Excerpt from Highlands Bankshares, Inc.
1996 Annual Report

Item 7.        Management's Discussion and Analysis of Financial Condition and
               Results of Operation
<PAGE>


                              FINANCIAL HIGHLIGHTS
<TABLE>
<CAPTION>


Results of Operations                                   1996               1995              1994         1996/1995   1995/1994
                                                        (In Thousands except share and per share data)      Percentage Change


<S>                                                        <C>               <C>               <C>             <C>         <C>
Net Interest Income                                        $6,774            $5,424            $4,440          24.89%      22.16%
Net Income (Loss)                                           1,764             1,449             1,160          21.74       24.91

Financial Condition at Year-End


Assets
Loans                                                     207,739           162,543           128,749          27.81       26.25
Securities                                                154,951           113,743            93,738          36.23       21.34
Deposits                                                   31,345            32,276            27,389          (2.88)      17.84
Stockholders' Equity                                      189,719           147,327           117,314          28.77       25.58
Shares Outstanding                                         14,617            12,812            10,243          14.09       25.08
                                                            1,222             1,218             1,216           0.33        0.16

Significant Ratios


Return on average assets                                     0.97              1.00              1.00          (0.03)       0.00
Return on average equity                                    13.01             12.45             11.38           4.50        9.40
Average stockholders' equity to
        average assets                                       7.46              8.05              8.75          (7.33)      (0.08)
Allowance for loan losses as a
         percentage of total loans                           0.69              0.80              0.89         (12.50)     (10.11)
Non-performing loans to total loans                          0.01              0.00              0.00           0.00        0.00


Per Share Data
Based on weighted-average shares outstanding

Net Income                                         $         1.45    $         1.19    $         0.96          21.85       23.96
Stockholders' equity (book value)
         per shares outstanding at
         year-end                                           11.97             10.52              8.43          13.88       24.79

</TABLE>


<PAGE>









                     COMPARISON OF RESULTS OF OPERATIONS FOR
                   THE YEARS ENDED DECEMBER 31, 1996 AND 1995


Net  interest  income for the  year-ended  December 31, 1996  increased  24.89%,
approximately  $1.35  million and over 1995.  Average  interest  earning  assets
increased  $34.1  million  from  1995 to  1996  while  average  interest-bearing
liabilities  increased  $29.7  million.  The yield on  average  interest-earning
assets for the year ended  December 31, 1996 was 8.61%  compared  with 8.56% for
the comparable 1995 period.  The 1996 yield on loans decreased by 2 basis points
as compared to 1995 period at 9.38%. The yield on average  investments  remained
constant  at  6.01%  for  December  31,  1996 and  1995.  The  yield on  average
interest-bearing  liabilities  increased 5 basis points  during 1996 to 5.43% as
compared to 5.38% during 1995. Net income for the  year-ended  December 31, 1996
was $1.76  million,  an  increase  of 21.74%  over the 1995  period.  Income tax
expense for 1996 increased  10.01% to $857 thousand as compared to $779 thousand
for the 1995 period.


                     COMPARISON OF RESULTS OF OPERATIONS FOR
                   THE YEARS ENDED DECEMBER 31, 1995 AND 1994


Net  interest  income for the  year-ended  December 31, 1995  increased  22.16%,
approximately $980 thousand over 1994. Average interest earning assets increased
$26.6  million  from 1994 to 1995  while  average  interest-bearing  liabilities
increased $22.2 million.  The yield on average  interest-earning  assets for the
year-ended  December 31, 1995 was 8.51%  compared with 7.68% for the  comparable
1994 period. The 1995 yield on loans increased by 69 basis points as compared to
the 1994 period. The yield on average interest-bearing  liabilities increased to
6.02% as of December 31, 1995 from 5.34% for the  comparable  1994  period.  The
yield on average  interest-bearing  liabilities  increased  100.02  basis points
during  1995 to 5.38% as  compared  to 4.36%  during  1994.  Net  income for the
year-ended  December 31, 1995 was $1.45 million,  an increase of 24.91% over the
1994 period.  Income tax expense for 1995  increased  34.04% to $0.78 million as
compared to $0.58 million for the 1994 period.

                               [NET INCOME GRAPH]
                                 (In Millions)

                    $1.16          $1.45          $1.76
                     1994           1995           1996

<PAGE>

                        COMPARISON OF FINANCIAL CONDITION
                          AT DECEMBER 31, 1996 AND 1995


Total  assets at December  31, 1996 totaled  $207.7  million  compared to $162.5
million at December 31, 1995.  This 27.81% growth in assets was primarily due to
the large volume of loans  originated.  Total loans increased  36.23%,  or $41.2
million over the comparable 1995 period. The security portfolio  decreased 2.88%
to $31.3 million  during 1996 as contrasted to the 1995 period.  The majority of
the principle payments received were used to fund loans, rather than reinvesting
in lower  yielding  securities,  which  resulted  in the 2.88%  decrease  in the
security  portfolio.  Total deposits  increased to $189.7 million or 28.77% from
1995's level of $147.3 million.  Stockholder's  equity  increased  14.09% during
1996. The Financial  Accounting Standards Board's (FASB) Statement on Accounting
Standards No. 115 was implemented  during 1994. FASB's SAS 115 required that all
securities  classified  as  "Available-for-Sale"  be  adjusted  to market  value
through  the use of a valuation  account,  and that any paper gains or losses be
run through the Stockholder's Equity section of the balance sheet. The effect of
implementing SAS 115 caused an increase in Stockholder's  Equity at December 31,
1995 of $18 thousand,  net of the related  deferred tax. As of December 31, 1996
the Corporation's  security  portfolio had $18 thousand in paper losses,  net of
deferred taxes.  The Corporation  notes that it does have the ability and intent
to carry to maturity  approximately  $31.3  million of the  "Available-for-Sale"
securities.


                        COMPARISON OF FINANCIAL CONDITION
                          AT DECEMBER 31, 1995 AND 1994


Total  assets at December  31, 1995 totaled  $162.5  million  compared to $128.8
million at December  31,1994.  This 26.24% growth in assets was primarily due to
the large volume of loan demand.  Total loans increased 21.34%, or $20.0 million
over the comparable  1994 period.  The security  portfolio  increased  17.84% to
$32.3  million  during 1995 as  contrasted  to the 1994 period.  Total  deposits
increased  to $147.4  million or 25.66%  from  1994's  level of $117.3  million.
Stockholder's  Equity  increased  25.09% during 1995.  The Financial  Accounting
Standards  Board's  (FASB)  Statement  on  Accounting   Standards  No.  115  was
implemented during 1994. FASB's SAS 115 required that all securities  classified
as  "Available-for-Sale"  be  adjusted  to  market  value  through  the use of a
valuation  account,  and that any  paper  gains or  losses  be run  through  the
Stockholder's  Equity section of the balance sheet.  The effect of  implementing
SAS 115 caused a reduction in Stockholder's Equity at December 31, 1994 of $1.09
million,  net  of  the  related  deferred  tax.  As of  December  31,  1995  the
Corporation's  security  portfolio  had  recovered  this $1.09  million in paper
losses and had net unrealized  holding gains of approximately $18 thousand,  net
of  deferred  taxes.  The  Corporation  notes that it does have the  ability and
intent   to   carry   to   maturity   approximately   $32.3   million   of   the
"Available-for-Sale" securities.


                              [TOTAL ASSETS GRAPH]
                                 (In Millions)

                    $128.7              $162.5              $207.7
                     1994                1995                1996




                              [TOTAL LOANS GRAPH]
                                 (In Millions)

                    $93.7               $113.7              $154.9
                     1994                1995                1996

<PAGE>

                       COMPARISON OF SIGNIFICANT RATIOS AT
                           DECEMBER 31, 1996 AND 1995


Return on average assets dropped  slightly to 0.97% for the year-ended  December
31, 1996 as compared to 1.00% for the comparable 1995 period.  The 27.81% growth
in assets and the  absorption  of the  operational  costs  from the new  Bristol
Branch both had significant  impact relating to the decrease in this performance
ratio. Return on average equity increased 4.50% from 12.45% at December 31, 1995
to 13.01% at  year-end  1996.  Average  stockholders'  equity to average  assets
declined  to 7.46% at  December  31,  1996  from  8.05% at  December  31,  1995.
Non-performing  loans to total loans  increased to 0.01% as of December 31, 1996
as compared to 0.00% for the comparable  1995 period.  Allowance for loan losses
as a percentage  of total loans  decreased  7.33% to 0.69% at December 31, 1996.
The decreases in average  stockholders'  equity to average  assets and allowance
for loan losses as a percentage of total loans  reflects the enormous  amount of
growth which the Corporation has sustained during 1996.


                       COMPARISON OF SIGNIFICANT RATIOS AT
                           DECEMBER 31, 1995 AND 1994


Return on average assets remained constant at 1.00% for the year-ended  December
31, 1995 and the comparable 1994 period.  Considering the  Corporation's  24.91%
growth rate in average assets during 1995 it is a great  achievement to maintain
such a steady performance  ratio.  Return on average equity increased 9.40% from
11.38% at December 31, 1994 to 12.45% at year-end  1995.  Average  stockholders'
equity to average  assets  declined to 8.05% at December  31, 1995 from 8.75% at
December  31, 1994.  Non-performing  loans to total loans  remained  constant at
0.00% for the two comparable periods.  Allowance for loan losses as a percentage
of total loans decreased  10.11% to 0.80% at December 31, 1995. The decreases in
average  stockholders' equity to average assets and allowance for loan losses as
a percentage  of total loans  reflects  the enormous  amount of growth which the
Corporation has sustained during 1995.


                        [RETURN ON AVERAGE EQUITY GRAPH]
                                  (In Percent)

                         11.38          12.45          13.01
                          1994           1995           1996


<PAGE>

                      COMPARISON OF PER SHARE DATA FOR THE
                     YEARS ENDED DECEMBER 31, 1996 AND 1995


Net income per share, on a weighted average basis,  increased 21.85% to $1.45 at
December  31, 1996 as compared to $1.19 for the  comparable  1995  period.  Book
value per  share of  common  stock  increased  by 13.88% to $11.97  per share as
compared to $10.52 at December 31, 1995. The Corporation had  approximately  $18
thousand in paper losses as of December 31 1996, net of deferred  taxes,  due to
FASB;s SAS 115 which had virtually no affect on the book value computation.


                      COMPARISON OF PER SHARE DATA FOR THE
                     YEARS ENDED DECEMBER 31, 1995 AND 1994


Net income per share, on a weighted average basis,  increased 23.96% to $1.19 at
December  31, 1995 as  compared  to $0.96 for the  comparable  1994  period,  as
adjusted  for the 1995 2:1 stock  split.  Book  value per share of common  stock
increased  by 24.79% to $10.52 per share as compared  to $8.43 at  December  31,
1994.  Due to the  implementation  of FASB's SAS 115, which was explained in the
Comparison of Financial  Condition,  the Corporation  recovered over $1 million,
net of  deferred  taxes,  in  paper  losses  on it's  security  portfolio  which
significantly affected the stock's book value at December 31, 1995.



                           [EARNINGS PER SHARE GRAPH]
                                  (In Dollars)

                 $0.96               $1.19               $1.45
                  1994                1995                1996
<PAGE>


Item 14(a).    Financial Statements


                    HIGHLANDS BANKSHARES, INC. AND SUBSIDIARY

                          CONSOLIDATED FINANCIAL REPORT

                                DECEMBER 31, 1996



<PAGE>



                                 C O N T E N T S


                                                                          Page

INDEPENDENT AUDITOR'S REPORT                                                F1

FINANCIAL STATEMENTS
  Consolidated Balance Sheets                                               F2
  Consolidated Statements of Income                                         F3
  Consolidated Statements of Stockholders' Equity                           F4
  Consolidated Statements of Cash Flows                                     F5
  Notes to Consolidated Financial Statements                          F6 - F18


<PAGE>

                          INDEPENDENT AUDITOR'S REPORT


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

We have  audited  the  accompanying  consolidated  balance  sheets of  Highlands
Bankshares,  Inc. and Subsidiary as of December 31, 1996, 1995, and 1994 and the
related consolidated statements of income,  stockholders' equity, and cash flows
for the years then ended.  These financial  statements are the responsibility of
the  Bank's  management.  Our  responsibility  is to express an opinion on these
financial statements based on our audits.

We  conducted  our  audits  in  accordance  with  generally   accepted  auditing
standards.  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 financial statements.  An audit also includes
assessing the  accounting  principles  used and  significant  estimates  made by
management, as well as evaluating the overall financial statements 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 Subsidiary as of December 31, 1996,  1995 and 1994 and the
results  of its  operations  and its cash  flows  for the  years  then  ended in
conformity with generally accepted accounting principles.


                                           /s/ Brown, Edwards & Company, L.L.P.
                                           CERTIFIED PUBLIC ACCOUNTANTS

468 East Main Street
Abingdon, VA 24210
January 31, 1997


<PAGE>


                    HIGHLANDS BANKSHARES, INC. AND SUBSIDIARY
                                                                         Page F2
<TABLE>
<CAPTION>
                           CONSOLIDATED BALANCE SHEETS
                        December 31, 1996, 1995 and 1994
                                 (In thousands)

                ASSETS                                         1996         1995        1994
                                                            ----------------------------------
<S>                                                         <C>          <C>         <C>
Cash and due from banks (Note 18)                           $   8,008    $   5,618   $   3,883
Federal funds sold                                              7,948        5,535        --
Investment securities available for sale (Note 3)              31,345       32,276      27,389
Loans, net of allowance for credit losses of $1,072,
  $908, and $836 thousand for 1996, 1995 and 1994,
  respectively (Notes 4 and 5)                                153,879      112,835      92,902

Bank premises and equipment (Note 6)                            4,583        4,346       2,605
Interest receivable                                             1,271        1,068         806
Other assets (Note 9)                                             705          865       1,164
                                                            ---------    ---------    --------

               Total Assets                                 $ 207,739    $ 162,543   $ 128,749
                                                            =========    =========   =========


             LIABILITIES AND STOCKHOLDERS' EQUITY
Deposits (Note 7)
     Interest bearing                                       $ 163,468    $ 127,024   $ 101,162
     Noninterest bearing                                       26,003       20,303      16,152
                                                            ---------    ---------    --------

               Total Deposits                                 189,471      147,327     117,314
                                                            ---------    ---------    --------

Short term borrowings (Note 8)                                     71        1,000         327
Notes Payable (Note 10)                                         1,858         --          --
Interest, taxes and other liabilities                           1,722        1,404         865
                                                            ---------    ---------    --------
                                                                3,651        2,404       1,192
                                                            ---------    ---------    --------

               Total Liabilities                              193,122      149,731     118,506
                                                            ---------    ---------    --------

STOCKHOLDERS' EQUITY
     Common stock (Notes 12 and 14)                             3,054        3,044       3,038
     Surplus                                                    5,187        5,120       5,116
     Undivided profits                                          6,394        4,630       3,181
     Unrealized gains (losses) on securities available
       for sale                                                   (18)          18      (1,092)
                                                            ---------    ---------    --------
               Total Stockholders' Equity                      14,617       12,812      10,243
                                                            ---------    ---------    --------


               Total Liabilities and Stockholders' Equity   $ 207,739    $ 162,543    $128,749
                                                            =========    =========    ========


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

                    HIGHLANDS BANKSHARES, INC. AND SUBSIDIARY
                                                                         Page F3
<TABLE>
<CAPTION>

                        CONSOLIDATED STATEMENTS OF INCOME
                  Years Ended December 31, 1996, 1995 and 1994
                                 (In thousands)

 INTEREST INCOME                                          1996        1995        1994
                                                     -----------------------------------
<S>                                                    <C>         <C>         <C>
     Interest and fees on loans                        $   12,310  $   9,590   $   6,765
     Interest on securities available for sale
          Taxable                                           2,009      1,735       1,509
          Exempt from taxable income                           73         58          70
     Interest on Federal funds sold                           204        202          76
     Interest on deposits with banks                         --         --             5
                                                       ----------  ---------   ---------
               Total Interest Income                       14,596     11,585       8,425

INTEREST EXPENSE
     Interest on deposits                                   7,822      6,161       3,985
                                                       ----------  ---------   ---------
          Net interest income                               6,774      5,424       4,440
     Provision for loan losses (Note 5)                       374        143         120
                                                       ----------  ---------   ---------
          Net interest income after provision for loan
            losses                                          6,400      5,281       4,320
                                                       ----------  ---------   ---------

NON-INTEREST INCOME
     Securities gains (losses), net                            23         (1)         15
     Service charges on deposit accounts                      474        371         291
     Insurance commissions                                     24         25          29
     Other service charges, commissons and fees                96         58          65
     Other operating income, rents                             43         35          25
                                                       ----------  ---------   ---------
               Total Non-Interest Income                      660        488         425
                                                       ----------  ---------   ---------

NON-INTEREST EXPENSES
     Salaries and employee benefits (Note 13)               2,481      1,904       1,555
     Compensation related to stock options
       granted (Note 14)                                       53          4          78
     Occupancy expense of bank premises                       298        212         177
     Furniture and equipment expense                          564        510         308
     Other operating expenses (Note 20)                     1,043        911         886
                                                       ----------  ---------   ---------
               Total Non-Interest Expenses                  4,439      3,541       3,004
                                                       ----------  ---------   ---------
               Income Before Taxes on Income                2,621      2,228       1,741

     Income Tax Expense (Note 9)                              857        779         581
                                                       ----------  ---------   ---------


               Net Income                              $   1,764   $   1,449   $  1,160
                                                       =========   =========   ========


Net Income Per Share (Note 12)                         $    1.45   $     .19   $   0.96
                                                       =========   =========   ========

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




                    HIGHLANDS BANKSHARES, INC. AND SUBSIDIARY
                                                                         Page F4
                 CONSOLIDATED STATEMENTS OF STOCKHOLDERS' EQUITY
                  Years Ended December 31, 1995, 1994 and 1993
                                 (In thousands)

<TABLE>
<CAPTION>

                                                                                                                         Unrealized
                                                                                                                         Gain (loss)
                                                                                                                         Securities
                                                                Common Stock                                Undivided     Available
                                                            Shares        Par Value          Surplus          Profits      for sale

<S>                                                          <C>             <C>             <C>             <C>            <C>
 Balance, December 31, 1993 as
   restated                                                  $1,206          $3,014          $ ,007          $2,021            --

     Net income                                                --              --              --             1,160            --

     Common stock issued for
        stock options exercised                                  10              24              31            --              --

     Stock options granted                                     --              --                78            --              --
         (Note 14)

     Unrealized gains (losses)                                 --              --              --              --            (1,092)
                                                             ------          ------          ------          ------          ------

Balance, December 31, 1994 as
   restated                                                   1,216           3,038           5,116           3,181          (1,092)

     Net income                                                --              --              --             1,449            --

     Common stock issued for
        stock options exercised                                   2               6            --              --              --

     Stock options granted                                     --              --                 4            --              --
          (Note 14)

     Unrealized gains (losses)                                 --              --              --              --             1,110
                                                             ------          ------          ------          ------          ------


Balance, December 31, 1995                                    1,218           3,044           5,120           4,630              18

     Net income                                                --              --              --             1,764            --

     Common stock issued for
        stock options exercised                                   4              10              14            --              --

     Stock options granted                                     --              --                53            --              --
          (Note 14)

     Unrealized gains (losses)                                 --              --              --              --               (36)
                                                             ------          ------          ------          ------          ------


Balance, December 31, 1996                                   $1,222          $3,054          $ ,187          $6,394          $  (18)
                                                             ======          ======          ======          ======          ======

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

                    HIGHLANDS BANKSHARES, INC. AND SUBSIDIARY
                                                                         Page F5
<TABLE>
<CAPTION>

                CONSOLIDATED STATEMENTS OF CASH FLOWS Years Ended
                        December 31, 1996, 1995 and 1994
                                 (In thousands)

                                                                        1996        1995        1994
                                                                  ------------------------------------
<S>                                                                   <C>         <C>         <C>
 CASH FLOWS FROM OPERATING ACTIVITIES:
     Net income                                                       $  1,764    $  1,449    $  1,160
     Adjustments to reconcile net income to net cash
       provided by operating activities:
          Provision for loan losses                                        374         143         120
          Provision for deferred income taxes                              (67)        596        (589)
          Deferred compensation expense                                     53           4          78
          Depreciation                                                     214         157         124
          Securities (gains) losses                                        (23)          1         (15)
          Net amortization on securities                                   125          76         103
          Increase in interest receivable                                 (203)       (262)       (303)
          (Increase) decrease in other assets                              227         299         (48)
          Increase (decrease) in interest, taxes and other
            liabilities                                                    318         (58)        240
                                                                      --------    --------    --------
               Net Cash Provided by Operating Activities                 2,782       2,405         870
                                                                      --------    --------    --------

CASH FLOWS FROM INVESTING ACTIVITIES:
     Net (increase) decrease in time balances with banks                  --          --           100
     Securities available for sale:
          Proceeds from sale of securities                              12,779         586       1,349
          Proceeds from maturities of debt securities                    2,125       3,209         720
          Purchase of securities                                       (14,128)     (7,648)     (6,066)
          Net (increase) decrease in federal funds sold                 (2,413)     (5,534)      7,825
          Net increase in loans                                        (41,418)    (20,077)    (26,592)
          Premises and equipment expenditures                             (446)     (1,899)       (310)
                                                                      --------    --------    --------
               Net Cash Used in Investing Activities                   (43,501)    (31,363)    (22,974)
                                                                      --------    --------    --------

CASH FLOWS FROM FINANCING ACTIVITIES:
          Net increase in certificates of deposit                       29,811      22,582      17,136
          Net increase in demand, savings and other deposits            12,333       7,432       5,324
          Increase (decrease) in federal funds purchased                  --          (327)        327
          Net proceeds from Federal Home Loan Bank
            Advances                                                       929       1,000        --
          Proceeds from issuance of common stock                            36           6          55
                                                                      --------    --------    --------
               Net cash provided by financing activities                43,109      30,693      22,842
                                                                      --------    --------    --------
               Net increase (decrease) in cash and cash equivalents      2,390       1,735         738

CASH AND CASH EQUIVALENTS AT BEGINNING OF YEAR                           5,618       3,883       3,145
                                                                      --------    --------    --------

CASH AND CASH EQUIVALENTS AT END OF YEAR                              $  8,008    $  5,618    $  3,883
                                                                      ========    ========    ========


SUPPLEMENTAL DISCLOSURE OF NON-CASH
  TRANSACTIONS

     Unrealized gain (loss) in value of  securities
       available for sale (net of tax effects of
       $(19), $572 and $(563) at December 31, 1996,
       1995 and 1994, respectively                                    $    (36)   $  1,110    $ (1,092)
       ====     =====                                                 ========    ========    ========


      Investment securities transferred to
      available for sale                                              $     -     $     -     $ 24,733
                                                                      ========    ========    ========


SUPPLEMENTAL DISCLOSURES OF CASH FLOW
  INFORMATION:
Cash paid during the year for:
     Interest                                                         $  7,595    $  5,629    $  3,755
                                                                      ========    ========    ========
     Income taxes                                                     $    901    $    783    $    579
                                                                      ========    ========    ========

</TABLE>

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

<PAGE>


                    HIGHLANDS BANKSHARES, INC. AND SUBSIDIARY
                                                                         Page F6
                   NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
                                December 31, 1996
                                 (In thousands)


         Note  1. Summary of Significant Accounting Policies

                  Basis of Presentation:

                  The accounting and reporting policies of Highlands Bankshares,
                  Inc. and Subsidiary conform to generally  accepted  accounting
                  principles and the  predominant  practices  within the banking
                  industry.  The accompanying  consolidated financial statements
                  have been prepared on the accrual basis.

                  Principles of Consolidation:

                  The accompanying consolidated financial statements include the
                  accounts of Highlands  Bankshares,  Inc. and  Subsidiary  (the
                  "Company") and its  wholly-owned  subsidiary,  Highlands Union
                  Bank (the "Bank"). All significant  intercompany  balances and
                  transactions have been eliminated in consolidation.

                  Nature of Operations:

                  Highlands  Bankshares,   Inc.  and  Subsidiary  operates  in
                  Abingdon, Virginia and surrounding Southwest Virginia, under
                  the laws of the  Commonwealth  of Virginia.  The Company was
                  organized  December  29,  1995.  Highlands  Union Bank,  its
                  wholly-owned  subsidiary,  began banking operations on April
                  27, 1985.

                  Securities Available for Sale:

                  Securities  classified  as  available  for sale are those debt
                  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 stockholders' equity, net of the related deferred
                  tax effect. Realized gains or losses,  determined on the basis
                  of the cost of  specific  securities  sold,  are  included  in
                  earnings.

                  Reserve for Possible Loan Losses:

                  The reserve for possible loan losses for  financial  statement
                  purposes  is based  upon  management's  evaluation  of amounts
                  required  to maintain  the  reserve at an adequate  level upon
                  consideration  of  losses  charged  to  the  reserve,  current
                  economic conditions,  changes in the size and character of the
                  loan   portfolio,   and  other  relevant   factors  which,  in
                  management's judgment, deserve current recognition.

                  Premises and Equipment:

                  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:

                  Organizational  costs  are  stated  at cost  less  accumulated
                  amortization.  Amortization  is computed on the  straight-line
                  method over 60 months.



                                   (Continued)
<PAGE>

                    HIGHLANDS BANKSHARES, INC. AND SUBSIDIARY
                                                                         Page F7
                   NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
                                December 31, 1996
                                 (In thousands)

         Note  1. Summary of Significant Accounting Policies (Continued)

                  Cash and Cash Equivalents:

                  For   purposes  of  reporting   cash  flows,   cash  and  cash
                  equivalents include cash on hand and amounts due from banks.

                  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.

                  Income on Loans and Loan Fees:

                  Accrual  of  interest  on  commercial  loans,   mortgages  and
                  consumer  single-payment loans is based generally on the daily
                  amount of principal outstanding. Interest on installment loans
                  is  reported  as  income  over the term of the loan  under the
                  simple interest method and the sum-of-the-months'-digits (Rule
                  of 78's)  method.  The Rule of 78's  method is not  materially
                  different  from the interest  method.  Beginning with 1996 the
                  Bank has discontinued the use of the "Rule of 78's". It is the
                  Bank's policy to discontinue  the accrual of interest on loans
                  based  on  their  delinquency  status  and  evaluation  of the
                  related collateral and the financial strength of the borrower.
                  The accrual of interest income is normally discontinued when a
                  loan  becomes 90 days past due as to  principal  or  interest.
                  Management  may elect to continue the accrual of interest when
                  the net realizable  value of collateral is sufficient to cover
                  the  principal  balance and accrued  interest.  When  interest
                  accruals are discontinued,  interest accrued and not collected
                  in the current year is reversed  and interest  accrued and not
                  collected  in prior  years is  charged  to the  allowance  for
                  credit losses.

                  For mortgage loans,  the portion of loan origination fees that
                  exceeds the direct costs of underwriting  and closing loans is
                  deferred.  The deferred  fees received are amortized to income
                  over  the  estimated  lives  of the  mortgage  loans  using  a
                  straight line method. The deferred fees received in connection
                  with  installment  loans  are  amortized  over the life of the
                  loan.  The   aforementioned   amortization   methods  are  not
                  materially different from the interest method.

                  Earnings Per Share:

                  Earnings  per  share  are  calculated  based  on the  weighted
                  average outstanding shares during the year.

                  Estimates:

                  The  preparation  of financial  statements in conformity  with
                  generally accepted  accounting  principles requires management
                  to make estimates and assumptions that affect certain reported
                  amounts and  disclosures.  Actual  results  could  differ from
                  those estimates.

                  Reclassification of Financial Statement Presentation:

                  Certain  reclassifications have been made to the 1995 and 1994
                  financial  statements  to  conform  with  the  1996  financial
                  statement  presentation.  Such reclassifications had no effect
                  on net income as previously reported.

<PAGE>

                    HIGHLANDS BANKSHARES, INC. AND SUBSIDIARY
                                                                         Page F8
                   NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
                                December 31, 1996
                                 (In thousands)

         Note  2. Business Combination

                  On  December  29,  1995  Highlands  Bankshares,   Inc.  issued
                  approximately  1.2  million  shares  of its  common  stock  in
                  exchange  for all the  outstanding  common  stock of Highlands
                  Union Bank. In addition, outstanding employee stock options to
                  purchase Highlands Union Bank common stock were converted into
                  options to purchase shares of Highlands  Bankshares,  Inc. The
                  merger  has been  accounted  for as a  pooling  of  interests.
                  Restatement of prior year financial  statements was not deemed
                  necessary due to immateriality.

         Note  3. Investment Securities

                  Effective  January 1, 1994, the Company adopted the provisions
                  of  Statement  of  Financial  Accounting  Standards  No.  115,
                  "Accounting  for  Certain   Investments  in  Debt  and  Equity
                  Securities."  Statement No. 115 addresses the  classification,
                  accounting  and  disclosure of  investments in debt and equity
                  securities. In connection with the adoption of this statement,
                  securities were  classified  into two  categories:  securities
                  available for sale and investment securities held-to-maturity.
                  Prior to January 1, 1994,  securities  available for sale were
                  recorded at the lower of aggregate cost or market value. Under
                  Statement No. 115, securities  available for sale are recorded
                  at  market  value  with the  unrealized  gain or loss,  net of
                  deferred  income taxes,  reflected as a separate  component of
                  stockholders'  equity.  The amortized cost and market value of
                  securities classified as available for sale are as follows:

                  Securities available for sale:


<TABLE>
<CAPTION>
                                                                      1996
                                       -------------------------------------------------------------------
                                            Gross             Gross                            Approximate
                                          Amortized        Unrealized        Unrealized          Market
                                            Cost              Gains            Losses            Values
                                       ----------------  ----------------  ----------------  -------------

<S>                                         <C>             <C>                <C>               <C>
 U.S. Treasury securities                   $1,003          $    -             $   4             $   999
 U.S. Government agencies and
   corporations                              3,500               -                38               3,462
 State and political subdivisions            1,004              27                 -               1,031
 Mortgage Backed Securities                 25,005               -                13              24,992
 Other securities                              861               -                 -                 861
                                       -------------------------------------------------------------------

                                           $31,373          $   27             $   5             $31,345
                                       ===================================================================

</TABLE>


<TABLE>
<CAPTION>
                                                                      1995
                                       -------------------------------------------------------------------
                                            Gross             Gross                            Approximate
                                          Amortized        Unrealized        Unrealized          Market
                                            Cost              Gains            Losses            Values
                                       ----------------  ----------------  ----------------  -------------

<S>                                          <C>            <C>                 <C>                <C>
 U.S. Treasury securities                   $ 3,008        $    -              $   20             $ 2,988
 U.S. Government agencies and
   corporations                               8,139             68                 67               8,140
 State and political subdivisions             1,331             77                  -               1,408
 Mortgage Backed Securities                  18,861            152                182              18,831
 Other securities                               909              -                  -                 909
                                       -------------------------------------------------------------------

                                            $32,248        $   297             $  269             $32,276
                                       ===================================================================
</TABLE>



                                   (Continued)


<PAGE>

                    HIGHLANDS BANKSHARES, INC. AND SUBSIDIARY
                                                                         Page F9
                   NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
                                December 31, 1996
                                 (In thousands)


         Note  3. Investment Securities (Continued)


<TABLE>
<CAPTION>
                                                                       1994
                                       -------------------------------------------------------------------
                                            Gross             Gross                            Approximate
                                          Amortized        Unrealized        Unrealized          Market
                                            Cost              Gains            Losses            Values
                                       ----------------  ----------------  ----------------  -------------

<S>                                         <C>            <C>                 <C>                <C>
 U.S. Treasury securities                   $ 4,513        $    -              $  178             $ 4,335
 U.S. Government agencies and
   corporations                               7,987             -                 618               7,369
 State and political subdivisions               816             8                   6                 818
 Mortgage Backed Securities                  14,946            26                 873              14,099
 Other securities                               768             -                   -                 768
                                       -------------------------------------------------------------------

                                            $29,030        $   34              $1,675            $27,389
                                       ===================================================================

</TABLE>



                  Securities being held to maturity:

                  Investment securities available for sale with a carrying value
                  of $1,003,  $3,808 and $2,503  thousand at December  31, 1996,
                  1995  and  1994  respectively,  and a  market  value  of $998,
                  $3,782,  and $2,443  thousand at December 31,  1996,  1995 and
                  1994 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,  1996  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.
<TABLE>
<CAPTION>


                                                                                                          Approx-
                                                                                                            imate
                                                                                        Amortized          Market
                                                                                             Cost           Value
                                                                                     ------------       -----------

<S>                                                                                  <C>                <C>
                           Due in one year or less                                   $        567       $       565
                           Due after one year through five years                            4,151             4,109
                           Due after five years through ten years                             789               818
                           Due after ten years                                              -                -
                                                                                     ------------       -----------
                                                                                            5,507             5,492
                                                                                     ------------       -----------

                           Mortgage-backed securities                                      25,005            24,992
                           Other securities                                                   861               861
                                                                                     ------------       -----------
                                                                                           25,866            25,853
                                                                                     ------------       -----------

                                                                                     $     31,373       $    31,345
                                                                                     ============       ===========

</TABLE>
                                   (Continued)


<PAGE>

                    HIGHLANDS BANKSHARES, INC. AND SUBSIDIARY
                                                                        Page F10
                   NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
                                December 31, 1996
                                 (In thousands)


         Note  3. Investment Securities (Continued)

                  Gross realized gains and losses for the years ended December
                  31, 1996, 1995 and 1994 on investment  securities  available
                  for sale are as follows:
<TABLE>
<CAPTION>

                                                                            1996             1995              1994

<S>                                                                    <C>              <C>                <C>
                           Realized gains                              $      50        $       3          $     25
                           Realized losses                              $(    27)       $(      4)         $(    10)
</TABLE>

         Note  4. Loans

                  The composition of the net loans is as follows:
<TABLE>
<CAPTION>

                                                                            1996             1995              1994

<S>                                                                <C>                 <C>              <C>
                           Commercial                                 $   20,370       $   12,699        $    8,538
                           Real estate                                   101,570           76,590            62,955
                           Installment                                    30,656           23,342            21,890
                           Other                                           2,967            2,743             2,166
                                                                      ----------        ---------        ----------
                                                                         155,563          115,374            95,549
                                                                      ----------        ---------        ----------

                           Deduct:
                           Unearned discount                                 455            1,377             1,550
                           Allowance for credit losses                     1,072              908               836
                           Unearned net loan fees                            157              254               261
                                                                      ----------       ----------        ----------
                                                                           1,684            2,539             2,647
                                                                      ----------       ----------        ----------

                                                                      $  153,879       $  112,835        $   92,902
                                                                       =========       ==========        ==========

</TABLE>

                  In May 1993, the Financial Accounting Standards Board issued
                  Statement  No.  114,   "Accounting   by  Creditors  for  the
                  Impairment  of a Loan" which is  effective  for fiscal years
                  beginning after December 15, 1994. In October 1994,  certain
                  provisions  of  Statement  No. 114 were amended by Statement
                  No.  118.  Statements  114 and 118 address the methods to be
                  used by a creditor to measure the  impairment  of a loan and
                  the  proper  recognition  of a  change  in the  value  of an
                  impaired  loan. The Company has no loans that are considered
                  impaired in conformity with SFAS 114.

                  Nonaccruing  loans  totaling $99,  $235,  and $0 thousand at
                  December 31,  1996,  1995 and 1994 are included in the above
                  loans.  Interest income lost on these  nonaccruing loans was
                  approximately  $6, $12, and $0 for  December 31, 1996,  1995
                  and 1994, respectively.

                  Loans have been pledged as part of the floating blanket lien
                  to secure Federal Home Loan Bank advances. (Note 8)



                                   (Continued)



<PAGE>

                    HIGHLANDS BANKSHARES, INC. AND SUBSIDIARY
                                                                        Page F11
                   NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
                                December 31, 1996
                                 (In thousands)


         Note  5. Allowance for Credit Losses

                  Activity in the  allowance for credit losses is as follows for
                  the periods ended December 31, 1996, 1995, 1994:
<TABLE>
<CAPTION>

                                                                            1996             1995              1994
                                                                            ----             ----              ----

<S>                                                                     <C>             <C>                <C>
                  Balance, beginning                                    $    908         $    836          $    782
                  Provisions charged to
                   operations                                                374              143               120
                  Loans charged to reserve                              (    255)        (    188)         (     87)
                  Recoveries                                                  45              117                21
                                                                        --------         --------          --------

                  Balance, ending                                       $  1,072         $    908          $    836
                                                                        ========         ========          ========
</TABLE>

         Note  6. Premises and Equipment

                  Premises and  equipment,  stated at cost, are comprised of the
following:
<TABLE>
<CAPTION>

                                                                            1996             1995              1994
                                                                            ----             ----              ----

<S>                                                                     <C>              <C>               <C>
                  Land                                                  $  1,451         $  1,301          $    765
                  Bank premises                                            2,909            2,876             1,785
                  Equipment                                                1,316            1,053               783
                                                                        --------         --------          --------
                                                                           5,676            5,230             3,333
                  Less accumulated
                   depreciation                                            1,093              884               728
                                                                        --------         --------          --------

                                                                        $  4,583         $  4,346          $  2,605
                                                                        ========         ========          ========
</TABLE>

                  The depreciation  expense is $214, $157, and $124 thousand for
                  1996, 1995, and 1994, respectively.

         Note  7.  Deposits

                  The composition of deposits is as follows:

<TABLE>
<CAPTION>
                                                                                              December 31,
                                                                       --------------------------------------------
                                                                            1996             1995              1994
                                                                            ----             ----              ----

<S>                                                                    <C>             <C>               <C>
                  Demand                                               $  39,381        $  31,968        $   27,587
                  Savings                                                 21,930           17,010            18,257
                  Time deposits, $100,000 or
                   more                                                   31,007           26,297            18,836
                  Other time deposits                                     97,153           72,052            52,634
                                                                       ---------        ---------         ---------

                                                                       $ 189,471        $ 147,327         $ 117,314
                                                                       =========        =========         =========

</TABLE>



                                   (Continued)
<PAGE>

                    HIGHLANDS BANKSHARES, INC. AND SUBSIDIARY
                                                                        Page F12
                   NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
                                December 31, 1996
                                 (In thousands)


         Note  7. Deposits (Continued)

                  The remaining maturities of time deposits at December 31, 1996
                  are as follows:


                  Three months or less                              $     28,128
                  Three through twelve months                             61,171
                  Over twelve months                                      38,861
                                                                     -----------

                                                                    $    128,160
                                                                    ============

         Note  8. Short Term Borrowings

                  Borrowed  funds  consist  of Federal  Home Loan Bank  advances
                  which are secured by a floating  blanket lien on assets of the
                  Bank, including loans.  Short-term borrowings for December 31,
                  1996,  1995 and  1994  were  $71,  $1,000  and $327  thousand,
                  respectively.


         Note  9. Income Taxes

                  The  components  of the net deferred tax asset at December 31,
                  1996, 1995 and 1994 were as follows:
<TABLE>
<CAPTION>

                                                                            1996             1995              1994
                                                                           -----             ----              ----

<S>                                                                    <C>               <C>               <C>
                  Deferred tax assets:
                  Allowance for loan
                   loss                                                $     323         $    245          $    254
                  Deferred compensation
                   accruals                                                   90               78                77
                  Gain (loss) on securities
                   available for sale                                          9            -                   563
                                                                       ---------         --------          --------
                                                                             422              323               894
                                                                       ---------         --------          --------
                  Deferred tax liability:
                  Depreciation
                   differences                                         (     128)        (    106)         (     90)
                  Gain (loss) on securities
                   available for sale                                    -               (      9)             -
                                                                       ---------         --------          --------
                                                                       (     128)        (    115)         (     90)
                                                                       ---------         --------          --------

                  Net deferred tax asset                               $     294         $    208          $    804
                                                                       =========         ========          ========
</TABLE>

                  The net  deferred  tax asset is included in the balance  sheet
                  under the caption "Other Assets".


                                   (Continued)


<PAGE>

                    HIGHLANDS BANKSHARES, INC. AND SUBSIDIARY
                                                                        Page F13
                   NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
                                December 31, 1996
                                 (In thousands)


         Note  9. Income Taxes (Continued)

                  The  components  of income tax  expense  (benefit)  related to
                  continuing operations are as follows:
<TABLE>
<CAPTION>

                                                                            1996             1995              1994
                                                                           -----             ----              ----

<S>                                                                          <C>          <C>             <C>
                  Federal:
                    Current                                                  924          $   755          $    607
                    Deferred                                            (     67)              24          (     26)
                                                                        --------          -------          --------

                        Total                                           $    857          $   779          $    581
                                                                        ========          =======          ========
</TABLE>

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

<TABLE>
<CAPTION>

                                                                            1996             1995              1994
                                                                            ----             ----              ----

<S>                                                                     <C>               <C>               <C>
                  Statutory rate applied to
                   earnings before income taxes                         $    891          $   758           $   592
                  Tax exempt interest                                   (     15)         (    20)          (    24)
                  Other, net                                            (     19)              41                13
                                                                        --------          -------           -------

                                                                        $    857          $   779           $   581
                                                                        ========          =======           =======
</TABLE>

         Note 10. Notes Payable

                  During  the year,  the Bank had the  following  notes  payable
                  agreements:
<TABLE>
<CAPTION>

                                                                                        Current         Long-Term       Total
                                                                                        -------         ---------       -----
<S>                                                                                <C>                 <C>           <C>
                  Note  payable  Federal  Home Loan Bank  dated June 6, 1996 for
                  $1,000,000 with an annual  interest rate of 5.6325%,  due June
                  8, 1998. The note requires annual interest payments.  The loan
                  is secured by a floating blanket lien on
                  assets of the Bank, including loans.                                     -            1,000,000     1,000,000

                  Note  payable  Federal  Home Loan Bank  dated June 6, 1996 for
                  $1,000,000 with an annual interest rate of 7.02%,  due June 6,
                  2003. The note requires  annual  installments  of $71,429 plus
                  interest.  The loan is secured by a floating  blanket  lien on
                  assets of the Bank,
                  including loans.                                                       71,429           857,571       929,000
                                                                                   ------------       -----------    ----------

                           Totals                                                  $     71,429        $1,857,571    $1,929,000
                                                                                   ============        ==========    ==========


</TABLE>


                                   (Continued)
<PAGE>

                    HIGHLANDS BANKSHARES, INC. AND SUBSIDIARY
                                                                        Page F14
                   NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
                                December 31, 1996
                                 (In thousands)


         Note 10. Notes Payable (Continued)

                  Principal maturities of notes payable at December 31, 1996 are
                  as follows:

                  1997                               $     71,429
                  1998                                  1,071,429
                  1999                                     71,429
                  2000                                     71,429
                  2001                                     71,429
                  Thereafter                              571,855
                                                      -----------

                                                      $ 1,929,000
                                                      ===========

         Note 11. Operating Leases

                  The following is a schedule by years of future  minimum rental
                  payments  required under operating leases that have initial or
                  remaining  noncancelable  terms  in  excess  of  one  year  as
                  follows:

                  Year ending December 31:

                    1997                                        $   303
                    1998                                            198
                    1999                                            111
                    2000                                             -
                    2001                                             -
                                                                -------

                  Total minimum payments required               $   612
                                                                =======

                  Total operating lease expense was  $359, $261 and $158 for
                  December 31, 1996, 1995 and 1994 respectively.

         Note 12. Common Stock, Stock Split, and Net Income Per Share

                  On April 13, 1995, the Board  authorized a 2 for 1 stock split
                  to be  distributed to all  shareholders  of record as of April
                  12,  1995.  As a  result,  authorized  shares  increased  from
                  5,000,000 to 10,000,000 and par value  decreased from $5.00 to
                  $2.50 per share. All references in the financial statements to
                  number of shares,  per share  amounts and market prices of the
                  Bank's  common  stock  have  been  retroactively  restated  to
                  reflect the increased number of common shares outstanding.

                  At December 31, 1996, 1995 and 1994, the Bank had 1,222, 1,218
                  and  1,216   thousand   shares  of  common  stock  issued  and
                  outstanding,  respectively.  Net income per share is  computed
                  using the weighted average  outstanding shares of 1,220, 1,214
                  and 1,208  thousand for the periods  ended  December 31, 1996,
                  1995 and 1994, respectively.  The stock options (Note 14) have
                  an antidilutive effect on earnings per share.

         Note 13. Profit Sharing Plan

                  Effective  January 1, 1986,  the Bank adopted a profit sharing
                  plan covering  substantially  all employees with over one year
                  of  service.  The  plan  provides  for  contributions  in such
                  amounts as the Board of Directors may annually determine,  but
                  not in  excess of the  amount  permitted  under  the  Internal
                  Revenue Code as a deductible expense.  The Bank accrued to the
                  plan $120,  $92 and $88 thousand for the years ended  December
                  31,  1996,  1995  and  1994,  respectively,  which  represents
                  approximately  6%, 7% and 8% of qualifying  salaries and wages
                  of the Bank.


<PAGE>


                    HIGHLANDS BANKSHARES, INC. AND SUBSIDIARY
                                                                        Page F15
                   NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
                                December 31, 1996
                                 (In thousands)


         Note 14. Stock Option Plan

                  In 1995,  Highlands  Bankshares,  Inc. adopted a non-qualified
                  stock  incentive  option  plan,  which  is  identical  to  and
                  replaced the plan adoped by Highlands  Union Bank in 1986, for
                  key employees,  officers,  and directors and reserved  150,000
                  shares  of  common  stock  for  issuance  thereunder.  Options
                  granted under the plan expire ten years from date of grant.

                  Shares  under  options  which  subsequently   expire,  or  are
                  canceled are available for subsequent grant. Option prices are
                  determined  by the Board of  Directors,  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 Bank'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.  During 1996,  1995 and 1994 12,900,  700
                  and 9,600  shares were  granted at $15.000,  $9.333 and $8.330
                  per share at grant date, respectively.

                  Options  outstanding  at  option  price  for the  years  ended
                  December 31, are as follows:
<TABLE>
<CAPTION>


                                                               1996                       1995                      1994
                                                    -----------------------       --------------------     ----------------------
                                                       Dollars     Number of        Dollars    Number of     Dollars     Number of
                                                    (Thousands)      Shares       (Thousands)   Shares     (Thousands)     Shares
                                                    -----------      ------       -----------   ------     -----------     ------

<S>                                                  <C>             <C>            <C>          <C>        <C>             <C>
                  Options outstanding January 1      $     226       65,082         $    225     66,742      $    179       66,678
                  Granted                                   53       12,900                4        700            78        9,600
                  Exercised                            (    13)    (  4,194)         (     3)  (  2,360)      (    32)    (  9,536)
                                                     ---------     --------         --------   --------      --------     --------

                  Options outstanding December 31    $     266       73,788         $    226     65,082      $    225       66,742
                                                     =========     ========         ========   ========      ========     ========
</TABLE>

                  At the time  options are  granted,  the  difference  in market
                  value and the option  price is  recorded as an expense and the
                  related  accrual is included in  surplus.  For 1996,  1995 and
                  1994 $53, $4 and $78 thousand was recorded as  compensation as
                  a result of options granted. As of December 31, 1996, 1995 and
                  1994 $266,  $226 and $225  thousand  remained as accrued stock
                  options outstanding included in surplus.

         Note 15. Commitments, Contingencies and Concentrations of Credit

                  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.  These commitments  include standby
                  letters  of credit of  approximately  $2,026,  $218,  and $341
                  thousand  and  unused  portions  of credit  lines of  $10,335,
                  $8,202 and $7,085  thousand  for the years ended  December 31,
                  1996, 1995 and 1994,  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.

                  The Bank has made  arrangements  with and has  available  from
                  other corresponding banks, approximately $48,942,000 of unused
                  lines of credit to fund any necessary cash  requirements.  The
                  Bank  has  $1,929,000  of  Federal  Home  Loan  Bank  advances
                  outstanding as of December 31, 1996.






                                   (Continued)
<PAGE>

                    HIGHLANDS BANKSHARES, INC. AND SUBSIDIARY
                                                                        Page F16
                   NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
                                December 31, 1996
                                 (In thousands)


         Note 15. Commitments, Contingencies and Concentrations of Credit
                  (Continued)

                  The Bank  grants  various  types of credit  including  but not
                  limited   to,   agribusiness,    commercial,   consumer,   and
                  residential loans to customers  primarily  located  throughout
                  Southwest  Virginia.  Each  customer's  credit  worthiness  is
                  examined  on a case by case  basis.  The amount of  collateral
                  obtained,   if  any,  is  determined  by  management's  credit
                  evaluation of the customer.  Collateral  held varies,  but may
                  include property,  accounts receivable,  inventory,  plant and
                  equipment,  securities and other income producing  properties.
                  Although the loan portfolio is generally well  diversified and
                  geographically  dispersed  within the region,  aggregate loans
                  extended for real estate mortgages  represent greater than 50%
                  of the loan portfolio. A substantial portion of the customers'
                  ability  to honor  their  contractual  commitment  is  largely
                  dependent upon the economic conditions of the region.

         Note 16. Fair Values of Financial Instruments

                  The carrying  amounts and fair values of the Bank's  financial
                  instruments at December 31 were as follows (asset/liability):

                                1996                        1995

                        Carrying       Fair        Carrying        Fair
                          Amount       Value        Amount         Value
                          ------       -----        ------         -----

Cash and short-term
   investments         $  15,956     $  15,956     $  11,153     $  11,153
Investments in
   securities             31,345        31,345        32,276        32,276
Loans, net               153,879       156,977       112,835       115,272
Deposits                (189,471)     (190,071)     (147,327)     (148,463)
Short-term
   borrowings           (  1,929)     (  1,929)     (  1,000)     (  1,000)


                  Cash and Short-Term Investments

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

                  Investments in Securities

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

                  Loans

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

                  Deposits

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

                  Short-Term Borrowings

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

<PAGE>

                    HIGHLANDS BANKSHARES, INC. AND SUBSIDIARY
                                                                        Page F17
                   NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
                                December 31, 1996
                                 (In thousands)


         Note 17. Related Party Transactions

                  In the normal  course of business,  the Bank has made loans to
                  directors and officers of the Bank.  All loan 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
                  involve more than the normal risk of collectibility or present
                  other  unfavorable  features.  The  activity  of such loans is
                  approximately as follows:

                                               1996         1995        1994

                  Balance, beginning        $ 6,317     $  5,712    $  4,528
                  Loan additions              2,712        3,525       1,889
                  Amounts collected         ( 3,488)    (  2,920)   (    705)
                                            -------     --------    --------

                  Balance, ending           $ 5,541     $  6,317    $  5,712
                                            =======     ========    ========

         Note 18. Restrictions on Cash

                  The Bank is required to maintain reserve balances in cash with
                  the Federal Reserve Bank. The total of those reserve  balances
                  was approximately $789 thousand at December 31, 1996.

         Note 19. Undivided Profits and Capital

                  Banking  laws and  regulations  limit the amount of  dividends
                  that  may  be  paid  without  prior  approval  of  the  Bank's
                  regulatory agency. Under that limitation,  the Bank could have
                  declared  dividends of $9,080 and $5,216  thousand in 1996 and
                  1995, respectively.

                  Federal  regulatory  agencies  have  adopted  various  capital
                  standards for  financial  institutions,  including  risk-based
                  capital standards. The primary objectives of comparing capital
                  positions of financial  institutions  are to take into account
                  the different risks among financial  institutions'  assets and
                  off-balance sheet items.

                  Risk-based  capital  standards  have  been  supplemented  with
                  requirements  for a minimum leverage ratio. The leverage ratio
                  is the Company's  Tier I Capital  divided by the amount of the
                  Company's  total assets as reported on the balance  sheet.  In
                  addition,  the  regulatory  agencies  consider  the  published
                  capital  levels as minimum  levels and may require a Financial
                  Institution to maintain capital at higher levels.

                  A comparison of the Company's capital as of December 31, 1996,
                  1995  and  1994  with  the  minimum   requirements   for  well
                  capitalized   and  adequately   capitalized   institutions  is
                  presented below.
<TABLE>
<CAPTION>

                                                                       Minimum Requirements
                                                     1996        1995          1994         Well       Adequately
                                                   Actual      Actual        Actual     Capitalized   Capitalized

<S>                                                 <C>        <C>           <C>           <C>             <C>
                  Tier I Risk-based Capital         9.41%      11.11%        12.10%        6.00%           4.00%
                  Total Risk-based Capital         10.12%      11.90%        13.00%       10.00%           8.00%
                  Leverage Ratio                    6.82%       7.48%         8.32%        5.00%           4.00%

</TABLE>


<PAGE>




                    HIGHLANDS BANKSHARES, INC. AND SUBSIDIARY
                                                                        Page F18
                   NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
                                December 31, 1996
                                 (In thousands)


         Note 20. Other Operating Expenses

                  Other operating expenses consist of the following:

                                                       1996       1995      1994

                  Data processing                 $       9     $   22    $   12
                  FDIC insurance                          2        134       214
                  Postage and freight                   161        130       105
                  Regulatory agency assessments          33         34        29
                  Supplies                              146        124       106
                  Bank stock tax                        122        126       107
                  Other                                 570        341       313
                                                    -------       ----      ----

                                                    $ 1,043      $ 911     $ 886
                                                     ======       ====      ====


         Note 21. Condensed Parent Company Balance Sheet

                  The  condensed  balance  sheets  below  relates to Highlands
                  Bankshares,  Inc. for December 31, 1996 and 1995 and for the
                  years then  ended.  Highlands  Bankshares,  Inc.  was formed
                  December 29, 1995 and exchanged  common stock for the common
                  stock of Highlands Union Bank. All significant  transactions
                  of Highlands Bankshares,  Inc. affect the balance sheet only
                  and accordingly,  no condensed income statement or condensed
                  cash flow statement has been presented below.
<TABLE>
<CAPTION>

                  CONDENSED BALANCE SHEETS

                                                                            1996             1995

                  ASSETS
<S>                                                                  <C>           <C>
                    Cash                                               $     331        $       -
                    Investments in subsidiaries                           14,122           12,812
                    Land                                                     141                -
                    Other assets                                              24               10
                                                                       ---------         --------

                            Total Assets                                $ 14,618         $ 12,822
                                                                        ========         ========

                  LIABILITIES AND STOCKHOLDERS' EQUITY
                    Interest, taxes and other
                       liabilities                                      $   -            $     10
                                                                        --------         --------

                            Total Liabilities                           $   -                  10
                                                                        --------         --------

                  STOCKHOLDERS' EQUITY
                    Unrealized gain (loss) securities                   (     18)              18
                    Common stock                                           3,055            3,044
                    Surplus                                                5,187            5,120
                    Undivided profits                                      6,394            4,630
                                                                        --------         --------

                            Total Stockholders'  Equity                   14,618           12,812
                                                                        --------         --------

                            Total Liabilities and
                             Stockholders' Equity                       $ 14,618         $ 12,822
                                                                        ========         ========

</TABLE>