Highlands Bankshare, Inc. is the holding company of Highlands Union Bank. It was formed in 1995 to take advantage of additional financial opportunities for the bank and its investors.

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• 2006 Annual Report*

• Message from the CEO

April 1, 2007

Dear Shareholders:

Many of the economic trends of 2005 continued in 2006. Interest rate margins continued to shrink for the third year within the banking industry. Interest rates stabilized somewhat as the Federal Reserve Bank was less active in interest rate adjustments during the year. We continue to operate in an inverted yield curve environment. The economic environment going forward remains challenging, with long-term rates still below our current fed funds rate. Many of the economic indicators remained strong at the end of the year, including a low inflation rate, a low unemployment rate and lower energy prices. The most recent area of concern, however, has been the housing market, which has seen a steady decline in sales in recent months. Although impossible to predict, there is general consensus that we will see a slight decrease in the interest rates over the next year. There will likely be continued pressure on interest margins.

Several initiatives were undertaken or completed during the year. In August, the new branch bank in Sevierville, Tennessee, was opened. It has been a successful entry into this new, growing market. A new addition to the Glade Spring branch in Virginia was completed and opened. The need for expansion is attributed to the expanding customer base in that market. The previously vacant second floor of the Commonwealth Avenue bank in Bristol, Virginia, was completely renovated and converted to a large, modern training facility that will be used primarily for the continued development of our employee training program at the bank. The Rogersville branch in Tennessee was renovated to give it a much-needed fresh look.

Your company was able to repurchase approximately $2 million of Highlands Bankshares, Inc. stock on the open market under our stock repurchase program, thus reducing the number of outstanding shares. As a result of prior year technology purchases, we were able to extend our business day for accepting deposits and withdrawals from 2 p.m. to 5 p.m. This move has been well received by our customers. It is with pleasure that we announce the beginning of construction of a new Highlands Union Bank branch in Knoxville, Tennessee. We are very excited about the entry into another new market in 2007. A mid-summer opening is planned.

We are at the end of another trying year in the banking industry, with considerable investment to facilitate future growth and profitability of your company. Our efforts are paying off. We are pleased to report that 2006 was another record year for net income and net earnings per share. Net income showed an increase of 3.48 percent over the previous record year in 2005.

Results of operations for 2006 reflect an increase in assets of $33.3 million or 5.56 percent; gross loans increased by $26 million or 6.31 percent; deposits increased by $13.2 million or 2.71 percent. It was a record year for earnings. Net income was $5.21 million, an increase of 3.48 percent. Return on average equity was 12.01 percent compared to 12.43 percent in 2005. Return on average assets was .85 percent compared to .86 percent in 2005. Earnings per share was $1.00 compared to $0.95 in 2005, an increase of 5.26 percent. Shareholders’ equity (book value) per share at year end was $8.81 compared to $7.98 in 2005, an increase of 10.40 percent.

Although we enter this year with an uncertain economic environment, we are excited about the new opportunities before us. We will remain focused, as always, on our opportunities for enhanced future earnings, growth and enhanced shareholder value.

The directors, officers and employees of Highlands Bankshares, Inc. and its subsidiary, Highlands Union Bank, wish to say thank you to our customers, shareholders and friends for your continued confidence and support. We look forward to reporting to you on the future progress of your company.

Sincerely,

Samuel L. Neese
Chief Executive Officer

James. T. Riffe
Executive Vice President, Cashier