Exhibit 13.1

                 [EXCERPTS FROM ANNUAL REPORT TO SHAREHOLDERS]


                              FINANCIAL HIGHLIGHTS
<TABLE>
<CAPTION>

Results of Operation                        2002          2001         2000           2002/2001     2001/2000
                                     (In thousands except share and per share data)      Percentage change


<S>                                        <C>           <C>           <C>              <C>          <C>
Net Interest Income                        $ 16,678      $14,111       $12,718          18.19%       10.95%
Net Income (Loss)                          $  4,104      $ 3,301       $ 2,979          24.33%       10.81%


Financial Condition at Year-End


Assets                                     $ 485,603     $453,745      $405,212          7.02%       11.98%
Loans                                      $ 339,521     $325,460      $291,895          4.32%       11.50%
Securities                                 $ 104,925     $100,270      $82,632           4.64%       21.35%
Deposits                                   $ 410,301     $392,093      $346,315          4.64%       13.22%
Stockholders' Equity                       $ 32,199      $27,452       $24,183          17.29%       13.52%

Shares Outstanding                            2648        2,644        2,637             0.15%        0.27%


Significant Ratios


Return on Average Assets                     0.87%        0.77%        0.78%            12.99%       -1.28%
Return on Average Equity                     13.82        12.78        13.69             8.14%       -6.65%
Average stockholders' equity to
   average assets                             6.32         6.00         5.71             5.33%        5.08%
Allowance for loan lossess as a
   percentage of total loans                  1.14         1.05         1.01             8.57%        3.96%
Non-performing loans to total loans           0.76         0.57         0.51            33.33%       11.76%


Per Share Data
Based on weighted average shares outstanding

Net Income                                  $ 1.55        $1.25        $1.13            24.00%       10.62%
Stockholders' equity (book value)
    per shares outstanding at
    year-end                                 12.16        10.38         9.17            17.15%       13.20%


Income Tax Expense                         1107000      1229276      1120934            -9.95%        9.67%

</TABLE>
<PAGE>
Info for graphs
Annual report                                        2002      2001      2000

Graph 1       Net Income                              4.1       3.30      2.98
              in millions


Graph 2       Total Assets                          485.6      453.7     405.2
              in millions

Graph 3       Total Loans                           339.5      325.5     291.9
              in millions

Graph 4       Earnings Per Share                  $  1.55     $ 1.25    $ 1.13
              In dollars

Graph 5       Return on Average Equity              13.82      12.78     13.69
              in percent

Graph 6       Book Value per share at Year end    $ 12.16    $ 10.38    $ 9.17
              in dollars

Graph 7       Deposits                              410.3      392.1     346.3
              in millions

Graph 8       Shareholders'  Equity                  32.2       27.5      24.2
              in millions


<PAGE>
                      Management's Discussion and Analysis


                                   2002 - 2001


           For the year ended December 31, 2002,  total assets grew from $453.75
million on  December  31,  2001 to $485.60  million at December  31,  2002.  The
increase  totaling  7.02% was due to several  factors  including  the  continued
growth of our Boone N. C. and Rogersville TN. branch offices.  Outstanding loans
at  the  Boone  office  exceeded  $27  million  as of  December  31,  2002.  The
Rogersville  office has tripled is deposit  size since the  acquisition  date in
September of 2000. The growth of assets during 2002 was funded  primarily by the
increase in savings and  checking  accounts as  individuals  continued  to place
their  dollars in banks as a result of the market's  decline.  Our deposits grew
from $392.10  million at the end of last year to $410.30 million on December 31,
2002. The continued  reduction of interest rates during 2002 allowed  management
of the company another year of opportunity to shift the overall  position of our
interest bearing liabilities to longer-term maturities.  We feel that the Bank's
asset  liablility mix is now much more favorably  positioned when interest rates
rise.  As of  December  31,  2002 our deposit  portfolio  consisted  of 57% time
deposits,  17% savings deposits and 26% transaction  accounts. We also were able
to increase the percentage of adjustable rate assets compared to fixed rate over
the prior year.  This too has  strengthened  our position in the event of rising
interest rates. During 2002, outstanding loans grew 4.32% or $14.06 million. The
loan growth was helped by the continued  refinancing of mortgages nationwide due
to the low interest rate  environment  during the year. Our  "collateral  mix"of
loans  strengthened with 71% of our loan portfolio  secured by real estate,  23%
secured by  collateral  other  than real  estate  and only 6%  unsecured.  . The
investment  securities  portfolio of the company  increased a moderate  4.64% or
$4.66 million  during the year.  During the second quarter of 2002, we purchased
$7.8 million of Bank Owned Life Insurance. The earnings related to this purchase
will be used to offset  future  employee  benefit  costs.  Also during 2002,  we
purchased an equity owner's  interest in Virginia Title Center,  LLC.,  which is
headquartered in Roanoke, Virginia.
         Our net income for the year 2002 increased $803 thousand over 2001which
resulted in a record year of earnings  for your  Company.  We had an increase in
net income of 24.33% from $3.30  million in 2001 to $4.10  million in 2002.  Our
growth in outstanding  loans and securities  helped offset the declining  yields
related to our loan and securities portfolios. Our net interest income increased
18.19%  from  $14.11  million  in 2001 to $16.68  million  in 2002.  We  greatly
benefited this past year by our interest bearing liabilities re-pricing downward
more rapidly than our interest  earning  assets.  Interest income declined $2.05
million  from the prior year as  compared to interest  expense  which  decreased
$4.62   million   from   2001.   The   tax-equivalent   yield  on  our   average
interest-earning  assets for 2002 was 7.18% compared to 8.24% for the year ended
December 31st, 2001. The yield on our average  interest-bearing  liabilities for
2002  declined to 3.73% from 5.34% for the prior year. We also had a significant
increase in our non-interest bearing checking accounts which helped to lower our
cost of funds.

<PAGE>

         Non-interest   income   increased  282  thousand  over  2001.  This  is
especially  encouraging  since net  securities  gains for 2002  totaled only $17
thousand as compared to $494  thousand  in 2001.  The  increase in  non-interest
income was primarily  attributable to an increase in overdraft  fees,  increased
debit card / credit card fee income,  earnings  related to our  purchase of Bank
Owned Life  Insurance  and dividends  received  from our  investment in Virginia
Title Center.  Non-interest  expenses  increased  from $11.62 million in 2001 to
$13.05 million in 2002. A portion of this increase was due to the opening of the
Boone,  N. C. branch  office in January of 2001 and the addition of personnel in
the Abingdon market area.
         Our  allowance  for loan  losses  as a  percentage  of  total  loans at
December  31, 2002  increased  8.57% to 1.14% as compared to 1.05% for the prior
year. Management is especially pleased to mention that earnings per common share
increased  from $1.25 in 2001 to $1.55 in 2002 which  represents  an increase of
24% for the year.  Book value per share also  increased  from $10.38 at December
31, 2001 to $12.16 at December  31,  2002.  Return on Average  Equity  increased
8.14% in 2002 to 13.82%.  Return on Average Assets  increased  12.99% to .87% at
December 31, 2002.
         We are  also  pleased  to  report  that we paid our  fifth  consecutive
dividend in 2002.  During the first quarter of 2002, we implemented our Dividend
Reinvestment  and Optional Stock Purchase Plan and we are happy to report to you
that the response from our shareholders has been very positive.

                                    2001-2000

           For the year ended December 31, 2001,  total assets grew from $405.21
million on December 31, 2000 to $453.75 million at December 31, 2001. The growth
totaling 11.98% was due to several  factors  including the opening of the Boone,
N.  C.  office  in  January  of 2001  and the  continued  growth  of our  branch
acquisition in  Rogersville,  Tenn. from September of 2000. The Boone office has
produced over $15 million of loans and the Rogersville office has almost tripled
is deposit size since the  acquisition.  Overall the growth of assets was fueled
by the increase in bank deposits  nationwide as individuals placed their dollars
in banks as a result of the market's decline and uncertainty in the economy. Our
deposits grew from $346.32 million at the end of last year to $392.10 million on
December  31,  2001.  This  growth  of $45.78  million  or  13.22%  allowed  the
management of the company an opportunity to realign the position of a portion of
our  interest  bearing  liabilities  to  longer-term  maturities.   Our  deposit
portfolio as of December 31, 2001  consisted of 62% time  deposits,  15% savings
deposits and 23% transaction accounts.  These longer-term maturities of interest
bearing liabilities should enable the bank to hold a good position going forward
if interest rates rise. Our growth on the asset side of the ledger was primarily
due to our loan growth of 11.50% or $33.56 million from $291.90  million in 2000
to $325.46  million on December 31,  2001.  The strong loan growth was helped by
the  refinancing  of mortgages  nationwide  during the low interest rates of the
last  half of the  year.  The  mix of  collateral  securing  our  loans  remains
excellent with 66% of our loan portfolio secured by real estate,  28% secured by
collateral  other  than  real  estate  and  only 6%  unsecured.  The  investment
securities  portfolio of the company  increased  21.25% or $17.64 million during
the year. The leading  categories of growth were an increase of $6.02 million in
adjustable rate
<PAGE>

mortgage-  backed  securities  and  $10.49  million in  securities  of state and
political  subdivisions.  A decrease  in other  securities  and U.S.  government
agencies accounted for the difference in the total change of $17.64 million.

         Our income for the year 2001  followed  the strong  performance  of the
balance sheet growth with an increase in net income of 10.95% from $2.98 million
in 2000 to $3.30 million in 2001.  Our strong loan growth lead to an increase of
$2.50  million in loan income,  which is excellent  considering  the lowering of
interest rates over the past year.  This growth of 9.96%  compares  favorably to
the deposit expense growth of 7.24%. since our deposit balance growth included a
significant increase in non-interest  checking. The increase in our net interest
income  before  the  provision  for loan  losses was a very  respectable  10.95%
resulting from the increase in our interest  margin between  deposit expense and
loan  income  due  to  the  falling  rate  environment  and  the  re-pricing  of
liabilities  faster  than  assets  on the  balance  sheet.  Non-interest  income
increases  came from an increase in  securities  gains of $494  thousand in 2001
compared to a loss of $95 thousand in 2000. Non-interest expenses increased from
$9.71  million  in 2000 to  $11.62  million  in 2001.  A large  portion  of this
increase was due to the opening of the Boone,  N. C. branch office in January of
2001 and the operation for a full year of the Rogersville office.  Management is
pleased to note that earnings per common share  increased  from $1.13 in 2000 to
$1.25 in 2001 which  represents  an increase of 10.62% for the year.  Book value
per share also  increased  from $9.17 at December 31, 2000 to $10.38 at December
31,  2001.  Return on Average  Equity  decreased  6.65% in 2001 to 12.78%.  This
decline  was  partly  due to  the  market  value  of  our  securities  portfolio
increasing  significantly  throughout the year. Return on Average Assets dropped
1.28% to .77% at December 31, 2001.



                  In  summary,  as always we are very  excited  to report to our
valued  shareholders  what has  occurred  during  the past three  years.  We are
especially  pleased with not only the improved earnings of your Company but also
the program  initiatives  that have been put in place. We feel optimistic  about
the continued  opportunity  for growth in our market  areas.  As of December 31,
2002, we have broken ground to build a new branch in Blountville,  Tennessee. We
truly believe that the products,  services,  and delivery systems that have been
implemented  in our  tri-state  market  area  will  certainly  add value to your
Company in the years to come.


<PAGE>




                  HIGHLANDS BANKSHARES, INC., AND SUBSIDIARIES

                          CONSOLIDATED FINANCIAL REPORT

                                DECEMBER 31, 2002




























<PAGE>

                                 C O N T E N T S


                                                                          Page

INDEPENDENT AUDITOR'S REPORT                                                3

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


<PAGE>


                          INDEPENDENT AUDITOR'S REPORT


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

         We  have  audited  the  accompanying  consolidated  balance  sheets  of
Highlands Bankshares,  Inc. and Subsidiaries,  as of December 31, 2002, 2001 and
2000 and the related consolidated statements of income, changes in stockholders'
equity, and cash flows for the years then ended. These financial  statements are
the   responsibility   of   Highlands   Bankshares,   Inc.'s   management.   Our
responsibility  is  to  express  an  opinion  on  these  consolidated  financial
statements based on our audits.

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

         In our opinion, the consolidated financial statements referred to above
present fairly, in all material  respects,  the financial  position of Highlands
Bankshares,  Inc. and Subsidiaries,  as of December 31, 2002, 2001 and 2000, and
the results of their operations and their cash flows for the years then ended in
conformity with accounting principles generally accepted in the United States of
America.


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

1969 Lee Highway
Bristol, VA 24201
January 24, 2003




<PAGE>

                  HIGHLANDS BANKSHARES, INC., AND SUBSIDIARIES

                           CONSOLIDATED BALANCE SHEETS
                        December 31, 2002, 2001 and 2000
                             (Amounts in thousands)
<TABLE>
<CAPTION>


                ASSETS                                                     2002                 2001                 2000
                                                                      -------------         ------------          -----------
<S>                                                                    <C>                  <C>                   <C>
 Cash and due from banks                                               $     13,369         $     10,921          $    12,510
 Federal funds sold                                                           5,132                1,320                2,782
                                                                      -------------         ------------          -----------

                Total Cash and Cash Equivalents                              18,501               12,241               15,292

 Investment securities available-for-sale (Note 2)                          102,743               98,299               80,748
 Other Investments, at cost (Note 3)                                          2,182                1,971                1,884
 Loans, net of allowance for loan losses of $3,877, $3,418
    and $2,950 in 2002, 2001, and 2000 respectively (Note 4)                335,644              322,042              288,947
 Premises and equipment, net (Note 5)                                        13,157               12,900               12,454
 Interest receivable                                                          2,708                2,904                2,965
 Other assets (Note 6)                                                       10,668                3,388                2,922
                                                                      -------------         ------------          -----------

                Total Assets                                          $     485,603         $     453,74          $   405,212
                                                                      =============         ============          ===========


              LIABILITIES AND STOCKHOLDERS' EQUITY
 Deposits (Note 8)
      Noninterest bearing                                             $      55,597         $     50,248          $    45,343
      Interest bearing                                                      354,704              341,845              300,972
                                                                      -------------         ------------          -----------

                Total Deposits                                              410,301              392,093              346,315
                                                                      -------------         ------------          -----------

 Interest, taxes and other liabilities                                        2,309                3,217                3,545
 Other short term borrowings (Note 9)                                        19,094               13,000                5,000
 Long-term debt (Note 10)                                                    14,200               10,483               18,669
 Capital securities (Note 11)                                                 7,500                7,500                7,500
                                                                      -------------         ------------          -----------
                                                                             43,103               34,200               34,714
                                                                      -------------         ------------          -----------

                Total Liabilities                                           453,404              426,293              381,029
                                                                      -------------         ------------          -----------

 STOCKHOLDERS' EQUITY
      Common stock, 2,648, 2,644, and 2,637 shares
          issued and outstanding as of December 31, 2002,
          2001, and 2000, respectively  (Notes 13 and 15)                     3,309                3,304                3,296
      Additional paid-in capital                                              6,150                6,063                5,952
      Retained Earnings                                                      21,729               17,863               14,773
      Accumulated other comprehensive income                                  1,011                  222                  162
                                                                      -------------         ------------          -----------

                Total Stockholders' Equity                                   32,199               27,452               24,183
                                                                      -------------         ------------          -----------

                Total Liabilities and Stockholders' Equity            $     485,603         $    453,745          $   405,212
                                                                      =============         ============          ===========
</TABLE>

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

                                       4
<PAGE>
                   HIGHLANDS BANKSHARES, INC. AND SUBSIDIARIES

                        CONSOLIDATED STATEMENTS OF INCOME
                  Years Ended December 31, 2002, 2001 and 2000
                             (Amounts in thousands)


<TABLE>
<CAPTION>

 INTEREST INCOME                                                            2002                 2001                2000
                                                                       ------------         ------------          -----------
<S>                                                                    <C>                  <C>                   <C>
      Loans receivable and fees on loans                               $     26,095         $     27,574          $    25,077
      Securities available for sale:
         Taxable                                                              3,299                4,135                4,691
         Tax-exempt                                                           1,459                  972                  527
      Federal funds sold                                                         91                  317                  123
                                                                       ------------         ------------          -----------
            Total Interest Income                                            30,944               32,998               30,418
                                                                       ------------         ------------          -----------

 INTEREST EXPENSE
     Deposits                                                                11,768               16,740               15,610
     Federal funds purchased                                                      3                    -                   62
     Other borrowed funds                                                     2,495                2,147                2,028
                                                                       ------------         ------------          -----------
           Total interest expense                                            14,266               18,887               17,700
                                                                       ------------         ------------          -----------

           Net interest income                                               16,678               14,111               12,718

 PROVISION FOR LOAN LOSSES (Note 4)                                           1,825                1,448                1,277
                                                                       ------------         ------------          -----------

           Net interest income after provision for loan losses               14,853               12,663               11,441
                                                                       ------------         ------------          -----------

 NON-INTEREST INCOME
      Securities gains (losses), net                                             17                  494                  (95)
      Service charges on deposit accounts                                     2,620                2,181                1,949
      Other service charges, commissions and fees                               634                  586                  490
      Other operating income                                                    375                  103                  136
                                                                       ------------         ------------          -----------
             Total Non-Interest Income                                        3,646                3,364                2,480
                                                                       ------------         ------------          -----------

 NON-INTEREST EXPENSES
      Salaries and employee benefits (Note 14)                                7,167                6,456                5,220
      Occupancy expense of bank premises                                        568                  565                  435
      Furniture and equipment expense                                         1,718                1,570                1,442
      Other operating expenses (Note 23)                                      3,593                3,028                2,616
                                                                       ------------         ------------          -----------
             Total Non-Interest Expenses                                     13,046               11,619                9,713
                                                                       ------------         ------------          -----------
             Income Before Income Taxes                                       5,453                4,408                4,208

      Income Tax Expense (Note 7)                                             1,349                1,107                1,229
                                                                       ------------         ------------          -----------

             Net Income                                                $      4,104         $      3,301          $     2,979
                                                                       ============         ============          ===========

 Earnings Per Common Share (Note 13)                                   $       1.55         $       1.25          $      1.13
                                                                       ============         ============          ===========

 Earnings Per Common Share - assuming dilution (Note 13)               $       1.54         $       1.24          $      1.12
                                                                       ============         ============          ===========
</TABLE>

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

                                       5
<PAGE>

                HIGHLANDS BANKSHARES, INC., AND SUBSIDIARIES

        CONSOLIDATED STATEMENTS OF CHANGES IN STOCKHOLDERS' EQUITY Years
                     Ended December 31, 2002, 2001 and 2000
                             (Amounts in thousands)
<TABLE>
<CAPTION>

                                                                                          Accumulated
                                           Common Stock           Additional                 Other          Total
                                     -------------------------     Paid-in     Retained   Comprehensive  Stockholders'
                                       Shares      Par Value       Capital     Earnings      Income         Equity
                                     -----------   -----------   -----------  ----------- -------------  -------------
<S>                                      <C>      <C>           <C>         <C>             <C>         <C>
 Balance, December 31, 1999                2,624   $     3,280   $     5,768  $    11,979   $      (619)  $    20,408
                                                                                                          -----------

                                                                                                             ---------

 Comprehensive income:
      Net income                               -             -             -        2,979             -         2,979
      Change in unrealized gain
        (loss) on securities available-
        for-sale, net of deferred
        income tax expense of $402             -             -             -            -             -          7188
      Less: reclassification adjustment,
        net of income tax benefit of $32       -             -             -            -            63            63
                                                                                                          -----------

          Total comprehensive income           -             -             -                          -         3,760
                                                                                                          -----------

      Common stock issued for
         stock options exercised              13            16           184            -             -           200
      Cash dividend                            -             -             -         (185)            -          (185)
                                     -----------   -----------   -----------  -----------   -----------   -----------

 Balance, December 31, 2000                2,637         3,296         5,952        14,773          162        24,183
                                                                                                          -----------

 Comprehensive income:
      Net income                               -             -             -         3,301            -         3,301
      Change in unrealized gain
        (loss) on securities available-
        for-sale, net of deferred
        income tax expense of $31              -             -             -             -            -          3866
      Less: reclassification adjustment,
        net of income tax expense of $168      -             -             -             -            -          (326)
                                                                                                          -----------

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

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

 Balance, December 31, 2001                2,644         3,304         6,063       17,863           222        27,452
                                                                                                          -----------

 Comprehensive income:
      Net income                               -             -             -        4,104             -         4,104
      Change in unrealized gain
        (loss) on securities available-
        for-sale, net of deferred
        income tax expense of $412             -             -             -            -           800           800
      Less: reclassification adjustment,
        net of income tax expense of $6        -             -             -            -           (11)          (11)
                                                                                                          -----------

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

      Common stock issued for
         stock options exercised               3             4            74            -             -            78
      Common stock issued for
        dividend reinvestment and optional
        cash purchase plan                     1             1            13            -             -            14
      Cash dividend                            -             -             -         (238)            -          (238)
                                     -----------   -----------   -----------  -----------   -----------   -----------

 Balance, December 31, 2002                2,648    $    3,309    $    6,150  $     21,729    $   1,011   $     32,199
                                          ======      ========      ========    =========      ========      =========

</TABLE>

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

                                       6
<PAGE>
                  HIGHLANDS BANKSHARES, INC., AND SUBSIDIARIES

                      CONSOLIDATED STATEMENTS OF CASH FLOWS
                  Years Ended December 31, 2002, 2001 and 2000
                             (Amounts in thousands)

<TABLE>
<CAPTION>

                                                                            2002            2001             2000
                                                                         ----------      ----------       ----------
<S>                                                                      <C>             <C>              <C>
CASH FLOWS FROM OPERATING ACTIVITIES:
      Net income                                                         $    4,104      $    3,301       $    2,979
      Adjustments to reconcile net income to net cash
        provided by operating activities:
           Provision for loan losses                                          1,825           1,448            1,277
           Provision for deferred income taxes                                  (96)           (129)             (33)
           Depreciation and amortization                                        968             917              774
           Net realized (gains) losses on available-for-sale securities         (17)           (494)              95
           Net amortization on securities                                       160             (11)             (44)
           (Increase) decrease  in interest receivable                          196              61             (810)
           (Increase) in other assets                                        (7,215)           (626)            (174)
           Increase (decrease) in interest, taxes and other
             liabilities                                                       (908)           (328)           1,084
                                                                         ----------      ----------       ----------
                Net Cash provided by (used in) operating activities            (983)          4,139            5,148
                                                                         ----------      ----------       ----------

 CASH FLOWS FROM INVESTING ACTIVITIES:
      Securities available for sale:
          Proceeds from sale of debt and equity securities                    9,394          11,455            4,979
          Proceeds from maturities of debt and equity securities             20,922          26,500           11,382
          Purchase of debt and equity securities                            (34,114)        (54,770)         (27,399)
      Purchase of other investments                                            (212)              -                -
      Net increase in loans                                                 (15,426)        (34,543)         (31,040)
      Premises and equipment expenditures                                    (1,194)         (1,332)          (3,536)
                                                                         ----------      ----------       ----------
                Net Cash used in investing activities                       (20,630)        (52,690)         (45,614)
                                                                         ----------      ----------       ----------

 CASH FLOWS FROM FINANCING ACTIVITIES:
      Net increase (decrease) in time deposits                               (9,367)          9,712           33,585
      Net increase in demand, savings and other deposits                     27,575          36,066            6,537
      Decrease in federal funds purchased                                         -               -           (3,187)
      Proceeds from issuance of short-term borrowings                             -               -            5,000
      Repayment of short-term borrowings                                          -               -           (8,000)
      Proceeds from issuance of long-term debt                               10,000               -            8,000
      Repayment of long-term debt                                              (189)           (186)            (180)
      Cash dividends paid                                                      (238)           (211)            (185)
      Proceeds from exercise of common stock options                             78             119              200
      Proceeds from issuance of common stock                                     14               -                -
                                                                         ----------      ----------       ----------
                Net Cash provided by financing activities                    27,873          45,500           41,770
                                                                         ----------      ----------       ----------
                Net increase (decrease) in cash and cash equivalents          6,260          (3,051)           1,304

 CASH AND CASH EQUIVALENTS AT BEGINNING OF YEAR                              12,241          15,292           13,988
                                                                         ----------      ----------       ----------

 CASH AND CASH EQUIVALENTS AT END OF YEAR                                $   18,501      $   12,241        $  15,292
                                                                         ==========      ==========        =========

 SUPPLEMENTAL DISCLOSURE OF NON-CASH
    TRANSACTIONS

      Premises and equipment purchased through seller financed
        transactions                                                     $        -      $        -        $     250
                                                                         ==========      ==========        =========

 SUPPLEMENTAL DISCLOSURES OF CASH FLOW
   INFORMATION:
 Cash paid during the year for:
      Interest                                                           $   15,194      $   19,411        $  17,306
                                                                         ==========      ==========        =========
      Income taxes                                                       $    1,619      $    1,111        $   1,348
                                                                         ==========      ==========        =========
</TABLE>

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

                                       7

<PAGE>
                 HIGHLANDS BANKSHARES, INC., AND SUBSIDIARIES

                   NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
                                December 31, 2002
                             (Amounts in thousands)


         Note  1.  Summary of Significant Accounting Policies

                  Basis of Presentation and Consolidation

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

                  Nature of Operations

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

                  Cash and Cash Equivalents

                  For  purposes of the  consolidated  statements  of cash flows,
                  cash and cash equivalents  include cash and due from banks and
                  federal funds sold, all of which mature within ninety days.

                  Securities Available-for-Sale

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

                  Securities  available-for-sale  are  carried  at  fair  value.
                  Unrealized  gains or  losses  are  reported  as  increases  or
                  decreases in other  comprehensive  income,  net of the related
                  deferred  income  tax  effect.  Realized  gains or losses  are
                  recorded on the trade date and are  determined on the basis of
                  the amortized cost of specific securities sold. Realized gains
                  or losses are included in earnings. Premiums and discounts are
                  recognized in interest  income using the interest  method over
                  the period to maturity.


                                   (Continued)
                                        8

<PAGE>
                  HIGHLANDS BANKSHARES, INC., AND SUBSIDIARIES

                   NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
                                December 31, 2002
                             (Amounts in thousands)

         Note  1.  Summary of Significant Accounting Policies (Continued)

                  Loans

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

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

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

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

                  Allowance for Loan Losses

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

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

                  A  loan  is  considered   impaired  when,   based  on  current
                  information  and events,  it is probable that the Company will
                  be unable to collect the  scheduled  payments of  principal or
                  interest  when due according to the  contractual  terms of the
                  loan   agreement.   Factors   considered   by   management  in
                  determining  impairment  include  payment  status,  collateral
                  value, and the probability of collecting  scheduled  principal
                  and  interest   payments  when  due.  Loans  that   experience
                  insignificant  payment delays and payment shortfalls generally
                  are not  classified  as impaired.  Management  determines  the
                  significance  of payment  delays and payment  shortfalls  on a
                  case-by-case  basis,  taking  into  consideration  all  of the
                  circumstances surrounding the loan and the borrower, including
                  the length


                                   (Continued)
                                        9
<PAGE>
                  HIGHLANDS BANKSHARES, INC., AND SUBSIDIARIES

                   NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
                                December 31, 2002
                             (Amounts in thousands)

         Note  1.  Summary of Significant Accounting Policies (Continued)

                  Allowance for Loan Losses (Continued)

                  of the delay,  the reasons for the delay, the borrower's prior
                  payment record, and the amount of the shortfall in relation to
                  the principal and interest  owed.  Impairment is measured on a
                  loan by loan basis by either  the  present  value of  expected
                  future cash flows discounted at the loan's effective  interest
                  rate, the loan's obtainable market price, or the fair value of
                  the collateral if the loan is collateral  dependent.  Interest
                  income is not recognized on impaired loans.

                  Premises and Equipment

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

                  Intangible Assets

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

                  Income Taxes

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

                  Earnings Per Common Share

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

                  Use of Estimates

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


                                   (Continued)
                                       10

<PAGE>
                  HIGHLANDS BANKSHARES, INC., AND SUBSIDIARIES

                   NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
                                December 31, 2002
                             (Amounts in thousands)


         Note  1.  Summary of Significant Accounting Policies (Continued)

                  Business Segments

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

                  Reclassification of Financial Statement Presentation

                  Certain  reclassifications have been made to the 2001 and 2000
                  financial  statements  to  conform  with  the  2002  financial
                  statement  presentation.  Such reclassifications had no effect
                  on net income as previously reported.


         Note  2. Investment Securities Available-For-Sale

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

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

                                                          $101,211         $   1,866      $     334        $102,743
                                                          ========         =========      =========        ========

</TABLE>
<TABLE>
<CAPTION>

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

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

                                                          $ 97,963         $     701      $     365        $ 98,299
                                                          ========         =========      =========        ========

</TABLE>

                                   (Continued)
                                       11
<PAGE>
                  HIGHLANDS BANKSHARES, INC., AND SUBSIDIARIES

                   NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
                                December 31, 2002
                             (Amounts in thousands)


         Note 2.  Investment Securities Available-for-Sale (Continued)
<TABLE>
<CAPTION>

                                                                                    2000
                                                          ---------------------------------------------------------
                                                                               Gross         Gross
                                                          Amortized         Unrealized     Unrealized       Fair
                                                              Cost             Gains         Losses         Value
                                                          -------------    --------------  -----------  -----------

<S>                                                       <C>              <C>            <C>              <C>
                  U.S. Government agencies and
                    corporations                          $  4,085         $       -      $       1        $  4,084
                  State and political subdivisions          13,403               413              -          13,816
                  Mortgage backed securities                62,515                 -            107          62,408
                  Other securities                             500                 -             60             440
                                                          --------         ---------      ---------        --------

                                                          $ 80,503         $     413      $     168        $ 80,748
                                                          ========         =========      =========        ========
</TABLE>
                  Investment securities available-for-sale with a carrying value
                  of $8,432,  $6,713,  and $7,522 at December 31, 2002, 2001 and
                  2000 respectively,  and a market value of $8,675,  $6,686, and
                  $7,516 at December 31, 2002, 2001 and 2000,  respectively were
                  pledged  as  collateral  on  public  deposits  and  for  other
                  purposes as required or permitted by law.

                  The  amortized  cost and  estimated  fair value of  securities
                  available-for-sale   at  December  31,  2002  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>

                                                                                                 Approximate
                                                                                 Amortized          Market
                                                                                    Cost            Value
                                                                                ----------       -----------
<S>                                                                             <C>              <C>
                           Due in one year or less                              $        -       $         -
                           Due after one year through five years                     1,352             1,437
                           Due after five years through ten years                      955               986
                           Due after ten years`                                     27,517            28,296
                                                                                ----------       -----------
                                                                                    29,824            30,719

                           Mortgage-backed securities                               57,052            57,730
                           Other securities                                         14,335            14,294
                                                                                ----------       -----------
                                                                                $  101,211       $   102,743
                                                                                ==========       ===========
</TABLE>
                  For the  years  ended  December  31,  2002,  2001,  and  2000,
                  proceeds  from sale of  securities  were  $9,394,  $11,455 and
                  $4,979,  respectively.  Gross  realized  gains  and  losses on
                  investment securities available for sale were as follows:

<TABLE>
<CAPTION>
                                                                          2002             2001               2000
                                                                      ----------       ----------        ----------

<S>                                                                   <C>              <C>               <C>
                           Realized gains                             $       67       $       494       $        2
                           Realized losses                            $       50       $        -        $(      97)
                           Tax (benefit) provision                    $        6       $       168       $(      32)
</TABLE>


                                       12
<PAGE>
                  HIGHLANDS BANKSHARES, INC., AND SUBSIDIARIES

                   NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
                                December 31, 2002
                             (Amounts in thousands)


         Note 3.  Other Investments

                  Federal  Home Loan Bank (FHLB)  stock,  Federal  Reserve  Bank
                  (FRB) stock and Community  Bankers' Bank Stock with a carrying
                  value of $2,182,  $1,971 and $1,884 at December 31, 2002, 2001
                  and 2000,  respectively are listed as " Other  Investments" on
                  the Company's  financial  statements.  These  investments  are
                  considered  to be  restricted  as the  Company is  required by
                  these agencies to hold these investments,  and the only market
                  for this stock is the issuing agency.


         Note  4. Loans

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

                                                                          2002             2001               2000
                                                                      ----------       ----------        ----------
<S>                             <C>                                   <C>              <C>               <C>
                    Real Estate Secured:
                    Residential 1-4 family                            $  128,462       $  114,556        $  102,631
                    Multifamily                                            3,383            3,011             3,909
                    Commercial, Construction and Land Development         85,468           80,673            61,666
                    Second mortgages                                      11,676            7,737             5,342
                    Equity lines of credit                                 5,253            4,166             3,455
                    Farmland                                               5,589            5,065             4,928
                                                                      ----------       ----------        ----------
                                                                         239,831          215,208           181,931

                    Secured, Other:
                    Personal                                              49,483           60,532            63,137
                    Commercial                                            26,043           26,002            26,463
                    Agricultural                                           4,209            3,274             2,498
                                                                      ----------       ----------        ----------
                                                                          79,735           89,808            92,098
                                                                      ----------       ----------        ----------

                    Unsecured                                             20,135           20,614            18,059
                                                                      ----------       ----------        ----------
                                                                         339,701          325,630           292,088
                                                                      ----------       ----------        ----------

                    Less:
                       Unearned discount                                       -                1                 4
                       Allowance for loan losses                           3,877            3,418             2,950
                       Net deferred loan fees                                180              169               187
                                                                      ----------       ----------        ----------
                                                                           4,057            3,588             3,141
                                                                      ----------       ----------        ----------

                    Loans, net                                        $  335,644       $  322,042        $  288,947
                                                                      ==========       ==========        ==========

</TABLE>
                                   (Continued)
                                       13
<PAGE>
                  HIGHLANDS BANKSHARES, INC., AND SUBSIDIARIES

                   NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
                                December 31, 2002
                             (Amounts in thousands)

         Note  4. Loans (Continued)

                  Activity in the allowance for loan losses is as follows:

<TABLE>
<CAPTION>
                                                                         2002              2001              2000
                                                                      ----------       ----------        ----------
<S>                                                                   <C>              <C>               <C>
                  Balance, beginning                                  $    3,418       $    2,950        $    2,494
                  Provision charged to operations                          1,825            1,448             1,277
                  Loans charged to reserve                            (    1,526)      (    1,204)       (      994)
                  Recoveries                                                 160              224               173
                                                                      ----------       ----------        ----------

                  Balance, ending                                     $    3,877       $    3,418        $    2,950
                                                                      ==========       ==========        ==========
</TABLE>

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

<TABLE>
<CAPTION>
                                                                                      December 31,
                                                                      ---------------------------------------------


                                                                          2002             2001              2000
                                                                      ----------       ----------        ----------
<S>                                                                   <C>              <C>               <C>
                  Impaired loans without a
                     valuation allowance                              $        -       $        -        $      727
                  Impaired loans with a valuation
                     Allowance                                             1,728            1,159               202
                                                                      ----------       ----------        ----------
                  Total impaired loans                                $    1,728       $    1,159        $      929
                                                                      ==========       ==========        ==========

                  Valuation allowance related to
                      impaired loans                                  $      642       $      570        $      202
                                                                      ==========       ==========        ==========

                  Average investment in
                      impaired loans                                  $    1,607       $      879        $    1,109
                                                                      ==========       ==========        ==========
</TABLE>

                  No interest income was recognized on impaired loans during the
                  periods presented, and no additional funds are committed to be
                  advanced in connection with impaired loans.

         Note  5. Premises and Equipment

                  Premises and equipment are comprised of the following:

<TABLE>
<CAPTION>
                                                                         2002             2001              2000
                                                                      ----------       ----------        ----------
<S>                                                                   <C>              <C>               <C>
                  Land                                                $    4,445       $    4,120        $    4,120
                  Bank premises                                            7,821            7,506             6,475
                  Equipment                                                5,940            5,402             4,391
                                                                      ----------       ----------        ----------
                                                                          18,206           17,028            14,986

                  Less: accumulated depreciation                           5,112            4,201             3,326
                                                                      ----------       ----------        ----------
                                                                          13,094           12,827            11,660

                  Construction in Progress                                    63               73               794
                                                                      ----------       ----------        ----------

                                                                      $   13,157       $   12,900        $   12,454
                                                                      ==========       ==========        ==========
</TABLE>

                  Depreciation  expense was $937,  $886, and $757 for 2002, 2001
                  and 2000, respectively.

                  Construction  in  progress  for  2002  consists  of the  costs
                  related  to a new branch  being  constructed  in  Blountville,
                  Tennessee.

                                       14
<PAGE>
                HIGHLANDS BANKSHARES, INC., AND SUBSIDIARIES

                   NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
                                December 31, 2002
                             (Amounts in thousands)


         Note 6.  Bank Owned Life Insurance

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


         Note  7. Income Taxes

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

<TABLE>
<CAPTION>
                                                                          2002              2001              2000
                                                                       ---------        ---------         ---------
<S>                                                                    <C>              <C>               <C>
                  Deferred tax assets:
                  Allowance for loan loss                              $     937        $     841         $     735
                  Deferred compensation                                        3                3                 4
                                                                       ---------        ---------         ---------
                                                                             940              844               739
                                                                       ---------        ---------         ---------
                  Deferred tax liability:
                  Depreciation                                         (     293)       (     293)        (     311)
                  Net unrealized gain on securities
                     available-for-sale                                (     521)       (     114)        (      83)
                                                                       ---------        ---------         ---------
                                                                       (     814)       (     407)        (     394)
                                                                       ---------        ---------         ---------

                  Net deferred tax asset                               $     126        $     437         $     345
                                                                       =========        =========         =========

</TABLE>

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

<TABLE>
<CAPTION>
                                                                          2002             2001              2000
                                                                       ---------        ---------         ---------
<S>                                                                    <C>              <C>               <C>
                  Federal:
                    Current                                            $   1,445        $   1,236         $   1,262
                    Deferred                                           (      96)       (     129)        (      33)
                                                                       ---------        ---------         ---------

                        Total                                          $   1,349        $   1,107         $   1,229
                                                                       =========        =========         =========
</TABLE>


                  The Bank's  income tax expense  differs  from the expected tax
                  expense at the statutory federal rate of 34% as follows:
<TABLE>
<CAPTION>

                                                                          2002              2001             2000
                                                                       ---------        ---------         ---------
<S>                                                                    <C>              <C>               <C>
                  Statutory rate applied to
                     earnings before income taxes                      $   1,852        $   1,498         $   1,431
                  Tax exempt interest                                  (     496)       (     331)        (     179)
                  Other, net                                           (       7)       (      60)        (      23)
                                                                       ---------        ---------         ---------

                                                                       $   1,349        $   1,107         $   1,229
                                                                       =========        =========         =========

</TABLE>
                                       15
<PAGE>
                  HIGHLANDS BANKSHARES, INC., AND SUBSIDIARIES

                   NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
                                December 31, 2002
                             (Amounts in thousands)

         Note  8. Deposits

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

                                                                          2002              2001             2000
                                                                       ---------        ---------         ---------

<S>                                                                    <C>              <C>               <C>
                  Noninterest bearing demand                           $  55,597        $  50,248         $  45,343
                  Interest bearing demand                                 49,519           37,464            25,697
                  Savings deposits                                        70,258           60,166            45,826
                  Time deposits, in amounts of
                     $100,000 or more                                     61,465           65,437            55,054
                  Other time deposits                                    173,462          178,778           174,395
                                                                       ---------        ---------         ---------

                                                                       $ 410,301        $ 392,093         $ 346,315
                                                                       =========        =========         =========

</TABLE>

                  The  scheduled  maturities  of time  deposits at December  31,
                  2002, are as follows:

                  2003                                                 $ 131,536
                  2004                                                    41,216
                  2005                                                    30,279
                  2006                                                     6,676
                  2007                                                    21,158
                  Thereafter                                               4,062
                                                                       ---------

                                                                       $ 234,927

         Note 9.  Other Short-Term Borrowings

                  Other  short-term  borrowings  in the balance sheet consist of
                  four  Federal  Home Loan Bank  advances  that are secured by a
                  floating blanket lien on a specific class of mortgage loans of
                  the Bank. The Federal Home Loan Bank has the option to convert
                  three of these  advances  which  total $19  million to a three
                  month  LIBOR-based  floating rate  advance.  These notes carry
                  interest rates of 5.51%,  6.28%, and 6.17%. The fourth advance
                  matures in June of 2003. The advance  carries an interest rate
                  of 7.02%,  and  requires  semi-annual  principal  payments and
                  monthly interest payments.

                  Additionally,    other   short-term   borrowings   include   a
                  seller-financing  transaction  with a current unpaid principal
                  balance of $23.  The note carries an annual  interest  rate of
                  8.50% and a maturity date in 2003.  The note requires  monthly
                  installments  of  principal  and  interest  of $2. The loan is
                  secured by a first deed of trust on real  estate.  The debt is
                  listed under long-term debt for the years 2000 and 2001.


                                       16
<PAGE>
                HIGHLANDS BANKSHARES, INC., AND SUBSIDIARIES

                   NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
                                December 31, 2002
                             (Amounts in thousands)


         Note 10.  Long-Term Debt

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

                                                                           2002            2001              2000
                                                                       ---------        ---------         ---------


<S>                                                                    <C>               <C>               <C>
                   Note  payable  Federal  Home Loan Bank dated
                   June 6, 1996 for $1,000  with an annual
                   interest rate of 7.02%,  due June 6, 2003. The
                   note requires semi-annual installments of
                   $71 plus interest.  The loan is secured by a        Included in
                   floating blanket lien on a specific class of        short term
                   mortgage loans of the Bank.                         borrowings       $     214         $     357



                   Note payable  Federal Home Loan Bank dated
                   March 26, 1998 for $6,000 with an annual
                   interest rate of 5.51%,  due March 26, 2008.
                   The note requires  quarterly  interest payments
                   and has an early conversion option at March
                   26, 2003.  The loan is secured by a floating        Included in
                   blanket lien on a specific class of mortgage        short term
                   loans of the Bank.                                  borrowings           6,000             6,000



                   Note  payable  Federal  Home Loan Bank dated
                   August 13, 1999, for $4,000 with an annual
                   interest rate of 6.385%, due August 13, 2009.
                   The note requires  quarterly  interest payments
                   an has an early  conversion  option at
                   August 13, 2004. The loan is secured by a
                   floating blanket lien on a specific class of
                   mortgage loans of the Bank.                             4,000            4,000             4,000



                   Note  payable to Federal  Home Loan Bank dated
                   March 3, 2000 for $8,000 with an annual
                   interest rate of 6.28%,  due March 3, 2010. The
                   note requires quarterly interest  payments and has
                   an early conversion option at March 3, 2002.        Included in      Included in
                   The loan is secured by a floating blanket lien      short term       short term
                   on a specific class of mortgage loans of the Bank.  borrowings       borrowings            8,000
</TABLE>


                                   (Continued)
                                       17





<PAGE>
                  HIGHLANDS BANKSHARES, INC., AND SUBSIDIARIES

                   NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
                                December 31, 2002
                             (Amounts in thousands)


         Note 10.  Long-Term Debt (Continued)
<TABLE>
<CAPTION>

                                                                           2002            2001              2000
                                                                       ---------        ---------         ---------

<S>                                                                    <C>              <C>               <C>
                   Note  payable to Federal  Home Loan Bank dated
                   February  13, 2002, for $5,000 with an annual
                   interest rate of 4.64%,  due February  13,  2012.
                   The note  requires  quarterly  interest payments
                   and has an early  conversion  option at
                   February 13, 2007.  The loan is secured by a
                   floating  blanket  lien on a specific class of
                   mortgage loans of the Bank.                         $   5,000        $       -         $       -

                   Note payable  Federal  Home Loan Bank dated
                   May 7, 2002,  for $5,000  with an annual
                   interest  rate of  4.72%,  due May 7, 2012.
                   The note requires  quarterly  interest payments
                   and has an  early  conversion  option  at
                   May 7,  2007.  The  loan is secured by a
                   floating blanket lien on a specific class of
                   mortgage loans of the Bank.                             5,000                -                 -

                   Other  notes  payable   resulting   from  seller-
                   financing transactions for $375 with annual
                   interest rates ranging from 8.0% to 8.50%,  and
                   due dates  ranging  from  2003-2010.  The notes
                   require monthly  installments of principal and
                   interest of $6. The loans are secured by a first
                   deed of trust on real estate.                             200              269               312
                                                                       ---------        ---------         ---------

                   Total long-term debt                                $  14,200        $  10,483         $  18,669
                                                                       =========        =========         =========
</TABLE>


                  Principal  maturities  of long-term  debt at December 31, 2002
                  are as follows:

                   2003                                                $      21
                   2004                                                    4,022
                   2005                                                       24
                   2006                                                       26
                   2007                                                   10,028
                   Thereafter                                                 79
                                                                       ---------

                                                                       $  14,200
         Note 11.  Capital Securities

                   On January 21, 1998, Highlands Capital Trust I, issued $7,500
                   of 9.25% Capital  Securities which will mature on January 15,
                   2028.  The  principal  asset of the  Trust is  $7,500  of the
                   Parent  Company's  junior  subordinated  debt securities with
                   like  maturities  and  like  interest  rates  to the  Capital
                   Securities.  Additionally,  the Trust has issued 9,000 shares
                   of common securities to the Parent Company. The 9.25% Capital
                   Securities  had $7,500  outstanding at December 31, 2002, and
                   an  estimated  fair  value  of  $7,752.  The  related  junior
                   subordinated  debt  securities had an estimated fair value of
                   $7,752.

                                   (Continued)
                                       18

<PAGE>


                  HIGHLANDS BANKSHARES, INC., AND SUBSIDIARIES

                   NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
                                December 31, 2002
                             (Amounts in thousands)


         Note 11.  Capital Securities (Continued)

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

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

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

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


         Note 12.  Operating Leases

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

                   Year ending December 31:

                    2003                                               $     222
                    2004                                                      40
                    2005                                                       4
                                                                       ---------

                   Total minimum payments required                     $     266
                                                                       =========

                   Total  operating  lease  expense was $ 232, $226 and $337 for
                   December 31, 2002, 2001, and 2000 respectively.


         Note 13.  Common Stock and Earnings Per Common Share

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

                                   (Continued)
                                       19

<PAGE>
                  HIGHLANDS BANKSHARES, INC., AND SUBSIDIARIES

                   NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
                                December 31, 2002
                  (Amounts in thousands, except per share data)


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

                   The following is a  reconciliation  of the numerators and the
                   denominators  of the basic and  diluted  earnings  per common
                   share computation:
<TABLE>
<CAPTION>
                                                                          2002             2001              2000
                                                                       ---------        ---------         ---------

<S>                                                                    <C>              <C>               <C>
                    Income available to common stockholders            $   4,104        $   3,301         $   2,979
                    Weighted average shares outstanding                    2,645            2,639             2,632
                    Shares outstanding including assumed conversion        2,669            2,651             2,655
                    Basic earnings per share                           $   1.55         $    1.25         $    1.13
                    Fully diluted earnings per share                   $   1.54         $    1.24         $    1.12
</TABLE>

                  Highlands Bankshares,  Inc., paid dividends of $238, $211, and
                  $185 or $0.09 per share,  $0.08 per share, and $0.07 per share
                  in 2002, 2001 and 2000, respectively.


         Note 14.  Profit Sharing and Retirement Savings Plan

                   The Bank has a 401(K) savings plan available to substantially
                   all employees meeting minimum eligibility  requirements.  The
                   Bank makes a 2% profit sharing  contribution to all employees
                   exclusive of employee  contributions  and employer  matching.
                   Employees may elect to make  voluntary  contributions  to the
                   plan up to 15% of  their  base  pay.  In  addition  to the 2%
                   profit  sharing  contribution,  the Bank  matches  50% of the
                   employee's  initial 6% contribution;  therefore,  the maximum
                   employer  matching  contribution  per employee could be 3% of
                   base pay.  The cost of Bank  contributions  under the savings
                   plan  was  $207,  $186  and  $150,  in  2002,  2001  and 2000
                   respectively.


         Note 15.  Stock Option Plan

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

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

                                   (Continued)
                                       20
<PAGE>
                  HIGHLANDS BANKSHARES, INC., AND SUBSIDIARIES

                   NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
                                December 31, 2002
                  (Amounts in thousands, except per share data)


         Note 15.  Stock Option Plan (Continued)

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

<TABLE>
<CAPTION>
                                                                                  Years Ended December 31,
                                                                       -----------------------------------------
                                                                             2002           2001           2000
                                                                       -----------    -----------    -----------

<S>                                                                    <C>            <C>            <C>
                   Net income               As reported                $     4,104    $     3,301    $     2,979
                                            Pro forma                  $     3,830    $     3,070    $     2,797

                   Earnings per share       As reported                $      1.55    $      1.25    $      1.13
                                            Pro forma                  $      1.45    $      1.16    $      1.06

                   Earnings per share -     As reported                $      1.54    $      1.24    $      1.12
                    Assuming dilution       Pro forma                  $      1.43    $      1.15    $      1.05

</TABLE>

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

                                                                                   Years Ended December 31,
                                                                       --------------------------------------------
                                                                            2002            2001              2000
                                                                       -------------- -----------------------------
<S>                                                                       <C>             <C>            <C>
                   Expected life                                          10 years        10 years       10 years
                   Expected volatility                                    6.30%            8.33%         7.16%
                   Risk-free interest rate                                5.43%            5.48%         6.25%

</TABLE>
                                   (Continued)
                                       21
<PAGE>

                  HIGHLANDS BANKSHARES, INC., AND SUBSIDIARIES

                   NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
                                December 31, 2002
                  (Amounts in thousands, except per share data)

         Note 15.   Stock Option Plan (Continued)

                  A summary of the status of the Company's  stock option plan is
                  presented below:
<TABLE>
<CAPTION>

                                                            2002                     2001                  2000
                                                  --------------------  --------------------- ---------------------

                                                   Weighted              Weighted              Weighted
                                                   Average               Average               Average
                                                   Exercise   Number of  Exercise Number of    Exercise  Number of
                                                     Price     Shares     Price     Shares      Price      Shares
                                                  ---------   ---------  -------- ---------    --------  ---------
<S>                                               <C>         <C>       <C>        <C>        <C>           <C>
                   Options outstanding January 1  $ 19.70     107,501   $ 17.40     81,274    $  14.76      69,122
                   Granted                          26.00      30,000     25.00     32,900       23.50      25,300
                   Exercised                        23.35   (   3,403)    17.81   (  6,673)      15.24   (  13,148)
                   Expired                           2.83   (     880)       -           -           -           -
                                                  -------    --------   -------    -------    --------    --------

                   Options outstanding and
                     exercisable at December 31   $ 20.98     133,218   $ 19.70    107,501    $  17.40      81,274
                                                             ========              =======                ========

                   Weighted-average fair
                     value of options granted
                     during the year              $ 26.00               $ 25.00               $ 23.50

</TABLE>

                  Information  pertaining to options outstanding at December 31,
                  2002 is as follows:

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

<S>                <C>                                                 <C>             <C>         <C>
                   $  4.17  - $  7.50                                  5,700           2.25 years  $    5.98
                     10.50  -   15.50                                 29,896           5.06            13.95
                     19.00  -   26.00                                 97,622           8.02            24.01
                                                                   ---------

                   Outstanding at end of year                        133,218           7.11 years     $20.98
                                                                   =========
</TABLE>

         Note 16.  Off-Balance Sheet Activities

                   The Bank is  party  to  various  financial  instruments  with
                   off-balance  sheet  risk  arising  in the  normal  course  of
                   business  to meet the  financing  needs  of their  customers.
                   Those  financial  instruments  include  commitments to extend
                   credit and standby letters of credit of approximately $2,694,
                   $2,722,  and  $1,901,  unfunded  commitments  under  lines of
                   credit of $28,716,  $20,324 and  $23,689 and  commitments  to
                   grant loans of $6,540, $9,320, and $2,632 for the years ended
                   December  31,  2002,  2001  and  2000   respectively.   These
                   instruments  contain various  elements of credit and interest
                   rate  risk  in  excess  of  the  amount   recognized  in  the
                   statements of financial condition.

                                   (Continued)
                                       22

<PAGE>
                  HIGHLANDS BANKSHARES, INC., AND SUBSIDIARIES

                   NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
                                December 31, 2002
                             (Amounts in thousands)

         Note 16.  Off-Balance Sheet Activities (Continued)

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

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

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

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


         Note 17. Commitments and Contingencies

                  The Bank has made  arrangements  with and has  available  from
                  other corresponding banks,  approximately $128,300 of lines of
                  credit to fund any necessary cash  requirements.  The Bank has
                  $33,072 of Federal Home Loan Bank advances  outstanding  as of
                  December 31, 2002. A specific  class of mortgage  loans with a
                  balance of $124,141 at December  31, 2002 were  pledged to the
                  FHLB as collateral.


         Note 18.   Fair Values of Financial Instruments

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


                                   (Continued)
                                       23
<PAGE>
                  HIGHLANDS BANKSHARES, INC., AND SUBSIDIARIES

                   NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
                                December 31, 2002
                             (Amounts in thousands)


         Note 18.  Fair Values of Financial Instruments (Continued)

                   and  all   nonfinancial   instruments   from  its  disclosure
                   requirements.  Accordingly,  the aggregate fair value amounts
                   presented may not  necessarily  represent the underlying fair
                   value of the Company.

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

                   Cash and Cash Equivalents

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

                   Securities Available for Sale

                   Fair value for securities,  excluding  Federal Home Loan Bank
                   and Federal  Reserve Bank stock,  are based on quoted  market
                   prices.  The  carrying  value of  Federal  Home Loan Bank and
                   Federal Reserve Bank stock  approximates  fair value based on
                   the redemption provisions of those Banks.

                   Loans

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

                   Deposits

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

                   Other Short-Term Borrowings

                   The  carrying   amounts  of   borrowings   under   repurchase
                   agreements,  and other short-term  borrowings maturing within
                   ninety days  approximate  their fair  values.  Fair values of
                   other  short-term  borrowings are estimated using  discounted
                   cash flow analyses based on the Company's current incremental
                   borrowing rates for similar types of borrowing arrangements.

                   Long-Term Debt and Capital Securities

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


                                   (Continued)
                                       24

<PAGE>

                  HIGHLANDS BANKSHARES, INC., AND SUBSIDIARIES

                   NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
                                December 31, 2002
                             (Amounts in thousands)


         Note 18.  Fair Values of Financial Instruments (Continued)

                   Off-Balance-Sheet Instruments

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

                   The  carrying  amounts  and  fair  values  of  the  Company's
                   financial instruments at December 31 were as follows:
<TABLE>
<CAPTION>
                                                            2002                     2001                     2000
                                                   ----------------------     --------------------    -------------------
                                                     Carrying       Fair      Carrying        Fair    Carrying       Fair
                                                     Amount        Value      Amount         Value      Amount      Value
                                                   --------     ---------     ------      ------------  -----------------------
<S>                                                <C>          <C>           <C>         <C>         <C>        <C>
                   Cash and cash equivalents       $ 18,501     $  18,501     $ 12,241    $ 12,241    $ 15,292   $ 15,292
                   Securities available for sale    102,743       102,743       98,299      98,299      80,748     80,748
                   Loans, net                       335,644       340,976      322,042     328,059     288,947    286,306
                   Deposits                        (410,301)    ( 412,779)    (392,093)   (395,684)   (346,315)  (346,888)
                   Other short-term borrowings     ( 19,094)    (  19,112)    ( 13,000)   ( 13,198)   (  5,000)  (  5,110)
                   Long-term debt                  ( 14,200)    (  15,071)    ( 10,483)   ( 10,523)   ( 18,669)  ( 18,066)
                   Capital securities              (  7,500)    (   7,752)    (  7,500)   (  7,637)   (  7,500)  (  7,240)
</TABLE>


         Note 19.  Related Party Transactions

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

                                                          2002              2001             2000
                                                       ---------        ---------         ---------
<S>                                                    <C>              <C>               <C>
                   Balance, beginning                  $   9,394        $   8,279         $   7,767
                   Additions                               7,279            2,814             3,839
                   Reductions                          (   7,239)       (   1,699)        (   3,327)
                                                       ---------        ---------         ---------

                   Balance, ending                     $   9,434        $   9,394         $   8,279
                                                       =========        =========         =========

                   Unused Commitments                  $     620        $     719         $     555
                                                       =========        =========         =========
</TABLE>

                    Deposits  from related  parties held by the Bank at December
                   31, 2002,  2001,  and 2000 were $3,156 and $2,750 and $2,354,
                   respectively.

                                       25
<PAGE>
                  HIGHLANDS BANKSHARES, INC., AND SUBSIDIARIES

                   NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
                                December 31, 2002
                             (Amounts in thousands)


         Note 20.  Restrictions on Cash

                   The Bank is  required to  maintain  reserve  balances in cash
                   with the Federal  Reserve  Bank.  The total of those  reserve
                   balances at December  31,  2002,  2001 and 2000 were  $4,641,
                   $3,550 and $2,763, respectively.


         Note 21.  Minimum Regulatory Capital Requirements

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

                   Quantitative  measures  established  by  regulation to ensure
                   capital adequacy require the Company and the Bank to maintain
                   minimum  amounts and ratios of total  risk-based  capital and
                   Tier I capital to  risk-weighted  assets  (as  defined in the
                   regulations), and Tier I capital to adjusted total assets (as
                   defined). Management believes, as of December 31, 2002, 2001,
                   and 2000,  that the  Company and the Bank met all the capital
                   adequacy requirements to which they are subject.

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


                                   (Continued)
                                       26
<PAGE>
                  HIGHLANDS BANKSHARES, INC., AND SUBSIDIARIES

                   NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
                                December 31, 2002
                             (Amounts in thousands)


         Note 21.   Minimum Regulatory Capital Requirements (Continued)

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

                                                                               For Capital
                                                           Actual           Adequacy Purposes
                                                     ------------------   --------------------
                                                     Amount      Ratio      Amount       Ratio
                                                     ------      -----      ------       -----

<S>                                                 <C>         <C>         <C>           <C>
                   As of December 31, 2002:
                     Total Risk-Based Capital
                          (to Risk-Weighted Assets) $ 42,254    13.33%      $ 25,349    =>8.0%
                     Tier I Capital
                          (to Risk-Weighted Assets)   38,377    12.11%        12,675    =>4.0%
                     Tier I Capital
                          (to Adjusted Total Assets)  38,377     7.94%        19,323    =>4.0%

                   As of December 31, 2001:
                     Total Risk-Based Capital
                          (to Risk-Weighted Assets) $ 37,783    12.39%      $ 24,388    8.0=>%
                     Tier I Capital
                          (to Risk-Weighted Assets)   34,366    11.27%        12,194    4.0=>%
                     Tier I Capital
                          (to Adjusted Total Assets)  34,366     7.53%        18,255    4.0=>%

                   As of December 31, 2000:
                     Total Risk-Based Capital
                          (to Risk-Weighted Assets) $ 34,116    12.38%      $ 25,055    =>8.0%
                     Tier I Capital
                          (to Risk-Weighted Assets)   31,167    11.31%        11,027    =>4.0%
                     Tier I Capital
                          (to Adjusted Total Assets)  31,167     7.32%        17,026    =>4.0%
</TABLE>

                                  (Continued)
                                       27
<PAGE>

                  HIGHLANDS BANKSHARES, INC., AND SUBSIDIARIES

                   NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
                                December 31, 2002
                             (Amounts in thousands)


         Note 21. Minimum Regulatory Capital Requirements (Continued)

                  The Bank's actual and required  capital amounts and ratios are
                  as follows:
<TABLE>
<CAPTION>
                                                                                                 To be Well Capitalized
                                                                                                   under the Prompt
                                                                               For Capital         Corrective Action
                                                           Actual           Adequacy Purposes      Adequacy Purposes
                                                     ------------------   --------------------   ----------------------
                                                     Amount      Ratio      Amount       Ratio    Amount       Ratio
                                                     ------      -----      ------       -----    ------       -----
<S>                                                 <C>         <C>         <C>           <C>      <C>           <C>
                   As of December 31, 2002:
                       Total Risk-Based Capital
                         (to Risk-Weighted Assets)   $35,598    11.44%      $ 24,892   =>%8.0      $31,115    =>%10.0
                       Tier I Capital
                         (to Risk-Weighted Assets)    31,741    10.20%        12,446   =>%4.0        18,669    =>%6.0
                       Tier I Capital
                         (to Adjusted Total Assets)   31,741     6.66%        19,057   =>%4.0        23,821    =>%5.0

                   As of December 31, 2001:
                       Total Risk-Based Capital
                         (to Risk-Weighted Assets)  $ 32,143    10.71%      $ 24,004    =>8.0%     $ 30,005    =>10.0%
                       Tier I Capital
                         (to Risk-Weighted Assets)    28,744     9.58%        12,002    =>4.0%       18,003     =>6.0%
                       Tier I Capital
                         (to Adjusted Total Assets)   28,744     6.38%        18,027    =>4.0%       22,534     =>5.0%

                   As of December 31, 2000:
                       Total Risk-Based Capital
                         (to Risk-Weighted Assets)  $ 28,098    10.40%      $ 21,623    =>8.0%     $ 27,029    =>10.0%
                       Tier I Capital
                         (to Risk-Weighted Assets)    25,167     9.31%        10,812    =>4.0%       16,217     =>6.0%
                       Tier I Capital
                         (to Adjusted Total Assets)   25,167     6.37%        15,803    =>4.0%       19,753     =>5.0%
</TABLE>


         Note 22.  Restrictions on Dividends

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

                   Under applicable laws and without prior regulatory  approval,
                   the total dividend  payments of the Bank in any calendar year
                   are  restricted  to the net profits of that year, as defined,
                   combined  with the retained net profits for the two preceding
                   years.  The  total  dividends  that may be  declared  in 2003
                   without  regulatory  approval total $11,365 plus year-to-date
                   2003 net profits as of the declaration date.

                                       28
<PAGE>

                  HIGHLANDS BANKSHARES, INC., AND SUBSIDIARIES

                   NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
                                December 31, 2002
                             (Amounts in thousands)

         Note 23.  Other Operating Expenses

                   Other  operating  expenses  that  exceed  1% of the  total of
                   interest income and other income presented separately consist
                   of the following:
                                              2002          2001         2000
                                           ---------     ---------    ---------

                   Postage and freight     $       -     $     392    $     305
                                           =========     =========    =========

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

         Note 24.  Condensed Parent Company Financial Statements

                   The condensed financial  statements below relate to Highlands
                   Bankshares,  Inc., as of December 31, 2002, 2001 and 2000 and
                   for the years then ended. Equity in undistributed earnings of
                   subsidiary  includes the change in unrealized gains or losses
                   on securities, net of tax.

                   CONDENSED BALANCE SHEETS
<TABLE>
<CAPTION>

                                                                           2002             2001              2000
                                                                       ---------        ---------         ---------
<S>                                                                    <C>              <C>               <C>
                   ASSETS
                     Cash                                              $   1,103        $     989         $     551
                     Investment securities available
                       for sale                                                -                -               151
                     Loans, net of allowance for loan losses
                         of $20, $18 and $18 in 2002, 2001 and
                        2000, respectively                                 3,881            2,906             3,728
                     Equity in subsidiaries                               33,064           29,330            25,624
                     Premises and equipment, net                           1,468            1,513             1,394
                     Other assets                                            345              361               383
                                                                       ---------        ---------         ---------

                             Total Assets                              $  39,861        $  35,099         $  31,831
                                                                       =========        =========         =========

                   LIABILITIES AND STOCKHOLDERS' EQUITY
                     Interest, taxes and other
                        liabilities                                    $     162        $     147         $     148
                     Capital securities                                    7,500            7,500             7,500
                                                                       ---------        ---------         ---------
                             Total Liabilities                             7,662            7,647             7,648
                                                                       ---------        ---------         ---------

                   STOCKHOLDERS' EQUITY                                   32,199           27,452            24,183
                                                                       ---------        ---------         ---------

                             Total Liabilities and
                              Stockholders' Equity                     $  39,861        $  35,099         $  31,831
                                                                       =========        =========         =========
</TABLE>

                                   (Continued)
                                       29
<PAGE>
                  HIGHLANDS BANKSHARES, INC., AND SUBSIDIARIES

                   NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
                                December 31, 2002
                             (Amounts in thousands)


         Note 24.  Condensed Parent Company Financial Statements (Continued)

<TABLE>
<CAPTION>

                   CONDENSED STATEMENTS OF INCOME
                                                                           2002            2001              2000
                                                                       ---------        ---------         ---------

<S>                                                                    <C>              <C>               <C>
                   Dividends from subsidiary                           $   1,500        $       -         $     300
                   Interest income                                           290              300               314
                   Other income                                              226              226               154
                   Interest expense                                    (     694)       (     694)        (     696)
                   Operating expense                                   (     162)       (     178)        (     146)
                                                                       ---------        ---------         ---------
                                                                           1,160        (     346)        (      74)

                   Income tax benefit                                        116              118                25
                   Equity in undistributed earnings of subsidiary          2,828            3,529             3,028
                                                                       ---------        ---------         ---------

                   Net income                                          $   4,104        $   3,301         $   2,979
                                                                       =========        =========         =========

</TABLE>
                                  (Continued)
                                       30
<PAGE>
                  HIGHLANDS BANKSHARES, INC., AND SUBSIDIARIES

                   NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
                                December 31, 2002
                             (Amounts in thousands)


         Note 24.  Condensed Parent Company Financial Statements (Continued)

                   CONDENSED STATEMENTS OF CASH FLOWS
<TABLE>
<CAPTION>

                                                                           2002             2001              2000
                                                                        ---------        ---------         ---------
<S>                                                                     <C>              <C>               <C>
                   Cash flows from operating activities:
                     Net income                                         $   4,104        $   3,301         $   2,979
                     Adjustments to reconcile net income to
                      net cash provided by operating activities:
                         Allowance for loan losses                              2                -                12
                         Depreciation and amortization                         58               50                40
                         Provision for deferred income taxes            (      45)       (      28)                7
                         Equity in undistributed earnings of subsidiary (   2,828)       (   3,529)        (   3,028)
                         Net amortization on securities                                          -                 2
                         Increase in other assets                       (      67)       (      79)        (      45)
                         Increase in other liabilities                         15                -                 2
                                                                        ---------        ---------         ---------

                         Net cash provided by (used in)
                               operating activities                         1,239        (     285)        (      31)
                                                                        ---------        ---------         ---------


                   Cash flows from investing  activities:
                     Securities  available for sale:
                         Proceeds from sale of securities                       -              151               819
                         Proceeds from maturities of securities                 -                -                91
                     Net (increase) decrease in loans                   (     977)             822         (   1,188)
                     Premises and equipment expenditures                (       2)       (     158)        (      42)
                                                                        ---------        ---------         ---------

                         Net cash provided by (used in)
                           investing activities                         (     979)             815         (     320)
                                                                        ---------        ---------         ---------


                   Cash flows from financing activities:
                     Cash dividends paid                                (     238)       (     211)        (     185)
                     Proceeds from issuance of common stock                    14                -                 -
                     Proceeds from exercise of common stock options            78              119               200
                                                                        ---------        ---------         ---------
                         Net cash provided by (used in) financing
                            activities                                  (     146)       (      92)               15
                                                                        ---------        ---------         ---------

                         Net increase (decrease) in cash and cash
                           equivalents                                        114              438         (     336)

                     Cash and cash equivalents
                       at beginning of yeAR                                   989              551               887
                                                                        ---------        ---------         ---------

                     Cash and cash equivalents
                       at end of yeAR                                   $   1,103        $     989         $     551
                                                                        =========        =========         =========

</TABLE>
                                       31
<PAGE>

                  HIGHLANDS BANKSHARES, INC., AND SUBSIDIARIES

                   NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
                                December 31, 2002
                             (Amounts in thousands)

         Note 25. Quarterly Data (Unaudited)

                  Consolidated quarterly results of operations were as follows:
<TABLE>
<CAPTION>


                                                                                     2002
                                                              ------------------------------------------------
                                                               March 31     June 30      Sept 30       Dec 31
                                                               --------    ---------    ---------    ---------
<S>                                                           <C>          <C>          <C>          <C>
         Interest Income                                      $   7,850    $   7,767    $   7,735    $   7,592
         Interest Expense                                     (   3,739)   (   3,551)   (   3,523)   (   3,453)
                                                              ---------    ---------    ---------    ---------

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

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

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

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

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

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

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

         Income before income taxes                               1,013        1,033        1,198        1,164
         Income taxes                                         (     280)   (     257)   (     314)   (     256)
                                                               --------     --------     --------     --------

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

         Earnings per common share:
           Basic                                              $     .28    $     .29    $     .33    $      .35
                                                              =========    =========    =========    ==========
           Diluted                                            $     .28    $     .29    $     .33    $      .34
                                                              =========    =========    =========    ==========
</TABLE>

                                   (Continued)
                                       32
<PAGE>

                  HIGHLANDS BANKSHARES, INC., AND SUBSIDIARIES

                   NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
                                December 31, 2002
                  (Amounts in thousands, except per share data)


         Note 25.  Quarterly Data (Unaudited) (Continued)

<TABLE>
<CAPTION>

                                                                                    2000
                                                              ------------------------------------------------
                                                               March 31     June 30      Sept 30       Dec 31
                                                               --------    ---------    ---------    ---------
<S>                                                           <C>          <C>          <C>          <C>
         Interest Income                                      $   6,975    $   7,425    $   7,830    $   8,188
         Interest Expense                                     (   3,921)   (   4,253)   (   4,643)   (   4,883)
                                                               --------     --------     --------     --------

         Net interest income                                      3,054        3,172        3,187        3,305
         Provision for loan losses                            (     362)   (     314)   (     297)   (     304)
                                                               --------     --------     --------     --------
         Net interest income after provision for
           possible loan losses                                   2,692        2,858        2,890        3,001
         Other income                                               473          635          662          710
         Other expenses                                       (   2,227)   (   2,335)   (   2,465)   (   2,686)
                                                               --------     --------     --------     --------

         Income before income taxes                                 938        1,158        1,087        1,025
         Income taxes                                         (     300)   (     342)   (     321)   (     266)
                                                               --------     --------     --------     --------

         Net income                                           $     638    $     816    $     766    $     759
                                                              =========    =========    =========    =========

         Earnings per common share:
           Basic                                              $     .24    $     .31    $     .29    $      .29
                                                              =========    =========    =========    ==========
           Diluted                                            $     .24    $     .31    $     .28    $      .29
                                                              =========    =========    =========    ==========


</TABLE>

                                       33