Item 1.
Business
Item 1A.
Item 1A. Risk Factors
Not applicable
Item 1B.
Item 1B. Unresolved Staff Comments
None
Item 2.
Item 2. Properties
The Company’s and the Bank’s headquarters are located at 340 W. Main Street, Abingdon, Virginia. In addition to the Bank's Main Office location, the Bank owns twelve branch offices: one in the Town of Abingdon, Virginia; one in Washington County, Virginia; two in the City of Bristol, Virginia; one in the Town of Glade Spring, Virginia; one in the Town of Marion, Virginia; one in the City of Bristol, Tennessee; one in the Town of Rogersville, Tennessee; one in the Town of Boone, North Carolina; one in the Town of Banner Elk, North Carolina; two in the City of Sevierville, Tennessee; and one in the City of Knoxville, Tennessee. The Bank owns the land and buildings of all of these branch offices as well as the main office for the Company and Bank.
The Bank also owns the land and two buildings used for its Collections, Human Resources, Customer Call Center, IRA Operations, Internal Audit and Facilities departments in Abingdon, Virginia. The Bank owns a vacant piece of land in Bristol, Tennessee and two parcels in Washington County, Virginia that are being held for potential future branch sites.
The Bank also owns the land and buildings used as the Bank’s Operations Center and Technology House in Abingdon, Virginia. The Bank owns approximately 14 acres of vacant land in Abingdon, Virginia for future possible development of a corporate headquarters. The Bank also owns an additional lot in Boone, North Carolina (approximately 1 acre) for future branching.
All of the existing properties are in good operating condition and are adequate for the Company’s present and anticipated future needs.
The Bank owns all its computer and data processing hardware and is a licensee of the software it utilizes.
Item 3.
Item 3. Legal Proceedings
In 2010, a former borrower filed two complaints in the Circuit Court of Washington County, VA, claiming that the Bank improperly handled the repossession and disposition of collateral from a warehouse in June/July 2008. The borrower also claims that the bank acted as its business advisor and breached fiduciary duties owed to it in this capacity. One complaint seeks $700,000 in damages for conversion based solely on the repossession/disposition of collateral. The second complaint seeks $7,850,000 in damages for breach of fiduciary duty, violation of UCC Article 9, actual fraud, unjust enrichment, and business conspiracy. In response, the Bank filed demurrers to both complaints. The Bank’s demurrer to the second complaint was granted in part and denied in part with leave granted to amend. The Bank is still awaiting a ruling on its demurrer to the conversion complaint. No trial date has been set. The Bank disputes the allegations and believes that they are without merit. The Bank intends to defend itself vigorously.
Item 4.
Item 4. Reserved
Part II
Item 5.
Item 5. Market for Registrant's Common Equity, Related Stockholder Matters and Issuer Purchases of Equity Securities
Common Stock Information and Dividends
Trades in the Company’s common stock are reported on the Over-The-Counter Bulletin Board (OTCBB) and in the Pinksheets by at least five broker dealers under the symbol HBKA.OB. In addition, the Company maintains a list of individuals who are interested in purchasing its common stock and connects these people with shareholders who are interested in selling their stock. These parties negotiate the per share price independent of the Company. The stock transfer agent of the Company attempts to keep a record of stock sales by asking the parties about the trade price per share. Please refer to the table below entitled Common Stock Performance for a summary of sales prices known to the Company for each of the four quarters of 2010 and 2009.
The Company is currently prohibited from paying dividends without regulatory approval under the terms of the Written Agreement dated October 13, 2010. For additional information regarding regulatory restrictions on the Company’s ability to pay dividends, see “Certain Regulatory Considerations - Highlands Union Bank - Limits on Dividend and Other Payments in Item 1 above.
As of March 9, 2011, the Company had approximately 1,482 shareholders of record.
Issuer Repurchases of Equity Securities
The Company had no repurchases of common stock during the three months ended December 31, 2010. The Company does not anticipate any repurchases during 2011 in an effort to retain regulatory capital. In addition, the Company currently is prohibited from repurchasing its common stock without regulatory approval under the terms of the Written Agreement dated October 13, 2010.
The Company currently has 5,011,152 shares of common stock outstanding.
Item 6.
Item 6. Selected Financial Data
Not Applicable
Item 7.
Item 7. Management’s Discussion and Analysis of Financial Condition and Results of Operations
The purpose of this discussion is to provide information about the financial condition and results of operations of the Company and its wholly-owned subsidiaries and other information included in this report. This discussion should be read in conjunction with the Company’s Consolidated Financial Statements and Notes to Consolidated Financial Statements.
Caution About Forward-Looking Statements
This Annual Report on Form 10-K contains forward-looking statements within the meaning of Section 27A of the Securities Act of 1933 and Section 21E of the Securities Exchange Act of 1934, including certain plans, expectations, goals and projections, which are inherently subject to numerous assumptions, risks and uncertainties. The Company's actual results could differ materially from those set forth or implied in the forward-looking statements.
Such forward-looking statements involve known and unknown risks including, but not limited to, the following factors:
·
Our inability to comply with the Written agreement dated October 13, 2010
·
Our inability to comply with certain covenants of the Company’s Loans with Community Bankers Bank;
·
Continued problems related to the national credit crisis and deepening recession;
·
Unemployment continuing to rise;
·
The ability to attract and maintain capital levels adequate to support the Company’s asset levels;
·
Difficult market conditions in our industry;
·
Unprecedented levels of market volatility;
·
Effects of the soundness of other financial institutions;
·
Potential impact on us of recently enacted legislation;
·
Further deterioration in the housing market and collateral values;
·
The ability to successfully manage the Company’s strategic plan.
·
The ability to continue to attract low cost core deposits to fund asset growth
·
Reliance on the Company’s management team, including its ability to attract and retain key personnel;
·
The successful management of interest rate risk;
·
Further adverse changes in general economic and business conditions in the Company’s market area;
·
Changes in interest rates and interest rate policies;
·
Risks inherent in making loans such as repayment risks and fluctuating collateral values;
·
Competition with other banks and financial institutions, and companies outside of the banking industry, including those companies that have substantially greater access to capital and other resources;
·
Demand, development and acceptance of new products and services;
·
Problems with technology utilized by the Company;
·
Changing trends in customer profiles and behavior; and
·
Changes in banking and other laws and regulations applicable to the Company.
Overview
At December 31, 2010, the Bank had total assets of $655.45 million. Total deposits at this date were $539.39 million. The Bank’s net loss for 2010 was $1.51 million which produced a return on average assets of -.23% and a return on average stockholders' equity of -3.63%. Refer to Note 22 of the Notes to Consolidated Financial Statements for the Bank’s risk-based capital ratios.
The Bank offers general retail and commercial banking services to individuals, businesses and local government units. These products and services include accepting deposits in the form of checking accounts, money market deposit accounts, interest-bearing demand deposit accounts, savings accounts and time deposits; making real estate, commercial, revolving, consumer, credit card and agricultural loans; offering letters of credit; providing other consumer financial services, such as automatic funds transfer, collections, night depository, safe deposit, travelers checks and savings bond sales; and providing other miscellaneous services normally offered by commercial banks.
The Company makes money primarily by earning an interest rate spread between the interest rates it earns on loans and securities and interest rates it pays on deposits and other borrowed money. The Company also earns money through fees, service charges and other non-interest income.
Critical Accounting Policies
General
The financial condition and results of operations presented in the Consolidated Financial Statements, accompanying Notes to Consolidated Financial Statements and management’s discussion and analysis are, to a large degree, dependent upon the accounting policies of the Company. The selection and application of these accounting policies involve judgments, estimates, and uncertainties that are susceptible to change.
Presented below is a discussion of the Accounting Policy that management believes is important to the understanding of the Company’s financial condition and results of operations. This critical accounting policy requires management’s most difficult, subjective and complex judgments about matters that are inherently uncertain. In the event that different assumptions or conditions were to prevail, and depending upon the severity of such changes, the possibility of materially different financial condition or results of operations is a reasonable likelihood. See also Note 1 of the Notes to Consolidated Financial Statements.
Allowance for Loan Losses
The Company monitors and maintains an allowance for loan losses to absorb the estimate of probable losses inherent in the loan portfolio. The allowance for loan losses is based on management’s judgment and analysis of current and historical loss experience, risk characteristics of the loan portfolio, concentrations of credit and asset quality, as well as other internal and external factors, such as general economic conditions. The Company recognizes the inherent imprecision in estimates of losses due to various uncertainties, and variability related to the factors used. If different assumptions or conditions were to prevail and it is determined that the allowance is not adequate to absorb the new estimate of probable losses, an additional provision for loan losses would be made, which amount may be material to the Consolidated Financial Statements.
Other than Temporary Impairment
On a quarterly basis the Company reviews any securities which are considered to be impaired as defined by accounting guidance. During this review, the Company determines if the impairment is deemed to be other than temporary. If it is determined that the impairment is other than temporary, i.e. impaired because of credit issues, the investment is written down through the Statement of Operations in accordance with accounting guidance. See Footnote 3 in the Notes to Consolidated Financial Statements for a discussion of the various imputs used as it pertains to the determination of other than temporary impairment.
Performance Summary
The following table shows the Company’s key performance ratios for the years ended December 31, 2010 and 2009:
(1) Net Interest Margin - Year-to-date tax equivalent net interest income divided by year-to-date average earning assets
Growth
The following table shows the Company’s key asset indicators for the years ended December 31, 2010 and 2009:
(dollar amounts in thousands)
Asset Quality
The following table shows the Company’s key asset quality indicators for the years ended December 31, 2010 and 2009:
(dollar amounts in thousands)
For further information see the discussion under "Provision and Allowances for Loan Losses".
Results of Operations
Net Interest Income
(dollar amounts in thousands)
Net interest income for 2010 was $18,320 or a decrease of $9 thousand from 2009. During 2010 interest income decreased by $3,616. This was a result of both existing interest earning assets re-pricing at lower rates and new loans made and securities purchased at lower rates. Average interest earning assets also decreased approximately $18,878 from 2009. Additionally, the amount of non-accruing assets increased from 2009. Interest-bearing liabilities also re-priced downward, causing a decrease in interest expense of $3,607. During 2010, the Federal Reserve Board continued to leave rates at historic lows. The federal funds rate remained at a range below .25% as the economy showed only minimal signs of recovery during the year. The net result of these changes was an increase in the Company’s net interest margin to 3.33% in 2010 from 3.28% in 2009. During 2010, the Company continued to shrink its loan and securities portfolio. The average balance of fed funds sold increased $19,462 during the year as loan and security runoff was primarily invested in overnight funds. The tax equivalent yield on earning assets for 2010 was 5.50%, decreasing 49 basis points during the year. During the same period, the yield on interest bearing liabilities was 2.39%, which was a decrease of 61 basis points. Average interest bearing liabilities decreased $12,588 from 2009. The Company continued to lower time deposit rates throughout the year in an effort to reduce its cost of funds as well as to reduce total assets. The reduction in both the volume and average rates on interest earnings assets was offset by a larger reduction in rates paid on interest bearing deposits.
Analysis of Net Interest Earnings
The following table shows the major categories of interest-earning assets and interest-bearing liabilities, the interest earned or paid, the average yield or rate on the average balance outstanding, net interest income and net yield on average interest-earning assets and average interest spread for the years indicated.
Analysis of Changes in Interest Income and Interest Expense
The Company's primary source of revenue is net interest income, which is the difference between the interest and fees earned on loans and investments and the interest paid on deposits and other funds. The Company's net interest income is affected by changes in the amount and mix of interest-earning assets and interest-bearing liabilities and by changes in yields earned on interest-earning assets and rates paid on interest-bearing liabilities. The following table sets forth, for the years indicated, a summary of the changes in interest income and interest expense resulting from changes in average asset and liability balances (volume) and changes in average interest rates (rate). The increases (decrease) due to change in volume is computed using the change in the average balances between 2009 and 2010 multiplied by the corresponding current year average rates. The remaining increase or decrease in net interest income is allocated to the change in rate.
Increase/(Decrease) Due to Volume and Rate
Non-interest Income
(dollar amounts in thousands)
Non-interest income for 2010 included an “other-than-temporary-impairment charge” in the amount of $1.26 million. In 2009, the Company incurred a $5.62 million charge for OTTI. Both amounts pertain to write-downs on our TRUP CDOs, which represent trust preferred securities issued primarily by banks and a limited number of insurance companies and real estate investment trusts. The cash flow projections for the pooled trust preferred securities utilize a discounted cash flow model that uses variables such as the estimate of future cash flows, creditworthiness of the underlying banks and determination of probability of default of the underlying collateral. Cash flows are constructed in an INTEX cash flow model. It includes each individual issues structural features updated with trustee information, including asset-by-asset detail, as it becomes available. The modeled cash flows are then used to determine if all the scheduled principal and interest payments of our investments will be returned.
The expected future default assumptions for the pooled trust preferred securities are based upon the Company’s best estimate of future bank deferrrals. Banks currently in default or deferring interest payments are assigned a 100% probability of default. In all cases, a 15% projected recovery rate is applied to current and projected deferrals.
Excluding OTTI charges, the Company’s non-interest income decreased by $1,62 million from 2009 to 2010. The majority of this decrease was related to two non-recurring items in 2009: life insurance benefits in the amount of $656 and a gain on the sale of a parcel of land in the amount of $292. Service charges on deposit accounts (primarily overdraft fees) decreased $181 as compared to 2009. The number of checks processed continues to decline as the number of electronic transactions increases. Debit card fee income increased by $149 over 2009 due to increases in visa check card interchange fees. The use of debit cards continued to increase significantly over the prior period.
Earnings related to the Company’s holdings of Bank Owned Life Insurance totaled $452 in 2010 and $458 in 2009. Net securities losses totaled $163 in 2010 compared to gains on securities sales of $380 in 2009.
Non-interest Expense
(dollar amounts in thousands)
Non-interest expense is comprised of salaries and employee benefit costs, occupancy expenses, furniture and equipment expenses and other operating expenses. Non-interest expense for 2010 was $20,690, an increase of $341 from 2009. Salaries and employee benefits decreased by 4.61% or $487. Medical insurance costs decreased $235 from 2009 as a result of fewer claims and continued reduction in staffing. Technology enhancements have allowed the bank to leverage its existing personnel base to help minimize overall increases in personnel costs. FDIC premiums totaled $1.30 million compared to $1.18 million in 2009. OREO write-downs and OREO expenses totaled $2.42 million in 2010 compared to $1.37 million in 2009 as the amount of OREO property held significantly increased over the past year. The depressed real estate values, resulting from the economic recession has made the selling of OREO very challenging even after significantly lowering asking prices. Additionally, surpluses of foreclosed and other properties in the Company’s market areas have affected sales of OREO properties.
Income Taxes
(dollar amounts in thousands)
Income tax benefit for 2010 totaled $2.26 million compared to $5.23 million in 2009. Decreases in the provision for loan losses and OTTI charges during 2010 were the primary contributors to the Company’s reduction in net loss before taxes. Interest income from tax exempt municipal bonds and earnings related to the Company’s investment in BOLI are the primary elements of tax exempt income.
Provision and Allowance for Loan Losses
(dollar amounts in thousands)
The adequacy of the allowance for loan losses is based on management's judgment and analysis of current and historical loss experience, risk characteristics of the loan portfolio, concentrations of credit and asset quality, as well as other internal and external factors, such as general economic conditions. The internal credit review department performs pre-approval analyses of large credits and also conducts credit review activities that provide management with an early warning of loan deterioration. The senior credit administration officer prepares quarterly analyses of the adequacy of the allowance for loans losses. These analyses include reviewing individual loans considered impaired for direct exposure. In addition, calculations are performed that considers identified potential losses on specific loans pools and pool allocations are based upon historical losses and other factors, as adjusted, for various loan types. In recent years, the Company used a rolling three-year history by loan category in determining pool allocation factors. However, due to the severe economic recession, the Company based its pool allocations as of December 31, 2010 and December 31, 2009 to more closely match losses incurred during 2009 and 2010 rather than the average of the prior three years. The Company has also incorporated state-wide averages in its pool allocations during 2010. In addition to the change in the period of historical losses included in the calculation, additional amounts were allocated based upon internal and external factors such as changing trends in the loan mix, the effects of changes in business conditions in our market area, unemployment trends, the effects of any changes in loan policies, the effects of competition, regulatory factors, and environmental factors related to our loan portfolio. The calculation for allowance for loan losses is reviewed by both the Credit Administration Committee and the Board of Directors. The Company allowance for loan losses percentage to total loans was 2.29% and 2.40%, respectively for December 31, 2010 and December 31, 2009.
At December 31, 2010 and 2009, the internal credit review department as well as management determined that the Company's allowance for loan losses is sufficient and is appropriate based on the requirements of US generally accepted accounting principles.
The following table presents the Company’s loan loss experience for the past five years:
Non-performing loans
(dollar amounts in thousands)
The loan portfolio of the Bank is reviewed regularly by senior officers to monitor loan performance. The frequency of the review is based on the rating of credit worthiness of the borrower utilizing various factors such as net worth, credit history and customer relationship. The evaluations emphasize different factors depending upon the type of loan involved. Commercial and real estate loans are reviewed on the basis of projections of cash flow and estimated net realizable value through an evaluation of collateral and the financial strength of the borrower. Installment loans are evaluated largely on the basis of delinquency data because of the large number of such loans and relatively small size of each individual loan.
Management’s review of commercial and other loans may result in a determination that a loan should be placed on non-accrual. It is the policy of the Bank to discontinue the accrual of interest on any loan on which full repayment of principal and / or interest is doubtful. Subsequent collection of interest is recognized as income on a cash basis upon receipt. Placing a loan on non-accrual status for the purpose of income recognition is not in itself a reliable indication of potential loss of principal. Other factors, such as the value of the collateral securing the loan and the financial condition of the borrower serve as more reliable indications of potential loss of principal.
The policy of the Bank is that non-performing loans consist of loans accounted for on a non-accrual basis and loans which are contractually past due 90 days or more in regards to interest and/or principal payments. The following table presents non-performing loans at December 31.
The Company has seen the greatest deterioration of its commercial real estate portfolio in its Sevierville, Tennessee market area and North Carolina market areas. Included above in non-performing loans for 2010 is one large relationship currently, approximately $3.6 million in the North Carolina market. This relationship is primarily secured by several residential and commercial properties. The Company is in the process of acquiring the collateral.
Due to the significant increase in non-performing loans the Company significantly increased its loan loss provision and reserve balance during 2009 and 2010 as compared to previous years. The allowance for loan losses to total loans decreased from 2.40% to 2.29% during 2010. This was primarily due to loans being transferred into OREO and / or liquidated and subsequently written down to current market values out of specific reserves allocated to such loans. As shown in the table below, loans loss reserves allocated to specific categories are adjusted each year based on recent loss percentages for each category. Additionally, specific reserves for individual loans are segregated by collateral type. Management feels that at December 31, 2010 and 2009 reserves are adequate to absorb future losses. The adequacy of the loan loss reserve is reviewed and approved quarterly by the Board of Directors.
Allocation of the allowance for loan losses
The following table provides an allocation of the allowance for loan losses at December 31, 2010, 2009, 2008, 2007 and 2006.
Financial Condition
Balance Sheet
(dollar amounts in thousands)
Total assets of the Company increased by $10,201 or 1.58% in 2010. Cash and cash equivalents increased by $52,815 during the year due to the decline in the loan and securities portfolio and the Company’s focus to reduce its risk weighted assets. Average interest earning assets decreased approximately $18,878 from 2009. Average interest bearing liabilities, including FHLB advances, decreased by $12,588 from in 2009. Total deposits increased $16,868 as customers continued to place their monies in insured accounts, primarily interest bearing demand deposits.
Loans
(dollar amounts in thousands)
Loans net of unearned income and deferred fees decreased by $35,525 or 7.31% in 2010. Loan demand has significantly subsided during the economic downturn. The Company has also implemented a plan to reduce risk weighted assets, primarily commercial real estate loans and other commercial loans.
Prior to 2009, the Company’s portfolio of commercial, construction and land development loans has also experienced significant growth. The Company made a concerted effort over the past two years to reduce its construction and land loans as these types of loans faced the greatest risk of loss due to the recession and began curtailing its lending for these types of loans during 2008 as the economy began to suffer. This segment of loans decreased by $20,920 or 12.04% during 2010. As construction and commercial lending has slowed significantly in the last 2 years, a diligent effort has been made to concentrate on permanent financing for residential mortgages.
The Company has also implemented a separate credit analysis department to review the larger loan requests, typically loan requests in excess of $250,000. This department operates separately from the loan origination arm of the Bank and completes independent and unbiased reviews of each new loan request. The senior officer of this department meets monthly with the Loan Committee of the Board of Directors.
Loan Portfolio
The table below classifies gross loans by major category and percentage distribution at December 31, for each of the past five years:
The following table shows the maturity of loans outstanding, inclusive of expected prepayments and contractual amortization, at December 31,
2010: (Non accrual loan balances are reflected in the immediate time period)
Foreclosed Assets (Other Real Estate Owned)
(dollar amounts in thousands)
At December 31, 2010 OREO balances were $15,320 and consisted of 32 relationships. Of the $15,320 balance, 17 properties (53%) were 1-4 family properties with a respective category balance of $5,650 (37% of the total balance). The next highest category was Land Development - Vacant Land, which contained 9 properties (28%) with a balance of $4,250 (28% of the total balance) The remaining 6 properties are Multifamily and Commercial -Owner Occupied. These categories combine to make up 19% of the total properties and represent $5,420 (35%) of the total balance at December 31, 2010. The following chart details each category type, number of properties and balance.
The one multifamily property totaling $3.1 million contains twenty - nine residential units outside the Sevierville, Tennessee area. The second largest OREO property totaling $2.08 million is a tract of land made up of partially developed lots and partially vacant land also in the Sevierville, Tennessee market area. The Bank is actively marketing all of its property through its website, listing agents, and other marketing methods.
Securities
(dollar amounts in thousands)
Investment securities available for sale decreased $14,852 (market value) from December 31, 2009 to December 31, 2010 as a result of maturities, sales, prepayments and write-downs. The Company made only a limited number of purchases during 2010 primarily due to the worsening credit crisis, the possible need for on balance sheet liquidity and the historically low yields available.
Yields on typical investment securities continued to be very low during 2010. Purchases during the year consisted primarily of fixed rate GNMA mortgage backed securities and SBA pools, both of which have the full faith and credit of the US government and also carry a zero risk weighting. During the year, management has continued its investment strategy to purchase securities that will not only blend in with the Company’s overall asset liability strategy but also maximize yield. The majority of the pay downs were contractual amortization and prepayments on variable rate securities as a result of prepayments occurring on the underlying mortgages. GNMA securities also carry a favorable risk weighting as it pertains to regulatory risk based capital. The Company also sold approximately $25,765 million of tax exempt municipal bonds during the year due to the current economic environment on municipal governmental units and also to increase its percentage of taxable earnings assets. Many of these municipal bonds had credit ratings affected by the economic recession.
The segment of our portfolio that contains the largest unrealized loss is our pooled trust preferred securities (TRUP CDOs) which represent trust preferred securities issued primarily by banks and a limited number of insurance companies and real estate investment trusts. As of December 31, 2010, our TRUP CDOs amortized cost totaled $4.34 million.
During 2010, we incurred credit-related OTTI charges on our TRUP CDOs of $1.26 million. For the 12 months ended December 31, 2009, we incurred credit-related OTTI charges on our TRUP CDOs of $5.62 million. The Company continues to review its investment portfolio on a quarterly basis for indications of other-than-temporary impairment (“OTTI”). See footnote 3 in the Notes to the Financial Statements for a detailed discussion of the Company’s OTTI analysis.
Investment Portfolio
The following table presents the maturity distribution, market value, amortized cost and approximate tax equivalent yield (assuming a 34% federal income tax rate) of the investment portfolio at December 31, 2010.
Mortgage backed securities-All of the MBS listed above are agency (FHLMC, FNMA, GNMA) issues. The Company does not hold any non-agency mortgage backed securities.
State and Municipals - A breakdown of the Company’s municipal bond portfolio is shown in the following table segregated by credit rating (Moody’s or S&P).
Pooled Trust Preferred Securities- See discussion above and Footnote 3 in the Notes to the Financial Statements for further information concerning the Company’s pooled trust preferred securities.
Single Issue Trust Preferred-All of the single issue trust preferred securities held by the Bank are issued by large regional or national banks that are well capitalized institutions. The Company reviews the filings of these institutions on a quarterly basis.
SBA Pools-All of the SBA pools owned by the Company have the full faith and credit of the US government and carry a zero risk weighting.
Deposits / Funding
(dollar amounts in thousands)
Total deposits increased by $16,868 or 3.24% in 2010. Non-interest bearing demand deposits increased by $1,850. Interest bearing demand deposits increased by $18,524. Total time deposits decreased by $7,549. Savings accounts increased by $4,043 during the year. The decrease in time deposits is primarily a result of the Company’s actions to reduce its higher cost CD’s in an effort to lower its overall cost of funds. The average rate paid on time deposits during 2010 decreased 61 basis points compared to the prior year. The Company has experienced a significant increase in interest bearing demand deposits as customers are still reluctant to invest in bonds, stocks, etc. The Company continues to face the challenge of gathering non-interest bearing deposits. The Company over the years has used its alternative funding sources (primarily FHLB advances) to help facilitate growth. As of December 31, 2010, the Company had $76,000 of FHLB borrowings. The Company secures the FHLB advances with a selected group of residential mortgage loans and commercial real estate loans as well as a specific group of securities available for sale. The Company also participates in the FDIC’s Temporary Liquidity Guarantee Program that was implemented in the fourth quarter of 2008. Under this program, non-interest bearing transaction accounts are fully insured above and beyond the existing FDIC insurance coverage amount.
The following table provides a breakdown of deposits at December 31 as indicated:
The average daily amount of deposits and rates paid on such deposits is summarized for the periods indicated in the following table:
The remaining maturities of time deposits greater than or equal to $100,000 at December 31, 2010 are as follows (Amount in thousands):
Effects of Inflation
The Company's consolidated statements of income generally reflect the effects of inflation. Since interest rates, loan demand, and deposit levels are related to inflation, the resulting changes are included in net income. The most significant item which does not reflect the effects of inflation is depreciation expense. Historical dollar values used to determine depreciation expense do not reflect the effects of inflation on the market value of depreciable assets after their acquisition.
Liquidity and Capital Resources
(dollar amounts in thousands)
Liquidity is the measure of the Bank’s ability to generate sufficient funds in order to meet customers’ demands for withdrawal of deposit balances and for the funding of loan requests. The Bank maintains cash reserves, in accordance with Federal Reserve Bank guidelines, and has sufficient flow of funds from investment security payments as well as loan payments to meet current liquidity needs.
Management of the Bank continuously monitors and plans the Bank’s liquidity position for the future. Liquidity is provided from cash and due from banks, federal funds sold, loan and investment security payments, core deposits, the national certificate of deposit market, lines of credit with correspondent banks and lines of credit with the Federal Home Loan Bank. Management believes that the current cash on hand and other sources of funds provide sufficient and timely liquidity for the foreseeable future. The Bank currently has approximately $30,000 of available credit with the FHLB and $15,000 of available unsecured credit with its correspondent banks.
The Company’s liquidity ultimately depends on dividends paid by the Bank, its wholly owned subsidiary. The Company and the Bank are currently prohibited from paying a dividend without the prior approval of the Federal Reserve Bank.
Both the Company and the Bank remained “well capitalized” under regulatory guidelines. (See Footnote 22 in the Company’s Consolidated Financial Report for further discussion concerning regulatory capital requirements).
In April 2009, the Company entered into a $7,500 Loan Commitment with Community Bankers Bank (“CBB”), pursuant to which CBB agreed to extend to the Company a Revolving Line of Credit of up to $3,000 and a Closed-End Term Loan of up to $4,500 (collectively, the “Loans”). The Company pledged the stock of the Bank as collateral for the Loans. The Loan proceeds may be down-streamed to the Bank and counted as Tier 1 capital at the Bank level. At December 31, 2010, the Company owed $3,845 on the Closed-End Loan and $1,000 on the Line of Credit. The Line of Credit accrues interest at the U.S. prime rate, subject to a floor of 5% and a ceiling of 9%. The Term Loan accrues interest at a rate of 6.75% using a ten year amortization period with a balloon date in five years. The Loans may be repaid in whole or in part at any time without penalty. The Line of Credit matures on April 21 ,2012. The Term Loan matures on April 21, 2014. Both loans may be renewed assuming no conditions of default exist.
Recent Accounting Pronouncements
See Note 1 of Notes to Consolidated Financial Statements for information relating to recent accounting pronouncements.
Off-Balance Sheet Arrangements
See Note 16 of Notes to Consolidated Financial Statements for information relating to Off-Balance Sheet Arrangements.
Item 7A.
Item 7A. Quantitative and Qualitative Disclosures About Market Risk
Not Applicable
Item 8.
Item 8. Financial Statements and Supplementary Data
The following financial statements are incorporated by reference from the Annual Report to Shareholders for the fiscal year ended December 31, 2010:
Report of Independent Registered Public Accounting Firm on the Financial Statements;
Consolidated Balance Sheets as of December 31, 2010 and 2009;
Consolidated Statements of Income for the years ended December 31, 2010 and 2009;
Consolidated Statements of Stockholders’ Equity for the years ended December 31, 2010 and 2009;
Consolidated Statements of Cash Flows for the years ended December 31, 2010 and 2009; and
Notes to Consolidated Financial Statements for December 31, 2010
Item 9.
Item 9. Changes in and Disagreements with Accountants on Accounting and Financial Disclosure
None.
Item 9A.
Item 9A. Controls and Procedures
On an on-going basis, senior management monitors and reviews the internal controls established for the various operating activities of the Company. Additionally, the Company has created a Disclosure Review Committee to review not only internal controls but the information used by Company’s financial officers to prepare the Company’s periodic SEC filings and corresponding financial statements. The Committee is comprised of the Senior Management Team of the Company and meets at least quarterly. Internal audits conducted by the Company’s internal audit department are also reviewed by senior officers to assist them in assessing the adequacy of the Company’s internal control structure. These audits are also discussed in detail with the Company’s Audit Committee.
We have carried out an evaluation, under the supervision and the participation of our management, including our Executive Vice President and Chief Executive Officer, our Chief Financial Officer and our Vice President of Accounting, of the effectiveness of the design and operation of our disclosure controls and procedures (as defined in Rule 13a-15(e) and 15d-15(e) under the Securities Exchange Act of 1934, as amended (the “Act”) as of the end of the fiscal year covered by this report. Based upon that evaluation, our CEO, CFO and VP Accounting concluded that our disclosure controls and procedures are effective in providing reasonable assurance that (a) the information required to be disclosed by us in the reports that we file or submit under the Act is recorded, processed, summarized and reported within the time periods specified in the Securities and Exchange Commission’s rules and forms, and (b) such information is accumulated and communicated to our management, including our CEO, CFO and VP Accounting, as appropriate to allow timely decisions regarding required disclosure.
Management’s Annual Report on Internal Control over Financial Reporting is incorporated by reference from the Consolidated Financial Report to Shareholders for the fiscal year ended December 31, 2010.
There were not any changes in the Company’s internal controls over financial reporting during the fourth fiscal quarter of the fiscal year covered by this report that have materially affected, or are reasonably likely to materially affect, our internal control over financial reporting.
Item 9B.
Item 9B. Other Information
None
Part III.
Item 10.
Item 10. Directors, Executive Officers and Corporate Governance
Pursuant to General Instruction G(3) of Form 10-K, the information contained under the headings “The Nominees,” “Executive Officers Who Are Not Directors,” “Section 16(a) Beneficial Ownership Reporting Compliance,” “The Board of Directors and its Committees” and “Code of Ethics” in the Company’s Proxy Statement for the 2011 Annual Meeting of Shareholders is incorporated herein by reference.
Item 11.
Item 11. Executive Compensation
Pursuant to General Instruction G(3) of Form 10-K, the information contained under the headings “Executive Compensation” in the Company’s Proxy Statement for the 2011 Annual Meeting of Shareholders is incorporated herein by reference.
Item 12.
Item 12. Security Ownership of Certain Beneficial Owners and Management and Related Stockholder Matters
Pursuant to General Instruction G(3) of Form 10-K, the information contained under the heading “Security Ownership of Management and Certain Beneficial Owners” in the Company’s Proxy Statement for the 2011 Annual Meeting of Shareholders is incorporated herein by reference.
The following table sets forth information as of December 31, 2010, with respect to compensation plans under which shares of Common Stock are authorized for issuance.
Equity Compensation Plan Information
(a)
Amounts exclude any securities to be issued upon exercise of outstanding options, warrants and rights.
(b)
On September 13, 2006, the Board of Directors of the Company approved the Highlands Bankshares, Inc. 2006 Equity Compensation Plan (the Plan). The Plan authorizes the Personnel and Compensation Committee (the Committee) of the Board of Directors to grant options, stock appreciation rights, stock awards and stock units to directors, officers, key employees, consultants and advisors to the Company and its subsidiaries who are designated by the Committee. The Company is authorized to issue under the Plan up to 200,000 shares of its Common Stock. Generally, if an award is forfeited, expires or terminates, the shares allocated to that award under the Plan may be reallocated to new awards under the Plan. Shares surrendered pursuant to the exercise of a stock option or other award or in satisfaction of tax withholding requirements under the Plan may also be reallocated to other awards.
Item 13.
Item 13. Certain Relationships and Related Transactions, and Director Independence
Pursuant to General Instruction G(3) of Form 10-K, the information contained under the heading “Transactions with Related Parties” and “The Board of Directors and its Committees” in the Company’s Proxy Statement for the 2011 Annual Meeting of Shareholders is incorporated herein by reference.
Item 14.
Item 14. Principal Accounting Fees and Services
Pursuant to General Instruction G(3) of Form 10-K, the information contained under the headings “Services and Fees” and “Pre-Approved Policies and Procedures” in the Company’s Proxy Statement for the 2011 Annual Meeting of Shareholders is incorporated herein by reference.
Part IV.
Item 15.
Item 15. Exhibits, Financial Statement Schedules
(a) (1) The response to this portion of Item 15 is submitted as a separate section of this report.
(2)
All applicable financial statement schedules required by Regulation S-X are included in the Notes to the 2010 Consolidated Financial Statements.
(3)
Exhibits:
3.1
Amended and Restated Articles of Incorporation of Highlands Bankshares, Inc., filed as Exhibit 3.1 to the Quarterly Report on Form 10-Q for the period ended March 31, 2009.
3.2
Bylaws of Highlands Bankshares, Inc. attached as Exhibit 3.2 to the Registration Statement on Form 8-A, File No. 000-27622, filed with the Commission on January 24, 1996, incorporated herein by reference.
10.1
Highlands Union Bank 1995 Stock Option Plan, attached as Exhibit 10.1 to the Annual Report on Form 10-K for the fiscal year ended December 31, 2002, File No. 000-27622, incorporated herein by reference.
10.2
Highlands Bankshares, Inc. 2006 Equity Compensation Plan, filed as Exhibit 3.1 to the Current Report on Form 8-K, File No. 000-27622, filed with the Commission on September 20, 2006, incorporated herein by reference.
10.3
Written Agreement, dated October 13, 2010, between Highlands Bankshares, Inc., Highlands Union Bank and the Federal Reserve Bank of Richmond, attached as Exhibit 10.1 to the Current Report on Form 8-K,
File No. 000-27622, filed with the Commission on October 19, 2010, incorporated herein by reference.
13.1
Annual Report to Shareholders - Financial Statements
Subsidiaries of the Corporation.
23.1
Consent of Brown, Edwards & Company, L.L.P.
31.1
Section 302 Certification of Chief Executive Officer.
31.2
Section 302 Certification of Chief Financial Officer of the Corporation
31.3
Section 302 Certification of Vice President of Accounting
32.1
Statement of Chief Executive Officer Pursuant to 18 U.S.C. § 1350.
32.2
Statement of Chief Financial Officer of the Corporation Pursuant to 18 U.S.C. § 1350.
32.3
Statement of Vice President of Accounting Pursuant to 18 U.S.C. § 1350.
(b)
Exhibits.
The response to this portion of Item 15 as listed in Item 15(a)(3) above is submitted as a separate section of this report.
(c)
Financial Statement Schedules.The response to this portion of Item 15 is submitted as a separate section of this report.
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.
/s/Robert M. Little, Jr.
/s/James R. Edmondson
Robert M. Little, Jr.
James R. Edmondson
Chief Financial Officer
Vice President of Accounting
Principal Financial Officer
Principal Accounting Officer
Pursuant to the requirements of the Securities Exchange Act of 1934, this report has been signed below by the following persons on behalf of the registrant and in the capacities and on the dates indicated on March 29, 2011.
Signature
Title
Date
/s/ James D. Morefield
James D. Morefield
Chairman of the Board, and Director
March 30, 2011
/s/ Dr. James D. Moore, Jr.
Dr. James D. Moore, Jr.
President
March 30, 2011
/s/ J. Carter Lambert
J. Carter Lambert
Vice Chairman
March 30, 2011
/s/ Samuel L. Neese
Samuel L. Neese
Executive Vice President, and Chief
Executive Officer (principal
executive officer)
March 30, 2011
Signature
Title
Date
/s/ William E. Chaffin
William E. Chaffin
Director
March 30, 2011
/s/ E. Craig Kendrick
E. Craig Kendrick
Director
March 30, 2011
/s/ Clydes B. Kiser
Clydes B. Kiser
Direc­tor
March 30, 2011
/s/ Charles P. Olinger
Charles P. Olinger
Direc­tor
March 30, 2011
/s/ William J. Singleton
William J. Singleton
Direc­tor
March 30, 2011
/s/ Dr. H. Ramsey White, Jr.
Dr. H. Ramsey White, Jr.
Direc­tor
March 30, 2011
EXHIBIT INDEX
Exhibit No. Description
3.1
Amended and Restated Articles of Incorporation of Highlands Bankshares, Inc., filed as Exhibit 3.1 to the Quarterly Report on Form 10-Q for the period ended March 31, 2009.
3.2
Bylaws of Highlands Bankshares, Inc. attached as Exhibit 3.2 to the Registration Statement on Form 8-A, File No. 000-27622, filed with the Commission on January 24, 1996, incorporated herein by reference.
10.1
Highlands Union Bank 1995 Stock Option Plan, attached as Exhibit 10.1 to the Annual Report on Form 10-K for the fiscal year ended December 31, 2002, File No. 000-27622, incorporated herein by reference.
10.2
Highlands Bankshares, Inc. 2006 Equity Compensation Plan, filed as Exhibit 3.1 to the Current Report on Form 8-K, File No. 000-27622, filed with the Commission on September 20, 2006, incorporated herein by reference.
10.3
Written Agreement, dated October 13, 2010, between Highlands Bankshares, Inc., Highlands Union Bank and the Federal Reserve Bank of Richmond, attached as Exhibit 10.1 to the Current Report on Form 8-K,
File No. 000-27622, filed with the Commission on October 19, 2010, incorporated herein by reference.
13.1
Annual Report to Shareholders - Financial Statements
Subsidiaries of the Corporation.
23.1
Consent of Brown, Edwards & Company, L.L.P.
31.1
Section 302 Certification of Chief Executive Officer.
31.2
Section 302 Certification of Chief Financial Officer of the Corporation
31.3
Section 302 Certification of Vice President of Accounting of the Bank.
32.1
Statement of Chief Executive Officer Pursuant to 18 U.S.C. § 1350.
32.2
Statement of Chief Financial Officer of the Corporation Pursuant to 18 U.S.C. § 1350.
32.3
Statement of Vice President of Accounting Pursuant to 18 U.S.C. § 1350.