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 fiscal year ended December 31, 2001         Commission file number: 0-16761

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

              West Virginia                              55-0650743
     (State or other jurisdiction of                  (I.R.S. Employer
     incorporation or organization)                  Identification No.)

                P. O. Box 929, Petersburg, West Virginia  26847
              (Address of principal executive offices) (Zip Code)

        Issuer's telephone number including area code:  (304) 257-4111

          Securities registered pursuant to Section 12(b) of the Act:
                                      None

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

                              Common Stock - $5 Par

    Check whether the issuer (1) filed all reports required to be filed by
Section 13 or 15(d) of the Exchange Act during the past 12 months (or for such
shorter period 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
.....

    Check if there is no disclosure  of delinquent  filers in response to Item
405 of  Regulation  S-B  contained  in this form,  and no  disclosure  will 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]

    Issuer's revenues for its most recent fiscal year:  $21,401,065

    The aggregate market value of the 457,154 shares of Common Stock of the
registrant issued and outstanding held by nonaffiliates on March 1, 2002 was
approximately $ 22,400,546 based on the closing sales price of $ 49.00 per share
on that date. For purposes of this calculation, the term "affiliate" refers to
all directors and executive officers of the registrant.

    State the number of shares outstanding of each of the issuer's classes of
common equity, as of the latest practicable date: As of March 1, 2002 - 501,898

                      DOCUMENTS INCORPORATED BY REFERENCE:

    Proxy  Statement of Highlands  Bankshares,  Inc. filed via Form DEF 14A on
March 13, 2002.

                            LOCATION OF EXHIBIT INDEX

    The index of exhibits is contained in Part IV herein on pages 49-50.

    TRANSITIONAL SMALL BUSINESS DISCLOSURE FORMAT  YES         NO   X
                                                       -----      -----


<PAGE> 2



                                 FORM 10-K INDEX



                                                                        Page
Part I

Item  1.  Description of Business                                        3
          General
          Services Offered by the Banks
          Employees
          Competition
          Regulation and Supervision

Item  2.  Description of Property                                        4

Item  3.  Legal Proceedings                                              5

Item  4.  Submission of Matters to a Vote of Security Holders            5


Part II

Item  5.  Market for Common Equity and
          Related Stockholder Matters                                    5

Item  6.  Management's Discussion and Analysis of Financial
          Condition and Results of Operation                             6

Item  7.  Financial Statements                                          26

Item  8.  Changes in and Disagreement with Accountants on
          Accounting and Financial Disclosure                           50


Part III

Item  9.  Directors, Executive Officers, Promoters and Control
          Persons; Compliance with Section 16(a) of the
          Exchange Act                                                  50

Item 10.  Executive Compensation                                        50

Item 11.  Security Ownership of Certain Beneficial Owners and
          Management                                                    50

Item 12.  Certain Relationships and Related Transactions                50


Part IV

Item 13.  Exhibits and Reports on Form 8-K                              50

Signatures                                                              52




<PAGE> 3



Part I

Item 1. Description of Business

    General

    Highlands Bankshares, Inc. (hereinafter referred to as "Highlands"),
incorporated under the laws of West Virginia in 1985, is a multi-bank holding
company subject to the provisions of the Bank Holding Company Act of 1956, as
amended, and owns 100% of the outstanding stock of its subsidiary banks, The
Grant County Bank and Capon Valley Bank (hereinafter referred to as the
"Banks"), its life insurance  subsidiary,  HBI Life Insurance Company
(hereinafter referred to as "HBI Life") and its trust subsidiary, Highlands
Bankshares Trust Company (hereinafter referred to as "HBTC").

    The Grant County Bank was chartered on August 6, 1902, and Capon Valley Bank
was chartered on July 1, 1918. Both are state banks chartered under the laws of
the State of West Virginia. HBI Life was chartered in April 1988 under the laws
of the State of Arizona. HBTC was chartered in December 2000 under the laws of
the state of West Virginia.

    Services Offered by the Banks

    The Banks offer all services  normally offered by a full service
commercial bank, including commercial and individual demand and time deposit
accounts, commercial and individual loans, drive-in banking services and
automated teller machines. No material portion of the banks' deposits have been
obtained from a single or small group of customers and the loss of the deposits
of any one customer or of a small group of customers would not have a material
adverse effect on the business of the banks. Credit life accident and health
insurance are sold to customers of the subsidiary banks through HBI Life. Trust
services are offered through HBTC.

    Employees

    As of December 31, 2001, The Grant County Bank had 58 full time equivalent
employees and Capon Valley Bank had 42 full time equivalent employees. Highlands
employs two persons as full time equivalents. No person is employed by HBI Life
on a full time basis. HBTC had two full time equivalent employees at year-end.

    Competition

    The banks' primary trade area is generally defined as Grant County, Hardy
County, Mineral County, Randolph County, Frederick County, portions of Western
Maryland and the northern part of Pendleton County. This area  includes
the cities of  Petersburg,  Wardensville, Moorefield and Keyser and several
rural towns. The banks' secondary trade area includes portions of Hampshire
County in West Virginia. The banks compete with four state chartered banks and
six national banks. In addition, the banks compete with money market mutual
funds and investment brokerage firms for deposits in their service area. No
financial institution has been chartered in the area within the last five years
although branches of state and nationally chartered banks have located in this
area within this time period. Competition for new loans and deposits in the
banks' service area is quite intense and all banks have been forced to pay rates
on deposits which exceed the national averages.

    Regulation and Supervision

    Highlands is subject to the periodic reporting requirements of the
Securities Exchange Act of 1934. These include, but are not limited to, the
filing of annual, quarterly and other current reports with the Securities and
Exchange Commission.




<PAGE> 4



    Regulation and Supervision (Continued)

    Highlands, as a bank holding company, is subject to the provisions of the
Bank Holding Company Act of 1956, as amended (the "Act"). It is registered as
such and is supervised by the Federal Reserve Board. The Act requires Highlands
to secure the prior approval of the Federal Reserve Board before Highlands
acquires ownership or control of more than five percent of the voting shares, or
substantially all of the assets of any institution, including another bank.

    As a bank holding company, Highlands is required to file with the Federal
Reserve Board an annual report and such additional information as it may require
pursuant to the Act. The Federal Reserve Board may also conduct examinations of
Highlands and any or all of its subsidiaries. Under Section 106 of the 1970
Amendments to the Act and the regulations of the Federal Reserve Board, a bank
holding company and its subsidiaries are prohibited from engaging in certain
tie-in arrangements in connection with an extension of credit, provision of
credit, sale, or lease of property or furnishing of services.

    Federal Reserve Bank regulations permit bank holding companies to engage in
nonbanking activities closely related to banking or to managing or controlling
banks. These activities include the making or servicing of loans, trust
services, performing certain data processing services, and certain leasing and
insurance agency activities. HBI Life acts as reinsurer of the credit life
insurance coverage sold by the Banks to bank customers. HBTC provides trust
services to customers of the Banks. Approval of the Federal Reserve Board is
necessary to engage in any of these activities or to acquire corporations
engaging in these activities.

    The operations of the Banks are subject to federal and state statutes which
apply to state chartered banks. Bank operations are also subject to the
regulations of the Federal Deposit Insurance Corporation (the "FDIC"), which
insures the banks' deposits. In addition, the Capon Valley Bank is a member of
the Federal Reserve Bank System and is subject to the regulations of the Federal
Reserve Bank Board.

    The supervisory authorities regularly examine such areas as reserves, loans,
investments, management practices, and other aspects of the banks' operations.
These examinations are designed primarily for the protection of depositors. In
addition to these regular examinations, the banks must furnish the various
regulatory authorities quarterly reports containing a full and accurate
statement of its affairs.

    The operations of the insurance subsidiary are subject to the oversight and
review of State of Arizona Department of Insurance.

    The operations of the trust company are subject to the oversight and review
of the State of West Virginia and the Federal Reserve Bank.

Item 2. Description of Properties

    The Grant County Bank's main office is located on Main Street in Petersburg,
West Virginia. In July 2000, the Bank acquired a full service branch in Harman
through the purchase of the Stockmans' Bank of Harman. This location primarily
serves Randolph County.  The Bank also has branch facilities in Moorefield,
Keyser and Riverton, West Virginia which provide banking services in Hardy
County, Mineral County, and northwest Pendleton County, respectively. The
Riverton branch building is leased while all other locations are owned by the
Bank.

    Capon Valley Bank has its main office in Wardensville, West Virginia and
branch offices located in Moorefield and Baker, West Virginia and Gore,
Virginia. The Wardensville location was substantially renovated and expanded in
2000 to enhance customer service. Capon's offices serve mainly Hardy County and
Hampshire County, West Virginia, with the Gore branch servicing Frederick
County, Virginia. All facilities include state-of-the-art drive in and automated
teller operations. All facilities are owned by the Bank and considered adequate
for current operations.




<PAGE> 5



Item 3. Legal Proceedings

    Management is not aware of any material pending or threatened litigation in
which Highlands or its subsidiaries may be involved as a defendant. In the
normal course of business, the banks periodically must initiate suits against
borrowers as a final course of action in collecting past due loans.


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

     Highlands has not submitted any matters to the vote of security holders for
the quarter ending December 31, 2001.


Part II

Item 5. Market for Common Equity and Related Stockholder Matters

    The Company had approximately 825 stockholders of record as of March 1,
2002. This amount includes all shareholders, whether titled individually or held
by a brokerage firm or custodian in street name. The Company's stock is not
traded on any national or regional stock exchange although brokers in
Cumberland, Maryland or  Winchester  and  Harrisonburg,  Virginia
may occasionally initiate or be a participant in a trade. Terms of an
exchange between individual parties may not be known to the Company. The
following outlines the dividends paid and market prices of the Company's stock
based on prices disclosed to management. Prices have been provided by a broker
in Winchester who is making a market in the Company's stock. Such prices may not
include retail mark-ups, mark-downs or commissions.


                             Dividends          Market Price Range
           2001              Per Share          High             Low
           ----              ---------          ----             ---

        First Quarter          $.34            $51.00         $47.00
        Second Quarter          .34             50.00          47.13
        Third Quarter           .34             50.25          47.75
        Fourth Quarter          .34             50.00          46.60


           2000

        First Quarter          $.31            $59.00         $57.00
        Second Quarter          .31             58.50          50.13
        Third Quarter           .31             55.00          51.00
        Fourth Quarter          .31             51.00          48.00






<PAGE> 6



Item 6. Management's  Discussion  and  Analysis of  Financial  Condition  and
        Results of Operations

Overview

    The Company's 2001 net income of $2,480,785 represents a 4.19% increase in
net income and earnings per share compared to 2000. This represented a return on
average equity of 9.08% for 2001 compared to 9.40% for 2000. Returns on
average  assets for 2001 and 2000 were .94% and 1.03%, respectively. The
increase in earnings was due to an increase in the volume of earning assets and
was achieved in spite of a declining interest margin.

    The tax equivalent interest income increased by $2,001,000 in 2001 to
$20,306,000 as compared to 2000. A 14.16% increase in the level of earning
assets, nearly double the previous year's increase, more than offset the
decrease in yields for 2001, creating the earnings improvement. A 12.49%
increase in average loans outstanding was the result of a good local economy and
was spread across all types of loans. The increase was also partly attributable
to the acquisition of the branch at Harman. The funding of the asset growth was
from deposits of local customers (primarily time deposits) and declines in
securities available for sale.

    Noninterest income decreased 5.47% in 2001 compared to 2000 due to an
absence of security gains, a slight reduction in service charge income and an
increase in the claims experience in the insurance company over year 2000.
Noninterest expenses increased 8.74% in 2001 due mainly to the higher personnel
and occupancy expenses.


Net Interest Margin

    2001 compared to 2000

    The Company's net interest margin on a tax equivalent  basis was
$10,257,000 for 2001 compared to $9,515,000 for 2000. The increase was due to an
increase in average earning assets (14.16%) while maintaining deposit and
borrowings liability costs at 4.84% for both years. Average loans outstanding
grew by 12.49% from 2000 to 2001. This growth reflected good local economic
conditions, even in a declining interest rate environment. The overall cost of
funds reflected the high level of competition for deposits in the Company's
service area which has traditionally paid higher rates on deposits than larger,
statewide financial institutions. Efforts to reduce this discrepancy have been
moderately successful and are expected to show future benefits in the form of
lower interest expenses. The deposit increase was the result of growth in the
area of time deposit accounts and was obtained primarily from customers in the
immediate service areas.

    Loans outstanding at December 31, 2001 increased 8.56% over amounts at
December 31, 2000. The loan increase was the result of continued efforts to
increase lending in existing markets. Loan growth was funded primarily by
deposit growth, with a small amount of additional borrowings from the Federal
Home Loan Bank. The increase in the dollar amount of tax equivalent net interest
margin for 2001 over the 2000 amounts is the result of an annualized growth in
average earning assets of 14.16%. The Company anticipates its net interest
margin to remain stable or rise slightly in the first six months of 2002 due to
the maturing of higher rate liabilities. This improvement in the net interest
margin should continue as long as interest rates remain stable or increase
gradually. Rates paid on deposits are expected to stabilize over the next twelve
months as the Federal Reserve Bank's rate cuts have been less frequent and the
economy shows signs of recovery. Returns on most loans have repricing
opportunities within the next twelve months and the Company should be able to
slightly improve its net interest margin in this anticipated rate environment.

    A summary of the net interest margin analysis is shown as Table II on page
22.




<PAGE> 7



Net Interest Margin (Continued)

    2000 Compared to 1999

    The Company's net interest margin on a tax equivalent  basis was
$9,515,000 for 2000 compared to $8,716,000 for 1999. The increase was due to an
increase in average earning assets (7.11%) and a consistent spread (the
difference in rates earned on assets and paid on liabilities) of 3.70% in 1999
to 3.69% in 2000. Average loans outstanding grew by 13.48% from 1999 to 2000.
This growth reflected good local and national economic conditions, slightly
increasing interest rates and acquiring an additional banking facility. The
deposit increase represented growth in savings and time deposit accounts and was
obtained primarily from customers in the immediate service areas.

    Loans outstanding at December 31, 2000 increased 13.60% over amounts at
December 31, 1999. The loan increase was the result of acquiring a branch in a
new market area and continued efforts to increase lending in existing markets.
Loan growth was funded primarily by deposit growth with declines in the level of
security investments. The net interest margin for 2000 was 4.43% and for 1999
was 4.35%, reflecting the results of increasing rates on all types of earning
assets and all types of deposit accounts.

    A summary of the net interest margin analysis is shown as Table II on Page
22.


Provision for Loan Losses

    The Company's provisions for loan losses were $600,000 for 2001, $500,000
for 2000, and $320,000 for 1999. Net loan losses were $490,000 in 2001 compared
to $412,000 in 2000 and $357,000 in 1999. The Company's three year charge off
rate of .24% of average loans outstanding compares closely with its peer group.
The 2001 charge off percentage of .25% of average loans was slightly above the
peer group average for the year 2001 and reflects some charged off loans
acquired in the prior year acquisition of the Harman Branch. (See the following
discussion relating to the allowance for loan losses.)


Noninterest Income

    2001 Compared to 2000

    Noninterest income for 2001 decreased 5.47% from 2000. Decreases in service
charge income of 1.76% were largely due to the loss of one large corporate
customer which was bought and financially managed from outside the local area.
Decreases in insurance commissions of 23.70% were the result of above average
claims experienced during the year. Offsetting these declines was greater income
from investments in insurance contracts which showed improved profitability in
2001. There were no gains or losses on security transactions in 2001 as no
securities were sold. The $104,000 gain on security transactions in 2000 was due
to unusual circumstances involving securities involved in the acquisition of the
Stockmans Bank and were not repeated in 2001.

    2000 Compared to 1999

    Overall noninterest income increased in 2000 by 23.03% when compared with
1999 operations. Increases in service charge income were the result of volume
increases and increased rates for non sufficient funds (NSF) checks. Other
operating income declined due to a $165,000 gain from the demutualization of an
insurance company in 1999 which was not repeated in 2000. The Company did
recognize greater income from investments in insurance contracts due to a
complete year of investing in these assets. Gains of $104,000 from the sale of
investments in 2000 compared to losses from the sale of investments in 1999 of
$65,000 added $169,000 to total noninterest income.



<PAGE> 8



Noninterest Expenses

    2001 Compared to 2000

    Total noninterest expenses increased 8.74% in 2001 when compared with 2000
operations. Salaries and benefits increased 8.49% due to the increase in staff
at the new branches, merit raises and higher benefit costs. Average full time
equivalent employees increased 9.89% in 2001 due mainly to staffing the new
branches in Gore, VA and Harman. The costs of occupancy and equipment increased
18.82% due to depreciation associated with the new and renovated facilities and
equipment upgrades.  Data processing expenses increased by 8.03% due to
general asset growth and expanded locations. Other operating expenses increased
4.30% for all of the reasons cited above. Noninterest expense as a percentage of
average assets was 2.73% in 2001 compared to 2.86% in 2000 and 2.74% in 1999.
These ratios compare favorably to the Company's peer group. The overall increase
in noninterest expenses is a reflection of additional locations which generally
take one to three years to become profitable.

    2000 Compared to 1999

    Overall, noninterest expense increased 12.15% in 2000 when compared to 1999.
Personnel expenses increased 12.34% as the result of additional locations,
higher benefit costs and merit raises. Occupancy and equipment expenses
increased 14.78% as the result of a full year of costs, including depreciation,
for the Moorefield branch and equipment  upgrades.  Data processing
expenses increased by 3.45% as a result of volume growth and expanded locations.
Other noninterest expenses increased by 13.22% due to asset growth and new
locations costs.


Financial Condition

     Loan Portfolio

     The Company is an active residential mortgage and construction lender and
generally extends commercial loans to small and medium sized businesses within
its primary service area. The Company's commercial lending activity extends
across its primary service areas of Grant, Hardy, Hampshire, Mineral, Randolph,
northern Pendleton counties and Frederick County, VA. Consistent with its focus
on providing community-based financial services, the Company does not attempt to
diversify its loan portfolio geographically by making significant amounts of
loans to borrowers outside of its primary service area.

     The principal economic risk associated with each of the categories of loans
in the Company's portfolio is the creditworthiness of its borrowers. Within each
category, such risk is increased or decreased depending on prevailing economic
conditions. The risk associated with the real estate mortgage loans and
installment loans to individuals varies based upon employment levels, consumer
confidence, fluctuations in value of residential real estate and other
conditions that affect the ability of consumers to repay indebtedness. The risk
associated with commercial, financial and agricultural loans varies based upon
the strength and activity of the local economies of the Company's market areas.
The risk associated with real estate construction loans varies based upon the
supply of and demand for the type of real estate under construction.

    Loans outstanding increased $16,201,000 or 8.56% in 2001. All loan types
recognized significant  growth  with  the  exception  of  real
estate construction. The loan to deposit ratio was 84.89% at December 31,
2001 compared to 87.39% at December 31, 2000. Management believes this level of
lending activity is satisfactory to generate adequate earnings without undue
credit risk. Loan demand is expected to remain satisfactory in the near future
with any growth a function of local and national economic conditions.




<PAGE> 9



Financial Condition (Continued)

     Loan Portfolio (Continued)

     The following table presents the year-end balances of loans, classified by
type (in thousands):

                           2001      2000      1999       1998      1997
                           ----      ----      ----       ----      ----
     Real estate loans:
       Construction and
        land
        development     $  4,105   $ 4,096   $  3,296   $ 2,969   $  2,189
       Secured by
        farmland           9,464    10,059      9,219     9,586      9,436
       Secured by 1-4
        family
        residential
        properties        75,771    72,408     67,775    64,372     59,126
       Secured by multi-
        Family (5 or
        more) residential
        properties
       Secured by nonfarm,
        non-residential
        properties        48,282    39,122     33,064    28,142     26,076

     Loans to farmers      1,238       567        391       449        541
     Commercial and
       industrial
       loans               9,652     8,029      6,568     4,498      3,101
     Consumer loans       56,366    54,691     46,266    38,353     35,414
     Loans for nonrated
       industrial
       development
       obligations           458       275
     All other loans         133        21         35        15      1,222
                         -------    ------    -------    ------    -------

       Loans - net of
        unearned
        income          $205,469  $189,268   $166,614  $148,384   $137,105
                         =======    =======   =======    =======   =======


     There were no foreign loans outstanding during any of the above periods.


     The following table summarizes the Company's loan portfolio, net of
unearned income:

                                                  At December 31,
                                 ----------------------------------------------
                                            2001        2000        1999
                                            ----        ----        ----
                                              (In Thousands of Dollars)
     Real Estate:
       Mortgage                           $111,668    $101,890    $ 93,391
       Construction                          3,868       4,061       3,296
     Commercial                             42,204      37,681      31,567
     Installment                            47,927      46,191      39,994
                                           -------     -------     -------

                                           205,667     189,823     168,248
     Less unearned discount                   (198)       (555)     (1,634)
                                           --------    -------     -------

                                           205,469     189,268     166,614
     Allowance for loan losses              (1,603)     (1,493)     (1,318)
                                           --------    -------     -------

       Loans, net                         $203,867    $187,775    $165,296
                                           =======     =======     =======




<PAGE> 10



Financial Condition (Continued)

     Loan Portfolio (Continued)
     The following table shows the maturity of loans  outstanding (in
thousands of dollars) as of December 31, 2001, 2000 and 1999.

    Maturity Range                          2001        2000        1999
    --------------                          ----        ----        ----

     Predetermined Rates:
       0 - 12 months                      $ 99,049    $105,054    $ 91,080
       13 - 60 months                       68,106      75,918      61,193
       More than 60 months                  37,429       8,264      14,147
     Nonaccrual Loans                          885          32         194
                                           -------     -------     -------

       Total Loans                        $205,469    $189,268    $166,614
                                           =======     =======     =======


     The following table shows the Company's loan maturity distribution (in
thousands of dollars) as of December 31, 2001:
                                             Maturity Range
                                Less Than     1-5        Over
       Loan Type                  1 Year     Years      5 Years    Total
       ---------                 -------     -----      -------    -----

     Commercial and
       Agricultural Loans     $ 29,425    $  6,280    $  6,499    $ 42,204
     Real Estate - mortgage     53,274      27,376      31,018     111,668
     Real Estate -
      construction               3,868                               3,868
     Consumer - installment     12,482      34,450         797      47,729
                               -------     -------     -------     -------

       Total                  $ 99,049    $ 68,106    $ 38,314    $205,469
                               =======     =======     =======     =======

     Nonperforming loans include nonaccrual loans, loans 90 days or more past
due and restructured loans. Nonaccrual loans are loans on which interest
accruals have been discontinued. Loans are placed in nonaccrual status when the
collection of principal or interest is 120 days past due and collection is
uncertain based on the net realizable value of the collateral and/or the
financial strength of the borrower. Also, the existence of any guaranties by
federal or state agencies is given consideration in this decision. The policy is
the same for all types of loans. Restructured loans are loans which a borrower
has been granted a concession on the interest rate or the original repayment
terms because of financial difficulties. Nonperforming loans do not represent or
result from trends or uncertainties  which management reasonably  expects
will materially impact future operating results, liquidity, or capital
resources. Nonperforming loans are listed in the table below.

     Real estate acquired through foreclosure was $58,250 at December 31, 2001,
$110,000 at December 31, 2000 and $121,000 at December 31, 1999. All foreclosed
property held at December 31, 2001 was in the Company's primary service area.
The Company's practice is to value real estate acquired through foreclosure at
the lower of (i) an independent current appraisal or market analysis less
anticipated costs of disposal, or (ii) the existing loan balance. The Company is
actively marketing all foreclosed real estate and does not anticipate material
write-downs in value before disposition.

     Nonperforming loans increased 16.69% at December 31, 2001 compared to 2000.
Nonaccrual loans  dramatically  increased as the result of two
bankruptcies. Loans 90 and more days past due decreased 1.96% in spite of an
8.56% increase in total loans outstanding. The decrease in delinquent loans is a
net result of the reclassification of the two bankruptcies and a corresponding
increase in commercial loans due to one failed business, one bankruptcy and one
workout. In addition, a substantial portion of the delinquent real estate loans
have been guaranteed by state or federal agencies. Management does not
anticipate any significant losses from the current level of nonperforming
assets.




<PAGE> 11



Financial Condition (Continued)

     Loan Portfolio (Continued)

     The following table summarizes the nonperforming loans:

                                                  At December 31,
                                          -------------------------------
                                           2001        2000        1999
                                           ----        ----        ----
                                               (Dollars in Thousands)

     Loans accounted for on a
       nonaccrual basis
       Real estate                       $   474      $   32      $   194
                                          ------       -----       ------

     Loans contractually past due 90 days
       or more as to interest or principal
       payments (not included in nonaccrual
       loans above)
         Commercial                          607          60           89
         Real estate                       1,352       1,984        1,465
         Installments                        336         297          140
                                          ------       -----       ------

       Total Delinquent Loans              2,295       2,341        1,694
                                          ------       -----       ------

       Total Nonperforming Loans         $ 2,769      $2,373      $ 1,888
                                          ======       =====       ======

    An inherent risk in the lending of money is that the borrower will not be
able to repay the loan under the terms of the original agreement. The allowance
for loan losses (see subsequent section) provides for this risk and is reviewed
periodically  for  adequacy.  This  review also  considers
concentrations of loans in terms of geography, business type or level of risk.
While lending is geographically diversified within the service area, the Company
does have some concentration of loans in the area of agriculture (primarily
poultry farming),  timber and related industries.  Management recognizes
these concentrations and considers them when structuring its loan portfolio. As
of December 31, 2001,  management is not aware of any significant potential
problem loans for which the debtor is currently meeting their obligations as
stated in the loan agreement but which may change in future periods.

     As of December 31, 2001, the Company did not have any potential problem
loans as defined in Guide 3 that would require disclosure.


Allowance for Loan Losses

     Management has analyzed the potential risk of loss on the Company's loan
portfolio given the loan balances and the value of the underlying collateral and
has recognized losses where appropriate. Nonperforming loans are closely
monitored on an ongoing basis as part of the Company's loan review process.
Management reviews the loan loss allowance at the end of each quarter. Based
primarily on the Company's loan classification system, which classifies problem
credits as substandard, doubtful or loss, additional provisions for losses are
made monthly. The ratio of the allowance for loan losses to total loans
outstanding was .78% at December 31, 2001 and .79% at both December 31, 2000 and
December 31, 1999. At December 31, 2001, the ratio of the allowance for loan
losses to nonperforming loans was 57.89% compared to 62.92% at December 31, 2000
and 69.83% at December 31, 1999.




<PAGE> 12



Allowance for Loan Losses (Continued)

     The computation of the allowance for loan losses is based on guidelines
established in FFIEC interagency statement SAB 102. This is a change in
methodology from their previous computation. Both banks continue to classify
loans into categories and assign a loss rate as follows to be used later in the
calculation:

                 Loss                        100%
                 Doubtful                     50%
                 Substandard                  15%
                 Special mention               5%

     All loans 90 days or more past due and nonaccrual loans are included in one
of the four categories above. Generally, all loans in excess of $250,000 are
evaluated individually as well as any loan regardless of size that is classified
as loss, doubtful, substandard or special mention. This detailed review
identifies each applicable loan for specific impairment and a specific
allocation for that impaired amount is set aside as the first element in the
calculation. In all sections of the calculation, the amounts are classified into
"Installment," "Real Estate" or "Commercial".

     After reducing the loan portfolio by the impaired loans, the above less
ratios are applied to each category. For "Doubtful" collectibility, all loan
balances receive a 50% allocation for loss; for "Substandard", a 15% allocation,
for "Special Mention", a 5% allocation is added to the required reserve.

     Additionally, all loans past due 90 days or more, not included in any of
the above four loss categories, receive a 15% allocation. All other loans in the
portfolio are evaluated as a group.

     The remaining portfolio balances are assigned a loss factor based on the
average net loss after recoveries over the last five years. Loss experience per
classification  varies significantly based on risk and collateral.
Installment loans and Commercial loans, generally, have higher loss volumes than
real estate secured loans. These actual loss experience factors are weighed by
the average life of the loan category. Installments have a two to three year
carrying life, real estate loans a five to six year life; and commercial loans a
three to four year life. The net result creates a low and high range of
allocated reserve. The Company's actual reserve balance is compared to this
range and adjusted as deemed necessary.

     The allowance for loan losses is computed quarterly and adjusted prior to
the issuance of the quarterly financial statements. All loan losses charged to
the allowance are approved by the boards of directors at their regular meetings.
The allowance is reviewed for adequacy after considering historical loss rates,
current economic  conditions (both locally and nationally) and any known
credit problems that have not been considered under the above formula.

     Management continues to monitor the economic health of the poultry
industry. The Company has direct loans to poultry growers and the industry is a
large employer in the Company's trade area. Operating results for the industry
have improved due to moderating grain prices and better turkey pricing but
profitability in this industry is still quite volatile. Since Pilgrim's Pride
purchase of WLR Foods, Inc. there has been no noticeable impact to the local
economy, either positively or negatively. Loan requests for poultry house loans
or expansion continue to be presented for approval.




<PAGE> 13


Allowance for Loan Losses (Continued)

     An analysis of the loan loss allowance is set forth in the following table
(in thousands):

                             2001       2000     1999      1998       1997
                             ----       ----     ----      ----       ----

     Balance at beginning
       of period          $ 1,493   $  1,318   $ 1,355   $  1,370   $ 1,257

     Charge-offs:
       Commercial loans       239        172       107        135        34
       Real estate loans       92        128        87         53        20
       Consumer loans         369        215       254        289       170
                           ------    -------    ------    -------    ------

                              700        515       448        477       224
                           ------    -------    ------    -------    ------

     Recoveries:
       Commercial loans        57          2        16          6         9
       Real estate loans       12         30         1          1        25
       Consumer loans         141         71        74        100       113
                           ------    -------    ------    -------    ------

                              210        103        91        107       147
                           ------    -------    ------    -------    ------

     Net charge-offs          490        412       357        370        77
     Provision for loan
       losses                 600        500       320        355       190
     Other                                87
                           ------    -------    ------    -------    ------
     Balance at end of
       period             $ 1,603   $  1,493   $ 1,318   $  1,355   $ 1,370
                           ======    =======    ======    =======    ======

     Percent of net charge-offs
       to average net loans
       outstanding during the
       period                  .25%       .23%      .23%       .26%      .06%
                          ========  =========  ========  =========  ========



<PAGE> 14

<TABLE>

<CAPTION>


   The following table shows the balance and percentage of the Company's
allowance for loan losses allocated to each major category of loans:

                                                              At December 31,
                 ------------------------------------------------------------------------------------------------------------------
                        2001                    2000                     1999                    1998              1997
               ------------------------ ----------------------   --------------------------  ---------------------  ----------------
                              Percent                  Percent                 Percent                 Percent               Percent
                                of                       of                      of                      of                    of
                              Loans                     Loans                   Loans                   Loans                 Loans
                      Percent  in             Percent    in            Percent  in            Percent   in           Percent    in
                        of    Category           of    Category           of   Category          of  Category          of   Category
                      Allow-  to Total         Allow-to  Total         Allow-  to Total        Allow- to Total       Allow- to Total
              Amount   ance   Loans    Amount   ance    Loans   Amount  ance    Loans  Amount  ance   Loans   Amount  ance    Loans
              ------   ----    -----   ------  -----    -----    ------ -----  ------   ------  ----   -----  ------ -----   -----
                             (Dollars in Thousands)
<S>             <C>     <C>     <C>    <C>       <C>     <C>    <C>      <C>    <C>    <C>      <C>    <C>    <C>      <C>    <C>

Commercial     $ 487    30%     21%    $ 507     34%     20%    $395     30%    19%    $ 379    28%    23%    $ 343    25%    22%
Real estate
   Mortgage      576    36      56       239     16      56      211     16     58       434    32     56       548    40     56
Installment      450    28      23       598     40      24      580     44     23       406    30     21       343    25     22
Unallocated       90    06               149     10              132     10              136    10              136    10
                ----   ---      ---     ----    ---     ---      ---     ---    --       ---    ---    ---      ---   ---     ---

              $1,603   100%    100%   $1,493    100%    100%  $1,318    100%   100%   $1,355   100%   100%   $1,370   100%   100%
               =====   ====    ====    =====    ====   ====     ====     ===    ====    =====   ====   ====     =====   ===   ====


</TABLE>


<PAGE> 15



Allowance for Loan Losses (Continued)

     Cumulative net loan losses, after recoveries, for the five year period
ending December 31, 2001 are as follows:

                  Commercial                   $   597         34.99%
                  Real estate                      311         18.23%
                  Consumer                         798         46.78%
                                                ------   -----------

                    Total                      $ 1,706        100.00%

     The above acts as the basis for allocating the overall allowances.
Additional changes have been made in the allocation of the allowance to address
unknowns, loan commitments, etc. The unallocated portion is not computed using a
specific formula and is management's best estimate of what should be allocated
for contingencies in the current portfolio. Without an unallocated reserve, the
allocation would have been made along the lines of the five year average losses
by loan type. In 2001, a greater portion was allocated to the real estate
allowance and a lesser amount to the consumer allowance as changes in the
calculation of the allowance placed more weight on the significantly higher
proportion of balances and estimated longer loan life in real estate. A
single loss involving the bankruptcy of one commercial loan was responsible for
about 63% of the gross commercial charge-offs in 2001.

     While 2001 losses were slightly above peer group amounts, they are
considered reasonable in the eyes of management. The allowance as of December
31, 2001 was .78% of loans outstanding which is below peer group levels.
However, management believes the present allowance, which is 3.82 times the
average annual net charge-off rate over the last three years, is adequate based
on its knowledge of the loan portfolio and historical performance.


Securities

     The Company's securities portfolio serves several purposes. Portions of the
portfolio are used to secure certain public and trust deposits. The remaining
portfolio is held as investments or used to assist the Company in liquidity and
asset liability management. During 2001, total securities increased to $31.9
million or 11.51% of total assets at December 31, 2001. Total securities were
$25.8 million or 10.39% of total assets at December 31, 2000.

     The securities portfolio consists of three components: securities held to
maturity, securities available for sale and restricted securities.
Securities are classified as held to maturity when management has the intent and
the Company has the ability at the time of purchase to hold the securities to
maturity. Held to maturity securities are carried at cost, adjusted for
amortization of premiums and accretion of discounts. Securities to be held for
indefinite periods of time are classified as available for sale and accounted
for at market value. Securities available for sale include securities that may
be sold in response to changes in market interest rates, changes in the
security's prepayment risk, increases in loan demand, general liquidity needs
and other similar factors. Restricted securities are those investments purchased
as a requirement of membership in certain loan banks and cannot be transferred
without the issuer's permission.  The Company's purchases of securities have
generally been limited to securities of high credit quality with short to medium
term maturities.


<PAGE> 16

Securities (Continued)

     The Company identifies at the time of acquisition those securities that are
available for sale. These securities are valued at their market value with any
difference in market value and amortized cost shown as an adjustment in
stockholders' equity. Changes within the year in market values are reflected as
changes in stockholders' equity, net of the deferred tax effect. As of December
31, 2001, the fair value of the securities available for sale exceeded their
cost basis by $449,000 ($283,000 after the related tax effect).

     The following table summarizes the carrying value of the Company's
securities at the dates indicated:
                              Held to Maturity         Available for Sale
                               Carrying Value             Carrying Value
                     ----------------------------------------------------------
                                December 31,              December 31,
                            2001    2000    1999      2001    2000    1999
                            ----    ----    ----      ----    ----    ----
                         (In Thousands of Dollars)   (In Thousands of Dollars)

     U.S. treasuries,
       agencies
       and corporations   $       $    88  $        $16,432  $18,719  $21,160
     Obligations of states
       and political
       subdivisions         1,597   2,131   2,837     6,380      789      243
     Mortgage-backed
       securities               6       9     340     6,609    3,275    4,339
                           ------  ------   -----    ------   ------   ------

       Total Debt
         Securities         1,603   2,228   3,177    29,421   22,783   25,742

     Other securities                                    39       52      151
                           ------  ------   -----    ------   ------   ------

       Total              $ 1,603 $ 2,228  $3,177   $29,460  $22,835  $25,893
                           ======  ======   =====    ======  ======   ======

     The carrying amount and estimated market value of debt securities (in
thousands of dollars) at December 31, 2001 by contractual maturity are shown
below. Expected maturities will differ from contractual maturities because
borrowers may have the right to call or prepay obligations with or without call
or prepayment penalties.

     Securities Held to Maturity         Amortized       Fair        Average
     ---------------------------
                                           Cost          Value        Yield
                                       ------------   -----------   ---------

     Due in one year or less             $     231    $      233      6.84%
     Due after one year through
       five years                            1,202         1,229      7.12%
     Due after five years through
       ten years                               171           177      7.41%
                                          --------     ---------     -----

       Total Held to Maturity            $   1,603    $    1,639      7.11%
                                          ========     =========     =====


     Securities Available for Sale       Amortized       Fair        Average
     -----------------------------
                                           Cost          Value        Yield
                                       ------------   -----------   ---------

     Due in one year or less             $   7,035    $    7,133      5.22%
     Due after one year through
       five years                           13,292        13,521      4.78%
     Due after five years through
       ten years                             3,836         3,918      5.92%
     Due after ten years                     4,806         4,848      5.98%
                                          --------     ---------     -----

       Total Fixed Rate Securities          28,969        29,421      5.24%

     Equities                                   42            39      6.07%
                                          --------     ---------     -----

       Total Available for Sale          $  29,011    $   29,460      5.24%
                                          ========     =========     =====

     Yields on tax exempt securities are stated at tax equivalent yields.

     Management has generally kept the maturities of investments relatively
short providing for flexibility in investing. Such a philosophy allows the
Company to better match deposit maturities with investment maturities and thus
react more quickly to interest rate changes.



<PAGE> 17



Deposits

     The Company's predominant source of funds is local deposits. The Company's
deposit base is comprised of demand deposits, savings and money market accounts
and other time deposits. The Company's deposits are provided by individuals and
businesses located within the communities served.

     The average balance of interest bearing deposits increased by 14.32% in
2001 over average levels in 2000. The average rate paid on deposits increased to
4.84% in 2001 from 4.82% in 2000 and 4.46% in 1999. The majority of the
Company's deposits are higher yielding time deposits as most of its customers
are individuals who seek higher yields than savings accounts or don't wish to
accept the risks of the stock market.

     The Company does not actively solicit large certificates of deposit (those
more than $100,000) due to the unstable nature of these deposits. Increases in
2001 are the result of overall deposit growth and higher than average rates
offered by the Company. A summary of the maturity of large deposits is as
follows:
                                                    December 31,
                                            ----------------------------
         Maturity Range                   2001        2000        1999
         --------------                   ----        ----        ----
                                            (In Thousands of Dollars)

     Three months or less               $  8,980    $  4,172    $   6,341
     Four to twelve months                21,965      14,336       12,342
     One year to three years              10,018      13,753        7,100
     Four years to five years              4,219       2,623        2,746
                                         -------     -------     --------

       Total                            $ 45,182    $ 34,884    $  28,529
                                        ========     =======     ========


Borrowed Money

     The Company occasionally borrows funds from the Federal Home Loan Bank to
reduce market rate risks and to fund capital additions. Such borrowings may have
fixed repay or variable interest rates and are amortized over a period of ten to
twenty years. Borrowings from this institution allow the banks to offer
long-term, fixed rate loans to their customers and match the interest rate
exposure of the receivable  and the  liability.  The Company had
additional borrowings in 2001 of $1,395,000 and repayments within the year of
$881,000.


Capital Resources

     The assessment of capital adequacy depends on a number of factors such as
asset quality, liquidity, earnings performance and changing competitive
conditions and economic forces. The Company seeks to maintain a strong capital
base to support its growth and expansion activities, to provide stability to
current operations and to promote public confidence.

     The Company's capital position continues to exceed regulatory minimums. The
primary indicators relied on by the Federal Reserve Board and other bank
regulators in measuring strength of capital position are the Tier 1 Capital,
Total Capital and Leverage ratios. Tier 1 Capital consists of common
stockholders' equity. Total Capital consists of Tier 1 Capital and a portion of
the allowance for loan losses. Risk-based capital ratios are calculated with
reference to risk-weighted  assets which consist of both on and off-balance
sheet risks.




<PAGE> 18



Capital Resources (Continued)

     The following table shows risk-based capital ratios and stockholders'
equity to total assets:

                                           Regulatory     December 31,
                                             Minimum    2001       2000
                                           -----------  ----       ----

     Capital Ratios
     --------------
       Risk-based capital to risk-
         weighted assets
         Tier 1                               8.00%     13.66%    15.17%
         Total                                4.00%     14.46%    16.03%
       Stockholders' equity to total assets   5.00%     10.06%    10.57%

     The capital management function is an ongoing process. Central to this
process is internal equity generation accomplished by earnings retention. During
2001, 2000, and 1999, total stockholders'  equity increased by $2,042,000,
$2,044,000 and $1,378,000, respectively, as a result of earnings retention and
changes in the unrealized  gains (losses) on securities available for sale.
The return on average equity was 9.08% in 2001 compared to 9.40% for 2000 and
9.94% for 1999. Total cash dividends declared represent 27.51% of net income for
2001 compared to 26.14% of net income for 2000 and 25.04% for 1999. Book value
per share was $56.41 at December 31, 2001 compared to $52.34 at December 31,
2000 and $48.26 at December 31, 1999.

     The Company's principal source of cash income is dividend payments from the
Banks and insurance  subsidiary.  Certain  limitations exist under
applicable law and regulation by regulatory agencies regarding dividend payments
to a parent by its subsidiaries. As of January 1, 2002, the Banks had $1,223,000
of retained earnings available for distribution to the Company as dividends
without prior regulatory approval.


Liquidity and Interest Rate Sensitivity

     Liquidity.  Liquidity  is the ability to meet present and future
financial obligations through either the sale or maturity of existing assets or
the acquisition of additional funds through liability management. Liquid assets
include cash, interest bearing deposits with banks, federal funds sold,
investments and loans maturing within one year. The Company's ability to obtain
deposits and purchase funds at favorable rates determines its liability
liquidity. As a result of the Company's management of liquid assets and the
ability to generate liquidity through liability funding, management believes
that the Company maintains overall liquidity sufficient to satisfy its
depositors' requirements and meet its customers' credit needs.

     Additional sources of liquidity available to the Company include, but are
not limited to, loan repayments, the ability to obtain deposits through the
adjustment of interest rates and the purchasing of federal funds. To further
meet its liquidity needs, the Company also maintains lines of credit with
correspondent financial institutions, the Federal Reserve Bank of Richmond and
the Federal Home Loan Bank of Pittsburgh. In the past, growth in deposits and
proceeds from the maturity of investment securities have been sufficient to fund
the net increase in loans.

     The investing activity saw a net increase in loans of $16,692,000, an
increase in investments of $5,763,000 and an increase in fed funds sold of
$6,245,000. New equipment and facility additions were $776,000 in 2001 compared
with $1,288,000 in 2000. Funding these investments was an increase in deposits
of $25,470,000 and retained operating income of $1,798,000.




<PAGE> 19



Liquidity and Interest Rate Sensitivity (Continued)

     In the year ending December 31, 2001, cash and due from banks decreased
$570,000 as cash provided by operations and financing activities was less than
cash used in investing activities. Cash provided by operations consists
primarily of earnings from operations and noncash expenses such as the provision
for loan losses, deferred income taxes and depreciation. The dividends paid of
$683,000 in 2001 were an increase of 9.68 percent over 2000 amounts.

     The Company is not aware of any trends, events or uncertainties that will
have or that are reasonably likely to have a material effect on the Company's
liquidity, capital resources or operations. The Company is not aware of any
proposals from any regulatory authority which, if implemented, would have such
an effect.


     Interest  Rate  Sensitivity.  In  conjunction  with
maintaining a satisfactory level of liquidity, management must also control the
degree of interest rate risk assumed on the balance sheet. Managing this risk
involves regular monitoring of the interest sensitive assets relative to
interest sensitive liabilities over specific time intervals.

     At December 31, 2001, the Company had a negative gap position as of twelve
months into the future. This position causes a squeeze on income in the short
term in reaction to rate changes by the Federal Reserve Bank. With assets
repricing at a level of 89% of the volume of interest bearing liabilities during
the first year, the impact to earnings should be minimal due to the history of
asset growth to absorb some of the effect. The Company expects a decrease in the
overall cost of money in the first half of 2001 due to the maturity of
certificates issued at higher rates and a gradual increase in all deposit rates
for the rest of the year.

     With the largest amount of interest sensitive assets and liabilities
repricing within one year, the Company monitors this position closely. Early
withdrawal of deposits, prepayments of loans and loan delinquencies are some of
the factors that could affect actual versus expected cash flows. In addition,
changes in rates on interest sensitive assets and liabilities may not be equal,
which could result in a change in the net interest margin. While the Company
does not match each of its interest sensitive assets against specific interest
sensitive liabilities, it does periodically review its cumulative position of
interest sensitive assets and liabilities.

     The majority of the Company's commercial and real estate loans are made
with repricing frequencies of three months to three years. For this reason, 82%
of all loans will reprice within three years of December 31, 2001. Installment
loans generally have a fixed rate of interest but have limited amortization
periods. These loans have an average life to maturity of less than two years.
Management believes that its philosophy of requiring loan repricing within a
three to five year period to be the most prudent approach to asset/liability
management.

     In the area of investments, the Company employs a management technique
known as "laddering" to minimize interest rate exposures and provide a constant
flow of maturities subject to repricing at current market rates. To assist in
the management of investments, the Company employs an independent investment
counsel that advises it in planning and risk diversification. The Company
utilizes many forms of investments with a significant use of mortgage-backed
securities issued by federally chartered institutions. The Company does not
employ the use of derivatives in its approach to controlling market risk.
Although the majority of its investments are classified as available for sale,
the Company rarely sells securities except in unusual circumstances.

     Table IV (page 24) shows the maturity of liabilities and assets in future
periods. Table III (page 23) shows the effects of rate and volume changes on the
net interest margin for the past three year period.



<PAGE> 20



Effects of Inflation

     Inflation  significantly  affects industries having high levels of
property, plant and equipment or inventories. Although the Company is not
significantly affected in these areas, inflation does have an impact on the
growth of assets. As assets grow rapidly, it becomes necessary to increase
equity capital at proportionate levels to maintain the appropriate equity to
asset ratios.  Traditionally,  the Company's earnings and high capital
retention levels have enabled the Company to meet these needs.

     The Company's reported earnings results have been affected by inflation,
but isolating the effect is difficult. The different types of income and expense
are affected in various ways. Interest rates are affected by inflation, but the
timing and magnitude of the changes may not coincide with changes in the
consumer price index. Management actively monitors interest rate sensitivity, as
illustrated by the Gap Analysis (Table IV, page 24) in order to minimize the
effects of inflationary trends on interest rates. Other areas of noninterest
expenses may be more directly affected by inflation.


Securities and Exchange Commission WEB Site

     The Securities and Exchange Commission maintains a WEB site that contains
reports, proxy and information statements and other information regarding
registrants (including the Company) that file electronically with the
Commission. That address is (http: //www.sec.gov)




<PAGE> 21


TABLE I


                              SUMMARY OF OPERATIONS



                             ---------- Years Ending December 31,--------------
                                     (In Thousands Except for Share Amounts)
                                  2001     2000     1999     1998     1997

Total Interest Income           $20,207  $18,207  $16,243  $15,772  $15,084
Total Interest Expense          (10,049)  (8,790)  (7,663)  (7,745)  (7,474)
                                 ------   ------   ------   ------   ------

Net Interest Income              10,158    9,417    8,580    8,027    7,610
Provision for Loan Losses           600      500      320      355      190
                                 ------   ------   ------   ------   ------

Net Interest Income after
   Provision for Loan Losses      9,558    8,917    8,260    7,672    7,420
Other Income                      1,194    1,263    1,026      735      571
Other Expenses                    7,210    6,631    5,912    5,377    5,115
                                 ------   ------   ------   ------   ------

Income before Income Taxes        3,542    3,549    3,374    3,030    2,876
Income Tax Expense                1,061    1,168    1,049    1,018      996
                                 ------   ------   ------   ------   ------

   Net Income                   $ 2,481  $ 2,381  $ 2,325  $ 2,012  $ 1,880
                                 ======   ======   ======   ======   ======


Net Income Per Share            $  4.94  $  4.74  $  4.63  $  4.01  $  3.73
Dividends Per Share             $  1.36  $  1.24  $  1.16  $  1.08  $  1.00

Total Assets at Year End       $276,778 $248,600 $220,481 $210,981 $190,770
                                =======  =======  =======  =======  =======



Return on Average Assets           .94%    1.03%    1.08%    1.01%    1.00%
Return on Average Equity          9.08%    9.40%    9.94%    9.12%    8.80%
Dividend Payout Ratio            27.51%   26.14%   25.04%   26.94%   26.80%
Year End Equity to Assets
   Ratio                         10.23%   10.57%   10.99%   10.83%   11.16%


<PAGE> 22
<TABLE>

<CAPTION>


TABLE II


                    NET INTEREST MARGIN AND AVERAGE BALANCE ANALYSIS
                              (Dollar amounts in thousands)


                                      2001                              2000                            1999
                            ------------------------      -----------------------------      --------------------------
                                      Income/   Yield/                 Income/     Yield/               Income/   Yield/
EARNING ASSETS             Average    Expense    Rate       Average    Expense      Rate     Average    Expense   Rate
--------------            -------     --------  -----      -------    --------    -----      -------    -------  ------
<S>                       <C>          <C>         <C>     <C>         <C>           <C>     <C>        <C>         <C>

Loans 1,3                 $  197,989   $17,895     9.04    $ 176,010   $ 15,893      9.03   $ 155,102   $ 13,699    8.83

Investment securities:
   Taxable 4                  24,686     1,445     5.85       26,583      1,641      6.17      29,235      1,755    6.00
   Nontaxable 1,4              3,501       267     7.63        3,285        262      7.98       3,192        271    8.49
                               -----    -----      ----        -----       ----      ---       ------     ------    -----

   Total Investment
     Securities               28,187     1,712     6.07       29,868      1,903      6.37      32,427      2,026    6.25

Interest bearing deposits
   in banks                    5,813       248     4.27        3,464        179      5.17       4,161        222    5.34

Federal funds sold            13,019       451     3.46        5,276        330      6.25       8,685        432    4.97
                               -----       --       ----       -----       ----      ---        ----         ----   ----

   Total Earning Assets      245,008    20,306     8.29      214,618     18,305      8.53     200,375     16,379    8.17
                               -----    ------     ---       ------       ----      ----      ------       ----     ----

Allowance for loan losses     (1,613)                         (1,474)                          (1,322)
Nonearnings assets            20,550                          18,608                           16,931
                              ------                          ------                           ------

   Total Assets             $263,945                       $ 231,752                         $215,984
                             =======                       =========                          =======

INTEREST-BEARING LIABILITIES

Deposits:
   Demand                   $ 28,330  $    520     1.84    $  30,015   $    867      2.89    $ 32,971    $   809    2.45
   Savings                    25,109       546     2.17       21,784        650      2.98      21,250        583    2.74
   Time deposits             149,867     8,771     5.85      126,041      7,061      5.60     114,632      6,133    5.35
                               -----     -----     ----      ------       -----     -----     ------       -----   ------

   Total Deposits            203,306     9,837     4.84      177,840      8,578      4.82     168,853      7,525    4.46
Other borrowed money           4,149       212     5.11        3,762        212      5.64       2,560        138    5.39
                              -----       ----     ----      ------        ----    ------         ----      -----   ----

   Total Interest Bearing
     Liabilities             207,455    10,049     4.84      181,602      8,790      4.84     171,413      7,663    4.47
                                        -----      ----                   -----     -----                  -----    ----

Noninterest bearing deposits  26,735                          23,035                           20,319
Other liabilities              2,436                           1,793                              856
                               -----                           -----                           ------

   Total Liabilities         236,626                         206,430                          192,588

   Stockholders' Equity       27,319                          25,322                           23,396
                              ------                           ------                          ------

   Total Liabilities and
    Equity                  $263,945                      $  231,752                         $215,984
                             =======                       ========                           =======

   Net Interest Earnings             $  10,257                        $   9,515                         $  8,716
                                       =======                          =======                           ======
   Net Yield on Interest
    Earning Assets                                 4.19%                             4.43%                          4.35%
                                                   =====                            ======                           ====

</TABLE>

1  Yields are  computed on a taxable  equivalent  basis using a 37% income tax
   rate.
2  Average balances are based on daily balances.
3  Includes loans in nonaccrual status.
4  Average balances for securities available for sale are based on amortized
   carrying values and do not reflect changes in market values.


<PAGE> 23


TABLE III


             EFFECT OF RATE-VOLUME CHANGES ON NET INTEREST INCOME
                      (On a fully taxable equivalent basis)
                            (In thousands of dollars)



                            2001 Compared to 2000        2000 Compared to 1999
                           -------------------------   -------------------------
                              Increase (Decrease)          Increase (Decrease)

                           Due to Change in: Total     Due to Change in:  Total
                          Average  Average  Increase  Average Average  Increase
                          Volume   Rate    (Decrease)  Volume   Rate  (Decrease)
                         -------- -------- ---------   ------  ------   -------

Interest Income:

   Loans 2                $1,985  $  17    $2,002     $1,841   $ 353    $2,194

   Investment Securities:
     Taxable                (117)   (79)     (196)      (159)     45      (114)
     Nontaxable               17    (12)        5          8     (17)       (9)
                           -----   ----     ----       ----     -----     -----

   Total Investment
     Securities             (100)   (91)     (191)      (151)     28      (123)

   Interest bearing
     deposits
     in banks                121    (52)       69        (37)     (6)      (43)
   Federal funds sold        484   (363)      121       (169)     67      (102)
                           -----   -----    ----       -----     ----      ----

   Total Interest Income   2,490   (489)    2,001      1,484     442     1,926
                           -----   -----    -----      -----    ----     -----


Interest Expense:

   Deposits:
     Demand                  (49)  (298)     (347)       (72)    130        58
     Savings                  99   (203)     (104)        15      52        67
     All other time
       deposits            1,334    376     1,710        610     318       928
   Other borrowed money       21    (21)        0         65       9        74
                           -----   -----    ----       ----     ----      ----

   Total Interest Expense  1,405   (146)    1,259        618     509     1,127
                           -----   -----    -----      ----     ----     -----

   Net Interest Income    $1,085  $(343)   $  742      $ 866  $  (67)   $  799
                           =====   ====     ====       ====     =====    ====





1  Changes in volume are calculated based on the difference in average balance
   multiplied  by the prior year average  rate.  Rate change
   differences are the difference in the volume changes and the actual dollar
   amount of interest income or expense changes.

2  Nonaccrual loans have been included in average asset balances.



<PAGE> 24


TABLE IV


                       INTEREST RATE SENSITIVITY ANALYSIS
                            (In thousands of dollars)
                                DECEMBER 31, 2001



                                                           More than
                                                           5 Years
                         1 - 90  91 - 365 1 to 3   3 to 5  or Without
                          Days     Days    Years    Years   Maturity   Total
EARNINGS ASSETS

   Loans                $26,953  $87,763  $54,024  $24,919  $11,810 $205,469
   Fed funds sold        13,284                                       13,284
   Securities             5,880    7,914   11,136    3,103    3,822   31,855
   Interest bearing
     time
     deposits             5,934      300      100                      6,334
                         ------   ------   ------   ------   -----   ------

   Total                 52,051   95,977   65,260   28,022   15,632  256,942
                         ------   ------   ------   ------   ------  -------

INTEREST BEARING LIABILITIES

   Transaction accounts  17,936                                       17,936
   Money market accounts 11,407                                       11,407
   Savings accounts      26,782                                       26,782
   Time deposits more
     than
     $100,000             8,980   21,965   10,018    4,219            45,182
   Time deposits less
     than
     $100,000            27,345   51,312   24,479    8,220      100  111,456
   Other borrowed money     337      163    1,320      725    1,978    4,523
                         ------   ------   ------   ------   -----    ------

   Total                 92,787   73,440   35,817   13,164    2,078  217,286
                         ------   ------   ------   ------   -----   -------


Discrete interest
   sensitivity GAP      (40,736)  22,537   29,443   14,858   13,544

Cumulative interest
   sensitivity GAP      (40,736) (18,199)  11,244   26,102   39,656

Ratio of cumulative
   Interest sensitive
   assets to cumulative
   interest sensitive
   liabilities            56.10%   89.05%  105.57%  112.13%  118.25%



Assumes all transaction, money market and savings deposit accounts reprice
within 90 days.



<PAGE> 25


TABLE V


                           QUARTERLY FINANCIAL RESULTS
                   (In thousands, except per share amounts)



                                 Fourth       Third      Second      First
                                 Quarter     Quarter     Quarter    Quarter
2001

Interest income               $   4,964   $   5,126   $   5,161   $   4,956
Interest expense                  2,451       2,562       2,537       2,499
                               --------    --------    --------    --------

   Net interest income            2,513       2,564       2,624       2,457
Provision for loan losses           210         135         135         120
                               --------    --------    --------    --------
   Net interest income after
     provision                    2,303       2,429       2,489       2,337

Non-interest income                 370         281         269         274
Non-interest expense              1,894       1,828       1,768       1,720
                               --------    --------    --------    --------

   Income before income tax
     provision                      779         882         990         891
Income tax provision                119         302         343         297
                               --------    --------    --------    --------

   Net Income                 $     660   $     580   $     647   $     594
                               ========    ========    ========    ========

Per common share:
   Net income (basic)         $    1.31  $     1.16  $     1.29  $     1.18
   Net income (diluted)            1.31        1.16        1.29        1.18
   Cash dividends                   .34         .34         .34         .34

2000

Interest income               $   4,922   $   4,737   $   4,368   $   4,180
Interest expense                  2,441       2,306       2,083       1,960
                               --------    --------    --------    --------

   Net interest income            2,481       2,431       2,285       2,220
Provision for loan losses           190          90         100         120
                               --------    --------    --------    --------
   Net interest income after
     provision                    2,291       2,341       2,185       2,100

Non-interest income                 432         284         268         279
Non-interest expense              1,767       1,654       1,639       1,571
                               --------    --------    --------    --------

   Income before income tax
     provision                      956         971         814         808
Income tax provision                229         356         313         270
                               --------    --------    --------    --------

   Net Income                 $     727   $     615   $     501   $     538
                               ========    ========    ========    ========

Per common share:
   Net income (basic)         $    1.45  $     1.22  $     1.00  $     1.07
   Net income (diluted)            1.45        1.22        1.00        1.07
   Cash dividends                   .31         .31         .31         .31


<PAGE> 26



Item 7. Financial Statements




                          Index to Financial Statements



                                                                        Page

Consolidated Balance Sheets as of December 31, 2001 and 2000             27

Consolidated Statements of Income for the Years Ended
  December 31, 2001, 2000 and 1999                                       28

Consolidated Statements of Changes in Stockholders' Equity for
  the Years Ended December 31, 2001, 2000 and 1999                       29

Consolidated Statements of Cash Flows for the Years Ended
  December 31, 2001, 2000 and 1999                                       30

Notes to Consolidated Financial Statements                               31

Independent Auditors' Report                                             49






<PAGE> 27


CONSOLIDATED BALANCE SHEETS

HIGHLANDS BANKSHARES, INC.
                                                           December 31,
ASSETS                                               2001          2000
                                                 ----------------------------

Cash and due from banks (notes 2, 3 and 16)      $  6,492,361   $  7,061,961
Interest bearing deposits in banks                  6,333,551      6,360,931
Federal funds sold                                 13,284,408      7,039,508
Investments:
  Securities held to maturity (note 4)              1,603,393      2,228,390
    (fair value of $1,638,968 and $2,233,856
     at December 31, 2001 and 2000, respectively)
  Securities available for sale (note 4)           29,460,117     22,835,324
  Other investments                                   791,650        763,050

Loans (notes 5, 14, 15 and 16)                    205,469,148    189,267,688
  Less allowance for loan losses (note 6)          (1,602,536)    (1,492,936)
                                                  -----------    -----------

  Net Loans                                       203,866,612    187,774,752

Bank premises and equipment (note 7)                7,055,640      6,809,453
Interest receivable                                 1,817,884      1,901,296
Investment in insurance contracts                   5,100,262      4,854,304
Other assets                                          971,993        971,124
                                                  -----------    -----------

  Total Assets                                   $276,777,871   $248,600,093
                                                  ===========     ===========

LIABILITIES

Deposits:
  Noninterest bearing                            $ 29,278,596   $ 26,369,759
  Interest bearing
    Money market and interest checking             17,935,755     17,678,521
    Money market savings                           11,407,235     12,281,053
    Savings accounts                               26,782,334     23,333,958
    Certificates of deposit over $100,000
      (note 8)                                     45,181,560     34,884,029
    All other time deposits (note 8)              111,456,188    102,023,919
                                                  -----------    -----------

  Total Deposits                                  242,041,668    216,571,239

Accrued expenses and other liabilities              1,902,794      1,751,921
Long-term debt (note 9)                             4,523,442      4,009,319
                                                  -----------    -----------

  Total Liabilities                               248,467,904    222,332,479
                                                  -----------    -----------

STOCKHOLDERS' EQUITY

Common stock, $5 par value, 3,000,000
shares authorized, 546,764 shares issued            2,733,820      2,733,820
Surplus                                             1,661,987      1,661,987
Retained earnings (note 12)                        24,623,951     22,825,747
Other accumulated comprehensive income                282,910         38,761
                                                  -----------    -----------

                                                   29,302,668     27,260,315
Treasury stock (at cost, 44,866 shares in 2001
  and 2000)                                          (992,701)      (992,701)
                                                  ------------   -----------

  Total Stockholders' Equity                       28,309,967     26,267,614
                                                  -----------    -----------

  Total Liabilities and Stockholders' Equity     $276,777,871   $248,600,093
                                                  ===========    ===========

        The accompanying notes are an integral part of this statement.



<PAGE> 28


CONSOLIDATED STATEMENTS OF INCOME

HIGHLANDS BANKSHARES, INC.

                                                Years Ended December 31,
                                          ----------------------------------
                                             2001        2000        1999
INTEREST INCOME:
  Loans, including fees                  $17,894,665 $15,891,868 $13,663,857
  Federal funds sold                         450,657     330,761     431,670
  Interest bearing deposits                  248,442     179,100     221,724
  Investment securities - taxable          1,445,327   1,641,057   1,754,509
  Investment securities - nontaxable         167,930     164,486     171,192
                                          ----------   ---------   ---------

  Total Interest Income                   20,207,021  18,207,272  16,242,952
                                          ----------  ----------  ----------

INTEREST EXPENSE:
  Time deposits over $100,000              2,623,584   1,865,498   1,524,334
  Other deposits                           7,213,321   6,712,478   6,000,044
                                          ----------   ---------   ---------

  Total Interest on Deposits               9,836,905   8,577,976   7,524,378

  Borrowed money                             211,827     212,054     138,313
                                          ----------   ---------   ---------

  Total Interest Expense                  10,048,732   8,790,030   7,662,691
                                          ----------  ----------   ---------

NET INTEREST INCOME                       10,158,289   9,417,242   8,580,261

PROVISION FOR LOAN LOSSES (note 6)           600,000     500,000     320,000
                                          ----------   ---------   ---------

Net Interest Income after Provision
  for Loan Losses                          9,558,289   8,917,242   8,260,261
                                          ----------   ---------   ---------

NONINTEREST INCOME:
  Service charges                            581,224     591,614     409,052
  Insurance commissions and income           100,801     132,105     112,339
  Insurance investment income                245,958     192,642     139,230
  Other operating income                     266,061     242,892     429,673
  Gain (loss) on security transactions
    (note 4)                                             103,870     (63,590)
                                          ----------   ---------   ---------

  Total Noninterest Income                 1,194,044   1,263,123   1,026,704
                                          ----------   ---------   ---------

NONINTEREST EXPENSES:
  Salaries and benefits (note 11)          3,937,908   3,629,664   3,230,973
  Occupancy expense                          381,029     302,738     269,483
  Equipment expense                          630,840     548,850     472,441
  Data processing expense                    529,054     489,744     473,392
  Other operating expenses                 1,731,258   1,659,834   1,466,016
                                          ----------   ---------   ---------

  Total Noninterest Expenses               7,210,089   6,630,830   5,912,305
                                          ----------   ---------   ---------

  Income before Income Tax Expense         3,542,244   3,549,535   3,374,660

INCOME TAX EXPENSE (note 10)               1,061,459   1,168,624   1,049,291
                                          ----------   ---------   ---------

NET INCOME                               $ 2,480,785  $2,380,911  $2,325,369
                                          ==========   =========   =========

Earnings Per Share                       $      4.94    $   4.74    $   4.63
                                          =========     =======       ======

Cash Dividends Paid Per Share            $      1.36    $   1.24    $   1.16
                                           =========      ======      =======

Weighted Average Shares Outstanding          501,898     501,898     501,898
                                          ==========   =========   =========

        The accompanying notes are an integral part of this statement.



<PAGE> 29


CONSOLIDATED STATEMENTS OF CHANGES IN STOCKHOLDERS' EQUITY

HIGHLANDS BANKSHARES, INC.
<TABLE>

<CAPTION>

                                                                           Accumulated
                                                                             Other
                                     Common                    Retained  Comprehensive    Treasury
                                      Stock       Surplus       Earnings    Income (Loss)   Stock         Total
<S>                                 <C>          <C>          <C>             <C>         <C>            <C>

BALANCE
   DECEMBER 31, 1998                $2,733,820   $1,661,987   $  19,324,019   $ 119,422   $(992,701)     $22,846,547

   Comprehensive Income
     Net income                                                   2,325,369                                2,325,369
     Change in unrealized
       loss on securities
       available for sale, net
       of tax effect of $214,757
       (see note 2(l))                                                         (365,672)                    (365,672)
                                                                                                            --------

   Total Comprehensive
     Income                                                                                                1,959,697

   Cash dividends                                                  (582,197)                                (582,197)
                                    -------       ---------         --------   --------    --------         --------

BALANCE
   DECEMBER 31, 1999                 2,733,820    1,661,987      21,067,191    (246,250)   (992,701)      24,224,047

   Comprehensive Income
     Net income                                                   2,380,911                                2,380,911
     Change in unrealized gain
       on securities
       available for sale, net
       of tax effect of $167,386
       (see note 2(l))                                                          285,011                      285,011
                                                                                                            --------

   Total Comprehensive
     Income                                                                                                2,665,922

   Cash dividends                                                  (622,355)                                (622,355)
                                    --------     --------          --------    --------    --------        --------

BALANCE
   DECEMBER 31, 2000                 2,733,820    1,661,987      22,825,747      38,761    (992,701)      26,267,614

   Comprehensive Income
     Net income                                                   2,480,785                                2,480,785
     Change in unrealized gain
       on securities
       available for sale, net
       of tax effect of $143,388
       (see note 2(l))                                                          244,149                      244,149
                                                                                                            --------

   Total Comprehensive
     Income                                                                                                2,724,934

   Cash dividends                                                  (682,581)                                (682,581)
                                    --------      --------         ---------   --------      --------      ---------

BALANCE
   DECEMBER 31, 2001                $2,733,820   $1,661,987     $24,623,951   $ 282,910   $(992,701)     $28,309,967
                                     ========    =========       =========      ======      =======       ==========
</TABLE>

             The accompanying notes are an integral part of this statement.



<PAGE> 30


CONSOLIDATED STATEMENTS OF CASH FLOWS

HIGHLANDS BANKSHARES, INC.
                                                   Years Ended December 31,
                                                2001      2000         1999
                                                -------------------------------
CASH FLOWS FROM OPERATING ACTIVITIES:
   Net income                             $ 2,480,785  $ 2,380,911  $ 2,325,369
   Adjustments to reconcile net income to
     net cash provided by operating
     activities:
       (Gain) loss on security
         transactions                                     (103,870)      63,590
       Gain on sale of property and
         equipment                                            (237)
       Depreciation                           523,626      447,697      407,147
       Increase in insurance contracts       (245,958)    (192,642)    (139,230)
       Net amortization of security
         premiums                             122,343        2,171      151,150
       Provision for loan losses              600,000      500,000      320,000
       Deferred income tax expense
         (benefit)                            (17,061)      18,010      (15,192)
       Change in other assets and liabilities:
         Interest receivable                   83,412     (158,422)     (71,527)
         Other assets                        (127,198)      86,378     (105,451)
         Accrued expenses                     150,873      315,869      116,566
                                             ---------   ---------   ----------

   Net Cash Provided by Operating
     Activities                             3,570,822    3,295,865    3,052,422
                                            ---------   ---------   ----------

CASH FLOWS FROM INVESTING ACTIVITIES:
   Purchase of branch, net of
     cash acquired                                      (1,220,000)
   Proceeds from maturity of securities
     held to maturity                         621,481      952,376      332,027
   Proceeds from maturities of securities
     available for sale                    17,116,010    7,590,970   15,000,285
   Proceeds from sales of securities
     available for sale                                  2,115,255      377,499
   Purchases of securities available
     for sale                             (23,472,091)  (3,978,886) (12,312,504)
   Net change in other investments            (28,600)     (17,500)     (14,600)
   Net change in deposits in other banks       27,380   (3,924,660)     995,252
   Net increase in loans                  (16,691,860) (17,279,029) (18,587,196)
   Change in federal funds sold            (6,244,900)  (2,736,875)   9,671,650
   Purchase of property and equipment        (776,171)  (1,287,893)  (1,338,297)
   Proceeds from sale of property and
     equipment                                  6,358        2,840
   Investment in insurance contracts                                 (2,400,000)
                                            ----------   ---------   ----------

   Net Cash Used in Investing
     Activities                           (29,442,393) (19,783,402)  (8,275,884)
                                          ------------  -----------  ----------

CASH FLOWS FROM FINANCING ACTIVITIES:
   Net change in time deposits             19,729,800   14,050,142    6,489,323
   Net change in other deposit accounts     5,740,629    1,368,109    1,268,300
   Additional long-term debt                1,395,300    1,731,532      394,922
   Repayment of long-term debt               (881,177)    (290,171)    (146,508)
   Dividends paid in cash                    (682,581)    (622,355)    (582,197)
                                            ---------   ---------   ----------

   Net Cash Provided by Financing
     Activities                            25,301,971   16,237,257    7,423,840
                                           ----------  ----------   ----------

CASH AND CASH EQUIVALENTS:
   Net (decrease) increase in cash and
     due from banks                          (569,600)    (250,280)   2,200,378
   Cash and due from banks, beginning
     of year                                7,061,961    7,312,241    5,111,863
                                           ---------    ---------   ----------

   Cash and Due from Banks, End of Year   $ 6,492,361   $7,061,961  $ 7,312,241
                                           ==========  =========   ==========

Supplemental Disclosures:
   Cash paid for:
     Interest expense                     $10,042,704   $8,610,571  $ 7,688,056
     Income taxes                           1,367,143    1,203,000    1,152,533

        The accompanying notes are an integral part of this statement.



<PAGE> 31


     NOTES TO CONSOLIDATED FINANCIAL STATEMENTS

     HIGHLANDS BANKSHARES, INC.


     NOTE 1   NATURE OF OPERATIONS:

              Highlands Bankshares, Inc. (the "Company") is a bank holding
              company and operates under a charter issued by the state of West
              Virginia. The Company owns all of the outstanding stock of The
              Grant County Bank, Capon Valley Bank, HBI Life Insurance Company,
              Inc. and Highlands Bankshares Trust Company, which operate under
              charters issued in Arizona and West Virginia, respectively. State
              chartered banks are subject to regulation by the West Virginia
              Division of Banking, The Federal Reserve Bank and the Federal
              Deposit Insurance Corporation while the insurance company is
              regulated by the Arizona Department of Insurance. The Banks
              provide services to customers located mainly in Grant, Hardy,
              Hampshire, Mineral, Pendleton and Randolph counties of West
              Virginia, including the towns of Petersburg, Keyser, Moorefield
              and Wardensville through eight locations and the county of
              Frederick in Virginia through a single location. The insurance
              company sells life and accident coverage exclusively through the
              Company's subsidiary banks. The Trust Company utilizes the
              subsidiary banks to facilitate the sales of trust services to its
              customers and citizens in those locales.


     NOTE 2   SUMMARY OF SIGNIFICANT ACCOUNTING POLICIES:

              The accounting and reporting policies of Highlands Bankshares,
              Inc. ("Company") and its subsidiaries conform to accounting
              principles generally accepted in the United States of America and
              to accepted practice within the banking industry.

              (a) Principles of Consolidation

                  The consolidated financial statements include the accounts of
                  The Grant County Bank, the Capon Valley Bank, HBI Life
                  Insurance Company and Highlands Bankshares Trust Company. All
                  significant intercompany accounts and transactions have been
                  eliminated.

              (b) Use of Estimates in the Preparation of Financial Statements

                  In preparing the financial  statements,  management is
                  required to make estimates and assumptions that affect the
                  reported amounts in those statements; actual results could
                  differ significantly from those estimates.  A material
                  estimate that is particularly susceptible to significant
                  changes is the determination of the allowance for loan losses,
                  which is sensitive to changes in local economic conditions.

              (c) Cash and Cash Equivalents

                  Cash and cash  equivalents  include cash on hand and
                  noninterest bearing funds at correspondent institutions.



<PAGE> 32


     NOTES TO CONSOLIDATED FINANCIAL STATEMENTS

     HIGHLANDS BANKSHARES, INC.


     NOTE 2   SUMMARY OF SIGNIFICANT ACCOUNTING POLICIES (CONTINUED):

              (d) Securities

                  Securities that the Company has both the positive intent and
                  ability to hold to maturity (at time of purchase) are
                  classified as held to maturity securities.  All other
                  securities are  classified  as  available  for
                  sale. Securities held to maturity are carried at historical
                  cost and adjusted for amortization of premiums and accretion
                  of discounts, using the effective interest method. Securities
                  available for sale are carried at fair value with any
                  valuation adjustments reported, net of deferred taxes, as
                  other accumulated comprehensive income.

                  Other investments consist of investments in the Federal Home
                  Loan Bank of Pittsburgh and the Federal Reserve Bank of
                  Richmond. Such investments are required as members of these
                  institutions and these investments cannot be sold without a
                  change in the members' borrowing or service levels.

                  Interest and dividends on securities and amortization of
                  premiums and discounts on securities  are reported as
                  interest income using the effective interest method. Gains
                  (losses) realized on sales and calls of securities are
                  determined using the specific identification method.

              (e) Loans

                  Loans are carried on the balance sheet net of any unearned
                  interest and the allowance for loan losses.  Interest
                  income on loans is determined using the effective interest
                  method on the daily amount of principal outstanding except
                  where serious doubt exists as to collectibility of the loan,
                  in which case the accrual of income is discontinued.

              (f) Allowance For Loan Losses

                  The allowance for loan losses is based upon management's
                  knowledge and review of the loan portfolio. Estimation of an
                  adequate allowance for loan losses involves the exercise of
                  judgement, the use of assumptions with respect to present
                  economic  conditions  and  knowledge  of  the
                  environment in which the Banks operate. Among the factors
                  considered in determining the level of the allowance are the
                  changes in composition of the loan portfolio, the amount of
                  delinquent and nonaccrual loans, past loan loss experience and
                  the value of collateral securing the loans.


<PAGE> 33


     NOTES TO CONSOLIDATED FINANCIAL STATEMENTS

     HIGHLANDS BANKSHARES, INC.


     NOTE 2   SUMMARY OF SIGNIFICANT ACCOUNTING POLICIES (CONTINUED):

              (g) Bank Premises and Equipment

                  Bank  premises and equipment are stated at cost less
                  accumulated depreciation. Depreciation is charged to income
                  over the estimated useful lives of the assets using a
                  combination of the straight-line and accelerated methods. The
                  ranges of the useful lives of bank premises and equipment are
                  as follows:

                        Buildings and Improvements    15 - 40 years
                        Furniture and fixtures         5 - 15 years

                  Maintenance, repairs, renewals, and minor improvements are
                  charged to operations as incurred. Gains and losses on routine
                  dispositions are reflected in other income or expense.

              (h) Income Taxes

                  Amounts provided for income tax expense are based on income
                  reported for financial  statement purposes rather than
                  amounts currently payable under federal and state tax laws.
                  Deferred taxes,  which arise  principally  from
                  differences between the period in which certain income and
                  expenses are recognized for financial accounting purposes and
                  the period in which they affect taxable income, are included
                  in the amounts provided for income taxes.

              (i) Earnings Per Share

                  Earnings per share are based on the weighted average number of
                  shares outstanding.

              (j) Foreclosed Real Estate

                  The components of foreclosed real estate are adjusted to the
                  lower of cost or fair value less estimated costs of disposal.
                  The current year provision for a valuation allowance has been
                  recorded as an expense to current operations.

              (k) Comprehensive Income

                  Accounting principles generally require that recognized
                  revenue, expenses, gains and losses be included in net income.
                  Certain changes in assets and liabilities, such as unrealized
                  gains  and  losses  on  available-for-sale
                  securities, are reported as a separate component of the equity
                  section of the balance sheet. Such items, along with net
                  income, are components of comprehensive income.



<PAGE> 34


     NOTES TO CONSOLIDATED FINANCIAL STATEMENTS

     HIGHLANDS BANKSHARES, INC.


     NOTE 2   SUMMARY OF SIGNIFICANT ACCOUNTING POLICIES (CONTINUED):

              (k) Comprehensive Income (Continued)

                  The components of other comprehensive income and related tax
                  effects are as follows:

                                                    Years Ended December 31,
                                                    ------------------------
                                                  2001        2000        1999
                                                  ----        ----        ----
                                                         (In thousands)

                   Unrealized holding gains
                      (losses) on available-
                      for-sale securities      $ 387,537   $ 556,267  $(644,019)

                   Reclassification adjustment for
                      (gains) losses realized in
                      income                                (103,870)    63,590
                                                --------    --------    --------

                   Net Unrealized Gains (Losses) 387,537     452,397   (580,429)
                   Tax effect                   (143,388)   (167,386)   214,757
                                                --------    --------   --------

                   Net Change                  $ 244,149   $ 285,011  $(365,672)
                                                ========    ========   ========


     NOTE 3   CASH AND DUE FROM BANKS:

              The Banks are required to maintain average reserve balances based
              on a percentage of deposits. The Banks have generally met this
              requirement through average cash on hand and balances with their
              correspondent institutions.



<PAGE> 35


     NOTES TO CONSOLIDATED FINANCIAL STATEMENTS

     HIGHLANDS BANKSHARES, INC.



NOTE 4    SECURITIES:

          The carrying amount and estimated fair value of securities are as
          follows:

                               Carrying   Unrealized Unrealized     Fair
                                 Amount       Gains     Losses      Value
                             ------------------------------------------------

          Held to Maturity

          December 31, 2001

          Mortgage-backed     $    6,022  $     422   $          $    6,444
          State and municipals 1,597,371     35,153               1,632,524
                               ---------   --------    --------   ---------

          Total Securities
            Held to Maturity  $1,603,393  $  35,575   $          $1,638,968
                               =========   ========    ========   =========

          December 31, 2000

          U.S. Agencies       $   88,609  $           $     319  $   88,290
          Mortgage-backed          8,893        298                   9,191
          State and municipals 2,130,888     13,042       7,555   2,136,375
                               ---------   --------    --------   ---------

          Total Securities
            Held to Maturity  $2,228,390  $  13,340   $   7,874  $2,233,856
                               =========   ========    ========   =========


          Available for Sale

          December 31, 2001

          U. S. Treasuries
            and Agencies     $10,562,796 $  197,676   $         $10,760,472
          Mortgage-backed      6,527,396      81,347              6,608,743
          State and
            municipals         6,318,613      65,393      3,505   6,380,501
          Marketable equities     42,206                  3,106      39,100
          Corporate
            obligations        5,560,038     111,263              5,671,301
                               ---------   ---------   ---------  ---------

          Total Securities
            Available for
              Sale           $29,011,049 $   455,679  $   6,611 $29,460,117
                               ==========  =========   =========  ==========

          December 31, 2000

          U. S. Treasuries
            and Agencies     $18,178,632 $    79,250  $  38,211 $18,219,671
          Mortgage-backed      3,257,381      24,107      6,402   3,275,086
          State and municipals   771,710      19,146      1,539     789,317
          Marketable equities     58,274                  6,574      51,700
          Corporate
            obligations          507,796                  8,246     499,550
                               ---------   ---------   ---------  ---------

          Total Securities
            Available for
            Sale             $22,773,793 $   122,503  $  60,972 $22,835,324
                               ==========  =========   =========  ==========


<PAGE> 36


NOTES TO CONSOLIDATED FINANCIAL STATEMENTS

HIGHLANDS BANKSHARES, INC.



NOTE 4    SECURITIES (CONTINUED):

          The carrying amount and fair value of debt securities at December 31,
          2001, by contractual maturity, are shown below. Expected maturities
          will differ from  contractual  maturities  because borrowers
          may have the right to call or prepay obligations with or without call
          or prepayment penalties.

          Securities Held to Maturity                                Fair
          ---------------------------
                                                       Cost         Value
                                                  -------------- ------------

          Due in one year or less                  $  230,741    $  233,068
          Due after one year through five years     1,196,015     1,222,517
          Due after five years through ten years      170,615       176,939
          Mortgage-backed securities                    6,022         6,444
                                                    ---------     ---------

            Total Held to Maturity                 $1,603,393    $1,638,968
                                                    =========     =========


          Securities Available for Sale                              Fair
          -----------------------------
                                                       Cost         Value
                                                  -------------- ------------

          Due in one year or less                  $7,034,575   $ 7,133,409
          Due after one year through five years    13,203,631    13,432,279
          Due after five years through ten years      992,472     1,000,180
          Due after ten years                       1,210,769     1,246,406
          Mortgage-backed securities                6,527,396     6,608,743
                                                    ---------    ----------

          Total Fixed Rate Securities              28,968,843    29,421,017
          Equities                                     42,206        39,100
                                                    ---------    ----------

            Total Available for Sale              $29,011,049   $29,460,117
                                                    ==========   ==========

          The carrying amount (which approximates market value) of securities
          pledged by the banks to primarily secure deposits amounted to
          $4,963,000 at December 31, 2001 and $10,786,000 at December 31, 2000.

          There were no holdings totaling more than 10% of stockholders' equity
          with any issuer as of December 31, 2001 and 2000.

          All gains and losses arose from the sale of securities available for
          sale. There were no sales of securities in 2001. Realized gains or
          losses for the years ending December 31 are as follows:

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

          Gains                       $       0    $  103,870    $    4,259
          Losses                              0                     (67,849)
                                       --------     ---------     ---------

            Total                     $       0    $  103,870    $  (63,590)
                                       ========     =========     =========


<PAGE> 37


NOTES TO CONSOLIDATED FINANCIAL STATEMENTS

HIGHLANDS BANKSHARES, INC.


NOTE 5    LOANS:

          Loans outstanding as of December 31 are summarized as follows:

                                                        2001         2000
                                                   -------------- -----------

          Commercial                              $ 42,204,159  $ 37,681,492
          Real estate construction                   3,868,000     4,061,000
          Real estate mortgages                    111,668,376   101,889,826
          Consumer installment                      47,926,399    46,191,314
                                                   -----------   -----------

            Subtotal                               205,666,934   189,823,632
            Unearned interest                         (197,786)     (555,944)
                                                   -----------   -----------

            Total Loans                           $205,469,148  $189,267,688
                                                   ==========     ==========


NOTE 6    ALLOWANCE FOR LOAN LOSSES:

          A summary of changes in the allowance for loan losses for the years
          ended December 31 is shown in the following schedule:

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

          Balance at beginning of
            year                    $1,492,936    $1,318,332    $ 1,355,377
          Allowance relating to
            loans acquired
            in purchase                               86,873
          Provision charged to
            operating expenses         600,000       500,000        320,000
          Loan recoveries              209,552       102,873         90,544
          Loans charged off           (699,952)     (515,142)      (447,589)
                                     ---------     ---------     ----------

            Balance at end of year  $1,602,536    $1,492,936    $ 1,318,332
                                     =========     =========     ==========

            Percentage of outstanding
              loans                        .78%           .79%          .79%


<PAGE> 38


NOTES TO CONSOLIDATED FINANCIAL STATEMENTS

HIGHLANDS BANKSHARES, INC.


NOTE 7    BANK PREMISES AND EQUIPMENT:

          Bank premises and equipment as of December 31 are summarized as
follows:

                                                         2001         2000
                                                    --------------------------

          Land                                     $ 1,137,485   $ 1,017,103
          Buildings and improvements                 6,400,610     6,087,509
          Furniture and equipment                    3,644,925     3,322,481
                                                    ----------    ----------

          Total cost                                11,183,020    10,427,093
            Less - accumulated depreciation         (4,127,380)   (3,617,640)
                                                    ----------   -----------

            Net Book Value                         $ 7,055,640   $ 6,809,453
                                                    ==========    ==========

          Provisions for depreciation of $523,626 in 2001, $447,697 in 2000 and
          $407,147 in 1999 were charged to operations.


NOTE 8    DEPOSITS:

          At December 31, 2001, the scheduled maturities of certificates of
          deposit are as follows:

                      2002                           107,511,843
                      2003                            26,462,399
                      2004                             8,043,528
                      2005                             7,258,612
                      2006                             7,361,366
                                                    ------------

                      Total                        $ 156,637,748
                                                    ============


NOTE 9    LONG-TERM DEBT:

          The Company has borrowed money from the Federal Home Loan Bank of
          Pittsburgh (FHLB). The interest rates on most of the notes payable
          were fixed at the time of the advance and fixed rates range from 2.50%
          to 6.85%; the largest borrowing is a variable rate loan whose rate is
          tied to LIBOR and was 1.42% at December 31, 2001. The weighted average
          interest rate is 5.68% at December 31, 2001. The debt is secured by
          the general assets of the Banks.

          Repayments of long-term debt are due either monthly or quarterly.
          Interest expense of $211,827, $212,054, and $138,313 was incurred on
          these debts in 2001, 2000, and 1999, respectively.  The
          maturities of long-term debt as of December 31, 2001 are as follows:

                      2002                         $    499,911
                      2003                              475,322
                      2004                              617,581
                      2005                              342,037
                      2006                              356,667
                      Thereafter                      2,231,924
                                                    -----------

                      Total                        $  4,523,442
                                                    ===========


<PAGE> 39


NOTES TO CONSOLIDATED FINANCIAL STATEMENTS

HIGHLANDS BANKSHARES, INC.


NOTE 10   INCOME TAX EXPENSE:

          The components of income tax expense for the years ended December 31,
          are summarized as follows:

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

          Current Expense
            Federal                        $  968,401  $ 953,961  $  930,223
            State                             110,119    196,653     134,260
                                            ---------   --------   ---------

            Total Current Expense           1,078,520  1,150,614   1,064,483
                                            ---------   ---------  ---------

          Deferred Expense (Benefit)
            Federal                           (15,690)    16,431     (13,961)
            State                              (1,371)     1,579      (1,231)
                                            ----------  --------   ---------

            Total Deferred Expense
               (Benefit)                      (17,061)    18,010     (15,192)
                                            ---------   --------   ---------

            Income Tax Expense             $1,061,459 $1,168,624  $1,049,291
                                            =========   =========  =========

          Income expense (benefits) relating
            to security transactions are as
            follows:                       $           $  38,432  $  (23,528)


          The deferred tax effects of temporary differences for the years ended
          December 31 as follows:

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

          Tax effect of temporary differences:
            Provision for loan losses       $  37,802  $(12,874)  $(10,937)
            Sale of loans                     (28,271)    3,693      7,192
            Pension expense                   (31,690)  (24,694)   (26,626)
            Depreciation                       47,406    52,928     23,945
            Deferred compensation             (57,251)  (38,471)   (24,797)
            Basis of securities sold                     75,369
            Miscellaneous                      14,943   (37,941)    16,031
                                             --------   -------    -------

            Net (increase) decrease
              in deferred
              income tax benefit            $ (17,061) $ 18,010   $(15,192)
                                             ========   =======    =======



<PAGE> 40


NOTES TO CONSOLIDATED FINANCIAL STATEMENTS

HIGHLANDS BANKSHARES, INC.


NOTE 10   INCOME TAX EXPENSE (CONTINUED):

          The net deferred tax assets arising from temporary differences as of
          December 31 are summarized as follows:

                                                         2001        2000
                                                     ------------------------

          Deferred Tax Assets:
            Provision for loan losses                $ 419,951   $ 382,072
            Insurance commissions                       32,130      32,181
            Sale of Loans                               31,183       2,935
            Deferred compensation                      146,232      89,319
            Accrued pension expense                                 23,965
            Other                                       12,228      22,375
                                                      --------    --------

            Total Assets                               641,724     552,847
                                                      --------    --------

          Deferred Tax Liabilities:
          -------------------------
            Unrealized gain on securities
              available for sale                       166,157      22,769
            Accretion income                            19,571      22,914
            Other liabilities                           28,471
            Property basis differences                 346,166     299,745
                                                      --------    --------

            Total Liabilities                          560,365     345,428
                                                      --------    --------

            Net Tax Asset                            $  81,359   $ 207,419
                                                      ========    ========


          The following table summarizes the difference between income tax
          expense and the amount computed by applying the federal statutory
          income tax rate for the years ended December 31:

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

          Amounts at federal
            statutory rates              $1,205,199  $1,206,848  $1,147,384
          Additions (reductions)
            resulting
            from:
              Tax-exempt income            (102,365)    (82,259)    (71,484)
              Partially exempt income       (28,142)    (36,606)    (30,125)
              State income taxes, net       105,278     115,964     100,227
              Income from life insurance
                contracts                   (97,014)    (71,798)    (51,515)
              Capital losses utilized                               (53,346)
              State income tax adjustment   (30,000)     30,000
              Other                           8,503       6,475       8,150
                                          ---------   ---------   ---------

              Income tax expense         $1,061,459  $1,168,624  $1,049,291
                                          =========   =========   =========


<PAGE> 41


NOTES TO CONSOLIDATED FINANCIAL STATEMENTS

HIGHLANDS BANKSHARES, INC.


NOTE 11   EMPLOYEE BENEFITS:

          The Company's two subsidiary banks each have separate retirement and
          profit sharing plans which cover substantially all full time employees
          at each bank. The Capon Valley Bank has a defined contribution pension
          plan with 401(k) features that is funded with discretionary
          contributions by the Company. The Company matches on a limited basis
          the contributions of the employees. Investment of employee balances is
          done through the direction of each employee.

          The Grant County Bank is a member of the West Virginia Bankers'
          Association Retirement Plan. Benefits under the plan are based on
          compensation and years of service with 100% vesting after seven years
          of service. The Plan's assets are in excess of the projected benefit
          obligations and thus the Bank was not required to make contributions
          to the Plan in 2001, 2000 or 1999. The amounts of the accrued
          liability and the net pension expense reflected in operations are
          insignificant. In addition, The Grant County Bank also maintains a
          profit sharing plan covering substantially all employees to which
          contributions are made at the discretion of the Board of Directors.

          The Company has established an employee stock ownership plan which
          will provide stock ownership to all employees of the Company. The Plan
          provides total vesting upon the attainment of seven years of service.
          Contributions to the plan are made at the discretion of the Board of
          Directors and are allocated based on the compensation of each employee
          relative to total compensation paid by the Company. All shares held by
          the Plan are considered outstanding in the computation of earnings per
          share. Shares of Company stock, when distributed, will have
          restrictions on transferability.

          Employer contributions related to the above benefit plans charged to
          operations totaled $234,455 in 2001, $266,601 in 2000 and $266,704 in
          1999.


NOTE 12   RESTRICTIONS ON DIVIDENDS OF SUBSIDIARY BANKS:

          The principal source of funds of Highlands Bankshares, Inc. is
          dividends paid by subsidiary  banks.  The various  regulatory
          authorities impose restrictions on dividends paid by a state bank. A
          state bank cannot pay dividends (without the consent of state banking
          authorities) in excess of the total net profits of the current year
          and the combined retained profits of the previous two years. As of
          January 1, 2002, the banks could pay dividends to the Company of
          approximately $1,223,000 without permission of the regulatory
          authorities.


NOTE 13   ACQUISITION OF THE STOCKMANS BANK OF HARMAN:

          On July 27, 2000, The Grant County Bank acquired the remaining stock
          not already  owned by  Highlands  Bankshares  from the
          stockholders of the Stockmans Bank of Harman (hereinafter referred to
          as "Harman"). Harman was a single branch bank serving Randolph County
          in West Virginia. The acquisition was accounted for as purchase under
          generally  accepted  accounting  principles and operations
          subsequent to July 26, 2000 are included as part of the operations of
          the Company for the year 2000. Grant purchased the 229 shares not
          already  owned by  Highlands  from  unrelated shareholders
          and Highlands contributed the 21 shares it owned to Grant as a capital
          contribution. Unrelated shareholders were paid $7,850 per share in
          cash for their shares at closing. The total acquisition cost,
          including shares acquired in previous years, was $1,878,000 plus
          expenses. The total purchase price was allocated as follows:

              Cash and Due From Banks               $  .7 million
              Loans Receivable                        5.7 million
              Securities                              2.2 million
              Fed Funds Sold                          1.6 million
              Other Assets                             .7 million
              Deposits Assumed                       (8.7) million
              Other Liabilities                       (.3) million
              Cash Paid and Expenses of Purchase     (1.9) million



<PAGE> 42


NOTES TO CONSOLIDATED FINANCIAL STATEMENTS

HIGHLANDS BANKSHARES, INC.


NOTE 13   ACQUISITION OF THE STOCKMANS BANK OF HARMAN (CONTINUED):

          As part of the accounting for this transaction, the Company acquired
          goodwill totaling $108,122 which is being amortized on a straight line
          basis over a period of ten years.


NOTE 14   TRANSACTIONS WITH RELATED PARTIES:

          During the year, officers and directors (and companies controlled by
          them) were customers of and had transactions with the subsidiary Banks
          in the normal course of business. These transactions were made on
          substantially the same terms as those prevailing for other customers
          and did not involve any abnormal risk. The aggregate amount of loans
          to related parties of $2,699,825 at December 31, 2000 was increased
          $661,577 by new loans and reduced $717,417 by payments resulting in an
          ending balance of $2,643,985 at December 31, 2001.


NOTE 15   COMMITMENTS AND GUARANTEES:

                  The Banks make commitments to extend credit in the normal
          course of business and issued standby letters of credit to meet the
          financing needs of their customers. The amount of the commitments
          represents the Banks' exposure to credit loss that is not included in
          the balance sheet. As of the balance sheet dates, the Banks had
          outstanding the following commitments:
                                                        2001        2000

          Commitments to extend credit              $ 8,991,000 $11,517,000
          Standby letters of credit                     252,000     438,000

          The Banks use the same credit policies in making commitments and
          issuing letters of credit as it does for the loans reflected in the
          balance sheet.

          Commitments to extend credit are agreements to lend to a customer as
          long as there is no violation of any condition established in the
          contract. Commitments generally have fixed expiration dates or other
          termination clauses and may require payment of a fee. Since many of
          the commitments are expected to expire without being drawn upon, the
          total commitment amounts do not necessarily represent future cash
          requirements.  The Banks evaluate each customer's creditworthiness
          on a case-by-case basis. The amount of collateral obtained, if deemed
          necessary by the Banks upon extension of credit, is based on
          management's  credit  evaluation of the borrower. Collateral
          held varies but may  include  accounts receivable, inventory,
          property, plant and equipment.



<PAGE> 43


NOTES TO CONSOLIDATED FINANCIAL STATEMENTS

HIGHLANDS BANKSHARES, INC.


NOTE 16   CONCENTRATIONS:

          The Banks grant commercial, residential real estate and consumer loans
          to customers located primarily in the eastern portion of the State of
          West Virginia. Although the Banks have a diversified loan portfolio, a
          substantial portion of the debtors' ability to honor their contracts
          is dependent upon the  agribusiness  economic sector. Collateral
          required by the Banks is determined on an individual basis depending
          on the purpose of the loan and the financial condition of the
          borrower. The ultimate collectibility of the loan portfolios is
          susceptible to changes in local economic conditions. Approximately 56%
          of the loan portfolio is secured by real estate. See note 5 for a
          complete breakdown of loans by type.

          The Bank has cash deposited in and federal funds sold to other
          commercial banks totaling $22,772,450 and $17,082,837 at December 31,
          2001 and 2000, respectively.


NOTE 17   DISCLOSURES ABOUT FAIR VALUE OF FINANCIAL INSTRUMENTS:

          The fair value of the Company's  assets and  liabilities is
          influenced heavily by market conditions. Fair value applies to both
          assets and liabilities, either on or off the balance sheet. Fair value
          is defined as the amount at which a financial instrument could be
          exchanged in a current  transaction between willing parties, other
          than in a forced or liquidation sale.

          The following methods and assumptions were used to estimate the fair
          value of each class of financial instruments for which it is
          practicable to estimate that value:

          Cash, Due from Banks and Money Market Investments

          The carrying amount of cash, due from bank balances, interest bearing
          deposits and federal funds sold is a reasonable estimate of fair
          value.

          Securities

          Fair values of securities are based on quoted market prices or dealer
          quotes. If a quoted market price is not available, fair value is
          estimated  using quoted  market  prices for similar  securities.

          Loans

          The fair value of loans is estimated by discounting the future cash
          flows using the current rates at which similar loans would be made to
          borrowers with similar credit ratings and for the same remaining
          maturities, taking into consideration the credit risk in various loan
          categories.

          Deposits

          The fair value of demand, interest checking, regular savings and money
          market deposits is the amount payable on demand at the reporting date.
          The fair value of fixed maturity certificates of deposit is estimated
          using the rates currently offered for deposits of similar remaining
          maturities.

          Long Term Debt

          The fair value of fixed rate loans is estimated using the rates
          currently offered by the Federal Intermediate Credit Bank for
          indebtedness with similar maturities.

          Interest Payable and Receivable

          The carrying value of amounts of interest receivable and payable is a
          reasonable estimate of fair value.


<PAGE> 44


NOTES TO CONSOLIDATED FINANCIAL STATEMENTS

HIGHLANDS BANKSHARES, INC.


NOTE 17   DISCLOSURES ABOUT FAIR VALUE OF FINANCIAL INSTRUMENTS (CONTINUED):

          Off-Balance-Sheet Items

          The carrying amount and estimated fair value of off-balance-sheet
          items were not material at December 31, 2001.

          The carrying  amount and estimated  fair values of financial
          instruments as of December 31 are as follows:

                                         2001                  2000
                                             Estimated             Estimated
                                 Carrying      Fair     Carrying     Fair
                                  Amount       Value      Amount       Value
                               ------------ -----------------------------------

          Financial Assets:
            Cash and due
              from banks      $  6,492,361 $  6,492,361 $  7,061,961 $ 7,061,961
            Interest bearing
              deposits           6,333,551    6,333,551    6,360,931   6,360,931
            Federal funds sold  13,284,408   13,284,408    7,039,508   7,039,508
            Securities held to
              maturity           1,603,393    1,638,968    2,228,390   2,233,856
            Securities available
              for sale          29,460,117   29,460,117   22,835,324  22,835,324
            Other investments      791,650      791,650      763,050     763,050
            Loans, net         203,866,612  204,748,161  187,774,752 187,498,412
            Interest receivable  1,817,884    1,817,884    1,901,296   1,901,296

          Financial Liabilities:
            Demand and savings
              deposits          85,403,920   85,403,920   79,663,291  79,663,291
            Term deposits      156,637,748  158,647,902  136,907,948 137,101,109
            Borrowed money       4,523,442    4,477,891    4,009,319   3,964,810
            Interest payable       848,606      848,606      842,979     842,979


NOTE 18   REGULATORY MATTERS:

          The Company is subject to various regulatory capital requirements
          administered by the federal banking agencies. Failure to meet minimum
          capital requirements can initiate certain mandatory - and possibly
          additional discretionary - actions by regulators that, if undertaken,
          could have a direct material effect on the Company's financial
          statements. Under capital adequacy guidelines and the regulatory
          framework for prompt corrective action, the Company must meet specific
          capital guidelines that involve quantitative measures of the Company's
          assets, liabilities, and certain off-balance-sheet items as calculated
          under regulatory accounting practices. The Company's capital amounts
          and classification are also subject to qualitative judgments by the
          regulators about components, risk weightings and other factors.

          Quantitative measures established by regulation to ensure capital
          adequacy require the Company to maintain minimum amounts and ratios
          (set forth in the table below) of total and Tier I capital (as defined
          in the regulations) to risk-weighted assets (as defined), and of Tier
          I capital (as defined) to average assets (as defined). The Company
          meets all capital adequacy requirements to which it is subject and as
          of the most recent examination, the Company was classified as well
          capitalized.



<PAGE> 45


NOTES TO CONSOLIDATED FINANCIAL STATEMENTS

HIGHLANDS BANKSHARES, INC.


NOTE 18   REGULATORY MATTERS (CONTINUED):

          To be categorized as well capitalized the Company must maintain
          minimum total risk-based, Tier I risk-based, and Tier I leverage
          ratios as set forth in the table. There are no conditions or events
          that management believes have changed the Company's category from a
          well capitalized status.

          The Company's actual capital ratios are presented in the following
          table:

                                        Actual       Regulatory Requirements
                                  -------------------------------------------
                                       December        Adequately     Well
                                     2001     2000     Capitalized  Capitalized

          Total risk-based ratio    14.46%   16.03%       8.00%      10.00%
          Tier 1 risk-based ratio   13.66%   15.17%       4.00%       6.00%
          Total assets leverage
            ratio                   10.06%   10.57%       4.00%       5.00%

          Capital ratios and amounts are applicable both at the individual bank
          level and on a consolidated basis. At December 31, 2001, both
          subsidiary banks had  capital  levels in excess of  minimum
          requirements. As such, both banks qualified as "well capitalized
          banks" for FDIC insurance purposes and thus were charged the minimum
          rate for insurance coverage.



<PAGE> 46


NOTES TO CONSOLIDATED FINANCIAL STATEMENTS

HIGHLANDS BANKSHARES, INC.


NOTE 19   PARENT CORPORATION ONLY FINANCIAL STATEMENTS:


                                 BALANCE SHEETS

          Assets                                            December 31,
                                                       ----------------------
                                                        2001         2000
                                                     ----------   ----------

            Cash                                   $   102,141   $     81,062
            Investment in subsidiaries              28,128,103     26,121,840
            Other investments                           15,304         10,304
            Other assets                                26,965         22,951
            Income taxes receivable                    208,372        237,959
                                                    ----------    -----------

            Total Assets                           $28,480,885   $ 26,474,116
                                                    ==========    ===========


          Liabilities

            Accrued Expenses                             2,315
            Due to subsidiaries                    $   168,603   $    206,502
                                                    ----------    -----------

            Total Liabilities                          170,918        206,502
                                                    ----------    -----------

          Stockholders' Equity

            Common stock, par value $5 per share
              3,000,000 shares authorized,
              546,764 shares issued                $ 2,733,820   $  2,733,820
            Surplus                                  1,661,987      1,661,987
            Retained earnings                       24,623,951     22,825,747
            Other accumulated comprehensive income     282,910         38,761
                                                    ----------    -----------

                                                    29,302,668     27,260,315
            Less treasury stock (at cost,
              44,866 shares
              in 2001 and 2000)                       (992,701)      (992,701)
                                                    ----------    -----------

            Total Stockholders' Equity              28,309,967     26,267,614
                                                    ----------    -----------

            Total Liabilities and Stockholders'
              Equity                               $28,480,885   $ 26,474,116
                                                    ==========    ===========


<PAGE> 47


NOTES TO CONSOLIDATED FINANCIAL STATEMENTS

HIGHLANDS BANKSHARES, INC.


NOTE 19   PARENT CORPORATION ONLY FINANCIAL STATEMENTS (CONTINUED):


                  STATEMENTS OF INCOME AND RETAINED EARNINGS

                                                 Years Ended December 31,
                                           ----------------------------------
                                            2001        2000        1999
                                         ------------------------ ----------

          Income

            Dividends from subsidiaries  $ 3,063,877  $  722,354  $   666,652
            Other dividends                                             1,680
                                          ----------   ---------   ----------

            Total                          3,063,877     722,354      668,332
                                          ----------   ---------   ----------

          Expenses

            Salary and benefits expense      169,325
            Professional fees                 34,413      48,988       34,056
            Directors' fees                   40,550      32,650       25,500
            Other expenses                    70,120      31,172       33,905
                                          ----------   ---------   ----------

            Total                            314,408     112,810       93,461
                                          ----------   ---------   ----------

          Net income before income
            tax benefit
            and undistributed income
            (deficit)
            of subsidiaries                2,749,469     609,544      574,871

          Income tax benefit                 112,779      43,006       37,866
                                          ----------   ---------   ----------

          Income before undistributed income
            (deficit) of subsidiaries      2,862,248     652,550      612,737

          Undistributed income (deficit) of
            subsidiaries                    (381,463)  1,728,361    1,712,632
                                          ----------   ---------   ----------

            Net Income                     2,480,785   2,380,911    2,325,369

          Retained earnings,
            Beginning of period           22,825,747  21,067,191   19,324,019
            Dividends paid                  (682,581)   (622,355)    (582,197)
                                          ----------   ---------   ----------

          Retained Earnings,
            End of Period                $24,623,951 $22,825,747  $21,067,191
                                          ==========   ==========  ==========


<PAGE> 48


NOTES TO CONSOLIDATED FINANCIAL STATEMENTS

HIGHLANDS BANKSHARES, INC.


NOTE 19   PARENT CORPORATION ONLY FINANCIAL STATEMENTS (CONTINUED):


                            STATEMENTS OF CASH FLOWS


                                                 Years Ended December 31,
                                              ------------------------------
                                                 2001       2000     1999
                                            ---------------------------------


          Cash Flows from Operating Activities:
            Net income                     $ 2,480,785 $2,380,911   $2,325,369
            Adjustments
              Undistributed subsidiary
                (income) deficit               381,463 (1,728,361)  (1,712,632)
              Depreciation                         397        446          624
              Increase (decrease) in payables  (35,584)   153,220       52,809
              (Increase) decrease in
                receivables                     29,587   (124,691)     (65,251)
              Increase in other assets          (4,411)
                                            ----------    -------        -----

            Net Cash Provided by Operating
              Activities                     2,852,237    681,525      600,919
                                            ----------  ---------    ---------

            Cash Flows from Investing Activities:
              Investment in subsidiaries    (2,143,577)
              Other investments                 (5,000)   (12,584)
                                            ----------     --------    -------

              Net Cash Used in Investing
                Activities                  (2,148,577)   (12,584)


          Cash Flows from Financing Activities:
            Dividends paid                    (682,581)  (622,355)    (582,197)
                                             ---------      -----       -----

            Net Cash Used in Financing
              Activities                      (682,581)  (622,355)    (582,197)
                                              --------     ------        -----

          Net Increase in Cash                  21,079     46,586       18,722

          Cash, Beginning of Year               81,062     34,476       15,754
                                            ----------  ---------    ---------

          Cash, End of Year                $   102,141 $   81,062   $   34,476
                                            ==========  =========   =========


<PAGE> 49





                          INDEPENDENT AUDITORS' REPORT




The Stockholders and Board of Directors
Highlands Bankshares, Inc.
Petersburg, West Virginia


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

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

In our opinion, the financial statements referred to above present fairly, in
all material respects, the consolidated financial position of Highlands
Bankshares, Inc. and subsidiaries as of December 31, 2001 and 2000, and the
consolidated results of their operations and their cash flows for each of the
years in the three year period ended December 31, 2001, in conformity with U.S.
generally accepted accounting principles.


                                    /s/ S. B. Hoover & Company, L.L.P.




January 24, 2002
Harrisonburg, Virginia



<PAGE> 50



Item  8. Changes in and  Disagreements  with  Accountants  on Accounting  and
-------- ---------------------------------------------------------------------
         Financial Disclosure
         ---------------------

     None

Part III

Item  9. Directors,  Executive  Officers,  Promoters  and  Control  Persons;
         Compliance with Section 16(a) of the Exchange Act

     We are  incorporating the Proxy Statement of Highlands  Bankshares,  Inc.
via Form DEF 14A filed March 13, 2002.

Item 10. Executive Compensation

     We are  incorporating the Proxy Statement of Highlands  Bankshares,  Inc.
via Form DEF 14A filed March 13, 2002.

Item 11. Security Ownership of Certain Beneficial Owners and Management

     We are  incorporating the Proxy Statement of Highlands  Bankshares,  Inc.
via Form DEF 14A filed March 13, 2002.

Item 12. Certain Relationships and Related Transactions

     We are  incorporating the Proxy Statement of Highlands  Bankshares,  Inc.
via Form DEF 14A filed March 13, 2002.

     Most of the directors, partnerships of which they may be general partners
and corporations of which they are officers or directors, maintain normal
banking relationships with the Bank. Loans made by the Bank to such persons or
other entities were made only in the ordinary course of business, were made on
substantially the same terms, including interest rates and collateral, as those
prevailing at the time for comparable transactions with other persons, and did
not involve more than normal risk of collectibility or present other unfavorable
features.  See Note 14 of the consolidated financial statements.

     John VanMeter is a partner with the law firm of VanMeter and VanMeter,
which has been retained by the Company as legal counsel and it is anticipated
that the relationship will continue. Jack H. Walters is a partner with the law
firm of Walters & Krauskopf, which provides legal counsel to the Company and it
is anticipated that the relationship will continue.

Part IV

Item 13. Exhibits and Reports on Form 8-K

     a)  Exhibits

         Exhibit No.                        Description

             2              Not applicable

            3 (i)           Articles    of    Incorporation    of    Highlands
                            Bankshares,  Inc. are incorporated by reference to
                            Appendix C to  Highlands  Bankshares,  Inc.'s Form
                            S-4 filed October 20, 1986.

                            Amendments  to the original  Articles of
                            Incorporation are incorporated by reference; filed
                            as Exhibit 3(i) with 1997 10-KSB.




<PAGE> 51



Item 13. Exhibits and Reports on Form 8-K (Continued)

     a)  Exhibits (Continued)
         --------------------

         Exhibit No.                        Description


           3 (ii)           Bylaws   of   Highlands   Bankshares,   Inc.   are
                            incorporated by reference to Appendix D to Highland
                            Bankshares, Inc.'s Form S-4 filed October 20, 1986.

                            Amendments    to   the    original    Bylaws   are
                            incorporated by reference;  filed as Exhibit 3(ii)
                            with 1997 10-KSB

             4              Not applicable

             9              Not applicable

            10              Not applicable

            11              Not applicable

            12              Not applicable

            16              Not applicable

            18              Not applicable

            21              Subsidiary  listing of the  Registrant

            22              Not applicable

            23              Consent of Certified  Public  Accountant

            24              Not applicable

            28              Not applicable


     b)  Reports on Form 8-K

         No reports on Form 8-K were filed in the fourth quarter of 2001.


<PAGE> 52


                                   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.


                                        By   /s/ LESLIE A. BARR
                                             -------------------------------
                                             Leslie A. Barr
                                             President, Chief Executive
                                             Officer


                                        Date   MARCH 27, 2002
                                             -------------------------



                                        By   /s/ CLARENCE E. PORTER
                                             ------------------------------
                                             Clarence E. Porter
                                             Treasurer


                                        Date   MARCH 27, 2002
                                             -------------------------

   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 and as of the date indicated.

        Signature                         Title                  Date

/s/ LESLIE A. BARR                                              MARCH 27, 2002
--------------                                                  -------------
Leslie A. Barr                          President
                                & Chief Executive Officer
                                        Director
/s/ ALAN L. BRILL                                               MARCH 27, 2002
--------------------                                            ------------
Alan L. Brill                           Secretary

/s/ KATHY G. KIMBLE                                             MARCH 27, 2002
----------------------                                          --------------
Kathy G. Kimble                         Director


George B. Moomau                        Director                ------------


/s/ THOMAS B. MCNEIL, SR.                                       MARCH 27, 2002
----------------------                                          --------------
Thomas B. McNeil, Sr.                   Director

/s/ CLARENCE E. PORTER                                          MARCH 27, 2002
----------------------                                          --------------
Clarence E. Porter                      Treasurer

/s/ COURTNEY R. TUSING                                          MARCH 27, 2002
----------------------                                          --------------
Courtney R. Tusing                      Director

/s/ JOHN G. VANMETER                                            MARCH 27, 2002
----------------------                                          --------------
John G. VanMeter                  Chairman of the Board
                                        Director

/s/ JACK H. WALTERS                                             MARCH 27, 2002
----------------------                                          --------------
Jack H. Walters                         Director

/s/ L. KEITH WOLFE                                              MARCH 27, 2002
----------------------                                          -------------
L. Keith Wolfe                          Director