Commonwealth Bankshares (CWBS) 10-Q 2005 Q1 Quarterly report

FORM 10-Q

U. S. SECURITIES AND EXCHANGE COMMISSION

Washington, D. C. 20549

x Quarterly Report pursuant to Section 13 or 15(d) of the Securities Exchange Act of 1934

For the quarterly period ended March 31, 2005

or

¨ 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 01-17377

COMMONWEALTH BANKSHARES, INC.

(Exact name of registrant as specified in its charter)

VIRGINIA	54-1460991
(State or other jurisdiction of incorporation or organization)	(I.R.S. Employer Identification No.)

403 Boush Street
Norfolk, Virginia	23510
(Address of principal executive offices)	(Zip Code)

(757) 446-6900

Registrant’s telephone number

Not Applicable

(Former name, former address and former fiscal year, if changed since last report.)

Indicate by check mark whether the registrant (1) has filed all documents and 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 periods 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 is an accelerated filer (as described in Rule 12b-2 of the Exchange Act).    Yes  ¨    No  x

APPLICABLE ONLY TO CORPORATE ISSUERS

Indicate the number of shares outstanding of each of the registrant’s classes of common equity, as of the latest practicable date.

Common Stock, $2.50 Par Value – 3,049,980 shares as of March 31, 2005

Commonwealth Bankshares, Inc.

Table of Contents

	Page
PART I - FINANCIAL INFORMATION
ITEM 1 – FINANCIAL STATEMENTS (unaudited)
Consolidated Balance Sheets	3
March 31, 2005
December 31, 2004
Consolidated Statements of Income	4
Three months ended March 31, 2005
Three months ended March 31, 2004
Consolidated Statements of Comprehensive Income	5
Three months ended March 31, 2005
Three months ended March 31, 2004
Consolidated Statements of Stockholders’ Equity	6
Three months ended March 31, 2005
Year ended December 31, 2004
Year ended December 31, 2003
Consolidated Statements of Cash Flows	7
Three months ended March 31, 2005
Three months ended March 31, 2004
Notes to Consolidated Financial Statements	8 - 11
ITEM 2 -MANAGEMENT’S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS OF OPERATIONS	11 -18
ITEM 3 –QUANTITATIVE AND QUALITATIVE DISCLOSURES AND MARKET RISK	19
ITEM 4 –CONTROLS AND PROCEDURES	19
PART II - OTHER INFORMATION
ITEM 1 –LEGAL PROCEEDINGS	20
ITEM 2 –CHANGES IN SECURITIES	20
ITEM 3 –DEFAULTS UPON SENIOR SECURITIES	20
ITEM 4 –SUBMISSION OF MATTERS TO A VOTE OF SECURITY HOLDERS	20
ITEM 5 –OTHER INFORMATION	20
ITEM 6 –EXHIBITS AND REPORTS ON FORM 8-K	20
SIGNATURES	21

2

Commonwealth Bankshares, Inc.

Consolidated Balance Sheets

	March 31, 2005 (Unaudited)			December 31, 2004 (Audited)
Assets:
Cash and cash equivalents:
Cash and due from banks	$	6,196,968		$	8,330,545
Interest bearing deposits in banks		201,780			195,729
Federal funds sold		458,771			419,867
Total cash and cash equivalents		6,857,519			8,946,141
Investment securities:
Available for sale, at fair market value		6,204,201			6,370,932
Held to maturity, at amortized cost (fair market value was $580,355 and $592,019, respectively)		565,522			574,199
Total investment securities		6,769,723			6,945,131
Equity securities, restricted, at cost		3,992,200			3,617,600
Loans held for sale		14,349,214			31,106,533
Loans		354,458,754			315,754,561
Allowance for loan losses		(3,121,565	)		(2,839,315	)
Loans, net		351,337,189			312,915,246
Premises and equipment, net		5,060,873			5,141,006
Accrued interest receivable		1,892,328			1,692,975
Other assets		4,256,229			3,696,153
Total assets	$	394,515,275		$	374,060,785
Liabilities and Stockholders’ Equity:
Liabilities:
Deposits:
Noninterest-bearing demand deposits	$	37,920,454		$	38,145,358
Interest-bearing		251,837,951			239,486,894
Total deposits		289,758,405			277,632,252
Short-term borrowings		49,983,000			44,139,750
Long-term debt		5,412,385			5,441,656
Junior subordinated debt securities		5,221,432			5,237,255
Accrued interest payable		882,990			803,289
Other liabilities		4,586,927			3,782,434
Total liabilities		355,845,139			337,036,636
Stockholders’ Equity:
Common stock, par value $2.50, 5,000,000 shares authorized; 3,049,980 and 2,984,794 shares issued and outstanding in 2005 and 2004, respectively		7,624,950			7,461,986
Additional paid-in capital		19,782,923			19,321,813
Retained earnings		11,253,315			10,187,132
Accumulated other comprehensive income		8,948			53,218
Total stockholders’ equity		38,670,136			37,024,149
Total liabilities and stockholders’ equity	$	394,515,275		$	374,060,785

See accompanying notes to the consolidated financial statement (unaudited).

3

Commonwealth Bankshares, Inc.

Consolidated Statements of Income (Unaudited)

	Three months ended
	March 31, 2005		March 31, 2004
Interest and dividend income:
Loans, including fees	$	6,505,673	$	4,718,484
Investment securities:
Taxable		62,922		98,408
Tax exempt		19,464		46,904
Dividend income, equity securities, restricted		39,490		13,133
Other interest income		6,860		27,365
Total interest income		6,634,409		4,904,294
Interest expense:
Deposits		1,944,249		1,951,078
Federal funds purchased and securities sold under agreements to repurchase		—		212
Federal Home Loan Bank		268,072		10,912
Junior subordinated debt securities		104,375		115,453
Long-term debt		53,267		2,328
Total interest expense		2,369,963		2,079,983
Net interest income		4,264,446		2,824,311
Provision for loan losses		330,000		465,000
Net interest income after provision for loan losses		3,934,446		2,359,311
Noninterest income:
Service charges on deposit accounts		240,400		228,434
Other service charges and fees		128,784		123,373
Mortgage brokerage income		338,731		—
Gain on sale / call of investment securities		—		240,054
Other		38,386		32,846
Total noninterest income		746,301		624,707
Noninterest expense:
Salaries and employee benefits		1,548,514		1,050,130
Net occupancy expense		234,994		258,711
Furniture and equipment expense		287,514		235,770
Other operating expense		769,053		635,566
Total noninterest expense		2,840,075		2,180,177
Income before provision for income taxes		1,840,672		803,841
Provision for income taxes		623,433		259,054
Net income	$	1,217,239	$	544,787
Basic earnings per share	$	0.40	$	0.28
Diluted earnings per share	$	0.35	$	0.22
Dividends paid per share	$	0.05	$	0.05
Basic weighted average shares outstanding		3,029,818		1,920,291
Diluted weighted average shares outstanding		3,696,600		2,831,149

See accompanying notes to the consolidated financial statement (unaudited).

4

Commonwealth Bankshares, Inc.

Consolidated Statements of Comprehensive Income (Unaudited)

	Three months ended
	March 31, 2005			March 31, 2004
Net income	$	1,217,239		$	544,787
Other comprehensive income, net of income tax:
Net change in unrealized gain on securities available for sale		(44,270	)		(86,549	)
Comprehensive income	$	1,172,969		$	458,238

See accompanying notes to the consolidated financial statement (unaudited).

5

Commonwealth Bankshares, Inc.

Consolidated Statements of Stockholders’ Equity

Three Months Ended March 31, 2005, and Years Ended December 31, 2004 and 2003

	Common Shares	Common Amount		Additional Paid-in Capital		Retained Earnings			Accumulated Other Comprehensive Income			Total
Balance, January 1, 2003	1,721,621	$	4,304,053	$	5,560,051	$	5,270,552		$	309,974		$	15,444,630
Comprehensive income:
Net income	—		—		—		2,542,491			—			2,542,491
Change in unrealized gains on securities available for sale, net of tax effect	—		—		—		—			82,989			82,989
Total comprehensive income													2,625,480
Issuance of common stock	166,650		416,625		987,428		—			—			1,404,053
Cash dividends - $0.16 per share	—		—		—		(283,598	)		—			(283,598	)
Balance, December 31, 2003	1,888,271		4,720,678		6,547,479		7,529,445			392,963			19,190,565
Comprehensive income:
Net income	—		—		—		3,101,209			—			3,101,209
Change in unrealized gains on securities available for sale, net of tax effect	—		—		—		—			(339,745	)		(339,745	)
Total comprehensive income													2,761,464
Issuance of common stock	1,096,523		2,741,308		12,774,334		—			—			15,515,642
Cash dividends - $0.20 per share	—		—		—		(443,522	)		—			(443,522	)
Balance, December 31, 2004	2,984,794		7,461,986		19,321,813		10,187,132			53,218			37,024,149
(Unaudited)
Comprehensive income:
Net income	—		—		—		1,217,239			—			1,217,239
Change in unrealized gains on securities available for sale, net of tax effect	—		—		—		—			(44,270	)		(44,270	)
Total comprehensive income													1,172,969
Issuance of common stock	65,186		162,964		322,730		—			—			485,694
Tax benefit of stock option exercises	—		—		138,380		—			—			138,380
Cash dividends - $0.05 per share	—		—		—		(151,056	)		—			(151,056	)
Balance, March 31, 2005	3,049,980	$	7,624,950	$	19,782,923	$	11,253,315		$	8,948		$	38,670,136

See accompanying notes to the consolidated financial statement (unaudited).

6

Commonwealth Bankshares, Inc.

Consolidated Statements of Cash Flows (Unaudited)

	Three months ended
	March 31, 2005			March 31, 2004
Operating activities:
Net income	$	1,217,239		$	544,787
Adjustments to reconcile net income to net cash provided by operating activities:
Provision for loan losses		330,000			465,000
Depreciation and amortization		240,764			229,006
Gain on the sale of premises and equipment		—			817
Gain on sale of investment securities available for sale		—			(240,054	)
Loss on the sale of other real estate owned		—			10,396
Deferred tax assets		(73,224	)		(76,019	)
Net change in:
Loans held for sale		16,757,319			33,884,016
Accrued interest receivable		(199,353	)		(4,540	)
Other assets		(464,046	)		(217,620	)
Accrued interest payable		79,701			31,697
Other liabilities		942,873			(629,473	)
Net cash provided by operating activities		18,831,273			33,998,013
Investing activities:
Purchase of securities available for sale		(9,938	)		(808,178	)
Purchase of equity securities, restricted		(3,139,600	)		—
Net purchase of premises and equipment		(160,631	)		(276,375	)
Net change in loans		(38,751,943	)		(9,260,491	)
Proceeds from:
Calls and maturities of securities held to maturity		8,680			47,838
Sales and maturities of securities available for sale		109,590			4,950,430
Sales of equity securities, restricted		2,765,000			1,191,200
Sale of other real estate owned		—			229,241
Net cash used in investing activities		(39,178,842	)		(3,926,335	)
Financing activities:
Net change in:
Demand, interest-bearing demand and savings deposits		10,018,365			5,641,621
Time deposits		2,152,788			1,006,827
Brokered time deposits		(45,000	)		—
Short-term borrowing		5,843,250			(37,003,714	)
Principal payments on long-term debt		(29,271	)		(26,112	)
Dividends reinvested and sale of stock		469,871			119,161
Dividends paid		(151,056	)		(96,369	)
Net cash provided by (used in) financing activities		18,258,947			(30,358,586	)
Net decrease in cash and cash equivalents		(2,088,622	)		(286,908	)
Cash and cash equivalents at January 1		8,946,141			8,591,123
Cash and cash equivalents at March 31	$	6,857,519		$	8,304,215
Supplemental cash flow disclosure:
Interest paid during the period	$	2,290,262		$	1,952,918
Income taxes paid during the period	$	175,000		$	378,731
Supplemental noncash disclosure:
Sale of other real estate owned financed by bank loans	$	—		$	855,000
Conversion of junior subordinated debt securities for common stock	$	15,823		$	297,125

See accompanying notes to the consolidated financial statements (unaudited).

7

Commonwealth Bankshares, Inc.

Notes to Consolidated Financial Statements (Unaudited)

March 31, 2005

Note A – Basis of Presentation

The accounting and reporting policies of Commonwealth Bankshares, Inc. (the “Parent”) and its subsidiaries, Commonwealth Bankshares Capital Trust I (the “Trust”), and Bank of the Commonwealth (the “Bank”) and its subsidiaries, BOC Title of Hampton Roads, Inc., BOC Insurance Agencies of Hampton Roads, Inc. and Community Home Mortgage of Virginia, Inc. are in accordance with accounting principles generally accepted in the United States of America and conform to accepted practices within the banking industry. The accompanying consolidated financial statements include the accounts of the Parent, the Bank and its subsidiaries, collectively referred to as “the Company”. All significant intercompany balances and transactions have been eliminated in consolidation. FASB Interpretation No. 46(R) requires that the Company no longer consolidate Commonwealth Bankshares Capital Trust I. The junior subordinated debt of the Trust is reflected as a liability of the Company.

The accompanying unaudited financial statements have been prepared in accordance with generally accepted accounting principles in the United States for interim financial reporting and with the instructions to Form 10-Q. Accordingly, they do not include all of the information and footnotes required by generally accepted accounting principles for complete financial statements. In the opinion of management, all adjustments (consisting of normal recurring accruals) considered necessary for a fair presentation have been included. For further information, refer to the financial statements and footnotes thereto included in the Company’s annual report on Form 10-KSB for the year ended December 31, 2004.

Certain 2004 amounts have been reclassified to conform to the 2005 presentation.

Note B – Earnings Per Share

Basic earnings per share is calculated by dividing net income by the weighted average number of shares of common stock outstanding. Diluted earnings per share is computed by dividing net income by the weighted average common and potential dilutive common equivalent shares outstanding, determined as follows:

	Three months ended
	March 31, 2005		March 31, 2004
Earnings available to common shareholders	$	1,217,239	$	544,787
Weighted average shares outstanding		3,029,818		1,920,291
Basic earnings per common share	$	0.40	$	0.28
Effect of dilutive securities:
Earning available to common shareholders	$	1,217,239	$	544,787
Junior subordinated debt securities interest net of tax effect		65,949		76,199
Earnings available to common plus assumed conversions	$	1,283,188	$	620,986
Effect of dilutive securities on EPS:
Weighted average shares outstanding		3,029,818		1,920,291
Effect of stock options		36,999		176,987
Effect of junior subordinated debt securities		629,783		733,871
Diluted average shares outstanding		3,696,600		2,831,149
Diluted earnings per common share	$	0.35	$	0.22

8

Note C – Investment Securities

The amortized costs and fair values of investment securities are as follows:

	Amortized Cost		Unrealized Gains		Unrealized Losses			Fair Value
March 31, 2005
Available for sale:
U.S. Treasury and agency securities	$	3,009,886	$	—	$	(26,771	)	$	2,983,115
Mortgage-backed securities		1,374,830		5,743		(6,116	)		1,374,457
State and municipal securities		1,555,928		46,351		—			1,602,279
Equities and other bonds		250,000		—		(5,650	)		244,350
	$	6,190,644	$	52,094	$	(38,537	)	$	6,204,201
Held to maturity:
Mortgage-backed securities	$	400,229	$	1,568	$	—		$	401,797
State and municipal securities		165,293		13,265		—			178,558
	$	565,522	$	14,833	$	—		$	580,355
December 31, 2004
Available for sale:
U.S. Treasury and agency securities	$	3,009,891	$	9,000	$	(5	)	$	3,018,886
Mortgage-backed securities		1,473,523		13,178		—			1,486,701
State and municipal securities		1,556,885		66,685		—			1,623,570
Equities and other bonds		250,000		—		(8,225	)		241,775
	$	6,290,299	$	88,863	$	(8,230	)	$	6,370,932
Held to maturity:
Mortgage-backed securities	$	411,090	$	1,041	$	—		$	412,131
State and municipal securities		163,109		16,779		—			179,888
	$	574,199	$	17,820	$	—		$	592,019

Note D - Loans

Major classifications of loans are summarized as follows:

	March 31, 2005			December 31, 2004
Commercial	$	46,808,692		$	45,421,914
Commercial construction		29,317,114			20,912,504
Commercial mortgage		199,560,579			187,934,731
Residential mortgage		69,024,007			51,320,177
Installment loans to individuals		10,187,557			10,574,566
Other		1,066,595			1,057,303
Gross loans		355,964,544			317,221,195
Unearned income		(1,505,790	)		(1,466,634	)
Allowance for loan losses		(3,121,565	)		(2,839,315	)
Loans, net	$	351,337,189		$	312,915,246

9

Non-performing assets are as follows:

	March 31, 2005			December 31, 2004
Non-accrual loans:
Commercial	$	425,593		$	437,093
Commercial construction		—			—
Commercial mortgage		—			—
Residential mortgage		—			1,281
Installment loans to individuals		7,189			13,108
Other		—			—
		432,782			451,482
Loans contractually past-due 90 days or more:
Commercial		—			—
Commercial construction		—			—
Commercial mortgage		—			—
Residential mortgage		—			—
Installment loans to individuals		10,264			8,333
Other		49,613			7,756
		59,877			16,089
Total non-performing loans	$	492,659		$	467,571
Other real estate owned	$	—		$	—
Total non-performing assets	$	492,659		$	467,571
Allowance as a percentage of non-performing assets		633.62	%		607.25	%
Non-performing assets as a percentage of total asset		0.12	%		0.12	%

Note E – Allowance For Loan Losses

A summary of transactions in the allowance for loan losses for the three months ended March 31, 2005 and 2004 were as follows:

	March 31, 2005			March 31, 2004
Balance at beginning of year	$	2,839,315		$	2,503,000
Provision charged to operating expense		330,000			465,000
Loans charged-off		(48,446	)		(125	)
Recoveries of loans previously charged-off		696			4,006
Balance at end of period	$	3,121,565		$	2,971,881

Note F – Premises and Equipment

Premises and equipment are summarized as follows:

	March 31, 2005		December 31, 2004
Land	$	345,403	$	345,403
Building and improvements		3,028,688		3,028,688
Leasehold improvements		794,717		789,783
Furniture and equipment		6,918,826		6,766,101
Construction in progress		29,103		26,131
		11,116,737		10,956,106
Less accumulated depreciation		6,055,864		5,815,100
	$	5,060,873	$	5,141,006

10

Note G – Subsequent Events

On April 19, 2005, the Company declared a $0.05 per share cash dividend payable May 31, 2005, to shareholders of record on May 2, 2005.

Subsequent to March 31, 2005 through April 30, 2005, 6,345 shares of the 8.0% cumulative preferred securities were converted to 3,965 shares of the Parent’s common stock.

Item 2. Management’s Discussion and Analysis of Financial Condition and Results of Operations.

General

The sole business of Commonwealth Bankshares, Inc. is to serve as a holding company for Bank of the Commonwealth. The Company was incorporated as a Virginia Company on June 6, 1988, and on November 7, 1988 it acquired the Bank.

Bank of the Commonwealth was formed on August 28, 1970 under the laws of Virginia. Since the Bank opened for business on April 14, 1971, its main banking and administrative offices have been located in Norfolk, Virginia. The Bank currently operates three branches in Norfolk, four branches in Virginia Beach, one branch in Chesapeake, and one branch in Portsmouth. To capture the growing market and the real estate boom in the Ocean View area of Norfolk, Bank of the Commonwealth recently opened a loan origination office on Pretty Lake Avenue at East Beach and is negotiating a lease for a permanent branch site nearby. This will be the Bank’s tenth branch site in the Hampton Roads area. The Bank’s mortgage subsidiary currently operates one mortgage branch office in Norfolk, one mortgage branch office in Gloucester and one mortgage branch office in Richmond, Virginia.

The Bank concentrates its marketing efforts in the cities of Norfolk, Virginia Beach, Portsmouth and Chesapeake, Virginia. The Company’s present intention is to continue concentrating its banking activities in its current market, which the Company believes, is an attractive area in which to operate.

The following discussion provides information about the important factors affecting the consolidated results of operations, financial condition, capital resources and liquidity of the Company. This report identifies trends and material changes that occurred during the reporting period and should be read in conjunction with the Company’s 2004 annual report.

In addition to historical information, the following discussion contains forward looking statements that are subject to risks and uncertainties that could cause the Company’s actual results to differ materially from those anticipated, including risks associated with general economic conditions and interest rate trends. These forward looking statements include, but are not limited to, statements regarding management’s expectations that the Company will continue to experience growth in core operating earnings, improved credit quality and increased service fee income, and that the Company may pay cash dividends in the future. Readers are cautioned not to place undue reliance on these forward looking statements, which reflect management’s analysis only as of the date hereof.

Critical Accounting Policies

Certain critical accounting policies affect the more significant judgments and estimates used in the preparation of the consolidated financial statements. The Company’s most critical accounting policy relates to the Company’s allowance for loan losses, which reflects the estimated losses resulting from the inability of the Company’s borrowers to make required loan payments. If the financial condition of the Company’s borrowers were to deteriorate, resulting in an impairment of their ability to make payments, the Company’s estimates would be updated, and additional provisions for loan losses may be required.

11

Recent Accounting Pronouncements

In December 2004, the FASB issued SFAS No. 123 (Revised 2004),Share-Based Payments (“SFAS No. 123(R)”). The new pronouncement replaces the existing requirements under SFAS No. 123 and Accounting Principals Board Opinion No. 25 (“APB Opinion No. 25”). According to SFAS No. 123(R), all forms of share-based payments to employees, including employee stock options and employee stock purchase plans, would be treated the same as any other form of compensation by recognizing the related cost in the statement of operations. This pronouncement eliminates the ability to account for stock-based compensation transactions using APB Opinion No. 25 and generally would require that such transactions be accounted for using a fair-value based method. Since the December 2004 issuance of FAS 123(R), the SEC has elected to defer the effective date. For public companies, the FASB has determined that SFAS No. 123(R) is effective for awards and stock options granted, modified or settled in cash in annual periods beginning after December 31, 2005. SFAS No. 123(R) provides transition alternatives for public companies to restate prior interim periods or prior years. The Company expects to adopt the new standards as of its effective date. The impact to compensation expense is not expected to be material, however, the final impact to compensation expense will be dependent on the number of equity instruments granted during any year, including their timing and vesting period, and the method used to calculate the fair value of the awards, among other factors.

Stock Compensation Plans

Statement of Financial Accounting Standards (SFAS) No. 123,Accounting for Stock-Based Compensation, encourages all entities to adopt a fair value based method of accounting for employee stock compensation plans, whereby compensation cost is measured at the grant date based on the value of the award and is recognized over the service period, which is usually the vesting period. However, it also allows an entity to continue to measure compensation cost for those plans using the intrinsic value based method of accounting prescribed by Accounting Principles Board Opinion No. 25,Accounting for Stock Issued to Employees, whereby compensation cost is the excess, if any, of the quoted market price of the stock at the grant date (or other measurement date) over the amount an employee must pay to acquire the stock. Stock options issued under the Company’s stock option plan have no intrinsic value at the grant date, and under Opinion No. 25 no compensation cost is recognized for them. The Company has elected to continue with the accounting methodology in Opinion No. 25. The fair value based method of accounting did not have a material effect on the Company’s net income and earnings per share.

Financial Condition

Total assets at March 31, 2005 reached a new high of $394.5 million, up 5.5% or $20.4 million from $374.1 million at December 31, 2004. Total loans, the Company’s largest and most profitable asset, ended the quarter at a record $354.5 million, up $38.7 million or 12.3% from December 31, 2004. The low interest rate environment, our strong local economy and the efforts of our experienced loan officers to develop new loan relationships combined with the support of existing customers continue to generate record loan demand for the Company. Loans held for sale declined $16.8 million or 53.9% which tempered the growth in total assets. Of this decrease, $10.9 million is the result of a reclassification from the loans held for sale portfolio to the loan portfolio as management plans to hold these loans for the foreseeable future or until maturity or pay-off.

As of March 31, 2005, 77.4% of the Company’s loan portfolio consisted of commercial loans, which are considered to provide higher yields, but also generally carry a greater risk. It should be noted that 72.4% of these commercial loans are collateralized with real estate, and accordingly do not represent an unfavorable risk. At March 31, 2005, 75.5% of the Bank’s total loan portfolio consisted of loans collateralized with real estate.

12

Deposits are the most significant source of the Company’s funds for use in lending and general business purposes. The Company’s strong growth in deposits continued into the first quarter 2005 with deposits at March 31, 2005 reaching a record $289.8 million, an increase of $12.2 million from December 31, 2004. Non-interest bearing demand deposits decreased by $224.9 thousand or 0.6%, and interest bearing deposits increased by $12.4 million or 5.2%. Time deposits, a higher interest bearing liability, increased $2.1 million during the first quarter of 2005, with interest bearing demand and savings accounts increasing $10.6 million and decreasing $335.3 thousand, respectively. Management believes the growth in deposits is a result of the increased promotional efforts put forth by the Company as well as the efforts of our experienced staff to attract new customers through our special promotions, product enhancements, and offering unsurpassed service. The Company’s deposits are predominantly provided by individuals and businesses located within communities served.

As of March 31, 2005, short term borrowings (advances from FHLB) were $50.0 million, compared to $44.1 million outstanding on December 31, 2004. The increase in short term borrowings was primarily a result of our loan demand continuing to increase at a faster pace than our deposit growth.

Results of Operation

During the first three months of 2005, the Company reached a record $1.2 million in net income, an increase of 123.4% over the $544.8 thousand reported in the first quarter of 2004. On a per share basis, diluted earnings was 35 cents in the first quarter of 2005, up 13 cents or 59.1% from the 22 cents reported in the first quarter of 2004. First quarter basic earnings per share equaled 40 cents for the three months ended March 31, 2005 compared to 28 cents for same period of 2004.

Profitability as measured by the Company’s return on average assets (ROA) was 1.32% and 0.74% for the three months ended March 31, 2005 and 2004, respectively. ROA was impacted by the record increase in net income of 123.4% which was offset by an increase in average assets of $77.4 million or 26.1% from March 31, 2004 to March 31, 2005. The return on average equity (ROE) was 13.14% and 11.21% for the three months ended March 31, 2005 and 2004, respectively. The increase in ROE is the result of the record 123.4% increase in net income which was offset by the growth in average equity of $18.0 million or 92.3% from March 31, 2004 to March 31, 2005. The substantial growth in average equity is the result of the $15.0 million in additional capital raised by the Company during the fourth quarter of 2004 through a private placement of its common stock.

A fundamental source of the Company’s earnings, net interest income, is defined as the difference between income on earning assets and the cost of funds supporting those assets. Significant categories of earning assets are loans and securities, while deposits and short-term borrowings represent the major portion of interest bearing liabilities. The level of net interest income is impacted primarily by variations in the volume and mix of these assets and liabilities, as well as changes in interest rates when compared to previous periods of operations. Net interest income was $4.3 million for the quarter ended March 31, 2005, an increase of $1.4 million or 51.0% over the comparable period in 2004.

Total interest income was $6.6 million for the quarter ended March 31, 2005, an increase of $1.7 million or 35.3% over the same period of 2004. Strong loan demand continued into the first quarter of 2005 generating record increases in interest income. Interest income on loans increased $1.8 million or 37.9% to $6.5 million for the three months ended March 31, 2005.

Interest expense of $2.4 million for the quarter ended March 31, 2005 represented a $290.0 thousand increase from the comparable period in 2004. The increase was primarily attributable to the record increase in the Company’s average interest bearing liabilities, which was offset by the decrease in overall rates paid on liabilities as a result of higher priced time deposits repricing at lower rates throughout the quarter. Average interest bearing liabilities increased $55.7 million or 23.1% from March 31, 2004 to March 31, 2005, while the overall rates paid on these liabilities decreased 24 basis points to 3.23%.

13

The net interest margin, which is calculated by expressing net interest income as a percentage of average interest earning assets, is an indicator of the Company’s efficiency in generating income from earning assets. The net interest margin is affected by the structure of the balance sheet as well as by competition and the economy. The Company’s net interest margin (tax equivalent basis) increased from 4.11% during the first three months of 2004 to 4.81% for the same period in 2005. This increase can be attributed to changes in the balance sheet mix, changes in the yields obtained from interest earning assets and paid on interest bearing liabilities, the prevailing interest rate environment and changes in volume.

The provision for loan losses is the annual cost of maintaining an allowance for inherent credit losses. The amount of the provision each year and the level of the allowance are matters of judgment and are impacted by many factors, including actual credit losses during the period, the prospective view of credit losses, loan performance measures and trends (such as delinquencies and charge-offs), and other factors, both internal and external that may affect the quality and future loss experience of the credit portfolio. At March 31, 2005, the Company had total allowance for loan losses of $3,121,565 or 0.88% of total loans. The provision for loan losses was $330,000 for the first three months of 2005 compared to $465,000 for the same period of 2004. This decrease was due to additional amounts of provision being recorded during the first quarter of 2004 related to one significant commercial credit. Loan charge-offs for the three months ended March 31, 2005 totaled $48,446 and recoveries for the same period totaled $696.

During the first quarter of 2005, non-performing assets increased $25.1 thousand to $492.7 thousand as of March 31, 2005. Nonaccrual loans at March 31, 2005 consisted of five loans which totaled $432.8 thousand. $420.9 thousand of the total represents one significant commercial credit. Management is closely monitoring this credit, and at this time, does not anticipate a loss based on the customers current monthly payment stream and strength of the underlying collateral securing the loan. Management believes that the current monthly provision and allowance for loan losses is sufficient to absorb any potential loss associated with this credit and the potential loss will not negatively impact the Company’s ability to conduct its business on a going forward basis. The remaining $11.9 thousand in non-accrual loans represents four (4) loans, with the majority making monthly payments and in most cases are secured with workout arrangements currently in place. Based on current expectations relative to portfolio characteristics and performance measures including loss projections, management considers the level of the allowance to be adequate.

Noninterest income for the quarter ended March 31, 2005 equaled $746.3 thousand an increase of $121.6 thousand over the $624.7 thousand reported for the three months ended March 31, 2004. Revenues generated from the mortgage company acquisition (third quarter 2004) contributed $338.7 thousand to other income. In addition, service charges on deposit accounts, a primary source of the Company’s non-interest income, increased $12.0 thousand or 5.2% over the comparable period for 2004. This increase was attributable to the record increase in the number of deposit accounts. These increases do not include any gains from sale of investments, which were $240.1 thousand for the three months ended March 31, 2004.

Non-interest expense represents the overhead expenses of the Company. Non-interest expense for the quarter ended March 31, 2005 totaled $2.8 million, an increase of $659.9 thousand over the $2.2 million recorded during the quarter ended March 31, 2004. Salaries and employee benefits, the largest component of non-interest expense, increased by $498.4 thousand or 47.5% over the $1.1 million reported during the first three months of 2004. This increase was driven by annual merit increases, the addition of several new positions, including three leading commercial loan officers, an increase in certain employee benefit costs and the acquisition of the mortgage company. Salaries and benefit costs associated with the mortgage company was $260.3 thousand for the quarter ended March 31, 2005. Other non-interest operating expenses, which include a grouping of numerous transactions relating to normal banking operations, increased $133.5 thousand or 21.0% over the comparable period for 2004. The major part of this increase is the result of the Company’s continued investment in an extensive multimedia advertising campaign utilizing billboards, radio, and newspaper to promote and reinforce its presence throughout Southside Hampton Roads. For the three months ended March 31, 2005, advertising and marketing expense increased $129.9 thousand or 261.3% over the comparable period for 2004.

14

Capital Resources

Total stockholders’ equity for the Company increased to $38.7 million from $37.0 million or 4.4% from December 31, 2004 to March 31, 2005. Contributing to the increase in total stockholders equity was our record earnings of $1.2 million for the first three months of 2005. Stockholders’ equity for March 31, 2005 reflects a $8.9 thousand net unrealized gain on securities available for sale in accordance with FASB 115, as compared to a $53.2 thousand net unrealized gain as of December 31, 2004.

The Federal Reserve Board, the Office of Controller of the Currency, and the FDIC have issued risk-based capital guidelines for U.S. banking organizations. These guidelines provide a capital framework that is sensitive to differences in risk profiles among banking companies.

Risk-based capital ratios are another measure of capital adequacy. At March 31, 2005 and 2004, the Bank’s risk-adjusted capital ratios were 12.24% and 9.98% for Tier 1 and 13.16% and 11.27% for total capital, well above the required minimums of 4.0% and 8.0%, respectively. These ratios are calculated using regulatory capital (either Tier 1 or total capital) as the numerator and both on and off-balance sheet risk-weighted assets as the denominator. Tier 1 capital consists primarily of common equity less goodwill and certain other intangible assets. Total capital adds certain qualifying debt instruments and a portion of the allowance for loan losses to Tier 1 capital. One of four risk weights, primarily based on credit risk, is applied to both on and off-balance sheet assets to determine the asset denominator. Under Federal Reserve Bank rules, the Bank was considered “well capitalized,” the highest category of capitalization defined by the regulators, as of March 31, 2005.

In order to maintain a strong equity capital position and to protect against the risks of loss in the investment and loan portfolios and on other assets, management will continue to monitor the Bank’s capital position. Several measures have been or will be employed to maintain the Bank’s strong capital position, including but not limited to continuing its efforts to return all non-performing assets to performing status, monitoring the Bank’s growth, and continued utilization of its formal asset/liability policy.

Cash Dividend

At the January 18, 2005 meeting, the Board of Directors declared a $0.05 cash dividend per share, totaling $151.1 thousand. The dividend was paid February 28, 2005 on the Company’s common shares for shareholders of record as of February 21, 2005, in compliance with the Company’s dividend payout policy. At the January 20, 2004 meeting, the Board of Directors declared a $0.05 cash dividend per share, totaling $96.4 thousand. The dividend was paid February 27, 2004 on the Company’s common shares for shareholders of record as of February 23, 2004.

Interest Sensitivity and Liquidity

The Company’s primary component of market risk is exposure to interest rate volatility. Fluctuations in interest rates will impact both the level of interest income and interest expense and the market value of the Company’s interest earning assets and interest bearing liabilities.

The Company’s Asset/Liability Management Committee (ALCO) is responsible for formulating liquidity strategies, monitoring performance based on established objectives and approving new liquidity initiatives. ALCO’s overall objective is to optimize net interest income within the constraints of prudent capital adequacy, liquidity needs, the interest rate and economic outlook, market opportunities, and customer requirements. General strategies to accomplish this objective include maintaining a strong balance sheet, achieving solid core deposit growth, taking on manageable interest rate risk, and adhering to conservative financial management on a daily basis. These strategies are monitored regularly by ALCO and reviewed periodically with the Board of Directors.

15

The primary goal of the Company’s asset/liability management strategy is to maximize its net interest income over time while keeping interest rate risk exposure within levels established by the Company’s management. The Company’s ability to manage its interest rate risk depends generally on the Company’s ability to match the maturities and repricing characteristics of its assets and liabilities while taking into account the separate goals of maintaining asset quality and liquidity and achieving the desired level of net interest income. The principal variables that affect the Company’s management of its interest rate risk include the Company’s existing interest rate gap position, management’s assessment of future interest rates, and the withdrawal of liabilities over time.

The Company’s primary technique for managing its interest rate risk exposure is the management of the Company’s interest sensitivity gap. The interest sensitivity gap is defined as the difference between the amount of interest earning assets anticipated, based upon certain assumptions, to mature or reprice within a specific time period and the amount of interest bearing liabilities anticipated, based upon certain assumptions, to mature or reprice within that time period. At March 31, 2005, the Company’s one year “positive gap” (interest earning assets maturing or repricing within the same period exceed interest bearing liabilities maturing or repricing within the same period) was approximately $22.1 million, or 5.60% of total assets. Thus, during periods of rising interest rates, this implies that the Company’s net interest income would be positively affected because the yield of the Company’s interest earning assets is likely to rise more quickly than the cost of interest bearing liabilities. At December 31, 2004, the Company’s one year “positive gap” was approximately $32.6 million, or 8.71% of total assets.

The following tables set forth the amount of interest earning assets and interest bearing liabilities outstanding at March 31, 2005 and December 31, 2004 that are subject to re-pricing or that mature in each of the future time periods shown. Loans and securities with call or balloon provisions are included in the period in which they balloon or may first be called. Except as stated above, the amount of assets and liabilities shown that re-price or mature during a particular period were determined in accordance with the contractual terms of the asset or liability.

16

Interest Rate Sensitivity Analysis

	March 31, 2005
(in thousands)	Within 90 Days			91 Days to One Year			After One but Within Five Years			After Five Years			Total
Interest Earning Assets:
Investment securities	$	1,002		$	326		$	3,680		$	1,762		$	6,770
Equity securities		—			—			—			3,992			3,992
Loans held for sale		14,349			—			—			—			14,349
Loans		164,706			11,770			113,683			65,806			355,965
Interest bearing deposits		202			—			—			—			202
Federal funds sold		459			—			—			—			459
Total	$	180,718		$	12,096		$	117,363		$	71,560		$	381,737
Cumulative totals		180,718			192,814			310,177			381,737
Interest Bearing Liabilities:
Deposits:
Demand	$	50,388		$	—		$	—		$	—		$	50,388
Savings		9,250			—			—			—			9,250
Time deposits, $100,000 and over		3,360			13,349			28,877			8,437			54,023
Other time deposits		10,998			32,993			88,531			5,655			138,177
Short-term borrowing		49,983			—			—			—			49,983
Long-term borrowing		377			10			5,025			—			5,412
Junior subordinated debt securities		—			—			—			5,221			5,221
Total	$	124,356		$	46,352		$	122,433		$	19,313		$	312,454
Cumulative totals		124,356			170,708			293,141			312,454
Interest sensitivity gap	$	56,362		$	(34,256	)	$	(5,070	)	$	52,247		$	69,283
Cumulative interest sensitivity gap	$	56,362		$	22,106		$	17,036		$	69,283
Cumulative interest sensitivity gap as a percentage of total assets		14.29	%		5.60	%		4.32	%		17.56	%

17

Interest Rate Sensitivity Analysis

	December 31, 2004
(in thousands)	Within 90 Days			91 Days to One Year			After One but Within Five Years			After Five Years			Total
Interest Earning Assets:
Investment securities	$	931		$	419		$	3,792		$	1,803		$	6,945
Equity securities		—			—			—			3,618			3,618
Loans held for sale		19,817			—			325			10,965			31,107
Loans		151,353			13,760			97,670			54,438			317,221
Interest bearing deposits		196			—			—			—			196
Federal funds sold		420			—			—			—			420
Total	$	172,717		$	14,179		$	101,787		$	70,824		$	359,507
Cumulative totals		172,717			186,896			288,683			359,507
Interest Bearing Liabilities:
Deposits:
Demand	$	39,809		$	—		$	—		$	—		$	39,809
Savings		9,585			—			—			—			9,585
Time deposits, $100,000 and over		2,936			14,951			28,334			4,889			51,110
Other time deposits		9,366			33,096			92,269			4,252			138,983
Short-term borrowing		44,140			—			—			—			44,140
Long-term borrowing		404			10			5,028			—			5,442
Junior subordinated debt securities		—			—			—			5,237			5,237
Total	$	106,240		$	48,057		$	125,631		$	14,378		$	294,306
Cumulative totals		106,240			154,297			279,928			294,306
Interest sensitivity gap	$	66,477		$	(33,878	)	$	(23,844	)	$	56,446		$	65,201
Cumulative interest sensitivity gap	$	66,477		$	32,599		$	8,755		$	65,201
Cumulative interest sensitivity gap as a percentage of total assets		17.77	%		8.71	%		2.34	%		17.43	%

18

Item 3. Quantitative and Qualitative Disclosures and Market Risk

Not applicable pursuant to instructions to Item 305(c) of Regulation S-K.

Item 4. Controls and Procedures

(a) As of March 31, 2005, the Company carried out an evaluation, under the supervision and with the participation of the Company’s management, including the Company’s Chief Executive Officer and Chief Financial Officer, of the effectiveness of the design and operation of the Company’s disclosure controls and procedures pursuant to Rule 13a-15 (e) of the Securities Exchange Act of 1934, as amended (the “Exchange Act”). Based on that evaluation, the Chief Executive Officer and the Chief Financial Officer concluded that the Company’s disclosure controls and procedures are effective in timely alerting them to material information relating to the Company (including its consolidated subsidiaries) required to be included in the Company’s Exchange Act filings.

(b) There have been no significant changes in the Company’s internal controls or in other factors which could significantly affect its internal controls subsequent to the date the Company carried out its evaluation.

19

Part II. OTHER INFORMATION

Item 1. Legal proceedings

As of March 31, 2005, there were no legal proceedings against the Company.

Item 2. Changes in securities

There were no changes in the Company’s securities during the quarter.

Item 3. Defaults upon senior securities

There were no defaults upon senior securities during the quarter.

Item 4. Submission of matters to a vote of security holders

There were no matters submitted to a vote of security holders during the quarter.

Item 5. Other information

None.

Item 6. Exhibits and Reports on Form 8-K

(a) Exhibits

31.1	Certification of CEO pursuant to Rule 13a-14(a).
31.2	Certification of Principal Financial Officer pursuant to Rule 13a-14(a).
32.1	Certification of CEO pursuant to Section 906 of the Sarbanes-Oxley Act of 2002.
32.2	Certification of Principal Financial Officer pursuant to Section 906 of the Sarbanes-Oxley Act of 2002.

(b) Report on Form 8-K

Form 8K – filed January 28, 2005, related to the declaration of a dividend payable during the first quarter of 2005, is incorporated herein by reference.

Form 8K – filed March 1, 2005, related to the earnings release for the year ended December 31, 2004, is incorporated herein by reference.

Form 8K/A – filed March 11, 2005 related to the corrected earnings release for the year ended December 31, 2004, is incorporated herein by reference.

20

SIGNATURES

In accordance with the requirements of the Securities Exchange Act of 1934, the registrant caused this report to be signed on its behalf by the undersigned, thereunto duly authorized.

	Commonwealth Bankshares, Inc.
	(Registrant)
Date: May 13, 2005	by:	/s/ Edward J. Woodard, Jr., CLBB
		Edward J. Woodard, Jr., CLBB
		Chairman of the Board,
		President and Chief Executive Officer
Date: May 13, 2005	by:	/s/ Cynthia A. Sabol, CPA
		Cynthia A. Sabol, CPA
		Executive Vice President,
		& Chief Financial Officer

21