SECURITIES AND EXCHANGE COMMISSION
                            Washington, D. C. 20549

                                  FORM 10-KSB

        ANNUAL REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES
                             EXCHANGE ACT OF 1934

For fiscal year ended December 31, 1997      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-KSB or any amendment to this Form 10-KSB. [X]

    Issuer's revenues for its most recent fiscal year:  $15,655,000

    State the aggregate market value of the voting stock held by non-affiliates
computed by reference to the price at which the stock was sold, or the average
bid and asked prices of such stock, as of a specified date within the past 60
days: As of March 1, 1998 - most recent bid price $53.00
                            most recent ask price $55.00

    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, 1998 -
501,898

                     DOCUMENTS INCORPORATED BY REFERENCE:

    Proxy Statement of Highlands  Bankshares,  Inc. filed via Form DEF 14A on
March 18, 1998.

                           LOCATION OF EXHIBIT INDEX

    The index of exhibits is contained in Part IV herein on pages 46-47.

    TRANSITIONAL SMALL BUSINESS DISCLOSURE FORMAT  YES         NO   X


<PAGE>

                               FORM 10-KSB 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 Properties                                      4

Item  3.  Legal Proceedings                                              5

Item  4.  Results of Votes of Security Holders                           5


Part II

Item  5.  Market for Registrant's 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                                          24

Item  8.  Changes in and Disagreement with Accountants on
          Accounting and Financial Disclosure                           46


Part III

Item  9.  Directors and Executive Officers                              46

Item 10.  Executive Compensation                                        46

Item 11.  Security Ownership of Certain Beneficial Owners
          and Management                                                46

Item 12.  Certain Relationships and Related Transactions                46


Part IV

Item 13.  Exhibits and Reports on Form 8-K                              46

Signatures                                                              48


<PAGE> 3

Part I

Item 1. Description of Business

    General

    Highlands Bankshares, Inc. (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") and its life insurance
subsidiary, HBI Life Insurance Company (HBI Life). Capon Valley Bank became a
member of Highlands effective July 1, 1987, in a combination accounted for as a
pooling of interests.

    The Grant County Bank was chartered on May 20, 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.

    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 automatic teller
machine banking. 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 Insurance
Company.

    Employees

    As of December 31, 1997, The Grant County Bank had 43 full time equivalent
employees and Capon Valley Bank had 36 full time equivalent employees. No person
is employed by Highlands or HBI Life on a full time basis.

    Competition

    The banks' primary trade area is generally defined as Grant County, Hardy
County, Mineral County and the northern part of Pendleton County. This area
includes the cities of Petersburg, Wardensville, Moorefield and Keyser and
several rural towns. The banks compete with three state chartered banks and two
national banks. 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 competition has
been forced to pay rates on deposits which exceed the national averages.

    The banks' secondary trade area includes portions of Hampshire County in
West Virginia and Frederick County in Virginia. In addition, the banks compete
with money market mutual funds and investment brokerage firms for deposits in
their service area.

    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 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, 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. 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.

Item 2. Description of Properties

    The Grant County Bank's main office is located on Main Street in Petersburg,
West Virginia. The Bank recently modernized its existing facility which included
an additional 6,000 square feet of operating space and new, state-of-the-art
drive-up facilities. An automatic teller machine allows customers greater
flexibility in their banking transactions. In late 1996, the Bank opened a full
service branch in Mineral County to serve the Keyser area. This facility is
owned by the Bank and features state-of-the-art drive-up facilities and an
automatic teller machine. The Bank also has a branch in Riverton, West Virginia
which provides banking services in northwest Pendleton County. The Riverton
branch building has an annual lease while the main and Keyser office facilities
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. Capon completed
the expansion of its Moorefield facilities in 1995 and it provides improved
drive-up capabilities and lobby service areas. The Bank opened its new Baker
branch in April of 1997 to serve the customer base between Moorefield and
Wardensville. This facility includes state-of-the-art drive in and automatic
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. Results of Votes of Security Holders

     Highlands has not submitted any matters to the vote of security holders for
the quarter ending December 31, 1997.


Part II

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

    The Company had approximately 840 stockholders of record as of March 1,
1997. The Company's stock is not traded on any national or regional stock
exchange although brokers in Cumberland, Maryland, 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. Such prices may not include retail
mark-ups, mark-downs or commissions.

                             Dividends          Market Price Range
           1997              Per Share          High           Low
           ----              ---------          ----           ---

        First Quarter         $ .25           $ 44.25        $ 41.00
        Second Quarter          .25             45.00          43.00
        Third Quarter           .25             46.86          44.00
        Fourth Quarter          .25             46.50          44.75

           1996

        First Quarter         $ .18           $ 39.88        $ 38.00
        Second Quarter          .18             40.50          38.00
        Third Quarter           .18             40.50          39.00
        Fourth Quarter          .40             42.00          40.50

           1995

        First Quarter         $ .16           $ 40.25        $ 39.00
        Second Quarter          .16             40.00          39.50
        Third Quarter           .16             41.25          37.00
        Fourth Quarter          .35             41.00          38.50


<PAGE> 6


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

Overview

    The net income of the Company declined 6.61% in 1997 compared to 1996
operations. While the net interest margin increased due to higher levels of
earning assets, noninterest expenses increased due to a full year of operations
of the branch in Keyser and eight months of operations at the Baker branch. In
addition, the Company had an increase in losses on security transactions due to
a recognized loss on the redemption of a mutual fund in the fourth quarter of
the year.

    Average assets for the year increased 6.77% for 1997 when compared to 1996.
Increases in average loans outstanding of 11.97% were funded by increases in
average deposits of 6.35% and declines in investment securities of 8.59%.
Average stockholders' equity increased 6.11% for the year due to retained
operating earnings and increases in the market value of securities available for
sale.

    The Company purchased treasury stock to be used for future business purposes
totaling $499,000 in 1997. Year end stockholders' equity increased 5.28% to
$21,297,000 at year end. This represents an equity/asset ratio of 11.16% and is
higher than most of our competitors. For 1997, the Company paid dividends
totaling 26.84% of income compared with 24.00% in 1996 and 23.03% in 1995.

    The following outlines returns on equity and average assets for the period
of 1995 to 1997:

                                             1997       1996       1995
                                             ----       ----       ----

       Return on average equity             8.80%      9.99%     10.15%
       Return on average assets             1.00%      1.15%      1.16%

    A complete five year summary of operations appears as Table I on page 20.

    The Company's yield on earning assets remained unchanged in 1997 as slight
declines in the yields on loans were offset by slight increases in the yields on
investments and federal funds sold. Declines in the cost of time deposits was
responsible for an eleven basis point decline in the cost of funds and thus a
three basis point increase in the overall net yield on earning assets. The
Company's loan/deposit ratio was 81.64% at December 31, 1997 compared with
79.31% at December 31, 1996. The increase is reflective of the strong national
and local economies and relatively low market rates. The Company expects
moderate loan growth in 1998 at a rate slightly lower than the 1997 growth rate.
The current loan/deposit ratio is reflective of the Company's commitment to
serve the local communities and provide financing for local investment.


Net Interest Margin

    1997 compared to 1996

    The Company's net interest income on a tax equivalent basis increased to
$7,721,000 for 1997 or 7.10% higher than the amount for 1996. Yields on loans
declined slightly (seventeen basis points) due to declines in mortgage rates.
The mortgage rate decline was the result of declines in the rate on long-term
government bonds and other market yields. Yields on investment securities
increased three basis points while yields on federal funds sold increased
eighteen basis points. The result of the above was a yield on earning assets of
8.55%, the same as the 1996 yield.


<PAGE> 7

Net Interest Margin (Continued)

    1997 compared to 1996 (Continued)

    The Company's overall cost of funds declined by eleven basis points in 1997
to 5.04%. The decline was primarily in the area of time deposits with a decline
of nineteen basis points. The decline was due to the maturity of higher costing
certificates that originated in 1995 and matured in the summer and fall of 1997.
Lesser reductions in the cost of demand and savings deposits were also
contributors to the decline in the cost of deposits.

    Management believes the cost of funds will decline slightly in 1998 despite
considerable competition in all geographical locations that have kept rates
above the national averages. While it expects that yields on loans should remain
relatively stable, changes in the monetary policies of the Federal Reserve Bank
could have an immediate impact on the yields of federal funds sold and new
investment securities purchased.

    A summary of the net interest margin analysis is shown as Table II on Page
21.

    1996 compared to 1995

    The Company's net interest margin on a tax equivalent basis was $7,209,000
for 1996, an increase of 8.39% over amounts for 1995. Increases in rates on
earning assets (fifteen basis points higher) were offset by higher rates paid on
certificates of deposit (39 basis points higher). Rates on contracts entered
into in 1995 are primarily responsible for the above average cost of funds.
Rates paid on certificates of deposit originated in 1996 were lower as the rates
paid on deposits in the local community declined to rates more in line with
state and national averages. Greater earnings were the result of volume
increases, mostly in the area of loan growth.

     The deposit growth of 9.19% in 1996 provided funding for loan and security
growth. The deposit growth, lower levels of federal funds sold and lower
interest bearing deposits in other banks provided the funding for a 18.30%
increase in average investment securities. Federal funds sold declined in 1996
as rates declined by 31 basis points. Federal Reserve monetary policy dictated
the yields of federal funds sold and 1996 saw only limited changes in the fed's
policies. Tax equivalent yields increased on an overall basis by fifteen basis
points as lower yielding investments matured and were reinvested at higher
rates.

     Average interest bearing deposits increased 8.38% in 1996, mainly in the
areas of time deposits. The rate declines for demand and savings accounts
continued with a 21 and 31 basis point decline, respectively. Rates on time
deposits increased 39 basis points and reflected high rates paid on certificates
originated in 1995. The overall cost of deposits increased by 26 basis points
which was slightly higher than the increase in the overall yield on earning
assets of fifteen basis points. The higher level of earning assets than interest
bearing liabilities tempered this slight difference in rates earned and paid.
The results were a net interest margin of 4.32% for 1996 compared to the 1995
margin of 4.34%.


Provision and Allowance for Loan Losses

    The Company's allowance for loan losses (the allowance against which future
losses will be charged) at December 31, 1997 increased $112,000 when compared to
the prior year end balance. As a percentage of loans outstanding, the allowance
was 1.00% at December 31, 1997 compared to 1.01% at December 31, 1996 and 1.16%
at December 31, 1995. Net charge offs declined to $78,000 in 1997 compared to
$197,000 in 1996 and $255,000 in 1995. The provision for loan losses was
increased to $190,000 in 1997 from $135,000 in 1996 due to the increase in
average loans outstanding. The Company's three year average charge off rate of
 .15% is in line with industry standards and its peer group.


<PAGE> 8

Provision and Allowance for Loan Losses (Continued)

    The Company did not have any loans in nonaccrual status as of December 31,
1997 or 1996. Loans contractually past due 90 days or more increased $866,000 to
$1,247,000 at December 31, 1997. This increase was due to the delinquency of a
single large borrower whose operations are tied to the poultry industry and an
unusually low level of delinquencies in the prior year. The Company is
adequately secured on these delinquencies and believes losses, if any, on these
loans will be minimal. Future loan losses in the entire loan portfolio may be
impacted by the problems currently being experienced by the poultry industry
which is a major employer in the Banks' service areas. Turkey prices have been
at historically low levels due to an oversupply of product. Compounding the
pricing problem has been high grain prices and high poult mortality levels. If
such problems continue into 1998, some poultry operators may not be able to
service their loans on their original terms and the value of the Company's
collateral may decline. The Company monitors this situation closely and believes
the current level of the allowance adequately addresses this problem.


Noninterest Income

    1997 compared to 1996

    Overall noninterest income declined in 1997 by 3.48% when compared with 1996
operations. The Company experienced a loss on the redemption of a mutual fund
investment that was redeemed in 1997. A loss of $123,000 was recognized on the
redemption though the Company may recover a portion of this loss in the
resolution of pending legal actions. Exclusive of the above, noninterest income
before security losses increased 10.77% as the result of higher service charges
on deposit accounts and the institution of minimum balance requirements on some
deposit accounts. Other types of noninterest income increased slightly in line
with asset growth. The Company expects future growth in noninterest income to
coincide with asset and deposit growth.

    1996 compared to 1995

    Service charge income increased 23.50% in 1996 compared to 1995 due to
increases in the levels of deposits and a full year of operations under an
increased fee structure implemented in 1995. Insurance commission income was
virtually unchanged ($162,000 in 1996 compared to $160,000 in 1995). Other
operating income declined 8.10%, the result of a bond loss recovery of $40,000
recognized in 1995 that was not repeated in 1996. Losses on security
transactions increased by $20,000 as the Company disposed of some
underperforming investments and reinvested the proceeds in higher yielding
obligations.


Noninterest Expenses

    1997 compared to 1996

    Total noninterest expenses increased 11.94% in 1997 when compared with 1996
operations. Salaries and benefits increased 13.41% due to the increase in staff
at the new branches and merit and inflationary raises. Average full time
equivalent employees increased 9.60% in 1997 and staffing the new branches was
the major reason for this increase. The costs of occupancy and equipment
increased 11.09% due to the branch openings and the equipment costs and
depreciation associated with this expansion. Data processing expenses increased
by 12.47% due to new communication lines, general asset growth and expanded
locations. Other noninterest expenses increased 8.92% in 1997 for all of the
reasons cited above. The overall noninterest expense as a percentage of average
assets was 2.73% in 1997 compared to 2.61% in 1996 and 2.62% in 1995. While the
ratio increased slightly in 1997, it is in line with peer group averages and was
expected by management.


<PAGE> 9

Noninterest Expenses (Continued)

    1996 compared to 1995

    Noninterest expenses rose 9.03% in 1996 when compared with 1995 operations.
Salaries and benefits rose 11.99% due to merit and inflationary raises, changes
in the employees' benefit packages and an increase in the number of full time
equivalent employees. Part of the increase was due to salaries paid new
employees for the Keyser branch during their training period. Occupancy and
equipment expenses rose 43.67% in 1996 as the Company incurred additional costs
in the expansion of facilities at Petersburg and Moorefield. In addition, the
Moorefield facility suffered flood damage in September of 1996 which was
responsible for about forty percent of the 1996 increase. FDIC insurance
expenses declined to almost zero in 1996 as insurance rates were virtually
eliminated in the second half of 1995. Data processing expense rose 5.61% due to
expanded volume and rate increases. Other noninterest expense increased 6.45%
due to inflation and asset growth. The overall noninterest expense as a
percentage of average assets was 2.61% for 1996 which is approximately the same
as in prior years.


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 and
northern Pendleton counties. 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 at December 31, 1997 increased 10.04% from amounts
outstanding at December 31, 1996. Commercial loans showed a 22.36% increase,
installment loans a 9.31% increase and real estate mortgages a 6.20% increase.
The loan to deposit ratio of 81.64% at December 31, 1997 was an increase over
the level of 79.31% at December 31, 1996 and 77.13% at December 31, 1995.


<PAGE> 10

Financial Condition (Continued)

     Loan Portfolio (Continued)

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

                                                  At December 31,
                                            1997        1996        1995
                                               (Dollars in Thousands)
     Real Estate:
       Mortgage                           $ 75,221    $ 70,829    $ 65,971
       Construction                          2,189       2,158       2,622
     Commercial                             30,716      25,104      20,749
     Installment                            31,492      28,693      26,740
                                           -------     -------     -------

                                           139,618     126,784     116,082
     Less unearned discount                 (2,513)     (2,184)     (2,147)
                                           -------     -------     -------

                                           137,105     124,600     113,935
     Allowance for loan losses              (1,369)     (1,257)     (1,319)
                                           -------     -------     -------

       Loans, net                         $135,736    $123,343    $112,616
                                           =======     =======     =======


     The following table shows the maturity of loans outstanding (in thousands
of dollars) as of December 31, 1997, 1996 and 1995.

    Maturity Range                          1997        1996        1995
    --------------                          ----        ----        ----

     Predetermined Rates:
       0 - 12 months                      $ 63,117    $ 45,402    $ 57,049
       13 - 60 months                       54,070      68,879      49,973
       More than 60 months                  19,918      10,319       6,818
     Nonaccrual Loans                                                   95

       Total Loans                        $137,105    $124,600    $113,935
                                           =======     =======     =======


     The following table shows the Company's loan maturity distribution (in
thousands of dollars) as of December 31, 1997:
                                                 Maturity Range
                                Less Than       1-5        Over
       Loan Type                  1 Year       Years      5 Years    Total
       ---------                 -------       -----      -------    -----

     Commercial and
       Agricultural Loans         $ 23,833    $  5,280    $  1,603    $ 30,716
     Real Estate - mortgage         30,053      27,171      17,997      75,221
     Real Estate - construction      2,189                               2,189
     Consumer - installment          7,042      21,619         318      28,979
                                   -------     -------     -------     -------

       Total                      $ 63,117    $ 54,070    $ 19,918    $137,105
                                   =======     =======     =======     =======


<PAGE> 11

Financial Condition (Continued)

     Loan Portfolio (Continued)

     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 which reach nonaccrual status may not be
restored to accrual status until all delinquent principal and interest has been
paid or the loan becomes both well secured and in the process of collection.
Restructured loans are loans with respect to which a borrower has been granted a
concession on the interest rate or the original repayment terms because of
financial difficulties. Loans classified for regulatory purposes as loss,
doubtful, substandard, or special mention do not represent or result from trends
or uncertainties which management reasonably expects will materially impact
future operating results, liquidity, or capital resources, or represent material
credits about which management is aware of any information which causes
management to have serious doubts as to the ability of such borrowers to comply
with the loan repayment terms.

     Nonperforming loans are listed in the table below. Real estate acquired
through foreclosure was $174,000 at December 31, 1997, $160,000 at December 31,
1996 and $269,000 at December 31, 1995. All foreclosed property held at December
31, 1997 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.

     Management has continued its efforts to reduce delinquencies through
greater efforts in the early stages of the delinquency. The increase in 1997 is
due to the delinquent status of a small number of borrowers whose income can be
cyclical. Management does not anticipate any material losses from the current
level of nonperforming assets.

     The following table summarizes the nonperforming loans:

                                                      At December 31,
                                                 1997      1996      1995
                                                  (Dollars in Thousands)

     Loans accounted for on a nonaccrual basis $      0  $      0   $   95

     Loans contractually past due 90 days or
       more as to interest or principal
       payments (not included in nonaccrual
       loans above)
         Commercial                                  17        63      487
         Real estate                                938       208      479
         Installments                               292       110      115
                                                 ------     -----   ------

       Total Delinquent Loans                     1,247       381    1,081
                                                 ------     -----   ------

       Total Nonperforming Loans                $ 1,247    $  381  $ 1,176
                                                 ======     =====   ======

     As of December 31, 1997, the Company did not have any potential problem
loans as defined in Guide 3 that would require disclosure.


<PAGE> 12

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 1.00% at December 31, 1997 compared to 1.01% at December 31,
1996 and 1.16% at December 31, 1995. At December 31, 1997, the ratio of the
allowance for loan losses to nonperforming loans was 109.78% compared to 329.92%
at December 31, 1996 and 112.16% at December 31, 1995.

     The following table summarizes changes in the allowance for loan losses:


                                               Year Ending December 31,
                                              1997       1996       1995
                                               (In Thousands of Dollars)


     Balance at beginning of period          $1,257     $1,319    $1,454
                                              -----      -----     -----

     Loan Losses:
       Commercial and agricultural               34         92       129
       Real estate - mortgage                    20         59        95
       Installment loans to individuals         170        186       156
                                              -----      -----     -----

       Total loan losses                        224        337       380
                                              -----      -----     -----

     Recoveries:
       Commercial and agricultural                9          9        12
       Real estate - mortgage                    25         15        11
       Installment loans to individuals         113        116       102
                                              -----      -----     -----

       Total recoveries                         147        140       125
                                              -----      -----     -----

       Net loan losses                           77        197       255
                                              -----      -----     -----

     Additions charged to operations            190        135       120
                                              -----      -----     -----

     Balance at end of period                $1,370     $1,257    $1,319
                                              =====      =====     =====


     The Company has allocated the allowance for loan losses according to the
amounts deemed to be reasonably necessary to provide for the possibility of
losses incurred within each of the above categories of loans. The allocation of
the allowance as shown in the table below should not be interpreted as an
indication that loan losses in future years will occur in the same proportions
or that the allocation indicates future loan loss trends. Furthermore, the
portion allocated to each loan category is not the total amount available for
future losses that might occur within such categories since the total allowance
is a general allowance applicable to the entire portfolio.


<PAGE> 13

Allowance for Loan Losses (Continued)

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

<TABLE>

<CAPTION>
                                                           At December 31,
                                 1997                             1996                             1995

                                          Percent                          Percent                         Percent
                                            of                               of                              of
                                           Loans                            Loans                           Loans
                                Percent     in                   Percent     in                   Percent    in
                                  of     Category                  of     Category                  of    Category
                                Allow-   to Total                Allow-   to Total                Allow-  to Total
                       Amount    ance      Loans         Amount   ance      Loans         Amount   ance     Loans
                                                          (Dollars in Thousands)
     <S>             <C>          <C>      <C>        <C>          <C>      <C>        <C>          <C>      <C>

     Commercial      $    343      25%      22%       $    314      25%      18%       $    325      25%      18%
     Real estate
       mortgage           548      40       56             440      35       59             463      35       60
     Installment          343      25       22             314      25       23             368      28       22
     Unallocated          136      10                      189      15                      163      12
                      -------     ---      ---         -------    ----     ----         -------    ----

                     $  1,370     100%     100%       $  1,257     100%     100%       $  1,319     100%     100%
                      =======    ====     ====         =======    ====     ====         =======    ====     ====

</TABLE>

     For each period presented, the provision for loan losses charged to
operations is based on management's judgment after taking into consideration all
factors connected with the collectibility of the existing portfolio. Management
evaluates the loan portfolio in light of economic conditions, changes in the
nature and value of the portfolio, industry standards and other relevant
factors. Specific factors considered by management in determining the amounts
charged to operations include internally generated loan review reports, previous
loan loss experience with the borrower, the status of past due interest and
principal payments on the loan, the quality of financial information supplied by
the borrower and the general financial condition of the borrower.

     Loan losses in 1997 were spread over all loan types with no individual loss
constituting a significant portion of the total. Recoveries are unpredictable
and 1997 showed a slightly higher recovery rate than the prior year. The net
credit losses of $77,000 were slightly below management expectations. Management
does not foresee credit losses to be a significant problem in the near future.

     The provision for loan losses totaled $190,000 for the year ended December
31, 1997, $135,000 for 1996 and $120,000 for 1995. In the opinion of management,
the provision charged to operations over this three year period has been
sufficient to absorb the net loan losses.


<PAGE> 14

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 1997, total securities decreased to $37.0
million or 19.38% of total assets at December 31, 1997. Total securities were
$42.3 million or 23.62% of total assets at December 31, 1996.

     The securities portfolio consists of two components, securities held to
maturity and securities available for sale. 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. The Company's
purchases of securities have generally been limited to securities of high credit
quality with short to medium term maturities.

     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, 1997, the market value of the securities available for sale exceeded their
cost by $63,000 ($39,700 after tax considerations).

     The following table summarizes the carrying value of the Company's
securities at the dates indicated:

<TABLE>

<CAPTION>
                                              Held to Maturity                      Available for Sale
                                               Carrying Value                          Carrying Value
                                                December 31,                           December 31,
                                        1997        1996        1995           1997        1996        1995
                                           (Dollars in Thousands)                 (Dollars in Thousands)
     <S>                              <C>         <C>         <C>            <C>         <C>         <C>

     U.S. treasuries, agencies
       and corporations               $   751     $ 4,200     $ 5,107        $20,349     $18,304     $14,312
     Obligations of states and
       political subdivisions           3,295       3,818       4,064            101                     200
     Mortgage-backed securities           531         541         636         10,665      13,807      13,321
                                       ------      ------      ------         ------      ------      ------

       Total Debt Securities            4,577       8,559       9,807         31,115      32,111      27,833

     Other securities                                                            567         946       1,207
                                       ------      ------      ------         ------      ------      ------

       Total                          $ 4,577     $ 8,559     $ 9,807        $31,682     $33,057     $29,040
                                       ======      ======      ======         ======      ======      ======

</TABLE>


<PAGE> 15

Securities (Continued)

     The carrying amount and estimated market value of debt securities (in
thousands of dollars) at December 31, 1997 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              Carrying     Market     Average
                                               Amount       Value      Yield

     Due in one year or less                 $ 760,922   $  761,983     7.18
     Due after one year through five years   1,295,899    1,306,313     4.66
     Due after five years through ten years  1,494,296    1,532,908     5.09
     Due after ten years                       495,108      540,915     7.08
     Mortgage-backed securities                530,738      535,545     7.08
                                              --------    ---------    -----

       Total Held to Maturity               $4,576,963   $4,677,664     5.76
                                             =========    =========    =====


     Securities Available for Sale           Amortized     Market      Average
                                               Cost         Value       Yield

     Due in one year or less               $ 5,958,403  $ 5,978,201     5.79
     Due after one year through five years  13,269,088   13,378,153     6.48
     Due after five years through ten years  1,002,330      991,957     6.85
     Due after ten years                       100,000      101,467     5.34
     Mortgage-backed securities             10,659,595   10,665,813     6.43
                                            ----------   ----------    -----

       Total Fixed Rate Securities          30,989,416   31,115,591     6.34
     Equities                                  629,908      566,767
                                              --------    ---------

       Total Available for Sale            $31,619,324  $31,682,358
                                            ==========   ==========


     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.

Deposits and Short-Term Borrowings

     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 6.70% in 1997
over average levels in 1996. The average rate paid on deposits declined to 5.03%
in 1997 from 5.15% in 1996 and 4.89% in 1995. 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.


<PAGE> 16

Deposits and Short-Term Borrowings (Continued)

     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
1997 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                   1997        1996        1995
         --------------                   ----        ----        ----
                                            (In Thousands of Dollars)

     Three months or less               $  6,086    $  4,832    $   2,567
     Four to twelve months                 8,497      11,360        6,699
     One year to five years                8,744       4,667        6,575
                                         -------     -------     --------

       Total                            $ 23,327    $ 20,859    $  15,841
                                         =======     =======     ========


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.

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

                                           Regulatory     December 31,
                                             Minimum    1997       1996

     Capital Ratios
       Risk-based capital to risk-weighted assets
         Tier 1                               4.00%     17.35%    18.85%
         Total                                8.00%     18.47%    18.82%
       Stockholders' equity to total assets   3.00%     11.16%    11.31%

     The capital management function is an ongoing process. Central to this
process is internal equity generation accomplished by earnings retention. During
1997, 1996 and 1995, total stockholders' equity increased by $1,068,000,
$1,367,000 and $2,086,000, 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 8.80% in 1997 compared to 9.99% for 1996 and 10.15%
for 1995. Total cash dividends declared represent 26.84% of net income for 1997
compared to 24.00% of net income for 1996 and 23.03% for 1995. Book value per
share was $42.43 at December 31, 1997 compared to $39.35 at December 31, 1996
and $36.69 at December 31, 1995.


<PAGE> 17


Capital Resources (Continued)


     In April of 1997, the Company repurchased 12,168 shares of common stock for
$499,000. The repurchased stock is being held as treasury stock and may be used
in future periods for a variety of business purposes. The stock was repurchased
from the estate of William G. VanMeter for whom the Company's chairman, John
VanMeter, is the executor.

     The Company's principal source of cash income is dividend payments from the
Banks. Certain limitations exist under applicable law and regulation by
regulatory agencies regarding dividend payments to a parent by its subsidiaries.
As of December 31, 1997, the Banks had $2,141,000 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 $12,504,000 and an
increase in federal funds sold of $4,401,000. New equipment and facility
additions totaled $607,000 in 1997. Funding these investments was a decline in
investment securities of $5,280,000, an increase in deposits of $10,827,000 and
retained operating income (after the purchase of treasury stock) of $877,000.

     In the year ending December 31, 1997, cash and due from banks increased
$50,000 as cash provided by operations and financing activities slightly
exceeded 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
$505,000 in 1997 was an increase of 6.38 percent over 1996 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.


<PAGE> 18


Liquidity and Interest Rate Sensitivity (Continued)

     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, 1997, the Company had a negative gap position. This
liability sensitive position typically produces a favorable contribution to
earnings during periods of decreasing rates and an unfavorable contribution to
earnings during a period of increasing rates. Although the financial markets
were in a relatively stable rate environment for 1997, certificates of deposit
entered into in early 1995 continued to affect the overall cost of funds through
the fall of 1997. Absent any major changes in federal reserve policy, the
Company expects a slight decline in the overall cost of money in 1998 due to the
maturity of these certificates and stability in other deposit rates.

     With the largest amount of interest sensitive assets and liabilities
repricing within three years, the Company monitors these areas 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 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, 77%
of all loans will reprice within three years of December 31, 1997. 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 generally 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 investment 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 23) shows the maturity of liabilities and assets in future
periods. Table III (page 22) shows the effects of rate and volume changes on the
net interest margin for the past three year period.


<PAGE> 19


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 23) in order to minimize the
effects of inflationary trends on interest rates. Other areas of noninterest
expenses may be more directly affected by inflation.


Preparing for the Year 2000

     Considerable media attention has heightened the awareness of our
shareholders, business partners, customers, and regulators to Year 2000 issues
associated with the banking industry. The Company's directors, officers, and
staff recognize the importance of minimizing any potential problems or business
disruptions attributable to Year 2000 or other date sensitivity issues. The
Company's subsidiaries have developed and implemented plans to identify and
address the issues raised by the century date change.

     The basic Year 2000 issue comes about because of design or programming
shortcuts used in the past to conserve valuable computer space. However, as the
reliance on computerized technology has grown, the Year 2000 problem has grown
from one of merely revising program code and replacing older hardware to an
"enterprise-wide" issue. The cost to the Company for necessary upgrades and
replacements should be absorbed in the normal course of business. As part of its
efforts, the Company is working closely with key customers, suppliers, and
business partners to educate them on pertinent issues and to assist them where
possible. The Company does not anticipate substantial, nonrecurring charges to
address this issue.

     At this time, the Company anticipates no problems in making the Year 2000
transition. Management is making every effort to ensure an enterprise-wide
solution with particular attention to the concerns of shareholders and
customers.

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> 20

TABLE I
<TABLE>
                             SUMMARY OF OPERATIONS
                         (Dollar amounts in thousands)

<CAPTION>
                                                     - - - - - - - - Years Ending December 31, - - - - - - -
                                                              In Thousands Except for Share Amounts)
                                                       1997        1996        1995        1994        1993
<S>                                                  <C>         <C>         <C>         <C>         <C>

Total Interest Income                                $15,084     $14,182     $12,758     $11,726     $12,038
Total Interest Expense                                (7,474)     (7,103)     (6,219)     (5,082)     (5,360)
                                                      ------      ------      ------      ------      ------

Net Interest Income                                    7,610       7,079       6,539       6,644       6,678
Provision for Loan Losses                                190         135         120         240         390
                                                      ------      ------      ------      ------      ------

Net Interest Income after
   Provision for Loan Losses                           7,420       6,944       6,419       6,404       6,288
Other Income                                             571         592         581         467         700
Other Expenses                                         5,115       4,570       4,191       4,052       3,830
                                                      ------      ------      ------      ------      ------

Income before Income Taxes                             2,876       2,966       2,809       2,819       3,158
Income Tax Expense                                       996         953         956         944       1,068
                                                      ------      ------      ------      ------      ------

   Net Income                                        $ 1,880     $ 2,013     $ 1,853     $ 1,875     $ 2,090
                                                      ======      ======      ======      ======      ======

Net Income Per Share                                 $  3.73     $  3.92     $  3.60     $  3.65     $  4.06
Dividends Per Share                                  $  1.00     $   .94     $   .83     $   .72     $   .63

Total Assets at Year End                            $190,770    $178,847    $167,884    $153,361    $150,964
                                                     =======     =======     =======     =======     =======

Return on Average Assets                               1.00%       1.15%       1.16%       1.22%       1.40%
Return on Average Equity                               8.80%       9.99%      10.15%      11.05%      13.93%
Dividend Payout Ratio                                 26.80%      24.00%      23.03%      19.74%      15.50%
Year End Equity to Assets Ratio                       11.16%      11.31%      11.24%      10.94%      10.49%
</TABLE>


<PAGE> 21
TABLE II
<TABLE>
                    NET INTEREST MARGIN AND AVERAGE BALANCE ANALYSIS
                              (Dollar amounts in thousands)

<CAPTION>
                                             1997                             1996                               1995
                                            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 3                          $130,848   $ 12,230   9.35       $116,864   $11,135    9.52       $ 108,659   $ 10,115     9.30

Investment securities:
   Taxable 4                       37,032      2,315   6.25         40,270     2,491    6.19          34,069      2,047     6.00
   Nontaxable 1,4                   3,568        298   8.35          4,146       354    8.53           3,475        302     8.69
                                   ------    -------  -----         ------   -------  ------          ------    -------  -------

   Total Investment
     Securities                    40,600      2,613   6.44         44,416     2,845    6.41          37,544      2,349     6.26

Interest bearing deposits
   in banks                           685         37   5.40            898        48    5.35             587         29     4.94

Federal funds sold                  5,561        314   5.65           5,192       284   5.47           6,524        377     5.78
                                   ------    -------  -----          ------    -------   -------      ------    -------  -------

   Total Earning Assets           177,694     15,194   8.55         167,370    14,312   8.55         153,314     12,870     8.40
                                  -------   -------                 -------   -------                -------   -------

Allowance for loan losses          (1,314)                           (1,288)                          (1,384)
Nonearnings assets                 10,860                             9,280                            7,986
                                   ------                            ------                           ------

   Total Assets                  $187,240                           $175,362                        $159,916
                                  =======                            =======                         =======

INTEREST-BEARING LIABILITIES

Deposits:
   Demand                         $27,823   $    799   2.87          $26,701   $  778   2.91          $27,913   $    870      3.12
   Savings                         18,684        659   3.53           17,535      620   3.54           16,674        642      3.85
   Time deposits                  100,444      5,930   5.90           93,482    5,695   6.09           82,477      4,704      5.70
Other borrowed money                1,443         85   5.89              148       10   6.75               49          3      6.12
                                   ------    -------  -----           ------   ------  -----           ------    -------   -------

   Total Interest Bearing
     Liabilities                  148,394      7,473   5.04          137,866    7,103   5.15          127,113      6,219      4.89
                                  -------   -------                  -------    ----- ------          -------

Noninterest bearing deposits       16,100                             15,600                           13,356
Other liabilities                   1,370                              1,751                            1,187
                                   ------                             ------                           ------

   Total Liabilities              165,864                            155,217                          141,656

   Stockholders' Equity            21,376                             20,145                           18,260
                                   ------                             ------                           ------

   Total Liabilities and Equity  $187,240                           $175,362                         $159,916
                                  =======                            =======                          =======

   Net Interest Earnings                    $  7,721                           $7,209                            $6,651
                                            ========                            =====                             =====

   Net Yield on Interest Earning Assets                4.35%                            4.32%                                4.34%
                                                       ====                             ====                                 ====

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.
</TABLE>


<PAGE> 22

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

<CAPTION>
                                         1997 Compared to 1996                     1996 Compared to 1995
                                          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)
<S>                              <C>         <C>           <C>               <C>         <C>         <C>

Interest Income:

   Loans 2                        $ 1,331    $    (236)    $   1,095         $   763     $   257     $ 1,020

   Investment Securities:
     Taxable                         (200)          24          (176)            372          72         444
     Nontaxable                       (49)          (7)          (56)             58          (6)         52
                                   ------     --------      --------          ------      ------      ------

   Total Investment Securities       (249)          17          (232)            430          66         496

   Interest bearing deposits
     in banks                         (11)                       (11)             15           4          19
   Federal funds sold                  20           10            30             (77)        (16)        (93)
                                   ------     --------      --------          ------      ------      ------

   Total Interest Income            1,091         (209)          882           1,131         311       1,442
                                   ------     --------      --------          ------      ------      ------


Interest Expense:

   Deposits:
     Demand                            33          (12)           21             (38)        (54)        (92)
     Savings                           41           (2)           39              33         (55)        (22)
     All other time deposits          424         (189)          235             627         364         991
   Other borrowed money                87          (12)           75               6           1           7
                                   ------     --------      --------          ------      ------      ------

   Total Interest Expense             585         (215)          370             628         256         884
                                   ------     --------      --------          ------      ------      ------

   Net Interest Income            $   506    $       6     $     512         $   503     $    55     $   558
                                   ======     ========      ========          ======      ======      ======

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.
</TABLE>


<PAGE> 23

TABLE IV
<TABLE>
                      INTEREST RATE SENSITIVITY ANALYSIS
                           (In thousands of dollars)
                               DECEMBER 31, 1997

<CAPTION>
                                                                                   More than
                                                                                    5 Years
                                    1 - 90     91 - 365     1 to 3      3 to 5    or Without
                                     Days        Days        Years       Years     Maturity      Total
EARNINGS ASSETS
<S>                                <C>         <C>         <C>         <C>         <C>         <C>

   Loans                           $19,814     $43,303     $42,456     $11,614     $19,918     $137,105
   Fed funds sold                    6,895                                                       6,895
   Securities                        4,274       6,559      16,526       4,611       5,004      36,974
   Interest bearing time
     deposits                          226         601                                             827
                                    ------      ------      ------      ------      ------      ------

   Total                            31,209      50,463      58,982      16,225      24,922      181,801
                                  --------    --------    --------    --------    --------    ---------

INTEREST BEARING LIABILITIES

   Transaction accounts             15,774                                                      15,774
   Money market accounts            12,179                                                      12,179
   Savings accounts                 19,389                                                      19,389
   Time deposits more than
     $100,000                        6,086       8,497       6,871       1,533         340      23,327
   Time deposits less than
     $100,000                       13,376      36,596      26,189       5,153                  81,314
   Other borrowed money                  5          17          48          54         102         226
                                    ------      ------      ------      ------      ------      ------

   Total                            66,809      45,110      33,108      6,740          442      152,209
                                   -------    --------    --------    -------        -----    ---------

Discrete interest
   sensitivity GAP                 (35,600)      5,353      25,874       9,485      24,480      29,592

Cumulative interest
   sensitivity GAP                 (35,600)    (30,247)     (4,373)      5,112      29,592

Ratio of cumulative interest
   sensitive assets to cumulative   46.71%      72.97%      96.98%     103.37%     119.44%
   interest sensitive liabilities


Assumes all transaction, money market and savings deposit accounts reprice
within 90 days.
</TABLE>


<PAGE> 24

Item 7. Financial Statements


                         Index to Financial Statements



                                                                       Page

Consolidated Balance Sheets as of December 31, 1997 and 1996             25

Consolidated Statements of Income for the Years Ended December 31,
  1997, 1996 and 1995                                                    26

Consolidated Statements of Changes in Stockholders' Equity for
  the Years Ended December 31, 1997, 1996 and 1995                       27

Consolidated Statements of Cash Flows for the Years Ended
  December 31, 1997, 1996 and 1995                                       28

Notes to Consolidated Financial Statements                               29

Independent Auditors' Report                                             45


<PAGE> 25

CONSOLIDATED BALANCE SHEETS

HIGHLANDS BANKSHARES, INC.
                                                        December 31,
ASSETS                                               1997           1996


Cash and due from banks (notes 2, 3 and 14)      $ 3,246,056    $ 3,195,822
Interest bearing deposits in banks                   826,636        833,626
Federal funds sold                                 6,895,115      2,494,077
Investments:
  Securities held to maturity (note 4)             4,576,963      8,558,956
  Securities available for sale (note 4)          31,682,358     33,056,700
  Other investments                                  715,250        638,850

Loans (notes 5, 12, 13 and 14)                   137,105,218    124,600,872
  Less allowance for loan losses (note 6)         (1,369,566)    (1,257,454)
                                                  ----------     ----------

  Net Loans                                      135,735,652    123,343,418

Bank premises and equipment (note 7)               4,772,798      4,525,538
Interest receivable                                1,547,604      1,361,433
Deferred income tax benefits (note 9)                164,988        275,337
Other assets                                         606,442        563,621
                                                  ----------     ----------

  Total Assets                                  $190,769,862   $178,847,378
                                                 ===========    ===========

LIABILITIES

Deposits:
  Noninterest bearing
    Demand deposits                              $15,952,124    $15,416,012
  Interest bearing
    Money market and interest checking            15,773,770     14,131,971
    Money market savings                          12,179,095     12,974,842
    Savings accounts                              19,389,384     17,993,883
    Certificates of deposit over $100,000         23,327,442     20,859,000
    All other time deposits                       81,313,896     75,733,399
                                                  ----------     ----------

  Total Deposits                                 167,935,711    157,109,107

Borrowed money                                       226,152        141,616
Accrued expenses and other liabilities             1,310,998      1,367,198
                                                  ----------     ----------

  Total Liabilities                               169,472,861    158,617,921
                                                  -----------    -----------

STOCKHOLDERS' EQUITY

Common stock, $5 par value, 1,000,000 shares
  authorized, 546,764 shares issued                2,733,820      2,733,820
Surplus                                            1,661,987      1,661,987
Retained earnings (note 11)                       17,854,185     16,478,655
Net unrealized gains (losses) on securities
  available for sale                                  39,710       (151,192)
                                                  ----------     -----------

                                                  22,289,702     20,723,270
Treasury stock (at cost, 44,866 shares in
  1997 and 32,698 shares in 1996)                   (992,701)      (493,813)
                                                  ----------     ----------

  Total Stockholders' Equity                      21,297,001     20,229,457
                                                  ----------     ----------

  Total Liabilities and Stockholders' Equity     $190,769,862   $178,847,378

        The accompanying notes are an integral part of this statement.


<PAGE> 26

CONSOLIDATED STATEMENTS OF INCOME

HIGHLANDS BANKSHARES, INC.

                                             Years Ended December 31,
                                           1997        1996       1995
INTEREST INCOME:
  Loans, including fees                 $12,229,824 $11,134,887 $10,115,016
  Federal funds sold                        314,382     284,286     377,367
  Interest bearing deposits                  36,915      48,357      29,131
  Investment securities - taxable         2,314,849   2,491,490   2,047,061
  Investment securities - nontaxable        187,667     223,795     189,953
                                          ---------    --------    --------

  Total Interest Income                  15,083,637  14,182,815  12,758,528
                                         ----------   ----------  ----------

INTEREST EXPENSE:
  Time deposits over $100,000             1,374,899   1,246,000     975,298
  Other deposits                          6,013,147   5,847,251   5,240,768
                                          ---------   ---------   ---------

  Total Interest on Deposits              7,388,046   7,093,251   6,216,066

  Borrowed money                             85,224       9,921       3,176
                                          ---------    --------    --------

  Total Interest Expense                  7,473,270   7,103,172   6,219,242
                                          ---------   ---------   ---------

NET INTEREST INCOME                       7,610,367   7,079,643   6,539,286

PROVISION FOR LOAN LOSSES (note 6)          190,000     135,000     120,000
                                          ---------    --------    --------

Net Interest Income after Provision
  for Loan Losses                         7,420,367   6,944,643   6,419,286
                                          ---------   ---------   ---------

NONINTEREST INCOME:
  Service charges                           302,726     252,689     204,614
  Insurance commissions and sales           174,061     162,306     160,316
  Other operating income                    211,546     206,398     224,583
  Loss on security transactions (note 4)   (117,036)    (29,503)     (9,185)
                                          ---------    --------    --------

  Total Noninterest Income                  571,297     591,890     580,328
                                          ---------    --------    --------

NONINTEREST EXPENSES:
  Salaries and benefits (note 10)         2,810,116   2,477,928   2,212,677
  Occupancy expense                         241,478     270,678     172,406
  Equipment expense                         424,032     328,372     244,554
  Data processing expense                   437,232     388,753     368,101
  Other operating expenses                1,202,271   1,103,804   1,193,310
                                          ---------   ---------   ---------

  Total Noninterest Expenses              5,115,129   4,569,535   4,191,048
                                          ---------   ---------   ---------

  Income before Income Tax Expense        2,876,535   2,966,998   2,808,566

INCOME TAX EXPENSE (note 9)                 996,390     953,874     956,085
                                          ---------    --------    --------

NET INCOME                               $1,880,145  $2,013,124  $1,852,481
                                          =========   =========   =========

Net Income Per Share                    $      3.73  $     3.92  $     3.60
                                         ==========   =========   =========

Cash Dividends Paid Per Share           $      1.00  $      .94  $      .83
                                         ==========   =========   =========

Weighted Average Shares Outstanding         504,330     514,066     514,066
                                          =========    ========    ========

        The accompanying notes are an integral part of this statement.

<PAGE> 27

CONSOLIDATED STATEMENTS OF CHANGES IN STOCKHOLDERS' EQUITY

HIGHLANDS BANKSHARES, INC.
<TABLE>

<CAPTION>
                                                                                   Net
                                                                               Unrealized
                                                                             Gain (Loss) on
                                                                               Securities
                                             Capital                Retained    Available     Treasury
                                               Stock     Surplus    Earnings    for Sale        Stock       Total
<S>                                         <C>         <C>         <C>         <C>         <C>          <C>

BALANCE
   DECEMBER 31, 1994                        $2,733,820  $1,661,987  $13,522,947 $(648,869)  $ (493,813)  $16,776,072

   Net income                                                         1,852,481                            1,852,481
   Cash dividends                                                      (426,671)                           (426,671)
   Change in unrealized gain
     on securities available
     for sale, net of tax
     effect of $387,706                                                           660,149                  660,149
                                             --------    --------     --------    --------    ---------    --------


BALANCE
   DECEMBER 31, 1995                        2,733,820   1,661,987    14,948,757    11,280     (493,813)  18,862,031

   Net income                                                         2,013,124                           2,013,124
   Cash dividends                                                      (483,226)                           (483,226)
   Change in unrealized loss
     on securities available
     for sale, net of tax
     effect of $95,420                                                           (162,472)                 (162,472)
                                             --------    --------      --------    --------    ---------    --------


BALANCE
   DECEMBER 31, 1996                        2,733,820   1,661,987    16,478,655   (151,192)   (493,813)  20,229,457

   Net income                                                         1,880,145                           1,880,145
   Cash dividends                                                      (504,615)                           (504,615)
   Change in unrealized loss
     on securities available
     for sale, net of tax
     effect of $112,119                                                            190,902                  190,902
   Purchase of treasury stock
     (12,168 shares)                                                                          (498,888)    (498,888)
                                             --------    --------      --------    --------    ---------    --------


BALANCE
   DECEMBER 31, 1997                       $2,733,820   $1,661,987  $17,854,185  $  39,710  $ (992,701) $21,297,001
                                            =========    =========   ==========  ========    =========   ==========
</TABLE>

             The accompanying notes are an integral part of this statement.


<PAGE>28


CONSOLIDATED STATEMENTS OF CASH FLOWS

HIGHLANDS BANKSHARES, INC.
                                                  Years Ended December 31,
                                                1997        1996       1995

CASH FLOWS FROM OPERATING ACTIVITIES:
   Net income                                $1,880,145  $2,013,124  $1,852,481
   Adjustments to reconcile net income to
     net cash provided by operating activities:
       Loss on equipment                                     26,339
       Loss on sale of securities               117,036      29,503       9,185
       Depreciation                             359,740     262,757     198,517
       Net amortization of security premiums     25,000      66,023     167,260
       Provision for loan losses                190,000     135,000     120,000
       Deferred income taxes                     (1,768)     62,065      89,518
       Change in other assets and liabilities:
         Interest receivable                   (186,171)    (58,820)        386
         Other assets                           (42,801)    (49,593)    (12,921)
         Accrued expenses                       (56,201)    239,230     130,256
                                              ---------   ---------   ---------

   Net Cash Provided by Operating Activities  2,284,980   2,725,628   2,554,682
                                             ---------- -----------  ----------

CASH FLOWS FROM INVESTING ACTIVITIES:
   Proceeds from maturity of securities
     held to maturity                         3,354,000   3,736,267   2,018,760
   Purchases of securities held to maturity    (620,600) (2,859,702)
   Proceeds from maturities of securities
     available for sale                       9,291,964  12,028,403  12,612,466
   Proceeds from sales of securities available
     for sale                                   501,000   1,511,173
   Purchases of securities available for sale(7,630,000)(19,863,779)(12,307,206)
   Net change in other investments              (76,065)
   Net change in deposits in other banks          6,990     160,957    (601,942)
   Net increase in loans                     12,582,234) 10,712,064)(10,109,618)
   Change in federal funds sold              (4,401,038)  3,522,275  (1,391,007)
   Purchase of property and equipment          (607,000) (1,476,627) (1,836,894)

   Net Cash Used in Investing Activities    (12,142,383)(11,713,995)(14,475,143)


CASH FLOWS FROM FINANCING ACTIVITIES:
   Net change in time deposits                8,048,939   9,398,863  12,080,569
   Net change in other deposit accounts       2,777,665      (2,468)     69,059
   Net change in borrowed money                  84,536     (15,844)    157,460
   Dividends paid in cash                      (504,615)   (483,226)    426,671)
   Purchase of treasury stock                  (498,888)
                                              ---------

   Net Cash Provided by Financing Activities  9,907,637   8,897,325   1,880,417
                                             ---------- -----------  ----------

CASH AND CASH EQUIVALENTS:
   Net increase (decrease) in cash and
     due from banks                              50,234     (91,042)    (40,044)
   Cash and due from banks, beginning of year 3,195,822   3,286,864   3,326,908
                                             ---------- -----------  ----------

   Cash and Due from Banks, End of Year      $3,246,056  $3,195,822  $3,286,864
                                              =========   =========   =========

Supplemental Disclosures:
   Cash paid for:
     Interest expense                        $7,525,000  $6,993,122  $6,040,215
     Income taxes                               939,000     940,000     908,608

          The accompanying notes are an integral part of this statement.


<PAGE> 29

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, the Capon Valley Bank and HBI Life Insurance
         Company, Inc. which operate under charters issued in West Virginia
         and Arizona. State chartered banks are subject to regulation by
         the West Virginia Division of Banking, 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 and Pendleton counties of West Virginia,
         including the towns of Petersburg, Keyser, Moorefield and
         Wardensville through six branch offices. The insurance company
         sells life and accident coverage exclusively through the Company's
         subsidiary banks.


 NOTE 2   SUMMARY OF SIGNIFICANT ACCOUNTING POLICIES:

          The accounting and reporting policies of Highlands Bankshares,
          Inc. ("Company") and its subsidiaries conform to generally
          accepted accounting principles 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 and HBI Life
              Insurance 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> 30


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 a separate component of
             stockholders' equity. Also included in securities available
             for sale are marketable equity securities.

             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> 31

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS

HIGHLANDS BANKSHARES, INC.


NOTE 2   SUMMARY OF SIGNIFICANT ACCOUNTING POLICIES (CONTINUED):

         (g) Impaired Loans

             Accounting standards require that impaired loans within the
             scope of the statements be presented in the financial
             statements at the present value of expected future cash flows
             or at the fair value of the loan's collateral. A valuation
             allowance is required to the extent that such measurement is
             less than the recorded investment. Under this standard a loan
             is considered impaired based on current information and
             events, if it is probable that the Company will be unable to
             collect the scheduled payments of principal and interest when
             due under the contractual terms of the loan agreement.
             Charge-offs for impaired loans occur when the loan, or portion
             of the loan is determined to be uncollectible, as is the case
             for all loans. The effect of these standards was not material
             to the Company's consolidated financial statements as of and
             for the years ended December 31, 1997, 1996 or 1995.

         (h) 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         6 - 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.

              (i) 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.

              (j) Earnings Per Share

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

              (k) 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.


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> 32

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, 1997

          U. S. Treasuries
            and Agencies      $  750,921  $   1,480   $     447  $  751,954
          Mortgage-backed        530,738      4,807                 535,545
          State and municipals 3,295,304     97,662       2,801   3,390,165
                               ---------   --------    --------   ---------

          Total Securities
            Held to Maturity  $4,576,963  $ 103,949   $   3,248  $4,677,664
                               =========   ========    ========   =========

          December 31, 1996

          U. S. Treasuries
            and Agencies      $4,200,310  $  23,351   $     855  $4,222,806
          Mortgage-backed        540,327      4,906                 545,233
          State and municipals 3,818,319     62,493      28,742   3,852,070
                               ---------   --------    --------   ---------

          Total Securities
            Held to Maturity  $8,558,956  $  90,750   $  29,597  $8,620,109
                               =========   ========    ========   =========

          Available for Sale

          December 31, 1997

          U. S. Treasuries
            and Agencies      $20,229,821 $ 131,837   $  13,347  $20,348,311
          Mortgage-backed      10,659,595    57,894      51,676   10,665,813
          State and municipals    100,000     1,467                  101,467
          Marketable equities     629,908                63,141      566,767
                                ---------   --------    --------   ---------

          Total Securities
            Available for Sale$31,619,324 $ 191,198   $ 128,164  $31,682,358
                               ==========  ========    ========   ==========

          December 31, 1996

          U. S. Treasuries
            and Agencies      $18,270,372 $ 100,114   $  66,191  $18,304,295
          Mortgage-backed      13,890,315    61,810     145,273   13,806,852
          Marketable equities   1,136,002               190,449      945,553
                                ---------   --------   --------    ---------

          Total Securities
            Available for Sale$33,296,689 $ 161,924   $ 401,913  $33,056,700
                               ==========  ========    ========   ==========


<PAGE> 33

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS

HIGHLANDS BANKSHARES, INC.

NOTE 4    SECURITIES (CONTINUED):

          The carrying amount and fair value of debt securities at December 31,
          1997, 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               Carrying        Fair
                                                     Amount         Value

          Due in one year or less                  $  760,922    $  761,983
          Due after one year through five years     1,295,899     1,306,313
          Due after five years through ten years    1,494,296     1,532,908
          Due after ten years                         495,108       540,915
          Mortgage-backed securities                  530,738       535,545
                                                    ---------     ---------

            Total Held to Maturity                 $4,576,963    $4,677,664
                                                    =========     =========


          Securities Available for Sale             Carrying        Fair
                                                     Amount         Value

          Due in one year or less                  $5,958,403    $5,978,201
          Due after one year through five years    13,269,088    13,378,153
          Due after five years through ten years    1,002,330       991,957
          Due after ten years                         100,000       101,467
          Mortgage-backed securities               10,659,595    10,665,813
                                                   ----------    ----------

          Total Fixed Rate Securities              30,989,416    31,115,591
          Equities                                    629,908       566,767
                                                    ---------     ---------

            Total Available for Sale              $31,619,324   $31,682,358
                                                   ==========    ==========

          The carrying amount (which approximates market value) of securities
          pledged by the banks to primarily secure deposits amounted to
          $8,116,050 at December 31, 1997 and $7,051,868 at December 31, 1996.

          There were no holdings totaling more than 10% of stockholders' equity
          with any issuer as of December 31, 1997 and 1996.

          Gains and losses recognized in 1997 are primarily from securities
          available for sale. All gains or losses in 1996 and 1995 are from
          calls or early payoffs of securities designated as held to maturity.
          Losses in 1997 include a loss on a mutual fund investment as well as
          gains/losses on calls and redemptions. Realized gains or losses for
          the years ending December 31 are as follows:

                                         1997          1996          1995
                                     ------------  ------------  --------

          Gains                       $   6,982    $    2,386    $      813
          Losses                       (124,018)      (31,889)       (9,998)
                                       --------     ---------     ---------

            Total                     $(117,036)   $  (29,503)   $   (9,185)
                                       ========-    =========     =========


<PAGE> 34


NOTES TO CONSOLIDATED FINANCIAL STATEMENTS

HIGHLANDS BANKSHARES, INC.

NOTE 5    LOANS:

          Loans outstanding as of December 31 are summarized as follows:

                                                      1997          1996


          Commercial                              $30,716,769   $25,103,784
          Real estate construction                  2,189,000     2,158,000
          Real estate mortgages                    75,221,128    70,829,083
          Consumer installment                     31,491,717    28,693,887
                                                   ----------    ----------

            Subtotal                              139,618,614   126,784,754
            Unearned interest                      (2,513,396)   (2,183,882)
                                                   ----------    ----------

            Total Loans                          $137,105,218  $124,600,872
                                                  ===========   ===========


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:

                                       1997          1996          1995

          Balance at beginning
            of year                 $1,257,454    $1,319,099    $1,454,307
          Provision charged to
            operating expenses         190,000       135,000       120,000
          Loan recoveries              146,855       140,289       124,501
          Loans charged off           (224,743)     (336,934)     (379,709)
                                     ---------     ---------     ----------

            Balance at end of year  $1,369,566    $1,257,454    $ 1,319,099
                                     =========     =========     ==========

            Percentage of outstanding
              loans                       1.00%         1.01%          1.16%


<PAGE> 35

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:

                                                         1997         1996

          Land                                       $ 553,652   $  553,652
          Buildings and improvements                 4,597,205    4,232,937
          Furniture and equipment                    2,680,767    2,446,961
                                                     ---------    ---------

          Total cost                                 7,831,624    7,233,550
            Less - accumulated depreciation         (3,058,826)  (2,708,012)
                                                    ----------   ----------

            Net Book Value                          $4,772,798   $4,525,538
                                                     =========    =========

          Provisions for depreciation of $359,740 in 1997,  $262,757 in 1996
          and $198,517 in 1995, were charged to operations.


NOTE 8    DEPOSITS:

          At December 31, 1997, the scheduled maturities of certificates of
          deposit are as follows:

                      1998                         $64,555,588
                      1999                          22,130,930
                      2000                          10,929,125
                      2001                           3,007,298
                      2002 and thereafter            4,018,397
                                                    ----------

                      Total                       $104,641,338


NOTE 9    INCOME TAX EXPENSE:

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

                                           1997         1996        1995
                                       ------------ --------------------

          Current expense
            Federal                     $ 883,728   $ 829,724   $  751,593
            State                         114,430      62,085      114,974
                                       ----------   ---------   ----------

            Total current expense         998,158     891,809      866,567
                                         --------    --------    ---------

          Deferred expense
            Federal                        (1,625)     56,940       82,260
            State                            (143)      5,125        7,258
                                          -------    --------     --------

            Total deferred expense         (1,768)     62,065       89,518
                                         --------    --------    ---------

            Income tax expense          $ 996,390   $ 953,874   $  956,085
                                         ========    ========    =========


          Income expense (benefits)
            relating to losses on
            security transactions
            are as follows:              $   2,040   $ (10,916)  $   (3,398)


<PAGE> 36

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS

HIGHLANDS BANKSHARES, INC.


NOTE 9    INCOME TAX EXPENSE (CONTINUED):

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

                                               1997      1996       1995
                                           --------------------------------

          Tax effect of temporary differences:
            Provision for loan losses        $(42,793)  $ 2,492   $ 60,187
            Sale of loans                      (7,744)   11,105     12,128
            Pension expense                   (10,404)  (13,587)    (2,053)
            Depreciation                       51,675    41,825     14,363
            Miscellaneous                       7,498    20,230      4,893
                                              -------    ------    -------

            Net (increase) decrease in
              deferred income tax benefit    $ (1,768)  $62,065   $ 89,518
                                              =======    ======    =======


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

                                                          1997        1996

          Deferred Tax Assets:
            Provision for loan losses                   $282,258  $231,530
            Insurance commissions                         32,199    34,350
            Sale of loans                                 46,385    38,640
            Capital loss carryforward                     45,343
            Unrealized loss on securities
              available for sale                                    88,797
            Other                                         26,819    20,635
              Less valuation allowance                   (45,343)

            Total Assets                                 387,661   413,952
                                                         -------   -------

          Deferred Tax Liabilities:
            Pension prepaids                              43,070    53,474
            Unrealized gain on securities
              available for sale                          23,322
            Accretion income                              47,828    28,272
            Accelerated depreciation                     108,453    56,869
                                                         -------   -------

            Total Liabilities                            222,673   138,615
                                                         -------   -------

            Net Tax Asset                               $164,988  $275,337
                                                         =======   =======


<PAGE> 37

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS

HIGHLANDS BANKSHARES, INC.


NOTE 9    INCOME TAX EXPENSE (CONTINUED):

          The following table summarizes the difference between income tax
          expense and the amount computed by applying the federal statutory
          income tax rate of 34 percent for the years ended December 31:

                                                1997      1996       1995


          Amounts at federal statutory rates  $978,023  $1,008,779  $954,912
          (Reductions) additions resulting
            from:
              Tax-exempt income                (69,759)    (77,900)   (54,343)
              Partially exempt income          (39,429)    (39,771)   (35,739)
              State income taxes, net           80,113      69,538     86,179
              Nondeductible capital losses      45,343
              Other                              2,099      (6,772)     5,076
                                              --------   ---------   --------

              Income tax expense             $ 996,390  $  953,874   $956,085
                                              ========   =========   ========


NOTE 10   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 able to make contributions to
          the Plan in 1997, 1996 or 1995. The amounts of the prepaid expense 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 will be considered outstanding in the computation of earnings
          per share. Shares of Company stock when distributed will have
          restrictions on transferability.

          Deferred compensation expenses for the above benefits charged to
          operations totaled $189,595 in 1997, $206,893 in 1996 and $139,371 in
          1995.


<PAGE> 38


NOTES TO CONSOLIDATED FINANCIAL STATEMENTS

HIGHLANDS BANKSHARES, INC.


NOTE 11   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, 1998, the banks could pay dividends to the Company of
          approximately $2,140,964 without permission of the regulatory
          authorities.


NOTE 12   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 $1,593,252 at December 31, 1996, was increased
          $2,762,595 by new loans and reduced $1,017,330 by payments, resulting
          in an ending balance of $3,338,517 at December 31, 1997.


NOTE 13   COMMITMENTS AND GUARANTEES:

          The Banks make commitments to extend credit in the normal course of
          business and issues standby letters of credit to meet the financing
          needs of its 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:
                                                       1997        1996

          Commitments to extend credit              $8,414,000  $5,743,000
          Standby letters of credit                    645,000     677,000

          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> 39


NOTES TO CONSOLIDATED FINANCIAL STATEMENTS

HIGHLANDS BANKSHARES, INC.


NOTE 14   CONCENTRATIONS OF CREDIT:

          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 its 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 59%
          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 $7,661,626 and $3,511,000 at December 31,
          1997 and 1996, respectively.


NOTE 15   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.


<PAGE> 40


NOTES TO CONSOLIDATED FINANCIAL STATEMENTS

HIGHLANDS BANKSHARES, INC.


NOTE 15   DISCLOSURES ABOUT FAIR VALUE OF FINANCIAL INSTRUMENTS (CONTINUED):

          Interest Payable and Receivable

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

          Off-Balance-Sheet Items

          The carrying amount and estimated fair value of off-balance-sheet
          items were not material at December 31, 1997.

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

<TABLE>

<CAPTION>
                                                             1997                             1996
                                                                   Estimated                        Estimated
                                                    Carrying         Fair            Carrying         Fair
                                                     Amount          Value            Amount          Value
          <S>                                     <C>            <C>               <C>            <C>

          Financial Assets:
            Cash and due from banks               $3,246,056     $3,246,056        $3,195,822     $3,195,822
            Interest bearing deposits                826,636        826,636           833,626        833,626
            Federal funds sold                     6,895,115      6,895,115         2,494,077      2,494,077
            Securities held to maturity            4,576,963      4,677,664         8,558,956      8,620,109
            Securities available for sale         31,682,358     31,682,358        33,056,700     33,056,700
            Other investments                        715,250        715,250           638,850        638,850
            Loans, net                           135,735,652    136,215,953       123,343,418    123,592,407
            Interest receivable                    1,547,604      1,547,604         1,361,433      1,361,433

          Financial Liabilities:
            Demand deposits                       63,294,373     63,294,373        60,516,708     60,516,708
            Term deposits                        104,641,338    104,624,538        96,592,399     96,535,118
            Borrowed money                           226,152        226,152           141,616        141,616
            Interest payable                         743,000        743,000           795,000        795,000
</TABLE>

NOTE 16   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.


<PAGE> 41

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS

HIGHLANDS BANKSHARES, INC.


NOTE 16   REGULATORY MATTERS (CONTINUED):


          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). Management
          believes, as of December 31, 1997 and 1996, that the Company meets all
          capital adequacy requirements to which it is subject.

          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
                                        1997    1996     Capitalized Capitalized

          Total risk-based ratio       17.35%   18.82%       8.00%      10.00%
          Tier 1 risk-based ratio      18.47%   18.85%       4.00%       6.00%
          Total assets leverage ratio  11.15%   11.58%       3.00%       5.00%

          Capital ratios and amounts are applicable both at the individual bank
          level and on a consolidated basis. At December 31, 1997, both
          subsidiary banks had capital levels far 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> 42


NOTES TO CONSOLIDATED FINANCIAL STATEMENTS

HIGHLANDS BANKSHARES, INC.


NOTE 17   PARENT CORPORATION ONLY FINANCIAL STATEMENTS:


                                BALANCE SHEETS

          Assets                                          December 31,
                                                       1997         1996

            Cash                                    $   18,695   $   29,819
            Investment in subsidiaries              21,155,702   20,087,421
            Other investments                          100,000      100,000
            Other assets                                                652
            Income taxes receivable                      5,436       11,565
            Due from subsidiaries                       17,168
                                                     ---------

            Total Assets                           $21,297,001  $20,229,457
                                                    ==========   ==========


          Stockholders' Equity

            Common stock, par value $5 per share
              authorized 1,000,000 shares; 546,764
              shares issued                          2,733,820    2,733,820
            Surplus                                  1,661,987    1,661,987
            Retained earnings                       17,854,185   16,478,655
            Net unrealized gains (losses) on
              securities available for sale             39,710     (151,192)
                                                     ---------    ---------

                                                    22,289,702   20,723,270
            Less treasury stock (at cost,
              44,866 shares in 1997 and
              32,698 shares in 1996)                  (992,701)    (493,813)
                                                     ---------    ---------

            Total Stockholders' Equity              21,297,001   20,229,457
                                                    ----------   ----------

            Total Liabilities and Stockholders'
              Equity                               $21,297,001  $20,229,457
                                                    ==========   ==========


<PAGE> 43


NOTES TO CONSOLIDATED FINANCIAL STATEMENTS

HIGHLANDS BANKSHARES, INC.


NOTE 17   PARENT CORPORATION ONLY FINANCIAL STATEMENTS (CONTINUED):


                  STATEMENTS OF INCOME AND RETAINED EARNINGS

                                                 Years Ended December 31,
                                              1997         1996         1995

          Income

            Dividends from subsidiaries     $1,055,054   $ 483,226    $ 451,675
            Other dividends                        630         630          630
                                              --------    --------     --------

            Total                             1,055,684    483,856      452,305
                                             ----------  ---------   ----------

          Expenses

            Professional fees                    37,980      34,478      22,203
            Advertising                           6,094       3,320       3,452
            Other expenses                       39,054      18,754      26,189
                                               --------    --------    --------

            Total                                83,128      56,552      51,844
                                              ---------   ---------   ---------

          Net income before income tax benefit
            and undistributed income of
            subsidiaries                        972,556     427,304     400,461

          Income tax benefit                    (30,211)    (18,815)    (20,112)
                                               --------    --------    --------

          Income before undistributed income
            of subsidiaries                   1,002,767     446,119     420,573

          Undistributed income of
            subsidiaries                        877,378   1,567,005   1,431,908
                                               --------   ---------   ---------

            Net Income                        1,880,145   2,013,124   1,852,481

          Retained earnings,
            Beginning of period              16,478,655  14,948,757  13,522,947
            Dividends paid                     (504,615)   (483,226)   (426,671)
                                               --------    --------    --------

          Retained Earnings,
            End of Period                   $17,854,185 $16,478,655 $14,948,757
                                             ==========  ==========  ==========


<PAGE> 44


NOTES TO CONSOLIDATED FINANCIAL STATEMENTS

HIGHLANDS BANKSHARES, INC.


NOTE 17   PARENT CORPORATION ONLY FINANCIAL STATEMENTS (CONTINUED):


                           STATEMENTS OF CASH FLOWS


                                                  Years Ended December 31,
                                                1997       1996        1995


          Cash Flows from Operating Activities:
            Net income                       $1,880,145  $2,013,124  $1,852,481
            Adjustments
              Undistributed subsidiary income  (877,378) (1,567,005) (1,431,908)
              Depreciation                          181         408         391
              Increase (decrease) in payables               (41,738)     16,901
              (Increase) decrease in receivables(10,569)     19,139     (31,176)

            Net Cash Provided by Operating
              Activities                        992,379     423,928     406,689
                                               --------    --------    --------


          Cash Flows from Financing Activities:
            Dividends paid                     (504,615)   (483,226)   (426,671)
            Purchase of treasury stock         (498,888)
                                               --------

            Net Cash Used in Financing
              Activities                     (1,003,503)   (483,226)   (426,671)
                                             ----------   ---------  ----------

          Net Decrease in Cash                  (11,124)    (59,298)    (19,982)

          Cash, Beginning of Year                29,819      89,117     109,099
                                               --------    --------    --------

          Cash, End of Year                   $  18,695   $  29,819   $  89,117
                                               ========    ========    ========


<PAGE> 45


                         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, 1997 and 1996, 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,
1997. 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 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, 1997 and 1996, and the
consolidated results of their operations and their cash flows for each of the
years in the three year period ended December 31, 1997, in conformity with
generally accepted accounting principles.

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



January 15, 1998
Harrisonburg, Virginia


<PAGE> 46

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

     None

Part III

Item  9. Directors and Executive Officers

     We  are   incorporating the Proxy Statement of Highlands Bankshares, Inc.
     via  Form   DEF  14A   filed March 18, 1998.

Item 10. Executive Compensation

     We  are   incorporating   the   Proxy   Statement   of   Highlands
     Bankshares,   Inc.   via  Form   DEF  14A   filed March 18, 1998.

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 18, 1998.

Item 12. Certain Relationships and Related Transactions

     We  are   incorporating   the   Proxy   Statement   of   Highlands
     Bankshares,   Inc.   via  Form   DEF  14A   filed March 18, 1998.

     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 12 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 & Roth, 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
                            were filed on December 8, 1997 and are attached
                            hereto.


<PAGE> 47

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 were filed with
                            the West Virginia Secretary of State on December 8,
                            1997 and are attached hereto.

             4              Not applicable

             9              Not applicable

            10              Not applicable

            11              Not applicable

            12              Not applicable

            16              Not applicable

            18              Not applicable

            21              Subsidiaries of the Small Business Issuer is
                            attached on Page 49

            22              Not applicable

            23              Consent of Certified Public Accountant attached on
                            Page 50

            24              Not applicable

            27              Financial Data Schedule attached

            28              Not applicable


     b)  Reports on Form 8-K

         No reports on Form 8-K were filed in the fourth quarter of 1997.


<PAGE> 48


                                  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   LESLIE A. BARR
                                             Leslie A. Barr
                                             President, Chief Executive Officer


                                        Date  March 27, 1998



                                        By   CLARENCE E. PORTER
                                             Clarence E. Porter
                                             Secretary/Treasurer,
                                             Chief Financial Officer
                                             and Chief Accounting Officer


                                        Date   March 27, 1998

   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

                                                                March 27, 1998
LESLIE A. BARR                                              ------------------
Leslie A. Barr                          President
                               & Chief Executive Officer
                                        Director
                                                                March 27, 1998
THOMAS B. MCNEIL, SR.                                       ------------------
Thomas B. McNeil, Sr.                   Director


GEORGE B. MOOMAU                                                March 27, 1998
George B. Moomau                        Director


CLARENCE E. PORTER                                              March 27, 1998
Clarence E. Porter                 Secretary/Treasurer
                                     Chief Financial
                                 and Accounting Officer
                                        Director

COURTNEY R. TUSING                                              March 27, 1998
Courtney R. Tusing                      Director



John G. VanMeter                  Chairman of the Board
                                        Director




Jack H. Walters                         Director




L. Keith Wolfe                          Director