-----BEGIN PRIVACY-ENHANCED MESSAGE----- Proc-Type: 2001,MIC-CLEAR Originator-Name: webmaster@www.sec.gov Originator-Key-Asymmetric: MFgwCgYEVQgBAQICAf8DSgAwRwJAW2sNKK9AVtBzYZmr6aGjlWyK3XmZv3dTINen TWSM7vrzLADbmYQaionwg5sDW3P6oaM5D3tdezXMm7z1T+B+twIDAQAB MIC-Info: RSA-MD5,RSA, OAWTIE7ElES/JO5OO0NEX14K2RkpnUI8c2NK9SMp9oDbIM3wn1e5DSPZ+GLBRSac pr/oCVTrZasH3gZbQPPRMA== 0000928385-02-001248.txt : 20020415 0000928385-02-001248.hdr.sgml : 20020415 ACCESSION NUMBER: 0000928385-02-001248 CONFORMED SUBMISSION TYPE: 10KSB40 PUBLIC DOCUMENT COUNT: 1 CONFORMED PERIOD OF REPORT: 20011231 FILED AS OF DATE: 20020401 FILER: COMPANY DATA: COMPANY CONFORMED NAME: COMMONWEALTH BANKSHARES INC CENTRAL INDEX KEY: 0000835012 STANDARD INDUSTRIAL CLASSIFICATION: NATIONAL COMMERCIAL BANKS [6021] IRS NUMBER: 541460991 STATE OF INCORPORATION: VA FISCAL YEAR END: 1231 FILING VALUES: FORM TYPE: 10KSB40 SEC ACT: 1934 Act SEC FILE NUMBER: 000-17377 FILM NUMBER: 02596106 BUSINESS ADDRESS: STREET 1: 403 BOUSH ST CITY: NORFOLK STATE: VA ZIP: 23510 BUSINESS PHONE: 8044466900 MAIL ADDRESS: STREET 2: 403 BOUSH STREET CITY: NORFOLK STATE: VA ZIP: 23510 10KSB40 1 d10ksb40.txt FORM 10-KSB40 DATED 12/31/2001 SECURITIES AND EXCHANGE COMMISSION Washington, D.C. 20549 Form 10-KSB |X| Annual Report under Section 13 or 15(d) of the Securities Exchange Act of 1934 For the fiscal year ended December 31, 2001 Commission file number 01-17377 Commonwealth Bankshares, Inc. ---------------------------------------- (Exact name of small business issuer in its charter) Virginia 54-1460991 - ---------------------------------------- ---------- (State or other jurisdiction of (I.R.S. Employer Identification No.) incorporation or organization) 403 Boush Street Norfolk, Virginia 23510 - ---------------------------------------- ---------- (Address of principal executive offices) (Zip Code) Issuer's telephone number: (757) 446-6900 -------------- Securities registered pursuant to Section 12(b) of the Act: Name of each exchange Title of each class on which registered ------------------- ------------------- None None - --------------------------- ------------------- Securities registered pursuant to Section 12(g) of the Act: Common Stock, $2.50 Par Value - -------------------------------------------------------------------------------- Check whether the issuer (1) filed all reports required to be filed by Section 13 or 15(d) of the Securities Exchange Act of 1934 during the past 12 months, and (2) has been subject to such filing requirements for the past 90 days. Yes [X] No |_| Indicate by check mark if disclosure of delinquent filers in response to Item 405 of Regulation S-B is not contained in this form, and no disclosure will be contained, to the best of the registrant's knowledge, in definitive proxy or information statements incorporated by reference in Part III of this Form 10-KSB or any amendment to this Form 10-KSB. [X] Issuer's revenue for fiscal year ended December 31, 2001: $18.8 million The aggregate market value of the voting stock held by non-affiliates of the registrant as of March 12, 2002: $12.8 million (In calculating the aggregate market value, the registrant used the closing sale price of the registrant's common stock on the NASDAQ National Market on March 12, 2002 which was $7.50 per share, voting stock held by non-affiliates of the registrant at March 12, 2002 was 1,703,103 shares). Shares of common equity outstanding as of March 12, 2002: Common Stock, $2.50 Par Value - 1,703,103 shares Part I Item 1. Description of Business The Company and the Bank. The sole business of Commonwealth Bankshares, Inc. (the "Corporation") is to serve as a holding company for Bank of the Commonwealth (the "Bank"). The Corporation was incorporated as a Virginia corporation 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 office has 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. Principal Market Area. The Bank concentrates its marketing efforts in the cities of Norfolk, Virginia Beach, Portsmouth and Chesapeake, Virginia. The Corporation's present intention is to continue concentrating its banking activities in its current market, which the Corporation believes is an attractive area in which to operate. Banking Service. Through its network of banking facilities, the Bank provides a wide range of commercial banking services to individuals and small and medium-sized businesses. The Bank conducts substantially all of the business operations of a typical independent, commercial bank, including the acceptance of checking and savings deposits, and the initiating of commercial, real estate, personal, home improvement, automobile and other installment and term loans. The Bank also offers other related services, such as home banking, trust, travelers' checks, safe deposit, lock box, depositor transfer, customer note payment, collections, notary public, escrow, drive-in facility and other customary banking services. Competition The Bank encounters strong competition for its banking services within its primary market area. There are fifteen commercial banks actively engaged in business in the cities of Norfolk, Virginia Beach, Portsmouth and Chesapeake, Virginia, including six major state-wide banking organizations. The Bank is the oldest independent bank in its market area. Finance companies, mortgage companies, credit unions and savings and loan associations also compete with the Bank for loans and deposits. In addition, in some instances, the Bank must compete for deposits with money market mutual funds that are marketed nationally. Most of the Bank's competitors have substantially greater resources than the Bank. Employees As of December 31, 2001, the Bank had 93 full-time equivalent employees. Management of the Corporation and the Bank considers its relations with employees to be excellent. No employees are represented by a union or any similar group, and the Bank has never experienced any strike or labor dispute. Regulation and Supervision Commonwealth Bankshares, Inc. Bank Holding Company Act. In order to acquire the shares of the Bank and thereby become a bank holding company within the meaning of the Bank Holding Company Act, the Corporation was required to obtain approval from, and register as a bank holding company, with the Federal Reserve Board (the "Board"), and it is subject to ongoing regulation, supervision and examination by the Board. As a condition to its approval, the Board required the Corporation to agree that it would obtain approval of the Federal Reserve Bank of Richmond prior to incurring any indebtedness. The Corporation is required to file with the Board periodic and annual reports and other information concerning its own business operations and those of its subsidiaries. In addition, the Bank Holding Company Act requires a bank holding company to obtain Board approval before it acquires, directly or indirectly, ownership or control of any voting shares of a second or subsequent bank if, after such acquisition, it would own or control more than 5.0% of such shares, unless it already owns or controls a majority of such voting shares. Board approval must also be obtained before a bank holding company acquires all or substantially all of the assets of another bank or merges or consolidates with another bank holding company. Any acquisition by a bank holding company of more than 5.0% of the voting shares, or of all or substantially all of the assets, of a bank located in another state may not be approved by the Board unless such acquisition is specifically authorized by the laws of that second state. Unless it chooses to become a financial holding company, as further described below, a bank holding company is prohibited under the Bank Holding Company Act, with limited exceptions, from acquiring or obtaining direct or indirect ownership or control of more than 5.0% of the voting shares of any company which is not a bank, or from engaging in any activities other than those of banking or of managing or controlling banks or furnishing services to or performing services for its subsidiaries. An exception to these prohibitions permits a bank holding company to engage in, or acquire an interest in a company which engages in, activities which the Board, after due notice and opportunity for hearing, by regulation or order has determined is so closely related to banking or of managing 2 or controlling banks as to be proper incident thereto. A number of such activities have been determined by the Board to be permissible, including servicing loans, performing certain data processing services, and acting as a fiduciary, investment or financial advisor. The Corporation may not, without providing prior notice to the Board, purchase or redeem its own stock if the gross consideration to be paid, when added to the net consideration paid by the Corporation for all purchases or redemptions by the Corporation of its equity securities within the preceding 12 months, will equal 10.0% or more of the Corporation's consolidated net worth, unless it meets the requirements of a well capitalized and well managed organization. Dividend Restrictions. The ability of the Corporation to pay dividends depends upon the amount of dividends declared by the Bank. Regulatory restrictions exist with respect to the Bank's ability to pay dividends. See Note 7 to Consolidated Financial Statements included in this report. Virginia Financial Institution Holding Company Act. Under certain amendments to the Virginia Financial Institutions Holding Company Act that became effective July 1, 1983, no corporation, partnership or other business entity may acquire, or make any public offer to acquire, more than 5.0% of the stock of any Virginia financial institution, or any Virginia financial institution holding company, unless it first files an application with the Virginia State Corporation Commission - Bureau of Financial Institutions ("SCC"). The SCC is directed by the statute to solicit the views of the affected financial institution, or financial institution holding company, with respect to such stock acquisition, and is empowered to conduct an investigation during the 60 days following receipt of such an application. If the SCC takes no action within the prescribed period, or if during the prescribed period it issues notice of its intent not to disapprove an application, the acquisition may be completed. Under the Bank Holding Company Act, the Board may disapprove an application or approve an application subject to such conditions as it may deem advisable. Securities and Exchange Commission Regulation. The Corporation is required to make certain periodic filings with the Securities and Exchange Commission ("SEC") as well as file certain reports on the occurrence of certain material events specified in the Securities Exchange Act of 1934 ("Exchange Act"). Specifically, the Corporation is required to file quarterly and annual reports with the SEC under Section 13 of the Exchange Act, furnish annual reports to shareholders prior to annual meetings of shareholders, and send proxy statements to shareholders prior to any shareholders' meeting, all of which must comply with the provisions of the Exchange Act. In addition, directors, officers and certain shareholders must make detailed disclosures under the Exchange Act regarding their ownership of the Corporation's common stock. Financial Holding Companies. Under the Gramm-Leach-Bliley Act, a bank holding company may elect to become a financial holding company and thereby engage in a broader range of financial and other activities than are permissible for traditional bank holding companies. In order to qualify for the election, all of the depository institution subsidiaries of the bank holding company must be well capitalized and well managed, as defined by regulation, and all of its depository institution subsidiaries must have achieved a rating of satisfactory or better with respect to meeting community credit needs. Pursuant to the Gramm-Leach-Bliley Act, financial holding companies are permitted to engage in activities that are "financial in nature" or incidental or complementary thereto, as determined by the Board. The Gramm-Leach-Bliley Act identifies several activities as "financial in nature," including, among others, insurance underwriting and agency, investment advisory services, merchant banking and underwriting, and dealing or making a market in securities. Being designated a financial holding company allows insurance companies, securities brokers and other types of financial companies to affiliate with and/or acquire depository institutions. The Corporation currently does not intend to become a financial holding company. The Bank The Bank, as a member bank of the Federal Reserve System, is subject to regulation and examination by the Virginia State Corporation Commission and the Board. In addition, the Bank is subject to the rules and regulations of the Federal Deposit Insurance Corporation, which currently insures the deposits of each member bank to a maximum of $100.0 thousand per depositor. The commercial banking business is affected by the monetary policies adopted by the Board. Changes in the discount rate on member bank borrowing, availability of borrowing at the "discount window," open market operations, the imposition of any changes in reserve requirements against member banks' deposits and certain borrowing by banks and their affiliates, and the limitation of interest rates which member banks may pay on deposits are some of the instruments of monetary policy available to the Board. Taken together, these controls give the Board a significant influence over the growth and profitability of all banks. Management of the Bank is unable to predict how the Board's monetary policies (or the fiscal policies or economic controls imposed by Federal or state governments) will affect the business and earnings of the Bank or the Corporation, or what those policies or controls will be. The references in this section to various aspects of supervision and regulation are brief summaries which do not purport to be complete and which are qualified in their entirety by reference to applicable laws, rules and regulations. 3 Distribution of Assets, Liabilities and Shareholders' Equity; Interest Rates and Interest Differential
Year Ended December 31, 2001 2000 1999 --------------------------------- ------------------------------- ------------------------------- Average Average Average Balance Interest Yield/Rate Balance Interest Yield/Rate Balance Interest Yield/Rate ------- -------- ---------- ------- -------- ---------- ------- -------- ---------- ASSETS (Dollars in Thousands) - ------ ---------------------- Interest earning assets (taxable-equivalent basis (1)) : Loans (net of unearned discount (2)) $172,516 $15,404 8.95% $141,769 $13,056 9.27% $106,664 $ 9,514 8.95% Investment securities 18,190 1,024 5.63 20,218 1,202 6.66 22,443 1,296 6.43 Federal funds sold 5,845 231 3.95 4,799 334 6.96 1,053 51 4.84 Interest bearing cash and due 17,077 669 3.92 -- -- -- -- -------- ------- ---- -------- ------- ---- -------- ------- ---- Total interest earning assets 213,628 17,328 8.20 166,786 14,592 8.89 130,160 10,861 8.48 Non-interest earning assets: Cash and due from Banks 6,007 6,234 4,735 Premises and equipment 4,999 3,544 2,784 Other assets 1,872 2,235 1,880 -------- -------- -------- TOTAL $226,506 $178,799 $139,559 ======== ======== ========
(1) Tax equivalent adjustments (using 34.0% federal tax rates) have been made in calculating yields on tax-free loans and investments. Virginia banks are exempt from state income tax. (2) For the purposes of these computations, nonaccruing loans are included in the daily average loan amounts outstanding. 4 Distribution of Assets, Liabilities and Shareholders' Equity; Interest Rates and Interest Differential continued
Year Ended December 31, 2001 2000 1999 --------------------------------- ------------------------------- ------------------------------- Average Average Average Balance Interest Yield/Rate Balance Interest Yield/Rate Balance Interest Yield/Rate ------- -------- ---------- ------- -------- ---------- ------- -------- ---------- LIABILITIES & SHAREHOLDERS' EQUITY Interest bearing liabilities: Savings and time deposits $181,845 $10,446 5.74% $139,515 $7,800 5.59% $105,560 $5,263 4.99% Short term debt 4,145 160 3.86 5,865 319 5.44 4,798 209 4.36 Long term debt 479 23 4.80 505 32 6.34 531 30 5.65 Convertible Preferred Securities 3,035 254 8.37 -- -- -- -- -------- ------- ---- -------- ------ ---- -------- ------ ---- Total interest bearing Liabilities 189,504 10,883 5.74 145,885 8,151 5.59 110,889 5,502 4.96 Non-interest bearing liabilities Demand deposits 21,301 17,850 14,946 Other 2,889 2,184 1,724 -------- -------- -------- Total liabilities 213,694 165,919 127,559 Common shareholders' equity 12,812 12,880 12,000 -------- -------- -------- TOTAL $226,506 $178,799 $139,559 ======== ======== ======== Net interest earnings $6,445 $6,441 $5,359 ====== ====== ====== Net margin on interest earning assets on a taxable equivalent basis 2.93 4.00 4.25 Average interest spread (taxable equivalent basis) 2.46 3.30 3.52
5 As the largest component of income, net interest income represents the amount that interest and fees earned on loans and investments exceeds the interest costs of funds used to support these earning assets. Net interest income is determined by the relative levels, rates and mix of earning assets and interest-bearing liabilities. The following table attributes changes in net interest income either to changes in average volume or to rate changes in proportion to the relationship of the absolute dollar amount of the change in each.
Year Ended December 31, 2001 Year Ended December 31, 2000 Year Ended December 31, 1999 compared to compared to compared to Year Ended December 31, 2000 Year Ended December 31, 1999 Year Ended December 31, 1998 Net Net Net Increase Increase Increase Volume Rate (decrease) Volume Rate (decrease) Volume Rate (decrease) ------ ---- ---------- ------ ---- ---------- ------ ---- ---------- INTEREST INCOME Investment securities $ (116) $ (62) $ (178) $ (134) $ 40 $ (94) $ (23) $ (53) $ (76) Federal funds sold 640 (74) 566 252 31 283 (249) (30) (279) Loans 2,731 (383) 2,348 3,224 320 3,544 1,930 (255) 1,675 ------- ------- ------- ------- ------- ------- ------- ------- ------- 3,255 (519) 2,736 3,342 391 3,733 1,658 (338) 1,320 ------- ------- ------- ------- ------- ------- ------- ------- ------- INTEREST EXPENSE Savings and time Deposits 2,427 219 2,646 1,842 695 2,537 607 (251) 356 Short term debt (80) (79) (159) 52 58 110 85 3 88 Long term debt 235 10 245 (1) 3 2 (1) (1) (2) ------- ------- ------- ------- ------- ------- ------- ------- ------- 2,582 150 2,732 1,893 756 2,649 691 (249) 442 ------- ------- ------- ------- ------- ------- ------- ------- ------- Increase (Decrease) in Net Interest Income $ 673 $ (669) $ 4 $ 1,449 $ (365) $ 1,084 $ 967 $ (89) $ 878 ======= ======= ======= ======= ======= ======= ======= ======= =======
6 Investment Portfolio The following table shows the book value (carrying value) of the Corporation's investment securities at December 31 of the years indicated below: December 31, --------------------------------- 2001 2000 1999 ---- ---- ---- (In thousands) U. S. Government and its Agencies $ 6,415 $12,817 $14,029 State and Municipals 6,013 6,165 5,934 Preferred Stock 2,176 451 222 Corporate Bonds 1,782 -- -- Other Securities 175 187 8 Federal Home Loan Bank Stock 403 396 396 Federal Reserve Bank Stock 339 144 144 ------- ------- ------- $17,303 $20,160 $20,733 ======= ======= ======= The maturity distribution, par value, market value, and yield of the investment portfolio at December 31, 2001, is presented in the following table: December 31, 2001 --------------------------------- Par Value Market Value Yield --------- ------------ ----- (In thousands) Within 3 months $ 489 $ 490 5.94% After 3 but within 12 months 715 724 5.87 After 1 but within 5 years 6,122 6,163 5.79 After 5 but within 10 years 4,373 4,332 6.22 After 10 years 4,640 4,708 6.38 Other Securities 175 175 7.42 Federal Home Loan Bank Stock 403 403 6.95 Federal Reserve Bank Stock 339 339 6.00 ------- ------- $17,256 $17,334 6.44 ======= ======= 7 Loan Portfolio The table below classifies loans, net of unearned income, by major category and percentage distribution at December 31 for each of the past three years:
December 31 -------------------------------------------------------------------------- 2001 2000 1999 (In thousands) Amount % Amount % Amount % -------- ------ -------- ------ -------- ------ Commercial $ 28,435 15.97% $ 25,301 16.02% $ 23,307 18.64% - --------------------------------------------------------------------------------------------------------------------- Commercial construction 5,669 3.18 3,659 2.32 -- -- Commercial mortgage 95,425 53.59 81,627 51.68 67,698 54.14 Residential mortgage 36,480 20.49 36,451 23.08 25,146 20.11 Installment loans to individuals 9,889 5.55 7,222 4.57 6,077 4.86 Other 2,171 1.22 3,682 2.33 2,817 2.25 -------- ------ -------- ------ -------- ------ TOTAL $178,069 100.00% $157,942 100.00% $125,045 100.00% ======== ====== ======== ====== ======== ======
The following table shows the maturity of loans outstanding as of December 31, 2001. Loans are classified based upon the period in which the final payment is due.
December 31, 2001 --------------------------------------------------------------------- Maturing --------------------------------------------------------------------- After One Within But Within After One Year Five Years Five Years Total -------- ---------- ---------- ----- (In thousands) Commercial $ 9,921 $ 6,684 $ 11,830 28,435 Commercial construction 3,559 -- 2,110 5,669 Commercial mortgage 10,622 4,545 80,258 95,425 Residential mortgage 4,539 3,609 28,332 36,480 Installment loans to individuals 2,440 4,634 3,426 10,500 Other 956 60 1,155 2,171 ------- ------- -------- -------- TOTAL $32,037 $19,532 $127,111 $178,680 ======= ======= ======== ========
8 Non-performing Loans Non-performing loans consist of loans accounted for on a non-accrual basis (as judgmentally determined by management based upon anticipated realization of interest income) and loans which are contractually past due 90 days or more as interest and/or principal payments. The following table presents information concerning non-performing loans for the periods indicated: December 31, 2001 2000 1999 Non-accrual: Real estate loans $ -- $ 50 $ 881 Installment loans 20 194 184 Credit cards and related plans -- -- -- Commercial (time and demand) and all other loans 1,302 240 44 Lease financing receivables -- -- -- ------ ------ ------ $1,322 $ 484 $1,109 Contractually past - due 90 days or more: Real estate loans 62 17 -- Installment loans -- 2 13 Credit cards and related plans 1 5 22 Commercial (time and demand) and all other loans 1 83 38 Lease financing receivables -- -- -- ------ ------ ------ Total Non-performing $1,386 $ 591 $1,182 ====== ====== ====== It is management's practice to cease accruing interest on loans when payments are 120 days delinquent. However, management may elect to continue the accrual of interest when the estimated net realizable value of collateral is sufficient to cover the principal balance and accrued interest, and the loan is in the process of collection. If nonaccruing loans had been performing fully, these loans would have contributed an additional $122.8 thousand to interest income in 2001, $35.4 thousand in 2000, and $84.3 thousand in 1999. 9 Summary of Loan Loss Experience The allowance for loan losses is increased by the provision for loan losses and reduced by loans charged off, net of recoveries. The allowance for loan losses is established and maintained at a level judged by management to be adequate to cover any anticipated loan losses to be incurred in the collection of outstanding loans. In determining the adequate level of the allowance for loan losses, management considers the following factors: (a) loan loss experience; (b) problem loans, including loans judged to exhibit potential charge-off characteristics, loans on which interest is no longer being accrued, loans which are past due and loans which have been classified in the most recent regulatory examination; and (c) anticipated economic conditions and the potential impact these conditions may have on individual classifications of borrowers. The following table presents the Corporation's loan loss experience for the past five years:
------------------------------------------------------------------ 2001 2000 1999 1998 1997 (In Thousands) Allowance at Beginning of Period $ 1,920 $ 931 $ 969 $ 969 $ 932 ======== ======== ======== ======= ======= Provision for Losses 360 1,155 110 102 50 Charge off Commercial 7 30 49 21 -- Commercial Construction -- -- -- -- -- Commercial Mortgage 238 79 -- 32 -- Residential Mortgage 35 36 -- -- -- Installment Loans to Individuals 13 10 53 41 27 Other 10 17 55 11 4 -------- -------- -------- ------- ------- Total Loans charged off: 303 172 157 105 31 -------- -------- -------- ------- ======= Recoveries: Commercial 1 -- -- -- 3 Commercial Construction -- -- -- -- -- Commercial Mortgage -- -- 2 -- 11 Residential Mortgage 1 -- -- -- -- Installment Loans to Individuals -- 5 7 2 3 Other 9 1 -- 1 4 -------- -------- -------- ------- ------- Total recoveries 11 6 9 3 18 -------- -------- -------- ------- ------- Net Charge-offs 292 166 148 102 13 -------- -------- -------- ------- ------- Allowance at end of period $ 1,988 $ 1,920 $ 931 $ 969 $ 969 ======== ======== ======== ======= ======= Loans at end of period (net of unearned income) $178,069 $157,942 $125,045 $91,576 $78,251 ======== ======== ======== ======= ======= Ratio of allowance to loans 1.12% 1.22% 0.74% 1.06% 1.23% Average Amount of loans outstanding (net of unearned income) 172,516 141,769 106,664 84,917 71,481 Ratio of net charge-offs to average loans outstanding 0.17% 0.12% 0.14% 0.12% 0.02%
10 Allocation of the Allowance for Loan Losses The following table provides an allocation of the allowance for loan losses as of December 31, 2001: December 31, 2001 ----------------- Percent of Loans on each category Amount to total loans ------ -------------- (Dollars in Thousands) Commercial $ 107 11.50% Commercial construction -- -- Commercial mortgage 787 84.31 Residential mortgage 36 3.87 Installment loans to individuals 3 0.32 Other -- -- Unallocated 1,055 N/A ------ ------ Total $1,988 100.00% ====== ====== 11 Deposits The breakdown of deposits at December 31 for the years indicated is as follows: December 31, ---------------------------------- 2001 2000 1999 ---------------------------------- (In Thousands) Noninterest-bearing demand deposits $ 23,537 $ 17,340 $ 15,072 Interest-bearing demand deposits 24,182 18,053 18,243 Savings deposits 5,864 5,174 4,659 Certificates of deposit: Less than $100,000 116,248 110,548 80,994 $100,000 or more 35,078 33,500 19,390 -------- -------- -------- $204,909 $184,615 $138,358 ======== ======== ======== The average daily amount of deposits and rates paid on such deposits is summarized for the periods indicated in the following table:
December 31, ----------------------------------------------------------------------- 2001 2000 1999 Amount Rate Amount Rate Amount Rate ------ ---- ------ ---- ------ ---- (Dollars in Thousands) Noninterest-bearing demand deposits $ 21,301 0.00% $17,850 0.00% $14,946 0.00% Interest-bearing demand deposits 20,992 1.66 19,206 2.31 18,479 2.42 Savings deposits 6,484 1.69 6,110 2.35 6,288 2.30 Certificates of deposit: Less than $100,000 120,540 6.44 90,395 6.22 64,119 5.76 $100,000 or more 33,828 6.42 23,804 6.32 16,674 5.59 -------- ------- ------- $203,145 $157,365 $120,506 ======== ======== ========
Remaining maturities of certificates $100,000 or more at December 31, 2001 as follows: Maturity Amount - -------- ------ (In Thousands) 3 months or less $ 4,851 Over 3 through 12 months 16,558 Over 12 months 13,669 ------- $35,078 ======= 12 Interest Rate Sensitivity Analysis The following table provides the maturities of investment securities, loans, and deposits at December 31, 2001, and measures the interest rate sensitivity gap for each range of maturity indicated:
December 31, 2001 -------------------------------------------------------------------- Maturing --------------------------------------------------- Non- Interest Earning/ After Bearing one but Assets/ Within Within After Liabili- One Five Five ties and Year Years Years Equity Total ---- ----- ----- ------ ----- (In Thousands) Assets Investment securities $ 1,206 $ 6,157 $ 9,940 -- $ 17,303 Loans 32,037 19,532 127,111 -- 178,680 Other assets 19,296 -- -- 15,289 34,585 --------- ------- -------- -------- -------- Total Assets 52,539 25,689 137,051 15,289 230,568 Liabilities and Shareholders' Equity Demand deposits-noninterest -- -- -- 23,537 23,537 All interest-bearing deposits 135,311 20,855 25,206 -- 181,372 Other liabilities 1,424 -- 7,764 2,898 12,086 Shareholders' equity -- -- -- 13,573 13,573 --------- ------- -------- -------- -------- Total liabilities and Shareholders' equity 136,735 20,855 32,970 40,008 230,568 Interest rate sensitivity gap $ (84,196) $ 4,834 $104,081 $(24,719) $ 0 ========= ======= ======== ======== ========
13 Return on Equity and Assets The following table highlights certain ratios for the periods indicated: Year Ended December 31, ------------------------- 2001 2000 1999 ------------------------- Net income to: Average total assets .25 .17 .83 Average shareholders' equity 4.51 2.34 9.63 Dividend payout ratio (dividends declared per share divided by net income per share) 41.18 77.78 14.79 Average shareholders' equity to average total assets ratio 7.00 7.20 8.60 Item 2. Description of Properties The headquarters building (the "Headquarters") of the Corporation and the Bank, located at the corners of Freemason and Boush Streets, Norfolk, Virginia, was completed in 1986 and is a three story building of masonry construction, with approximately 21.0 thousand square feet of floor space. The Bank utilizes the building for its main office branch, executive offices, and operational departments. The Corporation currently leases to outside parties approximately 4.0 thousand square feet on the third floor. The office operates nine teller windows, including two drive-up facilities, one walk-up facility and a 24 hour teller machine. The Bank has entered into a lease with Boush Bank Building Associates, a limited partnership (the "Partnership"), to rent the Headquarters. The lease requires the Bank to pay all taxes, maintenance and insurance. The term of the lease is twenty-three years and eleven months, and began on December 19, 1984. In connection with this property, the lessor has secured financing in the form of a $1.6 million industrial development revenue bond from the Norfolk Redevelopment and Housing Authority payable in annual installments, commencing on January 1, 1987, at amounts equal to 3.0% of the then outstanding principal balance through the twenty-fifth year, when the unpaid balance will become due. Interest on this bond is payable monthly, at 68.6% of the prime rate of SunTrust Bank in Richmond, Virginia. Monthly rent paid by the Bank is equal to interest on the above bond, plus any interest associated with secondary financing provided the lessor by the Bank. The Bank has the right to purchase, at its option, an undivided interest in the property at undepreciated original cost, and is obligated to purchase in each January after December 31, 1986 an undivided interest in an amount equal to 90.0% of the legal amount allowed by banking regulations for investments in fixed properties, unless the Bank's return on average assets is less than seven-tenths of one percent. Under this provision the Bank purchased 19.7% of this property for $362.2 thousand in 1987. At the time of the 1987 purchase the Bank assumed $305.7 thousand of the above-mentioned bond. Pursuant to the purchase option contained in the lease agreement, the Bank recorded an additional interest of $637.4 thousand (34.7%) in the leased property as of December 31, 1988 by assuming a corresponding portion ($521.9 thousand) of the unpaid balance of the related revenue bond and applying the difference of $115.5 thousand to amounts due from the lessor. Accordingly the Bank now owns 54.4%, of the Headquarters property. No purchases have been made after 1988. The general partner of the Partnership is Boush Bank Building Corporation. The limited partners of the Partnership are Messrs. Woodard and Kellam, who are directors of the Bank and the Corporation and the estate of George H. Burton, a former director. In the opinion of the Corporation, the terms of the lease are not less favorable than could be obtained from a non-related party. Prior to executing the lease, the shareholders of the Bank owning a majority of Bank common stock consented to the foregoing lease. Additionally, formal shareholder approval of the lease, due to the above described interest of the Bank's directors, was obtained during the Bank's 1985 Annual Meeting of Shareholders. In addition to the headquarters, the Bank operates two branch offices in Norfolk, four branches in Virginia Beach, one branch in Chesapeake, and one branch in Portsmouth. The Norfolk branches are located at the Webb Center on the campus of Old Dominion University and 4101 Granby Street. The Virginia Beach branch offices are at 225 South Rosemont Road, 2712 North Mall Drive, 1124 First Colonial Road and 1870 Kempsville Road. The address of the Chesapeake branch is 1217 Cedar Road. The address of the Portsmouth branch is 4940 West Norfolk Road. The branch location at First Colonial Road, Virginia Beach and the West Norfolk Road branch in Portsmouth are owned by the Bank and the remaining six are leased under long-term operating leases with renewal options, at total annual rentals of approximately $230.0 thousand paid to unrelated parties. 14 Item 3. Legal Proceedings The Corporation is not a party to, nor is any of its property the subject of, any material pending legal proceedings incidental to its business other than those arising in the ordinary course of business. Although the amount of any ultimate liability with respect to such matters cannot be determined, in the opinion of management, any such liability will not have a material adverse effect on the consolidated financial position or results of operations of the Corporation. Item 4. Submission of Matters to a Vote of Security Holders No matters were submitted to the Corporation's shareholders for a vote during the fourth quarter of 2001. Part II Item 5. Market for Common Equity and Related Stockholder Matters Market Information. The Corporation's common stock began trading on the NASDAQ National Market under the symbol CWBS on October 30, 2000. Prior to listing on the NASDAQ National Market, the Corporation's common stock traded on the Over-the-Counter Bulletin Board ("OTC Bulletin Board"), an NASD sponsored and operated inter-dealer quotation system for equity securities not listed on the NASDAQ Stock Market. Set forth below is high and low trading information for the common stock for each quarter during 2001 and 2000. For periods in which the Corporation's common stock traded on the OTC Bulletin Board, the information set forth below reflects inter-dealer prices, without retail mark-up, mark-down or commission and may not represent actual transactions. Common Stock Performance Common Stock Prices ------------------- 2001 2000 ---- ---- High Low High Low ---- --- ---- --- First Quarter $7.50 $6.31 $7.50 $6.00 Second Quarter $7.50 $4.90 $7.25 $5.50 Third Quarter $7.25 $6.30 $7.12 $6.38 Fourth Quarter $7.25 $6.55 $7.00 $5.63 Holders of Record. The Corporation had 1,703,103 shares of common stock outstanding as of March 12, 2001. The Corporation's common stock is held by 592 shareholders of record. Dividends. The Corporation paid a $0.035 cash dividend on March 31, June 30, October 1, and December 31, 2001 and March 31, June 30, September 30 and December 31, 2000 and on June 30, September 30 and December 31 1999. No cash dividend was declared for the quarter ending March 31, 1999. The Corporation also issued a 50.0% stock dividend on May 27, 1999. All per share figures in this Form 10-KSB have been adjusted to give effect to this stock dividend and any other stock dividends or stock splits that occurred during the periods presented in this Form 10-KSB. In April 1999, the Corporation's Board of Directors approved a Dividend Reinvestment and Stock Purchase Plan. Under this Plan, shares purchased from the Corporation with reinvested dividends are issued at a five percent (5.0%) discount from market value. As of March 12, 2002, 57.4% of the Corporation's shareholders were participating in this Plan. The Plan also permits participants to make optional cash payments of up to $20.0 thousand per quarter for the purchase of additional shares of the Corporation's common stock. These shares are issued at market value without incurring brokerage commissions. The ability of the Corporation to pay dividends depends upon the amount of dividends declared by the Bank. Regulatory restrictions exist with respect to the Bank's ability to pay dividends. See Note 7 to Consolidated Financial Statements included in this Report. 15 Item 6. MANAGEMENT'S DISCUSSION AND ANALYSIS OF OPERATIONS AND FINANCIAL CONDITION This section of the Form 10-KSB should be read in conjunction with the statistical information, Financial Statements and related Notes, and the selected financial data appearing elsewhere in this Form 10-KSB. In addition to historical information, the following discussion contains forward looking statements that are subject to risks and uncertainties that could cause the Corporation'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 Bank will continue to experience growth in core operating earnings, improved credit quality and increased service fee income, and that the Corporation 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. New Accounting Standards In June 1998 the Financial Accounting Standards Board (FASB) issued Statement No. 133, "Accounting for Derivative Instruments and Hedging Activities". The Statement establishes accounting and reporting standards for derivative instruments, including certain derivative instruments embedded in other contracts, and for hedging activities. The Statement also allows securities classified as held to maturity to be transferred to the available for sale category at the date of initial application of this standard. Statement No. 133 was to become effective for all fiscal years beginning after June 15, 1999. Statement No. 137 changed the effective date to all fiscal years beginning after June 15, 2000. In addition, Statement No. 138 changed certain provisions of Statement No. 133. Management has determined that there will be no impact from these Statements since neither the Corporation nor the Bank currently employs such derivative instruments and does not intend to do so in the future. On July 6, 2001, the Securities and Exchange Commission (SEC) issued Staff Accounting Bulletin (SAB) No. 102, "Selected Loan Loss Allowance Methodology and Documentation Issues". The guidance contained in the SAB is effective immediately. This SAB expresses the views of the SEC staff regarding a registrant's development, documentation, and application of a systematic methodology for determining the allowance for loan and lease losses, as required by SEC Financial Reporting Release (FRR) No. 28. The guidance in the SAB focuses on the documentation the SEC staff normally expects registrants to prepare and maintain in support of the allowance for loan and lease losses. Concurrent with the SEC's issuance of SAB No. 102, the federal banking agencies (the Federal Deposit Insurance Corporation (FDIC), the Board of Governors of the Federal Reserve System (FRB), the Office of the Comptroller of the Currency (OCC), and the Office of Thrift Supervision (OTS)) represented by the Federal Financial Institutions Examination Council issued an interagency policy statement entitled "Allowance for Loan and Lease Losses Methodologies and Documentation for Banks and Savings Institutions" (Policy Statement). The SAB and Policy Statement were the result of an agreement between the SEC and the federal banking agencies in March 1999 to provide guidance on allowance for loan and lease methodologies and supporting documentation. The guidance contained in the SAB does not prescribe specific allowance estimation methodologies registrants should employ in estimating their allowance for loan and lease losses, but rather emphasizes the need for a systematic methodology that is properly designed and implemented by registrants. In August 2001, the FASB issued Statement No. 143, "Accounting for Asset Retirement Obligations", which addresses financial accounting and reporting for obligations associated with the retirement of tangible long-lived assets and the associated asset retirement costs. The standard applies to legal obligations associated with the retirement of long-lived assets that result from the acquisition, construction, development and (or) normal use of the asset. Statement No. 143 requires that the fair value of a liability for an asset retirement obligation be recognized in the period in which it is incurred if a reasonable estimate of a fair value can be made. The fair value of the liability is added to the carrying amount of the associated asset and this additional carrying amount is depreciated over the life of the asset. The liability is accreted at the end of each period through charges to operating expense. If the obligation is settled for other than the carrying amount of the liability, an entity would recognize a gain or loss on settlement. Statement No. 143 is effective for fiscal years beginning after June 15, 2002. The adoption of Statement No. 143 is not expected to have a material effect on the financial position, results of operations or the liquidity of the Corporation. In October 2001, the FASB issued Statement No. 144, "Accounting for the Impairment or Disposal of Long-Lived Assets", which addresses financial accounting and reporting for the impairment or disposal of long-lived assets. Statement No. 144 supersedes Statement No. 121, "Accounting for the Impairment of Long-Lived Assets and for Long-Lived Assets to Be Disposed Of"; however, it retains many of the fundamental provisions of that Statement. Statement No. 144 also supersedes the accounting and reporting provisions of Accounting Principles Board (APB) Opinion No. 30, "Reporting the Results of Operations - Reporting the Effects of Disposal of a Segment of a Business, and Extraordinary, Unusual and Infrequently Occurring Events and Transactions", for the disposal of a segment of a business. However, it retains the requirement in APB No. 30 to report separately discontinued operations and extends that reporting to a component of an entity that either has been disposed of (by sale, abandonment, or in a distribution to owners) or is classified as held for sale. By broadening the presentation of discontinued 16 operations to include more disposal transactions, the FASB has enhanced management's ability to provide information that helps financial statement users to assess the effects of a disposal transaction on the ongoing operations of an entity. Statement No. 144 is effective for fiscal years beginning after December 15, 2001 and interim periods within those fiscal years. Early application is encouraged. The provisions of Statement No. 144 generally are to be applied prospectively. The adoption of Statement No. 144 is not expected to have a material effect on the financial position, results of operations or liquidity of the Corporation. Financial Condition and Results of Operations Commonwealth Bankshares, Inc. and Subsidiary This commentary provides an overview of the Corporation's financial condition, changes in financial condition and results of operations for the years 1999 through 2001. The following discussions should assist readers in their analysis of the consolidated financial statements and supplemental financial information for the Corporation appearing elsewhere in this Form 10-KSB. Earnings Overview The Corporation's net income continued to be negatively impacted during 2001 as a result of the continued absorption of operating expenses associated with the expansion of the branch network initiated during 2000 and 2001 along with the unanticipated rapid decline in "interest rates" during the year. As previously reported, the Bank: . Entered the Chesapeake market with the opening of a branch facility on Cedar Road in the Great Bridge section of Chesapeake in July, 2000. . Opened a new branch facility at Old Dominion University in August, 2000. . Entered the Portsmouth market with the opening of a branch facility on West Norfolk Road in the Churchland section of Portsmouth in April, 2001. . Has expanded the ATM network by seven units during the most recent two years. The Corporation's additional operating expense associated in the expansion of its branch facilities impacted 2001 operating performance by approximately $520.0 thousand. Net income was further impacted by the substantial and unanticipated decline in the "Prime Lending Rate" during 2001. The "Prime Lending Rate" is an index published daily in the Wall Street Journal and is defined as the rate of interest charged to the Bank's most creditworthy customers for short term borrowings. During 2001, the index was reduced a total of eleven times from 9.5% at the beginning of the year to 4.75% at year-end, resulting in a loss to the Bank of the Commonwealth of approximately $700.0 thousand in lost interest. Net income in 2001 equaled $577.3 thousand or a 91.4% increase from the $301.5 thousand reported for the year ended 2000. Again, the Corporation's net income during both 2001 and 2000 was impacted by a focus on growth and a substantial investment in new facilities, which management believes will benefit the Bank's operating performance in future periods. The Corporations' core earnings defined by the Corporation as pre-tax earnings exclusive of the provision for loan losses and nonrecurring items such as securities gains, equaled $1.1 million in 2001 compared with the $1.5 million reported at December 31, 2000. The key profitability measures of return on average assets (ROA) and return on average total shareholders' equity (ROE) were also impacted by the Corporation's investments during 2001. ROA equaled 0.25% in 2001 compared with 0.17% in 2000 and 0.83% in 1999. ROE equaled 4.51% in 2001 compared with 2.34% in 2000 and 9.63% in 1999. These ratios, along with other significant earnings and balance sheet information for each of the years in the five-year period ended December 31, 2001, are shown in Table 1 as follows: Table 1 - Selected Financial Information
(Dollars in thousands, except per share data) Results of Operations (for the year): 2001 2000 1999 1998 1997 ---- ---- ---- ---- ---- Income From Earning Assets $ 17,328 $ 14,592 $ 10,861 $ 9,547 $ 8,553 Net Interest Income 6,445 6,441 5,359 4,487 4,143 Provision for Loan Losses 360 1,155 110 102 50 Net Income 577 302 1,155 1,105 930 Earnings Per Share: Net Income - Basic (1) $ 0.34 $ 0.18 $ 0.71 $ 0.68 $ 0.57 Average Shares Outstanding (1) 1,692,125 1,667,329 1,631,684 1,626,107 1,626,107
17 Financial Condition (at December 31): Total Assets $230,568 $205,735 $157,016 $132,237 $116,106 Total Equity 13,573 12,827 12,227 11,580 10,531 Selected Ratios (for the year): Return on Average Common Shareholders' Equity 4.51% 2.34% 9.63% 9.91% 9.35% Return on Average Assets 0.25% 0.17% 0.83% 0.90% 0.85% Net Interest Margin 2.93% 4.00% 4.25% 4.04% 4.21%
(1) Adjusted to reflect 1999 &1998 stock dividends. Earnings per share during 2001 equaled $0.34 per share, an increase of 88.9% or $0.16 per share over the $0.18 per share reported in 2000. Earnings per share decreased 74.7% during 2000 over the $0.71 per share reported in 1999. Significant items affecting the change in earnings per share for 2001, 2000 and 1999 are summarized as follows:
2001 2000 vs. vs. 2000 1999 ---- ---- . Interest on loans and 18.75% increase 34.36% increase investments and loan fees . Interest on deposits and 33.52% increase 48.15% increase short-term borrowings . Net interest income 0.06% increase 20.20% increase . Provision for loan losses $794.5 thousand decrease $1,044.8 thousand increase
Net income in 2000 of $301.5 thousand represented a 73.9% decrease over the $1.2 million reported for the year 1999. The earnings recorded during this period reflects a provision for loan losses of $1.2 million in 2000 compared to only $109.8 thousand in 1999. NET INTEREST INCOME AND NET INTEREST MARGIN A fundamental source of the Corporation'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. The net interest margin is calculated as tax-equivalent net interest income divided by average earning assets, and represents the Corporation's net yield on its earning assets. In 2001, the net interest margin of 2.9% represented a decrease of 107 basis points over the net interest margin of 4.0% recorded in 2000. The decrease in net interest margin during this period of 27.5% was brought about primarily as a result of the rapid and unprecedented decline in the "Prime Lending Rate" when compared with a less rapid decline in rates on the Bank's deposit products. Deposit products were repriced throughout the year at the earliest opportunity available. The net interest margin for 2000 was 4.0% compared to 4.3% for 1999. The decrease in net interest margin of 7.0% was brought about by a more rapid decline in the rate of return on the loans and securities portfolios combined with a moderate increase in the cost of the Bank's sources of funding. The performance reported herein is reflected in the Corporation's earning assets yield of 8.2% in 2001 compared with 8.9% in 2000 and 8.5% in 1999. The Corporation's average cost of deposits increased 15 basis points in 2001 to 5.7% when compared with an increase of 63 basis points in 2000 from 1999. Nonperforming assets increased 992 thousand to $1.7 million in 2001, $1.1 million decrease to $722 thousand at the end of 2000, and $527 thousand decrease to $1.8 million at the end of 18 1999. The level of nonperforming assets negatively impacted earnings during 2001, 2000 and 1999 in the amounts of $122.8 thousand, $35.4 thousand, and $84.3 thousand, respectively. Average interest earning assets increased $46.8 million in 2001, $36.6 million in 2000, and $16.3 million in 1999. Average net loans increased $30.7 million in 2001, $35.1 million in 2000, and $21.7 million in 1999. Average investment securities decreased by $2.0 million in 2001, $2.0 million in 2000 and $386.1 thousand during 1999. Provision and Allowance for Loan Losses 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 judgement 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. On a quarterly basis, the Corporation's management evaluates the adequacy of the allowance for loan losses, and based on such review, establishes the amount of the provision for loan losses. For large commercial and real estate exposure, a detailed loan-by-loan review is performed. The remainder of the commercial and real estate portfolio is analyzed utilizing a formula-based determination of the allowance. The formula is impacted by the risk rating of the loan, historical losses and expectations. Loan loss allowances for the various consumer credit portfolios are based on historical and anticipated losses and the current and projected characteristics of the various portfolios. In addition, consideration of factors such as economic conditions, underwriting standards, and compliance and credit administration practices may impact the level of inherent credit loss. Management's evaluation and resulting provision and allowance decisions are reviewed by the Board of Directors monthly. The Corporation made provisions for loan losses of $360.0 thousand in 2001 compared to a provision of $1.2 million in 2000. The unusually high provision for 2000 was based on significant loan growth and the Corporation's expansion plans for the future, and accordingly management chose, after consultation with banking regulators, to significantly increase the loan loss provision in the fourth quarter of 2000. The Corporation made provisions for loan losses of $109.8 thousand in 1999. Details of the activity in the allowance for loan losses for the past three years are shown in Note 4 to the Consolidated Financial Statement. Net charge-offs in 2001 were $292.0 thousand compared to $165.6.0 thousand for 2000 and $148.3 thousand for 1999. The level of charge-offs for 2001 reflected normal increases because of continued growth in the loan portfolio and remain relatively unchanged as a percentage of total loans. Total loan charge-offs for 2001 and 2000 represented a modest two-tenths of one percent of total loans outstanding in 2001 and one-tenth of one percent in 2000. The allowance for loan losses at December 31, 2001 was $2.0 million, compared with $1.9 million at December 31, 2000 and $931.0 thousand at December 31, 1999. This represented 1.1% of year-end gross loans at December 31, 2001 compared with 1.2% of year-end gross loans at December 31, 2000 and 0.7% of year-end gross loans at December 31, 1999. The tables on the following pages provide an analysis of the activity in the Corporation's nonperforming assets and allowance for loan losses for each of the last three years. Based on current expectations relative to portfolio characteristics and performance measures including loss projections, management considers the level of the allowance to be adequate. Nonperforming loans at December 31, 2001 increased by $795 thousand to $1.4 million. Nonperforming loans were $591 thousand at year-end 2000. The increase in total nonperforming assets during this period is attributable to a single loan to a long standing borrower that was placed on non-accrual in January 2001. The balance of this loan at year-end 2001 was $1.1 million. Although the loan is classified as non-accrual full collection is expected. During 2001 the Bank collected payments on the loan equaling $134.1 thousand. During 2000, nonperforming loans declined $591 thousand when compared with 1999. Nonperforming loans continue to be centered in a relatively small number of loans with large balances. Most of the loans are fully secured and, in management's opinion, represent minimal risk. The Corporation continues to allocate significant resources to the expedient disposition and collection of nonperforming and other lower quality assets. As a part of this workout process, the Corporation routinely reevaluates all reasonable alternatives, including the sale of these assets. Individual action plans have been developed for each nonperforming asset. The amount of loans past due 90 days or more that were not classified as nonaccrual loans totaled $64 thousand at December 31, 2001, $107 thousand at December 31, 2000 and $73 thousand at December 31, 1999. The following table reflects the trends discussed herein: 19 Nonperforming Assets December 31 2001 2000 1999 - ----------- ---- ---- ---- 90 Days delinquent and still accruing $ 64,000 $107,000 $ 73,000 Nonaccrual 1,322,000 484,000 1,109,000 Foreclosed properties 328,000 131,000 601,000 ---------- -------- ---------- Total Nonperforming Assets $1,714,000 $722,000 $1,783,000 ========== ======== ========== ASSET QUALITY REVIEW AND CREDIT RISK MANAGEMENT In conducting business activities, the Corporation is exposed to the possibility that borrowers or counterparties may default on their obligations to the Corporation. Credit risk arises through the extension of loans, leases, certain securities, and financial guarantees. To manage this risk, the Corporation establishes policies and procedures to manage both on and off-balance sheet risk and communicates and monitors the application of these policies and procedures throughout the Corporation. Loan Portfolio The Corporation's credit risk is centered in its loan portfolio which on December 31, 2001 totaled $178.7 million, or 77.5 % of total earning assets compared with $158.5 million, or 85.3% of total earning assets at year end 2000 and $125.5 million or 85.3% of total earning assets at year end 1999. The Corporation's overall objective in managing loan portfolio risk is to minimize the adverse impact of any single event or set of occurrences. To achieve this objective, the Corporation strives to maintain a loan portfolio that is diverse in terms of loan type, industry concentration, geographic distribution and borrower concentration. For commercial loans, loan officers prepare proposals supporting the extension of credit. These proposals contain an analysis of the borrower and an evaluation of the ability of the borrower to repay the potential credit. The proposals are subject to varying levels of approval by senior line and credit policy management, prior to the extension of credit. Commercial loans receive an initial risk rating by the originating loan officer. This rating is based on the amount of credit risk inherent in the loan and reviewed for appropriateness by senior line and credit policy personnel for deterioration in a borrower's financial condition which would impact the borrower's ability to repay the credit. Risk ratings are adjusted as necessary. For consumer loans, approval and funding is conducted in various locations with the majority of loans being approved at the Corporation's headquarters facility. The Bank has entered into an agreement with an independent credit review group to conduct ongoing reviews of the loan portfolio, reexamining on a regular basis risk assessments for loans and overall compliance with policy. To limit credit exposure, the Corporation obtains collateral to support credit extensions and commitments when deemed necessary. The most significant categories of collateral are real and personal property, cash on deposit and marketable securities. The Corporation obtains real property as security for some loans that are made on the basis of the general creditworthiness of the borrower and whose proceeds were not used for real estate related purposes. Senior level management is devoted to the management and/or collection of certain nonperforming assets as well as certain performing loans. Aggressive collection strategies and a proactive approach to managing overall credit risk has expedited the Corporation's disposition, collection and re-negotiation of nonperforming and other lower-quality assets and allowed loan officers to concentrate on generating new business. As the volume of past due loans continues to decline, it is anticipated that the level of nonaccrual loans will be reduced, although no assurance can be given in this regard. It should be noted that of all loans on nonaccrual, the majority are making regular monthly payments. In addition, in most cases these loans are fully secured with workout arrangements currently in place. If non-accruing loans had been performing fully, these loans would have contributed an additional $122.8 thousand to interest income in 2001, $35.4 thousand in 2000 and $84.3 thousand in 1999. The Corporation's Other Real Estate Owned (OREO) at December 31, 2001 increased to $328.4 thousand as compared with $130.6 thousand at December 31, 2000 and $601.1 thousand at December 31, 1999. At December 31, 2001 the Corporation held a total 20 of three (3) properties. During the last three years, there have been additions to and liquidations of other real estate owned. There were three (3) in 2001, none during 2000, and one (1) addition during 1999. Proceeds from the properties disposed of during 2001 equaled $173.6 thousand compared with $480.0 thousand during 2000 and $434.2 thousand in 1999. During 2001, 2000 and 1999, there were net losses on the sale of other real estate of $43.7 thousand, $62.6 thousand and $65.6 thousand, respectively. The Bank has developed individual action plans for each property for the ultimate liquidation of these properties. The objectives are diligently pursued by management and reviewed with the Board of Directors monthly. Noninterest Income Total noninterest income increased in 2001 to $1.5 million compared with $1.2 million reported in 2000, a 26.0% increase. Total noninterest remained relatively unchanged at $1.2 million for 2000 and 1999. The income achieved in service charges and fees on deposits is indicative of the recent trend in commercial banking to generate additional income from services not related to the lending function. In each of the three years mentioned, income from OREO properties equaled $2.9 thousand, $41.0 thousand and $71.2 thousand. The decrease during the three-year period was due to the reduction of OREO. Noninterest Expense Total noninterest expense increased to $6.8 million in 2001 or 10.9% following increases of 26.9% and 21.9% in 2000 and 1999, respectively. This represents a moderate increase when compared to the Bank's overall growth. Noninterest expense has been impacted by the opening of two new branch locations and seven ATM's in 2001 and 2000. Salaries and employee benefits, the largest component of noninterest expense increased by 8.2% in 2001 following increases of 30.3% in 2000 and 23.0% in 1999. Net occupancy expense increased $87.1 thousand in 2001, $147.7 thousand in 2000 and $28.7 thousand in 1999. Other noninterest operating expenses, which include a grouping of numerous transactions relating to normal banking operations, increased $52.5 thousand or 2.8% in 2001 compared with an increase of $353.2 or 23.7% in 2000, and an increase of $354.7 thousand or 31.2% in 1999. Liquidity and Interest Sensitivity Bank liquidity is a measure of the ability to generate and maintain sufficient cash flows to fund operations and to meet financial obligations to depositors and borrowers promptly and in a cost-effective manner. Asset liquidity is provided primarily by maturing loans and investments, and by cash received from operations. Other sources of asset liquidity include readily marketable assets, especially short-term investments, and longer-term investment securities that can serve as collateral for borrowings. On the liability side, liquidity is affected by the timing of maturing liabilities and the ability to generate new deposits or borrowings as needed. The Corporation'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, adhering to conservative financial management on a daily basis, monitored regularly by ALCO and reviewed periodically with the Board of Directors. The Bank's funding requirements are supplied from a wide range of traditional sources, including various types of demand deposits, money market accounts, certificates of deposit and short-term borrowings. Large certificates of deposit, over $100.0 thousand accounted for 17.1%, 18.1%, and 14.0% of the Bank's total deposits at December 31, 2001, 2000, and 1999, respectively. As a percentage of average assets, core deposits increased to 95.3% in 1999 and decreased to 84.5% in 2000 and decreased to 75.0% in 2001. Management seeks to ensure adequate liquidity to fund loans, deposit withdrawals, and the Bank's financial requirements and opportunities. To provide liquidity for current ongoing and unanticipated needs the Bank maintains a portfolio of marketable investment securities, and structures and monitors the flow of funds from these securities and from maturing loans. The Bank maintains access to short-term funding sources as well, including a federal funds line of credit with its correspondent banks up to $4.5 million, and the ability to borrow from the Federal Reserve System up to $1.6 million and Federal Home Loan Bank up to $18.4 million. The Corporation's loan portfolio net of unearned income and allowance for loan losses increased by 12.9% to $176.1 million in 2001 compared with an increase of 25.7% to $156.0 million in 2000 and compared with a 37.0% increase in 1998 to $124.1 million. Balances in a number of loan categories also increased. Total commercial loans increased 17.1% to $129.5 million in 2001 compared with an increase of 21.5% to $110.6 million in 2000 and an increase of 42.4% to $91.0 million in 1999. Consumer loans increased $2.7 million or 35.4% in 2001 following increases of $1.2 million or 18.6% in 2000 and of $973.9 thousand or 17.5% in 1999. 21 Sources of Funds Purchased liabilities are composed of Fed Funds purchased, certificates of deposit of $100.0 thousand and over (large CDs) and balances held in "sweep accounts" for customers. Purchased funds at December 31, 2001 equaled $36.5 million or a 6.2% decrease in short-term borrowings during 2001 following a $15.3 million increase to $38.9 million during 2000, as compared with the $3.2 million increase reported in 1999. At December 31, 2001, 2000 and 1999, approximately 100.0% of The Corporation's purchased funds consisted of funds invested by local customers which, as such, are less volatile than other categories of purchased funds or brokered deposits. Uses of Funds Total earning assets at December 31, 2001 increased 11.4% from year-end 2000 compared with 2000's increase of 31.8% from year-end 1999's increase of 19.6%. The increase in earning assets over the last three years has been primarily attributable to the increase in the loan portfolio which has increased from $124.1 million in 1999 to $176.1 million in 2001. The composition of long-term investment securities as of December 31, 2001 and 2000 is presented in Note 3 to the Consolidated Financial Statements, appearing elsewhere in this Form 10-KSB. At year-end 2001, 2000 and 1999, investment securities totaled $16.4 million, $19.4 million and $20.2 million respectively. In managing the investment securities portfolio, management's philosophy has been to provide the maximum return over the long term on funds invested while giving consideration to risk and other corporate objectives. During periods of increasing interest rates, the market value of the investment portfolio declines in relation to book value. During periods of declining interest rates, the opposite is true. Decisions to acquire investments of a particular type are based on an assessment of economic and financial conditions, including interest rate risk, liquidity, capital adequacy, the type of incremental funding available to support such assets, and an evaluation of alternative loan or investment instruments. Investment securities are purchased with the ability to hold until maturity and with the intent to hold for the foreseeable future. Management reevaluates asset and liability strategies when economic and financial conditions fluctuate in a magnitude that might adversely impact the Corporation's overall interest rate risk, liquidity, or capital adequacy positions. Reassessment may alter management's intent to hold certain securities for the foreseeable future and result in repositioning a portion of the investment portfolio. Often, security sales are required to implement a change in strategy. The total investment in the securities portfolio at December 31, 2001 was approximately $16.4 million, down from $19.4 million at the end of 2000. The portfolio is well diversified among several market sectors as summarized below: Sector % - ------ ---- Municipals 41.0 Fixed Agency 1.5 Floating MBS 18.0 Floating CMO 12.0 Fixed MBS 9.5 Fixed CMO 2.2 Corporates 12.0 Other 3.4 As of December 31, 2001, the overall portfolio was projected to yield 6.1% on a fully taxable equivalent basis. It has a weighted average repricing term of 4.8 years, and 70.0% of total holdings are invested in fixed rate securities. 80.0% of the portfolio has been placed in the Available For Sale (AFS) category for FAS 115 purposes. As of December 31, 2001 the portfolio currently contained an unrealized gain on sale of $78.3 thousand. The portfolio has a short repricing distribution with 40.6% repricing within the next twelve months. Adjustable rate securities total $4.4 million par value and represent 30.0% of the total portfolio. These securities are well diversified among a variety of indices. The diversity in indices results in a consistent performing adjustable rate portfolio regardless of the direction or level of interest rates. Currently, the adjustable rate securities portfolio is projected to yield 5.5% with a weighted average months-to-reset of 6.46. Municipal holdings total $6.1 million par value, or 41.0% of total holdings, and have a taxable equivalent yield to the effective maturity date of 6.5%. Management believes these issues have excellent credit quality, as 98.0% of the portfolio is AA-rated or higher. 22 The two largest states represented in the portfolio include New York at 22.0% and Pennsylvania at 16.0%. The average duration date of the municipal portfolio is approximately 4.32 years. Fixed rate mortgage pools total $1.4 million par value, or 9.5% of total holdings. These securities are invested in a variety of, 15-year, 20-year, and 30-year final maturity pools and are well diversified among coupon rates. Overall, the portfolio is projected to yield 6.5% with a projected average life of 3.2 years based on current prepayment rates. Management frequently assesses the performance of the investment portfolio to ensure its yield and cash flow performances are consistent with the broad strategic plan of the entire Bank. Flexibility is one of the hallmarks of the Bank's ability to meet the banking needs of its customers. Year-end total loans net of unearned income increased $20.1 million or 12.7% in 2001 following an increase of $32.9 million or 26.3% in 2000 and an increase of $33.5 million or 36.5% increase in 1999. The results were largely due to the efforts of the Bank's officers to develop new loan relationships with customers from the area's regional institutions and the Banks penetration into two new markets. Loans represented the largest category of earning assets and the Bank will continue with its efforts to develop creditable loan relationships in order to enhance its earnings opportunities while simultaneously strengthening its underwriting criteria. The policies, procedures and lending guidelines implemented during the past two years have been reported in detail in previous quarterly and annual reports. A number of measures have been taken by the Corporation over the past several years to reduce overall exposure and earnings vulnerability in the real estate sectors of the Bank's trade area. These measures include strengthening real estate underwriting, management review policies and practices, and reducing higher risk concentrations within the real estate portfolio. The Corporation's real estate portfolio is comprised of loans to customers located within the Corporation's established marketplace. Diversification of the loan portfolio continues. During the past three years, a considerable volume of new loan relationships have been developed with "old line and well-established" local businesses, who have transferred their relationships to the Bank from other "regional financial institutions" that are experiencing further consolidation. This has been an excellent source of new business for the Bank. The Bank intends to aggressively continue to target these relationships in future periods. Dividends and Dividend Policy The Corporation's Board of Directors determines the amount of and whether or not to declare dividends. Such determinations by the Board take into account the Corporation's financial condition, results of operations, and other relevant factors. The Corporation's only source of funds for cash dividends are dividends paid to the Corporation by the Bank. In April 1999, the Corporation's Board of Directors approved a Dividend Reinvestment and Stock Purchase Plan. Shares purchased from the Corporation with reinvested dividends are issued at a five percent discount from the market value. As of December 31, 2001, 57.4% of the Corporation's shareholders were participating in the plan. The plan also permits optional cash payments up to $20 thousand per quarter for the purchase of additional shares of common stock. These shares are issued at market value, without incurring brokerage commissions. Based on the Corporation's earnings record for 2001, the Corporation paid a $0.035 cash dividend on March 31, June 30, October 1, and December 31, 2001. The Corporation also paid a $0.035 cash dividend on March 31, June 30, September 30, and December 31, 2000 and on June 30, September 30, and December 30, 1999. There were no cash dividends declared for the quarter ending March 31, 1999 . The Corporation issued a fifty (50.0%) percent stock dividend on May 27, 1999. Income Taxes Corporations are required to pay the greater of the regular corporate income tax or the alternative minimum tax (AMT). In 2001, income tax expense was $162.7 thousand, up from $3.7 thousand in 2000, and down from the $446.4 thousand in 1999. The decrease in income tax expense in 2000 was a result of the one time additional loan loss provision. Inflation The Corporation carefully reviews Federal Reserve monetary policy in order to insure an appropriate position between the cost and utilization of funds. The effect of changing prices on financial institutions is typically different than on non-banking companies since virtually all of 23 a bank's assets and liabilities are monetary in nature. In particular, interest rates are significantly affected by inflation, but neither the timing nor magnitude of the changes are directly related to price level indices. Therefore, the Corporation can best counter inflation over the long term by managing net interest income and controlling net increases in noninterest income and expenses. Capital Resources and Adequacy Average shareholders' equity decreased at the rate of 0.6% in 2001 compared with an increase of 7.3% in 2000, and 7.6% in 1999. During these periods, the sole source of capital to the Bank has been internally generated retained earnings. The Federal Reserve Board, the Office of the 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. On July 27, 2001 Commonwealth Bankshares, Inc. generated $6.5 million in new regulatory capital from the initial funding of a trust preferred stock offering. A subsequent funding on August 9, 2001 resulted in $800 thousand of new regulatory capital. At December 31, 2001, the Bank's risk-adjusted capital ratios were 9.9% for Tier 1 and 10.9% for total capital, well above the required minimums of 4.0% and 8.0% respectively, as compared with 7.6% and 8.8%, respectively at December 31, 2000, and 9.9% and 10.7% at December 31, 1999. 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 Deposit Insurance Corporation (FDIC) rules, the Bank was considered well capitalized. At December 31, 2001, shareholders' equity stood at $13.6 million as compared with $12.8 million at year-end 2000, and $12.2 million at year-end 1999. These increases were brought about by a net profit of $577.3 thousand in 2001 a net profit of $301.5 million in 2000 and a net profit of $1.2 million in 1999. 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 capital position, including but not limited to: . Continuing its efforts to return all nonperforming assets to performing status, . Monitoring the Bank's growth, and . Continued utilization of its formal asset/liability policy. Once again, it should be noted that the Bank's capital position has always exceeded and continues to exceed the minimum standards established by the regulatory authorities. Item 7. Financial Statements. The Corporation's consolidated financial statements are included with this Form 10-KSB as Exhibit 99.1. Refer to the index to the Consolidated Financial Statements on page F-1 for the required information. Item 8. Changes In and Disagreements With Accountants on Accounting and Financial Disclosure. None. PART III Item 9. Directors, Executive Officers, Promoters and Control Persons; Compliance With Section 16(a) of the Exchange Act. The Board of Directors Commonwealth Bankshares' board of directors is currently comprised of 10 members who are divided into three classes. These directors serve for the terms of their respective classes, which expire in 2002, 2003 and 2004. The following table sets forth the composition of the board of directors. 24 Class I Class II Class III (Term Expiring in 2004) (Term Expiring in 2002) (Term Expiring in 2003) Morton Goldmeier Herbert Perlin William P.Kellam William D. Payne, M.D. Kenneth J.Young Edward J. Woodard, Jr., CLBB Richard J. Tavss Thomas W. Moss, Jr. Laurence C. Fentriss E. Carlton Bowyer The following paragraphs set forth certain information, as of December 31, 2001, for each of the 10 directors of Commonwealth Bankshares. Class I (Term Expiring in 2004) Morton Goldmeier, 78, has served as President of Hampton Roads Management Associates, Inc. since 1990. Mr. Goldmeier has served as a director of Commonwealth Bankshares since 1988 and as a director of Bank of the Commonwealth since 1988. William D. Payne, M.D., 66, retired from Drs. Payne, Ives, and Holland, Inc. in 2001. Dr. Payne has served as a director of Commonwealth Bankshares since 1988 and as a director of Bank of the Commonwealth since 1988. Richard J. Tavss, 62, has served as Senior Counsel of Tavss, Fletcher, Maiden, and King, P.C. since 1977. Mr. Tavss has served as a director of Commonwealth Bankshares since 1988 and as a director of Bank of the Commonwealth since 1988. E. Carlton Bowyer, 68, served as superintendent of the Virginia Beach School System before retiring in 1991. Mr. Bowyer was employed with the Virginia Beach School System for 31 years. Mr. Bowyer served as a Virginia Beach Advisory Board director prior to becoming a director of Commonwealth Bankshares and Bank of the Commonwealth in 2001. Class II (Term Expiring in 2002) Herbert L. Perlin, 61, has served as President of Perlin Benefit Resources, Inc., a regional pension company located in Virginia Beach, Virginia since 1983. Mr. Perlin has served as a director of Commonwealth Bankshares since 1988 and as a director of Bank of the Commonwealth since 1987. Kenneth J. Young, 51, has served as President of Leisure & Recreation Consultants, Inc., located in Tampa, Florida, since 1996. Mr. Young has served as a director of Commonwealth Bankshares since 1999 and as a director of Bank of the Commonwealth since 1999. Thomas W. Moss, Jr., 73, was elected Treasurer of the City of Norfolk in 2001. Mr. Moss has served as a director of Commonwealth Bankshares since 1999 and as a director of Bank of the Commonwealth since 1999. Class III (Term Expiring in 2003) William P. Kellam, 87, served as the President of Kellam - Eaton Insurance Agency, Inc., a real estate and insurance firm in Virginia Beach, Virginia, for 30 years prior to his retirement in 1986. Mr. Kellam has served as a director of Commonwealth Bankshares since 1988 and as a director of Bank of the Commonwealth since 1971. Edward J. Woodard, Jr., CLBB, 59, has served as President and Chief Executive Officer of Bank of the Commonwealth since 1973 and as Chairman of the Board since 1988. He has served as Chairman of the Board, President and Chief Executive Officer of Commonwealth Bankshares since 1988. Mr. Woodard is also President and Director of BOC Title of Hampton Roads and BOC Insurance of Hampton Roads, President of Boush Bank Building Corporation and a general partner in Boush Bank Building Associates. Mr. Woodard has served as a director of Bank of the Commonwealth since 1973 and as a director of Commonwealth Bankshares since 1988. Laurence C. Fentriss, 47, has served as co-founder of Baxter, Fentriss & Company, a merger and acquisition firm since 1992. Mr. Fentriss has served as a director of Commonwealth Bankshares since 2001 and as a director of Bank of the Commonwealth since 2001. Executive Officers of Commonwealth Bankshares and Bank of the Commonwealth In addition to Mr. Woodard, the following individuals serve as our executive officers. 25 John H. Gayle, 63, Executive Vice President and Secretary of Commonwealth Bankshares and Executive Vice President and Cashier of Bank of the Commonwealth since 1990; Director, Vice President, Secretary and Treasurer of BOC Title of Hampton Roads, Inc.; and Director, Vice President and Treasurer of BOC Insurance Agency of Hampton Roads, Inc. Simon Hounslow, 37, Senior Vice President and Commercial Loan Officer of Bank of the Commonwealth since 1993. Section 16(a) Beneficial Ownership Reporting Compliance Section l6(a) of the Securities Exchange Act of 1934, as amended, requires directors, officers and persons who beneficially own more than 10.0% of the Corporation's common stock to file initial reports of ownership and reports of changes in beneficial ownership with the SEC. Such persons are also required to furnish the Corporation with copies of all Section 16(a) forms they file. Based solely on a review of the copies of such forms furnished to the Corporation, the Corporation believes that all Section 16(a) filing requirements applicable to its directors, officers and greater than 10.0% beneficial owners were complied with in 2001. Item 10. Executive Compensation. Summary Executive Compensation Table The following table sets forth the annual compensation paid or accrued by the Corporation and its subsidiaries to Edward J. Woodard, Jr., CLBB, Chairman of the Board, President and Chief Executive Officer of the Corporation and the Bank for the past three fiscal years. Compensation for each other executive officer of the Corporation or the Bank did not exceed $100.0 thousand in 2001 and, therefore, is not shown in the table. Summary Compensation Table Name and Principal Position Annual Compensation - ------------------ ------------------- Other Annual Year Salary Bonus Compensation (1) ---- ------ ----- ---------------- Edward J. Woodard, Jr., CLBB 2001 $199,000 $0 $31,300 Chairman of the Board 2000 187,500 -- 28,400 President and Chief 1999 182,500 18,500 23,600 Executive Officer - ---------- (1) Includes director fees, 401k matching contribution, 401k profit sharing , and deferred compensation. Director Compensation Each director of Commonwealth Bankshares is paid $900 for attendance at each board meeting and $400 for attendance at each meeting of a committee of the board of which he or she is a member. Additionally, Commonwealth Bankshares has a Director's Deferred Compensation Plan which allows directors to defer recognition of income on all or any portion of the directors' fees they earn. During 2001 a total of $71.6 thousand was deferred by directors under this plan. The terms and conditions of this plan and the two plans are very similar to the terms and conditions of the Bank of the Commonwealth Supplemental Executive Retirement plan described on page 29 in this 10KSB. 26 Option Grants in Last Fiscal year The following table sets forth information for the year ended December 31, 2001 regarding grants of stock options to Mr. Woodard. Option Grants in Year Ended December 31, 2001
Potential Realizable Value at Assumed Annual Rates of Percent of Total Stock Price Number of Securities Options Granted to Appreciation for Underlying Options Employees in Expiration Option Term Name Granted Fiscal Year Exercise Price Date 5.0%($) 10.0%($) ------------------------------------------------------------------------------------------------------------- Edward J. Woodard, Jr 5,000 35.1% $7.13 10/01/11 $58,070 $92,467
Option Exercises in Last Fiscal Year Set forth in the table below is information concerning the exercise of stock options during the fiscal year ended December 31, 20021 by each of the named executive officers named in the Summary Compensation Table. Aggregated Option Exercises in Year Ended December 31, 2001 and Fiscal Year End Option Values
Number of Securities Underlying Value of Unexercised Unexercised Options In-The-Money Options at December 31, 2001 (#) at December 31, 2001 ($)(1) ------------------------ ---------------------------- Shares Acquired on Value Name Exercise (#) Realized ($)(1) Exercisable Unexercisable Exercisable Unexercisable ---- ------------ --------------- ----------- ------------- ----------- ------------- Edward J. Woodard, Jr. 0 0 29,133 -- 23,771 --
(1) These values are based on $7.00, the closing price of Commonwealth Bankshares common stock on December 31, 2001. 27 Employment Agreements Edward J. Woodard, Jr., Chairman of the Board, President and Chief Executive Officer of Commonwealth Bankshares and Bank of the Commonwealth has entered into an employment agreement with Bank of the Commonwealth. The agreement provides for Mr. Woodard's employment until the earlier of December 31, 2004, his death or his physical or mental disability; provided, however, the employment agreement allows for the termination of employment by either Bank of the Commonwealth or Mr. Woodard in the event of a "change of control" of Commonwealth Bankshares or Bank of the Commonwealth, or by Mr. Woodard for "good reason." Mr. Woodard's employment agreement will be renewed automatically each year unless either party elects not to renew the agreement. Under the employment agreement, in the case of a termination by Commonwealth Bankshares or Bank of the Commonwealth prior to a "change of control," but not "for good cause," Mr. Woodard will be entitled to receive twelve (12) equal monthly payments, which, in total, equal his annual base salary, plus directors' fees. In the event of a termination of the employment agreement by Mr. Woodard for "good reason," or by Commonwealth Bankshares or Bank of the Commonwealth subsequent to a "change of control," but not "for good cause," Mr. Woodard will be entitled to receive sixty (60) equal monthly payments which, in total, equal approximately three times the present value of his annual compensation at the time of termination. Under the Agreement, a "change of control" will be deemed to have occurred upon: . any third party acquiring, or entering into a definitive agreement to acquire, more than twenty-five percent (25.0%) of the stock of either Commonwealth Bankshares or Bank of the Commonwealth; . a change in the majority of the members of the board of directors of either Commonwealth Bankshares or Bank of the Commonwealth during any one year period; or . Commonwealth Bankshares ceasing to be the owner of all of Bank of the Commonwealth's common stock, except for any directors' qualifying shares. The term "for good cause" includes a termination of Mr. Woodard for his failure to perform the required services, gross or willful neglect of his duty or a legal or intentional act demonstrating bad faith. The term "good reason" is defined as any assignment to Mr. Woodard of duties or responsibilities inconsistent with those in effect on the date of the agreement or a change of control of either Commonwealth Bankshares or Bank of the Commonwealth. Mr. Woodard has also entered into an amended and restated deferred supplemental compensation agreement with Bank of the Commonwealth. Under the supplemental agreement, upon Mr. Woodard attaining the age of 65, upon his termination with Bank of the Commonwealth for any reason whatsoever or upon his death, Mr. Woodard or his beneficiary shall be entitled to payment from the Bank of: (i) two hundred fifty thousand dollars ($250,000) in one hundred twenty (120) equal consecutive monthly installments of two thousand eighty-three and 33/100 dollars ($2,083.33) each, and (ii) seven hundred twenty thousand dollars ($720,000) in one hundred eighty (180) equal consecutive monthly installments of four thousand dollars ($4,000) each, both such payments being payable on the first day of each such month. Any payments described above shall be made on each such payment date to employee, regardless of whether employee is employed by the Bank at the time he becomes eligible for such payments. In addition to all payments described above, upon employee's death, the Bank shall pay to the beneficiary a lump sum payment of two hundred fifty thousand and no/100 dollars ($250,000), payable on the first day of the second calendar month immediately following the date of death. Under the supplemental agreement, Mr. Woodard is obligated to make himself available to Bank of the Commonwealth after his retirement, so long as he receives payments under the supplemental agreement, for occasional consultation which Bank of the Commonwealth may reasonably request. Any amounts unpaid under the supplemental agreement may be forfeited, after notice to Mr. Woodard, in the event that the board of directors of Bank of the Commonwealth determines in good faith that Mr. Woodard is performing services of any kind for a firm or other entity competitive with the business of Bank of the Commonwealth during the period that he is receiving payments under the supplemental agreement. Stock Option and Employee Benefit Plans 1990 Stock Option Plan. On February 20, 1990, Commonwealth Bankshares' board of directors approved a non-qualified stock option plan for the issuance of 25,000 shares of Commonwealth Bankshares' common stock to eligible officers 28 and key employees of Commonwealth Bankshares and Bank of the Commonwealth at prices not less than the market value of Commonwealth Bankshares' common stock on the date of grant. On April 29, 1997, the shareholders approved an amendment to this plan to increase the number of shares available for issuance under the plan to 45,000 shares. This plan expired on February 20, 2000. However, the terms of this plan continue to govern unexercised options awarded under the plan that have not expired. 401(k) Profit Sharing Plan. In 1993, Bank of the Commonwealth adopted a thrift and profit sharing plan qualified under Section 401(k) of the Internal Revenue Code to replace Bank of the Commonwealth's former profit sharing plan. Employees who have attained the age of 20 years and six months and completed six months of service with Bank of the Commonwealth are eligible to participate in the 401(k) plan. Eligible employees who elect to participate may contribute up to 15.0% of their annual salary to the 401(k) plan. The Bank of the Commonwealth may make a matching contribution, the amount of which, if any, will be determined by Bank of the Commonwealth each year. Bank of the Commonwealth contributed a matching contribution of $36.6 thousand and a discretionary profit sharing contribution of $23.4 thousand to the 401(k) plan during 2001. Non-Employee Director Stock Compensation Plan. On April 25, 1995 Commonwealth Bankshares' shareholders approved a non-employee director stock compensation plan. This plan provided for the issuance of options to acquire 50,000 shares of Commonwealth Bankshares' common stock to eligible non-employee directors at prices determined by the average of the five most recent trades of the common stock on the over-the-counter market during the period immediately preceding an option's grant date or such other value per share as was determined by the employee directors. On April 29, 1997, shareholders approved an amendment to this plan to increase shares available for issuance under this plan to 70,000 shares. This plan expired January 17, 2000. However, the terms of this plan continue to govern unexercised options awarded under the plan that have not expired. 1999 Stock Incentive Plan. On April 27, 1999, Commonwealth Bankshares' shareholders approved the Commonwealth Bankshares, Inc. 1999 Stock Incentive Plan. This plan provides for the issuance of up to the lesser of (i) fifteen percent (15.0%) of Commonwealth Bankshares' issued and outstanding common stock less the aggregate number of shares subject to issuance pursuant to options granted, or available for grant, under the 1990 plan and non-employee director plan described above, or (ii) 350,000 shares. Of the aggregate number of shares of Commonwealth Bankshares' common stock that may be subject to award under this plan, sixty percent (60.0%) are available for issuance to Commonwealth Bankshares' non-employee directors, and forty percent (40.0%) are available for issuance to Commonwealth Bankshares' employees. All the employees of Commonwealth Bankshares and Bank of the Commonwealth, and all other members of the board of directors of Commonwealth Bankshares, are eligible to receive awards under this plan. Bank of the Commonwealth Supplemental Executive Retirement Plan. Effective February 1, 2002, Commonwealth Bankshares' board of directors approved an executive deferred compensation plan in order to provide a select group of management and highly compensated executives the opportunity to elect to defer part or all of the compensation (including bonuses) payable to such executives during any plan year. Under this plan, a participant may designate a fixed dollar amount or a percentage to be deducted from his or her salary and/or bonus and then indicated how the deferred amount is to be deemed invested as between a fund that tracks the value of Commonwealth Bankshares' stock and a simple interest bearing fund. The amount of deferred compensation in an executive's account is held in a rabbi trust, but such amounts continue to be subject to the claims of the Bank of the Commonwealth's general creditors until such time as they are distributed to the executive. Distributions are generally available at retirement age, death, or on account of disability. In addition, an executive who separates from service for a reason other than because of retirement, death, or disability, is entitled to receive distribution when he or she reaches age 65 (unless he or she dies or becomes disabled in the meantime, in which case benefits will be payable pursuant to the plan terms regarding such distributions). Distributions may also be made in certain situations following a change in control. Distributions are generally made in the form of installment payments, although a distribution in a lump sum is available in limited situations. Item 11. Security Ownership of Certain Beneficial Owners and Management. Management The following table sets forth the beneficial ownership of the Coporation's common stock by each of its directors and named executive officers as of March 12, 2002 Corporation's Common Stock. 29 Number and Percent of Shares Beneficially Name Owned (1)(2) ---- ------------ E. Carlton Bowyer 1,601 * Laurence C. Fentriss 165,057(3) 9.2% Morton Goldmeier 80,697(4) 4.7% William P. Kellam 35,603(5) 2.1% Thomas W. Moss, Jr 3,993(6) * William D. Payne, M.D 22,777(7) 1.3% Herbert L. Perlin 45,256(8) 2.6% Richard J. Tavss 124,109(9) 7.2% E. J. Woodard, Jr., CLBB 48,589(10) 2.8% Kenneth J. Young 7,777(11) * All Directors and executive 568,223 officers as group (12 persons) 28.9% * Percentage of ownership is less than 1.0% of the outstanding shares of Common Stock of the Corporation. (1) Beneficial ownership as reported in the above table has been determined in accordance with Rule 13d-3 of the Securities and Exchange Commission under the Securities Exchange Act of 1934, as amended, and includes shares, where applicable, which an individual has the right to acquire within 60 days through the exercise of stock options. (2) Based on 1,703,103 issued and outstanding shares of common stock as of March 12, 2002. (3) Includes (i) 75,000 shares which Mr. Fentriss has the right to acquire through the conversion of convertible preferred securities and (ii) 8,750 shares which Mr. Fentriss's wife has the right to acquire through conversion of convertible preferred securities. (4) Includes (i) 18,000 shares which Mr. Goldmeier has the right to acquire through the exercise of stock options and (ii) 13,940 shares owned by Mr. Goldmeier's wife, for which Mr. Goldmeier disclaims beneficial ownership, and (ii) 3,750 shares which Mr. Goldmeier has the right to acquire through the conversion of convertible preferred securities. (5) Includes (i) 18,000 shares which Mr. Kellam has the right to acquire through the exercise of stock options and (ii) 16,834 shares registered in the name of Mr. Kellam's wife, for which Mr. Kellam disclaims beneficial ownership. 30 (6) Includes (i) 2,000 shares which Mr. Moss has the right to acquire through the exercise of stock options and (ii) 1,500 shares held in trust, representing the proceeds of a self directed individual Retirement Account for the benefit of Thomas W. Moss, Jr. (7) Includes (i) 18,000 shares which Dr. Payne has the right to acquire through the exercise of stock options, (ii) 635 shares registered in the name of Dr. Payne's wife, for which Dr. Payne disclaims beneficial ownership, and (iii) 3,287 shares registered in the name of Payne Pension and Profit Sharing Plan FBO William D. Payne. (8) Includes (i) 18,000 shares which Mr. Perlin has the right to acquire through the exercise of stock options, (ii) 18,834 shares registered in the name of Herbert L. Perlin, Profit Sharing Trust, of which Mr. Perlin is Acting Trustee, (iii) 4,066 shares owned jointly by Mr. Perlin and his wife, (iv) 3,734 shares registered as the Perlin Revocable Living Trust, and (v) 205 shares in Mr. Perlin's investment account at Anderson & Strudwick. (9) Includes (i) 18,000 shares which Mr. Tavss has the right to acquire through the exercise of stock options, (ii) 1,265 shares registered in the name of Richard J. Tavss, Custodian for Bobbie J. Tavss, (iii) 286 shares registered in the name of Richard J. Tavss, Custodian for Sanders T. Schoolar V, (iv) 282 shares registered in the name of Richard J. Tavss, Custodian for Zachary I. Maiden, and (v) 333 shares registered in the name of Richard J. Tavss, Custodian for Taylor Tavss Scholar. (10) Includes (i) 29,133 shares which Mr. Woodard has the right to acquire through the exercise of stock options, (ii) 646 shares registered in the name of E. J. Woodard, Jr., Custodian for Troy Brandon Woodard, (iii) 1,534 shares registered in the name of E. J. Woodard, Jr. and Sharon W. Woodard, Custodians of Troy Brandon Woodard, (iv) 2,022 shares held in trust, representing the proceeds of a self directed Individual Retirement Account for the benefit of E. J. Woodard, Jr., and (v) 8,906 shares owned jointly by Mr. Woodard and his wife. (11) Includes (i) 2,000 shares which Mr. Young has the right to acquire through the exercise of stock option, and (ii) 5,250 shares representing the proceeds of a self directed Individual Retirement Account for the benefit of Kenneth J. Young. Security Ownership of Certain Beneficial Owners The following table sets forth certain information with respect to beneficial ownership of the Corporation's common stock as of March 12, 2002 by each beneficial owner of more than 5.0% of the Corporation's common stock. Name and Address Of Holder Beneficial Ownership --------- -------------------- Shares Percent ------ ------- Laurence C. Fentriss 165,057 9.2% Baxter, Fentriss & Company Suite 280 Richmond, VA 23236 James E. Baxter 90,396 5.3% Baxter, Fentriss & Company Suite 280 Richmond, VA 23236 Richard J. Tavss 124,109 7.2% PO Box 3747 Norfolk, VA 23514 31 Item 12. Certain Relationships and Related Transactions. Loans to Officers and Directors Certain directors and officers of the Corporation and the Bank, members of their immediate families, and corporations, partnerships and other entities with which such persons are associated, are customers of the Bank. As such, some of these persons engaged in transactions with the Bank in the ordinary course of business during 2001, and will have additional transactions with the Bank in the future. All loans extended and commitments to lend by the Bank to such persons were made in the ordinary course of business upon substantially the same terms, including interest rates and collateral, as those prevailing at the time for comparable transactions with unaffiliated persons and do not involve more than the normal risk of collectability or present other unfavorable features. As of December 31, 2001, the amount of loans from the Bank to all officers and directors of the Corporation and the Bank, and entities in which they are associated, was approximately $2.6 million. This amount represented 19.1% of the total equity capital of the Bank as of December 31, 2001. Business Relationships and Transactions with Management In the ordinary course of its business, the Corporation and the Bank engaged in certain transactions with their officers and directors in which such officers and directors have a significant interest. All such transactions have been made on substantially the same terms as those prevailing at the time for comparable transactions with unaffiliated parties. The Bank has from time to time retained the Norfolk, Virginia law firm of Tavss, Fletcher, Maiden and King, P.C., of which Mr. Tavss, a director of the Corporation and the Bank, is senior counsel, to perform certain legal services for the Corporation and the Bank. In 1984, the Bank entered into a lease with Boush Bank Building Associates, a limited partnership (the "Partnership"), to rent the headquarters building (the "Headquarters") of the Corporation and the Bank, which is located at the corners of Freemason and Boush Streets, Norfolk, Virginia. The general partner of the Partnership is Boush Bank Building Corporation. The limited partners of the Partnership are Messrs. Woodard and Kellam, who are directors of the Corporation and the Bank, and the estate of George H. Burton, a former director. The lease requires the Bank to pay all taxes, maintenance and insurance. The term of the lease if twenty-three years and eleven months, and began on December 19, 1984. In connection with this property, the lessor has secured financing in the form of a $1.6 million industrial development revenue bond from the Norfolk Redevelopment and Housing Authority payable in annual installments, commencing on January 1, 1987, at amounts equal to 3.0% of the then outstanding principal balance through the twenty-fifth year, when the unpaid balance will become due. Interest on this bond is payable monthly, at 68.6% of the prime rate of Suntrust Bank in Richmond, Virginia. Monthly rent paid by the Bank is equal to interest on the above bond, plus any interest associated with secondary financing provided the lessor by the Bank. The Bank has the right to purchase, at its option, an undivided interest in the property at undepreciated original cost, and is obligated to purchase in each January after December 31, 1986, an undivided interest in an amount equal to 90.0% of the legal amount allowed by banking regulations for investments in fixed properties, unless the Bank's return on average assets is less than seven-tenths of one percent. Under this provision the Bank has purchased 54.4% of this property for a total of $999.6 thousand. No purchases have been made after 1988. The terms of the lease are not less favorable than could be obtained from a non-related party. Additionally, in 1998, the Bank of the Commonwealth entered into a lease with respect to its branch at 1217 Cedar Road, Chesapeake, Virginia with Morton Realty Associates, a Virginia general partnership, and Richard J. Tavss and several other parties who share ownership and responsibility as landlord under the lease. Morton Goldmeier is a partner in Morton Realty Associates, one of the landlords under the lease, and is also a member of the board of directors of the Bank of the Commonwealth and Commonwealth Bankshares. Richard J. Tavss, also one of the landlords under the lease, is also a member of the board of directors of the Bank of the Commonwealth and Commonwealth Bankshares. Annual lease payments under the lease currently are $95.1 thousand. The board of directors of Commonwealth Bankshares reviewed two independent appraisals with respect to this property prior to entering into this lease. We believe the terms of this lease are no less favorable than could be obtained from a non-related party in an arms-length transaction. 32 Item 13. Exhibits and Reports on Form 8-K. (a)(3) Exhibits 3.1 Articles of Incorporation. Filed June 15, 1988, as Exhibit 3.1 to the Registrant's Form S-4, and incorporated herein by reference. 3.2 Bylaws. Filed June 15, 1988, as Exhibit 3.2 to the Registrant's Form S-4, and incorporated herein by reference. 3.3 Amendment to Articles of Incorporation dated July 28, 1989. Filed March 20, 1990, as Exhibit 3.3 to the Registrant's Form 10-K, and incorporated herein by reference. 3.4 Amendment to Articles of Incorporation dated November, 2000. Filed as Exhibit 3.4 to the Registrant's Form S-1, and incorporated herein by reference. 10.1 Lease. Filed June 15, 1988, as Exhibit 10.1 to theRegistrants Form S-4, and incorporated herein by reference. 10.5 Bank of the Commonwealth Directors' Deferred Compensation Plan. Filed February 1, 2002, as Exhibit 4.1 to the Registrant's Form S-8, and incorporated herein by reference. 10.6 Bank of the Commonwealth Supplemental Executive Retirement Plan. Filed February 1, 2002, as Exhibit 4.2 to the Registrant's Form S-8, and incorporated herein by reference. 10.7 Deferred Supplemental Compensation Agreement with Edward J. Woodard, Jr. Filed March 21, 1989, as Exhibit 10.7 to the Registrant's Form 10-K, and incorporated herein by reference. 10.8 Employment Agreement with Edward J. Woodard, Jr. Filed March 20, 1990, as Exhibit 10.8 to Registrant's Form 10-K, and incorporated herein by reference 10.9 Employment Agreement with John H. Gayle. Filed March 28, 1991, as Exhibit 10.9 to Registrant's Form 10-K, and incorporated herein by reference. 10.10 Amendment to Deferred Supplemental Compensation Agreement with Edward J. Woodard, Jr. Filed March 30,1994, as Exhibit 10.10 to Registrant's Form 10-K, and incorporated herein by reference. 10.11 Amendment to Employment Agreement with Edward J. Woodard, Jr. Filed March 30, 1994, as Exhibit 10.11 to Registrant's Form 10-K, and incorporated herein by reference. 10.12 Amendment to Employment Agreement with John H. Gayle. Filed March 30, 1994, as Exhibit 10.12 to Registrant's Form 10-K, and incorporated herein by reference. 10.13 Non-Employee Director Stock Compensation Plan. Filed March 30, 1996, as Exhibit 10.13 to Registrant's form 10-K, and incorporated herein by reference. 10.14 Second amendment to deferred supplemental agreement dated December 27, 1978, with Edward J. Woodard, Jr. Filed April 2, 2001 as Exhibit 10.14 to The Registrant's Form 10-K. 10.15 Certificate of Trust of the Trust, included as Exhibit 4.1 to the Registrants' Registration Statement on form S-1, Registration No. 333-63314, and incorporated herein by reference. 10.16 Declaration of Trust between the Company and the Trust. Included as Exhibit 4.2 to the Registrants' Registration Statement on Form S-1, Registration No. 333-63314, and incorporated herein by reference. 10.17 Form of Amended and Restated Declaration of Trust of the Trust, included as Exhibit 4.3 to the Registrants' Registration Statement on Form S-1, Registration No. 333-63314, and incorporated herein by reference. 33 10.18 Form of Junior Subordinated Indenture between the Company and Wilmington Trust Company, as trustee, included as Exhibit 4.4 to the Registrants' Registration Statement on Form S-1, Registration No. 333-63314, and incorporated herein by reference. 10.19 Form of Convertible Security certificate, included as Exhibit 4.5 to the Registrants' Registration Statement on Form S-1, Registration No. 333-63314, and incorporated herein by reference. 10.20 Form of Junior Subordinated Debt Securities, included as Exhibit 4.4 to the Registrants' Registration Statement on Form S-1, Registration No. 333-63314, and incorporated herein by reference. 10.21 Form of Guarantee Agreement with respect to the Convertible Securities, included as Exhibit 4.7 to the Registrants' Registration Statement on Form S-1, Registration No. 333-63314, and incorporated herein by reference. 99.1 Consolidated Financial Statements. * *Filed herewith. (b) Reports filed on Form 8-K for the quarter ended December 31, 2001. None SIGNATURES Pursuant to the requirements of Section 13 or 15(d) of the Securities Exchange Act of 1934, the registrant has duly caused this Report to be signed on its behalf by the undersigned, thereunto duly authorized. Commonwealth Bankshares, Inc. (Registrant) Date: March 29, 2002 by: ---------------------------------- E. J. Woodard, Jr., CLBB Chairman of the Board, President and Chief Executive Officer by: ---------------------------------- John H. Gayle Executive Vice President & Cashier (Principal Financial Officer) by: ---------------------------------- E. Carlton Bowyer Director by: ---------------------------------- Laurence C. Fentriss Director by: ---------------------------------- Morton Goldmeier Director 34 by: ---------------------------------- William P. Kellam Director by: ---------------------------------- Thomas W. Moss, Jr. Director by: ---------------------------------- William D. Payne, M.D. Director by: ---------------------------------- Herbert L. Perlin Director by: ---------------------------------- Richard J. Tavss Director by: ---------------------------------- Kenneth J. Young Director 35 Exhibit 99.1 Commonwealth Bankshares, Inc. List of Financial Statements The following consolidate financial statements of Commonwealth Bankshares, Inc. and subsidiary are included: Consolidated balance sheets-December 31, 2001 and 2000 Consolidated statements of income-Year ended December 31, 2001, 2000 and 1999. Consolidated statements of stockholders' equity-Year ended December 31, 2001, 2000 and 1999. Consolidated statements of cash flows-Years ended December 31, 2001, 2000 and 1999. Notes to consolidated financial statements-December 31, 2001. Schedules to the consolidated financial statements required by Article 9 of Regulations S-X are not required under the related instructions or are inapplicable, and therefore have been omitted. 36 INDEX PAGE Independent Auditors' Report F-2 Financial Statements Consolidated balance sheets F-3 Consolidated statements of income F-5 Consolidated statements of stockholder's equity F-6 Consolidated statements of cash flows F-7 Notes to consolidated financial statements F-8 COMMONWEALTH BANKSHARES, INC. Independent Auditors' Report Board of Directors Commonwealth Bankshares, Inc. Norfolk, Virginia We have audited the accompanying consolidated balance sheets of Commonwealth Bankshares, Inc. and its subsidiaries as of December 31, 2001 and 2000, and the related consolidated statements of income, stockholders' equity and cash flows for each of the three years in the period ended December 31, 2001. These financial statements are the responsibility of the Company's management. Our responsibility is to express an opinion on these financial statements based on our audits. We conducted our audits in accordance with auditing standards generally accepted in the United States of America. Those standards require that we plan and perform the audit to obtain reasonable assurance about whether the financial statements are free of material misstatement. An audit includes examining, on a test basis, evidence supporting the amounts and disclosures in the financial statements. An audit also includes assessing the accounting principles used and significant estimates made by management, as well as evaluating the overall financial statement presentation. We believe that our audits provide a reasonable basis for our opinion. In our opinion, the consolidated financial statements referred to above present fairly, in all material respects, the financial position of Commonwealth Bankshares, Inc. and its subsidiaries as of December 31, 2001 and 2000, and the results of their operations and their cash flows for each of the three years in the period ended December 31, 2001, in conformity with accounting principles generally accepted in the United States of America. POTI, WALTON & ASSOCIATES, PC Richmond, Virginia January 18, 2002 F-2 COMMONWEALTH BANKSHARES, INC. CONSOLIDATED BALANCE SHEETS DECEMBER 31, 2001 AND 2000 ASSETS 2001 2000 ------------- ------------- Cash and cash equivalents: Cash and due from banks $ 6,434,225 $ 6,886,063 Federal funds sold 5,319,706 7,181,134 ------------- ------------- Total cash and cash equivalents 11,753,931 14,067,197 Interest-bearing deposits in bank 13,976,555 7,572,395 Investment securities: Available for sale 13,498,407 15,087,131 Held to maturity 2,887,315 4,345,966 Equity securities, restricted, at cost 917,270 726,751 Loans receivable: Commercial 28,435,499 25,300,477 Commercial construction 5,668,581 3,659,197 Commercial mortgage 95,424,615 81,627,100 Residential mortgage 36,480,368 36,451,466 Installment loans to individuals 10,499,578 7,756,748 Other 2,171,349 3,682,353 ------------- ------------- Gross loans 178,679,990 158,477,341 Unearned income (611,159) (535,058) Allowance for loan losses (1,988,000) (1,920,000) ------------- ------------- Loans, net 176,080,831 156,022,283 Premises and equipment, net 5,587,834 4,537,213 Foreclosed real estate 328,433 130,609 Accrued interest receivable 1,321,763 1,346,527 Other assets 4,215,378 2,027,582 ------------- ------------- $ 230,567,717 $ 205,863,654 ============= ============= F-3 LIABILITIES AND STOCKHOLDERS' EQUITY 2001 2000 ------------ ------------ Liabilities: Deposits: Noninterest-bearing demand deposits $ 23,537,438 $ 17,339,931 Interest-bearing: Demand deposits 23,091,671 18,053,072 Savings deposits 5,433,537 5,173,633 Other time deposits 152,846,281 144,048,327 ------------ ------------ Total deposits 204,908,927 184,614,963 Short-term borrowings 1,424,312 5,382,245 Long-term debt 478,720 504,832 Accrued interest payable 1,038,892 906,164 Other liabilities 1,858,588 1,628,580 ------------ ------------ Total liabilities 209,709,439 193,036,784 Convertible preferred securities 7,285,000 -- Stockholders' equity: Common stock, par value $2.50, 5,000,000 shares authorized; 1,703,002 and 1,683,562 shares issued and outstanding in 2001 and 2000, respectively 4,257,506 4,208,906 Additional paid-in capital 5,477,930 5,400,499 Retained earnings 3,775,600 3,435,372 Accumulated other comprehensive income (loss) 62,242 (217,907) ------------ ------------ Total stockholders' equity 13,573,278 12,826,870 ------------ ------------ $230,567,717 $205,863,654 ============ ============ The accompanying notes are an integral part of these consolidated financial statements. F-4 COMMONWEALTH BANKSHARES, INC. CONSOLIDATED STATEMENTS OF INCOME FOR THE YEARS ENDED DECEMBER 31, 2001, 2000, AND 1999
2001 2000 1999 ----------- ----------- ----------- Interest income: Loans, including fees $15,403,576 $13,056,166 $ 9,512,833 Investment securities 987,708 1,201,907 1,296,281 Other interest income 936,340 334,029 51,463 ----------- ----------- ----------- Total interest income 17,327,624 14,592,102 10,860,577 Interest expense: Deposits 10,699,299 7,799,662 5,262,773 Other interest expense 183,157 351,077 238,804 ----------- ----------- ----------- Total interest expense 10,882,456 8,150,739 5,501,577 ----------- ----------- ----------- Net interest income 6,445,168 6,441,363 5,359,000 Provision for loan losses 360,046 1,154,582 109,823 ----------- ----------- ----------- Net interest income after provision for loan losses 6,085,122 5,286,781 5,249,177 Noninterest income: Service charges on deposit accounts 817,865 710,075 842,240 Other service charges and fees 526,634 372,237 235,099 Other 144,265 99,530 131,857 ----------- ----------- ----------- Total noninterest income 1,488,764 1,181,842 1,209,196 Noninterest expenses: Salaries and employee benefits 3,228,974 2,983,840 2,290,700 Net occupancy expense 699,340 612,199 464,458 Furniture and equipment expense 1,007,915 722,300 609,499 Other operating expense 1,897,633 1,845,128 1,491,902 ----------- ----------- ----------- Total noninterest expenses 6,833,862 6,163,467 4,856,559 ----------- ----------- ----------- Income before income taxes 740,024 305,156 1,601,814 Provision for income taxes 162,731 3,651 446,424 ----------- ----------- ----------- Net income $ 577,293 $ 301,505 $ 1,155,390 =========== =========== =========== Earnings per share: Basic $ .34 $ .18 $ .71 =========== =========== =========== Diluted $ .31 $ .16 $ .64 =========== =========== ===========
The accompanying notes are an integral part of these consolidated financial statements. F-5 COMMONWEALTH BANKSHARES, INC. CONSOLIDATED STATEMENTS OF STOCKHOLDERS' EQUITY FOR THE YEARS ENDED DECEMBER 31, 2001, 2000, and 1999
Accumulated Additional Other Common Paid-in Retained Comprehensive Stock Capital Earnings Income (Loss) Total ---------- ---------- ----------- --------- ------------ Balance, December 31, 1998 $2,710,383 $5,175,939 $ 3,740,072 $ (46,649) $ 11,579,745 Comprehensive income: Net income -- -- 1,155,390 -- 1,155,390 Net change in unrealized gain (loss) on securities available for sale -- -- -- (480,984) (480,984) ------------ Total comprehensive income 674,406 Issuance of common stock - 18,636 shares 46,590 98,849 -- -- 145,439 50% stock dividend - 541,954 shares 1,354,885 -- (1,354,885) -- -- Cash dividend - $.105 per share -- -- (172,992) -- (172,992) ---------- ---------- ----------- --------- ------------ Balance, December 31, 1999 4,111,858 5,274,788 3,367,585 (527,633) 12,226,598 Comprehensive income: Net income -- -- 301,505 -- 301,505 Net change in unrealized gain (loss) on securities available for sale -- -- -- 309,726 309,726 ------------ Total comprehensive income 611,231 Issuance of common stock - 38,819 shares 97,048 125,711 -- -- 222,759 Cash dividend - $.14 per share -- -- (233,718) -- (233,718) ---------- ---------- ----------- --------- ------------ Balance, December 31, 2000 4,208,906 5,400,499 3,435,372 (217,907) 12,826,870 Comprehensive income: Net income -- -- 577,293 -- 577,293 Net change in unrealized gain (loss) on securities available for sale -- -- -- 280,149 280,149 Total comprehensive income 857,442 ------------ Issuance of common stock - 19,440 shares 48,600 77,431 -- -- 126,031 Cash dividend - $.14 per share -- -- (237,065) -- (237,065) ---------- ---------- ----------- --------- ------------ Balance, December 31, 2001 $4,257,506 $5,477,930 $ 3,775,600 $ 62,242 $ 13,573,278 ========== ========== =========== ========= ============
The accompanying notes are an integral part of these consolidated financial statements. F-6 COMMONWEALTH BANKSHARES, INC. CONSOLIDATED STATEMENTS OF CASH FLOWS FOR THE YEARS ENDED DECEMBER 31, 2001, 2000, 1999
2001 2000 1999 ------------ ------------ ------------ Operating activities: Net income $ 577,293 $ 301,505 $ 1,155,390 Adjustments to reconcile net income to net cash from (used in) operating activities: Provision for loan losses 360,046 1,154,582 109,823 Depreciation and amortization 651,027 490,385 411,795 Other, net (2,236) (327,729) (15,477) Net change in: Accrued interest receivable 24,764 (302,316) (187,753) Accrued interest payable 132,728 355,247 169,850 Other assets (2,016,557) 34,069 362,897 ------------ ------------ ------------ Net cash from (used in) operating activities (272,935) 1,705,743 2,006,525 Investing activities: Net change in interest-bearing deposits in bank (6,404,160) (7,572,395) -- Purchase of securities available for sale (3,845,680) (288,746) (3,773,059) Purchase of equity securities, restricted (190,519) (178,673) (44,400) Net purchase of premises and equipment (1,713,249) (2,211,660) (494,140) Net expenditures on foreclosed real estate (395,302) (74,786) (30,448) Net change in loans (20,418,594) (32,597,774) (33,692,449) Proceeds from: Maturities of securities held to maturity 1,458,651 360,795 959,072 Sales and maturities of securities available for sale 5,811,015 1,149,285 4,386,431 Sale of real estate acquired in settlement of loans 173,622 8,866 434,194 ------------ ------------ ------------ Net cash used in investing activities (25,524,216) (41,405,088) (32,254,799) Financing activities: Net change in: Other time deposits 8,797,954 43,662,453 22,848,926 Demand, interest-bearing demand and savings 11,496,010 2,594,541 (660,772) deposits Short-term borrowings (3,957,933) 1,226,052 1,672,468 Proceeds from issuance of convertible preferred securities 7,285,000 -- -- Other (137,146) (37,071) (53,665) ------------ ------------ ------------ Net cash from financing activities 23,483,885 47,445,975 23,806,957 ------------ ------------ ------------ Net increase (decrease) in cash and cash equivalents (2,313,266) 7,746,630 (6,441,317) Cash and cash equivalents, January 1 14,067,197 6,320,567 12,761,884 ------------ ------------ ------------ Cash and cash equivalents, December 31 $ 11,753,931 $ 14,067,197 $ 6,320,567 ============ ============ ============ Supplemental disclosure of cash paid during the year: Interest $ 10,749,726 $ 7,795,494 $ 5,331,577 Income taxes 195,000 481,101 562,366
The accompanying notes are an integral part of these consolidated financial statements. F-7 COMMONWEALTH BANKSHARES, INC. NOTES TO CONSOLIDATED FINANCIAL STATEMENTS DECEMBER 31, 2001 Note 1 Summary of Significant Accounting Policies 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. and BOC Insurance Agencies of Hampton Roads, Inc., are in accordance with accounting principles generally accepted in the United States of America and conform to accepted practices within the banking industry. A summary of significant accounting policies is briefly described below. Principles of Consolidation - The accompanying consolidated financial statements include the accounts of the Parent, the Trust and the Bank and its subsidiaries, collectively referred to as "the Company." All significant intercompany balances and transactions have been eliminated in consolidation. Nature of Operations - The Bank operates under a state bank charter and provides full banking services, including trust services. As a state bank, the Bank is subject to regulation of the Bureau of Financial Institutions and the Federal Reserve System. The Bank serves Norfolk, Virginia Beach, Chesapeake and Portsmouth, Virginia through its nine banking offices. Estimates - Management uses estimates and assumptions in preparing financial statements. These estimates and assumptions affect the reported amounts of assets and liabilities, the disclosure of contingent assets and liabilities and the reported revenue and expenses. Actual results could differ from those estimates. A material estimate that is particularly susceptible to significant change in the near term relates to the determination of the allowance for loan losses. Investment Securities - Investment securities which the Bank intends to hold until maturity or until called are classified as held to maturity. These investment securities are stated at cost, adjusted for amortization of premiums and accretion of discounts. Investment securities which the Bank intends to hold for indefinite periods of time, including investment securities used as part of the Bank's asset/liability management strategy, are classified as available for sale. These investment securities are carried at fair value. Net unrealized gains and losses, net of deferred income taxes, are excluded from earnings and reported as accumulated other comprehensive income (loss). Gains and losses on the sale of investment securities are determined using the specific identification method. F-8 COMMONWEALTH BANKSHARES, INC. NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (CONTINUED) DECEMBER 31, 2001 Note 1 Summary of Significant Accounting Policies (Continued) Loans Receivable - Loans receivable are intended to be held until maturity and are shown on the balance sheet net of the allowance for loan losses. Interest is computed by methods which generally result in level rates of return on principal. Interest on past due and problem loans is accrued until serious doubt arises as to the collectibility of the interest. The Bank grants commercial, real estate, and consumer installment loans to its customers. Collateral requirements for loans are determined on a loan by loan basis depending upon the purpose of the loan and the financial condition of the borrower. In the normal course of business, to meet the credit needs of its customers, the Bank has made commitments to extend credit. These commitments represent a credit risk which is not recognized in the balance sheet. The Bank uses the same credit policies in making commitments as it does for other loans. Commitments to extend credit are generally made for a period of one year or less and interest rates are determined when funds are disbursed. Collateral and other security for the loans are determined on a case by case basis. Since some of the commitments are expected to expire without being drawn upon, the contract or notional amounts do not necessarily represent future cash requirements. Allowance for Loan Losses - The allowance for loan losses is increased by charges to income and decreased by charge-offs (net of recoveries). Management's periodic evaluation of the adequacy of the allowance is based on the Bank's past loan loss experience, known and inherent risks in the portfolio, adverse situations that may affect the borrower's ability to repay, the estimated value of any underlying collateral, and current economic conditions. Foreclosed Real Estate - Foreclosed real estate is stated at the lower of cost or estimated fair market value of the property, less estimated disposal costs, if any. Cost includes loan principal and accrued interest. Any excess of cost over the estimated fair market value at the time of acquisition is charged to the allowance for loan losses. The estimated fair market value is reviewed periodically by management and any write-downs are charged against current earnings. Premises and Equipment - Premises and equipment are stated at cost less accumulated depreciation. Deprecation is computed generally by the straight-line method. It is the Company's policy to capitalize additions and improvements and depreciate the cost thereof over the estimated useful lives as follows: Buildings and improvements 5 to 40 years Furniture and equipment 3 to 10 years F-9 COMMONWEALTH BANKSHARES, INC. NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (CONTINUED) DECEMBER 31, 2001 Note 1 Summary of Significant Accounting Policies (Continued) Income Taxes - Deferred tax assets and liabilities are reflected at currently enacted income tax rates applicable to the period in which the deferred tax assets or liabilities are expected to be realized or settled. As changes in tax laws on rates are enacted, deferred tax assets and liabilities are adjusted through the provision for income taxes. Per Share Data - Basic earnings per share is computed 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:
2001 2000 1999 --------- --------- --------- Weighted average shares outstanding used to compute basic earnings per share 1,692,125 1,667,329 1,631,684 Incremental shares issuable upon the assumed exercise of stock options 191,229 189,369 172,517 --------- --------- --------- Shares used to compute diluted earnings per share 1,883,354 1,856,698 1,804,201 ========= ========= =========
On April 27, 1999, the Board of Directors declared a 3 for 2 stock split effected in the form of a 50 percent stock dividend. Accordingly, outstanding shares of common stock were increased by 541,954 shares and a transfer of $1,354,885, representing the par value of additional shares issued, was made from retained earnings to common stock. Financial Instruments - In the ordinary course of business the Bank has entered into off-balance sheet financial instruments consisting of commitments to extend credit, commitments under credit card arrangements, commercial letters of credit, and standby letters of credit. Such financial instruments are recorded in the financial statements when they are funded or related fees are incurred or received. F-10 COMMONWEALTH BANKSHARES, INC. NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (CONTINUED) DECEMBER 31, 2001 Note 1 Summary of Significant Accounting Policies (Continued) Fair Value of Financial Instruments - The carrying value of cash and cash equivalents, interest-bearing deposits in bank, accrued interest receivable, demand deposits, savings deposits, and short-term borrowings approximates fair value. The fair value of securities is based on quoted market prices. The remainder of the recorded financial instruments were valued based on the present value of estimated future cash flows, discounted at various rates in effect for similar instruments at year end. Fair values for off-balance sheet lending commitments approximate the contract or notional value taking into account the remaining terms of the agreements and the counterparties' credit standings. Cash and Cash Equivalents - For purposes of the consolidated statements of cash flows, cash and cash equivalents includes cash and due from banks and federal funds sold. Interest-bearing Deposits in Bank - Interest-bearing deposits in bank mature within one year and are carried at cost. Reclassifications - Certain prior year amounts have been reclassified to conform to the 2001 presentation. These reclassifications have no effect on previously reported net income. Note 2 Concentrations of Credit Risk At December 31, 2001, the Bank's cash and due from banks included three commercial bank deposit accounts aggregating $3,416,220 in excess of the Federal Deposit Insurance Corporation (FDIC) insured limit of $100,000 per institution. Interest-bearing deposits in bank are not subject to FDIC coverage. F-11 COMMONWEALTH BANKSHARES, INC. NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (CONTINUED) DECEMBER 31, 2001 Note 3 Investment Securities The carrying and market values of investment securities are as follows:
Carrying Unrealized Unrealized Market Amount Gains Losses Value ----------- --------- ------------ ----------- December 31, 2001 Available for sale: U.S. Government and agency securities $ 215,000 $ -- $ (5,981) $ 209,019 Mortgage-backed securities 4,893,328 46,955 (13,989) 4,926,294 State and municipal securities 4,452,832 7,179 (54,782) 4,405,229 Other equities 3,890,797 118,866 (51,798) 3,957,865 ----------- --------- ------------ ----------- $13,451,957 $ 173,000 $ (126,550) $13,498,407 =========== ========= ============ =========== Held to maturity: Mortgage-backed securities $ 1,279,108 $ 9,160 $ (8,540) $ 1,279,728 State and municipal securities 1,608,207 31,239 -- 1,639,446 ----------- --------- ------------ ----------- $ 2,887,315 $ 40,399 $ (8,540) $ 2,919,174 =========== ========= ============ =========== December 31, 2000 Available for sale: U.S. Government and agency securities $ 4,500,000 $ -- $ (74,557) $ 4,425,443 Mortgage-backed securities 5,969,200 1,712 (133,056) 5,837,856 State and municipal securities 4,448,092 483 (75,899) 4,372,676 Other equities 500,000 -- (48,844) 451,156 ----------- --------- ------------ ----------- $15,417,292 $ 2,195 $ (332,356) $15,087,131 =========== ========= ============ =========== Held to maturity: U.S. Government and agency securities $ 750,000 $ -- $ (69,375) $ 680,625 Mortgage-backed securities 1,804,190 4,119 (19,357) 1,788,952 State and municipal securities 1,791,776 14,608 (2,022) 1,804,362 ----------- --------- ------------ ----------- $ 4,345,966 $ 18,727 $ (90,754) $ 4,273,939 =========== ========= ============ ===========
F-12 COMMONWEALTH BANKSHARES, INC. NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (CONTINUED) DECEMBER 31, 2001 Note 3 Investment Securities (Continued) A maturity schedule of investment securities as of December 31, 2001 is as follows:
Available for Sale Held to Maturity ------------------------- ----------------------- Carrying Market Carrying Market Amount Value Amount Value ----------- ----------- ---------- ---------- Due: In one year or less $ -- $ -- $ 970,254 $ 977,895 After one year through five years 900,162 895,979 -- -- After five years through ten years 1,177,343 1,174,061 637,953 661,551 After ten years 2,590,327 2,544,208 -- -- ----------- ----------- ---------- ---------- 4,667,832 4,614,248 1,608,207 1,639,446 Mortgage-backed securities 4,893,328 4,926,294 1,279,108 1,279,728 Equity securities 3,890,797 3,957,865 -- -- ----------- ----------- ---------- ---------- $13,451,957 $13,498,407 $2,887,315 $2,919,174 =========== =========== ========== ==========
Securities with a carrying value of $11,940,672 and $19,223,297 and market value of $11,965,103 and $18,870,720 at December 31, 2001 and 2000, respectively, were pledged as collateral to secure public deposits and for other purposes. Note 4 Loans Receivable Although the Bank has a diversified loan portfolio, a substantial portion of the borrowers' ability to honor their contracts is dependent upon the commercial real estate operators and hotel/motel sectors. The majority of these loans are collateralized by a deed of trust on real estate. The approximate outstanding balances of loans in these sectors are as follows: December 31, 2001 2000 ----------- ----------- Commercial real estate operators $22,400,000 $23,800,000 Hotel/motel 21,100,000 14,700,000 F-13 COMMONWEALTH BANKSHARES, INC. NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (CONTINUED) DECEMBER 31, 2001 Note 4 Loans Receivable (Continued) A summary of transactions in the allowance for loan losses follows:
2001 2000 1999 ----------- ----------- --------- Balance at beginning of year $ 1,920,000 $ 931,000 $ 969,000 Provision charged to operating expense 360,046 1,154,582 109,823 Loans charged-off (303,220) (171,935) (156,963) Recoveries of loans previously charged-off 11,174 6,353 9,140 ----------- ----------- --------- Balance at end of year $ 1,988,000 $ 1,920,000 $ 931,000 =========== =========== =========
Note 5 Premises and Equipment Premises and equipment are summarized as follows: December 31, 2001 2000 ---------- ---------- Land $ 345,403 $ 263,802 Buildings and improvements 2,521,715 2,074,704 Leasehold improvements 604,070 478,100 Furniture and equipment 4,791,751 4,247,963 Construction in progress 655,085 353,360 ---------- ---------- 8,918,024 7,417,929 Less accumulated depreciation 3,330,190 2,880,716 ---------- ---------- $5,587,834 $4,537,213 ========== ========== Note 6 Deposits The aggregate amount of time deposits in denominations of $100,000 or more at December 31, 2001 and 2000 was approximately $35,396,000 and $33,498,000, respectively. F-14 COMMONWEALTH BANKSHARES, INC. NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (CONTINUED) DECEMBER 31, 2001 Note 6 Deposits (Continued) At December 31, 2001, the scheduled maturities of certificates of deposit included in other time deposits on the balance sheet are as follows: 2002 $ 97,771,419 2003 11,103,835 2004 7,846,560 2005 16,799,903 2006 5,331,583 Thereafter 70,574 ------------ $138,923,874 ============ Note 7 Dividend Limitations Dividends may be paid to the Parent by the Bank under formulas established by the appropriate regulatory authorities. These formulas contemplate that the current earnings and earnings retained for the two preceding years may be paid to the Parent without regulatory approval. In 2002, the Bank can initiate dividend payments without said regulatory approvals of approximately $1,130,000 plus an additional amount equal to the Bank's net earnings for 2002 up to the date of any such dividend declaration. Substantially all of the retained earnings of the Parent are represented by undistributed earnings of the Bank. Note 8 Short-Term Borrowings Securities sold under agreements to repurchase generally mature within one to three days from the transaction date. The maximum amount outstanding at the end of a month was $7,230,860 and $7,801,453 during 2001 and 2000, respectively. The average daily balance was $4,143,453 and $5,865,425 during 2001 and 2000, respectively. The securities underlying these agreements were under the Bank's control. Note 9 Income Taxes The current and deferred components of income tax expense are as follows: 2001 2000 1999 --------- --------- --------- Current $ 220,245 $ 389,176 $ 540,657 Deferred (57,514) (385,525) (94,233) --------- --------- --------- Provision for income taxes $ 162,731 $ 3,651 $ 446,424 ========= ========= ========= F-15 COMMONWEALTH BANKSHARES, INC. NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (CONTINUED) DECEMBER 31, 2001 Note 9 Income Taxes (Continued) A reconciliation between the provision for income taxes and the amount computed by multiplying income by the current statutory 34% federal income tax rate is as follows: 2001 2000 1999 --------- --------- --------- Income tax expense at statutory rates $ 251,608 $ 103,753 $ 544,617 Increase (decrease) due to: Tax exempt income (97,032) (127,283) (98,220) Other 8,155 27,181 27 --------- --------- --------- Provision for income taxes $ 162,731 $ 3,651 $ 446,424 ========= ========= ========= Deferred income taxes result from timing differences between taxable income and the income for financial reporting purposes. The only significant timing difference relates to the provision for loan losses. The net deferred tax asset consists of the following: December 31, 2001 2000 ----------- ----------- Deferred tax asset $ 1,335,710 $ 1,336,446 Deferred tax liability (255,655) (215,704) ----------- ----------- Net deferred tax asset $ 1,080,055 $ 1,120,742 =========== =========== F-16 COMMONWEALTH BANKSHARES, INC. NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (CONTINUED) DECEMBER 31, 2001 Note 10 Related Parties During the year, officers, directors, principal stockholders, and their affiliates (related parties) were customers of and had transactions with the Bank in the ordinary course of business. In management's opinion these transactions were made on substantially the same terms as those prevailing for other customers for comparable transactions and did not involve more than normal risks. Loan activity to related parties is as follows: 2001 2000 ----------- ----------- Beginning of year $ 3,812,829 $ 3,161,389 Additional borrowings 228,982 1,316,885 Curtailments (1,439,000) (665,445) ----------- ----------- End of year $ 2,602,811 $ 3,812,829 =========== =========== Note 11 Convertible Preferred Stock On November 15, 2000, the Parent formed the Trust, a wholly owned subsidiary. The Trust issued 1,457,000 shares of 8.0% cumulative preferred securities maturing October 15, 2031 with an option to call on or after October 15, 2006 (call price of $5.00 per share) for $7,285,000. Conversion of the preferred securities into the Parent's stock may occur at any time prior to maturity. The Trust also issued 45,063 shares of convertible common stock for $225,315. The Parent purchased all shares of the common stock. The proceeds from the sale of the preferred securities were utilized to purchase from the Parent junior subordinated debt securities (guaranteed by the Parent), of $7,510,315 bearing interest at 8.0% and maturing October 15, 2031. All intercompany interest and equity was eliminated in consolidation. F-17 COMMONWEALTH BANKSHARES, INC. NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (CONTINUED) DECEMBER 31, 2001 Note 12 Regulatory Matters The Parent (on a consolidated basis) and the Bank are subject to various regulatory capital requirements administered by the federal banking agencies. Failure to meet minimum capital requirements can initiate certain mandatory and possibly additional discretionary actions by regulators that, if undertaken, could have a direct material effect on the Parent's and the Bank's financial statements. Under capital adequacy guidelines and the regulatory framework for prompt corrective action, the Parent and the Bank must meet specific capital guidelines that involve quantitative measures of their assets, liabilities, and certain off-balance sheet items as calculated under regulatory accounting practices. The capital amounts and classification are also subject to qualitative judgments by the regulators about components, risk weightings, and other factors. Prompt corrective action provisions are not applicable to bank holding companies. Quantitative measures established by regulation to ensure capital adequacy require the Parent and the Bank to maintain minimum amounts and ratios (set forth in the following table) of total and Tier I capital (as defined in the regulations) to risk-weighted assets (as defined) and of Tier I capital (as defined) to average assets (as defined). Management believes, as of December 31, 2001 and 2000, that the Parent and the Bank met all capital adequacy requirements to which they are subject. F-18 COMMONWEALTH BANKSHARES, INC. NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (CONTINUED) DECEMBER 31, 2001 Note 12 Regulatory Matters (Continued) As of December 31, 2001, the most recent notification from the Federal Reserve Bank categorized the Bank as well capitalized under the regulatory framework for prompt corrective action. To be categorized as well capitalized, an institution must maintain minimum total risk-based, Tier I risk-based, and Tier I leverage ratios as set forth in the following tables. There are no conditions or events since the notification that management believes have changed the Bank's category. The Parent's and the Bank's actual capital amounts and ratios as of December 31, 2001 and 2000 are also presented in the table.
Minimum To Be Well Capitalized Under Prompt Minimum Capital Corrective Action Actual Requirement Provisions ----------------- ---------------- ----------------- Amount Ratio Amount Ratio Amount Ratio ------ ----- ------ ----- ------ ----- (Dollars in thousands) As of December 31, 2001: Total capital to risk weighted assets: Consolidated $22,832 11.8% $15,515 8.0% N/A N/A Bank 21,104 10.9 15,442 8.0 $19,302 10.0% Tier I capital to risk weighted assets: Consolidated 18,014 9.3 7,757 4.0 N/A N/A Bank 19,068 9.9 7,721 4.0 11,581 6.0 Tier I capital to average assets: Consolidated 18,014 7.8 9,194 4.0 N/A N/A Bank 19,068 8.3 9,158 4.0 11,447 5.0 As of December 31, 2000: Total capital to risk weighted assets: Consolidated 14,965 9.0 13,277 8.0 N/A N/A Bank 14,585 8.8 13,254 8.0 16,568 10.0 Tier I capital to risk weighted assets: Consolidated 13,045 7.9 6,639 4.0 N/A N/A Bank 12,665 7.6 6,627 4.0 9,941 6.0 Tier I capital to average assets: Consolidated 13,045 6.7 7,811 4.0 N/A N/A Bank 12,665 6.5 7,803 4.0 9,754 5.0
F-19 COMMONWEALTH BANKSHARES, INC. NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (CONTINUED) DECEMBER 31, 2001 Note 13 Disclosures About Fair Value of Financial Instruments Fair value and the carrying value of the Bank's recorded financial instruments are as follows (in thousands): December 31, 2001 December 31, 2000 ------------------- ------------------- Carrying Fair Carrying Fair Amount Value Amount Value -------- -------- -------- -------- Cash and cash equivalents $ 20,430 $ 20,430 $ 14,418 $ 14,418 Investment securities 16,385 16,417 19,433 19,361 Net loans 175,611 183,431 155,560 158,776 Deposits 205,860 211,698 184,673 187,963 Short-term borrowings 1,424 1,424 5,382 5,382 Long-term debt 479 463 505 517 The contract or notional amount of financial instruments with off-balance sheet risk are as follows: December 31, 2001 2000 ----------- ----------- Commitments to extend credit $21,613,188 $22,444,891 Standby letters of credit 1,944,926 594,518 F-20 COMMONWEALTH BANKSHARES, INC. NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (CONTINUED) DECEMBER 31, 2001 Note 14 Parent Company Only Financial Information COMMONWEALTH BANKSHARES, INC. (PARENT COMPANY ONLY) BALANCE SHEETS DECEMBER 31, 2001 AND 2000 ASSETS 2001 2000 ----------- ----------- Cash on deposit with subsidiary $ 829,495 $ 57,977 Investment in subsidiaries 19,341,879 12,495,669 Due from subsidiary 752,405 12,450 Premises 111,192 114,577 Prepaid expense 41,474 85,811 Other assets 145,348 88,562 ----------- ----------- $21,221,793 $12,855,046 =========== =========== LIABILITIES AND STOCKHOLDERS' EQUITY Accrued expenses $ 8,877 $ 27,407 Accrued interest payable 128,508 -- Junior subordinated debentures 7,510,315 -- Other liabilities 815 769 Total stockholders' equity 13,573,278 12,826,870 ----------- ----------- $21,221,793 $12,855,046 =========== =========== F-21 COMMONWEALTH BANKSHARES, INC. NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (CONTINUED) DECEMBER 31, 2001 Note 14 Parent Company Only Financial Information (Continued) COMMONWEALTH BANKSHARES, INC. (PARENT COMPANY ONLY) STATEMENTS OF INCOME FOR THE YEARS ENDED DECEMBER 31, 2001, 2000, AND 1999
2001 2000 1999 --------- -------- ----------- Income: Dividends from subsidiaries $ 947,010 $225,000 $ -- Rental income 6,000 6,000 6,500 Interest income 2,647 3,195 -- --------- -------- ----------- Total income 955,657 234,195 6,500 Expenses: Interest expense 262,024 -- -- Legal expense 7,024 63,281 12,232 Other 58,482 57,313 8,577 --------- -------- ----------- Total expenses 327,530 120,594 20,809 --------- -------- ----------- Income (loss) before income taxes and equity in undistributed net income of subsidiary 628,127 113,601 (14,309) Income tax benefits 108,420 37,876 4,547 --------- -------- ----------- Income (loss) before equity in undistributed net income of subsidiary 736,547 151,477 (9,762) Equity in undistributed net income of subsidiary (159,254) 150,028 1,165,152 --------- -------- ----------- Net income $ 577,293 $301,505 $ 1,155,390 ========= ======== ===========
F-22 Note 14 Parent Company Only Financial Information (Continued) COMMONWEALTH BANKSHARES, INC. (PARENT COMPANY ONLY) STATEMENTS OF CASH FLOWS FOR THE YEARS ENDED DECEMBER 31, 2001, 2000, AND 1999
2001 2000 1999 ----------- --------- ----------- Operating activities: Net income $ 577,293 $ 301,505 $ 1,155,390 Adjustments to reconcile net income to net cash from (used in) operating activities: Depreciation 3,385 3,385 3,667 Equity in undistributed net income of 159,254 (150,028) (1,165,152) subsidiary Net change in: Amount due to subsidiaries (739,955) 991 1,181 Prepaid expenses 44,337 (71,722) (14,089) Other assets (56,786) (101,012) -- Accrued expenses (18,530) 27,407 -- Accrued interest payable 128,508 -- -- Deferred tax liability 46 191 578 ----------- --------- ----------- Net cash from (used in) operating activities 97,552 10,717 (18,425) Investing activities: Investments in subsidiaries (6,725,315) -- -- Financing activities: Proceeds from issuance of junior subordinated debentures 7,510,315 -- -- Proceeds from issuance of common stock 125,870 222,759 145,439 Dividends paid (236,904) (233,718) (172,992) ----------- --------- ----------- Net cash from (used in) financing activities 7,399,281 (10,959) (27,553) ----------- --------- ----------- Net increase (decrease) in cash on deposit with subsidiary 771,518 (242) (45,978) Cash on deposit with subsidiary, January 1 57,977 58,219 104,197 ----------- --------- ----------- Cash on deposit with subsidiary, December 31 $ 829,495 $ 57,977 $ 58,219 =========== ========= ===========
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