Commonwealth Bankshares (CWBS) 10-Q 2007 Q1 Quarterly report

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 31, 2007

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, including area code)

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 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 is a large accelerated filer, an accelerated filer, or a non-accelerated filer. See definition of “accelerated filer and large accelerated filer” in Rule 12b-2 of the Exchange Act. (Check one):

Large Accelerated Filer  ¨    Accelerated Filer  x    Non-Accelerated Filer  ¨

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.

Common Stock, $2.066 Par Value – 6,878,293 shares as of April 12, 2007

Commonwealth Bankshares, Inc.

Table of Contents

		Page
PART I - FINANCIAL INFORMATION
ITEM 1    –	FINANCIAL STATEMENTS (unaudited)
	Consolidated Balance Sheets	3
	March 31, 2007
	December 31, 2006
	Consolidated Statements of Income	4
	Three months ended March 31, 2007
	Three months ended March 31, 2006
	Consolidated Statements of Comprehensive Income	5
	Three months ended March 31, 2007
	Three months ended March 31, 2006
	Consolidated Statements of Stockholders’ Equity	6
	Three months ended March 31, 2007
	Year ended December 31, 2006
	Year ended December 31, 2005
	Consolidated Statements of Cash Flows	7
	Three months ended March 31, 2007
	Three months ended March 31, 2006
	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 ABOUT MARKET RISK	19
ITEM 4    –	CONTROLS AND PROCEDURES	19
PART II - OTHER INFORMATION		20
ITEM 1    –	LEGAL PROCEEDINGS	20
ITEM 1A –	RISK FACTORS	20
ITEM 2    –	UNREGISTERED SALES OF EQUITY SECURITIES AND USE OF PROCEEDS	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	20
SIGNATURES		21

2

Commonwealth Bankshares, Inc.

Consolidated Balance Sheets

	March 31, 2007 (Unaudited)			December 31, 2006 (Audited)
Assets
Cash and cash equivalents:
Cash and due from banks	$	10,675,872		$	10,567,691
Interest bearing deposits in banks		541,731			427,391
Federal funds sold		6,689,972			2,031,055
Total cash and cash equivalents		17,907,575			13,026,137
Investment securities:
Available for sale, at fair market value		7,042,296			7,206,153
Held to maturity, at amortized cost (fair market value was $469,402 and $476,041, respectively)		464,147			470,265
Total investment securities		7,506,443			7,676,418
Equity securities, restricted, at cost		7,739,650			7,184,850
Loans		697,407,421			669,541,325
Allowance for loan losses		(8,530,202	)		(8,144,265	)
Loans, net		688,877,219			661,397,060
Premises and equipment, net		15,221,966			12,939,966
Deferred tax assets		4,470,580			4,283,163
Accrued interest receivable		6,083,583			5,373,086
Other assets		3,534,942			3,324,594
Total assets	$	751,341,958		$	715,205,274
Liabilities and Stockholders’ Equity
Liabilities:
Deposits:
Noninterest-bearing demand deposits	$	46,112,525		$	43,045,107
Interest-bearing		464,516,545			444,129,720
Total deposits		510,629,070			487,174,827
Short-term borrowings		96,713,200			88,611,200
Long-term debt		5,322,048			5,348,160
Trust preferred capital notes		20,619,000			20,619,000
Accrued interest payable		1,648,634			1,678,156
Other liabilities		10,396,263			8,548,552
Total liabilities		645,328,215			611,979,895
Stockholders’ Equity:
Common stock, par value $2.066, 18,150,000 shares authorized; 6,878,291 and 6,844,975 shares issued and outstanding in 2007 and 2006, respectively		14,210,550			14,141,719
Additional paid-in capital		64,328,291			63,965,840
Retained earnings		27,471,892			25,123,140
Accumulated other comprehensive income (loss)		3,010			(5,320	)
Total stockholders’ equity		106,013,743			103,225,379
Total liabilities and stockholders’ equity	$	751,341,958		$	715,205,274

See notes to consolidated financial statements.

3

Commonwealth Bankshares, Inc.

Consolidated Statements of Income (Unaudited)

	Three months ended
	March 31, 2007			March 31, 2006
Interest and dividend income:
Loans, including fees	$	14,330,709		$	11,080,681
Investment securities:
Taxable		88,862			95,704
Tax exempt		12,324			16,911
Dividend income, equity securities, restricted		107,487			83,050
Other interest income		37,982			19,402
Total interest and dividend income		14,577,364			11,295,748
Interest expense:
Deposits		4,946,089			3,232,078
Federal Home Loan Bank		1,230,054			961,722
Junior subordinated debt securities		—			90,358
Trust preferred capital notes		322,945			322,945
Long-term debt		53,231			53,366
Total interest expense		6,552,319			4,660,469
Net interest income		8,025,045			6,635,279
Provision for loan losses		430,000			670,000
Net interest income after provision for loan losses		7,595,045			5,965,279
Noninterest income:
Service charges on deposit accounts		224,683			254,060
Other service charges and fees		147,542			120,989
Mortgage brokerage income		350,403			336,263
Title insurance income		216,896			214,025
Investment service income		201,469			116,599
Other		54,972			42,018
Total noninterest income		1,195,965			1,083,954
Noninterest expense:
Salaries and employee benefits		2,494,243			2,068,638
Net occupancy expense		457,065			396,611
Furniture and equipment expense		379,435			335,971
Other operating expense		1,242,736			1,141,452
Total noninterest expense		4,573,479			3,942,672
Income before provision for income taxes and noncontrolling interest		4,217,531			3,106,561
Provision for income taxes		1,451,428			1,055,430
Income before noncontrolling interest		2,766,103			2,051,131
Noncontrolling interest in subsidiary		(5,092	)		(5,396	)
Net income	$	2,761,011		$	2,045,735
Basic earnings per share	$	0.40		$	0.41
Diluted earnings per share	$	0.40		$	0.36
Dividends paid per share	$	0.06		$	0.05
Basic weighted average shares outstanding		6,867,731			5,024,484
Diluted weighted average shares outstanding		6,970,373			5,770,583

See notes to consolidated financial statements.

4

Commonwealth Bankshares, Inc.

Consolidated Statements of Comprehensive Income (Unaudited)

	Three months ended
	March 31, 2007		March 31, 2006
Net income	$	2,761,011	$	2,045,735
Other comprehensive income, net of income tax:
Net change in unrealized gain (loss) on securities available for sale		8,330		(15,242	)
Comprehensive income	$	2,769,341	$	2,030,493

See notes to consolidated financial statements.

5

Commonwealth Bankshares, Inc.

Consolidated Statements of Stockholders’ Equity

Three Months Ended March 31, 2007, and Years Ended December 31, 2006 and 2005

	Common Shares	Common Amount		Additional Paid-in Capital		Retained Earnings			Accumulated Other Comprehensive Income (loss)			Total
Balance, January 1, 2005	3,611,601	$	7,461,986	$	19,321,813	$	10,187,132		$	53,218		$	37,024,149
Comprehensive income:
Net income	—		—		—		6,634,308			—			6,634,308
Change in unrealized loss on securities available for sale, net of tax effect	—		—		—		—			(58,789	)		(58,789	)
Total comprehensive income													6,575,519
Issuance of common stock	147,310		304,360		1,049,696		—			—			1,354,056
Issuance of common stock through private placement	1,170,081		2,417,522		16,108,400		—			—			18,525,922
Cash dividends - $0.1736 per share	—		—		—		(749,627	)		—			(749,627	)
Balance, December 31, 2005	4,928,992	$	10,183,868	$	36,479,909	$	16,071,813		$	(5,571	)	$	62,730,019
Comprehensive income:
Net income	—		—		—		10,091,629			—			10,091,629
Change in unrealized gain on securities available for sale, net of tax effect	—		—		—		—			251			251
Total comprehensive income													10,091,880
Issuance of common stock	752,522		1,553,717		3,523,022		—			—			5,076,739
Issuance of common stock through private placement	1,163,461		2,404,134		23,867,509		—			—			26,271,643
Stock based compensation expense-options issued	—		—		95,400		—		��	—			95,400
Cash dividends - $0.1991 per share	—		—		—		(1,040,302	)		—			(1,040,302	)
Balance, December 31, 2006	6,844,975	$	14,141,719	$	63,965,840	$	25,123,140		$	(5,320	)	$	103,225,379
Comprehensive income:
Net income	—		—		—		2,761,011			—			2,761,011
Change in unrealized gain on securities available for sale, net of tax effect	—		—		—		—			8,330			8,330
Total comprehensive income													2,769,341
Issuance of common stock	33,316		68,831		362,451		—			—			431,282
Cash dividends - $0.06 per share	—		—		—		(412,259	)		—			(412,259	)
Balance, March 31, 2007	6,878,291	$	14,210,550	$	64,328,291	$	27,471,892		$	3,010		$	106,013,743

See notes to consolidated financial statements.

6

Commonwealth Bankshares, Inc.

Consolidated Statements of Cash Flows (Unaudited)

		Three months ended
		March 31, 2007			March 31, 2006
Operating activities:
Net income		$	2,761,011		$	2,045,735
Adjustments to reconcile net income to net cash provided by operating activities:
Provision for loan losses			430,000			670,000
Depreciation and amortization			341,239			298,452
Loss on the sale of premises and equipment			—			245
Net amortization of premiums and accretion of discounts on investments securities			(2,148	)		(788	)
Deferred tax assets			(191,708	)		(348,933	)
Net change in:
Accrued interest receivable			(710,497	)		(519,040	)
Other assets			(210,348	)		(279,802	)
Accrued interest payable			(29,522	)		113,656
Other liabilities			1,967,435			2,106,034
Net cash provided by operating activities			4,355,462			4,085,559
Investing activities:
Purchase of securities available for sale			(10,862	)		(9,887	)
Purchase of equity securities, restricted			(1,274,800	)		(2,975,400	)
Net purchase of premises and equipment			(2,623,239	)		(803,357	)
Net change in loans			(27,847,209	)		(53,084,975	)
Proceeds from:
Calls and maturities of securities held to maturity			8,393			15,973
Sales and maturities of securities available for sale			187,213			72,759
Sale of equity securities, restricted			720,000			2,299,500
Sale of premises and equipment			—			9,750
	��
Net cash used in investing activities			(30,840,504	)		(54,475,637	)
Financing activities:
Net change in:
Demand, interest-bearing demand and savings deposits			15,025,843			15,865,091
Time deposits			8,415,560			14,498,591
Brokered time deposits			12,840			10,137,000
Short-term borrowings			8,102,000			8,867,000
Principal payments on long-term debt			(26,112	)		(27,608	)
Dividends reinvested and sale of stock			248,608			201,593
Dividends paid			(412,259	)		(249,513	)
Net cash provided by financing activities			31,366,480			49,292,154
Net increase (decrease) in cash and cash equivalents			4,881,438			(1,097,924	)
Cash and cash equivalents, January 1			13,026,137			13,595,811
Cash and cash equivalents, March 31		$	17,907,575		$	12,497,887
Supplemental cash flow disclosure:
Interest paid during the period		$	6,581,841		$	4,546,813
Income taxes paid during the period		$	225,000		$	332,557
Supplemental noncash disclosure:
Conversion of convertible preferred securities for common stock		$	—		$	498,065

See notes to consolidated financial statements.

7

Commonwealth Bankshares, Inc.

Notes to Consolidated Financial Statements (Unaudited)

March 31, 2007

Note A – Basis of Presentation

The accounting and reporting policies of Commonwealth Bankshares, Inc. (the “Parent”) and its subsidiary, Bank of the Commonwealth (the “Bank”) and its subsidiaries, BOC Title of Hampton Roads, Inc., T/A Executive Title Center, BOC Insurance Agencies of Hampton Roads, Inc., Community Home Mortgage of Virginia, Inc., T/A Bank of the Commonwealth Mortgage and Commonwealth Financial Advisors, LLC, are in accordance with accounting principles generally accepted in the United States of America and conform to accepted practices within the banking industry. In December 2006, Commonwealth Bankshares Capital Trust I (“the Trust”) was dissolved. For further discussion see footnote 10 in the Company’s annual report on Form 10-K for the year ended December 31, 2006. 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. Financial Accounting Standards Board (“FASB”) Interpretation No. 46 (R) required that the Company no longer consolidate the Trust. Prior to dissolution the junior subordinated debt of the Trust was 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-K for the year ended December 31, 2006.

On November 27, 2006, the Board of Directors approved an amendment to the Articles of Incorporation of the Company to increase the number of authorized shares of Common Stock from 16,500,000 to 18,150,000 shares, to reduce the par value of each share from $2.273 to $2.066 per share, and effect an eleven-for-ten stock split distributed on December 29, 2006 to stockholders of record on December 18, 2006.

On May 16, 2006, the Board of Directors approved an amendment to the Articles of Incorporation of the Company to increase the number of authorized shares of Common Stock from 15,000,000 to 16,500,000 shares, to reduce the par value of each share from $2.50 to $2.273 per share, and effect an eleven-for-ten stock split distributed on June 30, 2006 to stockholders of record on June 19, 2006.

All share and per share amounts included in the accompanying consolidated financial statements and footnotes have been restated for all periods presented to reflect the stock splits.

Certain 2006 amounts have been reclassified to conform to the 2007 presentation.

8

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, 2007		March 31, 2006
Earnings available to common shareholders	$	2,761,011	$	2,045,735
Weighted average shares outstanding		6,867,731		5,024,484
Basic earnings per common share	$	0.40	$	0.41
Effect of dilutive securities:
Earnings available to common shareholders	$	2,761,011	$	2,045,735
Convertible preferred securities interest net of tax effect		—		55,466
Earnings available to common plus assumed conversions	$	2,761,011	$	2,101,201
Effect of dilutive securities on EPS:
Weighted average shares outstanding		6,867,731		5,024,484
Effect of stock options		102,642		100,759
Effect of convertible preferred securities		—		645,340
Diluted average shares outstanding		6,970,373		5,770,583
Diluted earnings per common share	$	0.40	$	0.36

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, 2007
Available for sale:
U.S. Government and agency securities	$	5,510,605	$	7,874	$	(11,667	)	$	5,506,812
Mortgage-backed securities		752,906		5,080		(4,873	)		753,113
State and municipal securities		774,224		8,147		—			782,371
	$	7,037,735	$	21,101	$	(16,540	)	$	7,042,296
Held to maturity:
Mortgage-backed securities	$	280,301	$	949	$	(531	)	$	280,719
State and municipal securities		183,846		4,837		—			188,683
	$	464,147	$	5,786	$	(531	)	$	469,402
December 31, 2006
Available for sale:
U.S. Government and agency securities	$	5,509,602	$	2,489	$	(16,514	)	$	5,495,577
Mortgage-backed securities		790,297		3,111		(7,423	)		785,985
State and municipal securities		914,314		10,277		—			924,591
	$	7,214,213	$	15,877	$	(23,937	)	$	7,206,153
Held to maturity:
Mortgage-backed securities	$	288,847	$	591	$	(599	)	$	288,839
State and municipal securities		181,418		5,784		—			187,202
	$	470,265	$	6,375	$	(599	)	$	476,041

9

Note D - Loans

Major classifications of loans are summarized as follows:

	March 31, 2007			December 31, 2006
Construction and development	$	192,786,374		$	178,804,545
Commercial		56,389,637			57,091,568
Commercial mortgage		331,096,060			323,729,404
Residential mortgage		103,942,893			97,395,290
Installment loans to individuals		13,740,843			13,027,309
Other		1,155,911			1,266,547
Gross loans		699,111,718			671,314,663
Unearned income		(1,704,297	)		(1,773,338	)
Allowance for loan losses		(8,530,202	)		(8,144,265	)
Loans, net	$	688,877,219		$	661,397,060
Non-performing assets are as follows:
	March 31, 2007			December 31, 2006
Non-accrual loans:
Construction and development	$	—		$	—
Commercial		847,247			884,149
Commercial mortgage		1,355,346			1,310,000
Residential mortgage		—			—
Installment loans to individuals		956			29,370
Other		—			—
		2,203,549			2,223,519
Loans contractually past-due 90 days or more:
Construction and development		—			—
Commercial		—			—
Commercial mortgage		—			—
Residential mortgage		690,000			—
Installment loans to individuals		22,535			—
Other		—			3,633
		712,535			3,633
Total non-performing loans	$	2,916,084		$	2,227,152
Allowance as a percentage of non-performing assets		292.52	%		365.68	%
Non-performing assets as a percentage of total assets		0.39	%		0.31	%
Note E – Allowance For Loan Losses A summary of transactions in the allowance for loan losses for the three months ended March 31, 2007 and 2006 were as follows:
	March 31, 2007			March 31, 2006
Balance at beginning of year	$	8,144,265		$	5,523,087
Provision charged to operating expense		430,000			670,000
Loans charged-off		(50,785	)		(41,084	)
Recoveries of loans previously charged-off		6,722			400
Balance at end of period	$	8,530,202		$	6,152,403

10

Note F – Premises and Equipment

Premises and equipment are summarized as follows:

	March 31, 2007			December 31, 2006
Land	$	345,403		$	345,403
Building and improvements		3,040,031			3,040,031
Leasehold improvements		7,266,453			3,391,944
Furniture and equipment		11,092,808			9,907,236
Construction in progress		1,758,475			4,197,094
		23,503,170			20,881,708
Less accumulated depreciation		(8,281,204	)		(7,941,742	)
	$	15,221,966		$	12,939,966

Note G – Subsequent Events

On April 17, 2007, the Company declared a $0.06 per share cash dividend payable May 31, 2007, to shareholders of record on May 21, 2007.

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 four branches in Norfolk, four branches in Virginia Beach, two branches in Chesapeake, two branches in Portsmouth and one branch in Powells Point, North Carolina. Bank of the Commonwealth Mortgage currently operates one mortgage branch office in Virginia Beach, one mortgage branch office in Gloucester, one mortgage branch office in Richmond, Virginia and one mortgage branch office in Kill Devil Hills, North Carolina. Executive Title Center currently operates one title insurance branch office in Norfolk and one title insurance branch in Gloucester, Virginia. Commonwealth Financial Advisors currently has three locations, one in Virginia Beach and two in Norfolk, 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 annual report on Form 10-K for the year ended December 31, 2006.

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.

11

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.

New Accounting Pronouncements

In September 2006, the Financial Accounting Standards Board (FASB) issued FASB Interpretation No. 48, “Accounting for Uncertainty in Income Taxes - an interpretation of FASB Statement No. 109” (FIN 48). FIN 48 prescribes a recognition threshold and measurement attribute for financial statement recognition and measurement of a tax position taken or expected to be taken in a tax return, and also provides guidance on derecognition, classification, interest and penalties, accounting in interim periods, disclosure, and transition. FIN 48 is effective for fiscal years beginning after December 15, 2006. We do not have any uncertain tax positions, and therefore adoption of FIN 48 effective January 1, 2007 did not impact our consolidated financial statements.

In February 2007, the Financial Accounting Standards Board (FASB) issued Statement No. 159, “The Fair Value Option for Financial Assets and Financial Liabilities – Including an Amendment of FASB Statement No. 115” (Statement 159). Statement 159 permits all entities to measure eligible items at fair value. Eligible items include recognized financial assets and financial liabilities with exceptions, firm commitments involving financial instruments, nonfinancial insurance contracts and warranties paid to a third party, and host financial instruments resulting from separation of an embedded nonfinancial instrument. The Amendment to FASB Statement 115 also provides the fair value measurement to all entities with available-for-sale and trading securities. Statement 159 is effective for fiscal years beginning after November 15, 2007. Management is currently evaluating the effect that adoption of this statement will have on the Company’s consolidated financial position and results of operations when it becomes effective in 2008.

Stock Compensation Plans

The Company adopted the provisions of SFAS No. 123(R),Share-Based Payments,on January 1, 2006 using the modified prospective method. Under this method, stock-based awards that are granted, modified, or settled after December 31, 2005, are measured and accounted for in accordance with the provisions of SFAS No. 123(R). Also under this method, expense is recognized for unvested awards that were granted prior to January 1, 2006, based upon the fair value determined at the grant date under SFAS No. 123,Accounting for Stock-Based Compensation. Share-based compensation expense is recorded in salary and employee benefits. Prior to the adoption of SFAS No. 123(R), the Company accounted for its share-based compensation under the intrinsic value method as permitted by Accounting Principles Board (“APB”) Opinion No. 25,Accounting for Stock Issued to Employees and related interpretations. Accordingly, the Company previously recognized no compensation expense for employee stock options that were granted with an exercise price equal to the fair value of the underlying common stock on the date of grant.

Stock option compensation expense is the estimated fair value of options granted on the date of grant using the Black-Scholes option-pricing model. Substantially, all employee stock options are awarded at the end of the year as part of an employees overall compensation, based on the individual’s performance during the year, and either vest immediately or over a nominal vesting period. There were no options granted during the three months ended March 31, 2007 and 2006, respectively. There have been no significant changes in the assumptions for the Black-Scholes option-pricing model previously disclosed in the Company’s Annual Report on Form 10-K for the year ended December 31, 2006.

See Note 20 - Stock Based Compensation Plans, in our Annual Report on Form 10-K for the year ended December 31, 2006, for further information related to stock based compensation.

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Financial Condition

Total assets at March 31, 2007 reached a new high of $751.3 million, up 5.1% or $36.1 million from $715.2 million at December 31, 2006. Total loans, the Company’s largest and most profitable asset, ended the quarter at a record $697.4 million, up $27.9 million or 4.2% from December 31, 2006. 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.

As of March 31, 2007, 83.0% 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 57.1% of these commercial loans are collateralized with real estate, and accordingly do not represent an unfavorable risk. At March 31, 2007, 62.2% of the Bank’s total loan portfolio consisted of loans collateralized with real estate.

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 of 2007 with deposits at March 31, 2007 reaching a record $510.6 million, an increase of $23.5 million from December 31, 2006. Noninterest-bearing demand deposits increased by $3.1 million or 7.1% and interest-bearing deposits increased by $20.4 million or 4.6%. Time deposits, excluding broker certificates of deposit, increased $8.4 million during the first three months of 2007, with interest-bearing demand and savings accounts increasing $12.2 million and decreasing $267.5 thousand, respectively. Management believes the growth in deposits is a result of the new branch locations, 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, 2007, short-term borrowings (advances from FHLB) were $96.7 million, compared to $88.6 million outstanding on December 31, 2006. 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 2007, the Company had net income of $2.8 million, an increase of 35.0% over the $2.0 million reported in the first three months of 2006. On a per share basis, diluted earnings was $0.40 for the three months ended March 31, 2007, up $0.04 or 11.1% from the $0.36 reported in the comparable period of 2006.

Profitability as measured by the Company’s return on average assets (ROA) was 1.54% and 1.45% for the three months ended March 31, 2007 and 2006, respectively. ROA was impacted by the increase in net income of 35.0% which was offset by an increase in average assets of $155.6 million or 27.2% from March 31, 2006 to March 31, 2007. The return on average equity (ROE) was 10.75% and 13.00% for the three months ended March 31, 2007 and 2006, respectively. The decrease in ROE is the result of the increase in net income which was offset by the significant growth in average equity of $40.4 million or 63.3% from March 31, 2006 to March 31, 2007. The substantial growth in average equity is the result of the $27.5 million in additional capital raised by the Company during the third quarter of 2006 through a private placement of its common stock, and the record 52.1% and 35.0% increase in net income for the year ended December 31, 2006 and quarter ended March 31, 2007, respectively.

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 reached our second highest quarterly total of $8.0 million for the three months ended March 31, 2007, an increase of $1.4 million or 20.9% over the comparable period in 2006.

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Total interest and dividend income was $14.6 million for the three months ended March 31, 2007, an increase of $3.3 million or 29.1% over the same period of 2006. Strong loan demand continued into the first quarter of 2007 generating record increases in interest income. Interest income on loans, including fees, increased $3.3 million or 29.3% to $14.3 million for the three months ended March 31, 2007 as compared to the same time period in 2006.

Interest expense of $6.6 million for the three months ended March 31, 2007 represented a $1.9 million increase from the comparable period in 2006. The increase was primarily attributable to the substantial increase in the Company’s average interest bearing liabilities, along with the increase in overall rates paid on these liabilities as a result of the rising interest rate environment along with the strong competition for local deposits, which lead to increased rates on deposit accounts. Year to date average interest bearing liabilities increased $111.7 million or 24.3% from March 31, 2006 to March 31, 2007, while the overall rates paid on these liabilities increased 54 basis points to 4.65%.

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) was 4.65% during the first three months of 2007 as compared to 4.88% for the same period in 2006. This slight decrease 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), loan growth, and other factors, both internal and external that may affect the quality and future loss experience of the credit portfolio. At March 31, 2007, the Company had total allowance for loan losses of $8.5 million or 1.22% of total loans. As a result of the growth in the loan portfolio, the Company made provisions for loan losses of $430,000 for the first three months of 2007, compared to $670,000 for the same period of 2006. Loan charge-offs for the three months ended March 31, 2007 totaled $50,785 and recoveries for the same period totaled $6,722.

Despite the rapid growth in the Company’s loan portfolio, asset quality remains exceptional. Non-performing assets were $2.9 million or 0.39% of total assets at March 31, 2007, compared to $2.2 million or 0.31% of total assets at December 31, 2006. Non-accrual loans at March 31, 2007 consisted of 11 loans which totaled $2.2 million. The majority of the non-accrual loans are 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 three months ended March 31, 2007 equaled $1.2 million, an increase of $112.0 thousand over the $1.1 million reported for the three months ended March 31, 2006. Revenues generated from the formation of the investment company (fourth quarter 2005) contributed $201.5 thousand to noninterest income for the three months ended March 31, 2007, compared to $116.6 thousand for the comparable time frame in 2006.

Noninterest expense represents the overhead expenses of the Company. Costs associated with handling our substantial asset and liability growth resulted in increases to almost every component of noninterest expense. Noninterest expense for the three months ended March 31, 2007 totaled $4.6 million, an increase of $630.8 thousand over the $3.9 million recorded during the quarter ended March 31, 2006.

A key measure of overhead is the operating efficiency ratio. The operating efficiency ratio is calculated by dividing noninterest expense by net bank revenue on a tax equivalent basis. Efficiency gains can be achieved by controlling costs and generating more drivers and higher levels of noninterest income along with increasing our margins. The Company’s efficiency ratio (tax equivalent basis) improved to 49.53% for the three months ended March 31, 2007, compared to 51.00% for the comparable period in 2006.

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Salaries and employee benefits, the largest component of noninterest expense, increased by $425.6 thousand or 20.6% over the $2.1 million reported during the first three months of 2006. This increase was driven by annual merit increases, the addition of several new positions, including the additional staff needed to operate the Bank’s two new branches which were opened in the first part of 2007 and the branch which opened in the second quarter of 2006, an increase in certain employee benefit costs, the expansion of the Investment Company and the Mortgage Company. Occupancy expense increased $60.5 thousand for the three months ended March 31, 2007 as compared to same period in 2006. This increase relates to the opening of the Bank’s Ocean View branch in its new permanent facility, the addition of the two branch locations in the first quarter of 2007, the addition of the private bank center which opened in the second quarter of 2006 and the expansion of our subsidiaries as mentioned above. Other noninterest operating expenses, which include a grouping of numerous transactions relating to normal banking operations, increased $101.3 thousand for the three months ended March 31, 2007 to $1.2 million or 8.9% over the comparable period for 2006. 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, 2007, advertising and marketing expense increased $55.5 thousand or 19.4% over the comparable period for 2006.

Capital Resources

Total stockholders’ equity for the Company increased to $106.0 million from $103.2 million or 2.7% from December 31, 2006 to March 31, 2007. Contributing to the overall increase in total stockholders’ equity was our strong earnings of $2.8 million for the first three months of 2007.

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, 2007, the Bank’s risk-adjusted capital ratios were 14.18% for Tier 1 and 15.40% for total capital, well above the required minimums of 4% and 8%, 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, 2007.

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 Dividends

In compliance with the Company’s dividend payout policy, on February 28, 2007, the Company paid a cash dividend of 6.0 cents per share, totaling $412.3 thousand. On February 28, 2006, the Company paid a cash dividend of 4.95 cents per share, totaling $249.5 thousand.

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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.

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 re-pricing 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. In addition, the Company uses simulation modeling to forecast future balance sheet and income statement behavior. By studying the effects on net interest income of rising, stable and falling interest rate scenarios, the Company can position itself to take advantage of anticipated interest rate movements, and protect itself from unanticipated interest rate movements, by understanding the dynamic nature of its balance sheet components.

One technique the Company uses in 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 re-price within a specific time period and the amount of interest bearing liabilities anticipated, based upon certain assumptions, to mature or re-price within that time period. At March 31, 2007, the Company’s one year “positive gap” (interest earning assets maturing or re-pricing within the same period exceed interest bearing liabilities maturing or re-pricing within the same period) was approximately $19.5 million, or 2.59% 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, 2006, the Company’s one year “positive gap” was approximately $36.6 million, or 5.12% of total assets.

The following tables set forth the amount of interest earning assets and interest bearing liabilities outstanding at March 31, 2007 and December 31, 2006 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.

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Interest Rate Sensitivity Analysis

	March 31, 2007
(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	$	1,148		$	1,010		$	4,481		$	867		$	7,506
Equity securities, restricted, at cost		—			—			—			7,740			7,740
Loans		325,725			33,989			226,924			112,474			699,112
Interest bearing deposits in banks		542			—			—			—			542
Federal funds sold		6,690			—			—			—			6,690
Total	$	334,105		$	34,999		$	231,405		$	121,081		$	721,590
Cumulative totals		334,105			369,104			600,509			721,590
Interest Bearing Liabilities:
Deposits:
Demand	$	92,306		$	—		$	—		$	—		$	92,306
Savings		6,902			—			—			—			6,902
Time deposits, $100,000 and over		15,747			32,917			40,889			4,029			93,582
Other time deposits		31,359			73,345			153,602			13,421			271,727
Short-term borrowings		96,713			—			—			—			96,713
Long-term debt		322			—			5,000			—			5,322
Trust preferred capital notes		—			—			20,619			—			20,619
Total	$	243,349		$	106,262		$	220,110		$	17,450		$	587,171
Cumulative totals		243,349			349,611			569,721			587,171
Interest sensitivity gap	$	90,756		$	(71,263	)	$	11,295		$	103,631		$	134,419
Cumulative interest sensitivity gap	$	90,756		$	19,493		$	30,788		$	134,419
Cumulative interest sensitivity gap as a percentage of total assets		12.08	%		2.59	%		4.10	%		17.89	%

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Interest Rate Sensitivity Analysis

	December 31, 2006
(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	$	189		$	510		$	6,416		$	561		$	7,676
Equity securities, restricted, at cost		—			—			—			7,185			7,185
Loans		317,206			24,097			222,713			107,299			671,315
Interest bearing deposits in banks		427			—			—			—			427
Federal funds sold		2,031			—			—			—			2,031
Total	$	319,853		$	24,607		$	229,129		$	115,045		$	688,634
Cumulative totals		319,853			344,460			573,589			688,634
Interest Bearing Liabilities:
Deposits:
Demand	$	80,080		$	—		$	—		$	—		$	80,080
Savings		7,170			—			—			—			7,170
Time deposits, $100,000 and over		1,693			41,459			39,894			6,908			89,954
Other time deposits		10,577			77,906			162,506			15,937			266,926
Short-term borrowings		88,611			—			—			—			88,611
Long-term debt		348			—			5,000			—			5,348
Trust preferred capital notes		—			—			20,619			—			20,619
Total	$	188,479		$	119,365		$	228,019		$	22,845		$	558,708
Cumulative totals		188,479			307,844			535,863			558,708
Interest sensitivity gap	$	131,374		$	(94,758	)	$	1,110		$	92,200		$	129,926
Cumulative interest sensitivity gap	$	131,374		$	36,616		$	37,726		$	129,926
Cumulative interest sensitivity gap as a percentage of total assets		18.37	%		5.12	%		5.27	%		18.17	%

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Item 3. Quantitative and Qualitative Disclosures about Market Risk

There have been no significant changes from the quantitative and qualitative disclosures made in the Company’s Annual Report on Form 10-K for the year ended December 31, 2006.

Item 4. Controls and Procedures

Disclosure Controls and Procedures. The Company, under the supervision and with the participation of the Company’s management, including the Company’s Chief Executive Officer and the Chief Financial Officer, has evaluated the effectiveness of the Company’s disclosure controls and procedures as of the end of the period covered by this report. Based on that evaluation, the Chief Executive Officer and the Chief Financial Officer have concluded that the Company’s disclosure controls and procedures are effective to ensure that information required to be disclosed by the Company in reports that it files or submits under the Securities Exchange Act of 1934 is recorded, processed, summarized and reported within the time periods specified in Securities and Exchange Commission rules and regulations and that such information is accumulated and communicated to the Company’s management, including the Company’s Chief Executive Officer and Chief Financial Officer, as appropriate to allow timely decisions regarding required disclosure. Because of the inherent limitations in all control systems, no evaluation of controls can provide absolute assurance that the Company’s disclosure controls and procedures will detect or uncover every situation involving the failure of persons within the Company or its subsidiary to disclose material information otherwise required to be set forth in the Company’s periodic reports.

Management’s Report on Internal Control over Financial Reporting.Management of the Company is responsible for establishing and maintaining effective internal control over financial reporting as defined in Rule 13a-15(f) under the Securities Exchange Act of 1934. The Company’s internal control over financial reporting is designed to provide reasonable assurance to the Company’s management and board of directors regarding the preparation and fair presentation of published financial statements.

Because of its inherent limitations, internal control over financial reporting may not prevent or detect misstatements. Therefore, even those systems determined to be effective can provide only reasonable assurance with respect to financial statement preparation and presentation.

Management assessed the effectiveness of the Company’s internal control over financial reporting as of March 31, 2007. In making this assessment, management used the criteria set forth by the Committee of Sponsoring Organizations of the Treadway Commission inInternal Control – Integrated Framework.Based on our assessment, we believe that, as of March 31, 2007, the Company’s internal control over financial reporting is effective based on those criteria.

Management’s assessment of the effectiveness of internal control over financial reporting as of December 31, 2006 has been audited by PKF Witt Mares, PLC, the independent registered public accounting firm who also audited the Company’s consolidated financial statements included in the Annual Report on Form 10-K for the year ended December 31, 2006.

Changes in Internal Control over Financial Reporting.There was no change in the internal control over financial reporting that occurred during the quarter ended March 31, 2007 that has materially affected, or is reasonably likely to materially affect, the internal control over financial reporting.

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Part II. OTHER INFORMATION

Item 1. Legal proceedings

As of March 31, 2007, there were no legal proceedings against the Company.

Item 1A. Risk factors

There have been no material changes from the risk factors previously disclosed in the Company’s Annual Report on Form 10-K for the year ended December 31, 2006.

Item 2. Unregistered sales of equity securities and use of proceeds

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 was no submission of matters to vote of security holders during the quarter.

Item 5. Other information

None.

Item 6. Exhibits

(a) Exhibits

31.1 Certification of Chief Executive Officer pursuant to Rule 13a-14(a).

31.2 Certification of Chief Financial Officer pursuant to Rule 13a-14(a).

32.1 Certification of Chief Executive Officer and Chief Financial Officer pursuant to Section 906.

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SIGNATURES

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

	Commonwealth Bankshares, Inc.
	(Registrant)
Date: May 7, 2007	by:	/s/ Edward J. Woodard, Jr., CLBB
		Edward J. Woodard, Jr., CLBB
		Chairman of the Board, President and Chief Executive Officer
Date: May 7, 2007	by:	/s/ Cynthia A. Sabol, CPA
		Cynthia A. Sabol, CPA
		Executive Vice President, & Chief Financial Officer

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