UNITED STATES

SECURITIES AND EXCHANGE COMMISSION

WASHINGTON, D.C. 20549

FORM 10-Q

[X] Quarterly Report Pursuant to Section 13 or 15(d)

of the Securities Exchange Act of 1934

For the quarterly period ended ~~March~~June 3130, 2019

[ ] Transition Report Pursuant to Section 13 or 15(d)

of the Securities Exchange Act of 1934

For the transition period from ____________ to _____________

Commission File Number: 0-27622

HIGHLANDS BANKSHARES, INC.

(Exact name of registrant as specified in its charter)



Virginia (State or other jurisdiction of incorporation or organization)	54-1796693 (I.R.S. Employer Identification No.)
P.O. Box 1128 Abingdon, Virginia (Address of principal executive offices)	24212-1128 (Zip Code)

276-628-9181

(Registrant's telephone number, including area code)

Indicate by check mark whether the registrant (1) has filed all reports required to be filed by Section 13 or 15(d) of the Securities Exchange Act of 1934 during the preceding 12 months (or for such shorter 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 [ ]

Indicate by check mark whether the registrant has submitted electronically and posted on its corporate Web site, if any, every Interactive Data File required to be submitted and posted pursuant to Rule 405 of Regulation S-T (§232.405 of this chapter) during the preceding 12 months (or for such shorter period that the registrant was required to submit and post such files). Yes [ X ] No [ ]

Indicate by check mark whether the registrant is a large accelerated filer, an accelerated filer, a non-accelerated filer, smaller reporting company, or an emerging growth company. See the definitions of "large accelerated filer," "accelerated filer," "smaller reporting company," and "emerging growth company" in Rule 12b-2 of the Exchange Act.



Large accelerated filer ☐	Accelerated filer ☐	Non-accelerated filer þ (Do not check if a smaller reporting company)
Smaller reporting company þ	Emerging growth company ☐

If an emerging growth company, indicate by check mark if the registrant has elected not to use the extended transition period for complying with any new or revised financial accounting standards provided pursuant to Section 13(a) of the Exchange Act. ☐

Indicate by check mark whether the registrant is a shell company (as defined in Rule 12b-2 of the Exchange Act). Yes [ ] No [X ]

Indicate the number of shares outstanding of each of the issuer's classes of common stock, as of the latest practicable date: 8,250,728 shares of common stock, par value $0.625 per share, outstanding as of ~~May~~August 1512, 2019.

Highlands Bankshares, Inc.

Form 10-Q

For the Quarter Ended ~~March~~June 3130, 2019

INDEX

PART I. FINANCIAL INFORMATION	PAGE
Item 1. Financial Statements
Consolidated Balance Sheets at March 31, 2019 (Unaudited) and December 31, 2018	3
Consolidated Balance Sheets at June 30, 2019 (Unaudited) and December 31, 2018	3
Consolidated Statements of Income (Unaudited) for the three-month periods ended March 31, 2019 and 2018	4
Consolidated Statements of Income (Unaudited) for the three- and six-month periods ended June 30, 2019 and 2018	4
Consolidated Statements of Comprehensive Income (Unaudited) for the three-month periods ended March 31, 2019 and 2018	5
Consolidated Statements of Comprehensive Income (Unaudited) for the three- and six-month periods ended June 30, 2019 and 2018	5
Consolidated Statements of Cash Flows (Unaudited) for the three-month periods ended March 31, 2019 and 2018	6
Consolidated Statements of Cash Flows (Unaudited) for the six-month periods ended June 30, 2019 and 2018	6
Consolidated Statements of Changes in Stockholders' Equity (Unaudited) for the three-month periods ended March 31, 2019 and 2018	7
Consolidated Statements of Changes in Stockholders' Equity (Unaudited) for the six-month periods ended June 30, 2019 and 2018	7
Notes to Consolidated Financial Statements (Unaudited)	8
Item 2. Management's Discussion and Analysis of Financial Condition and Results of Operations	2826
Item 3. Quantitative and Qualitative Disclosures About Market Risk	3332
Item 4. Controls and Procedures	3332
PART II. OTHER INFORMATION
Item 1. Legal Proceedings	3433
Item 1A. Risk Factors	3433
Item 2. Unregistered Sales of Equity Securities and Use of Proceeds	3433
Item 3. Defaults Upon Senior Securities	3433
Item 4. Mine Safety Disclosures	3433
Item 5. Other Information	3433
Item 6. Exhibits	3433
SIGNATURES AND CERTIFICATIONS	3534

PART I.

FINANCIAL INFORMATION

ITEM 1. Financial Statements

Consolidated Balance Sheets

(Amounts in thousands)

	(Unaudited)March 31, 2019			December 31, 2018
	(Unaudited)June 30, 2019			December 31, 2018
ASSETS
Cash and due from banks	$	2326,~~544~~684		$	19,965
Federal funds sold	3121,~~634~~138			10,101
Total cash and cash equivalents	5547,~~178~~822			30,066
Investment securities available for sale (amortized cost $69,104 at March 31, 2019, $71,260 at December 31, 2018)	67,558			68,631
Investment securities available for sale (amortized cost $66,647 at June 30, 2019, $71,260 at December 31, 2018)	66,227			68,631
Other investments, at cost	2,770			2,774
Loans held for sale	~~1,727~~863			265
Loans	~~442~~451,~~236~~590			448,121
Allowance for loan losses	(4,~~096~~243		)	(4,373		)
Net loans	~~438~~447,~~140~~347			443,748
Premises and equipment, net	17,~~367~~159			17,447
Real estate held for sale	~~600~~590			817
Deferred tax assets	65,~~017~~706			6,526
Interest receivable	12,~~706~~010			1,617
Bank-owned life insurance	15,~~113~~215			15,022
Other real estate owned	2,~~886~~892			2,212
Other assets	3,~~306~~120			2,816
Total assets	$	~~612~~611,~~368~~721		$	591,941
LIABILITIES AND STOCKHOLDERS' EQUITY
LIABILITIES
Deposits:
Non-interest bearing	$	~~149~~153,~~876~~982		$	156,408
Interest bearing	~~370~~364,~~823~~462			346,408
Total deposits	~~520~~518,~~699~~444			502,816
Interest, taxes and other liabilities	3,~~033~~179			2,391
Short-term borrowings	30,000			30,000
Long-term debt	8067			93
Total liabilities	~~553~~551,~~812~~690			535,300
STOCKHOLDERS' EQUITY
Common stock (8,251 shares issued and outstanding at March 31, 2019 and December 31, 2018)	5,156			5,156
Common stock (8,251 shares issued and outstanding at June 30, 2019 and December 31, 2018)	5,156			5,156
Preferred stock (2,092 shares issued and outstanding at March 31, 2019 and December 31, 2018)	4,184			4,184
Preferred stock (2,092 shares issued and outstanding at June 30, 2019 and December 31, 2018)	4,184			4,184
Additional paid-in capital	19,292			19,277
Retained earnings	31,~~191~~762			30,131
Accumulated other comprehensive loss	(~~1,267~~363		)	(2,107		)
Total stockholders' equity	5860,~~556~~031			56,641
Total liabilities and stockholders' equity	$	~~612~~611,~~368~~721		$	591,941

See accompanying Notes to Consolidated Financial Statements

Consolidated Statements of Income

(Amounts in thousands, except per share data)

(Unaudited)

	Three Months Ended March 31,
	Three Months Ended June 30,					Six Months Ended June 30,
	2019			2018		2019			2018
INTEREST INCOME
Loans receivable and fees on loans	$	5,~~653~~652		$	5,~~315~~276	$	11,305		$	10,591
Investment securities	~~412~~433			~~478~~438		845			916
Federal funds sold	~~141~~227			7057		368			127
Total interest income	6,~~206~~312			5,~~863~~771		12,518			11,634
INTEREST EXPENSE
Deposits	~~824~~955			463		1,779			926
Other borrowed funds	~~273~~275			~~364~~323		548			687
Total interest expense	1,~~097~~230			~~827~~786		2,327			1,613
Net interest income	5,~~109~~082			54,~~036~~985		10,191			10,021
Provision for loan losses	~~103~~836			172		939			344
Net interest income after provision for loan losses	54,~~006~~246			4,~~864~~813		9,252			9,677
NONINTEREST INCOME
Service charges on deposit accounts	~~342~~338			~~337~~342		680			679
Other service charges, commissions and fees	~~339~~378			~~419~~428		717			847
Mortgage banking income	48			~~100~~52		96			152
Other operating income	161			226
Securities gains, net	(7		)	—		(7		)	—
Total noninterest income	890			1,082
Other operating income	176			167		337			393
NONINTEREST EXPENSE
Total noninterest income	933			989		1,823			2,071
Salaries and employee benefits	2,416			2,403
NONINTEREST EXPENSE
Occupancy and equipment expense	615			731
Salaries and employee benefits	2,281			2,380		4,697			4,783
Foreclosed assets – write-down and operating expenses	50			131
Occupancy and equipment expense	527			750		1,142			1,481
Other operating expense	1,473			1,901
OREO expenses, net	92			146		142			277
Total noninterest expense	4,554			5,166
Other operating expense	1,633			1,356		3,106			3,257
Income before income taxes	1,342			780
Total noninterest expense	4,533			4,632		9,087			9,798
Income tax expense (Note 5)	282			170
Income before income taxes	646			1,170		1,988			1,950
Net income	$	1,060		$	610
Income tax expense (Note 5)	75			247		357			417
Net income per common share (Note 7)
Net income	$	571		$	923	$	1,631		$	1,533
Basic	$	0.13		$	0.07
Net income per common share (Note 7)
Fully diluted	0.10			0.06
Basic	$	0.07		$	0.11	0.20			0.19
Fully diluted	0.06			0.09		0.16			0.15

See accompanying Notes to Consolidated Financial Statements

Consolidated Statements of Comprehensive Income

(Amounts in thousands)

(Unaudited)

	Three Months Ended March 31,
	Three Months Ended June 30,						Six Months Ended June 30,
	2019			2018			2019			2018
Net income	$	~~1,060~~571		$	~~610~~923		$	1,631		$	1,533
Other comprehensive income (loss)
Unrealized gains (losses) on securities during the period	1,~~083~~126			(~~1,297~~332		)	2,209			(1,629		)
Less: reclassification adjustment	—7			—			7			—
Other comprehensive income (loss) before tax	1,~~083~~133			(~~1,297~~332		)	2,216			(1,629		)
Income tax (expense) benefit related to other comprehensive income (loss)	(~~243~~229		)	~~271~~71			(472		)	342
Other comprehensive income (loss)	~~840~~904			(~~1,026~~261		)	1,744			(1,287		)
Comprehensive income (loss)	$	1,900		$	(416	)
Comprehensive income	$	1,475		$	662		$	3,375		$	246

See accompanying Notes to Consolidated Financial Statements

Consolidated Statements of Cash Flows

(Amounts in thousands)

(Unaudited)

	Three Months Ended March 31,
	Six Months Ended June 30,
	2019			2018
CASH FLOWS FROM OPERATING ACTIVITIES:
Net income	$	1,~~060~~631		$	~~610~~1,533
Adjustments to reconcile net income to net cash provided by operating activities:
Provision for loan losses	~~103~~939			~~172~~344
Depreciation and amortization	~~342~~681			~~401~~809
Provision for deferred tax assets	~~266~~356			~~170~~351
Restricted stock expense	15			56
Net realized losses on available for sale securities	7			—
Originations of loans held for sale	(2,656		)	(7,651		)
Restricted stock expense	15			111
Proceeds from loans held for sale	1,194			10,664
Originations of loans held for sale	(4,182		)	(10,471		)
Increase (decrease) in interest receivable	(89		)	210
Proceeds from loans held for sale	3,584			13,855
Increase (decrease) in interest receivable	(393		)	259
Valuation adjustment of real estate held for sale	—			60
Valuation adjustment of other real estate owned	—			90199
(Increase) decrease in other assets	(~~590~~504		)	52143
Increase in interest, taxes and other liabilities	~~642~~668			~~590~~118
Net cash provided by operating activities	~~287~~2,802			57,~~424~~311
CASH FLOWS FROM INVESTING ACTIVITIES:
Securities available for sale:
Proceeds from maturities of securities	2,052			2,965
Proceeds from sale of securities	944			—
Redemptions of other investments	—			323
Proceeds from maturities of securities	4,475			5,864
Net decrease in loans	4,751			117
Purchase of debt and equity securities	(1,024		)	—
Proceeds from sales of other real estate owned	90			156
Redemptions of other investments	—			340
Proceeds from sale of real estate held for sale	217			—
Net decrease in loans	(5,792		)	(10,331		)
Premises and equipment expenditures	(155		)	(82		)
Proceeds from sales of other real estate owned	574			203
Net cash provided by investing activities	6,955			3,479
Proceeds from sale of real estate held for sale	227			378
Premises and equipment expenditures	(52		)	(99		)
Net cash used by investing activities	(648		)	(3,645		)
CASH FLOWS FROM FINANCING ACTIVITIES:
Net decrease in time deposits	14,293			(13,922		)
Net increase (decrease) in time deposits	16,672			(5,787		)
Net increase in demand, savings and other deposits	3,590			25,137
Net (decrease) increase in demand, savings and other deposits	(1,044		)	5,320
Net change in short-term borrowings	—			(10,000		)
Net decrease in short-term borrowings	—			(10,000		)
Decrease in long-term debt	(1326		)	(1326		)
Net cash provided by financing activities	17,870			1,202
Net cash provided (used) by financing activities	15,602			(10,493		)
Net change in cash and cash equivalents	2517,~~112~~756			10(6,~~105~~827		)
Cash and cash equivalents at beginning of period	30,066			30,797
Cash and cash equivalents at end of period	$	5547,~~178~~822		$	4023,~~902~~970
SUPPLEMENTAL DISCLOSURES OF CASH FLOW INFORMATION
Cash payments during the period for interest	$	21,~~183~~901		$	~~860~~1,623
Cash payments during the period for income taxes	—			—65
SUPPLEMENTAL DISCLOSURE OF NONCASH TRANSACTIONS
Transfer of loans to other real estate owned	754			65285

See accompanying Notes to Consolidated Financial Statements

Consolidated Statements of Changes in Stockholders' Equity

(Amounts in thousands)

(Unaudited)

	Common stock shares	Common stock par value		Preferred stock shares	Preferred stock par value		Additional paid-in-capital		Retained earnings		Accumulatedothercomprehensiveincome (loss)			Stockholders'equity
Balance December 31, 2017	8,199	$	5,124	2,092	$	4,184	$	19,113	$	26,539	$	(1,156	)	$	53,804
Three-month period
Net income	—	—		—	—		—		610		—			610
Other comprehensive income	—	—		—	—		—		—		(1,026		)	(1,026		)
Stock-based compensation	—	—		—	—		56		—		—			56
Balance March 31, 2018	8,199	$	5,124	2,092	$	4,184	$	19,169	$	27,149	$	(2,182	)	$	53,444
Net income	—	—		—	—		—		923		—			923
Other comprehensive loss	—	—		—	—		—		—		(261		)	(261		)
Stock-based compensation	—	—		—	—		55		—		—			55
Balance June 30, 2018	8,199	$	5,124	2,092	$	4,184	$	19,224	$	28,072	$	(2,443	)	$	54,161
Balance March 31, 2019	8,251	$	5,156	2,092	$	4,184	$	19,292	$	31,191	$	(1,267	)	$	58,556
Net income	—	—		—	—		—		571		—			571
Other comprehensive income	—	—		—	—		—		—		904			904
Stock-based compensation	—	—		—	—		—		—		—			—
Balance June 30, 2019	8,251	$	5,156	2,092	$	4,184	$	19,292	$	31,762	$	(363	)	$	60,031
Six-month period
Balance December 31, 2017	8,199	$	5,124	2,092	$	4,184	$	19,113	$	26,539	$	(1,156	)	$	53,804
Net income	—	—		—	—		—		1,533		—			1,533
Other comprehensive loss	—	—		—	—		—		—		(1,287		)	(1,287		)
Stock-based compensation	—	—		—	—		111		—		—			111
Balance June 30, 2018	8,199	$	5,124	2,092	$	4,184	$	19,224	$	28,072	$	(2,443	)	$	54,161
Balance December 31, 2018	8,251	$	5,156	2,092	$	4,184	$	19,277	$	30,131	$	(2,107	)	$	56,641
Net income	—	—		—	—		—		1,~~060~~631		—			1,~~060~~631
Other comprehensive income	—	—		—	—		—		—		~~840~~1,744			~~840~~1,744
Stock-based compensation	—	—		—	—		15		—		—			15
Balance March 31, 2019	8,251	$	5,156	2,092	$	4,184	$	19,292	$	31,191	$	(1,267	)	$	58,556
Balance June 30, 2019	8,251	$	5,156	2,092	$	4,184	$	19,292	$	31,762	$	(363	)	$	60,031

See accompanying Notes to Consolidated Financial Statements

Notes to Consolidated Financial Statements

(Unaudited)

(in thousands, except share, per share and percentage data)

Note 1 - General

The consolidated financial statements of Highlands Bankshares, Inc. (the "Company") conform to United States generally accepted accounting principles and to banking industry practices. The accompanying consolidated interim financial statements are unaudited. In the opinion of management, all adjustments necessary for a fair presentation of the consolidated financial statements have been included. All such adjustments are of a normal and recurring nature. The consolidated balance sheet as of December 31, 2018 has been extracted from the audited financial statements included in the Company's Annual Report on Form 10-K for the year ended December 31, 2018 (the "2018 Form 10-K"). The notes included herein should be read in conjunction with the notes to the consolidated financial statements included in the 2018 Form 10-K. The results of operations for the ~~three~~six-month period ended ~~March~~June 3130, 2019, are not necessarily indicative of the results to be expected for the full year.

The preparation of financial statements requires management to make estimates and assumptions that affect the reported amounts of assets and liabilities and disclosure of contingent assets and liabilities at the date of the financial statements and the reported amounts of revenues and expenses during the reporting period. Actual results could differ from those estimates.

Note 2 – Summary of Significant Accounting Policy Update For Certain Required Disclosures

In ~~May~~June ~~2014~~2016, ~~the FASB issued~~ ASU No. ~~2014~~2016-0913, ~~Revenue~~Measurement ~~from~~of ~~Contracts~~Credit ~~with~~Losses ~~Customers.~~on ~~ASU~~Financial ~~2014-09~~Instruments iswas aissued ~~comprehensive~~by ~~revenue~~the ~~recognition~~FASB. ~~model~~This ~~that~~ASU ~~requires~~significantly achanges ~~company~~how toentities ~~recognize~~will ~~revenue~~measure tocredit ~~depict~~losses ~~the~~for ~~transfer~~most offinancial ~~goods~~assets orand ~~services~~certain toother ainstruments ~~customer~~that aren't measured at anfair ~~amount~~value ~~that~~through ~~reflects~~net ~~the~~income. The ~~consideration~~ASU itis ~~expects~~intended to ~~receive~~improve infinancial ~~exchange~~reporting ~~for~~by ~~those~~requiring ~~goods~~timelier orrecording ~~services.~~of ~~ASU~~credit ~~2014-09,~~losses ason ~~subsequently~~loans ~~amended~~and byother financial instruments. As initially adopted, ASU No. ~~2015~~2016-1413 ~~issued~~is ineffective ~~August~~for ~~2015~~interim and annual reporting periods beginning after December 15, ~~required~~2019; early adoption inis permitted for interim and annual reporting periods beginning after December 15, ~~2017,~~2018. ~~including~~Entities ~~interim~~will ~~reporting~~apply ~~periods~~the ~~within~~standard's ~~that~~provisions as a cumulative-effect adjustment to retained earnings as of the beginning of the first reporting period in which the guidance is effective (i.e., ~~The~~modified ~~Company~~retrospective ~~adopted~~approach). During July 2019, the FASB voted to propose a deferral of the effective date for several of its recent standards, including ASU ~~2014~~2016-0913. Based on the proposed extended adoption date, the provisions of ASU 2016-13 would be effective for the Company beginning January 1, ~~2018~~2023. The Company continues to evaluate the effect that implementation of the new standard will have on its financial position, results of operations, and cash flows.

Application of ASU 2014-09 requires identification of customer contracts, identification of the performance obligations within those contracts, identification of the transaction price, allocation of the transaction price to the performance obligations, and recognition of revenue once the performance obligation is satisfied. ASU 2014-09 requires disclosure regarding the nature, amount, timing and uncertainty of revenue and cash flows arising from customer contracts, including significant judgments and changes in judgments and assets recognized from costs incurred to obtain or fulfill a contract.

The Company’s primary source of revenue is interest income, which is excluded from the scope of this guidance; however, the Company evaluated the impact on noninterest income, which includes fees for services, commissions on sales, and various deposit service charges. The Company concluded that no cumulative-effect adjustment to retained earnings was necessary. The adoption of the standard did not have a material effect on the Company’s financial position or results of operations.

In June 2016, ASU No. 2016-13, Measurement of Credit Losses on Financial Instruments was issued by the FASB. This ASU significantly changes how entities will measure credit losses for most financial assets and certain other instruments that aren't measured at fair value through net income. The ASU is intended to improve financial reporting by requiring timelier recording of credit losses on loans and other financial instruments. ASU No. 2016-13 is effective for interim and annual reporting periods beginning after December 15, 2019; early adoption is permitted for interim and annual reporting periods beginning after December 15, 2018. Entities will apply the standard's provisions as a cumulative-effect adjustment to retained earnings as of the beginning of the first reporting period in which the guidance is effective (i.e., modified retrospective approach). The Company continues to evaluate the effect that implementation of the new standard will have on its financial position, results of operations, and cash flows.

Other accounting standards that have been issued or proposed by the FASB or other standards-setting bodies are not expected to have a material impact on the Company's financial position, results of operations or cash flows.

In February 2016, the FASB issued ASU 2016-02, Leases, which revised certain aspects of recognition, measurement, presentation, and disclosure of leasing transactions. ASU 2016-02 was effective for the Company on January 1, 2019. The standard provides for a modified retrospective transition approach requiring lessees to recognize and measure leases on the balance sheet at the beginning of either the earliest period presented or as of the beginning of the period of adoption with the option to elect certain practical expedients. The Company has elected to apply the standard as of the beginning of the period of adoption (January 1, 2019) and did not restate comparative periods. The Company has adopted all the optional practical expedients available under ASU 2016-02.

The operating leases of the Company relate to office space and bank branches. As a result of implementing ASU 2016-02, the Company recognized an operating lease right-of-use (“ROU”) asset and an operating lease liability of $120,000 on January 1, 2019, with no impact on net income or stockholders’ equity. The ROU asset and operating lease liability are recorded in premises and equipment and other liabilities, respectively, in the consolidated balance sheet as of March 31, 2019.

Operating lease ROU assets represent our right to use an underlying asset during the lease term and operating lease liabilities represent our obligation to make lease payments arising from the lease. ROU assets and operating lease liabilities are recognized at lease commencement based on the present value of the remaining lease payments using a discount rate that represents our incremental borrowing rate at the lease commencement date. Operating lease expense, which is comprised of amortization of the ROU asset and the implicit interest accreted on the operating lease liability, is recognized over the lease term, and is recorded in occupancy expense in the consolidated statements of operations.

Note 3 - Investment Securities Available For Sale

The amortized cost and market value of securities available for sale are as follows:

March 31, 2019

June 30, 2019

Amortized cost

Gross unrealized gains

Gross unrealized losses

Fair value

State and political subdivisions

13,~~583~~261

48130

~~426~~122

13,~~205~~269

Mortgage backed securities

5048,~~355~~611

2161

~~1,041~~477

4948,~~335~~195

SBA pools

54,~~166~~775

—14

~~148~~26

54,~~018~~763

6966,~~104~~647

69205

~~1,615~~625

6766,~~558~~227



	December 31, 2018
	Amortized cost		Gross unrealized gains		Gross unrealized losses		Fair value
State and political subdivisions	$	13,590	$	9	$	763	$	12,836
Mortgage backed securities	52,344		8		1,798		50,554
SBA pools	5,326		—		85		5,241
	$	71,260	$	17	$	2,646	$	68,631

Investment securities available for sale with a fair value of $3738,~~923~~570 and $37,448 at ~~March~~June 3130, 2019 and December 31, 2018, respectively, were pledged as collateral on public deposits, FHLB advances and for other purposes as required or permitted by law.

The following table presents the age of gross unrealized losses and fair value by investment category:

March 31, 2019

June 30, 2019

Less than 12 months

12 months or more

Total

Fair value

Unrealized losses

Fair value

Unrealized losses

Fair value

Unrealized losses

State and political subdivisions

—1,017

—7

86,~~857~~651

~~426~~115

87,~~857~~668

~~426~~122

Mortgage-backed securities

~~228~~1,023

—1

4538,~~766~~643

~~1,041~~476

4539,~~994~~666

~~1,041~~477

SBA pools

—

54,~~053~~763

~~148~~26

54,~~053~~763

~~148~~26

Total

~~228~~2,040

—8

5950,~~676~~057

~~1,615~~617

5952,~~904~~097

~~1,615~~625



	December 31, 2018
	Less than 12 months				12 months or more				Total
	Fair value		Unrealized losses		Fair value		Unrealized losses		Fair value		Unrealized losses
State and political subdivisions	$	3,608	$	73	$	7,791	$	690	$	11,399	$	763
Mortgage-backed securities	2,319		8		46,661		1,790		48,980		1,798
SBA pools	—		—		5,218		85		5,218		85
Total	$	5,927	$	81	$	59,670	$	2,565	$	65,597	$	2,646

The Company assesses its securities for OTTI quarterly by reviewing credit ratings, financial and regulatory reports as well as other pertinent published financial data. As of ~~March~~June 3130, 2019 and December 31, 2018, the Company's assessment revealed no impairment other than that deemed temporary on those securities.

The amortized cost and estimated fair value of securities available for sale at ~~March~~June 3130, 2019 by contractual maturity are shown below. Expected maturities may differ from contractual maturities because borrowers may have the right to call or prepay obligations with or without call or prepayment penalties.

	March 31, 2019				December 31, 2018
	June 30, 2019				December 31, 2018
	Amortized cost		Fair value		Amortized cost		Fair value
Investment securities with scheduled maturities:
Due in one year or less	$	87208	$	88209	$	98	$	100
Due after one year through five years	~~394~~—		~~394~~—		367		366
Due after five years through ten years	3,~~280~~240		3,~~175~~241		2,782		2,638
Due after ten years	14,~~988~~588		14,~~566~~582		15,669		14,973
Total investment securities with scheduled maturities	18,~~749~~036		18,~~223~~032		18,916		18,077
Mortgage-backed securities	5048,~~355~~611		4948,~~335~~195		52,344		50,554
Total investment securities available for sale	$	6966,~~104~~647	$	6766,~~558~~227	$	71,260	$	68,631

~~There~~The ~~were~~following notable ~~gains~~summarizes ~~or losses on~~ the ~~sales~~securities ofgains ~~investment~~(losses) ~~securities~~recognized ~~during~~for the ~~first~~periods ~~three months of 2019 or 2018.~~ presented:



	Three months ended June 30,					Six months ended June 30,
	2019			2018		2019			2018
Gross gains	$	—		$	—	$	—		$	—
Gross losses	(7		)	—		(7		)	—
Securities gains, net	$	(7	)	$	—	$	(7	)	$	—

Note 4 - Loans and Allowance for Loan Losses

The composition of net loans is as follows:

	March 31, 2019		December 31, 2018
	June 30, 2019		December 31, 2018
Real estate secured:
Residential 1-4 family	$	~~165~~168,~~506~~196	$	165,109
Multifamily	1821,~~704~~270		18,378
Construction and land loans	2223,~~051~~204		21,029
Commercial, owner occupied	9596,~~301~~530		96,224
Commercial, non-owner occupied	3837,~~731~~388		39,869
Second mortgages	4,~~019~~012		4,054
Equity lines of credit	29,~~179~~778		30,221
Farmland	10,~~047~~007		12,149
Total real estate secured	~~383~~390,~~538~~385		387,033
Non-real estate secured
Personal	11,~~447~~225		12,754
Commercial	4447,~~825~~533		46,202
Agricultural	3,~~107~~117		2,830
Total non-real estate secured	5961,~~379~~875		61,786
Gross loans	~~442~~452,~~917~~260		448,819
Less:
Allowance for loan losses	4,~~096~~243		4,373
Net deferred fees	~~681~~670		698
Loans, net	$	~~438~~447,~~140~~347	$	443,748

The following table is an analysis of past due loans as of ~~March~~June 3130, 2019:

Past Due

30-89 days

90 days and over

Total

Current

Total

> 90 Days and Accruing

Real estate secured

Residential 1-4 family

~~1,840~~820

~~604~~1,356

2,~~444~~176

~~163~~166,~~062~~020

~~165~~168,~~506~~196

~~212~~—

Equity lines of credit

8320

—64

8384

29,~~096~~694

29,~~179~~778

—

Multifamily

—

402

1820,~~302~~868

1821,~~704~~270

—

Farmland

~~215~~818

~~341~~127

~~556~~945

9,~~491~~062

10,~~047~~007

—

Construction, land development, other land loans

70289

15118

85407

2122,~~966~~797

2223,~~051~~204

—

Commercial real estate:

Owner-occupied

27—

~~606~~707

~~633~~707

9495,~~668~~823

9596,~~301~~530

—

Non-owner-occupied

—85

~~1,316~~—

~~1,316~~85

37,~~415~~303

3837,~~731~~388

—

Second mortgages

—

4,~~019~~012

—

Non-real estate secured

Personal

~~111~~63

2711

~~138~~74

11,~~309~~151

11,~~447~~225

2—

Commercial

~~235~~253

~~106~~575

~~341~~828

4446,~~484~~705

4447,~~825~~533

—168

Agricultural

—

3,~~107~~117

—

Total

2,~~581~~348

3,~~417~~360

5,~~998~~708

~~436~~446,~~919~~552

~~442~~452,~~917~~260

~~214~~168

The following table is an analysis of past due loans as of December 31, 2018:



	Past Due
	30-89 days		90 days and over		Total		Current		Total		> 90 Days and Accruing
Real estate secured
Residential 1-4 family	$	1,481	$	819	$	2,300	$	162,809	$	165,109	$	105
Equity lines of credit	218		75		293		29,928		30,221		—
Multifamily	402		—		402		17,976		18,378		—
Farmland	754		—		754		11,395		12,149		—
Construction, land development, other land loans	16		—		16		21,013		21,029		—
Commercial real estate:
Owner-occupied	9		756		765		95,459		96,224		—
Non-owner-occupied	—		1,859		1,859		38,010		39,869		—
Second mortgages	—		—		—		4,054		4,054		—
Non-real estate secured
Personal	186		4		190		12,564		12,754		—
Commercial	82		114		196		46,006		46,202		2
Agricultural	—		—		—		2,830		2,830		—
Total	$	3,148	$	3,627	$	6,775	$	442,044	$	448,819	$	107

Loans are considered delinquent when payments have not been made according to the terms of the contract. The accrual of interest on loans is discontinued at the time the loan is 90 days delinquent unless the credit is well-secured and in process of collection. Additionally, in certain instances, loans that have been restructured or modified may also be classified as non-accrual per regulatory guidance until a satisfactory payment history has been established. Credit card loans and other personal loans are typically charged off no later than 180 days past due. In all cases, loans are placed on non-accrual or charged-off at an earlier date if collection of principal or interest is considered doubtful.

The following is a summary of non-accrual loans at ~~March~~June 3130, 2019 and December 31, 2018:

	March 31, 2019		December 31, 2018
	June 30, 2019		December 31, 2018
Real estate secured
Residential 1-4 family	$	~~726~~1,707	$	1,196
Multifamily	402		—
Construction and land loans	15124		8
Commercial real estate:
Owner-occupied	1,~~874~~967		2,038
Non-owner-occupied	~~1,460~~143		2,004
Farmland	484		142
Equity lines of credit	64		75
Farmland	127		142
Non-real estate secured
Personal	2612		26
Commercial and agricultural	~~407~~719		431
Total	$	5,~~394~~265	$	5,920

The following is a summary of residential real estate currently in the process of foreclosure as well as foreclosed residential real estate as of ~~March~~June 3130, 2019.

	Number	Balance
Real estate in the process of foreclosure	67	$	~~1,488~~972
Foreclosed residential real estate	137	~~997~~675

The following tables represent a summary of credit quality indicators of the Company's loan portfolio at ~~March~~June 3130, 2019 and December 31, 2018. The grades are assigned and/or modified by the Company's credit review and credit analysis departments based on the creditworthiness of the borrower and the overall strength of the loan.

The following tables provide the credit risk profile by internally assigned grade as of ~~March~~June 3130, 2019 and December 31, 2018:

March 31, 2019

Residential 1-4 Family

Multifamily

Farmland

Construction, Land Loans

Commercial Real Estate- Owner Occupied

Commercial Real Estate Non-Owner Occupied

June 30, 2019

Residential 1-4 Family

Multifamily

Farmland

Construction, Land Loans

Commercial Real Estate- Owner Occupied

Commercial Real Estate Non-Owner Occupied

Quality

1211,~~403~~706

—

~~595~~583

~~185~~1,384

~~128~~339

Satisfactory

9294,~~109~~347

56,~~249~~714

2,~~243~~100

45,~~949~~485

3935,~~114~~216

12,~~699~~028

Acceptable

5455,~~685~~983

12,~~301~~114

2,~~796~~827

1413,~~857~~976

4948,~~622~~807

2018,~~562~~758

Special Mention

~~1,206~~844

~~752~~2,039

—

12,~~565~~978

24,~~330~~784

34,~~882~~693

Substandard

5,~~103~~316

~~402~~403

5,~~008~~080

85182

46,~~050~~339

1,~~460~~570

Doubtful

—

Total

~~165~~168,~~506~~196

1821,~~704~~270

10,~~047~~007

2223,~~051~~204

9596,~~301~~530

3837,~~731~~388

December 31, 2018	Residential 1-4 Family		Multifamily		Farmland		Construction, Land Loans		Commercial Real Estate- Owner Occupied		Commercial Real Estate Non-Owner Occupied
Quality	$	12,991	$	—	$	—	$	724	$	1,632	$	131
Satisfactory	107,925		4,276		2,736		5,314		39,679		13,046
Acceptable	37,036		13,700		3,617		13,349		47,963		21,073
Special Mention	1,696		402		—		1,565		2,720		3,615
Substandard	5,461		—		5,796		77		4,230		2,004
Doubtful	—		—		—		—		—		—
Total	$	165,109	$	18,378	$	12,149	$	21,029	$	96,224	$	39,869



December 31, 2018	Residential 1-4 Family		Multifamily		Farmland		Construction, Land Loans		Commercial Real Estate- Owner Occupied		Commercial Real Estate Non-Owner Occupied
Quality	$	12,991	$	—	$	—	$	724	$	1,632	$	131
Satisfactory	107,925		4,276		2,736		5,314		39,679		13,046
Acceptable	37,036		13,700		3,617		13,349		47,963		21,073
Special Mention	1,696		402		—		1,565		2,720		3,615
Substandard	5,461		—		5,796		77		4,230		2,004
Doubtful	—		—		—		—		—		—
Total	$	165,109	$	18,378	$	12,149	$	21,029	$	96,224	$	39,869

Explanation of credit grades:

Quality-This grade is reserved for the Bank's top quality loans. These loans have excellent sources of repayment, with no significant identifiable risk of collection. Generally, loans assigned this rating will demonstrate the following characteristics:


•	Conformity in all respects with Bank policy, guidelines, underwriting standards, and Federal and State regulations (no exceptions of any kind).


•	Documented historical cash flow that meets or exceeds required minimum Bank guidelines, or that can be supplemented with verifiable cash flow from other sources.


•	Adequate secondary sources to liquidate the debt, including combinations of liquidity, liquidation of collateral, or liquidation value to the net worth of the borrower or guarantor.

For existing loans, all of the requirements above apply plus all payments have been made as agreed, current financial information on all borrowers and guarantors has been obtained and analyzed, and overall business operating trends are either stable or improving.

Satisfactory-This grade is given to performing loans. These loans have adequate sources of repayment, with little identifiable risk of collection. Loans assigned this rating will demonstrate the following characteristics:


•	General conformity to the Bank's policy requirements, product guidelines and underwriting standards. Any exceptions that are identified during the underwriting and approval process have been adequately mitigated by other factors.


•	Documented historical cash flow that meets or exceeds required minimum Bank guidelines, or that can be supplemented with verifiable cash flow from other sources.


•	Adequate secondary sources to liquidate the debt, including combinations of liquidity, liquidation of collateral, or liquidation value to the net worth of the borrower or guarantor.

For existing loans, all of the requirements outlined above will apply, plus all payments have been made as agreed, current financial information on all borrowers and guarantors has been obtained and analyzed, and overall business operating trends are stable with any declines considered minor and temporary.

Acceptable-This grade is given to loans that show signs of weakness in either adequate sources of repayment or collateral, but have demonstrated mitigating factors that minimize the risk of delinquency or loss. Loans assigned this rating may demonstrate some or all of the following characteristics:


•	Additional exceptions to the Bank's policy requirements, product guidelines or underwriting standards that present a higher degree of risk to the Bank. Although the combination and/or severity of identified exceptions is greater, all exceptions have been properly mitigated by other factors.


•	Unproved, insufficient or marginal primary sources of repayment that appear sufficient to service the debt at this time. Repayment weaknesses may be due to minor operational issues, financial trends, or reliance on projected (not historic) performance.


•	Marginal or unproven secondary sources to liquidate the debt, including combinations of liquidation of collateral and liquidation value to the net worth of the borrower or guarantor.

For existing loans, payments have generally been made as agreed with only minor and isolated delinquencies.

Special Mention-This grade is given to Watch List loans that include the following characteristics:


•	Loans with underwriting guideline tolerances and/or exceptions with no identifiable mitigating factors.


•	Extending loans that are currently performing satisfactorily but with potential weaknesses that may, if not corrected, weaken the asset or inadequately protect the Bank's position at some future date. Potential weaknesses are the result of deviations from prudent lending practices.


•	Loans where adverse economic conditions that develop subsequent to the loan origination do not jeopardize liquidation of the debt, but do substantially increase the level of risk may also warrant this rating.

Substandard-Loans in this category are characterized by deterioration in quality exhibited by any number of well-defined weaknesses requiring corrective action. A substandard loan is inadequately protected by the current sound net worth and paying capacity of the obligor or of the collateral pledged, if any. Loans classified as substandard must have a well-defined weakness or weaknesses that jeopardize the liquidation of the debt; they are characterized by the distinct possibility that the institution will sustain some loss if the deficiencies are not corrected.

The weaknesses may include, but are not limited to:


•	High debt to worth ratios and or declining or negative earnings trends


•	Declining or inadequate liquidity


•	Improper loan structure or questionable repayment sources


•	Lack of well-defined secondary repayment source, and


•	Unfavorable competitive comparisons.

Such loans are no longer considered to be adequately protected due to the borrower's declining net worth, lack of earnings capacity, declining collateral margins and/or unperfected collateral positions. A possibility of loss of a portion of the loan balance cannot be ruled out. The repayment ability of the borrower is marginal or weak and the loan may have exhibited excessive overdue status or extensions and/or renewals.

Doubtful-Loans classified Doubtful have all the weaknesses inherent in loans classified Substandard, plus the added characteristic that the weaknesses make collection or liquidation in full on the basis of currently existing facts, conditions, and values highly questionable and improbable. The ability of the borrower to service the debt is extremely weak, overdue status is constant, the debt has been placed on non-accrual status, and no definite repayment schedule exists.

However, these loans are not yet rated as loss because certain events may occur which would salvage the debt. Among these events are:


•	Injection of capital


•	Alternative financing


•	Liquidation of assets or the pledging of additional collateral.

Credit Risk Profile based on payment activity as of ~~March~~June 3130, 2019:

	Consumer - Non Real Estate		Equity Line of Credit /Second Mortgages		Commercial - Non Real Estate		Agricultural - Non Real Estate
Performing	$	11,~~420~~214	$	33,~~198~~726	$	4446,~~719~~958	$	3,~~107~~117
Nonperforming (>90 days past due)	2711		—64		~~106~~575		—
Total	$	11,~~447~~225	$	33,~~198~~790	$	4447,~~825~~533	$	3,~~107~~117

Credit Risk Profile based on payment activity as of December 31, 2018:



	Consumer - Non Real Estate		Equity Line of Credit /Second Mortgages		Commercial - Non Real Estate		Agricultural - Non Real Estate
Performing	$	12,750	$	34,200	$	46,088	$	2,830
Nonperforming (>90 days past due)	4		75		114		—
Total	$	12,754	$	34,275	$	46,202	$	2,830

The following tables reflect the Bank's impaired loans at ~~March~~June 3130, 2019:

March 31, 2019	Recorded Investment		Unpaid Principal Balance		Related Allowance		Average Recorded Investment		Interest Income Recognized
June 30, 2019	Recorded Investment		Unpaid Principal Balance		Related Allowance		Average Recorded Investment		Interest Income Recognized
With no related allowance
Real estate secured
Residential 1-4 family	$	4,~~338~~890	$	4,~~338~~890	$	—	$	4,~~332~~518	$	4314
Equity lines of credit	—		—		—		42		—
Multifamily	—		—		—		~~201~~134		—
Farmland	5,~~008~~074		5,~~008~~074		—		5,~~345~~254		—29
Construction, land development, other land loans	1,~~635~~967		1,~~635~~967		—		1,~~635~~746		164
Commercial real estate- owner occupied	3,~~606~~831		3,~~606~~831		—		4,~~469~~256		—133
Commercial real estate- non owner occupied	—		—		—		—		—
Second mortgages	~~285~~—		~~285~~—		—		~~193~~128		—
Non-real estate secured
Personal	—44		—44		—		—15		12—
Commercial and agricultural	~~306~~1,214		~~306~~1,214		—		~~312~~612		126
Total	$	1517,~~178~~020	$	1517,~~178~~020	$	—	$	16,~~491~~665	$	18566

March 31, 2019	Recorded Investment		Unpaid Principal Balance		Related Allowance		Average Recorded Investment		Interest Income Recognized
June 30, 2019	Recorded Investment		Unpaid Principal Balance		Related Allowance		Average Recorded Investment		Interest Income Recognized
With an allowance recorded
Real estate secured
Residential 1-4 family	$	~~529~~732	$	~~529~~732	$	91209	$	~~302~~445	$	—71
Equity lines of credit	6764		6764		2625		3444		—2
Multifamily	~~422~~402		~~422~~402		65112		~~211~~275		—8
Farmland	—		—		—		~~866~~577		—
Construction, land development, other land loans	—58		—58		—		—19		—9
Commercial real estate- owner occupied	12,~~702~~886		12,~~702~~886		~~549~~528		12,~~788~~154		—
Commercial real estate- non owner occupied	31,~~062~~599		31,~~062~~599		~~871~~362		32,~~477~~851		—23
Second mortgages	35—		35—		6—		1812		—
Non-real estate secured
Personal	1740		1740		63		1020		—8
Commercial and agricultural	1,~~181~~226		1,~~181~~226		~~895~~752		~~842~~970		—20
Total	$	7,~~015~~007	$	7,~~015~~007	$	21,~~509~~991	$	7,~~548~~367	$	—141

The following tables reflect the Bank's impaired loans at December 31, 2018:



December 31, 2018	Recorded Investment		Unpaid Principal Balance		Related Allowance		Average Recorded Investment		Interest Income Recognized
With no related allowance
Real estate secured
Residential 1-4 family	$	4,325	$	4,325	$	—	$	5,862	$	134
Equity lines of credit	7		7		—		28		—
Multifamily	402		402		—		201		—
Farmland	5,681		5,681		—		3,084		10
Construction, land development, other land loans	1,635		1,635		—		1,700		2
Commercial real estate- owner occupied	5,332		5,332		—		3,442		9
Commercial real estate- non owner occupied	—		—		—		32		—
Second mortgages	100		100		—		155		—
Non real estate secured
Personal	—		—		—		48		9
Commercial and agricultural	317		317		—		411		20
Total	$	17,799	$	17,799	$	—	$	14,963	$	184



December 31, 2018	Recorded Investment		Unpaid Principal Balance		Related Allowance		Average Recorded Investment		Interest Income Recognized
With an allowance recorded
Real estate secured
Residential 1-4 family	$	631	$	631	$	191	$	353	$	307
Equity lines of credit	105		105		80		53		6
Multifamily	—		—		—		—		—
Farmland	122		122		2		927		—
Construction, land development, other land loans	—		—		—		—		—
Commercial real estate- owner occupied	1,704		1,704		351		1,789		—
Commercial real estate- non owner occupied	3,686		3,686		844		3,789		45
Second mortgages	35		35		7		18		—
Non real estate secured
Personal	18		18		7		10		—
Commercial and agricultural	1,161		1,161		880		832		—
Total	$	7,462	$	7,462	$	2,362	$	7,771	$	358

The following tables present the balance in the allowance for loan losses and the recorded investment in loans by loan category and is segregated by impairment evaluation method as of and for the three- and six-month periods ended ~~March~~June 3130, 2019 and ~~March~~June 3130, 2018.

Three months ended March 31, 2019	Residential1-4 Family			Multifamily		Construction and Land Loans			Commercial Owner Occupied		Commercial Non-Owner Occupied			Second Mortgages			Equity Line of Credit		Farmland			Personal and Overdrafts			Commercial and Agricultural			Unallocated			Total
Six months ended June 30, 2019	Residential1-4 Family			Multifamily		Construction and Land Loans			Commercial Owner Occupied		Commercial Non-Owner Occupied			Second Mortgages			Equity Line of Credit		Farmland			Personal and Overdrafts			Commercial and Agricultural			Unallocated			Total
Allowance for loan losses:
Balance at December 31, 2018	$	492		$	25	$	27		$	1,022	$	895		$	13		$	127	$	11		$	114		$	957		$	690		$	4,373
Provision expense (credit) for credit losses	~~136~~327			65148		(124		)	6751		~~166~~517			(31		)	6296		(42		)	~~(10~~41		)	53160			(~~428~~426		)	~~103~~939
Charge-offs	~~167~~170			—		—			—		92656			—			75		—			4290			~~156~~274			—			~~532~~1,265
Recoveries	(514		)	—		(24		)	—		(1		)	(12		)	—		—			(2947		)	(~~114~~128		)	—			(~~152~~196		)
Net charge-offs (recoveries)	~~162~~156			—		(24		)	—		91655			(12		)	75		—			1343			42146			—			~~380~~1,069
Balance at March 31, 2019	$	466		$	90	$	28		$	1,089	$	970		$	11		$	114	$	7		$	91		$	968		$	262		$	4,096
Balance at June 30, 2019	$	663		$	173	$	55		$	1,073	$	757		$	14		$	148	$	13		$	112		$	971		$	264		$	4,243
Allowance allocated by impairment method:
Individually evaluated	$	91103		$	65119	$	—		$	~~549~~559	$	~~871~~382		$	65		$	26	$	—		$	6		$	~~895~~791		$	—		$	21,~~509~~991
Collectively evaluated	~~375~~560			2554		2855			~~540~~514		99375			59			88122		713			85106			73180			~~262~~264			12,~~587~~252
Loan balances by impairment method used:
Individually evaluated	$	4,~~867~~951		$	~~422~~429	$	1,~~635~~967		$	57,~~308~~823	$	31,~~062~~707		$	~~320~~471		$	6768	$	5,~~008~~074		$	1763		$	1,~~487~~474		$	—		$	2224,~~193~~027
Collectively evaluated	~~160~~163,~~639~~245			1820,~~282~~841		2021,~~416~~237			8988,~~993~~707		35,~~669~~681			3,~~699~~541			29,~~112~~710		54,~~039~~933			11,~~430~~162			4649,~~445~~176			—			~~420~~428,~~724~~233
Balance at March 31, 2019	$	165,506		$	18,704	$	22,051		$	95,301	$	38,731		$	4,019		$	29,179	$	10,047		$	11,447		$	47,932		—			$	442,917
Balance at June 30, 2019	$	168,196		$	21,270	$	23,204		$	96,530	$	37,388		$	4,012		$	29,778	$	10,007		$	11,225		$	50,650		—			$	452,260



Three months ended June 30, 2019	Residential 1-4 Family			Multifamily		Construction and Land Loans			Commercial Owner Occupied			Commercial Non-Owner Occupied		Second Mortgages			Equity Line of Credit		Farmland		Personal and Overdrafts			Commercial and Agricultural			Unallocated		Total
Allowance for loan losses:
Balance at March 31, 2019	$	466		$	90	$	28		$	1,089		$	970	$	11		$	114	$	7	$	91		$	968		$	262	$	4,096
Provision for credit losses	191			83		25			(16		)	351		2			34		6		51			107			2		836
Charge-offs	3			—		—			—			564		—			—		—		48			118			—		733
Recoveries	(9		)	—		(2		)	—			—		(1		)	—		—		(18		)	(14		)	—		(44		)
Net charge-offs (recoveries)	(6		)	—		(2		)	—			564		(1		)	—		—		30			104			—		689
Balance at June 30, 2019	$	663		$	173	$	55		$	1,073		$	757	$	14		$	148	$	13	$	112		$	971		$	264	$	4,243

Three months ended March 31, 2018	Residential1-4 Family			Multifamily		Construction and Land Loans			Commercial Owner Occupied			Commercial Non-Owner Occupied			Second Mortgages			Equity Line of Credit			Farmland			Personal and Overdrafts			Commercial and Agricultural			Unallocated		Total
Six months ended June 30, 2018	Residential1-4 Family			Multifamily		Construction and Land Loans			Commercial Owner Occupied			Commercial Non-Owner Occupied			Second Mortgages			Equity Line of Credit			Farmland			Personal and Overdrafts			Commercial and Agricultural			Unallocated		Total
Allowance for loan losses:
Balance at December 31, 2017	$	133		$	—	$	1		$	1,636		$	955		$	12		$	—		$	54		$	265		$	383		$	515	$	3,954
Balance at March 31, 2018	$	133		$	—	$	1		$	1,636		$	955		$	12		$	—		$	54		$	265		$	383		$	515	$	3,954
Provision for credit losses	388			3—		255			(~~219~~564		)	(~~167~~558		)	(310		)	6356			~~139~~241			21(17		)	~~(136~~321		)	~~523~~432		~~172~~344
Charge-offs	—25			—		—			9596			—			5			—			—1			88118			~~149~~242			—		~~337~~487
Recoveries	(834		)	—		(12		)	(17		)	—			—(4		)	—(1		)	(12		)	(3086		)	(~~154~~181		)	—		(~~211~~327		)
Net charge-offs (recoveries)	(89		)	—		(12		)	7879			—			51			—(1		)	(1		)	5832			(561		)	—		~~126~~160
Balance at March 31, 2018	$	144		$	3	$	4		$	1,339		$	788		$	4		$	6		$	194		$	228		$	252		$	1,038	$	4,000
Balance at June 30, 2018	$	230		$	—	$	58		$	993		$	397		$	1		$	357		$	296		$	216		$	643		$	947	$	4,138
Allowance allocated by impairment method:
Individually evaluated	$	19148		$	—	$	—		$	~~516~~153		$	~~782~~397		$	—		$	—		$	~~192~~296		$	241		$	~~233~~627		$	—	$	1,~~766~~622
Collectively evaluated	~~125~~82			3—		458			~~823~~840			6—			41			6357			2—			~~204~~215			1916			~~1,038~~947		2,~~234~~516
Loan balances by impairment method used:
Individually evaluated	$	57,~~269~~487		$	—	$	1,~~677~~636		$	34,~~194~~270		$	3,~~835~~483		$	~~122~~145		$	35—		$	2,~~200~~595		$	211		$	~~1,509~~488		$	—	$	1720,~~862~~105
Collectively evaluated	~~166~~162,~~462~~762			18,~~157~~079		1522,~~256~~935			7883,~~957~~375			3028,~~602~~966			4,~~548~~226			35,~~533~~702			10,~~777~~090			1314,~~596~~378			4041,~~227~~530			—		~~414~~422,~~115~~043
Balance at March 31, 2018	$	171,731		$	18,157	$	16,933		$	82,151		$	34,437		$	4,670		$	35,568		$	12,977		$	13,617		$	41,736		—		$	431,977
Balance at June 30, 2018	$	170,249		$	18,079	$	24,571		$	87,645		$	32,449		$	4,371		$	35,702		$	12,685		$	14,379		$	42,018		—		$	442,148



Three months ended June 30, 2018	Residential 1-4 Family			Multifamily			Construction and Land Loans			Commercial Owner Occupied			Commercial Non-Owner Occupied			Second Mortgages			Equity Line of Credit			Farmland			Personal and Overdrafts			Commercial and Agricultural			Unallocated			Total
Allowance for loan losses:
Balance at March 31, 2018	$	144		$	3		$	4		$	1,339		$	788		$	4		$	6		$	194		$	228		$	252		$	1,038		$	4,000
Provision for credit losses	85			(3		)	53			(345		)	(391		)	(7		)	350			102			(38		)	457			(91		)	172
Charge-offs	25			—			1			1			1			—			—			1			30			93			—			152
Recoveries	(26		)	—			(2		)	—			(1		)	(4		)	(1		)	(1		)	(56		)	(27		)	—			(118		)
Net charge-offs (recoveries)	(1		)	—			(1		)	1			—			(4		)	(1		)	—			(26		)	66			—			34
Reclassification of reserve for unfunded commitments	—			—			—			—			—			—			—			—			—			—			—			—
Balance at June 30, 2018	$	230		$	—		$	58		$	993		$	397		$	1		$	357		$	296		$	216		$	643		$	947		$	4,138

The Company's credit administration personnel and senior financial officers are responsible for tracking, coding, and monitoring loans that become Troubled Debt Restructurings ("TDRs"). Concessions are made to existing borrowers in the form of modified interest rates and / or payment terms. The loans are segregated for regulatory and external reporting. Each specific TDR is reviewed to determine if the accrual of interest should be discontinued and also reviewed for impairment. The Company's senior credit officer performs this analysis on a quarterly basis in addition to determining any other loans that are impaired within the loan portfolio. The Company had a total of $98,~~255~~445 and $11,546 of loans categorized as troubled debt restructurings as of ~~March~~June 3130, 2019 and December 31, 2018, respectively. Interest is accrued on TDRs if the loan is otherwise not impaired and the full collection of principal and interest under the modified terms is still deemed probable.

In the determination of the allowance for loan losses, management considers troubled debt restructurings and subsequent defaults in these restructurings by adjusting the loan grades of such loans. Defaults resulting in charge-offs affect the historical loss experience ratios which are a component of the allowance calculation. Additionally, specific reserves may be established on restructured loans evaluated individually.

The following table identifies restructurings completed during the six-month period ended June 30, 2019 that represent new TDRs.



Number	Pre-Modification Recorded Investment	Post-Modification Recorded Investment

Below Market Rate
Farmland	1	$	~~754~~$	754	$	~~754~~$	754
Commercial real estate-owner occupied	2		1,258			1,258
Commercial	1		65			65
Total below market rate	4		2,077			2,077

Total restructurings 14 $ ~~754~~2,077 $ ~~754~~2,077

The following table identifies restructurings completed during the ~~three~~six-month period ended ~~March~~June 3130, 2018 that represented new TDRs.

Below Market Rate
Residential 1-4 family	13	$	~~162~~549	$	~~162~~549
Commercial real estate-owner occupied	14	12,~~479~~524		12,~~479~~524
Total	27	$	13,~~641~~073	$	13,~~641~~073

There were no defaults in the ~~three~~six-month periods ending ~~March~~June 3130, 2019 and ~~March~~June 3130, 2018 of TDRs modified in the previous 12 months.

The Bank has engaged an external third party to perform its loan review function in order to identify weaknesses within the loan portfolio. The review, which seeks to cover 25 percent of loan balances each year, considers collateral, repayment history, guarantor strength, debt service coverage, and other relevant information on an individual and global level. These reviews consider borrower cash flow capacity, using financial statements, income tax returns and internally prepared interim statements for borrowers and guarantors. Debt service coverage (DSC) is calculated on each individual customer, or guarantor, as well as the aggregate or global DSC. Collateral evaluation includes an inspection of the collateral file to determine if the Bank is properly secured. Collateral is discounted, when appropriate, to determine a stressed loan to value (LTV) ratio.

The Company also seeks to identify potential problem relationships through watch list reviews, which include reviews of past due data and other information that might be helpful in evaluating a particular loan relationship that is exhibiting stress. Watch list relationships display distinct characteristics including, but not limited to, late payments greater than 60 days, a low DSC calculation, bankruptcy filings, casualty losses, or other issues that would cause a perceived increase in the risk of loss to the Bank.

The segments of the Company's loan portfolio are disaggregated to a level that allows management to monitor risk and performance. In reviewing risk, management has determined there to be several different risk categories within the loan portfolio. The allowance for loan losses consists of amounts applicable to: (i) the commercial loan portfolio; (ii) the commercial real estate loan portfolio; (iii) the construction loan portfolio; (iv) the consumer loan portfolio; and, (v) the residential loan portfolio. The commercial real estate ("CRE") loan segment is further disaggregated into two classes. Non-owner occupied CRE loans, which include loans secured by non-owner occupied nonfarm nonresidential properties, generally have a greater risk profile than all other CRE loans, which include multifamily structures and owner-occupied commercial structures. The construction loan segment is further disaggregated into two classes. One-to-four family residential construction loans are generally made to individuals for the

secured by non-owner occupied nonfarm nonresidential properties, generally have a greater risk profile than all other CRE loans, which include multifamily structures and owner-occupied commercial structures. The construction loan segment is further disaggregated into two classes. One-to-four family residential construction loans are generally made to individuals for the acquisition of and/or construction on a lot or lots on which a residential dwelling is to be built. Commercial construction loans are generally made to developers or investors for the purpose of acquiring, developing and constructing residential or commercial structures. Construction lending is generally considered to involve a higher degree of credit risk than long-term permanent financing.

The following describes the Company's basic methodology for computing its ALLL.

On a quarterly basis, the ALLL methodology begins with the identification of loans subject to ASC 310. All loans that are rated "7" (Doubtful) are assessed as impaired based on the expectation that the full collection of principal and interest is in doubt. All loans that are rated "6" (Substandard) or are expected to be downgraded to "6", require additional analysis to determine whether they may be impaired under ASC 310. All loans that are rated "5" (Special Mention) are presumed not to be impaired. However, "5" rated loans, together with any Troubled Debt Restructured (TDR) loan, may warrant further analysis before completing an assessment of impairment.

A loan is considered impaired and an allowance for loan losses is established on loans for which it is probable that the full collection of principal and interest is in doubt. Once a loan is identified as individually impaired, management measures impairment using one of several methods, including collateral value based on a recent appraisal, liquidation value and/or discounted cash flows. Those impaired loans not requiring an allowance represent loans for which the fair value of the expected repayments or collateral exceed the recorded investments in such loans. At ~~March~~June 3130, 2019 and December 31, 2018, all impaired loans were evaluated based on either the fair value of the collateral or the discounted cash flows.

For ASC 310 loans that are individually evaluated and found to be impaired (primarily those designated as Substandard and Doubtful), the associated ALLL will be based upon one of the three impairment measurement methods specified within ASC 310:

• the present value of expected future cash flows discounted at the loans' effective interest rate;

• the loan's observable fair value; or

• the fair value of the collateral

For impaired loans valued based on collateral value, the collateral value is adjusted for age and condition of the security, and, for real estate, adjusted for condition, location, and age of the most current appraisal. If the adjusted value of the collateral is less than the current principal balance, the difference is designated as direct exposure for loan loss calculations. The total balance of unsecured loans is considered as direct exposure.

For all other loans, including individual loans determined not to be impaired under ASC 310, the associated ALLL is calculated in accordance with ASC 450 that provides for estimated credit losses likely to be realized on groups of loans with similar risk characteristics. The Company uses standard call report categories to segregate loans into groups with similar risk characteristics. Estimated credit losses reflect significant factors that affect the collectability of the portfolio as of the evaluation date. Key factors that influence risk within the Company's loan portfolio are divided into three major categories:

•

Historical loss factors - To calculate the anticipated loan loss in each call report category for ASC 450 loans, the Company begins with the net loss in each category for each of the last twelve quarters. The Company uses a rolling twelve quarter weighted historical loss average where the most recent quarters are weighted heavier than the earlier quarters so that the calculation reflects current risk trends within the portfolio. The weighting used by the Company is similar to the Rule of 78's with the net losses of the most recent quarter weighted at 12/78ths and those in the first quarter in the twelve quarter period weighted at 1/78th. Therefore, the net losses of the most recent year represent approximately 54% of the calculation compared with 33% if a simple average of losses over the three-year period was used. The total of weighted factors for each call report category is applied to the current outstanding loan balance in each category to calculate expected loss based on historical data for a group of loans with similar risk characteristics. The same weighting is applied to all loan types.


•	External economic factors - Economic conditions have a significant impact on Company's loan portfolio because deteriorating conditions can adversely impact both collateral values and the customer's ability to service debt. Management has selected the following external factors as indicators of economic conditions:

a. National GDP growth rate

b. Local unemployment rates

c. Prime interest rate

The values for external factors are updated on a quarterly basis based on current data.


•	Internal process factors - Internal factors that influence loss rates as a result of risk management and control practices include the following:

a. Past-due loans

b. Non-accrual loans

c. Commercial real estate concentrations

d. Loan volume

e. Level and trend of classified loans

The values for internal factors are updated on a quarterly basis based on current portfolio metrics.

Once the quarterly ALLL is computed, the calculations are reviewed by the Company's management. The ALLL is then reviewed and approved by the Board of Directors.

Loans Held for Sale

The Company's mortgage division originates certain single family, residential first mortgage loans for sale to a third party broker. Loan sale activity is summarized below. Loans are typically sold to investors within 20 days of closing. Management feels the carrying amounts approximate the fair values of loans held for sale.

	Three months ended March 31,
	Six months ended June 30,
	2019		2018
Loans held for sale at end of period	$	~~1,727~~863	$	1,~~795~~424
Proceeds from sales of mortgage loans originated for sale	13,~~194~~584		1013,~~664~~855
Gain on sales of mortgage loans originated for sale	4896		~~100~~152

Note 5 - Income Taxes

Income tax expense at statutory rates for the three- and six-month periods ended ~~March~~June 3130, is provided below, with adjustments needed to determine income tax expense recorded in the consolidated statements of income.

	Three months ended March 31,
	Three months ended June 30,						Six months ended June 30,
	2019			2018			2019			2018
Tax expense (benefit) at statutory rate	$	282		$	164
Tax expense at statutory rate	$	136		$	246		$	417		$	410
Increase (decrease) in tax expense resulting from:
Tax-exempt interest	(29		)	(27		)	(58		)	(58		)
Other, net	29(32		)	3328			(2		)	65
Income tax expense	$	~~282~~75		$	~~170~~247		$	357		$	417
Statutory corporate federal income tax rate	21		%	21		%	21		%	21		%

Note 6 - Capital Requirements

Regulators of the Company and its subsidiary, Highlands Union Bank (the "Bank"), have implemented risk-based capital guidelines which require compliance with certain minimum capital ratios as a percent of assets and other certain off-balance sheet items that are adjusted for predefined credit risk factors. On July 7, 2013 the Federal Reserve Board approved Basel III final rules to improve the banking sector's ability to absorb shocks arising from financial and economic stress. The final rules include a new common equity tier 1 minimum ratio and raise the tier 1 risk-weighted assets ratio to 6 percent from 4 percent. In addition, beginning in 2016, the new rules required banks to maintain a capital conservation buffer between 2 and 2 ½ %. Additionally, the new rules increased the risk weighting of various assets. The new rules are being phased in between 2015 and 2019. Generally, the Basel III final rules require banks to maintain higher levels of common equity and regulatory capital.

On February 5, 2015 the Company received notification from the Federal Reserve Bank that it would no longer be required to report holding company consolidated capital ratios.

The following table presents the capital ratios for the Bank only.

	March 31, 2019		December 31, 2018
	June 30, 2019		December 31, 2018
Tier 1 leverage	9.2219	%	9.14	%
Tier 1 risk-based	12.9489	%	12.31	%
Total risk-based	13.9087	%	13.30	%
Common equity tier 1	12.9489	%	12.31	%

Note 7 – Stock and Earnings Per Share

Earnings per common share is computed using the weighted average outstanding shares for the six month periods ended June 30, 2019 and 2018. The following provides information for the calculation of basic and diluted earnings per common share:

	Three months ended March 31,
	Three months ended June 30,				Six months ended June 30,
(thousands, except per share information)	2019		2018		2019		2018
Net income available to common stockholders	$	~~1,060~~571	$	~~610~~923	$	1,631	$	1,533
Weighted average common shares outstanding	8,~~199~~251		8,199		8,251		8,199
Total shares outstanding including assumed conversion of preferred securities	10,343		10,292		10,343		10,292
Basic earnings per common share	$	0.1307	$	0.0711	$	0.20	$	0.19
Fully diluted earnings per share (including convertible preferred shares outstanding and restricted stock)	0.1006		0.0609		0.16		0.15

At the 2018 annual meeting, stockholders approved the 2018 Restricted Stock Plan, which authorized the board's Compensation Committee to issue up to 250,000 shares of Common Stock in grants of restricted stock and restricted stock unit awards to eligible employees. A total of 5152,~~500~~000 shares have been issued under the 2018 Restricted Stock Plan as of ~~March~~June 3130, 2019.

Note 8 – Commitments and Contingencies

The Bank is a party to various financial instruments with off-balance sheet risk arising in the normal course of business to meet the financing needs of its customers. Those financial instruments include commitments to extend credit and standby letters of credit.

At ~~March~~June 3130, 2019, unused commitments totaled $5852,~~165~~777, compared to $56,726 at December 31, 2018. Standby letters of credit totaled $~~1,977~~973 at ~~March~~June 3130, 2019 and $3,477 at December 31, 2018.

Note 9 – Fair Value

The Company utilizes fair value measurements to record fair value adjustments to certain assets and to determine fair value disclosures. Securities available-for-sale are recorded at fair value on a recurring basis. Additionally, from time to time, the Company may be required to record financial instruments at fair value on a nonrecurring basis. These nonrecurring fair value adjustments typically involve application of lower of cost or market accounting or write-downs of individual assets.

Fair Value Hierarchy

Under ASC Topic 820 on Fair Value Measurements and Disclosures, the Company groups assets and liabilities at fair value in three levels, based on the markets in which the assets and liabilities are traded and the reliability of the assumptions used to determine fair value. These levels are:



	Level 1		Valuation is based upon quoted prices for identical instruments traded in active markets.

	Level 2		Valuation is based upon quoted prices for similar instruments in active markets, quoted prices for identical or similar instruments in markets that are not active, and model-based valuation techniques for which all significant assumptions are observable in the market.

	Level 3		Valuation is generated from model-based techniques that use at least one significant assumption not observable in the market. These unobservable assumptions reflect estimates of assumptions that market participants would use in pricing the asset or liability. Valuation techniques include use of option pricing models, discounted cash flow models and similar techniques.

In general, fair value is based upon quoted market prices, where available. If such quoted market prices are not available, fair value is based upon third party models that primarily use, as inputs, observable market-based parameters. Valuation adjustments may be made to determine fair value. These adjustments may include amounts to reflect counterparty credit quality, the borrower's creditworthiness, among other things, as well as unobservable parameters. Any such valuation adjustments are applied consistently over time. The Company's valuation methodologies may produce a fair value calculation that may not be indicative of net realizable value or reflective of future fair values. While management believes the Company's valuation methodologies are appropriate and consistent with other market participants, the use of different methodologies or assumptions to determine the fair value of certain financial instruments could result in a different estimate of fair value at the reporting date.

Recurring - Investment Securities Available for Sale

Securities classified as available for sale are reported at fair value utilizing level 2. For level 2 securities, the Company obtains fair value measurements from multiple independent third party sources. The fair value measurements consider observable data that may include dealer quotes, market spreads, cash flows, the U.S. Treasury yield curve, live trading levels, trade execution data, market consensus prepayment speeds, credit information, and the bond's terms and conditions, among other things.

The following tables summarize the Company's available for sale securities portfolio measured at fair value on a recurring basis as of ~~March~~June 3130, 2019 and December 31, 2018, segregated by the level of the valuation inputs within the fair value hierarchy.

March 31, 2019

June 30, 2019

Level 1

Level 2

Level 3

Total Fair Value

State and political subdivisions

—

13,~~205~~269

—

13,~~205~~269

Mortgage backed securities

—

4948,~~335~~195

—

4948,~~335~~195

SBA pools

—

54,~~018~~763

—

54,~~018~~763

Total available for sale securities

—

6766,~~558~~227

—

6766,~~558~~227



December 31, 2018
	Level 1		Level 2		Level 3		Total Fair Value

State and political subdivisions	$	—	$	12,836	$	—	$	12,836
Mortgage backed securities	—		50,554		—		50,554
SBA pools	—		5,241		—		5,241
Total available for sale securities	$	—	$	68,631	$	—	$	68,631

Recurring - Derivatives

The Company has entered into interest rate swaps related to customer loan transactions to manage its interest rate risk. Interest rate swaps, which had a notional value of $12,890 as of March 31, 2019 and December 31, 2018, are recorded at fair value, based on third party pricing models that are sensitive to market observable data and are therefore classified as level 2 values. The fair value of derivative financial instruments as of March 31, 2019 totaled $83, compared to $38 at December 31, 2018.

Recurring - Derivatives

The Company has entered into interest rate swaps related to customer loan transactions to manage its interest rate risk. Interest rate swaps, which had a notional value of $12,890 as of June 30, 2019 and December 31, 2018, are recorded at fair value, based on third party pricing models that are sensitive to market observable data and are therefore classified as level 2 values. The fair value of derivative financial instruments as of June 30, 2019 totaled $268, compared to $38 at December 31, 2018.

Non Recurring - Loans

The Company does not record loans at fair value on a recurring basis. However, from time to time, a loan is considered impaired and an allowance for loan loss is established. Loans for which it is probable that payment of interest and principal will not be made in accordance with the contractual terms of the loan agreement are considered impaired. Once a loan is identified as individually impaired, management measures impairment using one of several methods, including recently appraised collateral value and /or tax assessed value, liquidation value and discounted cash flows. Those impaired loans not requiring an allowance represent loans for which the fair value of the expected repayments or collateral exceed the recorded investments in such loans. At ~~March~~June 3130, 2019 and December 31, 2018, all of the total impaired loans were evaluated based on the fair value of the collateral or the present value of the future cash flows. The Company frequently obtains appraisals prepared by external professional appraisers and applies discounts ranging from 8% to 40% depending on type of property, condition, location, etc. The Company also, in certain instances, prepares internally generated valuations from on-site inspections, third-party valuation models or other information.

Non Recurring – Loans Held for Sale

Loans held for sale are carried at the lower of cost or market value. The fair value of loans held for sale is based on inputs derived from secondary markets for loans with similar characteristics. The Company considers loans held for sale as non-recurring level 2.

Non Recurring –Other Real Estate Owned / Repossessions / Real Estate Held for Sale

Other real estate owned and repossessions are adjusted to fair value upon transfer of the loans to other real estate owned and repossessions. Subsequently, foreclosed assets and repossessions are carried at the lower of carrying value or fair value. Fair value is based upon independent market prices or recent appraised values of the collateral which the Company considers as nonrecurring level 2. When the current appraised value is not available or is further discounted below the most recent appraised value less selling costs due to absorption rates and market conditions, the Company records the foreclosed assets within level 3 of the fair value hierarchy.

Real estate held for sale is adjusted to fair value upon transfer from fixed assets or when no longer being used for banking purposes.

The following table summarizes the Company's assets at fair value on a non-recurring basis as of ~~March~~June 3130, 2019 and December 31, 2018, segregated by the level of the valuation inputs within the fair value hierarchy. The tables disclose the recorded investment of impaired loans requiring a specific allowance.

March 31, 2019

Level 1

Level 2

Level 3

Fair Value

June 30, 2019

Level 1

Level 2

Level 3

Fair Value

Impaired loans

—

45,~~506~~016

OREO

—

2,~~886~~892

Real estate held for sale

—

~~600~~590



December 31, 2018	Level 1		Level 2		Level 3		Fair Value
Impaired loans	$	—	$	—	$	5,100	$	5,100
OREO	—		—		2,212		2,212
Real estate held for sale	—		—		817		817

The following table presents additional quantitative information about assets measured at fair value on a nonrecurring basis for which the Company uses level 3 inputs to determine fair value:

Quantitative Information about Level 3 Fair Value Measurements

12/31/18

36/3130/2019

ValuationTechniques

UnobservableInput (2)

Range

OREO, net

2,212

2,~~886~~892

Appraisal of collateral (1)

Appraisal adjustments

0% to 20%

Liquidation expenses

0% to 10%

Real estate held for sale

817

~~600~~590

Appraisal of collateral (1)

Appraisal adjustments

0% to 20%

Liquidation expenses

0% to 10%

Impaired loans

5,100

45,~~506~~016

Fair value of collateral –real estate (1), (3)

Appraisal adjustments

0% to 100%

Fair value of collateral –equipment, inventory, other (1), (3)

Appraisal adjustments

25% to 80%

Liquidation expenses

0% to 12%

Valuation adjustments and liquidation cost adjustments represent unobservable inputs for OREO and impaired loans. The ranges of discounts applied are based on age of independent appraisals, type and condition of collateral, current market conditions, and experience with the local market.

(1) Fair value is generally determined through independent appraisals of the underlying collateral, which generally include various level 3 inputs which are not identifiable.

(2) Appraisals may be adjusted by management for qualitative factors such as economic conditions and estimated liquidation expenses. The range and weighted average of liquidation expenses and other appraisal adjustments are presented as a percent of the appraisal.

(3) Includes qualitative adjustments by management.

Fair Value of Financial Instruments

Fair value is the price that would be received to sell an asset or paid to transfer a liability in an orderly transaction between market participants at the measurement date. Fair value is best determined based upon quoted market prices. However, in many instances, there are no quoted market prices for the Company's various financial instruments. In cases where quoted market prices are not available, fair values are based on estimates using present value or other valuation techniques. Those techniques are significantly affected by the assumptions used, including the discount rate and estimates of future cash flows. Accordingly, the fair value estimates may not be realized in an immediate settlement. Accordingly, the aggregate fair value amounts presented may not necessarily represent the underlying fair value of the Company.

Cash and Cash Equivalents

The carrying amount reported in the balance sheets for cash, short-term investments and federal funds sold approximates fair value.

Securities Available for Sale

Fair values are determined in the manner as described above.

Other Investments

Other investments include Federal Home Loan Bank stock, Federal Reserve Bank stock, Community Bankers Bank stock, and Pacific Coast Bankers Bank. The carrying value of those securities approximates fair value based on the redemption provisions of those Banks. Also included in other investments are certificates of deposit purchased from other FDIC insured banks in which the carrying amount approximates fair value.

~~Loans~~Fair Value of Financial Instruments

The carrying amounts and fair values of the Company's financial instruments at June 30, 2019 and December 31, 2018 were as follows:

The fair value of loans represent the amount at which the loans of the Bank could be exchanged on the open market, based upon the current lending rate for similar types of lending arrangements discounted over the remaining life of the loans . For fixed rate loans and for variable rate loans with infrequent re-pricing or re-pricing limits, fair value is based on discounted cash flows using current market rates applied to the cash flow analysis.



		June 30, 2019				December 31, 2018
	Fair Value Inputs	Carrying Amount		Fair Value		Carrying Amount		Fair Value
Cash and cash equivalents	(1)	$	47,822	$	47,822	$	30,066	$	30,066
Securities available for sale	Level 2	66,227		66,227		68,631		68,631
Other investments	(2)	2,770		2,770		2,774		2,774
Loans, net	Level 2	447,347		434,819		443,748		429,289
Interest rate swaps	Level 2	268		268		38		38
Deposits	Level 2	518,444		449,357		502,816		422,570
Other short-term borrowings	Level 2	30,000		30,046		30,000		30,142
Long-term debt	Level 2	67		64		93		89

~~Deposits~~(1) - management believes the carrying value of cash and cash equivalents is a reasonable estimate of fair value

~~The~~(2) ~~fair~~- ~~value~~other ofinvestments ~~time~~include ~~deposits~~Federal isHome ~~based~~Loan onBank ~~discounted~~stock, ~~cash~~Federal ~~flows~~Reserve ~~using~~Bank ~~current~~stock, ~~market~~and ~~rates~~equity ~~applied~~investments toin Community Bankers Bank and Pacific Coast Bankers Bank; the ~~cash~~carrying ~~flow~~value ~~analysis~~of ~~for~~those ~~each~~securities ~~time~~approximates ~~deposit.~~fair ~~Other~~value ~~non-maturity~~based ~~deposits~~on ~~are~~the ~~reported~~redemption atprovisions ~~their~~of ~~carrying~~those ~~values.~~Banks

Other Short-Term Borrowings

Fair values of other short-term borrowings are estimated using discounted cash flow analyses based on the Company's current incremental borrowing rates for similar types of borrowing arrangements. Estimated maturity dates are also included in the calculation of fair value for these borrowings.

Long-term Debt and Capital Securities

Rates currently available to the Company for debt with similar terms and remaining maturities or established call prices are used to estimate fair value of existing debt.

Off-Balance Sheet Instruments

The carrying value of off-balance sheet commitments to extend credit, standby letters of credit, and financial guarantees, is considered equal to fair value. Because of the uncertainty involved in attempting to assess the likelihood and timing of commitments being drawn upon, coupled with the lack of an established market and the wide diversity of fee structures, the Company does not believe it is meaningful to provide an estimate of fair value that differs from the given value of the commitment.

The carrying amounts and fair values of the Company's financial instruments at March 31, 2019 and December 31, 2018 were as follows:

	March 31, 2019				December 31, 2018
	Carrying Amount		Fair Value		Carrying Amount		Fair Value
Cash and cash equivalents	$	55,178	$	55,178	$	30,066	$	30,066
Securities available for sale	67,558		67,558		68,631		68,631
Other investments	2,770		2,770		2,774		2,774
Loans, net	438,140		425,870		443,748		429,289
Interest rate swaps	83		83		38		38
Deposits	520,699		451,312		502,816		422,570
Other short-term borrowings	30,000		30,106		30,000		30,142
Long-term debt	80		77		93		89

Note 10–Formal Written Agreement

On October 13, 2010, the Company and Bank entered into a written agreement ("Written Agreement") with the Federal Reserve Bank of Richmond (the "Reserve Bank"). Under the terms of the Written Agreement, the Bank has agreed to develop and submit to the Reserve Bank for approval within the time periods specified therein written plans or programs to:

• strengthen board oversight of the management and operations of the Bank;

• strengthen credit risk management and administration;

• provide for the effective grading of the Bank's loan portfolio;

• summarize the findings of its review of the adequacy of the staffing of its loan review function;

• improve the Bank's position with respect to loans, relationships, or other assets in excess of $500 that currently are, or in the future become past due more than 90 days, on the Bank's problem loan list, or adversely classified in any report of examination of the Bank;

• review and revise the Bank's methodology for determining the allowance for loan and lease losses ("ALLL") and maintain an adequate ALLL;

• maintain sufficient capital at the Company and the Bank;

• establish a revised written contingency funding plan;

• establish a revised written strategic and capital plan;

• establish a revised investment policy;

• improve the Bank's earnings and overall condition;

• revise the Bank's information technology program;

• establish a disaster recovery and business continuity program; and,

• establish a committee to monitor compliance with all aspects of the written agreement.

Further, both the Company and the Bank have agreed to refrain from declaring or paying dividends without prior regulatory approval. The Company has agreed that it will not take any other form of payment representing a reduction in Bank's capital or make any distributions of interest, principal or other sums on subordinated debentures or trust preferred securities without prior regulatory approval. The Company also has agreed not to incur, increase or guarantee any debt or not to purchase or redeem any shares of its stock without prior regulatory approval.

ITEM 2. Management's Discussion and Analysis of Financial Condition and Results of Operations

The following discussion and analysis is provided to address information about the Company's financial condition and results of operations that is not otherwise apparent from the Consolidated Financial Statements and the notes thereto or included in this report. Reference should be made to those statements and the notes thereto for an understanding of the following discussion and analysis.

The Company generates a significant amount of its income from the net interest income earned by the Bank. Net interest income is the difference between interest income and interest expense. Interest income depends on the amount of interest-earning assets outstanding during the period and the interest rates earned thereon. The Company's cost of money is a function of the average amount of deposits and borrowed money outstanding during the period and the interest rates paid thereon. Asset quality affects the amount of interest income lost on non-accrual loans and the amount of the allowance for loan losses. Highlands Union Insurance Services and Highlands Union Financial Services, which are subsidiaries of Highlands Union Bank, generate fee income by providing insurance and financial service products to its clients. Russell Road Properties, LLC is also an entity in which the Bank has a significant interest and was created to hold and manage certain properties acquired by the Bank through foreclosure or deed in lieu of foreclosure.

Critical Accounting Policies

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. For a discussion of the Company's critical accounting policies related to its allowance for loan losses and other than temporary impairment, see the Company's Annual Report on Form 10-K for the year ended December 31, 2018.

Results of Operations

Consolidated net income totaled $~~1.1~~571,000 ~~million~~ for the three-month period ended ~~March~~June 3130, 2019, compared to $~~610~~923,000 for the three-month period ended ~~March~~June 3130, 2018. The large reduction resulted from a significant increase in provision expense.

~~The~~Consolidated ~~following~~net ~~table provides summarized~~ income ~~statements~~ for the ~~three~~six-month ~~periods~~period ended ~~March~~June 3130, 2019 totaled $1.6 million compared to $1.5 million for the comparable period of 2018. The increase in provision expense during 2019 was largely offset by lower noninterest expense.

	Three months ended March 31,
	2019		2018
Net interest income	$	5,109	$	5,036
Provision expense	103		172
Noninterest income	890		1,082
Noninterest expense	4,554		5,166
Income before income taxes	1,342		780
Income tax expense	282		170
Net income	$	1,060	$	610

The following table provides summarized income statements for the three and six-month periods ended June 30, 2019.

Comparison of First Quarter 2019 to First Quarter 2018



	Three months ended June 30,				Six months ended June 30,
	2019		2018		2019		2018
Net interest income	$	5,082	$	4,985	$	10,191	$	10,021
Provision expense	836		172		939		344
Noninterest income	933		989		1,823		2,071
Noninterest expense	4,533		4,632		9,087		9,798
Income before income taxes	646		1,170		1,988		1,950
Income tax expense	75		247		357		417
Net income	$	571	$	923	$	1,631	$	1,533

~~Net~~Comparison ~~interest~~of ~~income~~Second ~~for~~Quarter ~~the three-month period ended March 31,~~ 2019 ~~increased $73,000 or 1.4 percent compared~~ to ~~the~~Second ~~three~~Quarter ~~months ended March 31,~~ 2018 ~~primarily due to improved loan interest income and lower FHLB interest expense.~~

~~Average~~Net ~~loan~~interest ~~balances~~income for the three-month ~~months~~period ended ~~March~~June 3130, 2019 increased $~~13.7~~97,000 ~~million~~ or 31.29 percent compared to the three ~~month~~months ~~period~~ ended ~~March~~June 3130, 2018. ~~Average~~primarily ~~securities~~due ~~balances~~to ~~declined~~improved ~~$9.9~~loan ~~million~~interest orincome ~~12.48~~and ~~percent~~lower ~~during~~FHLB ~~the same period. The yield on average~~ interest~~-earning~~ ~~assets was 4~~expense.~~69 percent for the three-month period ended March~~ ~~31, 2019 compared to 4.41 percent in the same period of 2018.~~

Average loan balances for the three months ended June 30, 2019 increased $10.6 million or 2.5 percent compared to the three month period ended June 30, 2018. Average securities balances declined $6.4 million or 8.4 percent during the same period. The yield on average interest-earning assets was 4.66 percent for the three-month period ended June 30, 2019 compared to 4.45 percent in the same period of 2018.

Average interest-bearing liabilities increased $17.9 million in the three months ended June 30, 2019, when compared to the same period of 2018 primarily due to growth in time deposits. The average rate on interest-bearing liabilities increased from 0.83 percent in the three month period ended June 30, 2018, to 1.24 percent for the three months ended June 30, 2019 due to growth in time deposits and upward pressure on deposit rates.

The net interest margin declined from 3.84 percent in the three month period ended June 30, 2018, to 3.75 percent for the three months ended June 30, 2019. The net interest margin continues to experience gradual tightening as demand for time deposit products continues and existing time deposits reprice at current rates.

The provision for loan losses for the three-month period ended June 30, 2019 totaled $836,000, compared to $172,000 during the corresponding period of 2018. Net charge-offs for the three-month period ended June 30, 2019 totaled $689,000 compared to net charge-offs of $34,000 recorded during the same period of 2018. Net charge-offs during the second quarter of 2019 represent 0.62 percent of loans outstanding. The large increase in net charge-offs in the three-month period ended June 30, 2019 includes $565,000 of charge-offs on multiple non-owner occupied loans to a single borrower.

During the second quarter of 2019, noninterest income decreased $56,000 compared to the corresponding period for 2018. Most of the reduction related to other service charges, commissions and fees, which decreased $50,000 compared to the same period of 2018, primarily due to lower financial services income and merchant income. Smaller reductions were noted in mortgage income and service charge income.

Total noninterest expense for the three-month period ended June 30, 2019 decreased $99,000 from the comparable period in 2018. Salaries and employee benefits decreased $99,000 for the three months ended June 30, 2019 as compared to the prior year period. Occupancy expense was down due to lower rental expense associated with the mortgage origination offices. OREO-related expenses decreased during the three-month period ended June 30, 2019, when compared to the comparable period in 2018 due to lower net losses recorded on properties sold during the quarter. Other noninterest expense increased $277,000 during the three-month period ended June 30, 2019 due to higher professional services, printing and software-related expenses.

The annualized return on average equity was 3.89 percent for the three-month period ended June 30, 2019, compared to 6.89 percent for the corresponding period of 2018. Annualized return on average assets for the three months ended June 30, 2019 was 0.37 percent compared to 0.63 percent for the three months ended June 30, 2018. While both operating ratios remain below peer averages, the Company continues to identify and implement strategies to improve core operating results.

Comparison of Year-to-Date 2019 to Year-to-Date 2018

Net interest income increased $170,000 during the first six months of 2019 when compared to the same period of 2018, the result of higher loan interest income, higher fed funds interest income and lower FHLB interest expense, partially offset by higher deposit interest expense.

The provision for loan losses was $939,000 during the first six months of 2019, compared to $344,000 during the same period of 2018. Higher provision expense during 2019 results from increased net charge-offs and recent loan growth, particularly construction and commercial loans. Net charge-offs for the first six months of 2019 totaled $1.1 million or 0.48 percent of loans held for investment, compared to $160,000 during the same period of 2018. The net charge-offs for 2019 include $690,000 related to two isolated exposures.

Noninterest income declined $248,000 during the first six months of 2019. Other service charges and fees declined $130,000 primarily due to lower financial services income. Mortgage banking income declined $56,000 resulting from the reorganization and shrinkage of the mortgage division. Other operating income declined $56,000 due to a non-recurring swap-related fee recognized during 2018.

Noninterest expense decreased $711,000 during the first six months of 2019, when compared to the same period of 2018. Salaries and employee benefits declined $86,000 during the first six months of 2019, the result of the reorganization within the mortgage division, net of higher health care costs. Occupancy expense decreased $339,000 due to lower lease, depreciation, insurance and equipment maintenance expense. OREO-related expenses decreased $135,000 during 2019 due to lower writedowns resulting from updated appraisals and losses recorded upon liquidation of foreclosed properties. Other noninterest expense decreased $151,000 during the first six months of 2019, primarily due to $235,000 of 2018 writedowns of real estate held for sale. Partially offsetting these reductions was increases in software-related and printing expenses.

Income tax expense declined $60,000 during the first six months of 2019 due to lower pre-tax income.

~~Average~~The annualized ~~interest-bearing~~return ~~liabilities~~on ~~increased~~average $3equity was 5.667 ~~million~~percent infor the ~~three~~six-month ~~months~~period ended ~~March~~June 3130, 2019,~~when~~ compared to 5.74 percent for the ~~same~~corresponding period of 2018. ~~due~~Annualized toreturn ~~deposit~~on ~~growth,~~average ~~which~~assets ~~more~~for ~~than offset~~ the ~~impact~~six ofmonths ~~FHLB~~ended ~~advances~~June 30, ~~repayments.~~2019 ~~The~~was ~~average rate on interest-bearing liabilities increased from~~ 0.8654 percent incompared ~~the three month period ended March 31, 2018,~~ to 10.1352 percent for the ~~three~~six months ended ~~March~~June 3130, ~~2019 due to upward pressure on deposit rates during~~ 2018.

The net interest margin improved from 3.78 percent in the three month period ended March 31, 2018, to 3.86 percent for the three months ended March 31, 2019, the combined impact of repayment of the FHLB advances, favorable changes in asset mix, and higher market rates.

The provision for loan losses for the three-month period ended March 31, 2019 totaled $103,000, compared to $172,000 during the corresponding period of 2018. Net charge-offs for the three-month period ended March 31, 2019 totaled $380,000 compared to net charge-offs of $126,000 recorded during the same period of 2018. Net charge-offs during the first quarter of 2019 represent 0.34 percent of loans outstanding.

During the first quarter of 2019, noninterest income decreased $192,000 compared to the corresponding period for 2018, due to lower service charge, credit card and merchant income. Service charges on deposit accounts declined due to lower overdraft fees. Other service charges, commissions and fees decreased $80,000 as compared to the same period of 2018, primarily due to lower credit card interchange and merchant income.

Total noninterest expense for the three-month period ended March 31, 2019 decreased $612,000 from the comparable period in 2018. Salaries and employee benefits increased $13,000 for the three months ended March 31, 2019 as compared to the prior year period. Occupancy expense was down due to lower rental expense associated with the mortgage origination offices. The Company also benefited from lower OREO-related expenses and legal expense.

The annualized return on average equity was 7.53 percent for the three-month period ended March 31, 2019, compared to 4.49 percent for the corresponding period of 2018. Annualized return on average assets for the three months ended March 31, 2019 was 0.71 percent compared to 0.41 percent for the three months ended March 31, 2018. While both operating ratios remain below peer averages, the improvements reflect ongoing efforts to achieve stable and increasing profitability. The Company continues to identify and implement strategies to improve core operating results.

Financial Position

Investment securities available for sale totaled $6766.62 million at ~~March~~June 3130, 2019, compared to $68.6 million at December 31, 2018. Investment securities available for sale at ~~March~~June 3130, 2019 included mortgage-backed securities/CMOs (7372.08 percent of the total securities portfolio), municipal securities (1920.50 percent), and SBA loan pools (7.42 percent). There were no investment securities held to maturity at ~~March~~June 3130, 2019 or December 31, 2018.

Other investments include investments in the Federal Reserve Bank of Richmond, Federal Home Loan Bank of Atlanta, Pacific Coast Bankers Bank, and Community Bankers Bank. These investments had a carrying value of $2.8 million at ~~March~~June 3130, 2019 and December 31, 2018, and are considered to be non-marketable as the Company is required to hold these investments, and the only market for these investments is the issuer.

Loans, net of deferred fees, totaled $~~442~~451.26 million at ~~March~~June 3130, 2019, compared to $448.1 million at December 31, 2018. Loan demand was relatively weak during the ~~three-month~~first ~~period~~quarter ~~ended~~of ~~March 31,~~ 2019, ~~with~~but ~~customer~~more ~~payments~~robust ~~exceeding~~growth ~~loan~~during ~~origination~~the ~~activity,~~second ~~resulting~~quarter resulted in ~~lower~~a ~~period-end~~modest ~~balances.~~increase in loans as of June 30, 2019.

Deposits at ~~March~~June 3130, 2019 totaled $~~520~~518.74 million, a $1715.96 million increase since December 31, 2018. Despite the increase in total deposits during 2019, the Company has experienced reductions among non-interest bearing deposits, which have declined $62.54 million since December 31, 2018. Interest bearing deposits have increased $18.1 million since December 31, 2018.

The Company's loan to deposit ratio was 8487.91 percent at ~~March~~June 3130, 2019 compared to 89.1 percent at December 31, 2018, reflecting the combined impact of weak loan ~~shrinkage~~growth and more robust deposit growth during the ~~first~~six-month ~~quarter~~period ended June 30, 2019.

As of ~~March~~June 3130, 2019, the Company has $30.0 million in FHLB advances ~~with~~that are scheduled ~~maturities~~to ~~within~~mature ~~the~~in ~~next~~August ~~twelve months~~2019. The Company secures all of its existing and future advances from the FHLB with 1-4 family residential mortgage, commercial real estate, equity lines of credit and multi-family loans.

Non-performing assets include non-accrual loans, loans contractually past due 90 days or more and still accruing interest and other real estate owned. Non-performing assets were $8.3 million or 1.83 percent of loans held for investment and OREO at June 30, 2019, compared to $8.2 million or 1.83 percent of loans held for investment and OREO at December 31, 2018. Notwithstanding the slight increase in nonperforming assets, the Company continues its efforts to manage non-accrual exposures and liquidate other real estate owned.

At June 30, 2019, other real estate owned (OREO) totaled $2.9 million and consisted of 20 relationships. At December 31, 2018 OREO balances were $2.2 million and consisted of 20 relationships. The $680,000 increase in OREO since December 31, 2018 resulted from foreclosures of collateral securing loans previously classified as nonaccrual, net of writedowns and proceeds received.

As of June 30, 2019, the Company had loans with a total balance of $972,000 that were in process of foreclosure. During July, property with a carrying value of $904,000 as of June 30, 2019 was successfully auctioned. The Company expects the balance of other real estate owned will stabalize during the third quarter as anticipated foreclosures occur and the property sales are closed. The Company believes the related loans are generally well-secured. However, the ability to sell other real estate owned continues to be negatively affected by limited demand in certain of the Company's market areas, and future appraisal values may require additional writedowns once the properties are foreclosed.

Non-performing assets include non-accrual loans, loans contractually past due 90 days or more and still accruing interest and other real estate owned. Non-performing assets were $8.4 million or 1.90 percent of loans held for investment and OREO at March 31, 2019, compared to $8.2 million or 1.83 percent of loans held for investment and OREO at December 31, 2018. Notwithstanding the slight increase in nonperforming assets, the Company continues its efforts to manage non-accrual exposures and liquidate other real estate owned.

At March 31, 2019, other real estate owned (OREO) totaled $2.9 million and consisted of 25 relationships. At December 31, 2018 OREO balances were $2.2 million and consisted of 20 relationships. The $674,000 increase in OREO since December 31, 2018 resulted from foreclosures of collateral securing a loan previously classified as nonaccrual.

As of March 31, 2019, the Company had loans with a total balance of $1.5 million that were in process of foreclosure. The Company expects the balance of other real estate owned will increase significantly during the second quarter as these foreclosures occur. The Company believes the loans are generally well-secured, and any anticipated deficiencies in collateral values are offset by specific loan allowances that have been previously established. However, the ability to sell other real estate owned continues to be negatively affected by limited demand in certain of the Company's market areas, and future appraisal values may require additional writedowns once the properties are foreclosed.

The following chart details each category type, number of relationships, and balance.

	March 31, 2019			December 31, 2018
	June 30, 2019			December 31, 2018
Balance in thousands	Number	Balance		Number	Balance
Land development/vacant land	75	$	~~158~~130	8	$	308
1-4 family residential mortgage	138	~~997~~750		9	785
Commercial real estate	57	12,~~731~~012		3	1,119
Total	2520	$	2,~~886~~892	20	$	2,212

Marketability of OREO properties differs considerably between the Company's various market areas. The following table provides information about properties owned in each geographic area, the number of individual properties and book value.

	March 31, 2019			December 31, 2018
	June 30, 2019			December 31, 2018
Balance in thousands	Number	Balance		Number	Balance
Sevierville and Knoxville TN	21	$	~~221~~71	1	$	71
Southwest VA and Tri-City TN	2017	2,~~545~~722		17	2,089
Boone and Banner Elk NC	32	~~120~~99		2	52
Total	2520	$	2,~~886~~892	20	$	2,212

The allowance for loan losses is calculated 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, including general economic conditions. The calculation of the allowance for loan losses is reviewed by the senior credit officers, the chief risk officer, senior financial officers and the board of directors.

The Company continually monitors the loan portfolio for signs of credit weaknesses or developing collection problems. Loan loss provisions for each period are determined after evaluating the loan portfolio and determining the level necessary to absorb current charge-offs and maintain the reserve at adequate levels. The Company's allowance for loan losses at ~~March~~June 3130, 2019 was 0.9394 percent of total loans compared to 0.98 percent at December 31, 2018. The reduction in the allowance for loan losses since December 31, 2018 reflects the impact of charge-offs of previously impaired loans recorded during the first ~~quarter~~two quarters of 2019. At ~~March~~June 3130, 2019, management concluded that the Company's allowance for loan losses is adequate based on the requirements of accounting principles generally accepted in the United States of America.

Liquidity and Capital Resources

Total stockholders' equity of the Company was $5860.60 million at ~~March~~June 3130, 2019, compared to $56.6 million at December 31, 2018. The change in stockholders' equity during 2019 reflects current retained earnings and a reduction in accumulated other comprehensive loss related to the fair value of the Company's available for sale securities portfolio.

Quantitative measures established by regulation to ensure capital adequacy require the Bank to maintain minimum amounts and ratios of total risk-based capital and tier 1 capital to risk-weighted assets (as defined in the regulations), tier 1 capital to adjusted total assets (as defined), and tier 1 common equity (as defined). As of ~~March~~June 3130, 2019, each of the Bank's capital ratios exceeded the required level to be classified as well-capitalized. See Note 6 for a more detailed discussion of the Bank's regulatory capital ratios.

Liquidity is the ability to provide sufficient cash levels to meet financial commitments and to fund loan demand and deposit withdrawals. The Company and subsidiary Bank maintain a significant level of liquidity in the form of cash and cash equivalents ($5547.28 million as of ~~March~~June 3130, 2019) and unrestricted investment securities available for sale ($2927.67 million as of ~~March~~June 3130, 2019). Cash and cash equivalents are immediately available for satisfaction of deposit withdrawals, customer credit needs, and operations of the Bank. The Bank also maintains access to credit with both the Federal Home Loan Bank and other correspondent financial institutions. Unencumbered investment securities available for sale represent a secondary level of liquidity available for conversion to liquid funds in the event of extraordinary needs. The Company believes that it maintains sufficient liquidity to meet its current and projected requirements and needs.

Risk Management

The Company is exposed to various risks resulting from its normal operations, including, but not limited to, credit risk, liquidity risk, interest rate risk, compliance risk and other operational risks. Through its reliance on technology, the Company has risks related to the performance of its technology and information security risks related to customer information and other data. Through its reliance on third parties, the Company also has vendor risk, and, by extension, exposure to the technology and information security risks of its vendors. Collectively, all of these risks contribute to the Company’s reputational risk. The Company seeks to manage and mitigate each of these risks and other risks through various risk management techniques including effective policies and procedures, internal and external monitoring, and risk transfer.

Despite these efforts, the volume of business conducted through electronic devices, our internet presence, and reliance on external vendors expose the Company to various attacks, including cybersecurity attacks from both domestic and international sources that seek to obtain customer information for fraudulent purposes or to disrupt business activities. The Company continues to dedicate significant attention to risk management, with a goal of preventing cybersecurity attacks and, if they occur, to quickly detect and correct any weakness to prevent future attacks.

Caution About Forward-Looking Statements

This quarterly report 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:


•	adverse economic conditions in the market area and the impact on credit quality and risks inherent in the loan portfolio such as repayment risk and fluctuating collateral values;


•	our inability to manage, dispose of and properly value non-performing assets and other real estate owned;


•	further deterioration in the housing market and collateral values;


•	our inability to assess the creditworthiness of our loan portfolio and maintain a sufficient allowance for loan losses;


•	our inability to maintain adequate sources of funding and liquidity, including secondary sources such as Federal Home Loan Bank advances;


•	our ability to attract and maintain capital levels adequate to support our asset levels and risk profile;

• our inability to comply with the written agreement, dated October 13, 2010, with the Federal Reserve Bank of Richmond;


•	our successful management of interest rate risk and changes in interest rates and interest rate policies;


•	reliance on our management team, including our ability to attract and retain key personnel;


•	our ability to successfully manage our strategic plan;


•	difficult market conditions in our industry;


•	problems with technology utilized by us;


•	our ability to successfully manage third-party vendors upon whom we are dependent;


•	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;


•	potential impact on us of recently enacted legislation and future regulation;


•	changes in accounting policies or standards;


•	demand, development and acceptance of new products and services; and,


•	changing trends in customer profiles and behavior.

3231

ITEM 3. Quantitative and Qualitative Disclosures About Market Risk

Not Applicable

ITEM 4. Controls and Procedures

We have carried out an evaluation, under the supervision and the participation of our management, including our Interim Chief Executive Officer and Chief Financial Officer, of the effectiveness of the design and operation of our disclosure controls and procedures (as defined in Rule 13a-15(e) under the Exchange Act) as of the end of the period covered by this report. Based upon that evaluation, our Chief Executive Officer and Chief Financial Officer 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 Exchange Act is recorded, processed, summarized and reported within the time periods specified in the SEC's rules and forms, and (b) such information is accumulated and communicated to our management, including our Chief Executive Officer and Chief Financial Officer, as appropriate to allow timely decisions regarding required disclosure.

There have not been any changes in the Company's internal controls over financial reporting during the ~~first~~second quarter of 2019 that have materially affected, or are reasonably likely to materially affect, our internal control over financial reporting.

3332

PART II. OTHER INFORMATION

Item 1. Legal Proceedings

The Company, the Bank and other subsidiaries are occasionally named as defendants in various legal actions arising from our normal business activities in which damages in various amounts are claimed. Although the amount of any ultimate liability with respect to those matters cannot be determined, in the opinion of management, no legal actions currently exist that are expected to have a material effect on the Company's consolidated financial statements.

On December 23, 2015, James M. Brock and Jean W. Brock (together, "Brock") filed a complaint in the Circuit Court of Grayson County, Virginia, alleging that the Bank acted negligently when it foreclosed on property adjacent to the Brock's property and allegedly failed to remediate the foreclosed property, allegedly causing damage to Brock's property. Brock seeks damages of $200,000 plus prejudgment interest, attorneys' fees, and costs. The Bank denies any wrongdoing in this matter and intends to vigorously defend itself. No trial date has yet been set. The Company is unable to estimate the likelihood of an unfavorable outcome or the amount or range of potential loss.

Item 1A. Risk Factors

Not applicable

Item 2. Unregistered Sales of Equity Securities and Use of Proceeds

None

Item 3. Defaults Upon Senior Securities

None

Item 4. Mine Safety Disclosures

Not Applicable

Item 5. Other Information

None

Item 6. Exhibits

Exhibit Index
31.1	Rule 13a-14(a) Certification of President and Chief Executive Officer
312	Rule 13a-14(a) Certification of Chief Financial Officer
31.2	Rule 13a-14(a) Certification of Chief Financial Officer
32.1	Certification Statement of President and Chief Executive Officer pursuant to 18 U.S.C. Section 1350
32.2	Certification Statement of Chief Financial Officer pursuant to 18 U.S.C. Section 1350
101	The following materials from the Registrant's Quarterly Report on Form 10-Q for the quarter ended ~~March~~June 3130, 2019, formatted in Extensible Business Reporting Language (XBRL), include: (i) the Consolidated Balance Sheets, (ii) the Consolidated Statements of Income, (iii) the Consolidated Statements of Comprehensive Income, (iv) Consolidated Statements of Cash Flows; (v) Consolidated Statements of Changes in Stockholders' Equity and (vi) related notes (furnished herewith).

3433

SIGNATURES

Pursuant to the requirements of the Securities Exchange Act of 1934, as amended, the registrant has duly caused this report to be signed on its behalf by the undersigned thereunto duly authorized.

	HIGHLANDS BANKSHARES, INC
	(Registrant)
Date: May 15, 2019	By:	/s/ Bryan T. Booher
Date: August 12, 2019	By:	/s/ Bryan T. Booher
		Bryan T. Booher
		Interim Chief Executive Officer
Date: May 15, 2019		/s/ John H. Gray
Date: August 12, 2019		/s/ John H. Gray
		John H. Gray
		Chief Financial Officer



Exhibit Index
31.1	Rule 13a-14(a) Certification of President and Chief Executive Officer
31.2	Rule 13a-14(a) Certification of Chief Financial Officer
32.1	Certification Statement of President and Chief Executive Officer pursuant to 18 U.S.C. Section 1350.
32.2	Certification Statement of Chief Financial Officer pursuant to 18 U.S.C. Section 1350.
101	The following materials from the Registrant's Quarterly Report on Form 10-Q for the quarter ended June 30, 2019, formatted in Extensible Business Reporting Language (XBRL), include: (i) the Consolidated Balance Sheets, (ii) the Consolidated Statements of Income, (iii) the Consolidated Statements of Comprehensive Income, (iv) Consolidated Statements of Cash Flows; (v) Consolidated Statements of Changes in Stockholders' Equity and (vi) related notes (furnished herewith).

Exhibit Index
31.1	Rule 13a-14(a) Certification of President and Chief Executive Officer
31.2	Rule 13a-14(a) Certification of Chief Financial Officer
32.1	Certification Statement of President and Chief Executive Officer pursuant to 18 U.S.C. Section 1350.
32.2	Certification Statement of Chief Financial Officer pursuant to 18 U.S.C. Section 1350.
101	The following materials from the Registrant's Quarterly Report on Form 10-Q for the quarter ended March 31, 2019, formatted in Extensible Business Reporting Language (XBRL), include: (i) the Consolidated Balance Sheets, (ii) the Consolidated Statements of Income, (iii) the Consolidated Statements of Comprehensive Income, (iv) Consolidated Statements of Cash Flows; (v) Consolidated Statements of Changes in Stockholders' Equity and (vi) related notes (furnished herewith).

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