136
                                                       --------          --------          --------
                                                         20,868            20,135            20,614

                                                        377,997           339,701           325,630
                                                       --------          --------          --------
Less:
  Unearned discount                                         -                 -                   1
  Allowance for loan losses                               4,274             3,877             3,418
  Net deferred fees                                         189               180               169
                                                       --------          --------          --------
                                                          4,463             4,057             3,588
                                                       --------          --------          --------
Loans, net                                             $373,534          $335,644          $322,042
                                                       ========          ========          ========
</TABLE>

     Activity in the allowance for loan losses is as follows:
<TABLE>
<CAPTION>

                                           2003             2002               2001
                                           ----             ----               ----
<S>                                      <C>               <C>               <C>
Balance, beginning                       $ 3,877           $ 3,418           $ 2,950
Provision charged to operations            2,053             1,825             1,448
Loans charged to reserve                  (1,780)           (1,526)           (1,204)
Recoveries                                   124               160               224
                                         -------           -------           -------
Balance, ending                          $ 4,274           $ 3,877           $ 3,418
                                         =======           =======           =======
</TABLE>


<PAGE>

                   HIGHLANDS BANKSHARES, INC. AND SUBSIDIARIES

                   NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
                                December 31, 2003
                             (Amounts in thousands)

Note 4. Loans (Continued)

     The following is a summary of information pertaining to impaired loans:

<TABLE>
<CAPTION>
                                                                                      December 31,
                                                                    -------------------------------------------------
                                                                        2003              2002             2001
                                                                    --------------    -------------    --------------
<S>                                                                 <C>               <C>              <C>
         Impaired loans without a valuation  allowance              $      -          $     -          $     -

         Impaired loans with a valuation allowance                           2,064            1,130             1,252
                                                                    --------------    -------------    --------------
         Total impaired loans                                       $         2064    $       1,130    $        1,252
                                                                    ==============    =============    ==============
         Valuation allowance related to impaired loans              $          838    $         862    $          767
                                                                    ==============    =============    ==============

         Total non-accrual loans                                    $        3,723    $       1,728    $        1,159
                                                                    ==============    =============    ==============
         Total loans past due 90 days or more and still accruing    $          802    $         891    $          950
                                                                    ==============    =============    ==============
         Average investment in impaired loans                       $        1,597    $       1,191    $        1,113
                                                                    ==============    =============    ==============
         Interest income recognized on impaired loans               $            8    $           5    $      -
                                                                    ==============    =============    ==============
         Interest income recognized on a cash basis on impaired
         loans                                                      $            8    $           5    $      -
                                                                    ==============    =============    ==============
</TABLE>

     No  additional  funds are  committed  to be  advanced  in  connection  with
     impaired loans.

Note 5. Premises and Equipment

     Premises and equipment are comprised of the following:
<TABLE>
<CAPTION>

                                                             2003                  2002                  2001
                                                      -------------------    ------------------   -------------------
<S>                                                   <C>                    <C>                  <C>
         Land                                                       4,984                 4,445   $             4,120
         Bank Premises                                              8,989                 7,821                 7,506
         Equipment                                                  6,777                 5,940                 5,402
                                                      -------------------    ------------------   -------------------
                                                                   20,750                18,206                17,028
         Less: accumulated depreciation                             5,899                  5,112                4,201
                                                      -------------------    ------------------   -------------------
                                                                   14,851                13,094                12,827
         Construction in Progress                                     614                    63                    73
                                                      -------------------    ------------------   -------------------
                                                      $            15,465    $           13,157   $            12,900
                                                      ===================    ==================   ===================
</TABLE>

     Depreciation  expense  was  $862,  $937 and $886 for  2003,  2002 and 2001,
     respectively.

     Construction in progress for 2003 consists primarily of cost related to the
     new branch office being  constructed in Bannner Elk, North Carolina.  As of
     December 31, 2003 the branch office was substantially complete and expected
     to begin operations in February 2004.

Note 6. Bank Owned Life Insurance

     During 2002,  the Company  purchased  insurance on the lives of certain key
     directors  and  officers.  As  beneficiary,  the Company  receives the cash
     surrender value if the policy is terminated, and upon death of the insured,
     receives  all  benefits  payable.  The  current  value of the  policies  at
     December  31,  2003 and 2002 are $7,929 and  $7,571,  respectively  and are
     included in "Other Assets" in the balance sheet.


<PAGE>


                   HIGHLANDS BANKSHARES, INC. AND SUBSIDIARIES

                   NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
                                December 31, 2003
                             (Amounts in thousands)


Note 7. Income Taxes

     The components of the net deferred tax asset, included in other assets, are
     as follows:

<TABLE>
<CAPTION>

                                                       2003             2002              2001
                                                       ----             ----              ----
<S>                                                  <C>               <C>               <C>
       Deferred tax assets:
         Allowance for loan loss                     $ 1,167           $   937           $   841
         Deferred compensation                             2                 3                 3
         Net unrealized loss on securities
           available-for-sale                             92               -                 -
                                                     -------           -------           -------
                                                       1,261               940               844
                                                     -------           -------           -------

       Deferred tax liability:
         Depreciation                                   (496)             (293)             (293)
         Net unrealized gains on securities
           available-for-sale                            -                (521)             (114)
                                                     -------           -------           -------
                                                        (496)             (814)             (407)
                                                     -------           -------           -------

       Net deferred tax asset                        $   766           $   126           $   437
                                                     =======           =======           =======
</TABLE>



     The components of income tax expense  related to continuing  operations are
     as follows:

<TABLE>
<CAPTION>
                                    2003              2002               2001
                                    ----              ----               ----

<S>                                <C>               <C>               <C>
       Federal:
         Current                   $ 1,168           $ 1,445           $ 1,236
         Deferred                      (27)              (96)             (129)
                                   -------           -------           -------

           Total                   $ 1,195           $ 1,349           $ 1,107
                                   =======           =======           =======
</TABLE>


     The Company's  income tax expense  differs from the expected tax expense at
     the statutory federal rate of 34% as follows:

<TABLE>
<CAPTION>
                                                            2003                   2002                  2001
                                                      ------------------     ------------------   -------------------
<S>                                                   <C>                    <C>                  <C>
         Statutory rate applied to earnings before
           income taxes                               $           1,943      $           1,852    $           1,498
         Tax exempt interest                          (             742)     (             496)   (             331)
         Other, net                                   (               6)     (               7)   (              60)
                                                      ------------------     ------------------   -------------------
             Total                                    $           1,195      $           1,349    $           1,107
                                                      ==================     ==================   ===================

</TABLE>

<PAGE>


                   HIGHLANDS BANKSHARES, INC. AND SUBSIDIARIES

                   NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
                                December 31, 2003
                             (Amounts in thousands)

Note 8. Deposits

     The composition of deposits is as follows:
<TABLE>
<CAPTION>

                                                             2003                  2002                 2001
                                                      -------------------    ------------------   ------------------
<S>                                                   <C>                    <C>                   <C>
         Non-interest bearing demand                  $          59,057      $         55,597      $        50,248
         Interest bearing demand                                 64,048                49,519               37,464
         Savings deposits                                        80,764                70,258               60,166
         Time deposits, in amounts of $100,000
            or more                                              69,804                61,465               65,437
         Other time deposits                                    176,336               173,462              178,778
                                                      -------------------    ------------------   ------------------

         Total deposits                               $         450,009      $        410,301     $        392,093
                                                      ===================    ==================   ==================

</TABLE>

     The  scheduled  maturities  of time  deposits at December 31, 2003,  are as
     follows:


         2004                                         $       144,747
         2005                                                  47,528
         2006                                                  15,566
         2007                                                  22,336
         2008                                                   9,609
         Thereafter                                             6,354
                                                      -------------------

                                                      $       246,140
                                                      ===================



Note 9. Other Short-Term Borrowings

     Other  short-term  borrowings  in the balance sheet consist of four Federal
     Home Loan Bank  advances  that are secured by a floating  blanket lien on a
     specific  class of mortgage  loans of the Bank.  The Federal Home Loan Bank
     has the option to convert three of these  advances  which total $17 million
     to a three  month  LIBOR-based  floating  rate  advance.  These notes carry
     interest rates of 6.17%, 6.28%, and 6.385%. The fourth advance, which had a
     balance  of $16  million  is a daily  rate line of credit  that  matures in
     December of 2004. The advance carried an interest rate of 1.15% at December
     31, 2003 and floats daily. Interest is paid monthly.



<PAGE>

                   HIGHLANDS BANKSHARES, INC. AND SUBSIDIARIES

                   NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
                                December 31, 2003
                             (Amounts in thousands)

Note 10. Long-Term Debt

     At  December  31,  Highlands  Bankshares,  Inc.  and  Subsidiaries  had the
     following long-term debt agreements:
<TABLE>
<CAPTION>

                                                                                      2003            2002              2001
                                                                                      ----            ----              ----
<S>                                                                            <C>                <C>               <C>
                Note  payable  FHLB dated  06/06/96  for $1 million  with an
                annual  interest  rate of  7.02%,  due  06/06/03.  The  note
                requires semi-annual  installments of $71 plus interest. The                       Included in
                loan is  secured by a  floating  blanket  lien on a specific                       short term
                class of mortgage loans of the Bank.                                 Paid Off      borrowings        $        214

                Note  payable  FHLB dated  03/26/98  for $6 million  with an
                annual  interest  rate of  5.51%,  due  03/26/08.  The  note
                requires  quarterly  interest  payments  and  had  an  early
                conversion  option  that  expired on  03/26/03.  The loan is                       Included in
                secured by a floating  blanket  lien on a specific  class of                       short term
                mortgage loans of the Bank.                                     $      6,000       borrowings        $       6,000

                Note  payable  FHLB dated  08/13/99  for $4 million  with an
                annual  interest  rate of  6.385%,  due  08/13/09.  The note
                requires  quarterly  interest  payments  and  has  an  early
                conversion  option at  08/13/04.  The loan is  secured  by a    Included in
                floating  blanket lien on a specific class of mortgage loans     short term
                of the Bank.                                                     borrowings        $     4,000       $       4,000

                Note  payable FHLB dated  02/13/2002  for $5 million with an
                annual  interest rate of 4.640%,  due  02/13/2012.  The note
                requires  quarterly  interest  payments  and  has  an  early
                conversion  option at  02/13/07.  The loan is  secured  by a
                floating  blanket lien on a specific class of mortgage loans    $      5,000       $     5,000       $        -
                of the Bank.


                Note  payable FHLB dated  05/07/2002  for $5 million with an
                annual  interest rate of 4.720%,  due  05/07/2012.  The note
                requires  quarterly  interest  payments  and  has  an  early
                conversion  option at  05/07/2007.  The loan is secured by a
                floating  blanket lien on a specific class of mortgage loans
                of the Bank.                                                    $      5,000       $     5,000       $        -
</TABLE>

<PAGE>

                   HIGHLANDS BANKSHARES, INC. AND SUBSIDIARIES

                   NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
                                December 31, 2003
                             (Amounts in thousands)


Note 10. Long-Term Debt (Continued)

<TABLE>
<CAPTION>

<S>                                                                             <C>                <C>               <C>
                Other  notes   payable   resulting   from   seller-financing
                transactions  for $430 with annual  interest  rates  ranging
                from 3.2% to 8.0%, and due dates ranging from 2010-2013. The
                notes require monthly installments of principal and interest
                of $6.  The loans are  secured  by a first  deed of trust on
                real estate.                                                    $        429       $       200       $         269
                                                                                ------------       -----------       -------------

         Total long-term debt                                                   $     16,429       $    14,200       $      10,483
                                                                                ============       ===========       =============

</TABLE>

     Principal maturities of long-term debt at December 31, 2003 are as follows:

         2004                                         $         44
         2005                                                   48
         2006                                                   50
         2007                                               10,054
         2008                                                6,057
         Thereafter                                            176
                                                      ---------------

                                                       $    16,429
                                                      ===============



Note 11. Capital Securities

     On January 21,  1998,  Highlands  Capital  Trust I, issued  $7,500 of 9.25%
     Capital  Securities  which will mature on January 15, 2028.  The  principal
     asset of the Trust is $7,500 of the Parent  Company's  junior  subordinated
     debt securities with like maturities and like interest rates to the


     On January 21,  1998,  Highlands  Capital  Trust I, issued  $7,500 of 9.25%
     Capital  Securities  which will mature on January 15, 2028.  The  principal
     asset of the Trust is $7,500 of the Parent  Company's  junior  subordinated
     debt securities with like maturities and like interest rates to the Capital
     Securities.  Additionally,  the Trust  has  issued  9,000  shares of common
     securities to the Parent Company.  The 9.25% Capital  Securities had $6,300
     outstanding  at December 31, 2003,  and an estimated  fair value of $6,794.
     The related junior subordinated debt securities had an estimated fair value
     of  $6,794.  Highlands  Bankshares,   Inc.  repurchased  48,000  shares  of
     Highlands  Capital Trust I on April 18, 2003, on the open market, at $26.15
     per share.  The price paid per share  corresponds  to the January 2008 call
     price.  The premium paid of $55 will be expensed  when the  securities  are
     called or at the maturity date of the capital securities.

     The Capital  Securities,  the assets of the Trust and the common securities
     issued by the Trust are  redeemable in whole or in part on or after January
     15, 2008, or at any time in whole but not in part from the date of issuance
     on the occurrence of certain events.

     The Capital  Securities  may be  included in Tier I capital for  regulatory
     capital adequacy

<PAGE>


                   HIGHLANDS BANKSHARES, INC. AND SUBSIDIARIES

                   NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
                                December 31, 2003
                  (Amounts in thousands, except per share data)


Note 11. Capital Securities (Continued)

     determination purposes up to 25% of Tier I capital after its inclusion. The
     portion of the Capital  Securities  not considered as Tier I capital may be
     included  in Tier II capital.  Distributions  to the holders of the Capital
     Securities are included in interest expense.

     The  obligations  of the Parent Company with respect to the issuance of the
     Capital  Securities  constitute a full and  unconditional  guarantee by the
     Parent  Company of the  Trust's  obligations  with  respect to the  Capital
     Securities.

     Subject to certain exceptions and limitations, the Parent Company may elect
     from time to time to defer  interest  payments  on the junior  subordinated
     debt securities,  which would result in a deferral of distribution payments
     on the related Capital Securities.


Note 12. Operating Leases

     The  following  is a schedule by years of future  minimum  rental  payments
     required   under   operating   leases  that  have   initial  or   remaining
     non-cancelable terms in excess of one year.

         Year ending December 31:

         2004                                         $        57
         2005                                                  21
         2006                                                  21
                                                      -------------------

         Total minimum payments required              $        99
                                                      ===================

     Total  operating  lease  expense was $ 227,  $232 and $226 for December 31,
     2003, 2002, and 2001 respectively.


Note 13. Common Stock and Earnings Per Common Share

     Earnings  per  common  share  is  computed   using  the  weighted   average
     outstanding  shares for the years  ended  December  31.  Outstanding  stock
     options  (Note 15) have a dilutive  effect on earnings  per share,  and are
     determined using the treasury stock method.

     The following is a reconciliation of the numerators and the denominators of
     the basic and diluted earnings per common share computation:

<TABLE>
<CAPTION>
                                                             2003                  2002                 2001
                                                       ------------------    ------------------   ------------------
<S>                                                    <C>                   <C>                  <C>
         Income available to common stockholders       $           4,520     $           4,104    $           3,301
         Weighted average shares outstanding                       2,653                 2,645                2,639
         Shares outstanding including assumed
           conversion                                              2,675                 2,669                2,651
         Basic earnings per share                      $            1.70     $            1.55    $            1.25
                                                       ==================    ==================   ==================
         Fully diluted earnings per share              $            1.69     $            1.54    $            1.24
                                                       ==================    ==================   ==================

</TABLE>

<PAGE>


                   HIGHLANDS BANKSHARES, INC. AND SUBSIDIARIES

                   NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
                                December 31, 2003
                  (Amounts in thousands, except per share data)


Note 13. Common Stock and Earnings Per Common Share (Continued)

     Highlands Bankshares,  Inc. paid dividends of $265, $238, and $211 or $0.10
     per  share,  $0.09 per share,  and $0.08 per share in 2003,  2002 and 2001,
     respectively.


Note 14. Profit Sharing and Retirement Savings Plan

     The Bank has a 401(K) savings plan available to substantially all employees
     meeting  minimum  eligibility  requirements.  The  Bank  makes a 2%  profit
     sharing  contribution to all employees exclusive of employee  contributions
     and employer matching.  Employees may elect to make voluntary contributions
     to the plan up to 15% of their  base  pay.  In  addition  to the 2%  profit
     sharing  contribution,  the Bank matches 50% of the  employee's  initial 6%
     contribution;  therefore,  the maximum employer  matching  contribution per
     employee could be 3% of base pay. The cost of Bank contributions  under the
     savings plan was $223, $207 and $186, in 2003, 2002 and 2001 respectively.


Note 15. Stock Option Plan

     In  1996,  Highlands  Bankshares,   Inc.,  adopted  a  non-qualified  stock
     incentive  option plan,  for key  employees,  officers,  and  directors and
     reserved 150,000 shares of common stock for issuance  thereunder.  The plan
     is identical to and replaced the plan previously adopted by Highlands Union
     Bank.

     The exercise  price of each option equals the market price of the Company's
     stock on the date of  grant  and an  option's  maximum  term is ten  years.
     Option  exercise  prices are determined by the Board of Directors  based on
     recent open market sales, but shall not be less than the greater of the par
     value of such stock or 100% of the book value of such stock as shown by the
     Company's  last  published  statement  prior  to  granting  of the  option.
     Proceeds received upon exercise of options are credited to common stock, to
     the extent of par value of the related shares,  and the balance is credited
     to surplus.  Shares under  options  which are canceled  are  available  for
     subsequent grant.

     The  Company  applies  APB  Opinion  25  and  related   interpretations  in
     accounting for the stock option plan. Accordingly, no compensation cost has
     been recognized.  Had compensation cost for the Corporation's  stock option
     plan been determined  based on the fair value at the grant dates for awards
     under the plan consistent with the method  prescribed by FASB Statement No.
     123,  the  Company's  net income  and  earnings  per share  would have been
     adjusted to the pro forma amounts indicated below:
<TABLE>
<CAPTION>

                                                                             Years Ended December 31,
                                                               ------------------------------------------------------
                                                                    2003               2002                2001
                                                               ---------------    ----------------    ---------------

<S>                                                            <C>                <C>                 <C>
         Net income                            As reported     $         4,520    $          4,104    $         3,301
                                               Pro forma       $         4,316    $          3,830    $         3,070

         Earnings per share                    As reported     $          1.70    $           1.55    $          1.25
                                               Pro forma       $          1.63    $           1.45    $          1.16

         Earnings per share assuming           As reported     $          1.69    $           1.54    $          1.24
           dilution                            Pro forma       $          1.61    $           1.43    $          1.15
</TABLE>

<PAGE>

                   HIGHLANDS BANKSHARES, INC. AND SUBSIDIARIES

                   NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
                                December 31, 2003
                (Amounts in thousands, except for per share data)


Note 15. Stock Option Plan (Continued)

     The pro forma amount  shown above  reflect the options  granted  during the
     year discounted using the expected life,  expected volatility and risk-free
     interest  rates as shown  below.  The fair  value of each  option  grant is
     estimated on the date of grant using the Black-Scholes option-pricing model
     with the following weighted-average assumptions:
<TABLE>
<CAPTION>

                                                     Years Ended December 31,
                                       ------------------------------------------------------
                                            2003               2002                2001
                                       ---------------    ----------------    ---------------


<S>                                        <C>                <C>                 <C>
         Expected life                     10 years           10 years            10 years
         Expected volatility                6.20%              6.30%               8.33%
         Risk-free interest rates           5.15%              5.43%               5.48%
</TABLE>

     A summary of the status of the  Company's  stock  option plan is  presented
     below:

<TABLE>
<CAPTION>
                                                2003                       2002                      2001
                                      -------------------------- ------------------------- --------------------------

                                       Weighted                  Weighted                   Weighted
                                        Average                  Average                     Average
                                       Exercise     Number of    Exercise     Number of     Exercise     Number of
                                         Price        Shares       Price        Shares        Price        Shares
                                      ------------ ------------- ----------- ------------- ------------ -------------
<S>                                   <C>              <C>        <C>            <C>        <C>               <C>
Options outstanding at January 1      $    20.98       133,218    $   19.70      107,501    $   17.40         81,274
Granted                                    26.00        29,850        26.00       30,000        25.00         32,900
Exercised                                  13.43   (    11,010)       23.35  (     3,403)       17.81   (      6,673)
Expired                                    21.22   (     3,200)        2.83  (       880)          -            -
                                      ------------ ------------- ----------- ------------- ------------ -------------

Options outstanding and
   exercisable at December 31              22.48      148,858     $   20.98     133,218     $    19.70      107,501
                                      ============ ============= =========== ============= ============ =============
Weighted-average fair value of
   options granted during the year    $    26.00                  $    26.00                $    25.00
                                      ============               ===========               ============
</TABLE>

     Information  pertaining to options  outstanding  at December 31, 2003 is as
     follows:

<TABLE>
<CAPTION>
                                                                  Options Outstanding and Exercisable
                                                   ------------------------------------------------------------------
                                                                         Weighted Average             Weighted
                                                      Number          Remaining Contractual        Average Exercise
            Range of Exercise Prices                Outstanding                Life                    Price
                                                   --------------    -------------------------    -------------------

<C>                                                     <C>                 <C>                     <C>
$ 7.50  -  $ 7.50                                       2,900               2.68 years              $       7.50
$11.50  -  $14.25                                      25,079               4.31 years              $      13.90
$19.00  -  $26.00                                     120,879               7.82 years              $      24.62
                                                   --------------

Outstanding at end of year                            148,858               7.04 years              $      22.48
                                                   ==============
</TABLE>

<PAGE>

                   HIGHLANDS BANKSHARES, INC. AND SUBSIDIARIES

                   NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
                                December 31, 2003
                             (Amounts in thousands)


Note 16. Off-Balance Sheet Activities

     The Bank is party to various  financial  instruments with off-balance sheet
     risk arising in the normal course of business to meet the  financing  needs
     of their  customers.  Those financial  instruments  include  commitments to
     extend  credit  and  standby  letters  of credit of  approximately  $3,485,
     $2,694, and $2,722,  unfunded commitments under lines of credit of $29,665,
     $28,716 and $20,324 and commitments to grant loans of $5,073,  $6,540,  and
     $9,320 for the years ended December 31, 2003,  2002 and 2001  respectively.
     These instruments contain various elements of credit and interest rate risk
     in  excess  of  the  amount  recognized  in  the  statements  of  financial
     condition.

     The Bank's exposure to credit loss, in the event of  non-performance by the
     other party to the financial  instrument  for  commitments to extend credit
     and  standby  letters  of  credit,  is  the  contractual  amount  of  those
     instruments.  The Bank uses the same credit policies in making  commitments
     and conditional obligations that they do for on-balance sheet instruments.

     Commitments  to extend credit are  agreements to lend to a customer as long
     as there is no  violation of any  condition  established  in the  contract.
     Commitments  generally  have fixed  expiration  dates or other  termination
     clauses and may require  payment of a fee. The commitments for equity lines
     of credit  may  expire  without  being  drawn  upon.  Therefore,  the total
     commitment  amounts do not necessarily  represent future cash requirements.
     The  amount  of  collateral  obtained,  if it is  deemed  necessary  by the
     Company, is based on management's credit evaluation of the customer.

     Unfunded  commitments  under lines of credit,  revolving  credit  lines and
     overdraft  protection   agreements  are  commitments  for  possible  future
     extensions of credit to existing  customers.  These lines of credit usually
     do not contain a specified  maturity  date and may not be drawn upon to the
     total extent to which the Company is committed.

     Standby letters of credit are conditional commitments issued by the Company
     to guarantee the performance of a customer to a third party.  Those letters
     of credit are  primarily  issued to support  public and  private  borrowing
     arrangements.  Essentially  all letters of credit  issued  have  expiration
     dates  within one year.  The credit  risk  involved  in issuing  letters of
     credit  is  essentially  the  same  as  that  involved  in  extending  loan
     facilities to customers.  The Company generally holds collateral supporting
     those commitments if deemed necessary.


Note 17. Commitments and Contingencies

     The  Bank  has  made   arrangements  with  and  has  available  from  other
     corresponding banks,  approximately $140,567 of lines of credit to fund any
     necessary cash requirements. The Bank has $49,000 of Federal Home Loan Bank
     advances  outstanding as of December 31, 2003. A specific class of mortgage
     loans, with a balance of $141,693, at December 31, 2003 were pledged to the
     FHLB as collateral.

<PAGE>



                   HIGHLANDS BANKSHARES, INC. AND SUBSIDIARIES

                   NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
                                December 31, 2003
                             (Amounts in thousands)

Note 18. Fair Values of Financial Instruments

     The fair value of a financial  instrument is the current  amount that would
     be exchanged between willing parties,  other than in a forced  liquidation.
     Fair value is best determined based upon quoted market prices.  However, in
     many instances, there are no quoted market prices for the Company's various
     financial  instruments.  In  cases  where  quoted  market  prices  are  not
     available,  fair values are based on estimates using present value or other
     valuation  techniques.  Those techniques are significantly  affected by the
     assumptions used,  including the discount rate and estimates of future cash
     flows.  Accordingly,  the fair value  estimates  may not be  realized in an
     immediate settlement of the instrument. SFAS 107 excludes certain financial
     instruments   and  all   nonfinancial   instruments   from  its  disclosure
     requirements.  Accordingly,  the aggregate fair value amounts presented may
     not necessarily represent the underlying fair value of the Company.

     The  following  methods  and  assumptions  were  used  by  the  Company  in
     estimating fair value disclosures for financial instruments:

     Cash and Cash Equivalents

     The carrying  amount  reported in the balance  sheets for cash,  short-term
     investments and federal funds sold approximates fair value.

     Securities Available for Sale

     Fair value for securities are based on quoted market prices.

     Other Investments

     Other investments  include Federal Home Loan Bank, Federal Reserve Bank and
     Community Bankers Bank. The carrying value of those securities approximates
     fair value based on the redemption provisions of those Banks.

     Loans

     The fair value of loans represent the amount at which the loans of the Bank
     could be exchanged on the open market,  based upon the current lending rate
     for similar  types of lending  arrangements  discounted  over the remaining
     life of the loans.

     Deposits

     The fair  value of  deposits  represent  the  amount at which  the  deposit
     liabilities  of the Bank could be exchanged on the open market,  based upon
     the  incremental  borrowing rate of the Bank for similar types of borrowing
     arrangements.

     Other Short-Term Borrowings

     The carrying amounts of borrowings under repurchase  agreements,  and other
     short-term  borrowings  maturing within ninety days approximate  their fair
     values. Fair values of other short-

<PAGE>

                   HIGHLANDS BANKSHARES, INC. AND SUBSIDIARIES

                   NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
                                December 31, 2003
                             (Amounts in thousands)


Note 18. Fair Values of Financial Instruments (Continued)

     Other Short-Term Borrowings (Continued)

     term borrowings are estimated using  discounted cash flow analyses based on
     the  Company's  current  incremental  borrowing  rates for similar types of
     borrowing  arrangements.  Estimated maturity dates are also included in the
     calculation of fair value for these borrowings.

     Long-Term Debt and Capital Securities

     Rates  currently  available to the Company for debt with similar  terms and
     remaining maturities are used to estimate fair value of existing debt.

     Off-Balance-Sheet Instruments

     The amount of  off-balance  sheet  commitments  to extend  credit,  standby
     letters of credit,  and financial  guarantees,  is considered equal to fair
     value.  Because of the  uncertainty  involved in  attempting  to assess the
     likelihood  and timing of  commitments  being drawn upon,  coupled with the
     lack of an established market and the wide diversity of fee structures, the
     Company  does not believe it is  meaningful  to provide an estimate of fair
     value that differs from the given value of the commitment.

     The carrying amounts and fair values of the Company's financial instruments
     at December 31 were as follows:

<TABLE>
<CAPTION>
                                      2003                                 2002                               2001
                            ------------------------------     -----------------------------     ------------------------------
                            Carrying                           Carrying                          Carrying
                             Amount           Fair Value        Amount            Fair Value      Amount             Fair Value
                            ------------------------------     -----------------------------     ------------------------------
<S>                         <C>                 <C>            <C>                 <C>           <C>                 <C>
Cash and cash equivalents   $  14,473           $  14,473      $  18,501           $  18,501     $  12,241           $  12,241
Securities available for
 sale                         119,164             119,1644       100,561             100,561        96,328              96,328
Other investments               2,900               2,900          2,182               2,182         1,971               1,971
Loans, net                    373,534             376,354        335,644             340,976       322,042             328,059
Deposits                     (450,009)           (453,395)      (410,301)           (412,779)     (392,093)           (395,684)
Other short-term
  borrowings                  (33,043)            (33,909)       (19,094)            (19,112)      (13,000)            (13,198)
Long-term debt                (16,386)            (17,228)       (14,200)             15,071)       10,483)            (10,523)
Capital Securities             (6,300)             (6,794)        (7,500)             (7,752)       (7,500)             (7,637)

</TABLE>

<PAGE>

                   HIGHLANDS BANKSHARES, INC. AND SUBSIDIARIES

                   NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
                                December 31, 2003
                             (Amounts in thousands)


Note 19. Related Party Transactions

     In the normal course of business, the Bank has made loans to its' directors
     and officers and their  affiliates.  All loans and commitments made to such
     officers and  directors and to companies in which they are officers or have
     significant  ownership  interest have been made on  substantially  the same
     terms, including interest rates and collateral,  as those prevailing at the
     time for comparable  transactions with unrelated  persons,  and did not, in
     the opinion of management,  involve more than normal credit risk or present
     other unfavorable features. The activity of such loans are approximately as
     follows:


                                    2003            2002             2001
                                 ------------    ------------     ------------

         Balance, beginning      $    9,434      $    9,394       $    8,279
           Additions                  8,357           7,279            2,814
           Reductions            (    6,209)     (    7,239)      (    1,699)
                                 ------------    ------------     ------------

         Balance, ending         $   11,582      $    9,434       $    9,394
                                 ============    ============     ============

         Unused commitments      $       796     $      620       $      719
                                 ============    ============     ============


     Deposits from related parties held by the Bank at December 31, 2003,  2002,
     and 2001 were $3,398 and $3,156 and $2,750, respectively.


Note 20. Restrictions on Cash

     The Bank is required to maintain  reserve balances in cash with the Federal
     Reserve  Bank.  The total of those  reserve  balances at December 31, 2003,
     2002 and 2001 were $5,723, $4,641 and $3,550, respectively.


Note 21. Minimum Regulatory Capital Requirements

     The  Company  and the  Bank  are  subject  to  various  regulatory  capital
     requirements  administered  by its primary  regulator,  the Federal Reserve
     Bank  of  Richmond.   Failure  to  meet  the  minimum   regulatory  capital
     requirements  can  initiate  certain  mandatory  and  possible   additional
     discretionary  actions  by  regulators,  that if  undertaken,  could have a
     direct  material  effect  on the  Company  and  Bank  and the  consolidated
     financial statements.  Under the regulatory capital adequacy guidelines and
     the regulatory  framework for prompt corrective action, the Company and the
     Bank must meet specific capital guidelines involving  quantitative measures
     of  their  assets,  liabilities,  and  certain  off-balance-sheet  items as
     calculated under regulatory accounting  practices.  The capital amounts and
     classification  under the  prompt  corrective  action  guidelines  are also
     subject to qualitative  judgments by the regulators about components,  risk
     weightings,  and other factors. Prompt corrective action provisions are not
     applicable to bank holding companies.



<PAGE>


                   HIGHLANDS BANKSHARES, INC. AND SUBSIDIARIES

                   NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
                                December 31, 2003
                             (Amounts in thousands)


Note 21. Minimum Regulatory Capital Requirements (Continued)

     Quantitative  measures established by regulation to ensure capital adequacy
     require the Company and the Bank to maintain  minimum amounts and ratios of
     total  risk-based  capital and Tier I capital to  risk-weighted  assets (as
     defined in the  regulations),  and Tier I capital to adjusted  total assets
     (as defined). Management believes, as of December 31, 2003, 2002, and 2001,
     that the Company and the Bank met all the capital adequacy  requirements to
     which they are subject.

     Based on the regulatory framework for prompt corrective action, the Bank is
     considered  to be well  capitalized  for all  required  ratios.  To  remain
     categorized  as well  capitalized,  the Bank will have to maintain  minimum
     total  risk-based  capital  to  risk-weighted  assets,  Tier I  capital  to
     risk-weighted assets, and Tier I capital to adjusted total assets ratios as
     disclosed in the table below.  There are no  conditions or events since the
     most recent  notification that management  believes have changed the Bank's
     category.

     The  Company's  actual  and  required  capital  amounts  and  ratios are as
     follows:
<TABLE>
<CAPTION>

                                                                                             For Capital Adequacy
                                                                    Actual                         Purposes
                                                         -----------------------------    ---------------------------
                                                            Amount           Ratio          Amount          Ratio
                                                         -------------    ------------    -----------     -----------
<S>                                                      <C>                   <C>         <C>            <C>
         As of December 31, 2003:
         Total Risk-Based Capital (to Risk-Weighted
            Assets)                                      $    44,823           12.51%      $  28,653       =,> 8%
         Tier 1 Capital (to Risk-Weighted Assets)             40,549           11.32%         14,327       =,> 4%
         Tier 1 Capital (to Adjusted Total Assets)            40,549            7.52%         21,563       =,> 4%

         As of December 31, 2002:
         Total Risk-Based Capital (to Risk-Weighted
            Assets)                                      $    42,254           13.33%      $  25,349       =,> 8%
         Tier 1 Capital (to Risk-Weighted Assets)             38,377           12.11%         12,675       =,> 4%
         Tier 1 Capital (to Adjusted Total Assets)            38,377            7.94%         19,323       =,> 4%

         As of December 31, 2001:
         Total Risk-Based Capital (to Risk-Weighted
            Assets)                                      $    37,783           12.39%      $  24,388       =,> 8%
         Tier 1 Capital (to Risk-Weighted Assets)             34,366           11.27%         12,194       =,> 4%
         Tier 1 Capital (to Adjusted Total Assets)            34,366            7.53%         18,255       =,> 4%

</TABLE>

<PAGE>

                   HIGHLANDS BANKSHARES, INC. AND SUBSIDIARIES

                   NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
                                December 31, 2003
                             (Amounts in thousands)

Note 21. Minimum Regulatory Capital Requirements (Continued)

     The Bank's actual and required capital amounts and ratios are as follows:
<TABLE>
<CAPTION>

                                                                                                    To be Well
                                                                                              Capitalized under the
                                                                      For Capital Adequacy      Prompt Corrective
                                                   Actual                   Purposes            Action Provisions
                                          ------------------------- ------------------------- -----------------------
                                            Amount        Ratio        Amount       Ratio       Amount      Ratio
                                          ------------ ------------ ------------- ----------- ----------- -----------

<S>                                       <C>               <C>      <C>               <C>     <C>         <C>
         As of December 31, 2003:
         Total Risk-Based Capital (to
         Risk-Weighted  Assets)           $    38,508       10.85%   $  28,397     =,> 8%      $  35,496    =,> 10%
         Tier 1 Capital (to
         Risk-Weighted Assets)                 34,254        9.65%      14,198     =,> 4%         21,297    =,> 6%
         Tier 1 Capital (to Adjusted
         Total Assets)                         34,254        6.44%      21,272     =,> 4%         26,591    =,> 5%

         As of December 31, 2002:
         Total Risk-Based Capital (to
         Risk-Weighted Assets)            $    35,598       11.44%   $  24,892     =,> 8%      $  31,115    =,> 10%
         Tier 1 Capital (to
         Risk-Weighted Assets)                 31,741       10.20%      12,446     =,> 4%         18,669    =,> 6%
         Tier 1 Capital (to Adjusted
         Total Assets)                         31,741        6.66%      19,057     =,> 4%         23,821    =,> 5%

         As of December 31, 2001:
         Total Risk-Based Capital (to
         Risk-Weighted Assets)            $    32,143       10.71%   $  24,004     =,> 8%      $  30,005    =,> 10%
         Tier 1 Capital (to
         Risk-Weighted Assets)                 28,744        9.58%      12,002     =,> 4%         18,003    =,> 6%
         Tier 1 Capital (to Adjusted
         Total Assets)                         28,744        6.38%      18,027     =,> 4%         22,534    =,> 5%

</TABLE>

Note 22. Restrictions on Dividends

     The Parent  Company's  principal  asset is its  investment  in the Bank,  a
     wholly owned consolidated subsidiary.  The primary source of income for the
     Parent Company  historically  has been dividends from the Bank.  Regulatory
     agencies limit the amount of funds that may be transferred from the Bank to
     the Parent Company in the form of dividends, loans or advances.

     Under  applicable  laws and without prior  regulatory  approval,  the total
     dividend  payments of the Bank in any calendar  year are  restricted to the
     net  profits of that year,  as  defined,  combined  with the  retained  net
     profits  for the two  preceding  years.  The  total  dividends  that may be
     declared in 2003 without regulatory approval total $9,789 plus year-to-date
     2004 net profits as of the declaration date.


<PAGE>
                   HIGHLANDS BANKSHARES, INC. AND SUBSIDIARIES

                   NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
                                December 31, 2003
                             (Amounts in thousands)

Note 23. Other Operating Expenses

     Other operating expenses that exceed 1% of the total of interest income and
     other income presented separately consist of the following:


                                     2003            2002            2001
                                 -------------   -------------  ---------------

         Postage and freight     $      306      $           -  $       392
                                 =============   =============  ===============

         Other losses            $      396      $       389    $           -
                                 =============   =============  ===============


Note 24. Condensed Parent Company Financial Statements

     The condensed  financial  statements below relate to Highlands  Bankshares,
     Inc., as of December 31, 2003,  2002 and 2001 and for the years then ended.
     Equity in  undistributed  earnings  of  subsidiary  includes  the change in
     unrealized gains or losses on securities, net of tax.


<TABLE>
<CAPTION>
         CONDENSED BALANCE SHEETS
                                                            2003            2002              2001
                                                            ----            ----              ----
         ASSETS
<S>                                                        <C>              <C>              <C>
  Cash                                                     $ 1,232          $ 1,103          $   989
  Capital securities repurchased                             1,200              -                -
  Loans, net of allowance for loan losses of $20,
    $20, and $18 in 2003, 2002, and 2001
    respectively                                             3,383            3,881            2,906
  Equity in subsidiaries                                    35,440           33,064           29,330
  Premises and equipment, net                                1,431            1,468            1,513
  Other assets                                                 406              345              361
                                                           -------          -------          -------
     Total Assets                                          $43,092          $39,861          $35,099
                                                           =======          =======          =======

LIABILITIES AND STOCKHOLDERS' EQUITY
  Interest, taxes and other liabilities                    $   158          $   162          $   147
  Capital securities                                         7,500            7,500            7,500
                                                           -------          -------          -------
     Total Liabilities                                       7,658            7,662            7,647
                                                           -------          -------          -------

STOCKHOLDERS' EQUITY                                        35,434           32,199           27,452
                                                           -------          -------          -------

     Total Liabilities and Stockholders' Equity            $43,092          $39,861          $35,099
                                                           =======          =======          =======
</TABLE>

<PAGE>

                   HIGHLANDS BANKSHARES, INC. AND SUBSIDIARIES

                   NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
                                December 31, 2003
                             (Amounts in thousands)


Note 24. Condensed Parent Company Financial Statements (Continued)


<TABLE>
<CAPTION>

         CONDENSED STATEMENTS OF INCOME
                                                                     2003               2002               2001

<S>                                                              <C>                <C>               <C>
         Dividends from subsidiary                               $      1,200       $      1,500      $         -
         Interest income                                                  355                290                300
         Other income                                                     226                226                226
         Interest income                                                ( 694)             ( 694)             ( 694)
         Operating expense                                              ( 133)             ( 162)             ( 178)
                                                                 --------------     --------------    ---------------
                                                                          954              1,160              ( 346)

         Income tax benefit                                                84                116                118
         Equity in undistributed earnings of subsidiary                 3,482              2,828              3,529
                                                                        3,482              2,828              3,529
                                                                 --------------     --------------    ---------------

         Net income                                              $     4,520        $       4,104     $       3,301
                                                                 ==============     ==============    ===============
</TABLE>

<PAGE>



                   HIGHLANDS BANKSHARES, INC. AND SUBSIDIARIES

                   NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
                                December 31, 2003
                             (Amounts in thousands)

Note 24. Condensed Parent Company Financial Statements (Continued)

         CONDENSED STATEMENTS OF CASH FLOWS
<TABLE>
<CAPTION>

                                                                2003              2002             2001
                                                                ----              ----             ----

         CASH FLOWS FROM OPERATING ACTIVITIES:
<S>                                                            <C>               <C>               <C>
    Net income                                                 $ 4,520           $ 4,104           $ 3,301
    Adjustments to reconcile net income to net cash
      Provided by operating activities:
       Allowance for loan losses                                   -                   2               -
       Depreciation and amortization                                49                58                50
       Provision for deferred income taxes                           5               (45)              (28)
       Equity in undistributed earnings of subsidiary           (3,482)           (2,828)           (3,529)
       Increase in other assets                                   (162)              (67)              (79)
       Increase (decrease)  in other liabilities                    (4)               15               -
                                                               -------           -------           -------
       Net cash provided by (used in) operating
         activities                                                926             1,239              (285)
                                                               -------           -------           -------

CASH FLOWS FROM INVESTING ACTIVITIES:
    Securities available for sale:
       Proceeds from sale of securities                            -                 -                 151
    Net (increase) decrease in loans                               498              (977)              822
    Premises and equipment expenditures                            -                  (2)             (158)
                                                               -------           -------           -------
       Net cash provided by (used in) investing
         activities                                                498              (979)              815
                                                               -------           -------           -------

CASH FLOWS FROM FINANCING ACTIVITIES:

    Cash dividends paid                                           (265)             (238)             (211)

    Repurchase of capital securities                            (1,200)              -                 -

    Proceeds from issuance of common stock                          16                14               -

    Proceeds from exercise of common stock options                 154                78               119

                                                               -------           -------           -------

       Net cash provided by(used in) financing
        activities                                              (1,295)             (146)              (92)
                                                               -------           -------           -------

       Net increase in cash and cash  equivalents                  129               114               438


CASH AND CASH EQUIVALENTS AT
  BEGINNING OF YEAR                                              1,103               989               551
                                                               -------           -------           -------

CASH AND CASH EQUIVALENTS AT END OF
  YEAR                                                         $ 1,232           $ 1,103           $   989
                                                               =======           =======           =======
</TABLE>

<PAGE>

                  HIGHLANDS BANKSHARES, INC. AND SUBSIDIARIES

                   NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
                                December 31, 2003
                             (Amounts in thousands)

Note 25. Quarterly Data (Unaudited)

     Consolidated quarterly results of operations were as follows:

<TABLE>
<CAPTION>
                                                                                      2003
                                                            ---------------------------------------------------------
                                                             March 31       June 30        Sept. 30        Dec. 31
                                                            -----------    -----------    -----------     -----------

<S>                                                         <C>            <C>            <C>             <C>
         Interest Income                                    $   7,403      $   7,357      $   7,371       $   7,332
         Interest Expense                                   (   3,337)     (   3,279)     (   3,189)      (   3,072)
                                                            -----------    -----------    -----------     -----------

         Net interest income                                    4,066          4,078          4,182           4,260
         Provision for loan losses                          (     470)     (   ( 510)     (     447)      (    (626)
                                                            -----------    -----------    -----------     -----------
         Net interest income after provision for                3,596          3,568          3,735           3,634
           possible loan losses
         Other income                                           1,095          1,317          1,044           1,196
         Other expenses                                     (   3,268)     (   3,364)     (   3,389)      (   3,449)
                                                            -----------    -----------    -----------     -----------

         Income before income taxes                             1,423          1,521          1,390           1,381
         Income taxes                                       (     338)     (     338)     (     274)      (   ( 245)
                                                            -----------    -----------    -----------     -----------

         Net income                                         $   1,085      $   1,183      $   1,116       $   1,136
                                                            ===========    ===========    ===========     ===========

         Earnings per common share:
           Basic                                            $    0.41      $    0.45      $    0.42       $    0.42
                                                            ===========    ===========    ===========     ===========
           Diluted                                          $    0.41      $    0.44      $    0.42       $    0.42
                                                            ===========    ===========    ===========     ===========
</TABLE>

<TABLE>
<CAPTION>
                                                                                      2002
                                                            ---------------------------------------------------------
                                                             March 31       June 30        Sept. 30        Dec. 31
                                                            -----------    -----------    -----------     -----------

<S>                                                         <C>            <C>            <C>             <C>
         Interest Income                                    $   7,850      $   7,767      $   7,735       $   7,592
         Interest Expense                                   (   3,739)     (   3,551)     (   3,523)      (   3,453)
                                                            -----------    -----------    -----------     -----------

         Net interest income                                    4,111          4,216          4,212           4,139
         Provision for loan losses                          (     412)     (     575)     (    (387)      (   ( 451)
                                                            -----------    -----------    -----------     -----------
         Net interest income after provision for                3,699          3,641          3,825           3,688
           possible loan losses
         Other income                                             655            922          1,067           1,002
         Other expenses                                     (   3,104)     (   3,190)     (   3,418)      (   3,334)
                                                            -----------    -----------    -----------     -----------

         Income before income taxes                             1,250          1,373          1,474           1,356
         Income taxes                                       (     332)     (     371)     (   ( 362)      (    (284)
                                                            -----------    -----------    -----------     -----------

         Net income                                         $     918      $   1,002      $   1,112       $   1,072
                                                            ===========    ===========    ===========     ===========

         Earnings per common share:
           Basic                                            $    0.35      $    0.38      $    0.42       $    0.40
                                                            ===========    ===========    ===========     ===========
           Diluted                                          $    0.35      $    0.38      $    0.42       $    0.39
                                                            ===========    ===========    ===========     ===========

</TABLE>
<PAGE>


                   HIGHLANDS BANKSHARES, INC. AND SUBSIDIARIES

                   NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
                                December 31, 2003
                             (Amounts in thousands)

Note 25. Quarterly Data (Unaudited) (Continued)

<TABLE>
<CAPTION>

                                                                                      2001
                                                            ---------------------------------------------------------
                                                             March 31       June 30        Sept. 30        Dec. 31
                                                            -----------    -----------    -----------     -----------

<S>                                                         <C>            <C>            <C>             <C>
         Interest Income                                    $   8,306      $   8,196      $   8,244       $   8,252
         Interest Expense                                   (   4,918)     (   4,908)     (   4,756)      (   4,305)
                                                            -----------    -----------    -----------     -----------

         Net interest income                                    3,388          3,288          3,488           3,947
                                                            (              (              (               (
         Provision for loan losses                                430)           323)           253)            442)
                                                            -----------    -----------    -----------     -----------
         Net interest income after provision for                2,958          2,965          3,235           3,505
           possible loan losses
         Other income                                             791            904            871             798
         Other expenses                                     (   2,736)     (   2,836)     (   2,908)      (   3,139)
                                                            -----------    -----------    -----------     -----------

         Income before income taxes                             1,013          1,033          1,198           1,164

         Income taxes                                       (     280)     (     257)     (     314)      (     256)
                                                            -----------    -----------    -----------     -----------

         Net income                                         $     733      $     776      $     884       $     908
                                                            ===========    ===========    ===========     ===========

         Earnings per common share:
           Basic                                            $    0.28      $    0.29      $    0.33       $    0.35
                                                            ===========    ===========    ===========     ===========
           Diluted                                          $    0.28      $    0.29      $    0.33       $    0.34
                                                            ===========    ===========    ===========     ===========


</TABLE>