Securities and Exchange Commission
                             Washington, D.C. 20549


                                    FORM 10-K

                  Annual Report Pursuant to Section 13 or 15(d)
                     of the Securities Exchange Act of 1934


For the Fiscal Year ended:                              Commission File
      December 31, 1996                                 Number:  430893107
      -----------------                                          ---------


                           Highlands Bankshares, Inc.
             (Exact name of registrant as specified in its charter)


Virginia                                                54-1796693
--------                                                ----------
(State or other jurisdiction                            (I.R.S. Employer
of incorporation or organization)                       Identification Number)

340 West Main Street
Abingdon, Virginia                                      24210-1128
------------------                                      ----------
(Address of principal                                   (Zip Code)
executive offices)

Registrant's telephone number, including area code:   (540)628-9181


           Securities registered pursuant to Section 12(b) of the Act:
                                 Not Applicable
                                 --------------

           Securities registered pursuant to Section 12(g) of the Act:
                          Common Stock, $2.50 par value
                          -----------------------------
                                (Title of Class)


Indicate by check mark whether the registrant (1) has filed all reports required
to be filed by Section 13 or 15(d) of the Securities Exchange Act of 1934 during
the preceding 12 months and (2) has been subject to such filing requirements for
the past 90 days.
Yes_X_ No___

Indicate by check mark if disclosure of delinquent  filers  pursuant to Item 405
of Regulation S-K (Section 229.405 of this chapter) is not contained herein, and
will not be  contained,  to the best of  registrant's  knowledge,  in definitive
proxy or information  statements  incorporated  by reference in Part III of this
Form 10-K or any amendment to this Form 10-K. [ ]

As  of  December  31,  1996,   there  were  1,221,788  shares  of  Common  Stock
outstanding.



<PAGE>

                       Documents Incorporated by Reference



List hereunder the following documents if incorporated by reference and the Part
of Form 10-K into which the documents are incorporated:

(1)  Part II incorporates information by reference from the registrant's Annual
     Report to Stockholders for the fiscal year ended December 31, 1996.

(2)  Part III  incorporates by reference from the  registrant's  proxy statement
     for its Annual Meeting of Stockholders scheduled for May 14, 1997.

(3)  Part IV incorporates by reference from: (i) the registrant's  Annual Report
     to  Stockholders  for the fiscal year ended December 31, 1996, and (ii) the
     registrant's  proxy  statement  for  its  Annual  Meeting  of  Stockholders
     scheduled for May 14, 1997.

                                       2
<PAGE>


Part I.

Item I.  Business

                                     General

         Highlands  Bankshares  Inc. (the  "Corporation")  was  incorporated  in
Virginia in 1995 to serve as the holding  company for Highlands Union Bank, (the
"Bank"). The stockholders of the Bank approved the Plan of Reorganization at the
Annual Meeting on December 13, 1995, and the  reorganization  was consummated on
December  29,  1995 with the Bank  becoming  a  wholly-owned  subsidiary  of the
Corporation.  The  Bank  is a state  charted  bank  with  principal  offices  in
Abingdon, Virginia. The Bank was incorporated in 1985.

         At December 31, 1996, the Corporation had total assets of $207,739,000,
deposits of $189,471,000, and net worth of $14,617,000.

         The Corporation's  principal business  activities,  which are conducted
through the Bank, are attracting  checking and savings deposits from the general
public through its retail banking  offices and  originating  and servicing loans
secured  by  first  mortgage  liens  on   single-family   dwellings,   including
condominium  units.  All of the retail banking  offices are located in Virginia.
The  Corporation  also lends funds to retail banking  customers by means of home
equity and installment loans, and originates residential constructions loans and
loans secured by commercial  property,  multi-family  dwellings and manufactured
housing units.  The  Corporation  invests in certain U.S.  Government and agency
obligations and other investments  permitted by applicable laws and regulations.
The operating  results of the Corporation  are highly  dependent on net interest
income,  the difference  between interest income earned on loans and investments
and the cost of checking and savings deposits and borrowed funds.

         The Bank is a  member  of the  Federal  Deposit  Insurance  Corporation
("FDIC"),  and it's  deposit  accounts  are insured up to $100,000 as applied by
FDIC  guidelines.  The Bank is also a member of the Federal Reserve  System,  as
such, the Bank and the  Corporation are subject to the  supervision,  regulation
and examination of the Federal  Reserve.  As a Virginia state chartered bank the
Bank is also subject to supervision,  regulation and examination by the Virginia
State Corporation Commission.

         The   Corporation's   only  direct  subsidiary  is  the  Bank  and  the
Corporation has no material  assets or liabilities,  except for the stock of the
Bank.

         The  Corporation  operates  four full service and one express  facility
throughout Washington County and the City of Bristol, Virginia.

         The results of operations for the fiscal years ended December 31, 1996,
1995,  and 1994 ("fiscal year 1996",  "fiscal year 1995" and "fiscal year 1994",
respectively)  reflect the  Corporation's  strategies of expanding its community
banking operations.

         See "Management's  Discussion and Analysis" of operations and financial
condition, included as part of the Annual Report to Stockholders, for a detailed
discussion of certain aspects of the Corporation's business.

                               Lending Activities

Residential Mortgage Lending

         The Corporation's  lending policy is generally to lend up to 80% of the
appraised value of residential property.  The Corporation lends up to 95% of the
appraised value with the normal  requirement of insurance from private  mortgage
insurance  companies.  This insurance  normally  covers amounts in excess of 80%
loan to value up to 95%.
         The in-house  residential  mortgages  are  comprised of primarily  one,
three and five year adjustable  rate mortgages and a relatively  small number of
15 year fixed rate mortgages. Adjustable rate mortgages are indexed to 275 basis
points over the average yield on United States Treasury securities adjusted to a


                                       3
<PAGE>

constant  maturity  of  one,  three  or five  years.  An  adjustment  limitation
(increase  or  decrease)  of 2% per  annum  or 4% over  the  life of the loan is
included in the three and five year adjustable rate mortgages.
         The  corporation's   existing  loan  contracts  generally  provide  for
repayment  of  residential  mortgage  loans over  periods  ranging from 15 to 30
years.  However,  such loans normally have remained outstanding for much shorter
periods of time as borrowers refinance or prepay their loans through the sale of
their homes.
         Most of the Corporation's residential mortgage loans have "due on sale"
clauses  which allows the creditor the right to declare a loan  immediately  due
and payable in the event the borrower  sells or  otherwise  disposes of the real
property.  Most  of  the  Corporation's   residential  mortgage  loans  are  not
assumable.
         Mortgage  loans  exceeding  $450,000  but less  than  $750,000  must be
approved by the loan  committee  of the Board of  Directors.  Mortgage  loans in
excess of $750,000 must be approved by the Board of Directors.
         All  of  the   Corporation's   mortgage  lending  is  subject  to  loan
origination procedures established by the Board of Directors.  Most originations
require a property valuation by state licensed  appraisers,  for a fee, approved
by the Board of  Directors.  Loan  applications  are obtained to  determine  the
borrowers  ability to repay.  Significant  items are verified through the use of
credit reports, financial statements, etc.
         It is generally the Corporation's  policy to require title insurance on
first mortgage loans in excess of $100,000 (lower where deemed necessary). It is
also generally  policy to require an attorney's  opinion  statement on all first
mortgage  deeds of trust.  Fire and casualty  insurance  (extended  coverage) is
generally  required on all property serving as security for these loans.  Hazard
insurance and flood insurance (where required) is generally provided by customer
prior to closing of the loan. The borrower is generally  responsible  for paying
insurance premiums and real estate taxes.
         Federal  regulations  allow the  Corporation to originate loans on real
estate  within  the State of  Virginia,  and within  limits,  to  originate  and
purchase loans or loan participations secured by real estate located in any part
of the United States.  During fiscal year 1996 the Corporation's primary lending
area was Washington County and the City of Bristol, Virginia.
         Residential  loan  originations  come from many sources.  Some of these
sources include existing customers,  walk-in  applications,  referrals from real
estate brokers and others.
         Federal  regulation limits loans to one borrower to a maximum of 15% of
unimpaired capital and unimpaired surplus of the Bank.
         The Corporation  receives fees in addition to interest in connection
with real estate loan  originations,  loan  modifications,  late payments,  etc.
Income  from these  activities  varies from  period to period  depending  on the
volume  and  type  of loan  made.  Although  not a  significant  portion  of the
Corporation's  income,  late  charges are  received  when  monthly  payments are
delinquent but are later paid.
         The Corporation  also offers secondary market fixed rate mortgages with
terms up to 30 years and up to  95%loan  to  value.  These  loans and  servicing
rights  generally sold  immediately  into the secondary market and fees received
booked into income.  These loans must meet certain criteria generally set by the
secondary  market and are not a  significant  portion of the Bank's  residential
mortgage activity.
         Residential   mortgages  made  up  approximately  35.54%  of  the  loan
portfolio as of December 31, 1996.

Construction and Commercial Real Estate Lending

         The Corporation  generally makes  construction  loans for periods up to
one year on residential and commercial real estate property. These loans are for
interim  financing  and are either paid off or converted to permanent  financing
when  completed.  At December 31, 1996  outstanding  construction  loans (net of
undisbursed funds) totaled $2,382,000.  These loans are generally made at 80% or
less of  appraised  value at  completion.  Funds are  advanced as the project is
completed  after an inspection  by a staff  inspector or the appraiser as deemed
appropriate.  These loans are made based on established  corporate  underwriting
standards.  Most of these  construction  loans are one to four family dwellings.
The Corporation  generally  charges a 1% origination  fee on these  construction
loans in addition to applicable interest.
         Loans on commercial properties,  multi-family dwellings,  and apartment
buildings are typically made at 75% to 80% of the appraised  value.  These loans
totaled $42,207,000 or 27.13% of total loans held for investment at December 31,
1996.
         Commercial and construction loans, by nature, entail additional risk as
compared to residential  mortgage  lending.  They are generally more complex and
involve  larger  balances  than  typical  residential  mortgages.  Payments  are
typically  dependent upon successful  operation of a related real estate project
or business as compared to individual  earnings on most  residential  mortgages.
Therefore,  the market  risk is



                                       4
<PAGE>

somewhat  greater.  Construction  delays,  cost overruns or the inability of the
contractor to sell the finished product add an element of risk to such lending.

Consumer lending

         The Corporation  offers other types of loans in addition to real estate
mortgage and construction loans. Consumer loans of many types are offered by the
Corporation.  Some of these  loans are  loans to  purchase  automobiles,  boats,
recreational  vehicles and  manufactured  housing,  as well as other secured and
unsecured consumer loans. The Corporation further makes loans secured by savings
accounts at 2% above the rate of the savings instrument.  The terms generally do
not  exceed  ten years for  manufactured  housing  loans and five years on other
consumer   loans.   Outstanding   consumer  loans  at  December  31,  1996  were
$30,656,000.

Commercial and agriculture non-real estate loans

         The Corporation also makes commercial (including  agriculture) non-real
estate loans.  These loans in general have higher risk associated with them than
real estate loans. They are generally secured by inventory,  equipment, accounts
receivable,  etc.,  or unsecured in some cases backed by  appropriate  financial
condition  as per the  underwriting  standards of the  Corporation.  Agriculture
loans are generally secured by machinery,  equipment, other miscellaneous assets
or unsecured in keeping with the underwriting standards of the Corporation.  The
timely pay back is dependent  upon the  successful  operation of the business or
farm.  The  outstanding   balance  of  non-real  estate   commercial  loans  was
$20,370,000 at December 31, 1996 and the outstanding  balance of non-real estate
agriculture loans was $1,700,000 at December 31, 1996.

                                   Investments

Investment Securities

         The Corporation invests in mortgage-backed securities, agency notes and
bonds,  collateralized  mortgage  obligations  (CMO's),  municipal bonds, equity
securities and United States Treasury Notes.

         A  substantial  portion  of  the  mortgage-backed   security  portfolio
consists of securities  that are either insured or guaranteed by FHLMC,  FNMA or
GNMA.  Guaranteed  securities are more liquid than individual mortgage loans. At
December 31, 1996 the Corporation's  mortgage-backed  securities portfolio had a
carrying value of $22,645,000 or 10.90% of total assets  compared to $15,530,000
or  9.55%  of  total   assets  at  December  31,   1995.   Amortized   costs  of
mortgage-backed securities were $22,634,000 at December 31, 1996 and $15,582,000
for the  comparable  1995  period.  Due to  repayments  and  prepayments  of the
underlying  loans,  the actual  maturities  of  mortgage-backed  securities  are
expected to be substantially less than the scheduled maturities.

         The Corporation also holds  investments in CMO's with a market value at
December  31,  1996 of $498,000  and  amortized  cost of $506,000  compared to a
market value of $503,000 and amortized cost of $506,000 at December 31, 1995.

         The Corporation  had $998,000 and $2,988,000  invested in United States
Treasury  Notes at December 31, 1996 and 1995  respectively.  These  investments
represented approximately .48% and 1.84% of total assets at those dates.

         The   Corporation  had  $3,643,000  and  $8,140,000  in  United  States
Government-sponsored   Agency   Obligations   at  December  31,  1996  and  1995
respectively. These investments represent approximately 1.67% and 5.01% of total
assets at those dates.

         The Corporation holds the following equity investments: Federal Reserve
Bank  Stock  of  $246,000  and  $245,000  as  of  December  31,  1996  and  1995
respectively; Federal Home Loan Bank Stock of $560,000 and $470,000 for the same
dates as above; and Virginia  Bankers' Bank Stock of $55,000 and $44,000 for the
same dates as above.


                                       5
<PAGE>

         The Corporation also holds investments in municipal bonds of $1,031,000
and $1,407,000 as of December 31, 1996 and 1995 respectively.  These investments
represented approximately 0.50% and 0.87% of total assets at those dates.

Investment Activities

         Under  Federal  Reserve  regulations,  the Bank is required to maintain
certain  liquidity  ratios and does so by investing in certain  obligations  and
other   securities   which  qualify  as  liquid  assets  under  Federal  Reserve
regulations. See "Regulation".  As a state chartered bank, the Bank's investment
authority  is limited by federal law which  permits  investment  in, among other
things,  certain  certificates  of deposit issued by commercial  bank,  banker's
acceptances,  loans  to  commercial  banks  for  Federal  Funds,  United  States
government and agency obligations of state governments, and corporate bonds.

         The Corporation's  investment committee,  which meets monthly,  follows
Federal Reserve guidelines with respect to portfolio  investment and accounting.
Such Federal Reserve guidelines state that insured institutions must account for
securities held for investment, sale and/or trading in accordance with generally
accepted accounting  principles.  The Corporation maintains a written investment
policy to set forth investment  portfolio  composition and investment  strategy.
The investment portfolio composition policy considers,  among other factors, the
financial  condition of the  institution,  the types of  securities,  amounts of
investments  in  those  securities  and  safety  and  soundness   considerations
pertaining to the institution.  The investment strategy  considers,  among other
factors, interest rate risk, anticipated maturity of each type of investment and
the intent of the institution with respect to each investment.

                                Sources of Funds

General

         Deposit  accounts have  traditionally  been the principal source of the
Corporation's  funds for use in lending and for other general business purposes.
In addition to deposits,  the  Corporation  derives funds from loan  repayments,
FHLB  advances  and  loan  participation  sales.  Borrowings  may be  used  on a
short-term  basis to compensate for seasonal or other  reductions in deposits or
inflows  at less than  projected  levels,  as well as on a longer  term basis to
support expanded lending activities.

Deposit Activities

         The Corporation, in its continuing effort to remain a competitive force
in  its  markets,  offers  a wide  variety  of  deposit  services,  with  varied
maturities,  minimum-balance  requirements and  market-sensitive  interest rates
that are  attractive  to all  types of  depositors.  The  Corporation's  deposit
products include checking  accounts,  passbook  savings  accounts,  money market
deposit  accounts,   negotiable  orders  o  f  withdrawal  accounts,  individual
retirement  accounts and  certificates of deposit  accounts.  The Corporation is
able to offer a broad array of products that are consistent with current Federal
Reserve regulations,  and as a major result, the Corporation's deposit portfolio
is, for the most part, sensitive to general market fluctuations.



                                       6
<PAGE>

The  following  table sets forth the various  types of  accounts  offered by the
Corporation at December 31, 1996:

<TABLE>
<CAPTION>

                            Weighted
                            Average               Minimum         Amount
                            Interest              Balance         In                % of
Type of Account             Rate      Term        Deposit         Thousands         Total
---------------             ----      ----        -------         ---------         -----

<S>                          <C>      <C>       <C>               <C>               <C>
Checking Account             0.00%    none      $   100.00        $ 26,003          13.72%
Interest Checking            3.48     none          100.00           7,857           4.15
Passbook Accounts 4.01                none           25.00          21,911          11.57
Money Market
    Deposit Accounts         3.76     none          500.00           5,522           2.91
Christmas Club Accts         4.02     none            5.00              19           0.01
Individual Retirement
    Accounts                 6.57     various       500.00          17,019           8.98
Certificates of Deposit
    Accounts                 5.78     various       500.00         111,140          58.66
                                                                   -------          -----

Totals                                                            $189,471         100.00%
                                                                  --------         ------

</TABLE>

         The  variety of deposit  accounts  offered by the  Corporation  and the
competitive rates paid on these deposit accounts has increased the Corporation's
ability  to  retain  deposits  and  has  allowed  it to be more  competitive  in
obtaining new funds, reducing the threat of disintermediation (the flow of funds
away  from  deposit   institutions  into  direct  investment  vehicles  such  as
government  and  corporate  securities).  As  customers  have  become  more rate
conscious and willing to move funds to higher yielding accounts,  the ability of
the Corporation to attract and maintain deposits and the  Corporation's  cost of
funds have been, and will continue to be, significantly affected by money market
conditions.

         The   following   table  sets  forth   information   relating   to  the
Corporation's deposits flows during the years indicated.

                                              Years Ended December 31
(In Thousands)                               1996           1995           1994
--------------                               -----          ----           ----

Increase (decrease) in deposits before
   interest credited                         $35,813       $25,086       $19,107
Interest credited                              6,331         4,927         3,354
                                             -------       -------       -------

Net increase in deposits                      42,144        30,013        22,461
                                             -------       -------       -------

Total deposits at year end                  $189,471      $147,327      $117,314
                                             -------       -------       -------


Borrowings

         The  Corporation may obtain advances from the FHLB upon the security of
the  capital  stock it owns in the bank and certain of its home  mortgage  loans
provided  certain  standards  related to  creditworthiness  have been met.  Such
advances may be made pursuant to several different credit programs.  Each credit
program  has  its own  interest  rate  and  range  of  maturities  and the  FHLB
prescribes  the acceptable  uses to which the advances  pursuant to each program
may be used, as well as limitations  on the size of such advances.  Depending on
the program,  such  limitations  are based either on a fixed  percentage  of the
Corporation's  net  worth  or on the  FHLB's  assessment  of  the  Corporation's
creditworthiness.  The FHLB is  required  to review its credit  limitations  and
standards  at least once every six  months.  FHLB  advances  have from time been
available to meet  seasonal  and other  withdrawals  of savings  accounts and to
expand lending.


                                       7
<PAGE>

         The Bank also has established credit  arrangements with several of it's
correspondent banks. At December 31, 1996 the Bank had approximately $48,942,000
of unused lines of credit,  including  FHLB unused lines of credit,  to fund any
necessary cash requirements.

         The  following   table  sets  forth  certain   information  as  to  the
Corporation's advances and other borrowings at the dates indicated.  See Notes 8
and 14 to the Consolidated Financial Statements,  included as part of the Annual
Report  to  Stockholders,  for  information  as to  rates,  maturities,  average
balances and maximum amounts outstanding.

                                                        December 31
(In Thousands)                                  1996           1995        1994
--------------                                  ----           ----        ----

Advances from FHLB                              $1,929        $1,000       $-0-
Other borrowings                                   -0-           -0-        725
                                                ------        ------       ----
          Total borrowings                      $1,929        $1,000       $725

                                    Employees

         The Corporation at December 31, 1996, had 103 full time employees. None
of these  employees are represented by a collective  agent,  and the Corporation
believes its employee relations are excellent.

                                   Competition

         The Corporation encounters competition for both deposits and loans. For
deposits,  competition  comes  from other  commercial  banks,  savings  and loan
associations  and/or savings banks, mutual money market funds, credit unions and
various other corporate and financial institutions.  Competition also comes from
interest  paying  obligations  issued by various levels of government and from a
variety of securities paying dividends or interest.  Competition for loans comes
primarily from other  commercial  banks,  savings and loan  associations  and/or
savings  banks,  insurance  companies,  mortgage  companies  and  other  lending
institutions.

                                  Subsidiaries

         The  Corporation  was  incorporated in Virginia in 1995 to serve as the
holding  company for the Bank. The Bank is a state chartered bank with principal
offices in Abingdon,  Virginia. The Bank was incorporated in 1985 under the laws
of the Commonwealth of Virginia.

                          Federal Home Loan Bank System

         The Bank is a member  of the  Federal  Home  Loan  Bank  System,  which
consists of 12 regional  Federal  Home Loan  Banks.  The Federal  Home Loan Bank
System is regulated by the Federal Housing  Finance Board ("FHFB").  The FHFB is
composed  of  five  members,  including  the  Secretary  of  Housing  and  Urban
Development and four private citizens appointed by the President with the advice
and consent of the Senate for terms of seven years.  At least one director  must
be chosen from  organizations  with more than a two-year history of representing
consumer or community  interests on banking services,  credit needs,  housing or
financial consumer protections.

         The Bank,  as a member of the FHLB of Atlanta,  is required to purchase
and  maintain  stock in its bank in an amount as if 30 percent  of the  member's
assets were home mortgage loans.

         The FHFB is required to adopt  regulations  establishing  standards  of
community  investment or service for members of the Federal Home Loan Banks as a
condition for continued  access to advances.  The  regulations  are to take into
account  the  record of  performance  of the  institution  under  the  Community
Reinvestment Act of 1977 and its record of lending to first time home buyers.

         In  addition,  new  collateral  requirements  for  advances  are  to be
established which will be designed to insure credit quality and marketability of
the collateral.

                                        8
<PAGE>


                                   Regulation
General

         The  Corporation  and it's  subsidiary are subject to the  supervision,
regulation and  examination of the Federal  Reserve Board,  the Federal  Deposit
Insurance  Corporation and the state  regulators of the Commonwealth of Virginia
which has jurisdiction over financial  institutions and has obtained  regulatory
approval for it's various activities to the extent required.

Federal and State Laws and Regulations

         Bank  holding  companies  and banks  are  extensively  regulated  under
federal and state law. To the extent that the  following  information  describes
statutory  and  regulatory  provisions,  it is  qualified  in it's  entirety  by
reference to such  statutes and  regulations.  Any change in  applicable  law or
regulation  may have a material  effect on the business of the  Corporation  and
it's subsidiary.

Bank Holding Company Regulation

         The  Corporation  is registered  as a "bank  holding  company" with the
Board of Governors of the Federal  Reserve System  ("Federal  Reserve"),  and is
subject to supervision by the Federal Reserve under the Bank Holding Corporation
Act ("BHC Act").  The  Corporation is required to file with the Federal  Reserve
periodic  reports and such  additional  information  as the Federal  Reserve may
require  pursuant to the BHC Act. The Federal  Reserve  examines the Corporation
and the subsidiary bank.

         The BHC Act requires  prior Federal  Reserve  approval for, among other
things,  the  acquisition  by a bank  holding  company  of  direct  or  indirect
ownership or control of more than 5% of the voting shares or  substantially  all
of the assets of any bank,  or for a merger or  consolidation  of a bank holding
company with another bank holding company. With certain exceptions,  the BHC Act
prohibits a bank holding company from acquiring direct or indirect  ownership or
control of the voting  shares of any company which is not a bank or bank holding
company and from  engaging  directly or  indirectly  in any activity  other than
banking  or  managing  or  controlling  banks or  performing  services  for it's
authorized  subsidiaries.  A bank  holding  company may,  however,  engage in or
acquire an interest in a company  that engages in  activities  which the Federal
Reserve  has  determined  by  regulation  or order to be so  closely  related to
banking or managing or controlling banks as to be a proper incident thereto.

Bank Regulation

         The Bank, as a state chartered  member of the Federal Reserve  Systems,
is subject to  regulation  and  examination  by the Virginia  State  Corporation
Commission and the Federal  Reserve Board.  In addition,  the Bank is subject to
the rules and regulations of the Federal Deposit  Insurance  Corporation,  which
currently  insures the deposits of each member bank to a maximum of $100,000 per
depositor.

         The commercial  banking  business is affected by the monetary  policies
adopted by the Federal  Reserve  Board.  Changes in the discount  rate on member
bank borrowings, availability of borrowing at the "discount window", open market
operations, the imposition of any changes in reserve requirements against member
banks' deposits and certain  borrowings by banks and their  affiliates,  and the
limitation of interest  rates which member banks may pay on deposits are some of
the instruments of monetary policy available to the Federal Reserve Board. Taken
together,  these controls give the Board a significant influence over the growth
and profitability of all banks.  Management of the Bank is unable to predict how
the Board's  monetary  policies  (or the fiscal  policies  or economic  controls
imposed by Federal or state  governments)  will affect the business and earnings
of the Bank or the Corporation, or what those policies or controls will be.

         The references in this section to various  aspects of  supervision  and
regulation are brief summaries which do not purport to be complete and which are
qualified  in  their  entirety  by  reference  to  applicable  laws,  rules  and
regulations.



                                       9
<PAGE>


Federal Deposit Insurance Corporation Improvement Act

         The  difficulties  encountered  nationwide  by  financial  institutions
during 1990 and 1991 prompted federal legislation designed to reform the banking
industry  and to  promote  the  viability  of the  industry  and of the  deposit
insurance system. The Federal Deposit Insurance  Corporation  Improvement Act of
1991  ("FDICIA"),  which became  effective  on December  19, 1991,  bolsters the
deposit insurance fund,  tightens bank and thrift regulation and trims the scope
of federal deposit insurance as summarized below.

         FDICIA requires each federal banking regulatory agency to prescribe, by
regulation,  standards for all insured  depository  institutions  and depository
institution  holding companies  relating to (i) internal  controls,  information
systems and audit systems;  (ii) loan documentation;  (iii) credit underwriting;
(iv)  interest rate  exposure;  (v) asset growth;  (vi)  compensation,  fees and
benefits;  and (vii) such other  operational  and  managerial  standards  as the
agency determines to be appropriate.  The compensation  standards would prohibit
employment contracts,  compensation or benefit arrangements, stock option plans,
fee  arrangements  or other  compensatory  arrangements  that provide  excessive
compensation,  fees or  benefits or could lead to material  financial  loss.  In
addition,  each federal banking  regulatory  agency must prescribe by regulation
standards specifying (i) a maximum ration of classified assets to capital;  (ii)
minimum earnings sufficient to absorb losses without impairing capital; (iii) to
the extent feasible,  a minimum ratio of market value to book value for publicly
traded shares of depository  institutions  and  depository  institution  holding
companies; and (iv) such other standards relating to asset quality, earnings and
valuation as the agency determines to be appropriate.  If an insured institution
fails  to  meet  any of the  standards  promulgated  by  regulation,  then  such
institution will be required to submit a plan to its federal  regulatory  agency
specifying the steps it will take to correct the deficiency.

         Prompt  corrective  action measures  adopted in FDICIA and which became
effective  on  December  19,  1992,  impose  significant  new  restrictions  and
requirements on depository  institutions that fail to meet their minimum capital
requirements.  Under new Section 38 of the Federal  Deposit  Insurance Act ("FDI
Act"), the federal banking  regulatory  agencies have developed a classification
system pursuant to which all depository institutions are placed into one of five
categories based on their capital levels and other  supervisory  criteria:  well
capitalized,    adequately    capitalized;    undercapitalized;    significantly
undercapitalized; and critically undercapitalized.

         The Bank exceeded all of its regulatory  capital  requirements  and met
the  requirements  at December 31, 1996 to be classified as "well  capitalized".
This classification is determined solely for the purposes of applying the prompt
corrective action regulations and may not constitute an accurate  representation
of the Corporation's overall financial condition.

         An  undercapitalized  depository  institution  is  required to submit a
capital restoration plan to its principal federal regulator. The federal banking
agencies may not accept a capital plan without determining,  among other things,
that the plan is based on  realistic  assumptions  and is likely to  succeed  in
restoring the depository  institution's  capital and is guaranteed by the parent
holding company. If a depository institution fails to submit an acceptable plan,
it will be treated as if it were significantly undercapitalized.

         Unless its principal  federal  regulator has accepted its capital plan,
an  undercapitalized  bank may not  increase  its  average  total  assets in any
calendar quarter.  If an  undercapitalized  institution's  capital plan has been
accepted, asset growth will be permissible only if the growth is consistent with
the plan and the  institution's  ratio of  tangible  equity to assets  increases
during the quarter at a rate  sufficient  to enable the  institutions  to become
adequately capitalized within a reasonable time.

         An institution  that is  undercapitalized  may not solicit  deposits by
offering  rates of interest that are  significantly  higher than the  prevailing
rates on insured  deposits in the  institution's  normal  market areas or in the
market area in which the deposits would otherwise be accepted.

         An  undercapitalized  may not  branch,  acquire an  interest in another
business or institution or enter a new line of business  unless its capital plan
has been  accepted and its  principal  federal  regulator  approves the proposed
action.

                                       10
<PAGE>

         An insured  depository  institution  may not pay management fees to any
person having control of the institution  nor may an  institution,  except under
certain  circumstances  and with prior  regulatory  approval,  make any  capital
distribution  if,  after making such payment or  distribution,  the  institution
would be undercapitalized.

         Significantly  undercapitalized  depository institutions may be subject
to  a  number  of  requirements  and  restrictions,  including  orders  to  sell
sufficient voting stock to become adequately capitalized, requirements to reduce
total assets and  cessation  of receipt of deposits  from  correspondent  banks.
Critically  undercapitalized  institutions  are  subject  to  appointment  of  a
receiver or conservator.

         If its  principal  federal  regulator  determines  that  an  adequately
capitalized  institution is in an unsafe or unsound  condition or is engaging in
an unsafe or  unsound  practice,  it may  require  the  institution  to submit a
corrective action plan,  restrict its asset growth and prohibit  branching,  new
acquisitions  and new lines of  business.  An  institution's  principal  federal
regulator  may deem it to be  engaging in an unsafe or unsound  practices  if it
receives a less than satisfactory rating for asset quality, management, earnings
or liquidity in its most recent examination.

         In addition, regulators must draft a new set of non-capital measures of
bank safety, such as loan underwriting standards and minimum earnings levels, to
take effect  December 1, 1993.  The  legislation  also  requires  regulators  to
perform annual on-site bank examinations, place limits on real estate lending by
banks and tightens auditing requirements.

                           Federal And State Taxation

General

         The following  discussion  of federal  taxation is a summary of certain
pertinent  federal income tax matters as they pertain to the  Corporation.  With
some  exceptions,  including  particularly  the reserve for bad debts  discussed
below,  the  Corporation  is subject to  federal  income tax under the  Internal
Revenue  Code  of  1986  (the  "Code")  in the  same  general  manner  as  other
corporations.

Bad Debt Reserves

         Commercial  banks  such as the Bank,  which meet  certain  definitional
tests primarily relating to their assets and the nature of their businesses, are
permitted to  establish a reserve for bad debts and to make annual  additions to
the reserve.  These additions,  may within specified formula limits, be deducted
in  arriving  at the Bank's  taxable  income.  For  purposes  of  computing  the
deductible  addition to its bad debt reserve,  the Bank utilizes the  experience
method.

         Under the  experience  method,  the deductible  annual  addition is the
amount  necessary  to  increase  the  balance of the reserve at the close of the
taxable  year to the  greater  of (1) the amount  which  bears the same ratio to
loans  outstanding  at the close of the taxable  year as the total net bad debts
sustained during the current and five preceding taxable years to bear to the sum
of the loans outstanding at the close of those six years or (2) the lower of (a)
the balance in the reserve  account at the close of the last  taxable year prior
to the most recent adoption of the experience  method (the base year is the last
taxable year beginning  before 1988), or (b) if the amount of loans  outstanding
at the close of the taxable year is less than the amount of loans outstanding at
the close of the base  year,  the  amount  which  bears the same  ratio to loans
outstanding  at the close of the  taxable  year as the balance of the reserve at
the close of the base year bears to the amount of loans outstanding at the close
of the base year.
         The  experience  and  percentage  of  taxable  income  methods  are not
available after fiscal year 1996; instead, bad debts after fiscal year 1996 will
be deductible at the time they are charged-off.

Minimum Tax

         A 20% corporate  alternative minimum tax generally will apply to a base
of regular  taxable income plus certain tax  preferences  ("alternative  minimum
taxable  income"  or "AMTI")  and will be payable to the extent  such AMTI is in
excess of an exemption amount.  The Code provides that an item of tax preference
is the  excess of the bad debt  deduction  over the amount  allowable  under the
experience  method.  The other  items of tax  preference  that  constitute  AMTI
include (a) tax-exempt interest on newly-issued  (generally,



                                       11
<PAGE>

issued on or after  August 8, 1986)  private  activity  bonds other than certain
qualified  bonds  and  (b) 75% of the  excess  (if  any) of (i) 75% of  adjusted
current  earnings  as defined in the Code,  over (ii) AMTI  (determined  without
regard to this preference and prior to reduction by net operating losses).

Other

         For federal income tax purposes, the Corporation reports its income and
expenses  on the  accrual  basis  method of  accounting  and uses a year  ending
December 31 for filing its income tax returns.  The  Corporation  may carry back
net  operating  losses to the  preceding  three taxable years and forward to the
succeeding fifteen taxable years.

         The  Commonwealth  of  Virginia  imposes an income tax on  corporations
domiciled  in the state.  The  Virginia  taxable  income is based on the federal
taxable  income with certain  adjustments  for  interest and dividend  income on
obligations  of securities of the United States and states other than  Virginia.
The tax rate is 6% of taxable income.

         See Note 9 to the Consolidated  Financial Statements,  included as part
of the Annual Report to Stockholders,  for additional  information regarding the
income taxes of the Company.


Distribution of Assets, Liabilities and Shareholders' Equity; Interest Rates and
Interest Differential

<TABLE>
<CAPTION>

                                                        Year Ended December 31,
                                        1996                               1995                      1994
                                                          (Dollars in Thousands)
                          Average                Yield/  Average               Yield/   Average              Yield/
                          Balance  Interest      Rate    Balance   Interest     Rate    Balance    Interest   Rate
                          -------  --------      ----    -------   --------     ----    -------    --------   ----
<S>                      <C>        <C>          <C>    <C>        <C>          <C>    <C>        <C>         <C>
     ASSETS
Interest earning assets
 (taxable-equivalent
  basis (1) :

Loans (net of un-
  earned discount) (2)   $131,449   $12,310      9.36%  $102,216   $ 9,590      9.38%  $ 78,590   $6,765      8.61%
Securities (3)             34,350     2,082      6.06     30,079     1,793      5.96     29,643    1,584      5.34
Federal funds sold          3,822       204      5.34      3,686       202      5.48     2,099       76       3.62
                            -----       ---      ----      -----       ---      ----     -----       --       ----

Total interest-earning
  assets                 $169,621   $14,596      8.61%  $135,981   $11,585      8.52%  $110,332   $8,425      7.64%
                         --------   -------      ----   --------   -------      ----   --------   ------      ----

     LIABILITIES

Interest-bearing
  liabilities :

Savings & time dep.      $142,331   $ 7,714      5.42%  $113,215   $ 6,086      5.38%  $ 91,032   $3,967      4.36%
Other interest-bearing      1,803       108      5.99      1,198        75      6.34        390       18      4.62
                            -----       ---      ----      -----        --      ----        ---       --      ----
  liabilities

Total interest-bearing
  liabilities            $144,134   $ 7,822      5.43%  $114,413   $ 6,161      5.38%  $ 91,422   $3,985      4.36%
                         --------   -------      ----   --------   -------      ----   --------   ------      ----

Net interest income                 $ 6,774                        $ 5,424                        $4,440
Net margin on int.
  earning assets on a
  tax equivalent basis                           3.99%                          3.99%                         4.02%
Average interest
  spread                                         3.18%                          3.14%                         3.28%


</TABLE>


(1)  Tax equivalent  adjustments (using 34% federal tax rates) have been made in
     calculating  yields on tax-free loans and  investments.  Virginia banks are
     exempt from state income tax.
(2)  For the purposes of these  computations, non-accruing loans are included in
     the daily  average loan amounts  outstanding.
(3)  The yield on  securities classified as available for sale is computed based
     on the average balance of the historical amortized cost balance without the
     effects of the fair value adjustment required by FAS115

                                       12
<PAGE>



         As the largest component of income,  net interest income represents the
amount  that  interest  and fees  earned on loans and  investments  exceeds  the
interest  costs of funds used to support  these  earning  assets.  Net  interest
income is determined by the relative levels, rates and mix of earning assets and
interest-bearing  liabilities.  The following  table  attributes  changes in net
interest  income  either to changes in average  volume or to changes in interest
due to both rate and volume  has been  allocated  to volume and rate  changes in
proportion to the  relationship  of the absolute dollar amounts of the change in
each.

<TABLE>
<CAPTION>

                                                1996 Compared to 1995                          1995 Compared to 1994

                                    Increase          Increase                       Increase        Increase
                                 (decrease) due   (decrease) due                   (decrease) due (decrease) due
                                   to change in     to change in     Net increase   to change in   to change in        Net increase
Increase (Decrease) in              volume              rate          (decrease)       volume           rate            (decrease)
----------------------              ------              ----          ----------       ------           ----            ----------

<S>                                 <C>                <C>             <C>              <C>          <C>               <C>
INTEREST INCOME
Securities....................      $   288            $     1         $     289            25       $     184          $     209
Federal funds sold............            7                 (5)                2            57              69                126
Loans.........................        2,742                (22)            2,720         2,034             791              2,825
                                    -------            -------         ---------         -----       ---------          ---------

Total Income Change                 $ 3,037            $   (26)        $   3,011         2,116       $   1,044          $   3,160
                                    -------            -------         ---------         -----       ---------          ---------



INTEREST EXPENSE
Savings and time
   deposits...................      $ 1,566            $    62         $   1,628           967       $   1,152          $   2,119
Other interest-bearing
   liabilities................           38                 (5)               33            37              20                 57
                                    -------            -------         ---------         -----       ---------          ---------

Total Expense Change                $ 1,604            $    57         $   1,661         1,004       $   1,172          $   2,176
                                    -------            -------         ---------         -----       ---------          ---------

Increase (Decrease) in
   Net Interest Income              $ 1,433            $   (83)        $   1,350         1,112       $    (128)         $    $984
                                    -------            -------         ---------         -----       ---------          ---------
</TABLE>


Investment Portfolio

         The following table presents the maturity  distribution,  market value,
book value and approximate  tax equivalent  yield (assuming a 34% federal income
tax rate) of the investment portfolio at December 31, 1996.

                             (Dollars in Thousands)
<TABLE>
<CAPTION>
                           One Year   Five Years
               Within One  Through      Through     After Ten                Total Book       Market
                   Year   Five Years   Ten Years      Years         Yield        Value         Value
                   ----   ----------   ---------      -----         -----        -----         -----

<S>               <C>         <C>         <C>         <C>            <C>        <C>           <C>
U.S.T.N.'s        $  500      $  498      $  -0-      $   -0-        5.08%      $ 1,003       $   998
U.S. Gov Agency    1,246       5,863       1,184       20,162        5.70        28,505        28,455
State & Muni's        65         148         818          -0-        6.99         1,004         1,031
Other                -0-         -0-         -0-          861        6.75           861           861
                  ------      ------      ------      -------     -------       -------       -------
TOTAL             $1,811      $6,509      $2,002      $21,023        6.06       $31,373       $31,345
                  ------      ------      ------      -------     -------       -------       -------
</TABLE>




                                       13
<PAGE>

Loan Portfolio

         The table below  classifies  loans,  net of unearned  income,  by major
category and percentage  distribution  at December 31, 1996 for each of the past
three years:

<TABLE>
<CAPTION>

                                  December 31,
                             (Dollars in thousands)

                      1996                      1995                     1994

Description     Amount    Percentage      Amount     Percentage     Amount     Percentage
-----------     ------    ----------      ------     ----------     ------     ----------
<S>           <C>            <C>         <C>            <C>         <C>            <C>
Commercial    $ 20,365       13.14%      $ 12,699       11.16%      $ 8,538        9.11%
Real Estate   $101,491       65.50         76,516       67.27        62,903       67.11
Consumer        30,128       19.44         21,785       19.15        20,131       21.47
Other            2,967        1.92          2,743        2.41         2,166        2.31
                 -----        ----          -----        ----         -----        ----

Total         $154,951      100.00%      $113,743      100.00%      $93,738      100.00%
              --------      ------       --------      ------       -------      ------
</TABLE>

         The  following  table  shows the  maturity of loans  outstanding  as of
December 31, 1996.  Also provided are the amounts due after one year  classified
according to the sensitivity to changes in interest rates.  Loans are classified
based upon the period in which the final payment is due.

                               December 31, 1996
                             (Dollars in Thousands)

<TABLE>
<CAPTION>

              Fixed       Floating   Fixed   Floating    Fixed    Floating
               Rate         Rate      Rate     Rate       Rate      Rate      Total
               ----         ----      ----     ----       ----      ----      -----
<S>          <C>       <C>           <C>       <C>       <C>       <C> <C>  <C>
Commercial   $ 9,355   $     8,148   $ 2,459   $    42   $   361   $  -0-   $  20,365
Real Estate    6,305        36,046    37,160    11,403    10,577      -0-     101,491
Consumer       9,580           -0-    20,081       -0-       467      -0-      30,128
Other            -0-         2,967       -0-       -0-       -0-      -0-       2,967
             -------   -----------   -------   -------   -------     ----   ---------
Total        $25,240   $    47,161   $59,700   $11,445   $11,405   $  -0-   $ 154,951
             -------   -----------   -------   -------   -------     ----   ---------
</TABLE>


Non-performing loans

         The loan portfolio of the Bank is reviewed regularly by senior officers
to evaluate loan  performance.  The frequency of the review is based on a rating
of credit  worthiness  of the  borrower  utilizing  various  factors such as net
worth, credit history,  customer  relationship,  etc. The evaluations  emphasize
different factors  depending upon the type of loan involved.  The commercial and
real estate type loans are  reviewed on the basis of  estimated  net  realizable
value  through an evaluation  of  collateral  and the financial  strength of the
borrower.  Installment  loans are evaluated  largely on the basis of delinquency
data because of the large number of such loans and relatively small size of each
individual loan.
         Management  review  of  commercial  and  other  loans  may  result in a
determination  that a loan should be placed on a non-accrual of interest  basis.
It is the policy of the Bank to discontinue  the accrual of interest on any loan
on which  full  collectability  of  principal  and / or  interest  is  doubtful.
Subsequent  collection  of interest is recognized as income on a cash basis upon
receipt.  Placing  a loan on  non-accrual  status  for  the  purpose  of  income
recognition  is not in  itself  a  reliable  indication  of  potential  loss  of
principal.  Other factors, such as the value of the collateral securing the loan
and the financial condition of the borrower,  serve as more reliable indications
of potential loss of principal.
         The policy of the Bank is that  non-performing  loans  consist of loans
accounted for on a non-accrual basis and loans which are contractually  past due
90 days or more in regards to interest  and/ or  principal  payments.  As of the
three periods ended December 31, 1996, 1995 and 1994, non-accrual loans amounted
to $96,000, $235,000 and $0, respectively.

Summary of Loan Loss Experience

         The  allowance  for loan losses is increased by the  provision for loan
losses and reduced by loans  charged off net of  recoveries.  The  allowance for
loan losses is established  and maintained at a level judged by management to be
adequate to cover any  anticipated  loan losses to be incurred in the collection
of


                                       14
<PAGE>


outstanding  loans.  In determining the adequate level of the allowance for loan
losses,  management  considers the following factors:  (a) loan loss experience;
(b)  problem  loans,  including  loans  judged to exhibit  potential  charge-off
characteristics, loans on which interest is no longer being accrued, loans which
are past due and loans which have been classified in the most recent  regulatory
examination;  and (c) anticipated  economic  conditions and the potential impact
these conditions may have on individual classifications of borrowers.

         The following table presents the Corporation's loan loss experience for
the past three years:

                            Years Ended December 31,
                             (Dollars in Thousands)

<TABLE>
<CAPTION>

                                                  1996       1995        1994
                                               ---------   ---------  --------
<S>                                            <C>         <C>         <C>
Allowance for loan losses at
 beginning of year                             $    908    $    836    $   782
Loans charged off:
    Commercial                                      170          19         58
    Real Estate                                     -0-         122        -0-
    Consumer                                         85          47         29
    Other                                           -0-         -0-        -0-
                                               --------    --------    -------
    Total                                      $    255    $    188    $    87
                                               --------    --------    -------

Recoveries of loans previously charged off:
    Commercial                                 $     32         -0-         11
    Real Estate                                     -0-         106        -0-
    Consumer                                         13          11         10
    Other                                           -0-         -0-        -0-
                                               --------    --------    -------
    Total                                      $     45    $    117    $    21
                                               --------    --------    -------
Net loans charged off                          $    210    $     71    $    66
Provision for loan losses                           374         143        120
                                               --------    --------    -------
Allowance for loan losses end of year          $  1,072    $    908    $   836
                                               --------    --------    -------
Average total loans (net of unearned income)   $131,449    $103,069    $79,400
Total loans (net of unearned income)
  at year-end                                  $154,951    $113,722    $93,738

Ratio of net charge-offs to average loans           0.160%      0.069%     0.083%
Ratio of provision for loan losses to
  average loans                                     0.285%      0.140%     0.150%
Ratio of provision for loan losses to
  pet charge-off                                  178.100%    201.410%   181.820%
Allowance for loan losses to year-end loans         0.690%      0.880%     0.890%
</TABLE>


                                       15
<PAGE>

Allocation of the allowance for loan losses

         The  following  table  provides an allocation of the allowance for loan
losses as of December 31, 1996:

                          Year Ended December 31, 1996
                       Percent of Loans on each category

                             (Dollars in Thousands)


                   Allowance for    Percentage of   Percentage of
                     Loan Loss     Total Loan Loss   Total Loans
                  -------------    ---------------  ------------
Commercial              $ 451          42.07%           13.09%
Real Estate               162          15.13            65.29
Consumer                  404          37.69            19.71
Other                       6           0.58             1.91
Unallocated                41           4.53             0.00
                      -------         -------         -------
Total                 $ 1,072         100.00%          100.00
                      -------         -------         -------




Deposits

         The following table provides a breakdown of deposits at December 31 for
the years indicated is as follows:

                                                      December 31,
                                                 (Dollars in Thousands)

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

Non-interest bearing demand deposits       $  26,002   $  20,203    $  16,152
Interest bearing demand deposits              13,379      11,665       11,436
Savings deposits                              21,930      17,010       18,220
Time deposits                                128,160      98,349       71,506
                                           ---------   ---------    ---------
Total Deposits                             $ 189,471   $ 147,327    $ 117,314
                                           ---------   ---------    ---------


         The average daily amount of deposits and rates paid on such deposits is
summarized for the periods indicated in the following table:


<TABLE>
<CAPTION>

                                               Year Ended December 31,
                                               (Dollars in Thousands)

                                  1996                  1995                   1994

                           Amount       Rate     Amount        Rate     Amount         Rate
                           ------       ----     ------        ----     ------         ----

<S>                       <C>           <C>     <C>            <C>     <C>             <C>
Non-interest bearing
 demand deposits          $ 22,569      0.00%   $ 17,410       0.00%   $ 14,218        0.00%
Interest-bearing demand
 deposits                   12,566      3.60      11,294       3.64      10,673        3.42
Savings deposits            20,516      4.01      16,950       4.48      20,907        3.63
Time deposits              109,246      5.89      84,898       5.89      59,454        4.80
                           -------                ------                 ------

Total                     $164,897              $130,552               $105,252
                          --------              --------               --------
</TABLE>


                                       16
<PAGE>



         The  remaining  maturities of time deposits at December 31, 1996 are as
follows (in thousands) :

         Maturity

         3 months or less.............................$  28,128
         Over 3 through 12 months.....................   61,171
         Over 12 months...............................   38,861
                                                         ------

              Total                                    $128,160
                                                       --------

Interest Rate Sensitivity Analysis

         The following  table provides the maturities of investment  securities,
loans,  and  deposits as of December 31,  1996,  and measures the interest  rate
sensitivity gap for each range of maturity indicated:

<TABLE>
<CAPTION>

                                December 31 1996
                             (Dollars in Thousands)
                                    Maturing

                                        Within One      After One But       After Five
                                           Year       Within Five Years        Years          Total
                                           ----       -----------------        -----          -----

<S>                                     <C>                <C>                <C>           <C>
ASSETS

  Investment Securities                 $  22,726          $  6,114           $ 2,534       $  31,374
  Loans                                    90,128            58,109             5,642         153,879
  Other Assets                             15,822               -0-             6,664          22,486
                                        ---------          --------          --------       ---------
Total Assets                            $ 128,676          $ 64,223          $ 14,840       $ 207,739
                                        ---------          --------          --------       ---------
LIABILITIES AND SHARE-
  HOLDERS' EQUITY

  Demand Deposits Non-interest          $  17,677          $  8,557          $    -0-       $  26,234
  All Interest-bearing Deposits           103,607            57,780             2,098         163,485
  Other Liabilities                            71               -0-             3,332           4,003
  Shareholders' Equity                        -0-               -0-            14,617          14,617
                                        ---------          --------          --------       ---------
Total Liabilities and Shareholders'
  Equity                                $ 121,355          $ 66,337          $ 20,047       $ 207,739
                                        ---------          --------          --------       ---------
Interest Rate Sensitivity GAP           $   7,321          $ (2,114)         $ (5,207)      $     -0-

</TABLE>





Return on Equity and Assets

         The  following  table   highlights   certain  ratios  for  the  periods
indicated:

                                                  Year Ended December 31,
                                                        (Percentage)

                                                    1996     1995       1994
                                                    ----     ----       ----
Net income to:
  Average total assets                               0.97     1.00      1.00
  Average shareholders' equity                      13.01    12.45     11.38
Dividend payout ratio (dividends declared per
  share divided by net income per share)             0.00     0.00      0.00
Average shareholders' equity to average total
  assets ratio                                       7.46     8.05      8.75


                                       17
<PAGE>



Item 2. Properties

         The  Corporation's  and the Bank's main offices are located at 340 West
Main  Street,  Abingdon,  Virginia.  The main  office  are in a two story  brick
structure  owned by the Bank.  The Bank  utilizes the entire  structure for it's
banking operations.  The Bank maintains a separate drive-thru facility which has
five customer service lanes and is located on the main office property. The main
office opened for operations in 1985. In addition,  the Bank also has two branch
locations within Washington County,  Virginia. The East Abingdon branch is a one
story brick  facility  located at 24412  Maringo  Road which  operates as a full
service  facility.  This  branch was  completed  and opened  for  operations  in
1993.The  West Abingdon  Express  branch is a one-story  brick express  facility
which operates with four drive-thru customer service lanes and a walk-up window.
This is a  limited  service  facility.  The West  Abingdon  Express  branch  was
completed  and  opened  for  operations  in 1994 and is located at Exit 14 I-81,
Jonesboro Road,  Abingdon,  Virginia.  The Bank also has two full service branch
locations  within the City of  Bristol,  Virginia.  The East  Bristol  office is
located at 999 Old Airport Road,  Bristol,  Virginia.  This is a two-story brick
facility  with  interior  customer loan and deposit areas as well as a four lane
drive-thru  facility.  This office was  completed  and opened for  operations in
1988. The Commonwealth  office is located at 821 Commonwealth  Avenue,  Bristol,
Virginia. This is a two story block building with interior full service customer
facilities  and a four lane drive thru  facility.  This office was completed and
opened  for  operations  in 1995.  All of the  Bank's  locations  have  ATM's on
premises. All properties are owned by the Bank and are free of liens.

Item 3. Legal Proceedings

         The Corporation is not involved in any pending legal proceedings, other
than  non-material  legal  proceedings  undertaken  in the  ordinary  course  of
business.


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

         There were no matters  submitted to a vote of security  holders  during
the year ended December 31, 1996.

                                    Part II.

Item 5. Market for Registrant's Common Equity and Related Stockholder Matters

         There is no  established  trading  market  for the  stock of  Highlands
Bankshares,  Inc.. At December 31, 1996 the  Corporation has  approximately  936
stockholders  of  record.  The  Corporation  acts as it's own  registered  Stock
Transfer Agent,  without  charging a transfer fee,  ensuring that all applicable
federal  guidelines  relating to stock  transfers are enforced.  The Corporation
maintains a list of  individuals  who are  interested in purchasing  it's common
stock and connects these people with stockholders' who are interested in selling
their stock.  These  parties  negotiate the per share price  independent  of the
Corporation.  The stock  transfer  agent of the  Corporation  attempts to keep a
record of what the stock sales are  trading at by asking the  parties  about the
trade price per share  Please  refer to the table below  entitled  Common  Stock
Performance  for a breakdown of the trades for the four  quarters of 1996. It is
the opinion of management that this range  accurately  reflects the market value
of the Corporations common stock at the present time.

                    Common Stock Performance-December 31 1996

                          High               Low        Quarterly Average
                          ----               ---        -----------------

First Quarter          No Activity       No Activity       No Activity

Second Quarter           $20.00             $19.00            $19.29

Third Quarter            $25.00             $20.00            $19.87

Fourth Quarter           $23.00             $20.00            $21.36



                                       18
<PAGE>


         The Corporation's and the Bank's Board of Directors  determines whether
to  declare   dividends  and  the  amount  of  any  dividends   declared.   Such
determinations  by the  Board  take into  account  the  Corporation's  financial
condition,  results of operations,  and other relevant factors. The declaration,
amount  and  timing  of  future  dividends  will be  determined  by the Board of
Directors after a review of the  Corporation's  operations and will be dependent
upon, among other factors,  the Corporation's  income,  operating costs, overall
financial   condition  and  capital   requirements  and  upon  general  business
conditions.  The  Corporation's  only source of funds for cash dividends will be
dividends paid to the  Corporation  by the Bank,  which is subject to regulatory
restrictions.  During 1996 the Bank declared and paid cash dividends of $500,000
to the Corporation for operating  costs.  The Corporation did not declare or pay
any cash dividends during 1996.

         At  December  31,  1996,  there were  approximately  936 holders of the
Corporation's  common  stock  (based on the number of record  holders as of that
date).


Item 6. Selected Financial Data

         The following table sets forth certain selected consolidated  financial
data for the past five years.
<TABLE>
<CAPTION>

                            Years Ended December 31,
                  (Dollars in thousands, except per share data)


                                     1996       1995        1994      1993      1992
                                     ----       ----        ----      ----      ----
Income Statement Amounts:

<S>                                <C>        <C>        <C>        <C>        <C>
    Gross interest income          $ 14,596   $ 11,585   $  8,425   $  6,433   $ 5,581
    Gross interest expense            7,822      6,161      3,985      3,064     2,718
    Net interest income               6,774      5,424      4,440      3,369     2,863
    Provision for possible loan
      Losses                            374        143        120        150       304
    Net interest income after
      provision                       6,400      5,281      4,320      3,219     2,559
    Other operating income              660        488        425        395       402
    Other operating expense           4,439      3,541      3,004      2,264     1,873
    Income before income taxes
      and other items                 2,621      2,228      1,741      1,350     1,088
    Income taxes                        857        779        581        442       382
    Income before cumulative
      effect of change in
      accounting principles           1,764      1,449      1,160        908       706
    Cumulative effect of change
      in accounting principles          -0-        -0-        -0-        -0-       -0-
    Net income                     $  1,764   $  1,449   $  1,160   $    908       706

Per Share Data (1):

    Net income per share           $   1.45   $   1.19   $   0.96   $   0.98   $ 0.775
    Cash dividends per share            -0-        -0-        -0-        -0-       -0-
    Book value (at year end)          11.97      10.52       8.43       8.33     6.155

Balance Sheet Amounts (at year-
    end):

    Total assets                   $207,739   $162,543   $128,749   $105,520   $78,024
    Total loans (net of unearned
      income)                       154,951    113,743     93,738     67,212    49,213
    Total deposits                  189,719    147,327    117,314     94,853    71,697
    Long-term debt                    1,858        -0-        -0-        -0-       -0-
    Total equity                     14,617     12,812     10,243     10,042     5,610

</TABLE>


         (1) Adjusted for 1995 two-for-one  stock split, 1992 25% stock dividend
and 1990 20% stock dividend.


                                       19
<PAGE>

Management's Discussion and Analysis of Financial Condition and Results of
Operations

         The information required herein is incorporated by reference from pages
4 to 8 of the Annual Report to  Stockholders  for the fiscal year ended December
31, 1996.

Item 8. Financial Statements and Supplementary Data

         The financial  statements and  supplementary  data required  herein are
incorporated  by  reference  from  pages  9  to  28  of  the  Annual  Report  to
Stockholders for the fiscal year ended December 31, 1996.

Item 9. Changes in Accountants and Disagreements with Accountants on Accounting
        and Financial Disclosure

         None.

Part III.

Item 10.  Directors and Executive Officers of the Registrant

         The  information  required  herein is incorporated by reference to "The
Board of  Directors",  "Executive  Officers  Who Are Not  Directors",  "Security
Ownership of Certain Beneficial Owners" and "Compliance With Filing Requirements
Under the Securities  Exchange Act of 1934"  contained in the  definitive  proxy
statement  for the  Registrant's  1996  Annual  Meeting  of  Stockholders  to be
subsequently filed.

Item 11. Executive Compensation

         The  information  required  herein  is  incorporated  by  reference  to
"Remuneration"  contained in the definitive proxy statement for the Registrant's
1996 Annual Meeting of Stockholders to be subsequently filed.

Item 12. Security Ownership of Certain Beneficial Owners and Management

         The  information  required  herein  is  incorporated  by  reference  to
"Security Ownership of Management" and "Security Ownership of Certain Beneficial
Owners"  contained in the definitive proxy statement for the  Registrant's  1996
Annual Meeting of Stockholders to be subsequently filed.

Item 13. Certain Relationships and Related Transactions

         The  information  required  herein  is  incorporated  by  reference  to
"Indebtedness of Management" contained in the definitive proxy statement for the
Registrant's 1996 Annual Meeting of Stockholders to be subsequently filed.

Part IV.

Item 14. Exhibits, Financial Statement Schedules, and Reports on Form 8-K

         (a) (1)  The following financial statements are incorporated by
                  reference into Item 8 hereof from Exhibit 13 hereof:

                  Consolidated Statements of Financial Condition as of December
                  31, 1996 and 1995

                  Consolidated Statements of Operations for each of the years in
                  the three year period ended December 31, 1996

                  Consolidated  Statements of  Stockholder's  Equity for each of
                  the years in the three year period ended December 31, 1996

                  Consolidated Statements of Cash Flows for each of the years in
                  the three year


                                       20
<PAGE>

                  period ended December 31, 1996

                  Notes to Consolidated Financial Statements for December 31,
                  1996, 1995 and 1994

                  Independent Auditors' Report

         (a) (2)  There are no financial statement schedules required to be
                  filed herewith

             3a   The  following  exhibits are filed as part of this report on
                  Form 10-K, and this list includes the Exhibit Index.

                                    Exhibits


Exhibit No.                        Document


3(i)              Articles  of   Incorporation,   incorporated   by   reference
                  to  Exhibit  3.1  of  the Registrant's Registration Statement
                  on Form 8-A, filed January 24, 1996.
3(ii)             Bylaws,  incorporated  by  reference  to Exhibit  3.2 of the
                  Registrant's  Registration Statement on Form 8-A, filed
                  January 24, 1996.
13.1              Excerpts from Highlands Bankshares, Inc. 1996 Annual Report*
21                Subsidiaries of the Registrant*
27                Financial Data Schedule* (filed electronically only)

--------------------
*  Filed herewith



         (b) No reports on Form 8-K have been filed  during the last  quarter
             of the period covered by this report.

         (c) See (a) (3) above for all exhibits filed herewith and the Exhibit
             Index.

         (d) Separate financial statements are not applicable.






                                       21
<PAGE>

                                   SIGNATURES

         Pursuant to the  requirements  of Section 13 or 15(d) of the Securities
Exchange Act of 1934, the registrant has duly caused this report to be signed on
its behalf by the undersigned, thereunto duly authorized.

                                          HIGHLANDS BANKSHARES, INC.

Date:  March 26, 1997                     BY:  /S/ Samuel L. Neese
                                              ---------------------
                                              Samuel L. Neese
                                              Executive Vice President and
                                              Chief Executive Officer

         Pursuant to the  requirements  of the Securities  Exchange Act of 1934,
this  report has been  signed  below by the  following  persons on behalf of the
registrant and in the capacities indicated on March 26, 1997.
<TABLE>
<CAPTION>

                  Signature                                            Title
                  ---------                                            -----
<S>                                <C>              <C>

/S/ James D Morefield               03-26-97
--------------------------------------------
James D. Morefield                  Date            Chairman of the Board, and Director


/S/ James D. Morre, Jr.             03-26-97
--------------------------------------------
Dr. James D. Moore, Jr.             Date             President


/S/ J. Carter Lambert               03-26-97
--------------------------------------------
J. Carter Lambert                   Date             Vice Chairman


/S/ Samuel L. Neese                 03-26-97
--------------------------------------------
Samuel L. Neese                     Date             Executive Vice President, and Chief Executive
                                                     Officer

/S/ James T. Riffe                  03-26-97
--------------------------------------------
James T. Riffe                      Date             Executive Vice President and Cashier


/S/ William E. Chaffin              03-26-97
--------------------------------------------
William E. Chaffin                  Date             Director


/S/ V. D. Kendrick                  03-26-97
--------------------------------------------
V.D. Kendrick                       Date             Director


/S/ Clydes B. Kiser                 03-26-97
--------------------------------------------
Clydes B. Kiser                     Date             Director


/S/ Charles P. Olinger              03-26-97
--------------------------------------------
Charles P. Olinger                  Date             Director


/S/ William J. Singleton            03-26-97
--------------------------------------------
William J. Singleton                Date             Director


/S/ H. Ramsey White, Jr.            03-26-97
--------------------------------------------
Dr. H. Ramsey White, Jr.            Date             Director

</TABLE>

<PAGE>
                                  EXHIBIT INDEX


Exhibit No.                        Document


3(i)              Articles  of   Incorporation,   incorporated   by   reference
                  to  Exhibit  3.1  of  the Registrant's Registration Statement
                  on Form 8-A, filed January 24, 1996.
3(ii)             Bylaws,  incorporated  by  reference  to Exhibit  3.2 of the
                  Registrant's  Registration Statement on Form 8-A, filed
                  January 24, 1996.
13.1              Excerpts from Highlands Bankshares, Inc. 1996 Annual Report*
21                Subsidiaries of the Registrant*
27                Financial Data Schedule* (filed electronically only)

--------------------
*  Filed herewith