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                                UNITED STATES
                      SECURITIES AND EXCHANGE COMMISSION
                            Washington, D.C.  20549

                                  FORM 10-K

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

For the Fiscal Year ended:                                Commission File
    December 31, 2001                                     Number:  430893107
    -----------------                                              ---------

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

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

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

Registrant's telephone number, including area code: (276) 628-9181

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

               Securities registered pursuant to Section 12(g) of the Act:
                              Common Stock, $1.25 par value
                              -----------------------------
                                    (Title of Class)

Indicate by check mark whether the registrant (1) has filed all reports
required to be filed by Section 13 or 15(d) of the Securities Exchange Act of
1934 during the preceding 12 months and (2) has been subject to such filing
requirements for the past 90 days.
Yes X No___
   ---
Indicate by check mark if disclosure of delinquent filers pursuant to Item 405
of Regulation S-K (Section 229.405 of this chapter) is not contained herein,
and will not be contained, to the best of registrant's knowledge, in definitive
proxy or information statements incorporated by reference in Part III of this
Form 10-K or any amendment to this Form 10-K.  [ X ]

As of March 13, 2002, there were 2,644,097 shares of Common Stock outstanding.

As of March 13, 2002 the aggregate market value of voting and non-voting stock
held by non-affiliates totaled $50,031,025.50.

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                      DOCUMENTS INCORPORATED BY REFERENCE

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

(1) Part II incorporates information by reference from the registrant's Annual
Report to Stockholders for the fiscal year ended December 31, 2001.

(2) Part III incorporates by reference from the registrant's proxy statement
for its Annual Meeting of Stockholders scheduled for May 8, 2002.

(3) Part IV incorporates by reference from: (i) the registrant's Annual Report
to Stockholders for the fiscal year ended December 31, 2001, and (ii) the
registrant's proxy statement for its Annual Meeting of Stockholders scheduled
for May 8, 2002.

The exhibit index is located on page 32.

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                          FORWARD-LOOKING INFORMATION
                          ---------------------------

     This report contains forward-looking statements with respect to the
financial condition, results of operations and business of the Corporation.
These forward-looking statements involve risks and uncertainties and are based
on the beliefs and assumptions of the management of the Corporation, and on the
information available to management at the time that these disclosures were
prepared. Factors that may cause actual results to differ materially from those
contemplated by such forward-looking statements include, among others, the
following possibilities: (1) competitive pressures among depository and other
financial institutions may increase significantly; (2) changes in the interest
rate environment may reduce margins; (3) general economic conditions, either
nationally or regionally, may be less favorable than expected, resulting in,
among other things, a deterioration in credit quality and / or a reduced demand
for credit; (4) legislative or regulatory changes, including changes in
accounting standards, may adversely affect the businesses in which the
Corporation and its subsidiaries are engaged; (5) costs or difficulties related
to the integration of the businesses of the Corporation and its merger partners
may be greater than expected; (6) expected cost savings associated with pending
mergers may not be fully realized or realized within the expected time frame;
(7) deposit attrition, customer loss or revenue loss following pending mergers
may be greater than expected; (8) competitors may have greater financial
resources and develop products enable such competitors to compete more
successfully than the Corporation and its subsidiaries; and (9) adverse changes
may occur in the securities markets.

PART I.
------

ITEM I.  BUSINESS
-----------------

                                   GENERAL
                                   -------

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

     At December 31, 2001, the Corporation had total assets of $453,745,000,
deposits of $392,093,000, and net worth of $27,452,000.

     The Corporation's principal business activities, which are conducted
through the Bank, are attracting checking and savings deposits from the general
public through its retail banking offices and originating and servicing loans
secured by first mortgage liens on single-family dwellings, including
condominium units. All of the retail banking offices are located in Virginia
and Tennessee. The Corporation also lends funds to retail banking customers by
means of home equity and installment loans, and originates construction loans
and loans secured by commercial property, multi-family dwellings and
manufactured housing units. The Corporation opened an indirect lending
department in 1997. The majority of indirect lending originates through new and
used car dealerships. The indirect lending portfolio comprises a significant
portion of the total consumer loan portfolio. The Corporation invests in
certain U.S. Government and agency obligations and other investments permitted
by applicable laws and regulations. The operating results of the Corporation
are highly dependent on net

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interest income, the difference between interest income earned on loans and
investments and the cost of checking and savings deposits and borrowed funds.

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

     The Corporation has two direct subsidiaries as of December 31, 2001. The
Bank which was formed in 1985 and Highlands Capital Trust I, a statutory
business trust (the "Trust") which was created by the Corporation on January
21, 1998. The Corporation's material assets as of December 31, 2001 include:
cash in bank of approximately $989 thousand; building and land with a net book
value of approximately $1.513 million; approximately $2.924 million in loan
participations from the subsidiary bank; approximately $361 thousand in other
assets; and its investment in subsidiaries, approximately $29.330 million. The
Corporation's only material liability is the note payable on the trust
preferred debentures issued in January of 1998, $7.5 million.

     The Bank had two direct wholly-owned subsidiaries, Highlands Union
Insurance Services, Inc., that became effective on October 8, 1999. The Bank
through Highlands Union Insurance Services, Inc. joined a consortium of
approximately sixty other financial institutions to form Bankers' Insurance,
LLC. Bankers' Insurance LLC as of December 31, 2001 had purchased six full
service insurance agencies across the state of Virginia. This entity will be
used to sell insurance services through the Bankers' Insurance, LLC. Highlands
Union Financial Services, Inc., became effective March 5, 2001. This entity was
formed in order for the Bank to continue to offer third-party mutual funds,
annuities and other financial services to its customers in North Carolina.

     As of December 31, 2001 the Corporation operates eight full-service and one
express facility throughout Washington County, Virginia, the City of Bristol,
Virginia, Marion, Virginia, Glade Spring, Virginia, Rogersville, Tennessee and
Boone, North Carolina. The Corporation also opened a loan production office in
the fourth quarter of 2001. This office is located in Kingsport, Tennessee and
will offer a full range of loan products to customers in the Northeast
Tennessee area. The Corporation also operates twenty-seven off-site ATM's
throughout the service areas listed above as well as Russell County and Wythe
County, Virginia.

     The results of operations for the fiscal years ended December 31, 2001,
2000, and 1999 ("fiscal year 2001", "fiscal year 2000" and "fiscal year 1999",
respectively) reflect the Corporation's strategies of expanding its community
banking operations.

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

                              LENDING ACTIVITIES
                              ------------------

RESIDENTIAL MORTGAGE LENDING
----------------------------

     The Bank's lending policy is generally to lend up to 80% of the appraised
value of residential property. The Corporation lends up to 95% of the appraised
value with the normal requirement of insurance from private mortgage insurance
companies. This insurance normally covers amounts in excess of 80% loan to
value up to 95%.

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     The in-house residential mortgages are comprised of primarily one, three
and five year adjustable rate mortgages and 15 year fixed rate mortgages as
well as three and five year balloon mortgages. Adjustable rate mortgages are
indexed to 275 basis points over the average yield on United States Treasury
securities adjusted to a constant maturity of one, three or five years. An
adjustment limitation (increase or decrease) of 2% per annum applies to the one
year adjustable product. A 4% lifetime cap over the initial rate of the loan
is included in the one, three and five year adjustable rate mortgages.
     The Bank's existing loan contracts generally provide for repayment of
residential mortgage loans over periods ranging from 15 to 30 years. However,
such loans normally have remained outstanding for much shorter periods of time
as borrowers refinance or prepay their loans through the sale of their homes.
     Most of the Bank's residential mortgage loans have "due on sale" clauses
which allows the creditor the right to declare a loan immediately due and
payable in the event the borrower sells or otherwise disposes of the real
property. Most of the Bank's residential mortgage loans are not assumable.
     Mortgage loans exceeding $450,000 but less than $750,000 must be approved
by the loan committee of the Board of Directors. Mortgage loans in excess of
the customer's aggregate debt of $750,000 must be approved by the Board of
Directors.
     All of the Bank's mortgage lending is subject to loan origination
procedures established by the Board of Directors. Most originations require a
property valuation by state licensed appraisers, for a fee, approved by the
Board of Directors. Loan applications are obtained to determine the borrowers
ability to repay. Significant items are verified through the use of credit
reports, financial statements, etc.
     It is generally the Bank's policy to require title insurance on first
mortgage loans in excess of $100,000 (lower where deemed necessary). It is also
the Bank's general policy to require an attorney's opinion statement on all
first mortgage deeds of trust. Fire and casualty insurance (extended coverage)
is required on all property serving as security for these loans. Hazard
insurance and flood insurance (where required) is provided by the customer
prior to closing of the loan. The borrower is responsible for paying insurance
premiums and real estate taxes.
     Federal regulations allow the Bank to originate loans on real estate within
its designated market area, and within limits, to originate and purchase loans
or loan participations secured by real estate located in any part of the United
States. During fiscal year 2001 the Bank's primary lending area was Washington
County, Virginia , the City of Bristol, Virginia, Smyth County, Virginia,
Hawkins County, Tennessee, Sullivan County, Tennessee and Watauga County, North
Carolina.
     Residential loan originations come from many sources. Some of these
sources include existing customers, walk-in applications, referrals from real
estate brokers and others.
     Federal regulation limits loans to one borrower to a maximum of 15% of
unimpaired capital and unimpaired surplus of the Bank.
     The Bank receives fees in addition to interest in connection with real
estate loan originations, loan modifications, late payments, etc. Income from
these activities varies from period to period depending on the volume and type
of loan made. Although not a significant portion of the Corporation's income,
late charges are received when monthly payments are delinquent but are later
paid.
     The Bank also offers secondary market fixed rate mortgages with terms up to
30 years and up to 95% loan to value. These loans and servicing rights are
generally sold immediately into the secondary market and fees received booked
into income. These loans must meet certain criteria generally set by the
secondary market and are not a significant portion of the Bank's residential
mortgage activity.
     Residential mortgages, including equity lines of credit, made up
approximately 38.84% of the loan portfolio as of December 31, 2001.

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CONSTRUCTION AND COMMERCIAL REAL ESTATE LENDING
-----------------------------------------------

     The Bank generally makes construction loans for periods up to one year on
residential and commercial real estate property. These loans are for interim
financing and are either paid off or converted to permanent financing when
completed. At December 31, 2001 outstanding construction loans (net of
undisbursed funds) totaled $5,866,000. These loans are generally made at 80% or
less of appraised value at completion. Funds are advanced as the project is
completed after an inspection by a staff inspector or the appraiser as deemed
appropriate. These loans are made based on established corporate underwriting
standards. Most of these construction loans are one to four family dwellings.
The Bank generally charges a 1% origination fee on these construction loans in
addition to applicable interest.
     Loans on commercial properties, multi-family dwellings, and apartment
buildings are typically made at 75% to 80% of the appraised value. These loans
totaled $77,818,000 or 23.89% of total loans held for investment at December
31, 2001.
     Commercial and construction loans, by nature, entail additional risk as
compared to residential mortgage lending. They are generally more complex and
involve larger balances than typical residential mortgages. Payments are
typically dependent upon successful operation of a related real estate project
or business as compared to individual earnings on most residential mortgages.
Therefore, the market risk is somewhat greater. Construction delays, cost
overruns or the inability of the contractor to sell the finished product add an
element of risk to such lending.

CONSUMER LENDING
----------------

     The Bank offers other types of loans in addition to real estate mortgage
and construction loans. Consumer loans of many types are offered by the
Corporation. Some of these loans are loans to purchase automobiles, boats,
recreational vehicles and manufactured housing, as well as other secured and
unsecured consumer loans. The Bank further makes loans secured by savings
accounts at 5% above the rate of the savings instrument. The Bank also makes
loans secured by certificates of deposit issued internally. The terms generally
do not exceed ten years for manufactured housing loans and five years on other
consumer loans. Outstanding consumer loans at December 31, 2001 were
$67,290,000.

COMMERCIAL AND AGRICULTURE NON-REAL ESTATE LOANS
------------------------------------------------

     The Bank also makes commercial (including agriculture) non-real estate
loans. These loans in general have higher risk associated with them than real
estate loans. They are generally secured by inventory, equipment, accounts
receivable, etc., or unsecured in some cases backed by appropriate financial
condition as per the underwriting standards of the Bank. Agriculture loans are
generally secured by machinery, equipment, other miscellaneous assets or
unsecured in keeping with the underwriting standards of the Bank. The timely
pay back is dependent upon the successful operation of the business or farm.
The outstanding balance of non-real estate commercial loans was $39,314,000 at
December 31, 2001 and the outstanding balance of non-real estate agriculture
loans was $3,818,000 at December 31, 2001.

                                 INVESTMENTS
                                 -----------

INVESTMENT SECURITIES
---------------------

     The Corporation invests in mortgage-backed securities, agency notes and
bonds, collateralized mortgage obligations (CMO's), municipal bonds, agency
equity securities, asset-backed securities, equity securities and trust
preferred securities.

     A substantial portion of the mortgage-backed security portfolio consists
of securities that are either insured or guaranteed by FHLMC, FNMA or GNMA.
Guaranteed securities are more liquid than individual mortgage loans. At
December 31, 2001 the Corporation's mortgage-backed securities

                                      6

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portfolio had a carrying value of $53,957,000 or 11.89% of total assets
compared to $50,275,000 or 12.41% of total assets at December 31, 2000.
Amortized costs of mortgage-backed securities were $50,275,000 at December 31,
2000 and $53,483,000 for the comparable 2001 period. Due to repayments and
prepayments of the underlying loans, the actual maturities of mortgage-backed
securities are expected to be substantially less than the scheduled maturities.

     The Corporation held investments in CMO's for the years ended December 31,
2001 and 2000. At December 31, 2001 and 2000 the Corporation had carrying value
of CMO's of $8,885,000 and $9,587,000, respectively. These carrying values
represent 1.96% and 2.37% of total assets for the respective year-ends.
Amortized cost of CMO's were $8,901,000 and $9,791,000 as of December 31, 2001
and 2000.

     The Corporation had $502,000 and $4,084,000 market value in United States
Government-sponsored Agency Obligations at December 31, 2001 and 2000
respectively. These investments represent approximately 0.11% and 1.01% of
total assets at those dates. The amortized cost of these securities were
$501,000 and $4,085,000 as of December 31, 2001 and 2000, respectively.

     The Corporation invests in municipal securities that are bank-qualified. As
of December 31, 2001 and 2000 the Corporation had carrying values of
$24,305,000 and $13,816,000, respectively. These investments represent 5.36%
and 3.41% of total assets as of December 31, 2001 and 2000.

     The Corporation also invests in agency equity securities. As of December
31, 2001 and 2000 the Corporation had carrying values of $5,723,000 and
$2,307,000, respectively.

     The Corporation holds the following equity investments: Federal Reserve
Bank Stock of $295,000 for the periods ending December 31, 2001 and 2000
respectively; Federal Home Loan Bank Stock of $1,621,000 and $1,533,000 for the
same dates as above; and Community Bankers' Bank Stock of $54,750 and $54,750
for the same dates as above.

     The Corporation also holds investments in corporate bonds of $2,229,000 and
$679,000 as of December 31, 2001 and 2000 respectively. These investments
represented approximately 0.49% and 0.17% of total assets at those dates.

     The Corporation holds investments in SLMA and SBA issued securities. At
December 31, 2001 the Corporation had $2,699,000 in carrying value in these
investments.

INVESTMENT ACTIVITIES
---------------------

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

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

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considerations pertaining to the institution. The investment strategy
considers, among other factors, interest rate risk, anticipated maturity of
each type of investment and the intent of the institution with respect to each
investment.

                               SOURCES OF FUNDS
                               ----------------

GENERAL
-------

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

DEPOSIT ACTIVITIES
------------------

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

     The following table sets forth the deposit liabilities of the Corporation
at December 31, 2001.

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

Checking Account              0.00%    none     $ 100.00   $ 50,248     12.81%
Interest Checking             1.36     none       100.00     24,067      6.14
Statement Savings             2.10     none        25.00     60,167     15.34
Money Market
   Deposit Accounts           2.37     none       500.00     13,397      3.42
Christmas Club Accts          2.25     none         5.00         74      0.02
Individual Retirement
   Accounts                   6.01     various    500.00     38,892      9.92
Certificates of Deposit
   Accounts                   4.66     various    500.00    205,248     52.35
                                                           --------    ------

Totals                                                     $392,093    100.00%
                                                           --------    -------

     The variety of deposit accounts offered by the Corporation and the
competitive rates paid on these deposit accounts have increased the
Corporation's ability to retain deposits and has allowed it to be more
competitive in obtaining new funds, reducing the threat of disintermediation
(the flow of

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funds away from deposit institutions into direct investment vehicles such as
government and corporate securities). As customers have become more rate
conscious and willing to move funds to higher yielding accounts, the ability of
the Corporation to attract and maintain deposits and the Corporation's cost of
funds have been, and will continue to be, significantly affected by money
market conditions.

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

                                                Years Ended December 31
(In Thousands)                                  2001       2000       1999
--------------                                  ----       ----       ----

Increase (decrease) in deposits before
   interest credited back to accounts           $ 28,516  $ 25,586  $ 22,698
Interest credited back to accounts                17,262    14,536    11,154
                                                --------  --------  --------

Net increase in deposits                          45,778    40,122    33,852
                                                --------  --------  --------

Total deposits at year end                      $392,093  $346,315  $306,193
                                                --------  --------  --------

BORROWINGS
----------

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

     The Bank also has established credit arrangements with several of its
correspondent banks. At December 31, 2001 the Bank had approximately
$96,010,000 of unused lines of credit, including FHLB unused lines of credit,
to fund any necessary cash requirements.

     The following table sets forth certain information as to the Corporation's
advances and other borrowings at the dates indicated. See Notes 8, 9 and 15 to
the Consolidated Financial Statements, included as part of the Annual Report to
Stockholders, for information as to rates, maturities, average balances and
maximum amounts outstanding.

                                                     December 31,
(In Thousands)                            2001          2000        1999
--------------                            ----          ----        ----

Advances from FHLB                       $23,214       $23,357     $18,500
Guaranteed preferred beneficial
  interests in corporation's junior
  subordinated debt securities             7,500         7,500       7,500
Other borrowings                             269           312          99
                                         -------       -------     -------
  Total borrowings                       $30,983       $31,169     $26,099

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     In January of 1998 the Corporation issued $7,500,000 of trust-preferred
securities through its subsidiary Highlands Capital Trust I. The proceeds from
this issue are included in the Corporations' Tier 1 and Tier 2 capital up to
specified levels according to federal regulations. This subordinated note was
issued with a final maturity of 30 years and a ten-year call option at the
discretion of Corporation. The issue of these trust-preferred securities has
enabled the Corporation to continue expansion while maintaining a
well-capitalized position according to regulatory standards.

                                  COMPETITION
                                  -----------

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

                                   EMPLOYEES
                                   ---------

     The Corporation at December 31, 2001, had 196 full time employees. None of
these employees are represented by a collective agent, and the Corporation
believes its employee relations are excellent.

                                 SUBSIDIARIES
                                 ------------

     The Corporation was incorporated in Virginia in 1995 to serve as the
holding company for the Bank. The Bank is a state chartered bank with
principal offices in Abingdon, Virginia. The Bank was incorporated in 1985
under the laws of the Commonwealth of Virginia. The Corporation formed a
statutory business trust, Highlands Capital Trust I, in January of 1998 to
issue trust preferred securities in order to raise additional capital.

     The Bank formed a wholly-owned subsidiary, Highlands Union Insurance
Services, Inc., on October 8, 1999 for the purpose of selling insurance
services through Bankers' Insurance, LLC. The Bank, through Highlands Union
Insurance Services, Inc. joined a consortium of approximately sixty other
financial institutions to form Bankers' Insurance, LLC. Bankers' Insurance LLC
as of December 31, 2001 had purchased six full service insurance agencies
across the state of Virginia.

     The Bank also formed a wholly-owned subsidiary, Highlands Union Financial
Services, Inc., on March 5, 2001 for the purpose of selling non-banking
financial products through Independent Community Bankers' Financial Services.

                         FEDERAL HOME LOAN BANK SYSTEM
                         -----------------------------

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

                                     10

<PAGE>

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

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

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

                                   REGULATION
                                   ----------
GENERAL
-------

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

FEDERAL AND STATE LAWS AND REGULATIONS
--------------------------------------

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

BANK HOLDING COMPANY REGULATION
-------------------------------

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

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

BANK REGULATION
---------------

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

                                      11

<PAGE>

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

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

FEDERAL DEPOSIT INSURANCE CORPORATION IMPROVEMENT ACT
-----------------------------------------------------

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

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

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

                                      12

<PAGE>

     The Bank met the requirements at December 31, 2001 to be classified as
"well capitalized". This classification is determined solely for the purposes
of applying the prompt corrective action regulations and may not constitute an
accurate representation of the Corporation's overall financial condition.

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

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

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

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

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

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

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

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

                                      13

<PAGE>

                           FEDERAL AND STATE TAXATION
                           --------------------------

GENERAL
-------

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

BAD DEBT RESERVES
-----------------

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

     Under the experience method, the deductible annual addition is the amount
necessary to increase the balance of the reserve at the close of the taxable
year to the greater of (1) the amount which bears the same ratio to loans
outstanding at the close of the taxable year as the total net bad debts
sustained during the current and five preceding taxable years to bear to the
sum of the loans outstanding at the close of those six years or (2) the lower
of (a) the balance in the reserve account at the close of the last taxable year
prior to the most recent adoption of the experience method (the base year is
the last taxable year beginning before 1988), or (b) if the amount of loans
outstanding at the close of the taxable year is less than the amount of loans
outstanding at the close of the base year, the amount which bears the same
ratio to loans outstanding at the close of the taxable year as the balance of
the reserve at the close of the base year bears to the amount of loans
outstanding at the close of the base year.

MINIMUM TAX
-----------

     A 20% corporate alternative minimum tax generally will apply to a base of
regular taxable income plus certain tax preferences ("alternative minimum
taxable income" or "AMTI") and will be payable to the extent such AMTI is in
excess of an exemption amount. The Code provides that an item of tax preference
is the excess of the bad debt deduction over the amount allowable under the
experience method. The other items of tax preference that constitute AMTI
include (a) tax-exempt interest on newly-issued (generally, issued on or after
August 8, 1986) private activity bonds other than certain qualified bonds and
(b) 75% of the excess (if any) of (i) 75% of adjusted current earnings as
defined in the Code, over (ii) AMTI (determined without regard to this
preference and prior to reduction by net operating losses).

OTHER
-----

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

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

                                      14

<PAGE>

     See Note 5 to the Consolidated Financial Statements, included as part of
the Annual Report to Stockholders, for additional information regarding the
income taxes of the Company.

DISTRIBUTION OF ASSETS, LIABILITIES AND SHAREHOLDERS' EQUITY; INTEREST RATES
----------------------------------------------------------------------------
AND INTEREST DIFFERENTIAL
-------------------------

<TABLE>
<CAPTION>
                                                                       Year Ended December 31,
                                                       2001                        2000                      1999
                                                                       (Dollars in Thousands)
                                       Average                Yield/  Average              Yield/  Average             Yield/
                                       Balance     Interest    Rate   Balance   Interest    Rate   Balance   Interest   Rate
                                       -------     --------    ----   -------   --------    ----   -------   --------   ----
<S>                                    <C>         <C>         <C>    <C>       <C>         <C>    <C>       <C>        <C>

     ASSETS
Interest earning assets
(taxable-equivalent
 basis)

Loans (net of un-
  earned discount)/(2)/                $309,753    $ 27,574    8.90%  $277,115  $ 25,077    9.05%  $246,687  $21,873   8.87%
Securities /(1)//(3)/                    87,254       5,107    6.40     80,315     5,218    6.69     64,475    3,733   5.79
Federal funds sold                        9,133         317    3.47      1,834       123    6.68      1,446       65   4.50
                                       --------    --------   -----   --------  --------   -----   --------  -------  -----

Total interest-earning
  assets                               $406,140    $ 32,998    8.24%  $359,264  $ 30,418    8.51%  $312,608  $25,671   8.22%

     LIABILITIES
Interest-bearing
 liabilities :

Interest bearing dep.                  $322,847    $ 16,740    5.19%  $283,484  $ 15,610    5.51%  $255,385  $12,810   5.02%
Other interest-bearing                   31,117       2,146    6.90     31,169     2,090    6.71     19,262    1,357   7.05
                                       --------    --------   -----   --------  --------   -----   --------  -------  -----
 liabilities

Total interest-bearing
 liabilities                           $353,964    $ 18,886    5.34%  $314,653  $ 17,700    5.63%  $274,647  $14,167   5.16%
                                       --------    --------   -----   --------  --------   -----   --------  -------  -----

Net interest income                                $ 14,112                     $ 12,718                     $11,504
Net margin on int.
 earning assets on a
 tax equivalent basis                                          3.59%                        3.59%                      3.70%
Average interest
 spread                                                        2.90%                        2.88                       3.06%
</TABLE>

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

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

                                      15

<PAGE>

INCREASE / (DECREASE) DUE TO VOLUME AND RATE
--------------------------------------------

<TABLE>
<CAPTION>
                                               2001 Compared to 2000                          2000 Compared to 1999

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

<S>                            <C>                <C>               <C>             <C>              <C>               <C>
INTEREST INCOME
Securities.................    $       464        $      (576)      $    (112)      $   1,000        $      485        $  1,485
Federal funds sold.........            488               (293)            195              17                41              58
Loans......................          2,955               (458)          2,497           2,699               505           3,204
                               -----------        ------------      ---------       ---------        ----------        --------
Total Income Change            $     3,907        $    (1,327)      $   2,580       $   3,716        $    1,031        $  4,747
                               -----------        ------------      ---------       ---------        ----------        --------

INTEREST EXPENSE
Savings and time
  deposits.................    $     2,168        $    (1,038)      $   1,129       $   1,410        $    1,390        $  2,800
Other interest-bearing
  liabilities..............            (4)                 60              57             838              (105)            733
                               -----------        ------------      ---------       ---------        ----------        --------

Total Expense Change           $     2,164        $      (978)      $   1,186       $   2,248        $    1,285        $  3,533
                               -----------        ------------      ---------       ---------        ----------        --------

Increase (Decrease) in
  Net Interest Income          $     1,743        $      (349)      $   1,394       $   1,468        $     (254)       $  1,214
                               -----------        ------------      ---------       ---------        ----------        --------
</TABLE>

INVESTMENT PORTFOLIO
--------------------

     The following table presents the maturity distribution, market value, book
value and approximate tax equivalent yield (assuming a 34% federal income tax
rate) of the investment portfolio at December 31, 2001.

                                         (Dollars in Thousands)

<TABLE>
<CAPTION>
                                             One Year       Five Years
                           Within One        Through         Through      After Ten              Market     Book
                              Year         Five Years       Ten Years       Years       Yield     Value     Value
                              ----         ----------       ---------       -----       -----     -----     -----
<S>                       <C>             <C>              <C>             <C>           <C>     <C>       <C>
U.S. Gov Agency           $     -0-       $     -0-        $    502        $    -0-      5.50% $    502   $    501
State & Muni's                  -0-          1,023            1,345         21,937       7.57    24,305     24,378
Mtg-backed Sec /(1)/            90             923            1,660         60,094       5.24    62,767     62,309
Other                           -0-            750            1,500         10,446       4.54    12,696     12,746
                          ---------       ---------        --------        --------    ------   -------   --------

TOTAL                     $     90        $  2,696         $  5,007        $92,477       6.40  $100,270   $ 99,934
                          ---------       ---------        --------        --------    ------   -------   --------
</TABLE>

/(1)/ includes investments
in Collateralized Mtg.
Obligations (CMO's)

                                      16

<PAGE>

LOAN PORTFOLIO
--------------

      The table below classifies gross loans by major category and percentage
distribution at December 31, 2001 for each of the past five years:

<TABLE>
<CAPTION>
                                                           December 31,
                                                      (Dollars in thousands)
                                    2001                       2000                      1999

    Description              Amount     Percentage      Amount     Percentage     Amount      Percentage
    -----------              ------     ----------     -------     ----------     -------     ----------
<S>                         <C>           <C>          <C>         <C>            <C>          <C>
Real Estate Secured:
 Residential 1-4 family     $114,556       35.18%      $102,631       35.14%      $ 94,356      36.04%
 Multi-family                  3,011        0.92          3,909        1.34          3,072       1.17
 Commercial, Construction
Land Development              80,673       24.77         61,666       21.11         53,893      20.58
 Second Mortgages              7,737        2.38          5,342        1.83          4,199       1.60
 Equity Line of Credit         4,166        1.28          3,455        1.18          3,536       1.35
 Farmland                      5,065        1.56          4,928        1.69          4,403       1.68
                            --------      ------       --------      ------       --------   --------
                            $215,208       66.09%      $181,931       62.29%      $163,459      62.42%
                            --------      ------       --------      ------       --------   --------

Secured, Other:
 Personal                   $ 60,532       18.59%      $ 63,137       21.62%      $ 60,492      23.10%
 Commercial                   26,002        7.99         26,463        9.06         18,226       6.96
 Agricultural                  3,274        1.01          2,498        0.86          2,408       0.92
                            --------      ------       --------      ------       --------   --------
                            $ 89,808       27.58%      $ 92,098       31.53%      $ 81,126      30.98%
                            --------      ------       --------      ------       --------   --------

Unsecured                   $ 20,614        6.33%      $ 18,059        6.18%      $ 17,258       6.59
                            --------      ------       --------      ------       --------   --------

Loans, gross                $325,630      100.00%      $292,088      100.00%      $261,843     100.00%
                            --------      ------       --------      ------       --------   --------

<CAPTION>
                                    December 31,
                              (Dollars in thousands)
                                    1998                       1997

    Description              Amount     Percentage      Amount     Percentage
    -----------              ------     ----------     -------     ----------
<S>                          <C>          <C>          <C>         <C>
Real Estate Secured:
 Residential 1-4 family      $ 81,181       34.76%      $ 55,787     29.02%
 Multi-family                   1,888        0.81            166      0.09
 Commercial, Construction
Land Development               45,832       19.63         43,944     22.86
 Second Mortgages               2,606        1.12            704      0.37
 Equity Line of Credit          3,064        1.31          3,433      1.79
 Farmland                       1,768        0.76            865      0.45
                             --------     -------       --------    ------
                             $136,339       58.38%      $104,899     54.57%
                             --------     -------       --------    ------

Secured, Other:
 Personal                    $ 62,366       26.70%      $ 49,406     25.70%
 Commercial                    14,293        6.12         20,609     10.72
 Agricultural                   2,133        0.91          3,139      1.63
                             --------     -------       --------    ------
                             $ 78,792       33.74%      $ 73,154     38.05%
                             --------     -------       --------    ------

Unsecured                    $ 18,406        7.88%      $ 14,187      7.38%
                             --------     -------       --------    ------

Loans, gross                 $233,537      100.00%      $192,240    100.00%
                             --------     -------       --------    ------
</TABLE>

                                      17

<PAGE>

     The following table shows the maturity of loans outstanding, inclusive of
contractual amortization as of December 31, 2001.

<TABLE>
<CAPTION>
                                                           December 31, 2001
                                                        (Dollars in Thousands)

                                      Within One            After One But          After Five
                                         Year             Within Five Years           Years
                                         ----             -----------------           -----
                                 Fixed         Floating    Fixed   Floating     Fixed      Floating
                                  Rate          Rate        Rate      Rate       Rate       Rate      Total
                                  ----          ----        ----      ----       ----       ----      -----
<S>                           <C>          <C>         <C>         <C>        <C>      <C>        <C>
Real Estate Secured:
  Residential 1-4 family      $     5,984  $    3,320  $   19,501  $   7,121  $23,025  $  55,605  $ 114,556
  Multi-family                        284         -0-       1,913        -0-      814        -0-      3,011
  Commercial, Construction &
    Land Development               14,237       9,567      47,458        198    9,213        -0-     80,673
  Second Mortgages                    940         327       3,670         92    2,340        368      7,737
  Equity Line of Credit               -0-         417         -0-      1,666      -0-      2,083      4,166
  Farmland                          1,776         789       2,133        -0-      367        -0-      5,065

Secured, Other:
  Personal                         18,288         348      40,207         13    1,672          4     60,532
  Commercial                        8,474       5,047      11,198        767      516        -0-     26,002
  Agricultural                        655       1,314       1,169        132        4        -0-      3,274

Unsecured                          11,706       5,741       3,108         11       48        -0-     20,614
                              -----------  ----------  ----------  ---------  -------  ---------  ---------
Loans, Gross                  $    62,344  $   26,870  $  130,357  $  10,000  $37,999  $  58,060  $ 325,630
                              -----------  ----------  ----------  ---------  -------  ---------  ---------
</TABLE>

                                      18

<PAGE>

NON-PERFORMING LOANS
--------------------

     The loan portfolio of the Bank is reviewed regularly by senior officers to
evaluate loan performance. The frequency of the review is based on a rating of
credit worthiness of the borrower utilizing various factors such as net worth,
credit history, customer relationship, etc. The evaluations emphasize different
factors depending upon the type of loan involved. The commercial and real
estate type loans are reviewed on the basis of estimated net realizable value
through an evaluation of collateral and the financial strength of the borrower.
Installment loans are evaluated largely on the basis of delinquency data
because of the large number of such loans and relatively small size of each
individual loan.
     Management review of commercial and other loans may result in a
determination that a loan should be placed on a non-accrual of interest basis.
It is the policy of the Bank to discontinue the accrual of interest on any loan
on which full collectability of principal and / or interest is doubtful.
Subsequent collection of interest is recognized as income on a cash basis upon
receipt. Placing a loan on non-accrual status for the purpose of income
recognition is not in itself a reliable indication of potential loss of
principal. Other factors, such as the value of the collateral securing the loan
and the financial condition of the borrower, serve as more reliable indications
of potential loss of principal.
     The policy of the Bank is that non-performing loans consist of loans
accounted for on a non-accrual basis and loans which are contractually past due
90 days or more in regards to interest and/ or principal payments. As of the
five periods ended December 31, 2001, 2000, 1999, 1998 and 1997, non-accrual
loans amounted to $1,159,000, $929,000, $1,152,000, $1,396,000 and $888,000
respectively. Interest income lost on non-accruing loans was approximately
$73,000, $121,000, $136,000, $86,000 and $26,000 for the years ended December
31, 2001, 2000, 1999, 1998 and 1997 respectively.

SUMMARY OF LOAN LOSS EXPERIENCE
-------------------------------

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

                                      19

<PAGE>

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

<TABLE>
<CAPTION>
                                                        Years Ended December 31,
                                                        (Dollars in Thousands)

                                            2001         2000           1999          1998         1997

<S>                                    <C>             <C>            <C>          <C>           <C>
Allowance for loan losses at
  beginning of year                    $     2,950     $  2,494       $  2,008     $    1,636    $  1,072

Loans charged off:
    Commercial                                 107           69            357            270          42
    Real Estate                                 10          -0-             27            -0-         -0-
    Consumer                                 1,087          925            710            786         470
    Other                                      -0-          -0-            -0-            -0-         -0-
                                       -----------     --------       --------     ----------    --------

    Total                             $      1,204     $    994       $  1,094     $    1,056    $    512
                                       -----------     --------       --------     ----------    --------

Recoveries of loans previously
charged off:
    Commercial                        $          3     $      6            $97     $       41    $      6
    Real Estate                                -0-          -0-            -0-            -0-          -0-
    Consumer                                   221          167             65            157          68
    Other                                      -0-          -0-            -0-             -0-         -0-
                                      ------------     --------       --------     ----------    --------

Total                                 $        224     $    173       $    162     $       198   $     74
                                      ------------     --------       --------     ----------    --------

Net loans charged off                 $        980     $    821       $    932     $       858   $    438
Provision for loan losses                    1,448        1,277          1,418           1,230      1,002
                                      ------------     --------       --------     ----------    --------

Allowance for loan losses end of      $      3,418     $  2,950       $  2,494     $     2,008   $  1,636
year                                  ------------     --------       --------     ----------    --------

Average total loans (net of unearned  $    309,753     $277,115       $246,687     $   213,069   $175,542
income)
Total loans (net of unearned
income) at year-end                   $    325,460     $291,897       $261,678     $   233,372   $192,005

Ratio of net charge-offs to average
loans                                 0.316%           0.296%         0.378%       0.403%        0.249
Ratio of provision for loan losses to
average loans                         0.467%           0.461%         0.575%       0.577%        0.571
Ratio of provision for loan losses to
net charge-off                        147.755%         155.542%       152.146%     143.357%      228.770
Allowance for loan losses to year
end loans                             1.050%           1.011%         0.953%       0.860%        0.852
</TABLE>

                                      20

<PAGE>

ALLOCATION OF THE ALLOWANCE FOR LOAN LOSSES
-------------------------------------------

     The following table provides an allocation of the allowance for loan
losses as of December 31, 2001, 2000, 1999, 1998, and 1997.

<TABLE>
<CAPTION>
                                                     Year Ended December 31,
                                                 Percent of Loans on each category
                                                    (Dollars in Thousands)
                                  2001                                              2000

            Allowance for     Percentage of     Percentage of   Allowance for    Percentage of    Percentage of
             Loan Loss       Total Loan Loss     Total Loans      Loan Loss     Total Loan Loss    Total Loans
             ---------       ---------------     -----------      ---------     ---------------    -----------

<S>         <C>                  <C>                 <C>         <C>                <C>                <C>
Commercial  $     857            25.06%              7.98%      $      739          25.06%            12.52%
Real Estate       201             5.89              66.09              174           5.89             62.29
Consumer        2,356            68.93              24.92            2,033          68.93             24.09
Other       $       4             0.12               1.01                4           0.12              1.10
            ---------        ---------         ----------       ----------      ---------         ---------

Total       $   3,418           100.00%           100.00%       $    2,950         100.00%          100.00%
            ---------        ---------         ----------       ----------      ---------         ---------

<CAPTION>
                                 1999

             Allowance for   Percentage of     Percentage of
               Loan Loss    Total Loan Loss     Total Loans
               ---------    ---------------     -----------
<S>          <C>                 <C>             <C>
Commercial   $      625        25.06%              10.34%
Real Estate         147         5.89               62.42
Consumer          1,719        68.93               26.01
Other                 3         0.12                1.23
             ----------    ---------           ---------

             $    2,494       100.00%             100.00%
             ----------    ---------           ---------
</TABLE>

<TABLE>
<CAPTION>
                                   1998                                              1997

              Allowance for   Percentage of   Percentage of     Allowance for    Percentage of   Percentage of
                Loan Loss    Total Loan Loss   Total Loans        Loan Loss     Total Loan Loss   Total Loans
                ---------    ---------------   -----------        ---------     ---------------   -----------

<S>           <C>                  <C>           <C>            <C>               <C>                <C>
Commercial    $      503            25.05%        10.38%        $      540            33.01%          12.73%
Real Estate          118             5.88         58.38                167            10.21           54.57
Consumer           1,384            68.92         30.04                882            53.91           31.07
Other                  3             0.15          1.20                  6             0.36            1.63
Unallocated           -0-               0             0                 41             2.51               0
              ----------     ------------      --------         ----------         --------        --------

Total         $    2,008           100.00%       100.00%        $    1,636           100.00%         100.00%
              ----------     ------------      --------         ----------         --------        --------
</TABLE>

                                      21

<PAGE>

DEPOSITS
--------

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

<TABLE>
<CAPTION>
                                                                  December 31,
                                                             (Dollars in Thousands)

                                                 2001                 2000             1999
                                                 ----                 ----             ----

<S>                                           <C>                  <C>              <C>
Non-interest bearing demand deposits          $   50,248           $   45,343       $   39,504
Interest bearing demand deposits                  37,464               25,697           26,074
Savings deposits                                  60,166               45,826           44,751
Time deposits                                    244,215              229,449          195,864
                                              ----------           ----------       ----------

  Total Deposits                              $  392,093           $  346,315       $  306,193
                                              ----------           ----------       ----------
</TABLE>

                                      22

<PAGE>

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

<TABLE>
<CAPTION>
                                              Year Ended December 31,
                                                (Dollars in Thousands)

                                   2001                   2000                   1999
                          Amount         Rate    Amount         Rate    Amount         Rate

<S>                      <C>            <C>     <C>             <C>    <C>            <C>
Non-interest bearing
demand deposits          $ 47,271        0.00%  $ 42,228        0.00%  $ 38,651        0.00%
Interest-bearing demand
deposits                   29,003        2.80     25,636        3.52     24,728        3.59
Savings deposits           52,655        3.38     47,474        4.01     44,506        4.00
Time deposits             241,190        5.85    210,374        6.08    186,151        5.45
                         --------               --------               --------

Total                    $370,119               $325,712               $294,036
                         --------               --------               --------
</TABLE>

     The remaining maturities of time deposits at December 31, 2001 are as
follows (in thousands) :

        Maturity

3 months or less..............................$ 64,800
Over 3 through 12 months...................... 111,295
Over 12 months................................  68,120
                                                ------

   Total                                      $244,215
                                              --------

INTEREST RATE SENSITIVITY ANALYSIS
----------------------------------

     Interest rate risk refers to the exposure of the Corporation's earnings
and market value of equity ("MVE") to changes in interest rates. The amount of
change in net interest income and MVE resulting from shifts in interest rates
is determined by contractual maturity of fixed rate instruments, the repricing
date for variable rate instruments, competition and customer reactions.

     The Corporation runs simulation models through a range of positive and
negative interest rate movements to determine the effect these shifts in
interest rates would have on the market value of the Corporation's equity. The
market value is determined by applying a discount rate to the Corporations
interest-earning assets and interest-bearing liabilities based on current rate
levels at the time the model is run and calculating the present value of future
cash flows.

     There are several common sources of interest rate risk that must be
effectively managed to maintain minimal impact on the Corporation's earnings
and capital. Repricing risk comes largely from timing differences in the
pricing of interest-earning assets and interest-bearing liabilities.
Reinvestment risk refers to the reinvestment of cash flows from interest and
principal payments and maturing assets at lower or higher rates. Basis risk
arises when different yield curves or pricing indices do not change at
precisely the same moment in time or magnitude so that earning assets and
interest-bearing liabilities with the same maturity are not affected equally.
Yield curve risk refers to unequal movements in short-term and long-term
interest rates

     The following table provides the maturities of investment securities,
loans, and deposits as of December 31, 2001, and measures the interest rate
sensitivity gap for each

                                      23

<PAGE>

range of maturity indicated: The amounts below also reflect various prepayment
assumptions.

                                                      December 31, 2001
                                                    (Dollars in Thousands)
                                                             Maturing
<TABLE>
<CAPTION>
                                                   Within One      After One But        After Five
                                                       Year      Within Five Years       Years            Total
                                                       ----      -----------------       -----            -----
<S>                                             <C>            <C>                  <C>            <C>
ASSETS
Interest-bearing
    Investment Securities                        $   18,090     $     20,629         $  61,551      $  100,270
    Fed Funds Sold                                    1,320               -0-               -0-          1,320
    Loans                                            90,439          138,620            92,983         322,042
Noninterest-bearing
    Other Assets                                         -0-              -0-           30,113          30,113
                                                 ----------     ------------         ---------      ----------
Total Assets                                     $  109,849     $    159,249         $ 184,647      $ 453,745
                                                 ----------     ------------         ---------      ----------

LIABILITIES AND SHARE-
    HOLDERS' EQUITY
Interest-bearing
 /(1)/All Interest-bearing Deposits              $  274,115     $     65,333         $   2,397      $ 341,845
    Other Interest-bearing Liab.                     13,174           10,187             7,622         30,983
Noninterest-bearing
    Demand Deposit Non-Interest                          -0-              -0-           50,248         50,248
    Other Liabilities                                 3,217               -0-               -0-         3,217
    Shareholders' Equity                                 -0-              -0-           27,452         27,452
                                                 ----------     ------------         ---------      ----------
Total Liabilities and Shareholders'
    Equity                                       $  290,506     $     75,520         $  87,719      $ 453,745
                                                 ----------     ------------         ---------      ----------

Interest Rate Sensitivity GAP                    $ (180,657)    $     83,729         $  96,928      $      -0-

/(1)/ For purposes of this schedule, the
Corporation includes 100% of its
statement savings, NOW and
MMDA's in the one-year bucket
</TABLE>

                                     24

<PAGE>

ASSET LIABILITY MANAGEMENT
--------------------------

     The Corporation's primary objectives for asset and liability management
are to establish internal controls and procedures that will result in managing
interest rate risk, liquidity management, capital planning, asset mix and
volume control, and loan and deposit pricing. The Asset and Liability Committee
(ALCO) is headed by the CEO and includes management personnel from the
different areas of the Bank. The Committee meets on a monthly basis.
     Interest rate risk refers to the exposure of the Corporation's earnings to
changes in interest rates. There are several sources of interest rate risk that
must be effectively managed if there is to be minimal impact on the
Corporation's earnings and capital. Repricing risk arises from timing
differences in the repricing of assets and liablilites. Reinvestment risk
refers to the ability or lack therof to reinvest cash flows of maturing assets
at lower or higher rates.
     In determining the appropriate level of interest rate risk, the ALCO
reviews the changes in projected net interest income subject to various changes
in the interest rates. To help effectively measure interest rate risk, the ALCO
utilizes rate sensitivity and simulation analysis to determine the impact on
net interest income as well as the changes in the Economic Value of Equity.
Simulation analysis is used to subject or "shock" the current repricing and
maturing amounts to rising and falling interest rates. Rate change increments
of 1% and 2% up and down are used in the monthly simulation analysis. Loan and
investment security prepayments are estimated using current market information.
The following table shows the estimated cumulative impact on net interest
income for the next 12 months as of December 31, 2001, subject to the specified
interest rate changes.

Rate change               % change in net        $ change in net
increment                 interest income        interest income

Up 1%                     -8.04%                 $  -1,485,680

Up 2%                     -4.11%                 $    -759,662

Down 1%                    4.49%                 $     847,679

Down 2%                    8.65%                 $   1,599,999

LIQUIDITY
---------

     Liquidity is the measure of the Corporation's ability to generate
sufficient funds in order to meet customer's demands for withdrawal of deposit
balances and for the funding of loan requests. The Corporation maintains cash
reserves, in accordance with

                                      25

<PAGE>

Federal Reserve Bank guidelines, and has sufficient flow of funds from
investment security payments as well as loan payments to meet current liquidity
needs.
     Management of the Corporation continuously monitors and plans the
Corporation's liquidity position for future. Liquidity is provided from cash
and due from banks, federal funds sold, loan and investment security payments,
core deposits, the national certificate of deposit market, lines of credit with
correspondent banks and lines of credit with the Federal Home Loan Bank
Management believes that these sources of funds provide sufficient and timely
liquidity for the foreseeable future.
     The Corporation's major source of funding and liquidity is derived from
its deposit base. The mix of the deposit base (demand deposits, statement
savings, certificates of deposit, money market and interest checking) is
constantly subject to change. During 2001, as reflected in the Consolidated
Balance Sheets, the deposit mix changed with an increase in non-interest
bearing demand deposits of $4.9 million, an increase in interest-bearing NOW
and Money Market deposits of $11.8 million, an increase in statement savings
deposits of $14.3 million and an increase in total time deposits of $14.8
million. During 2000 total deposits increased $40.1 million.
     The Corporation had approximately $100.3 million in investment securities
at December 31, 2001. The Corporation utilizes its investment portfolio as a
secondary form of liquidity. Management has designated $98.3 million of the
investment portfolio as available for sale under the requirements of FAS 115.
Under this designation the Corporation has the ability to sell any of these
available for sale securities to meet extraordinary liquidity needs.
     The Consolidated Statements of Cash Flows appearing in the financial
statements of the Corporation reflects a net decrease in cash and cash
equivalents of $3.1 million over the comparable 2000 period. This decrease was
greatly due to the use of cash and cash equivalents for the Corporation's
investments in loans and investment securities
     Liquidity strategies are implemented and monitored on a daily basis by the
Corporation's Asset Liability Committee (ALCO). The Committee uses a simulation
model to assess future liquidity needs of the Corporation and to manage the
investment of funds. The ALCO Committee meets formally on a monthly basis

RETURN ON EQUITY AND ASSETS
---------------------------

     The following table highlights certain ratios for the periods indicated:

                                              Year Ended December 31,
                                                    (Percentage)

                                                2001   2000   1999
                                                ----   ----   ----
Net income to:
    Average total assets                        0.77   0.78   0.64
    Average shareholders' equity               12.78  13.69  11.13

Dividend payout ratio(dividends declared per
    share divided by net income per share)      6.39   6.21   7.04

Average shareholders' equity to average total
    assets ratio                                6.00   5.71   5.71

ITEM 2. PROPERTIES
------------------

     The Corporation's and the Bank's main offices are located at 340 W. Main
Street, Abingdon, Virginia. The main office is a two-story brick structure
owned by the Bank. The Bank utilizes the entire structure for its day-to-day
operations. Attached to the main

                                     26

<PAGE>

office is a four-lane drive thru facility constructed in 1998. The new drive
thru replaced an older unit that was detached from the main office's structure.
The main office opened for operations in 1985. In addition, the Bank has three
other branch locations within Washington County, Virginia. The East Abingdon
branch is a one story brick facility located at 24412 Maringo Road that
operates as a full service branch. The branch was completed and opened for
operation in 1993. The West Abingdon location operates as an "express
facility."  This location contains four drive thru lanes and a walk-up window.
This is a limited service facility. The West Abingdon Express branch was
completed and opened for operations in 1994 and is located at Exit 14, I-81,
Jonesboro Road, Abingdon, Virginia. During 1998, the Bank constructed and
placed in service a two-story brick building located at 506 Maple Avenue, Glade
Spring, Virginia. The Glade Spring Office is a full service location with four
drive thru lanes. The Bank also has two full service branch locations within
the City of Bristol, Virginia. The East Bristol office is located at 999 Old
Airport Road, Bristol, Virginia. This is a two story brick building with
interior customer loan and deposit areas as well as a four lane drive thru
unit. The office was completed and opened for operations in 1988. The
Commonwealth office is located at 821 Commonwealth Avenue, Bristol, Virginia.
This is a two story block building with full service customer service areas and
a four lane drive thru facility. The Bank also operates its dealer finance
division out of the Commonwealth office. This office was completed and opened
for operations in 1995. The Bank also has a full service branch at 1425 North
Main Street, Marion, Virginia. The branch was placed in service in December of
1997. It is a two story brick building and operates as a full service branch.
The Marion office has four drive thru lanes and a drive-up ATM. The Bank also
owns a vacant lot, located approximately 1/2 mile from the branch on North Main
Street, that originally had a drive-up ATM on location. The ATM was relocated
to the Marion branch during 2001. This property is free of all liens. All of
the Bank's branch locations except Marion have an on premises ATM. All branch
properties are owned by the Bank and are free of liens. In September 1998, the
Bank acquired the adjacent building to its Commonwealth office to facilitate
future expansion. This is a one story brick structure, located at 801-805
Commonwealth Avenue, Bristol, Virginia and is currently leased. A note payable
to the sellers was executed and is secured by a first deed of trust. The
balance on the note as of December 31, 2000 was approximately $73,000. Also
during 1998, the Bank initiated an off premises ATM program. This program has
continued to expand to include 27 offsite ATMs purchased and installed
throughout the Bank's market areas. Six machines are placed in Bristol,
Virginia; one is installed in Bristol, Tennessee; nine are installed in
Washington County, Virginia; two in Russell County, Virginia; seven in Smyth
County, Virginia, one in Wythe County, Virginia, and one in Boone, North
Carolina. All machines are free of liens. During 1999 the Bank purchased a
building, across from the Main Office in Abingdon, to provide for expansion of
the Bank's operations. The building is a brick and frame structure that is
being used to house the Bank's Financial Services Department, the Collections
Department, the Bank's credit card, Human Resources department, Customer Call
Center, Check Card and ATM Card Operations department, Security and Facilities
department as well as the Bank's Check Printing Department. The office space
not currently being used by the Bank is being leased to one other business.
This property is free of any liens. On September 23, 2000, the Bank closed on
the purchase of a branch office of a bank in Rogersville, Tennessee. This
purchase included all deposit accounts, approximately $3.9 million, overdraft
protection accounts, approximately $54 thousand, specified furniture and
equipment, approximately $7 thousand, and the building and real estate,
approximately $639 thousand. The branch office is a one-story masonry and
concrete structure constructed in 1985. The branch is located at 410 Highway 66
South in Rogersville, Tennessee. This building is being used as a Highlands
Union Bank full service facility with two drive-thru

                                     27

<PAGE>

lanes and a drive-up ATM. The Bank has also purchased a tract of land located
at 1250 Volunteer Parkway in Bristol, Tennessee for future expansion. The land
is approximately 1.08 +/- Acres and is currently zoned B-3. This property is
free of any liens. The Bank also purchased a tract of land located off of
Highway 11W in Bristol, Tennessee, known as Bristol West Development, for
future expansion. The land is approximately 1/2 acre and is currently zoned
B-3. This property is free of any liens. The Bank also purchased a lot in
Boone, North Carolina for a branch site. This 1.293 acre tract is located on
Highway 105 in the Town of Boone. During 2000 the Bank began construction of a
two-story brick building that opened as a full service branch of the Bank in
January of 2001. The Seller of this property originally financed $250,000 of
the purchase price of the land. The balance of this note as of December 31,
2001 was approximately $237 thousand

     The Corporation acquired a commercial building during 1997 that is located
at 266 West Plumb Alley, Abingdon, Virginia. The building is a two story
concrete structure that was originally constructed by another bank for use as
an operations center. During 1997, the Corporation entered into a leasing
arrangement with its subsidiary to lease the first floor to be used for its
operations center. This lease was expanded to include the second floor of the
building that was renovated during 2001. During 2001 the Corporation renovated
the second floor of this building and it currently houses the Bank's electronic
data processing operations, bookkeeping operations, proof operations and
electronic banking operations. The West Plumb Alley property is free of liens.
Also during 1998, the Corporation purchased the adjacent property to the
operations center. The property purchased is a one story brick structure which
is currently leased. It is management's intention to utilize the property as
growth continues. The property is owned free and clear of all liens.

ITEM 3. LEGAL PROCEEDINGS
-------------------------

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

ITEM 4. SUBMISSION OF MATTERS TO A VOTE OF SECURITY HOLDERS
-----------------------------------------------------------

     There were no matters submitted to a vote of security holders during the
quarter ended December 31, 2001.

                                  PART II.
                                  --------

ITEM 5. MARKET FOR REGISTRANT'S COMMON EQUITY AND RELATED STOCKHOLDER MATTERS
-----------------------------------------------------------------------------

     There is no established trading market for the stock of Highlands
Bankshares, Inc. At December 31, 2001 the Corporation has approximately 1,130
stockholders of record. The Corporation acts as its own registered Stock
Transfer Agent, without charging a transfer fee, ensuring that all applicable
federal guidelines relating to stock transfers are enforced. The Corporation
maintains a list of individuals who are interested in purchasing its common
stock and connects these people with stockholders' who are interested in
selling their stock. These parties negotiate the per share price independent of
the Corporation. The stock transfer agent of the Corporation attempts to keep a
record of what the stock sales are trading at by asking the parties about the
trade price per share.

                                     28

<PAGE>

Please refer to the table below entitled Common Stock Performance for a
breakdown of the trades for the four quarters of 2001 and 2000. It is the
opinion of management that this range accurately reflects the market value of
the Corporations common stock at the present time.

    Common Stock Performance-December 31, 2001

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

First Quarter     $28.00     $25.00         $25.44

Second Quarter    $25.00     $24.00         $25.00

Third Quarter     $25.50     $25.00         $25.19

Fourth Quarter    $25.50     $25.00         $25.15

      Common Stock Performance-December 31 2000

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

First Quarter     $24.00     $22.00         $22.71

Second Quarter    $27.00     $24.00         $19.40

Third Quarter     $25.00     $25.00         $25.00

Fourth Quarter    $25.00     $25.00         $25.00

The Corporation's Board of Directors determines whether to declare dividends
and the amount of any dividends declared. Such determinations by the Board take
into account the Corporation's financial condition, results of operations, and
other relevant factors. The declaration, amount and timing of future dividends
will be determined by the Board of Directors after a review of the
Corporation's operations and will be dependent upon, among other factors, the
Corporation's income, operating costs, overall financial condition and capital
requirements and upon general business conditions. The Corporation declared
and paid annual cash dividends of $211,000 or $0.08 per share during 2001 and
$185,000 in cash dividends or $0.07 per share during 2000. 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 fund
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

                                     29

<PAGE>

defined, combined with the retained net profits for the two preceding years. The
total dividends that may be declared in 2002 without regulatory approval totals
$6,998 plus year-to-date 2002 net profits as of the declaration date.

     At March 13, 2002, there were approximately 1,215 holders of the
Corporation's common stock (based on the number of record holders as of that
date).

ITEM 6. SELECTED FINANCIAL DATA
-------------------------------

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

<TABLE>
<CAPTION>
                                    Years Ended December 31,
                        (Dollars in thousands, except per share data)

                                            2001        2000        1999        1998        1997
                                            ----        ----        ----        ----        ----
<S>                                    <C>             <C>          <C>         <C>        <C>

Income Statement Amounts:

     Gross interest income             $    32,998    $ 30,418    $ 25,671    $ 22,897    $ 18,781
     Gross interest expense                 18,887      17,700      14,167      13,401      10,321
     Net interest income                    14,111      12,718      11,504       9,496       8,460
     Provision for possible loan
       Losses                                1,448       1,277       1,418       1,230       1,002
     Net interest income after
       provision                            12,663      11,441      10,086       8,266       7,458
     Other operating income                  3,364       2,480       1,353       1,367         842
     Other operating expense                11,619       9,713       8,187       6,962       5,382
     Income before income taxes
       and other items                       4,408       4,208       3,252       2,671       2,918
     Income taxes                            1,107       1,229       1,121         896         966
     Income before cumulative
       effect of change in
       accounting principles                 3,301       2,979       2,131       1,775       1,952
     Cumulative effect of change
       in accounting principles                 -0-         -0-         -0-         -0-         -0-
     Net income                        $     3,301    $  2,979    $  2,131    $  1,775       1,952

Per Share Data /(1)/:

     Net income per share              $      1.25    $   1.13    $   0.85    $   0.72    $   0.80
     Cash dividends per share                 0.08        0.07        0.06        0.05          -0-
     Book value (at year end)                10.38        9.17        7.77        7.33        6.82

Balance Sheet Amounts (at year-
     end):

     Total assets                      $   453,745    $405,212    $358,348    $307,764    $258,236
     Total loans (net of unearned
       income)                             325,460     291,895     261,678     233,371     192,005
     Total deposits                        392,093     346,315     306,193     272,341     236,646
     Long-term debt                         10,483      18,669      10,599       6,763       2,614
     Guaranteed preferred
       beneficial interests in
       junior subordinated debt
       securities                            7,500       7,500       7,500       7,500          -0-
     Total equity                           27,452      24,183      20,408      18,279      16,802
</TABLE>

     /(1)/ Adjusted for 1999 two-for-one stock split.

                                       30

<PAGE>

ITEM 7. MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND
-----------------------------------------------------------------------
RESULTS OF OPERATIONS
---------------------

     The information required herein is incorporated by reference from pages 8
to 12 of the Annual Report to Stockholders for the fiscal year ended December
31, 2001.

ITEM 7A. QUANTITATIVE AND QUALITATIVE DISCLOSURES ABOUT MARKET RISK.
--------------------------------------------------------------------

     The information required herein is incorporated by reference to pages 23-26
of the Corporation's Form 10-K on Interest Rate Sensitivity Analysis, Asset
Liability Analysis and Liquidity Analysis for the fiscal year ended December 31,
2001.

ITEM 8. FINANCIAL STATEMENTS AND SUPPLEMENTARY DATA
---------------------------------------------------

     The financial statements and supplementary data required herein are
incorporated by reference from pages 20 to 40 of the Annual Report to
Stockholders for the fiscal year ended December 31, 2001.

ITEM 9. CHANGES IN ACCOUNTANTS AND DISAGREEMENTS WITH ACCOUNTANTS ON ACCOUNTING
-------------------------------------------------------------------------------
AND FINANCIAL DISCLOSURE
------------------------

     None.

PART III.
---------

ITEM 10. DIRECTORS AND EXECUTIVE OFFICERS OF THE REGISTRANT
-----------------------------------------------------------

     The information required herein is incorporated by reference to "The Board
of Directors", "Executive Officers Who Are Not Directors", "Security Ownership
of Certain Beneficial Owners" and "Compliance With Filing Requirements Under
the Securities Exchange Act of 1934" contained in the definitive proxy
statement for the Registrant's 2002 Annual Meeting of Stockholders to be
subsequently filed.

ITEM 11. EXECUTIVE COMPENSATION
-------------------------------

     The information required herein is incorporated by reference to
"Remuneration" contained in the definitive proxy statement for the Registrant's
2002 Annual Meeting of Stockholders to be subsequently filed.

ITEM 12. SECURITY OWNERSHIP OF CERTAIN BENEFICIAL OWNERS AND MANAGEMENT
-----------------------------------------------------------------------

     The information required herein is incorporated by reference to "Security
Ownership of Management" and "Security Ownership of Certain Beneficial Owners"
contained in the definitive proxy statement for the Registrant's 2002 Annual
Meeting of Stockholders to be subsequently filed.

                                       31

<PAGE>

ITEM 13. CERTAIN RELATIONSHIPS AND RELATED TRANSACTIONS
-------------------------------------------------------

     The information required herein is incorporated by reference to "Certain
Transactions" contained in the definitive proxy statement for the Registrant's
2002 Annual Meeting of Stockholders to be subsequently filed.

PART IV.
--------

ITEM 14. EXHIBITS, FINANCIAL STATEMENT SCHEDULES, AND REPORTS ON FORM 8-K
-------------------------------------------------------------------------

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

              Consolidated Statements of Financial Condition as of December 31,
              2001, 2000 and 1999

              Consolidated Statements of Operations for each of the years in the
              three year period ended December 31, 2001

              Consolidated Statements of Stockholder's Equity for each of the
              years in the three year period ended December 31, 2001

              Consolidated Statements of Cash Flows for each of the years in the
              three year period ended December 31, 2001

              Notes to Consolidated Financial Statements for December 31, 2001,
              2000 and 1999

              Independent Auditors' Report

          (2) All applicable financial statement schedules required by
              Regulation S-X are included in the Notes to the 2001
              Consolidated Financial Statements.

     (b)      There were no reports on Form 8-K filed during the last
              quarter of the period covered by this report.

     (c)      Exhibits:

          (3) Articles of Incorporation and Bylaws

              The Registrant's Articles of Incorporation and By-Laws were
              previously filed as exhibits (4) (1) and (4) (2), respectively,
              with the Form S-3 Registration Statement filed on March 1, 2002 in
              connection with the Corporations Dividend Reinvestment Plan.

         (11) Statement Regarding Computation of Per Share Earnings

              The statement regarding computation of per share earnings is
              included as Note 1 of the Notes to Consolidated Financial
              Statements in the 2001 Annual Report to Stockholders and is
              incorporated herein by reference.

         (13) Annual Report to Security Holders

                                       32

<PAGE>

         (21) Subsidiaries of Registrant:

              Highlands Union Bank - a Virginia state chartered commercial
              bank

              Highlands Capital Trust I - a business pass-through trust
              organized under  the laws of Delaware.

                                       33

<PAGE>

                                  SIGNATURES

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

                                                HIGHLANDS BANKSHARES, INC.

Date: February 4, 2001                          BY:/s/ Samuel L. Neese
                                                   ----------------------------
                                                   Samuel L. Neese
                                                   Executive Vice President and
                                                   Chief Executive Officer

     Pursuant to the requirements of the Securities Exchange Act of 1934, this
report has been signed below by the following persons on behalf of the
registrant and in the capacities indicated on March 26, 2002.

          Signature                                      Title
          ---------                                      -----
/S/ James D Morefield        03-26-02
-------------------------------------
James D. Morefield           Date         Chairman of the Board, and Director

/S/ James D. Morre, Jr.      03-26-02
-------------------------------------
Dr. James D. Moore, Jr.      Date         President

/S/ J. Carter Lambert        03-26-02
-------------------------------------
J. Carter Lambert            Date         Vice Chairman

/S/ Samuel L. Neese          03-26-02
-------------------------------------
Samuel L. Neese              Date         Executive Vice President, and Chief
                                          Executive Officer

/S/ James T. Riffe           03-26-02
-------------------------------------
James T. Riffe               Date         Executive Vice President and Cashier

/S/ William E. Chaffin       03-26-02
-------------------------------------
William E. Chaffin           Date         Director

/S/ E. Craig Kendrick        03-26-02
-------------------------------------
E. Craig Kendrick            Date         Director

/S/ Clydes B. Kiser          03-26-02
-------------------------------------
Clydes B. Kiser              Date         Director

/S/ Charles P. Olinger       03-26-02
-------------------------------------
Charles P. Olinger           Date         Director

/S/ William J. Singleton     03-26-02
-------------------------------------
William J. Singleton         Date         Director

/S/ H. Ramsey White, Jr.     03-26-02
-------------------------------------
Dr. H. Ramsey White, Jr.     Date         Director

                                       34