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 December 31, 2002
                        Commission File 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 No.)

           340 West Main Street
            Abingdon, Virginia                         24210-1128
 (Address of Principal Executive Offices)              (Zip Code)

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

           Securities registered pursuant to Section 12(b) of the Act:

                                                  Name of Each Exchange
     Title of Each Class                           on Which Registered
     -------------------                           -------------------

            None                                            n/a

           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  (or for such  shorter  periods  that the
registrant was required to file such reports),  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 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]

         Indicate by check mark whether the registrant is an  accelerated  filer
(as defined in Exchange Act Rule 12b-2). Yes ___ No _X_

         State the aggregate  market value of the voting and  non-voting  common
equity held by  non-affiliates  computed by  reference to the price at which the
common  equity was last sold,  or the average bid and asked price of such common
equity as of the last business day of the registrant's  most recently  completed
second fiscal quarter. $53,341,288

         Indicate the number of shares  outstanding of each of the  registrant's
classes of common stock as of the latest practicable date. As of March 13, 2002,
there were 2,650,729 shares of Common Stock.

                       DOCUMENTS INCORPORATED BY REFERENCE

   Annual Report to Shareholders for the fiscal year ended December 31, 2002
                                --Parts I and II
 Proxy Statement for the 2003 Annual Meeting of Shareholders--Part III

<PAGE>

                                Table of Contents
<TABLE>
<CAPTION>

                                                                                        Page Number
                                                                                        -----------

Part I

<S>              <C>                                                                   <C>
Item 1.           Business                                                                  3-26
Item 2.           Properties                                                               27-28
Item 3.           Legal Proceedings                                                           28
Item 4.           Submission of Matters to a Vote of
                    Security Holders                                                          28

Part II

Item 5.           Market for Registrant's Common Equity
                    And Related Stockholder Matters                                        29-30
Item 6.           Selected Financial Data                                                     30
Item 7.           Managements Discussion and Analysis of
                    Financial Condition and Results of Operation                              31
Item 7A.          Quantitative and Qualitative Disclosures About
                    Market Risk                                                               31
Item 8.           Financial Statements and Supplemental Data                                  31
Item 9.           Changes in and Disagreements With Accountants With
                    Accountants on Accounting and Financial Disclosure                        31

Part III

Item 10.          Directors and Executive Officers of the Registrant                          31
Item 11.          Executive Compensation                                                      31
Item 12.          Security Ownership of Certain Beneficial Owners and Management
                    And Related Stockholder Matters                                           32
Item 13.          Certain Relationships and Related Transactions                              32
Item 14.          Controls and Procedures                                                     32

Part IV

Item 15.          Exhibits, Financial Statement Schedules, and Reports on Form 8-K         32-33

</TABLE>


                                       2
<PAGE>

Forward-Looking Information

         This report  contains  forward-looking  statements  with respect to the
financial condition, results of operations and business of Highlands Bankshares,
Inc. (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 that 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

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

         At December 31, 2002, the  Corporation had total assets of $485,603,000
deposits of $410,301,000 and net worth of $32,199,000.

         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,
North Carolina 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 interest income,


                                       3
<PAGE>

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 required 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, 2002:
the Bank,  which was formed in 1985, and Highlands  Capital Trust I, a statutory
business  trust  (the  "Trust")  which  was  formed in 1998.  The  Corporation's
material assets as of December 31, 2002 include:  cash in bank of  approximately
$1.1  million;   building,  land,  and  equipment  with  a  net  book  value  of
approximately  $1.47 million;  approximately $3.9 million in loan participations
from the Bank;  approximately  $345 thousand in other assets; and its investment
in subsidiaries,  approximately  $33.06 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 has two wholly-owned  subsidiaries,  Highlands Union Insurance
Services, Inc., which was formed in 1999 and Highlands Union Financial Services,
Inc.  which was formed in 2001.  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, 2002, had purchased  seven full service  insurance  agencies across
the state of Virginia.  Highlands Union Insurance Services, Inc. will be used to
sell insurance  services through the Bankers'  Insurance,  LLC.  Highlands Union
Financial  Services,  Inc. was formed in order for the Bank to continue to offer
third-party  mutual  funds,  annuities  and  other  financial  services  to  its
customers in all market areas served.

         Also during 2002, the Bank became an equity owner in the Virginia Title
Center,  LLC. This entity is owned by  approximately  16 member banks located in
Southwest  Virginia..  The  organization  is  involved in the  underwriting  and
issuance of title  insurance on real estate  closings,  primarily as a result of
referrals from the member banks.

         As of December 31, 2002, the Corporation operates one express and eight
full-service banking facilities 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 offers a full range of loan  products to customers in
the  Northeast  Tennessee  area.  The  Corporation  also  operates  twenty-eight
off-site  ATM's  throughout  the service  areas  listed above as well as Russell
County,  Virginia, Wythe County,  Virginia,  Bristol,  Tennessee and Banner Elk,
North Carolina.

         The results of operations for the fiscal years ended December 31, 2002,
2001,  and 2000 ("fiscal year 2002",  "fiscal year 2001" and "fiscal year 2000",
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 Shareholders, for a detailed
discussion of certain aspects of the Corporation's business.

                                       4
<PAGE>

         During the second  quarter of 2002,  the Bank  purchased  approximately
$7.38 million in bank owned life  insurance.  The policies were issued to insure
the lives of a selected  number of officers and directors of the Bank.  The Bank
is the named  beneficiary,  and the premiums were allocated  among four separate
highly  rated  carriers.  The earnings  related to the policies  will be used to
offset future employee benefit costs.  The life insurance  purchased by the Bank
will remain a corporate asset even after the employer / employee relationship is
terminated. The Bank has also entered into a separate agreement with each of the
insureds to provide their named  beneficiary(s)  a separate death benefit.  This
amount  is  approximately  20% of the  proceeds  received  by the Bank  from the
various  carriers and requires that the named insureds are actively  employed or
still serving as a director upon death.  This death benefit amount will be fully
taxable to the recipient(s) and tax deductible to the Bank.

                               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  Bank  lends  up to 95% of the
appraised value with the normal  requirement of insurance from private  mortgage
insurance  companies.  This insurance  normally  covers amounts in excess of 80%
loan to value up to 95%.

         The in-house  residential  mortgages  are  comprised of primarily  one,
three and five year  adjustable  rate mortgages and 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.

         Aggregate  debt to any one  borrower  exceeding  $850,000 but less than
$2,000,000  must be approved by the loan  committee  of the Board of  Directors.
Loan requests in excess of the customer's  aggregate debt of $2,000,000  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 $50,000 (lower where deemed  necessary).  It is also
the Bank's  general  policy to require

                                       5
<PAGE>


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 2002 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 Bank'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 are
booked into income.  These loans must meet certain criteria generally set by the
secondary market.

         Residential  mortgages,  including  equity  lines  of  credit,  made up
approximately 41.38% of the loan portfolio as of December 31, 2002.

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,  2002,  outstanding  construction  loans  (net  of
undisbursed funds) totaled $8,359,000.  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 $78,578,000 or 23.13% of total loans held for investment at December 31,
2002.

         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

                                       6
<PAGE>

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
Bank. Some of these loans are loans to purchase automobiles, boats, recreational
vehicles  and  manufactured  housing,  as well as other  secured  and  unsecured
consumer loans,  including credit cards. 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, 2002 were
$57,628,000.

         The Bank maintains a significant  portfolio of dealer paper  originated
through its indirect lending department.  As of December 31, 2002 this portfolio
had a balance of $23,280,000 included in the $57 million above.

Commercial and agriculture non-real estate loans

         The Bank also makes commercial (including  agriculture) non-real estate
loans.  These loans in general have higher risks  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  $37,371,000  at
December 31, 2002, and the outstanding  balance of non-real  estate  agriculture
loans was $4,871,000 at December 31, 2002.

                                   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, 2002, the Corporation's  mortgage-backed securities portfolio had a
carrying value of $57,729,952 or 11.89% of total assets  compared to $53,957,000
or  11.89%  of  total  assets  at  December  31,   2001.   Amortized   costs  of
mortgage-backed securities were $53,483,000 at December 31, 2001 and $57,051,975
for the  comparable  2002  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, 2002 and 2001. At December 31, 2002 and 2001, the  Corporation  had carrying
value of CMO's of

                                       7
<PAGE>

$2,305,000 and $8,885,000,  respectively.  These carrying values  represent .47%
and 1.96% of total assets for the respective year-ends.  Amortized cost of CMO's
were $2,292,000 and $8,901,000 as of December 31, 2002 and 2001.

         The   Corporation   invests   in   municipal    securities   that   are
bank-qualified.  As of December 31, 2002 and 2001, the  Corporation had carrying
values of $30,719,000 and $24,305,000 respectively.  These investments represent
6.33% and 5.36% of total assets as of December 31, 2002 and 2001.

         The  Corporation  also  invests  in  agency  equity  securities.  As of
December 31, 2002 and 2001 the Corporation had carrying values of $8,278,000 and
$5,723,000, respectively.

         The Corporation holds the following equity investments: Federal Reserve
Bank  Stock of  $295,000  for the  periods  ending  December  31,  2002 and 2001
respectively;  Federal Home Loan Bank Stock of $1,832,000 and $1,621,000 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 $2,201,000
and $2,229,000 as of December 31, 2002 and 2001 respectively.  These investments
represented approximately 0.47% and 0.49% of total assets at those dates.

         The Corporation holds investments in SLMA and SBA issued securities. At
December 31, 2002 the  Corporation  had  $1,413,000  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 banks,  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  internal investment  committee,  made up of the CEO,
Cashier,  CFO and V.P. of  Accounting,  meets  routinely to determine  portfolio
strategies  following  Federal  Reserve  guidelines  with  respect to  portfolio
investment and  accounting.  The Committee  performs  pre-purchase  and pre-sale
analysis on all individual  securities and presents this information to the full
board of directors  monthly.  Such Federal Reserve guidelines state that insured
institutions  must  account  for  securities  held for  investment,  sale and/or
trading  in  accordance  with  generally  accepted  accounting  principles.  The
Corporation  maintains  a written  investment  policy  to set  forth  investment
portfolio   composition  and  investment  strategy.   The  investment  portfolio
composition policy considers,  among other factors,  the financial  condition of
the  institution,  the types of  securities,  amounts  of  investments  in those
securities   and  safety  and   soundness   considerations   pertaining  to  the
institution.  The investment strategy considers,  among other factors,  interest
rate risk, anticipated maturity of each type of investment and the intent of the
institution with respect to each investment.

                                       8
<PAGE>

                                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, Federal Home Loan Bank System ("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 for the year ended December 31, 2002.
<TABLE>
<CAPTION>

                                   2002 Weighted                      Minimum          Amount
                                      Average                         Balance            in          % of
     Type of Account                    Rate           Term           Deposit         Thousands      Total
     ---------------                    ----           ----           -------         ---------      -----

<S>                                    <C>                           <C>             <C>            <C>
     Checking Account                  0.00%           none          $ 100.00         $55,597        13.55%
     Interest Checking                 1.35            none            100.00          26,028         6.34
     Statement Savings                 2.07            none             25.00          70,258        17.12
     Money Market
       Deposit Accounts                2.24            none            500.00          23,491         5.73
     Christmas Club Accts.             2.26            none              5.00              70         0.02
     Individual Retirement
       Accounts                        5.53           various          500.00          44,030        10.73
     Certificates of Deposit
       Accounts                        3.81           various          500.00         190,827        46.51
                                                                                      -------        -----

     Totals                                                                          $410,301       100.00%
                                                                                     --------       -------
</TABLE>

         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 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.

                                       9
<PAGE>
<TABLE>
<CAPTION>
                                                           Years Ended December 31,

       (In Thousands)                                     2002       2001       2000
       --------------                                     ----       ----       ----
<S>                                                      <C>        <C>       <C>
       Increase (decrease) in deposits before
         interest credited back to accounts              $  5,452   $ 28,516  $  25,586
       Interest credited back to accounts
                                                           12,756     17,262     14,536
                                                         --------   --------   --------

       Net increase in deposits
                                                           18,208     45,778     40,122
                                                         --------   --------   --------

       Total deposits at year end                        $410,301   $392,093   $346,315
                                                         --------   --------   --------
</TABLE>


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 to 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,  2002,  the  Bank  had   approximately
$95,228,000 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 9,
10, and 11 to the  Consolidated  Financial  Statements,  included as part of the
Annual Report to Shareholders,  for information as to rates, maturities, average
balances and maximum amounts outstanding.
<TABLE>
<CAPTION>

                                                            Years Ended December 31,

       (In Thousands)                                      2002       2001       2000
       --------------                                      ----       ----       ----

<S>                                                      <C>       <C>         <C>
       Advances from FHLB                                $ 33,072  $  23,214   $  23,357
       Guaranteed preferred beneficial
         interests in corporation's junior
         subordinated debt securities                       7,500      7,500       7,500

       Other borrowings                                       222        269         312
                                                         --------   --------   ---------

            Total Borrowings                             $ 40,794   $ 30,983   $  31,169

</TABLE>
         In January 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.  The subordinated notes were
issued  with a final  maturity  of 30 years and a  ten-year  call  option at the
discretion of the Corporation.  The issuance of these trust-preferred securities
has  enabled  the


                                       10
<PAGE>

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, 2002,  had 202 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 its
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  1998 to issue  trust
preferred securities in order to raise additional capital.

         The Bank formed a wholly-owned  subsidiary,  Highlands  Union Insurance
Services,  Inc., in 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, 2002,
had  purchased  seven  full  service  insurance  agencies  across  the  state of
Virginia.

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

                          Federal Home Loan Bank System

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

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

                                       11
<PAGE>

         The FHFB is required to adopt  regulations  establishing  standards  of
community  investment  or service  for  members of the FHLB 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 its  subsidiaries  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.  The  Corporation and its
subsidiaries has obtained  regulatory approval for its 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
subsidiaries.

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 of 1956 ("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 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.

                                       12
<PAGE>

Bank Regulation

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

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

                                       13
<PAGE>

         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 Section 38 of the Federal Deposit Insurance Act ("FDI Act"),
the federal banking regulatory  agencies have developed a classification  system
pursuant  to which  all  depository  institutions  are  placed  into one of five
categories based on their capital levels and other  supervisory  criteria:  well
capitalized,    adequately    capitalized;    undercapitalized;    significantly
undercapitalized; and critically undercapitalized.

         The Bank met the  requirements at December 31, 2002 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  depository institution 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  depository  institution 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

                                       14
<PAGE>

acquisitions  and new lines of  business.  An  institution's  principal  federal
regulator  may deem it to be  engaging  in 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.

                           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 bears to the sum
of the loans outstanding at the close of those six years or (2) the lower of (a)
the balance in the reserve  account at the close of the last  taxable year prior
to the most recent adoption of the experience  method (the base year is the last
taxable year beginning  before 1988), or (b) if the amount of loans  outstanding
at the close of the taxable year is less than the amount of loans outstanding at
the close of the base  year,  the  amount  which  bears the same  ratio to loans
outstanding  at the close of the  taxable  year as the balance of the reserve at
the close of the base year bears to the amount of loans outstanding at the close
of the base year.

         The Bank will be subject to the direct charge-off method of writing off
bad debts once it reaches $500 million.  Once the Bank is subject to this method
it will  not be  allowed  to carry a tax  reserve  that was  allowed  under  the
experience method.  Management  predicts that this change will occur in 2003 due
to growth projections.

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


                                       15
<PAGE>

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 its  subsidiaries.  The State of Virginia  assesses a Bank Franchise Tax for
Banks located in the Commonwealth.  The rate is 1% of capital subject to certain
deductions and  additions.  The majority of the tax is paid back to the Virginia
localities in which the Bank  operates.  The State of North  Carolina  imposes a
state income tax while Tennessee assesses a combined Franchise / Excise Tax.

         See Note 7 to the Consolidated  Financial Statements,  included as part
of the Annual Report to Shareholders,  for additional  information regarding the
income taxes of the Company.


                                       16
<PAGE>


Distribution of Assets, Liabilities and Shareholders' Equity; Interest Rates and
Interest Differential
<TABLE>
<CAPTION>

                                                        Year Ended December 31,
                                      2002                        2001                        2000
                                                        (Dollars in Thousands)
                                     Interest                     Interest                  Interest
                           Average   Income/   Yield/   Average   Income/  Yield/  Average  Income/  Yield/
                           Balance   Expense    Rate    Balance   Expense   Rate   Balance  Expense   Rate
                           -------   -------    ----    -------   -------   ----   -------  -------   ----
<S>                        <C>       <C>       <C>     <C>       <C>        <C>    <C>      <C>       <C>
ASSETS
Interest earning assets
  (taxable-equivalent
basis)

Loans (net of unearned
  discount (2)             $335,823  $ 26,095  7.77%   $309,753  $27,574    8.90%  $277,115 $25,077   9.05%
Securities (1)(3)            99,768     4,758  5.52      87,254    5,107    6.40     80,315   5,218   6.69
Federal funds sold            5,544        91  1.64       9,133      317    3.47      1,834     123   6.68
                           --------   -------  ----    --------   -------   ----   -------- -------   ----


Total interest-earning
  assets                   $441,134   $30,944  7.18%   $406,140   $32,998   8.42%  $359,264 $30,418   8.51%
                           --------   -------  ----    --------   -------   ----   -------- -------   ----

LIABILITIES
Interest bearing
  liabilities

Interest bearing dep.      $343,900  $ 11,768  3.42%   $322,847  $16,740    5.19%  $283,484 $15,610   5.51%
Other interest bearing
  liabilities                38,783     2,498  6.44      31,117    2,146    6.90     31,169   2,090   6.71
                           --------   -------  ----    --------   -------   ----   -------- -------   ----


Total interest-bearing
  liabilities              $382,683   $14,266  3.73%   $353,964   $18,886   5.34%  $314,653 $17,700   5.63%
                           --------   -------  ----    --------   -------   ----   -------- -------   ----

Net interest income.                  $16,678                     $14,112                   $12,718
Net margin on int.
  earning assets on a
  tax equivalent basis                         3.95%                        3.59%                     3.59%


Average interest spread                        3.45%                        2.90%                     2.88%
</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 FAS 115.


                                       17
<PAGE>

         As the largest component of income,  net interest income represents the
amount  that  interest  and fees  earned on loans  and  investments  exceed  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.

Increase/(Decrease) Due to Volume and Rate
<TABLE>
<CAPTION>

                                          2002 Compared to 2001                 2001 Compared to 2000

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

                                                            (Dollars in Thousands)

<S>                                 <C>          <C>        <C>           <C>           <C>       <C>
INTEREST INCOME
Securities                          $   800      $ (1,149)  $   (349)     $    464      $  (576)  $  (112)
Federal funds sold                     (125)         (101)      (226)          488         (293)      195
Loans                                 2,000        (3,479)    (3,479)        2,955         (458)    2,497
                                    -------      --------   --------       -------      -------   -------

Total Income Change                 $ 2,675      $ (4,729)  $ (2,054)      $ 3,907      $(1,327)  $ 2,580
                                    -------      --------   --------       -------      -------   -------


INTEREST EXPENSE
Savings and time deposits           $ 1,091      $ (6,063)  $ (4,972)      $ 2,168     $ (1,038)  $ 1,129
Other interest-bearing
  liabilities                           528          (177)       351            (4)          60        57
                                    -------      --------   --------       -------      -------   -------

Total Expense Change                $ 1,619      $ (6,240)  $ (4,621)      $ 2,164      $  (978)  $ 1,186
                                    -------      --------   --------       -------      -------   -------


Increase (Decrease) in
  Net Interest Income               $ 1,056      $  1,511   $  2,567       $ 1,743      $  (349)  $ 1,394
                                    -------      --------   --------       -------      -------   -------
</TABLE>


Investment Portfolio

         The following table presents the maturity  distribution,  market value,
amortized  cost and  approximate  tax equivalent  yield  (assuming a 34% federal
income tax rate) of the investment portfolio at December 31, 2002.

<TABLE>
<CAPTION>

                                                        (Dollars in Thousands)
                                       One Year    Five Years
                         Within One    Through      Through    After Ten             Market     Amortized
                            Year      Five Years   Ten Years     Years     Yield     Value         Cost

<S>                        <C>           <C>          <C>        <C>        <C>      <C>            <C>
 State & Muni's            $   0         $1,437       $  986     28,296     7.09     30,719         29,824
 Mtg.-backed Sec             133            216          528     56,853     4.25     57,730         57,052
 Other                       750              0          986     12,558     3.57     14,294         14,335
                           -----         ------       ------    -------     ----   --------       --------

 TOTAL                     $ 883         $1,653       $2,500    $97,707     5.02   $102,743       $101,211
                           -----         ------       ------    -------     ----   --------       --------
</TABLE>


                                       18
<PAGE>


Loan Portfolio

         The table below classifies gross loans by major category and percentage
distribution at December 31, 2002 for each of the past five years:

<TABLE>
<CAPTION>

                                                              December 31,
                                                        (Dollars in thousands)

                                      2002                         2001                        2000
                              Amount      Percentage       Amount      Percentage      Amount     Percentage
                              ------      ----------       ------      ----------      ------     ----------
<S>                         <C>              <C>         <C>              <C>        <C>            <C>
Real Estate Secured:
  Residential 1-4 family    $128,462         37.82%      $114,556         35.18%     $102,631       35.14%
  Multi-family                 3,383          1.00          3,011          0.92         3,909        1.34
  Commercial, Construction
Construction
      and Land Development    85,468         25.16         80,673         24.77        61,666       21.11
  Second Mortgages            11,676          3.43          7,737          2.38         5,342        1.83
  Equity Line of Credit        5,253          1.54          4,166          1.28         3,455        1.18
  Farmland                     5,589          1.65          5,055          1.56         4,928        1.69
                           ---------        ------       --------        ------      --------      ------
                           $ 239,831         70.60%      $215,208         66.09%     $181,931       62.29%

Secured, Other:
  Personal                  $ 49,483         14.57%       $60,532         18.59%      $63,137       21.62%
  Commercial                  26,043          7.67         26,002          7.98        26,463        9.05
  Agricultural                 4,209          1.23          3,274          1.01         4,498        0.86
                           ---------        ------       --------         -----      --------      ------
                            $ 79,735         23.47%       $89,808         27.58%      $92,098       31.53%

Unsecured:                  $ 20,135          5.93%       $20,614          6.33%      $18,059        6.18%
                           ---------        ------       --------        ------      --------      ------

Loans, gross               $ 339,701        100.00%      $325,630        100.00%     $292,088      100.00%
                           ---------        ------       --------        ------      --------      ------

</TABLE>

                                                 December 31,
                                            (Dollars in thousands)

<TABLE>
<CAPTION>
                                       1999                       1998
                               Amount      Percentage     Amount     Percentage
                               ------      ----------     ------     ----------
<S>                          <C>             <C>        <C>             <C>
Real Estate Secured:
  Residential 1-4 family     $ 94,356         36.04%    $ 81,181        34.76%
  Multi-family                  3,072          1.17        1,888         0.81
  Commercial, Construction
Construction
      and Land Development     53,893         20.58       45,832        19.63
  Second Mortgages              4,199          1.60        2,606         1.12
  Equity Line of Credit         3,536          1.35        3,064         1.31
  Farmland                      4,403          1.68        1,768         0.76
                             --------        ------     --------       ------
                             $163,459         62.42%    $136,339        58.38%

Secured, Other:
  Personal                    $60,492         23.10%     $62,366        26.70%
  Commercial                   18,226          6.97       14,293         6.12
  Agricultural                  2,408          0.92        2,133         0.91
                             --------        ------     --------       ------
                              $81,126         30.99%     $78,792        33.74%

Unsecured:                    $17,258          6.59%     $18,406         7.88%
                             --------        ------     --------       ------

Loans, gross                 $261,843        100.00%    $233,537       100.00%
                             --------        ------     --------       ------

</TABLE>

                                       19
<PAGE>

The  following  table shows the  maturity  of loans  outstanding,  inclusive  of
contractual amortization as of December 31, 2002.

<TABLE>
<CAPTION>
                                                               December 31, 2002
                                                             (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              $  6,973    $  4,119    $ 19,610    $  9,378    $ 20,964   $ 67,418    $128,462
  Multi-family                             233           0       2,431           0         719          0       3,383
  Commercial, Construction &
    Land Development                    21,195       7,088      45,859         841       6,679      3,806      85,468
  Second Mortgages                       1,455       3,542       3,858          93       2,283        445      11,676
  Equity Line of Credit                      0         407           0       1,867           0      2,979       5,253
  Farmland                                 893         844       3,016          81         755          0       5,589

Secured, Other:
  Personal                              15,720          44      32,348           0       1,371          0      49,483
  Commercial                             8,206       5,862       9,663       1,392         920          0      26,043
  Agricultural                             797       1,835       1,142          47         388          0       4,209

Unsecured                                8,588       7,635       2,709         939         264          0      20,135
                                      --------    --------    --------    --------    --------   --------    --------

Loans, Gross                          $ 64,060    $ 31,376    $120,636    $ 14,638    $ 34,343   $ 74,648    $339,701
                                      --------    --------    --------    --------    --------   --------    --------

</TABLE>

Non-performing loans

         The loan portfolio of the Bank is reviewed regularly by senior officers
to evaluate loan  performance.  The frequency of the review is based on a rating
of credit  worthiness  of the  borrower  utilizing  various  factors such as net
worth, credit history,  customer  relationship,  etc. The evaluations  emphasize
different factors depending upon the type of loan involved.  Commercial and real
estate 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's  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, 2002, 2001,  2000, 1999 and 1998  non-performing
loans amounted to $2,606,000,  $2,063,000, $1,502,000, $1,641,000 and $2,033,000
respectively.  As of the five periods ended December 31, 2002,  2001, 2000, 1999
and 1998 non-accrual  loans and more and still accruing  amounted to $1,657,000,
$950,000, $586,000, $559,000 and $1,380,000 respectively. As of the five periods
ended December 31, 2002,  2001,  2000,  1999 and 1998 loans past-due 90 days and
more  amounted  to  $949,000,  $1,113,000,  $916,000,  $1,082,000  and  $653,000
respectively.
                                       20
<PAGE>

Interest income lost on non-accruing loans was approximately $104,000,  $73,000,
$121,000,  $136,000 and $86,000 for the years ended  December  31,  2002,  2001,
2000, 1999 and 1998 respectively.  Interest income realized on loans past-due 90
days and more and still accruing was approximately  $15,000,  $18,000,  $15,000,
$17,000 and $10,000 for the years ended December 31, 2002,  2001, 2000, 1999 and
1998 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.

         The following table presents the Corporation's loan loss experience for
the past five years:
<TABLE>
<CAPTION>

                                                                        Years Ended December 31,
                                                                         (Dollars in Thousands)

                                                        2002         2001          2000         1999         1998
                                                        ----         ----          ----         ----         ----
<S>                                                    <C>          <C>           <C>          <C>          <C>
Allowance for loan losses at
  beginning of year                                    $  3,418     $  2,950       $ 2,494     $  2,008     $  1,636

Loans charged off:
    Commercial                                              389          107            69          357          270
    Real Estate - mortgage                                   94           10             0           27            0
    Consumer                                              1,043        1,087           925          710          786
    Other
                                                              0            0             0            0            0
                                                       --------     --------        ------     --------     --------

    Total                                              $  1,526     $  1,204        $  994     $  1,094     $  1,056
                                                       --------     --------        ------     --------     --------

Recoveries of loans previously charged off:
    Commercial                                         $      5     $      3        $    6     $     97     $     41
    Real Estate - mortgage                                    0            0             0            0            0
    Consumer                                                155          221           167           65          157
    Other                                                     0            0             0            0            0
                                                       --------     --------        ------     --------     --------

    Total                                              $    160     $    224        $  173     $    162     $    198
                                                       --------     --------        ------     --------     --------

Net loans charged off                                  $  1,366     $    980        $  821     $    932     $    858
                                                       --------     --------        ------     --------     --------
Provision for loan losses                                 1,825        1,448         1,277        1,418        1,230
                                                       --------     --------        ------     --------     --------


Allowance for loan losses end of year                  $  3,877     $  3,418       $ 2,950     $  2,494     $  2,008
                                                       --------     --------        ------     --------     --------

Average total loans (net of unearned income)           $335,823     $309,753     $ 277,115     $246,687     $213,069

Total loans (net of unearned income) at year-end       $339,521     $325,460     $ 291,897     $261,678     $233,372

Ratio of net charge-offs to average loans                0.407%       0.316%        0.296%       0.378%       0.403%

Ratio of provision for loan losses to average loan       0.543%       0.467%        0.461%       0.575%       0.577%

Ratio of provision for loan losses to net charge-off   133.602%     147.755%      155.542%     152.146%     143.357%

Allowance for loan losses to year-end loans              1.142%       1.050%        1.011%       0.953%       0.860%
</TABLE>


                                       21
<PAGE>

Allocation of the allowance for loan losses

         The  following  table  provides an allocation of the allowance for loan
losses as of December 31, 2002, 2001, 2000, 1999 and 1998.

<TABLE>
<CAPTION>

                                                                            Year Ended December 31,
                                                                       Percent of Loans on each Category

                                                                             (Dollars in Thousands)

                                        2002                                         2001

                    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             $   972          25.06%        10.87%        $   857          25.06%          7.98%
Real Estate                228           5.89         70.60             201           5.89          66.09
Consumer                 2,672          68.93         17.05           2,356          68.93          24.92
Other                        5           0.12          1.48               4           0.12           1.01
                       -------         ------        ------         -------         ------         ------

Total                  $ 3,877         100.00%       100.00%        $ 3,418         100.00%        100.00%
                       -------         ------        ------         -------         ------         ------

</TABLE>
<TABLE>
<CAPTION>

                              Year Ended December 31,
                         Percent of Loans on each Category

                               (Dollars in Thousands)

                                      2000

                    Allowance for   Percentage of   Percentage of
                       Loan Loss    Total Loan Loss  Total Loans
                       ---------    ---------------  -----------
<S>                    <C>              <C>           <C>
Commercial             $    739          25.06%        12.52%
Real Estate                 174           5.89         62.29
Consumer                  2,033          68.93         24.09
Other                         4           0.12
                       --------         ------        ------

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

</TABLE>
<TABLE>
<CAPTION>

                                        1999                                         1998

                    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              $  625          25.06%        10.34%         $  503          25.05%        10.38%
Real Estate                147           5.89         62.42             118           5.88         58.38
Consumer                 1,719          68.93         26.01           1,384          68.92         30.04
Other                        3           0.12          1.23               3           0.15          1.20
Unallocated                  0             0              0               0              0             0
                       -------         ------        ------         -------         ------        ------

Total                  $ 2,008         100.00%       100.00%        $ 2,008         100.00%       100.00%
                       -------         ------        ------         -------         ------        ------

</TABLE>

                                       22
<PAGE>

Deposits

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

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

                                                        2002            2001             2000
                                                        ----            ----             ----
<S>                                                   <C>              <C>             <C>
              Non-interest bearing demand deposits    $ 55,597         $ 50,248        $ 45,343
              Interest bearing demand deposits          49,519           37,464          25,697
              Savings deposits                          70,258           60,166          45,826
              Time deposits                            234,927          244,215         229,449
                                                      --------         --------        --------

              Total Deposits                          $410,301         $392,093        $346,315
</TABLE>

           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)

                                   2002                     2001                     2000

                           Amount         Rate      Amount         Rate       Amount         Rate
                           ------         ----      ------         ----       ------         ----
<S>                       <C>             <C>     <C>              <C>      <C>              <C>
Non-interest bearing
  demand deposits         $ 54,979        0.00%   $ 47,271         0.00%    $ 42,228         0.00%
Interest-bearing demand
  deposits                  43,537        1.76      29,003         2.80       25,636         3.52
Savings deposits            65,790        2.07      52,655         3.38       47,474         4.01
Time deposits              234,573        4.11     241,190         5.85      210,374         6.08
                          --------                --------                  --------

Total                     $398,879                $370,119                  $325,712
</TABLE>


         The  remaining  maturities  of time  deposits  greater than $100,000 at
December 31, 2002 are as follows (in thousands) :

         Maturity

         3 months or less....................................$  12,252
         3 months through 6 months...........................    8,269
         Over 3 through 12 months............................   80,173
         Over 12 months......................................   28,498
                                                               -------

              Total                                          $  61,390
                                                               -------

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.

                                       23
<PAGE>

         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,  2002,  and measures the interest  rate
sensitivity  gap for each range of maturity  indicated:  The amounts  below also
reflect various prepayment assumptions.

<TABLE>
<CAPTION>

                                                                    December 31, 2002
                                                                  (Dollars in Thousands)
                                                                         Maturing


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

<S>                                        <C>                 <C>                 <C>                 <C>
     ASSETS
     Interest-bearing
         Investment Securities             $ 13,426            $ 37,232            $ 54,267            $104,925
         Fed Funds Sold                       5,132                   0                   0               5,132
         Loans                              142,405             173,492              23,624             339,521
         Other interest-bearing                                                       7,571               7,571
     Noninterest-bearing
         Other Assets                             0                   0              28,454              28,454
                                           --------            --------            --------            --------

     Total Assets                          $160,963            $210,724            $113,916            $485,603
                                           --------            --------            --------            --------

     LIABILITIES AND SHARE-
       HOLDERS' EQUITY
     Interest-bearing
     (1) All Interest-bearing Deposits     $251,222            $ 99,400            $  4,082            $354,704
           Other Interest-bearing Liab       19,072              14,110               7,612              40,794
     Noninterest-bearing
           Demand Deposit Non-Interest            0                   0              55,597              55,597
           Other Liabilities                  2,309                   0                   0               2,309
           Shareholders' Equity                   0                   0              32,199              32,199
                                           --------            --------            --------            --------

     Total Liabilities and Shareholders'
           Equity                          $272,603            $113,510            $ 99,490            $485,603
                                           --------            --------            --------            --------

     Interest Rate Sensitivity GAP       $(111,640)            $ 97,214            $ 14,426              $    0
</TABLE>

(1)      For purposes of this  schedule,  the  Corporation  includes 100% of its
         statement savings, NOW and MMDA's in the one year column.

                                       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  liabilities.  Reinvestment  risk  refers  to the  ability,  or lack
thereof, 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 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, 2002,  subject to the specified
interest rate changes.
<TABLE>
<CAPTION>

      Rate change increment     % change in net interest income    $ change in net
                                                                   interest income
<S>                              <C>                               <C>
      Up 1%
                                -3.19%                             $     -559,000
      Up 2%
                                -5.71%                             $   -1,000,000
      Down 1%
                                 3.75%                             $      656,000
      Down 2%
                                 5.84%                             $    1,023,000
</TABLE>

Liquidity

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


                                       25
<PAGE>

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 2002,  as  reflected in the  Consolidated
Balance Sheets, the deposit mix changed with an increase in non-interest bearing
demand deposits of $5.3 million, an increase in  interest-bearing  NOW and Money
Market deposits of $12.1 million,  an increase in statement  savings deposits of
$10.1 million and a decrease in total time deposits of $9.3 million. During 2002
total deposits increased $18.2 million.

         The  Corporation  had   approximately   $102.7  million  in  investment
securities  at December  31,  2002.  The  Corporation  utilizes  its  investment
portfolio as a secondary form of liquidity.  Management  has  designated  $102.7
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
without negative impact to the financial position or results of operations.

         The  Consolidated  Statements of Cash Flows  appearing in the financial
statements  of  the  Corporation  reflects  a net  increase  in  cash  and  cash
equivalents of $6.3 million over the comparable  2001 period.  This increase was
greatly due to the bank's  increase in total deposits as well as the $10 million
advances from the Federal Home Loan Bank.

         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:


<TABLE>
<CAPTION>
                                                                   Year Ended December 31,
                                                                         (Percentage)

                                                   2002                       2001                      2000
                                                   ----                       ----                      ----
<S>                                               <C>                         <C>                      <C>
Net income to:
  Average total assets                             0.87                        0.77                     0.78
  Average shareholders' equity                    13.82                       12.78                    13.69

Divided payout ratio (dividends declared per
  share divided by net income per share)           5.81%                       6.39%                   6.21%

Average shareholders' equity to average total
  assets ratio                                     6.32                        6.00                     5.71
</TABLE>


                                       26
<PAGE>

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  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 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, 2002 was approximately $22,000.

         Also during 1998, the Bank initiated an off premises ATM program.  This
program  has  continued  to expand to  include  28 offsite  ATMs  purchased  and
installed  throughout  the  Bank's  market  areas.  Six  machines  are placed in
Bristol, Virginia; one is installed in Bristol,  Tennessee; ten are installed in
Washington  County,  Virginia;  two in Russell  County,  Virginia;  six in Smyth
County,  Virginia,  one in Wythe  County,  Virginia,  one in Banner  Elk,  North
Carolina 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

                                       27
<PAGE>

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 approximately
$3.9  million of deposit  accounts,  $54,000 of overdraft  protection  accounts,
$7,000 of specified  furniture and equipment and approximately  $639,000 for the
building and real estate.  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 lanes and a drive-up ATM.

         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, 2002 was approximately $200,000. The
Bank has  purchased  a tract of land on Highway  394, at its  intersection  with
Blountville Boulevard, in Blountville, Tennessee for the purpose of constructing
a  full-service  branch bank.  The property was  purchased for $315,000 plus the
conveyance  of  the  Bank's  Volunteer  Parkway  property  valued  at  $300,000.
Excavation of the Highway 394 property is underway and the branch is expected to
open in late summer of 2003.

         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.
During 1998, the Corporation  purchased the adjacent  property to the operations
center.  The property  purchased is a one story brick  structure  that currently
houses the Corporation's technology department.  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, 2002.


                                       28
<PAGE>

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, 2002, the Corporation had approximately  1,247
shareholders  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  shareholders who are
interested in selling their stock.  These parties  negotiate the per share price
independent of the  Corporation.  The stock  transfer  agent of the  Corporation
attempts  to keep a record of what the stock  sales are trading at by asking the
parties  about  the trade  price  per  share.  Please  refer to the table  below
entitled  Common  Stock  Performance  for a breakdown of the trades for the four
quarters  of 2002 and 2001.  It is the  opinion  of  management  that this range
accurately  reflects the market value of the Corporation's  common stock for the
periods presented.

                   Common Stock Performance-December 31, 2002

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

First Quarter           $25.50           $25.00               $25.47

Second Quarter          $26.00           $24.00               $25.26

Third Quarter           $26.00           $25.50               $25.93

Fourth Quarter          $26.00           $26.00               $26.00



                    Common Stock Performance-December 31 2001

                         High              Low            Quarterly 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


         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,  capital
requirements and upon general business conditions.  The Corporation declared and
paid

                                       29
<PAGE>


annual cash dividends of $238,000 or $0.09 per share during 2002 and $211,000 in
cash dividends or $0.08 per share during 2001. The Corporation's principal asset
is its  investment  in the Bank, a wholly  owned  consolidated  subsidiary.  The
primary  source of income for the  Corporation  historically  has been dividends
from the  Bank.  Regulatory  agencies  limit  the  amount  of funds  that may be
transferred from the Bank to the Corporation in the form of dividends,  loans or
advances. The Bank paid $1.5 million in dividends to the Corporation in 2002.

         Under applicable laws and without prior regulatory approval,  the total
dividend  payments of the Bank in any calendar  year are  restricted  to the net
profits of that year, as defined, combined with the retained net profits for the
two preceding  years.  The total  dividends that may be declared in 2003 without
regulatory  approval totals $11.4 million plus  year-to-date 2003 net profits as
of the declaration date.

         At March 13,  2003,  there  were  approximately  1,247  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)

                                                       2002         2001          2000         1999         1998
                                                       ----         ----          ----         ----         ----
<S>                                                   <C>          <C>           <C>          <C>          <C>
Income Statement Amounts:

   Gross interest income                              $  30,944    $  32,998     $  30,418    $  25,671    $  22,897
   Gross interest expense                                14,266       18,887        17,700       14,167       13,401
   Net interest income                                   16,678       14,111        12,718       11,504        9,496
   Provision for possible loan Losses                     1,825        1,448         1,277        1,418        1,230
   Net interest income after provision                   14,853       12,663        11,441       10,086        8,266
   Other operating income                                 3,646        3,364         2,480        1,353        1,367
   Other operating expense                               13,046       11,619         9,713        8,187        6,962
   Income before income taxes
       and other items                                    5,453        4,408         4,208        3,252        2,671
   Income taxes                                           1,349        1,107         1,229        1,121          896
   Income before cumulative effect of
       change in accounting principles                    4,104        3,301         2,979        2,131        1,775
   Cumulative effect of change in
       accounting principles                                  0            0             0            0            0
   Net income                                         $   4,104    $   3,301     $   2,979    $   2,131    $   1,775

Per Share Data(1):

   Net income per share                               $    1.55    $    1.25     $    1.13    $    0.85    $    0.72
   Cash dividends per share                                0.09         0.08          0.07         0.06         0.05
   Book value (at year end)                               12.16        10.38          9.17         7.77         7.33

Balance Sheet Amounts (at year-end):

   Total assets                                       $ 485,603    $ 453,745     $ 405,212    $ 358,348    $ 307,764
   Total loans (net of unearned income)                 339,521      325,460       291,895      261,678      233,371
   Total deposits                                       410,301      392,093       346,315      306,193      272,341
   Long-term debt                                        14,200       10,483        18,669       10,599        6,763
   Capital Securities                                     7,500        7,500         7,500        7,500        7,500
   Total equity                                          32,199       27,452        24,183       20,408       18,279
</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 the
Annual Report to Shareholders for the fiscal year ended December 31, 2002.

Item 7A. Quantitative and Qualitative Disclosures About Market Risk.

         The  information  required herein is incorporated by reference to pages
23-26 above on Interest Rate Sensitivity Analysis,  Asset Liability Analysis and
Liquidity.

Item 8. Financial Statements and Supplementary Data

         The following  financial  statements are incorporated by reference from
the Annual Report to Shareholders for the fiscal year ended December 31, 2002:

                  Independent Auditors' Report;
                  Consolidated  Statements of Financial Condition as of December
                  31, 2002, 2001 and 2000;
                  Consolidated Statements of Operations for each of the years in
                  the three year period ended  December 31, 2002;
                  Consolidated  Statements of  Stockholder's  Equity for each of
                  the years in the three year period ended December 31, 2002;
                  Consolidated Statements of Cash Flows for each of the years in
                  the three year period ended December 31, 2002; and
                  Notes to  Consolidated  Financial  Statements for December 31,
                  2002, 2001 and 2000.

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

         Pursuant  to General  Instruction  G(3) of Form 10-K,  the  information
contained under the headings  "Nominees for Election,"  "Executive  Officers Who
Are Not Directors" and "Section 16(a) Beneficial Ownership Reporting Compliance"
in the Company's  Proxy Statement for the 2003 Annual Meeting of Shareholders is
incorporated herein by reference.

Item 11. Executive Compensation

         Pursuant  to General  Instruction  G(3) of Form 10-K,  the  information
contained  under  the  headings  "Director  Compensation,"   "Executive  Officer
Compensation,"  "Stock  Options"  and "Option  Exercises  and  Holdings"  in the
Company's  Proxy  Statement  for the 2003  Annual  Meeting  of  Shareholders  is
incorporated herein by reference.

                                       31
<PAGE>

Item 12. Security Ownership of Certain Beneficial Owners and Management

         Pursuant  to General  Instruction  G(3) of Form 10-K,  the  information
contained  under the  headings  "Security  Ownership of  Management  and Certain
Beneficial  Owners" and "Equity  Compensation Plan Information" in the Company's
Proxy  Statement for the 2003 Annual  Meeting of  Shareholders  is  incorporated
herein by reference.

Item 13. Certain Relationships and Related Transactions

         Pursuant  to General  Instruction  G(3) of Form 10-K,  the  information
contained  under the  heading  "Certain  Transactions"  in the  Company's  Proxy
Statement for the 2003 Annual Meeting of Shareholders is incorporated  herein by
reference.

Item 14. Controls and Procedures

         On an  on-going  basis,  senior  management  monitors  and  reviews the
internal controls  established for the various  operating  segments of the Bank.
Additionally,  the Company has created a Disclosure  Review  Committee to review
not only  internal  controls but the  information  used by  Company's  financial
officers to prepare the  Corporation's  periodic  SEC filings and  corresponding
financial  statements.  The Committee is comprised of the Senior Management Team
of the Bank and  meets at least  quarterly.  Internal  audits  conducted  by the
Company's  internal  audit  department  are also reviewed by senior  officers to
assist  them  in  assessing  the  adequacy  of the  Company's  internal  control
structure.  These audits are also  discussed in detail with the Company's  Audit
Committee.  The Company feels that sufficient  internal  controls and disclosure
controls have been  established  and have reviewed such controls within the last
90 days.

         Furthermore,   management   asserts   that  there  have  not  been  any
significant  changes in the Corporation's  internal controls or in other factors
that could  significantly  affect these controls or other factors  subsequent to
the date of management's most recent evaluation.


Part IV.

Item 15. Exhibits, Financial Statement Schedules, and Reports on Form 8-K

         (a)  (1) The  response  to this  portion of Item 15 is  submitted  as a
                  separate section of this report.

              (2) All  applicable  financial  statement  schedules  required  by
                  Regulation   S-X  are  included  in  the  Notes  to  the  2002
                  Consolidated Financial Statements.

              (3) Exhibits:

                  3.1      Articles of  Incorporation  of Highlands  Bankshares,
                           Inc.  (restated  in  electronic  format),   filed  as
                           Exhibit  4.1 to the  Registration  Statement  on Form
                           S-3,  Registration  No.  333-83618,  filed  with  the
                           Commission on March 1, 2002,  incorporated  herein by
                           reference.

                  3.2      Bylaws of  Highlands  Bankshares,  Inc.  attached  as
                           Exhibit  3.2 to the  Registration  Statement  on Form
                           8-A, File No. 000-27622, filed with the Commission on
                           January 24, 1996, incorporated herein by reference.

                                       32
<PAGE>

                  10.1     Highlands Union Bank 1995 Stock Option Plan.

                  11       Statement regarding computation of per share earnings
                           (included  as  Note 1 of the  Notes  to  Consolidated
                           Financial  Statements  in the 2002  Annual  Report to
                           Shareholders and incorporated herein by reference).

                  13.1     Annual Report to Shareholders.

                  21       Subsidiaries of the Corporation.

                  23.1     Consent of Brown, Edwards & Company, L.L.P.

                  99.1     Statement of Chief Executive  Officer  Pursuant to 18
                           U.S.C.ss.1350.

                  99.2     Statement of Chief Operations  Officer Pursuant to 18
                           U.S.C.ss.1350.

                  99.3     Statement   of  Chief   Financial   Officer   of  the
                           Corporation Pursuant to 18 U.S.C.ss.1350.

                  99.4     Statement  of  Chief  Financial  Officer  of the Bank
                           Pursuant to 18 U.S.C.ss.1350.

         (b) Reports on Form 8-K.

                      No reports on  Form 8-K were filed  by the Company  during
                      the  last quarter of the period covered  by this report.

         (c) Exhibits.

                      The  response  to this  portion of  Item  15 as  listed in
                      Item 15(a)(3) above is submitted as a separate  section of
                      this report.

         (d) Financial Statement Schedules.

                      The  response to  this portion of Item  15 is submitted as
                      a separate section of this report.

                                       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:  March 26, 2003                      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, 2003.

<TABLE>
<CAPTION>
                 Signature                                      Title                                Date
                 ---------                                      -----                                ----

<S>                                             <C>                                             <C>

/s/ James D. Morefield                           Chairman of the Board, and Director               March 26, 2003
-----------------------------------------
             James D. Morefield


/s/ Dr. James D. Moore, Jr.                                   President                            March 26, 2003
-----------------------------------------
          Dr. James D. Moore, Jr.


/s/ J. Carter Lambert                                       Vice Chairman                          March 26, 2003
-----------------------------------------
             J. Carter Lambert


/s/ Samuel L. Neese                              Executive Vice President, and Chief               March 26, 2003
-----------------------------------------               Executive Officer
              Samuel L. Neese                       [principal executive officer]



/s/ James T. Riffe                              Executive Vice President and Cashier               March 26, 2003
-----------------------------------------           [principal financial and
               James T. Riffe                          accounting officer]


/s/ William E. Chaffin                                        Director                             March 26, 2003
-----------------------------------------
             William E. Chaffin


/s/ E. Craig Kendrick                                         Director                             March 26, 2003
-----------------------------------------
             E. Craig Kendrick

/s/ Clydes B. Kiser                                           Director                             March 26, 2003
-----------------------------------------
              Clydes B. Kiser


/s/ Charles P. Olinger                                        Director                             March 26, 2003
-----------------------------------------
             Charles P. Olinger


/s/ William J. Singleton                                      Director                             March 26, 2003
-----------------------------------------
            William J. Singleton


/s/ Dr. H. Ramsey White, Jr.                                  Director                             March 26, 2003
-----------------------------------------
          Dr. H. Ramsey White, Jr.

</TABLE>



<PAGE>
                           SECTION 302 CERTIFICATIONS

I, Samuel L. Neese,  certify that:

1.      I have reviewed this annual report on Form 10-K of Highlands Bankshares,
Inc.

2.      Based on my knowledge, this annual report does not contain any untrue
statement of a material fact or omit to state a material fact  necessary to make
the statements made, in light of the  circumstances  under which such statements
were made, not  misleading  with respect to the period covered by this annual
report;

3.      Based on my knowledge,  the financial  statements,  and other  financial
information  included in this annual  report,  fairly present in all material
respects the financial  condition,  results of operations  and cash flows of the
registrant as of, and for, the periods presented in this annual report;

4.      The  registrant's  other  certifying  officers and I are responsible for
establishing and maintaining  disclosure  controls and procedures (as defined in
Exchange Act Rules 13a-14 and 15d-14) for the registrant and have:

        a)      designed such disclosure  controls and procedures to ensure that
        material   information   relating  to  the  registrant,   including  its
        consolidated  subsidiaries,  is made known to us by others  within those
        entities,  particularly during the period in which this annual report
        is being prepared;

        b)      evaluated  the  effectiveness  of  the  registrant's  disclosure
        controls and  procedures as of a date within 90 days prior to the filing
        date of this annual report (the "Evaluation Date"); and

        c)      presented in this  annual  report our  conclusions  about the
        effectiveness  of the disclosure  controls and  procedures  based on our
        evaluation as of the Evaluation Date;

5.      The registrant's other certifying  officers and I have disclosed,  based
on our most  recent  evaluation,  to the  registrant's  auditors  and the  audit
committee  of  registrant's  board  of  directors  (or  persons  performing  the
equivalent functions):

        a)      all  significant  deficiencies  in the  design or  operation  of
        internal controls which could adversely affect the registrant's  ability
        to  record,  process,  summarize  and  report  financial  data  and have
        identified  for the  registrant's  auditors any material  weaknesses  in
        internal controls; and

        b)      any fraud, whether or not material,  that involves management or
        other employees who have a significant role in the registrant's internal
        controls; and

6.      The registrant's other certifying  officers and I have indicated in this
annual  report  whether or not there  were  significant  changes in  internal
controls or in other factors that could  significantly  affect internal controls
subsequent to the date of our most recent  evaluation,  including any corrective
actions with regard to significant  deficiencies  and material  weaknesses.


Date:  March 26, 2003                  /s/ Samuel L. Neese
Samuel L.  Neese                        ----------------------------------------
Executive Vice President and Chief Executive Officer


<PAGE>

I, James T. Riffe,  certify  that:

1.      I have reviewed this annual report on Form 10-K of Highlands Bankshares,
Inc.

2.      Based on my knowledge, this annual report does not contain any untrue
statement of a material fact or omit to state a material fact  necessary to make
the statements made, in light of the  circumstances  under which such statements
were made, not  misleading  with respect to the period covered by this annual
report;

3.      Based on my knowledge,  the financial  statements,  and other  financial
information  included in this annual  report,  fairly present in all material
respects the financial  condition,  results of operations  and cash flows of the
registrant as of, and for, the periods presented in this annual report;

4.      The  registrant's  other  certifying  officers and I are responsible for
establishing and maintaining  disclosure  controls and procedures (as defined in
Exchange Act Rules 13a-14 and 15d-14) for the registrant and have:

        a)      designed such disclosure  controls and procedures to ensure that
        material   information   relating  to  the  registrant,   including  its
        consolidated  subsidiaries,  is made known to us by others  within those
        entities,  particularly during the period in which this annual report
        is being prepared;

        b)      evaluated  the  effectiveness  of  the  registrant's  disclosure
        controls and  procedures as of a date within 90 days prior to the filing
        date of this annual report (the "Evaluation Date"); and

        c)      presented in this  annual  report our  conclusions  about the
        effectiveness  of the disclosure  controls and  procedures  based on our
        evaluation as of the Evaluation Date;

5.      The registrant's other certifying  officers and I have disclosed,  based
on our most  recent  evaluation,  to the  registrant's  auditors  and the  audit
committee  of  registrant's  board  of  directors  (or  persons  performing  the
equivalent functions):

        a)      all  significant  deficiencies  in the  design or  operation  of
        internal controls which could adversely affect the registrant's  ability
        to  record,  process,  summarize  and  report  financial  data  and have
        identified  for the  registrant's  auditors any material  weaknesses  in
        internal controls; and

        b)      any fraud, whether or not material,  that involves management or
        other employees who have a significant role in the registrant's internal
        controls; and

6.      The registrant's other certifying  officers and I have indicated in this
annual  report  whether or not there  were  significant  changes in  internal
controls or in other factors that could  significantly  affect internal controls
subsequent to the date of our most recent  evaluation,  including any corrective
actions with regard to significant  deficiencies  and material  weaknesses.


Date:  March 26, 2003                  /s/ James T. Riffe
James T. Riffe                         ----------------------------------------
Executive Vice President and Chief Executive Officer


<PAGE>

I, Robert M. Little, Jr.,  certify  that:

1.      I have reviewed this annual report on Form 10-K of Highlands Bankshares,
Inc.

2.      Based on my knowledge, this annual report does not contain any untrue
statement of a material fact or omit to state a material fact  necessary to make
the statements made, in light of the  circumstances  under which such statements
were made, not  misleading  with respect to the period covered by this annual
report;

3.      Based on my knowledge,  the financial  statements,  and other  financial
information  included in this annual  report,  fairly present in all material
respects the financial  condition,  results of operations  and cash flows of the
registrant as of, and for, the periods presented in this annual report;

4.      The  registrant's  other  certifying  officers and I are responsible for
establishing and maintaining  disclosure  controls and procedures (as defined in
Exchange Act Rules 13a-14 and 15d-14) for the registrant and have:

        a)      designed such disclosure  controls and procedures to ensure that
        material   information   relating  to  the  registrant,   including  its
        consolidated  subsidiaries,  is made known to us by others  within those
        entities,  particularly during the period in which this annual report
        is being prepared;

        b)      evaluated  the  effectiveness  of  the  registrant's  disclosure
        controls and  procedures as of a date within 90 days prior to the filing
        date of this annual report (the "Evaluation Date"); and

        c)      presented in this  annual  report our  conclusions  about the
        effectiveness  of the disclosure  controls and  procedures  based on our
        evaluation as of the Evaluation Date;

5.      The registrant's other certifying  officers and I have disclosed,  based
on our most  recent  evaluation,  to the  registrant's  auditors  and the  audit
committee  of  registrant's  board  of  directors  (or  persons  performing  the
equivalent functions):

        a)      all  significant  deficiencies  in the  design or  operation  of
        internal controls which could adversely affect the registrant's  ability
        to  record,  process,  summarize  and  report  financial  data  and have
        identified  for the  registrant's  auditors any material  weaknesses  in
        internal controls; and

        b)      any fraud, whether or not material,  that involves management or
        other employees who have a significant role in the registrant's internal
        controls; and

6.      The registrant's other certifying  officers and I have indicated in this
annual  report  whether or not there  were  significant  changes in  internal
controls or in other factors that could  significantly  affect internal controls
subsequent to the date of our most recent  evaluation,  including any corrective
actions with regard to significant  deficiencies  and material  weaknesses.


Date:  March 26, 2003                  /s/ Robert M. Little, Jr.
Robert M. Little, Jr.                  ----------------------------------------
Executive Vice President and Chief Executive Officer

<PAGE>

I, James R. Edmondson,  certify  that:

1.      I have reviewed this annual report on Form 10-K of Highlands Bankshares,
Inc.

2.      Based on my knowledge, this annual report does not contain any untrue
statement of a material fact or omit to state a material fact  necessary to make
the statements made, in light of the  circumstances  under which such statements
were made, not  misleading  with respect to the period covered by this annual
report;

3.      Based on my knowledge,  the financial  statements,  and other  financial
information  included in this annual  report,  fairly present in all material
respects the financial  condition,  results of operations  and cash flows of the
registrant as of, and for, the periods presented in this annual report;

4.      The  registrant's  other  certifying  officers and I are responsible for
establishing and maintaining  disclosure  controls and procedures (as defined in
Exchange Act Rules 13a-14 and 15d-14) for the registrant and have:

        a)      designed such disclosure  controls and procedures to ensure that
        material   information   relating  to  the  registrant,   including  its
        consolidated  subsidiaries,  is made known to us by others  within those
        entities,  particularly during the period in which this annual report
        is being prepared;

        b)      evaluated  the  effectiveness  of  the  registrant's  disclosure
        controls and  procedures as of a date within 90 days prior to the filing
        date of this annual report (the "Evaluation Date"); and

        c)      presented in this  annual  report our  conclusions  about the
        effectiveness  of the disclosure  controls and  procedures  based on our
        evaluation as of the Evaluation Date;

5.      The registrant's other certifying  officers and I have disclosed,  based
on our most  recent  evaluation,  to the  registrant's  auditors  and the  audit
committee  of  registrant's  board  of  directors  (or  persons  performing  the
equivalent functions):

        a)      all  significant  deficiencies  in the  design or  operation  of
        internal controls which could adversely affect the registrant's  ability
        to  record,  process,  summarize  and  report  financial  data  and have
        identified  for the  registrant's  auditors any material  weaknesses  in
        internal controls; and

        b)      any fraud, whether or not material,  that involves management or
        other employees who have a significant role in the registrant's internal
        controls; and

6.      The registrant's other certifying  officers and I have indicated in this
annual  report  whether or not there  were  significant  changes in  internal
controls or in other factors that could  significantly  affect internal controls
subsequent to the date of our most recent  evaluation,  including any corrective
actions with regard to significant  deficiencies  and material  weaknesses.


Date:  March 26, 2003                  /s/ James R. Edmondson
James R. Edmondson                     ----------------------------------------
Executive Vice President and Chief Executive Officer

<PAGE>


                                  EXHIBIT INDEX

Exhibit No.       Description
-----------       -----------

   3.1            Articles  of  Incorporation  of  Highlands  Bankshares,   Inc.
                  (restated in electronic  format),  filed as Exhibit 4.1 to the
                  Registration   Statement   on  Form  S-3,   Registration   No.
                  333-83618,  filed  with  the  Commission  on  March  1,  2002,
                  incorporated herein by reference.

   3.2            Bylaws of Highlands  Bankshares,  Inc. attached as Exhibit 3.2
                  to the Registration Statement on Form 8-A, File No. 000-27622,
                  filed with the  Commission  on January 24, 1996,  incorporated
                  herein by reference.

   10.1           Highlands Union Bank 1995 Stock Option Plan.

   11             Statement   regarding   computation   of  per  share  earnings
                  (included  as Note 1 of the  Notes to  Consolidated  Financial
                  Statements  in the 2002  Annual  Report  to  Shareholders  and
                  incorporated herein by reference).

   13.1           Annual Report to Shareholders.

   21             Subsidiaries of the Corporation.

   23.1           Consent of Brown, Edwards & Company, L.L.P.

   99.1           Statement   of  Chief   Executive   Officer   Pursuant  to  18
                  U.S.C.ss.1350.

   99.2           Statement  of  Chief   Operations   Officer   Pursuant  to  18
                  U.S.C.ss.1350.

   99.3           Statement  of  Chief  Financial  Officer  of  the  Corporation
                  Pursuant to 18 U.S.C.ss.1350.

   99.4           Statement of Chief  Financial  Officer of the Bank Pursuant to
                  18 U.S.C.ss.1350.


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