10KSB

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, 2003

Commission file number 000-17377

Commonwealth Bankshares, Inc.

(Exact name of small business issuer in its charter)

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

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

Issuer’s telephone number: (757) 446-6900

Securities registered pursuant to Section 12(b) of the Act:

Title of each class	Name of each exchange 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 (or for such shorter period that the registrant was required to file such reports), and (2) has been subject to such filing requirements for the past 90 days.    Yes  x    No  ¨

Check 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, 2003:  $21.0 million

The aggregate market value of the voting stock held by non-affiliates of the registrant as of March 4, 2004:  $34.9 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 4, 2004 which was $18.06 per share, voting stock held by non-affiliates of the registrant at March 4, 2004 was 1,930,124 shares).

Shares of common equity outstanding as of March 4, 2004:  Common Stock, $2.50 Par Value - 1,930,124 shares

Part I

Item 1. Description of Business

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

The accompanying consolidated financial statements include the accounts of the Parent, the Bank and its subsidiaries, collectively referred to as “the Company”.

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

Banking Service. Through its network of banking facilities, the Bank provides a wide range of commercial banking services to individuals and small to 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 fourteen commercial banks actively engaged in business in the cities of Norfolk, Virginia Beach, Portsmouth and Chesapeake, Virginia, including five major statewide banking organizations. Finance companies, mortgage companies, credit unions and savings and loan associations also compete with the Bank for loans and deposits. In some instances, the Bank must compete for deposits with money market mutual funds that are marketed nationally.

Employees

As of December 31, 2003, the Bank had 91 full-time equivalent employees. Management of the Company 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 Parent 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 Parent to agree that it would obtain approval of the Federal Reserve Bank of Richmond prior to incurring any indebtedness. The Parent 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 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.

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A bank holding company 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 Company for all purchases or redemptions by the Company of its equity securities within the preceding 12 months, will equal 10.0% or more of the Company’s consolidated net worth, unless it meets the requirements of a well capitalized and well managed organization.

Dividend Restrictions. The ability of the Company 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 8 to Consolidated Financial Statements included as exhibit 99.1 of 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 Company, 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 Company 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 Company 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 Company’s common stock.

Any material the Company files with the SEC is available to be read and copied by the public at the SEC’s Public Reference Room at 450 Fifth Street, NW, Washington, DC 20549. The public may obtain information on the operation of the Public Reference Room by calling the SEC at 1-800-SEC-0330. The SEC also maintains an internet site that contains reports, proxy information statements, and other information regarding issuers that file electronically with the SEC at http://www.sec.gov.

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 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 Company, or what those policies or controls will be.

USA Patriot Act of 2001. In October 2001, the USA Patriot Act of 2001 was enacted in response to the terrorist attacks in New York, Pennsylvania and Washington, D.C. which occurred on September 11, 2001. The Patriot Act is intended to strengthen the ability of U.S. law enforcement agencies and the intelligence communities to work cohesively to combat terrorism on a variety of fronts. The potential impact of the Patriot Act on financial institutions of all kinds is significant and wide ranging. The Patriot Act contains sweeping anti-money laundering and financial transparency laws and imposes various regulations, including standards for verifying client identification at account opening, and rules to promote cooperation among financial institutions, regulators and law enforcement entities in identifying parties that may be involved in terrorism or money laundering.

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.

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The information required by Guide 3 has been included under Item 6, Management’s Discussion and Analysis of Financial Condition and Results of Operations.

Item 2. Description of Properties

The headquarters building (the “Headquarters”) of the Company 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 Company currently subleases to outside parties approximately 4.0 thousand square feet on the third floor. The office operates four 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 Company. The limited partners of the Partnership are Messrs. Woodard and Kellam, who are directors of the Bank and the Company and the estate of George H. Burton, a former director. In the opinion of the Company, 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 located 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 $295.5 thousand.

Item 3. Legal Proceedings

The Company is not a party to, nor is any of its property the subject of, any material pending legal proceedings incidental to its businesses 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 Company.

Item 4. Submission of Matters to a Vote of Security Holders

No matters were submitted to the Company’s shareholders for a vote during the fourth quarter of 2003.

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Part II

Item 5. Market for Common Equity and Related Stockholder Matters

Market Information. The Company’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 Company’s common stock traded on the Over-the-Counter Bulletin Board (“OTC Bulletin Board”), a NASDAQ 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 2003 and 2002.

Common Stock Performance

	Common Stock Prices
	2003				2002
	High		Low		High		Low
First Quarter	$	16.70	$	11.07	$	7.70	$	6.65
Second Quarter	$	15.30	$	12.57	$	8.47	$	7.30
Third Quarter	$	20.00	$	15.25	$	9.27	$	8.05
Fourth Quarter	$	20.00	$	18.30	$	11.96	$	8.92

Holders of Record. The Company had 1,930,124 shares of common stock outstanding as of March 4, 2004, held by approximately 340 shareholders of record.

Dividends. The Company paid a $0.04 cash dividend on February 28, May 31, August 29, and November 30 of 2003, and a $0.035 cash dividend on March 31, June 30, and November 30 of 2002 and March 31, June 30, September 30, and December 31 of 2001.

In April 1999, the Company’s Board of Directors approved a Dividend Reinvestment and Stock Purchase Plan. Under this Plan, shares purchased from the Company with reinvested dividends are issued at a five percent (5.0%) discount from market value. 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 Company’s common stock. These shares are issued at market value without incurring brokerage commissions. Of the $283.6 thousand in dividends that were paid in 2003, $89.7 thousand were reinvested. In 2002, $179.2 thousand was paid in dividends with $66.4 thousand reinvested. In 2003, $51.7 thousand was invested through the optional cash payment plan compared to $11.0 thousand in 2002.

The ability of the Company 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 8 to Consolidated Financial Statements included as exhibit 99.1 of this report.

Securities Authorized for Issuance Under Equity Compensation Plans

Equity Compensation Plan Information

Plan category	Number of securities to be issued upon exercise of outstanding options, warrants and rights (a)		Weighted-average exercise price of outstanding options, warrants and rights (b)		Number of securities remaining available for future issuance under equity compensation plans (excluding securities reflected in column (a)) (c)
Equity compensation plans approved by security holders	236,776	(1)	$	9.31	19,731	(2)
Equity compensation plans not approved by security holders	N/A			N/A	N/A
Total	236,776	(1)	$	9.31	19,731	(2)

(1) Consists entirely of shares of common stock underlying previously granted stock options that have not been exercised. All of these options were granted pursuant to the Company’s stock options plans.

(2) Represents shares available for future issuance under the Company’s stock options plans.

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Item 6. MANAGEMENT’S DISCUSSION AND ANALYSIS OF OPERATIONS AND FINANCIAL CONDITION

This commentary provides an overview of the Company’s financial condition, changes in financial condition and results of operations for the years 2003 through 2001. This section of Form 10-KSB should be read in conjunction with the Consolidated Financial Statements and related Notes thereto included as Exhibit 99.1 of 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 Company’s actual results to differ materially from those anticipated, including risks associated with general economic conditions and interest rate trends. These forward looking statements include, but are not limited to, statements regarding management’s expectations that the Company will continue to experience growth in core operating earnings, improved credit quality and increased service fee income, and that the Company may pay cash dividends in the future. Readers are cautioned not to place undue reliance on these forward looking statements, which reflect management’s analysis only as of the date hereof.

Results of Operations and Financial Condition

Commonwealth Bankshares, Inc. and Subsidiaries

Earnings Overview

Management views 2003 as an outstanding year for Commonwealth Bankshares, Inc. The Company’s net income for 2003 reached a record $2.5 million or a 51.9% increase from the $1.7 million reported for the year ended 2002. Net income in 2002 represented a 190.0% increase from the $577.3 thousand reported for the year 2001. Earnings per share has steadily increased in conjunction with the Company’s record earnings performance. Basic earnings per share during 2003 equaled $1.44 per share, an increase of 46.9% or $0.46 per share over the $0.98 per share reported in 2002. Basic earnings per share increased 188.2% during 2002 over the $0.34 per share reported in 2001. With the dilutive effect of common stock equivalents, earnings per share was $1.03 for 2003, $0.73 for 2002 and $0.31 for 2001. Management has increased its dividends paid out to its shareholders in order to share in the Company’s success. In 2003, total dividends paid out to its shareholders equaled $0.16 per share up 52.4% from $0.105 per share paid in 2002. Book value per share has also seen favorable increases. Book value per share for the years 2003, 2002, and 2001 was $10.16, $8.97 and $7.97, respectively.

The Company’s core earnings defined by the Company as pre-tax earnings exclusive of the provision for loan losses and nonrecurring items such as security gains, grew to $4.3 million in 2003 compared with the $2.8 million reported at December 31, 2002.

ROA equaled 0.91% in 2003 compared with 0.70% in 2002 and 0.25% in 2001. ROE equaled 14.75% in 2003 compared with 11.69% in 2002 and 4.51% in 2001. These ratios, along with other significant earnings and balance sheet information for each of the years in the five-year period ended December 31, 2003, are shown in the table as follows:

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Selected Financial Information

Years Ended December 31,

(in thousands, except per share data)	2003			2002			2001			2000			1999
Operating Results:
Interest income	$	19,364		$	17,632		$	17,328		$	14,592		$	10,861
Interest expense		8,379			9,058			10,883			8,151			5,502
Net interest income		10,985			8,574			6,445			6,441			5,359
Provision for loan losses		525			419			360			1,155			110
Noninterest income		1,678			1,651			1,489			1,182			1,209
Noninterest expense		8,392			7,384			6,834			6,163			4,857
Income before provision for income taxes		3,746			2,422			740			305			1,601
Provision for income taxes		1,204			748			163			3			446
Net Income	$	2,542		$	1,674		$	577		$	302		$	1,155
Per Share Data:
Basic earning	$	1.44		$	0.98		$	0.34		$	0.18		$	0.71
Diluted earnings	$	1.03		$	0.73		$	0.31		$	0.16		$	0.64
Book value	$	10.16		$	8.97		$	7.97		$	7.62		$	7.43
Basic weighted average shares outsanding		1,771,556			1,708,698			1,692,125			1,667,329			1,631,684
Diluted weighted average shares outstanding		2,824,703			2,816,968			1,883,354			1,856,698			1,804,201
Shares outstanding at year-end		1,888,271			1,721,621			1,703,002			1,683,562			1,644,743
Year-End Balance:
Assets	$	318,295		$	256,514		$	230,568		$	205,864		$	157,016
Federal funds sold		341			59			5,320			7,181			—
Loans *		230,050			196,323			178,069			157,942			125,045
Loans held for sale		56,132			27,792			—			—			—
Investment securities		12,431			16,020			16,386			19,433			20,185
Equity securities		2,398			1,181			917			727			548
Deposits		250,658			228,087			204,909			184,615			138,358
Shareholders’ equity		19,191			15,445			13,573			12,827			12,227
Average Balance:
Assets	$	277,970		$	239,306		$	226,506		$	178,799		$	139,559
Federal funds sold		1,570			3,534			5,845			4,799			1,053
Loans *		214,731			186,195			172,516			141,769			106,664
Loans held for sale		29,092			8,887			—			—			—
Investment securities		14,214			16,769			17,425			19,607			21,897
Equity securities		1,386			1,099			765			611			546
Deposits		239,726			210,414			203,146			157,365			120,506
Shareholders’ equity		17,238			14,326			12,812			12,880			12,000
Ratios:
Return on average assets		0.91	%		0.70	%		0.25	%		0.17	%		0.83	%
Return on average shareholders’ equity		14.75	%		11.69	%		4.51	%		2.34	%		9.63	%
Year-end shareholders’ equity to total assets		6.03	%		6.02	%		5.89	%		6.23	%		7.79	%
Loan loss allowance to year-end loans *		1.09	%		1.19	%		1.12	%		1.22	%		0.74	%
Net interest margin (tax equivalent basis)		4.24	%		3.90	%		3.10	%		4.00	%		4.25	%

* Net of unearned income and loans held for sale.

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Net Interest Income and Net Interest Margin

Net interest income, the fundamental source of the Company’s earnings, 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.

Table 1 presents the average interest earning assets and average interest bearing liabilities, the average yields earned on such assets (on a tax equivalent basis) and rates paid on such liabilities, and the net interest margin for the indicated periods. The variance in interest income and expense caused by differences in average balances and rate is shown in Table 2.

Net interest income, on a taxable equivalent basis, for 2003 increased 27.4% or $2.4 million to $11.1 million. Net interest income for 2002 of $8.7 million increased 31.8% or $2.1 million over 2001. Increases in net interest income, for both years, were primarily attributable to the strong growth in average interest earning assets as well as a reduction of rates paid on deposit accounts during the respective time periods.

Average interest earning assets increased $38.6 million in 2003, $10.3 million in 2002, and $46.8 million in 2001. Average loans, a higher interest earning asset, accounted for 92.9% of average interest earning assets in 2003, 87.1% in 2002, and 80.8% in 2001. Due to the lower interest rate environment and the efforts of our experienced loan officers, average loans increased $48.7 million in 2003, $22.6 million in 2002, and $30.7 million in 2001. In an effort to fund the strong loan growth, investment securities, federal funds sold and interest bearing deposits in banks, lower yielding assets, declined. Average investment securities decreased by $2.6 million in 2003, $656.0 thousand in 2002, and $2.2 million in 2001. Average federal funds sold and interest bearing deposits in banks decreased $7.9 million in 2003 and $11.9 million in 2002, and increased $18.1 million in 2001.

The net interest margin is calculated by expressing tax-equivalent net interest income as a percentage of average interest earning assets, and represents the Company’s net yield on its earning assets. Net interest margin is an indicator of the Company’s effectiveness in generating income from its earning assets. Since January 2001, the Federal Reserve lowered the federal funds rate 13 times or 550 basis points down to 1.00%. Consequently, during the same time period, the Wall Street Journal Prime Rate, which influences the market price for loans, has decreased from 9.50% to 4.00%. Given the prevalent low interest rate environment which has put pressure on maintaining strong margins, the Company’s net interest margin has increased over the past two years, indicating the Company’s ability to manage its interest earning assets.

In 2003, the net interest margin of 4.24% represented an increase of 34 basis points over the net interest margin of 3.90% recorded in 2002. The 2003 increase in net interest margin of 8.7% was the result of the repricing of certificates of deposits and strong growth in average loans. The net interest margin for 2002 increased 25.8% over the 3.10% reported for 2001. Deposit products were repriced throughout the year at the earliest opportunity available. The performance reported herein is reflected in the Company’s earning assets yield of 7.43% in 2003 compared with 7.95% in 2002 and 8.20% in 2001, reflecting the continued impact of reductions in interest rates over the past three years. The Company’s average rate paid on deposits decreased 93 basis points in 2003 to 3.66%, with a decrease of 115 basis points in 2002 from 2001.

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Table 1: Average Balance Sheet and Net-Interest Margin Analysis

	Years Ended December 31,
	2003						2002						2001
(in thousands)	Average Balance(1) Yield/Rate(2)		Interest		Average Yield/ Rate(2)		Average Balance(1)		Interest		Average Yield/ Rate(2)		Average Balance(1)			Interest			Average
Assets
Interest earning assets:
Loans (3)(4)	$	243,823	$	18,553	7.61	%	$	195,082	$	16,516	8.47	%	$	172,516		$	15,445		8.95	%
Investment securities (3)		14,214		809	5.69			16,769		1,019	6.08			17,425			1,117		6.41
Equity securities		1,386		119	8.59			1,099		74	6.73			765			49		6.41
Federal funds sold		1,570		15	0.96			3,534		64	1.81			5,845			231		3.95
Interest bearing deposits in banks		1,540		15	0.97			7,483		124	1.66			17,077			669		3.92
Total interest earning assets		262,533		19,511	7.43	%		223,967		17,797	7.95			213,628			17,511		8.20
Noninterest earning assets:
Cash and due from banks		8,160						7,757						6,007
Premises and equipment		5,632						5,848						4,999
Other assets														3,951			3,881		3,900
Less: allowance for loan losses														(2,306	)		(2,147	)	(2,028	)
Total assets	$	277,970					$	239,306					$	226,506
Liabilities and Shareholders’ Equity
Interest bearing liabilities:
Interest bearing demand deposits	$	30,963	$	222	0.72	%	$	27,763	$	294	1.06	%	$	20,993		$	349		1.66	%
Savings deposits		7,694		50	0.65	%		6,462		67	1.04	%		5,353			91		1.70	%
Time deposits		172,865		7,424	4.29	%		151,574		8,045	5.31	%		155,499			10,006		6.43	%
Short-term debt		9,986		130	1.30	%		3,749		60	1.60	%		4,145			164		3.96	%
Long-term debt		426		10	2.35	%		453		12	2.65	%		479			19		3.97	%
Convertible preferred securities		6,863		543	7.91	%		7,285		580	7.96	%		3,035			254		8.37	%
Total interest bearing liabilities		228,797		8,379	3.66	%		197,286		9,058	4.59	%		189,504			10,883		5.74	%
Non interest bearing liabilities:
Demand deposits		28,204						24,615						21,301
Other		3,731						3,079						2,889
Total liabilities		260,732						224,980						213,694
Shareholders’ equity		17,238						14,326						12,812
Total liabilities and shareholders’equity	$	277,970					$	239,306					$	226,506
Net interest income	$	11,132					$	8,739					$	6,628
Net interest margin (5)
(taxable equivalent basis)					4.24	%					3.90	%							3.10	%
Average interest spread (6) (taxable equivalent basis)					3.77	%					3.36	%							2.46	%

(1) Average balances are computed on daily balances and Management believes such balances are representative of the operations of the Company.

(2) Yield and rate percentages are all computed through the annualization of interest income and expenses versus the average balance of their respective accounts.

(3) Tax equivalent basis. The tax equivalent adjustment to loans was $32 thousand, $36 thousand, and $41 thousand for the years ended December 31, 2003, 2002 and 2001, respectively. The tax equivalent adjustment to investment securities was $115 thousand, $129 thousand, and $142 thousand for the years ended December 31, 2003, 2002, and 2001, respectively.

(4) Non-accrual loans are included in the average loan balances, and income on such loans is recognized on a cash basis. Loans are net of unearned income, and inclusive of loans held for sale.

(5) Net interest margin is net interest income, expressed as a percentage of average earning assets.

(6) Interest spread is the average yield earned on earning assets, less the average rate incurred on interest bearing liabilities.

9

Table 2: Effect of Changes in Rate and Volume on Net Interest Income

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, 2003 compared to Year Ended December 31, 2002									Year Ended December 31, 2002 compared to Year Ended December 31, 2001									Year Ended December 31, 2001 compared to Year Ended December 31, 2000
	Increase (Decrease) Due to:						Interest Income/Expense (Variance)			Increase (Decrease) Due to:						Interest Income/Expense (Variance)			Increase (Decrease) Due to:						Interest Income/Expense (Variance)
(in thousands)	Volume			Rate						Volume			Rate						Volume			Rate
Interest Income:
Loans	$	3,424		$	(1,387	)	$	2,037		$	1,832		$	(761	)	$	1,071		$	2,735		$	(431	)	$	2,304
Investment securities		(148	)		(62	)		(210	)		(41	)		(57	)		(98	)		(146	)		(46	)		(192	)
Equity securities		22			23			45			22			3			25			14			(2	)		12
Federal funds sold		(27	)		(22	)		(49	)		(70	)		(97	)		(167	)		105			(208	)		(103	)
Interest bearing deposits in banks		(71	)		(38	)		(109	)		(269	)		(276	)		(545	)		—			669			669
		3,200			(1,486	)		1,714			1,474			(1,188	)		286			2,708			(18	)		2,690
Interest Expense:
Interest bearing demand deposits		40			(112	)		(72	)		438			(493	)		(55	)		47			(144	)		(97	)
Savings deposits		18			(35	)		(17	)		27			(51	)		(24	)		8			(36	)		(28	)
Time deposits		1,731			(2,352	)		(621	)		(247	)		(1,714	)		(1,961	)		2,583			185			2,768
Short-term debt		79			(9	)		70			(14	)		(90	)		(104	)		(80	)		(75	)		(155	)
Long-term debt		(1	)		(1	)		(2	)		(1	)		(6	)		(7	)		(2	)		(11	)		(13	)
Convertible preferred securities		(33	)		(4	)		(37	)		338			(12	)		326			—			254			254
		1,834			(2,513	)		(679	)		541			(2,366	)		(1,825	)		2,556			173			2,729
Increase (decrease) in net interest income	$	1,366		$	1,027		$	2,393		$	933		$	1,178		$	2,111		$	152		$	(191	)	$	(39	)

10

Asset Quality Review and Credit Risk Management

In conducting business activities, the Company is exposed to the possibility that borrowers or counterparties may default on their obligations to the Company. Credit risk arises through the extension of loans, leases, certain securities, and financial guarantees. To manage this risk, the Company 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 Company. The Company’s credit risk is centered in its loan portfolio.

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 judgment and are impacted by many factors, including actual credit losses during the period, the prospective view of credit losses, loan performance measures and trends (such as delinquencies and charge-offs), and other factors, both internal and external that may affect the quality and future loss experience of the credit portfolio.

On a monthly basis, the Company’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. In addition, the Company has entered into an agreement with an accounting firm that serves as an independent credit review group to conduct reviews of the loan portfolio, re-examining on a regular basis risk assessments for loans and overall compliance with policy.

The allowance for loan losses is increased by the provision for loan losses and reduced by loans charged off, net of recoveries. The following table presents the Company’s loan loss experience for the past five years:

Table 3: Summary of Loan Loss Experience

	Year Ended December 31,
(in thousands)	2003			2002			2001			2000			1999
Allowance at beginning of period	$	2,335		$	1,988		$	1,920		$	931		$	969
Provision for loan losses		525			419			360			1,155			110
Charge offs:
Commercial		82			4			7			30			49
Commercial construction		—			—			—			—			—
Commercial mortgage		—			—			238			79			—
Residential mortgage		247			43			35			36			—
Installment loans to individuals		28			36			13			10			53
Other		13			3			10			17			55
Total loans charged off		370			86			303			172			157
Recoveries:
Commercial		—			—			1			—			—
Commercial construction		—			—			—			—			—
Commercial mortgage		—			2			—			—			2
Residential mortgage		—			—			1			—			—
Installment loans to individuals		12			2			—			5			7
Other		1			10			9			1			—
Total recoveries		13			14			11			6			9
Net charge-offs		357			72			292			166			148
Allowance at end of period	$	2,503		$	2,335		$	1,988		$	1,920		$	931
Year end loans *	$	230,050		$	196,323		$	178,069		$	157,942		$	125,045
Ratio of allowance to year end loans		1.09	%		1.19	%		1.12	%		1.22	%		0.74	%
Average loans outstanding *	$	214,731		$	186,195		$	172,516		$	141,769		$	106,664
Ratio of net charge-offs to average loans outstanding		0.17	%		0.04	%		0.17	%		0.12	%		0.14	%

* Net of unearned income and loans held for sale.

11

The Company made provisions for loan losses of $524.8 thousand in 2003, compared to $419.0 thousand in 2002, and $360.0 thousand in 2001. Net charge-offs in 2003 were $356.8 thousand compared to $71.2 thousand for 2002 and $292.0 thousand for 2001. This represents 0.17% of average loans outstanding in 2003, 0.04% in 2002, and 0.17% in 2001. Although the Company experienced an increase in charge-offs in 2003, net charge-offs as a percentage of average loans outstanding remained low, and below the Company’s peer group for the last three years.

The allowance for loan losses at December 31, 2003 was $2.5 million, compared with $2.3 million at December 31, 2002, and $2.0 million at December 31, 2001. This represented 1.09% of year-end loans at December 31, 2003 compared with 1.19% of year-end loans at December 31, 2002 and 1.12% of year-end loans at December 31, 2001. Based on current expectations relative to portfolio characteristics and performance measures including loss projections, management considers the level of the allowance to be adequate as of December 31, 2003.

The following table provides an allocation of the allowance for loan losses and the ratio of related outstanding loan balances to total loans as of December 31, 2003.

Table 4: Allocation of the Allowance for Loan Losses

(in thousands)	Amount		Percent of Loans in Each Category to Total Loans
Commercial	$	833	63.98	%
Commercial construction		—	—
Commercial mortgage		414	31.80
Residential mortgage		54	4.14
Installment loans to individuals		1	0.08
Other		—	—
Unallocated		1,201	N/A
Total	$	2,503	100.00	%

Non-performing Assets

Non-performing assets consist of loans accounted for on a non-accrual basis (as judgmentally determined by management based upon anticipated realization of interest income), loans which are contractually past due 90 days and other real estate owned. 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.

The following table presents information concerning non-performing assets for the periods indicated.

Table 5: Non-performing Assets

	December 31,
(in thousands)	2003		2002		2001		2000		1999
Non-accrual loans:
Commercial	$	2,358	$	946	$	1,302	$	240	$	44
Commercial construction		—		—		—		—		—
Commercial mortgage		415		318		—		46		76
Residential mortgage		67		437		—		4		805
Installment loans to individuals		5		10		20		194		184
Other		—		—		—		—		—
		2,845		1,711		1,322		484		1,109
Loans contractually past-due 90 days or more:
Commercial		—		—		—		83		38
Commercial construction		—		—		—		—		—
Commercial mortgage		—		—		—		—		—
Residential mortgage		—		—		62		17		—
Installment loans to individuals		—		18		1		7		35
Other		—		—		1		—		—
		—		18		64		107		73
Total non-performing loans		2,845		1,729		1,386		591		1,182
Other real estate owned		1,095		—		328		131		601
Total non-performing assets	$	3,940	$	1,729	$	1,714	$	722	$	1,783

12

Non-accrual loans increased $1.1 million in 2003 to $2.8 million. This increase is primarily due to one (1) commercial loan that represents $1.5 million of the $2.8 million in nonaccrual. Management is closely monitoring this credit and believes that the allowance for loan losses is adequate to offset any potential loss that may occur. The remaining $1.3 million represents eight (8) loans, the majority of which are making monthly payments, and in most cases these loans are secured with workout arrangements currently in place.

If non-accrual loans had been performing fully, these loans would have contributed an additional $137.4 thousand to interest income in 2003, $116.8 thousand in 2002, $122.8 thousand in 2001, $35.04 thousand in 2000, and $84.3 thousand for 1999.

There were no loans past due 90 days or more that were not classified as non-accrual loans as of December 31, 2003 compared to $18 thousand at December 31, 2002, and $64 thousand at December 31, 2001.

Other real estate owned totaled $1.1 million at December 31, 2003, which included one commercial property and one residential property. Subsequent to December 31, these properties are under contract to be sold. Management does not anticipate any material losses to occur upon disposition of these properties.

The Company 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 Company routinely reevaluates all reasonable alternatives, including the sale of these assets. Individual action plans have been developed for each nonperforming asset.

USES OF FUNDS

Total earning assets at December 31, 2003 increased 24.8% from year-end 2002 compared with 2002’s increase of 12.5% from year-end 2001’s increase of 11.3%. 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 $178.7 million in 2001 to $287.1 million in 2003.

Loan Portfolio

The loan portfolio is the largest component of earning assets and accounts for the greatest portion of total interest income. As of December 31, 2003, total gross loans, including loans held for sale, grew to a record $287.1 million, a $63.3 million or a 28.2% increase from $224.8 million at year end 2002. This is a continuation of the growth experienced from year end 2001 to year end 2002 of $46.1 million or 25.8%. The tremendous growth experienced during the past two years was achieved not only by the high loan demand generated by the low interest rate environment, but also by the efforts of the Company’s officers to develop new loan relationships combined with the support of existing customers.

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 Company from other “regional financial institutions” that are experiencing further consolidation. This has been an excellent source of new business for the Bank, as customers still value the personal attention traditionally offered by a community bank. The Bank intends to aggressively continue to target these relationships in future periods.

The Company’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 Company strives to maintain a loan portfolio that is diverse in terms of loan type, industry concentration, geographic distribution and borrower concentration.

The table below classifies gross loans by major category and percentage distribution of gross loans at December 31 for each of the past three years:

Table 6: Loans By Classification

	December 31
(in thousands)	2003				2002				2001
	Amount		%		Amount		%		Amount		%
Commercial	$	45,584	19.74	%	$	36,279	18.45	%	$	28,435	15.97	%
Commercial construction		7,759	3.36			7,458	3.79			5,669	3.18
Commercial mortgage		131,744	57.05			108,103	54.74			95,425	53.59
Residential mortgage		36,269	15.70			33,995	17.25			36,480	20.49
Installment loans to individuals		8,226	3.56			9,186	4.67			9,889	5.55
Other		1,369	0.59			2,033	1.10			2,171	1.22
Total gross loans		230,951	100.00	%		197,054	100.00	%		178,069	100.00	%
Loans held for sale		56,132				27,792				—
Total	$	287,083			$	224,846			$	178,069

13

Total commercial loans increased 21.9% to $185.1 million in 2003 compared with an increase of 17.2% to $151.8 million in 2002 and an increase of 17.1% to $129.5 million in 2001. Consumer real estate loans increased $36.3 million or 6.7% in 2003, compared to a decrease of 6.8% to $34.0 in 2002, and a 6.1% increase to $36.5 million in 2001. Consumer loans decreased $1.6 million or 14.5% in 2003 following a decrease of $1.3 million or 12.5% in 2002, and an increase of $2.7 million or 35.4% in 2001. Included in total loans as of December 2003, were $56.1 million in loans classified as held for sale. These loans are pre-committed for sale prior to funding and are secured by First Deeds of Trust on residential 1 to 4 family dwellings. As of December 2002, the Company had $27.8 million in loans classified as held for sale.

The Company will continue with its efforts to develop creditable loan relationships in order to enhance its earnings opportunities while simultaneously strengthening its underwriting criteria. To limit credit exposure, the Company 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 Company 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.

A number of measures have been taken by the Company 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 Company’s real estate portfolio is comprised of loans to customers located within the Company’s established marketplace.

Senior level management is devoted to the management and/or collection of certain non-performing assets as well as certain performing loans. Aggressive collection strategies and a proactive approach to managing overall credit risk has expedited the Company’s disposition, collection and re-negotiation of non-performing and other lower-quality assets and allowed loan officers to concentrate on generating new business.

The following table shows the maturity or period of re-pricing of gross loans outstanding as of December 31, 2003. Demand loans as well as loans having no stated schedule of repayments and no stated maturity are reported as due within one year. Adjustable and floating-rate loans are included in the period in which interest rates are next scheduled to adjust rather than in which they contractually mature. Fixed rate loans are included in the period in which the final contractual repayment is due. Since the majority of the Company’s loan portfolio is short-term, the Company can re-price its portfolio more frequently to minimize long-term interest rate fluctuations and maintain a steady interest margin.

Table 7: Loan Maturities and Re-Pricing Schedule

	December 31, 2003
(in thousands)	Within One Year		After One But Within Five Years		After Five Years		Total
Variable Rate:
Commercial	$	18,894	$	7,180	$	1,244	$	27,318
Commercial construction		2,397		190		—		2,587
Commercial mortgage		41,498		38,168		5,350		85,016
Residential mortgage		8,834		7,107		3,448		19,389
Installment and other loans		2,045		—		990		3,035
Total variable rate	$	73,668	$	52,645	$	11,032	$	137,345
Fixed Rate:
Commercial	$	5,450	$	5,846	$	6,970	$	18,266
Commercial construction		644		—		4,528		5,172
Commercial mortgage		5,643		8,170		32,915		46,728
Residential mortgage		2,035		3,717		11,128		16,880
Installment and other loans		691		2,998		2,871		6,560
Total fixed rate	$	14,463	$	20,731	$	58,412	$	93,606
Total	$	88,131	$	73,376	$	69,444	$	230,951

Investments

The investment portfolio plays a primary role in the management of interest rate sensitivity of the Company and generates interest income. In addition, the portfolio serves as a source of liquidity and is used as needed to meet collateral requirements. Table 8 presents information pertaining to the composition of the securities portfolio. At year-end 2003, 2002, and 2001, investment securities totaled $12.4 million, $16.0 million, and $16.4 million, respectively. Investments that matured or were called during 2003 were used to fund the strong loan demand, resulting in a 22.4% decline in the total investment portfolio.

14

Table 8: Composition of Investments

	December 31,
(in thousands)	2003		2002		2001
Securities available for sale (1):
U. S. government and its agencies	$	809	$	1,304	$	209
State and municipals		4,647		4,970		4,405
Mortgage-backed securities		2,182		4,877		4,926
Corporate bonds		1,624		1,550		1,782
Preferred stock		2,332		2,272		2,177
		11,594		14,973		13,499
Securities held to maturity (2):
State and municipal		254		246		1,608
Mortgage-backed securities		583		801		1,279
		837		1,047		2,887
Total investment securities	$	12,431	$	16,020	$	16,386

(1) Carried at fair value

(2) Carried at cost, adjusted for amortization of premium or accretion of discount using the interest method.

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 re-evaluates asset and liability strategies when economic and financial conditions fluctuate in a magnitude that might adversely impact the Company’s overall interest rate risk, liquidity, or capital adequacy positions. Re-assessment 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.

Management views the portfolio as well diversified among several market sectors as summarized below:

Sector	%
U.S. treasuries	8.4
Municipals	44.7
Fixed Agency	3.1
Floating MBS	14.2
Floating CMO	8.1
Fixed MBS	3.1
Fixed CMO	2.7
Corporates	13.6
Other	2.1
	100.0	%

The following table presents information on the maturities and weighted average yields of the Company’s investment securities at December 31, 2003. The weighted average yields are calculated on the basis of book value of the investment securities and on the interest income of the investments adjusted for amortization of premium and accretion of discount.

15

Table 9: Investment Maturities and Yields

	December 31, 2003
	Held to Maturity						Available for Sale
(in thousands)	Amortized Cost		Fair Value		Weighted Average Yield		Amortized Cost		Fair Value		Weighted Average Yield
US Government agencies:
Within one year	$	—	$	—	—		$	809	$	809	0.93	%
After one year to five years		—		—	—			—		—	—
After five years through ten years		—		—	—			—		—	—
After ten years		—		—	—			—		—	—
Total		—		—	—			809		809	0.93	%
State and municipals:
Within one year		—		—	—			—		—	—
After one year to five years		254		276	7.66	%		1,246		1,324	6.39	%
After five years through ten years		—		—	—			1,700		1,809	6.23	%
After ten years		—		—	—			1,406		1,514	6.74	%
Total		254		276	7.66	%		4,352		4,647	6.44	%
Mortgage-backed:
Within one year		29		29	3.88	%		221		220	4.21	%
After one year to five years		503		503	5.68	%		1,453		1,486	4.78	%
After five years through ten years		51		51	2.84	%		474		476	3.55	%
After ten years		—		—	—			—		—	—
Total		583		583	5.35	%		2,148		2,182	4.45	%
Other securities:
Within one year		—		—	—			248		252	8.61	%
After one year to five years		—		—	—			—		—	4.08	%
After five years through ten years		—		—	—			775		815	6.64	%
After ten years		—		—	—			532		557	—
Total		—		—	—			1,555		1,624	5.66	%
Total debt securities	$	837	$	859	6.77	%	$	8,864	$	9,262	5.33	%
Equity securities		—		—	—		$	2,135	$	2,332	9.54	%
Total securities	$	837	$	859	6.05	%	$	10,999	$	11,594	4.28	%

As of December 31, 2003, the overall portfolio has a yield of 5.7%, on a fully taxable equivalent basis. It has a weighted average repricing term of 4.1 years, and 77.7% of total holdings are invested in fixed rate securities. 93.3% of the portfolio is categorized as available for sale (AFS). As of December 31, 2003, the total portfolio currently contained an unrealized gain of $618 thousand.

Municipal holdings total $4.3 million par value, or 44.7% of total holdings, and have a taxable equivalent yield to the effective maturity date of 6.7%. Management believes these issues have excellent credit quality, as most of the portfolio is AA-rated or higher. The average duration date of the municipal portfolio is approximately 3.7 years.

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 Company. Flexibility is one of the hallmarks of the Company’s ability to meet the banking needs of its customers.

SOURCES OF FUNDS

Deposits

The Company’s predominant source of funds is depository accounts. The Company’s deposit base, which is provided by individuals and businesses located within the communities served, is comprised of demand deposits, savings and money market accounts, and time deposits. The Company’s balance sheet growth is largely determined by the availability of deposits in its markets, the cost of attracting the deposits, and the prospects of profitably utilizing the available deposits by increasing the loan or investment portfolios.

16

Total deposits reached a record $250.7 million as of December 31, 2003, an increase of 9.9% or $22.6 million over 2002. This is a continuation of the growth experienced in 2002 of $23.2 million or 11.3% to $228.1 million. Management believes the growth in deposits is a result of the Company’s competitive interest rates on all deposit products, special deposit promotions and product enhancements, as well as the Company’s continued marketing efforts.

Interest rates paid on specific deposit types are set by management and are determined based on (i) the interest rates offered by competitors, (ii) anticipated amount and timing of funding needs (iii) availability of and cost of alternative sources of funding and (iv) anticipated future economic conditions and interest rates. Customer deposits are attractive sources of liquidity because of their stability, cost and the ability to generate fee income through the cross-sale of other services to the depositors. The Company will continue funding assets with deposit liability accounts and focus upon core deposit growth as its primary source of liquidity and stability.

The breakdown of deposits at December 31 for the three previous years is shown in the following table.

Table 10: Deposits by Classification

	December 31,
	2003				2002				2001
(in thousands)	Balance		%		Balance		%		Balance		%
Noninterest bearing demand deposits	$	31,975	12.76		$	25,575	11.21		$	23,537	11.49
Interest bearing demand deposits		33,730	13.46			28,746	12.60			24,182	11.80
Savings deposits		7,997	3.19			6,502	2.85			5,864	2.86
Time deposits:
Less than $100,000		129,124	51.51			123,599	54.20			116,248	56.73
$100,000 or more		47,832	19.08			43,665	19.14			35,078	17.12
	$	250,658	100.00	%	$	228,087	100.00	%	$	204,909	100.00	%

Table 11: Maturities of Time Deposits $100,000 or More at December 31, 2003

(in thousands)	Amount
3 months or less	$	14,322
Over 3 through 12 months		12,399
Over 12 months		21,111
Total	$	47,832

Borrowings

The Company’s ability to borrow funds through nondeposit sources provides additional flexibility in meeting the liquidity needs of customers while enhancing its cost of funds structure.

Purchased liabilities are composed of federal funds purchased, advances from the Federal Home Loan Bank, and certificates of deposit of $100.0 thousand and over (large CDs). The strong loan demand experienced over the last several years outpaced the Company’s increase in core deposits, and as a result purchased funds at December 31, 2003 equaled $84.8 million compared to $45.6 million during 2002, and $36.8 million in 2001. See Notes 9 and 10 in the Notes to Consolidated Financial Statements for additional disclosures related to borrowing arrangements.

Noninterest Income

Total noninterest income increased in 2003 to $1.7 million, an increase of $26.6 thousand reported in 2002. Total noninterest income increased $173.6 thousand or 11.7% in 2002 and $306.9 thousand or 26.0% in 2001. Service charges on deposit accounts, the Company’s primary source of noninterest income, increased 7.1% in 2003, 2.1% in 2002 and 15.2% in 2001. These increases were attributable to the increase in the number of deposit accounts. 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.

Included in other service charges and fees are cash management fees relating to off-balance sheet customer sweep accounts which had average balances of approximately $9.3 million during 2003. During 2003, cash management fees declined 30.9%. The Company’s fees on sweep accounts are based on a percentage of the earnings on these accounts. As a result of the extremely low interest rate environment, the Company’s fees were substantially less during 2003 compared to 2002.

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Noninterest Expense

Noninterest expense represents the overhead expenses of the Company. One of the core operating principles of management continues to be the careful monitoring and control of these expenses. Total noninterest expense increased to $8.4 million in 2003 or 13.7%, following increases of 8.0% and 10.9% in 2002 and 2001, respectively. The increase in noninterest expense is in line when compared to the Bank’s overall growth. The ratio of noninterest expense to average total assets was 3.02%, 3.09% and 3.02% for the year ended December 31, 2003, 2002 and 2001, respectively. Cost associated with handling our substantial asset and liability growth resulted in increases to almost every component of noninterest expense.

Salaries and employee benefits, the largest component of noninterest expense increased by 16.4% in 2003 following an increase of 8.3% in 2002 and 8.2% in 2001. These increases were driven by annual merit increases, in addition to an increase in the number of full-time equivalent employees and an increase in certain employee benefit costs experienced in 2003. Net occupancy expense increased $142.1 thousand in 2003, $78.2 thousand in 2002 and $87.1 thousand in 2001. The major part of this increase can be attributable to improvements to several of the branch facilities; the cost of which did not qualify for capitalization. Other noninterest operating expenses, which include a grouping of numerous transactions relating to normal banking operations, increased $294.3 thousand or 9.5% in 2003 compared with an increase of $208.8 thousand or 11.0% in 2002 and an increase of $52.5 thousand or 2.8% in 2001.

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 long-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 Company maintains a liquid portfolio of both assets and liabilities and attempts to mitigate the risk inherent in changing rates in this manner. Cash, interest-bearing deposits in banks, federal funds sold and investments classified as available for sale totaled $20.2 and $22.5 million as of December 31, 2003 and 2002, respectively. To provide liquidity for current ongoing and unanticipated needs, the Company maintains a portfolio of marketable investment securities, and structures and monitors the flow of funds from these securities and from maturing loans. The Company maintains access to short-term funding sources as well, including a federal funds line of credit with its correspondent banks up to $6.5 million, and the ability to borrow from the Federal Reserve System up to $1.2 million and Federal Home Loan Bank up to $44.8 million. As a result of the Company’s management of liquid assets, and the ability to generate liquidity through liability funding, management believes that the Company maintains overall liquidity sufficient to satisfy its depositor’s requirements and to meet customers’ credit needs.

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

The Company’s primary market risk is exposure to interest rate volatility. Fluctuations in interest rates will impact both the level of interest income and interest expense and the market value of the Company’s interest earning assets and interest bearing liabilities. The Company’s ability to manage its interest rate risk depends generally on the Company’s ability to match the maturities and re-pricing characteristics of its assets and liabilities while taking into account the separate goals of maintaining asset quality and liquidity and achieving the desired level of net interest income. The principal variables that affect the Company’s management of its interest rate risk include the Company’s existing interest rate gap position, management’s assessment of future interest rates, and the withdraws of liabilities over time.

The Company’s primary technique for managing its interest rate risk exposure is the management of the Company’s interest sensitivity gap. The interest sensitivity gap is defined as the difference between the amount of interest earning assets anticipated, based upon certain assumptions, to mature or re-price within a specific time period and the amount of interest bearing liabilities anticipated, based upon certain assumptions, to mature or re-price within that time period. At December 31, 2003, the Company’s one year “positive gap” (interest earning asset maturing or re-pricing within a period exceed interest bearing liabilities maturing or re-pricing within the same period) was approximately $6.3 million, or 1.99% of total assets. Thus, during periods of rising interest rates, this implies that the company’s net interest income would be positively affected because the yield on the Company’s interest earning assets is likely to rise more quickly than the cost of its interest bearing liabilities. In periods of falling interest rates, the opposite effect on net interest income is likely to occur.

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Table 12 sets forth the amount of interest earning assets and interest bearing liabilities outstanding at December, 31, 2003 that are subject to re-pricing or that mature in each of the future time periods shown. Loans and securities with call or balloon provisions are included in the period in which they balloon or may first be called. Except as stated above, the amount of assets and liabilities shown that re-price or mature during a particular period were determined in accordance with the contractual terms of the asset or liability.

Table 12: Interest Rate Sensitivity Analysis

	December 31, 2003
(in thousands)	Within 90 Days			91 Days to One Year			After One but Within Five Years			After Five Years			Total
Interest Earning Assets:
Investment securities	$	2,231		$	15		$	2,559		$	7,626		$	12,431
Equity securities		—			—			—			2,398			2,398
Loans held for sale		56,132			—			—			—			56,132
Loans		72,860			15,271			73,376			69,444			230,951
Interest bearing deposits		134			—			—			—			134
Federal funds sold		341			—			—			—			341
Total	$	131,698		$	15,286		$	75,935		$	79,468		$	302,387
Cumulative totals		131,698			146,984			222,919			302,387
Interest Bearing Liabilities:
Deposits
Demand	$	33,730		$	—		$	—		$	—		$	33,730
Savings		7,997			—			—			—			7,997
Time deposits, $100,000 and over		1,393			15,388			31,051			—			47,832
Other time deposits		4,454			40,264			84,406			—			129,124
Short-term borrowing		37,004			—			—			—			37,004
Long-term borrowing		426			—			—			—			426
Convertible preferred securities		—			—			—			6,025			6,025
Total	$	85,004		$	55,652		$	115,457		$	6,025		$	262,138
Cumulative totals		85,004			140,656			256,113			262,138
Interest sensitivity gap	$	46,694		$	(40,366	)	$	(39,522	)	$	73,443		$	40,249
Cumulative interest sensitivity gap	$	46,694		$	6,328		$	(33,194	)	$	40,249
Cumulative interest sensitivity gap as a percentage of total assets		14.67	%		1.99	%		(10.43	)%		12.65	%

Dividends and Dividend Policy

The Company’s Board of Directors determines the amount of and whether or not to declare dividends. Such determinations by the Board take into account the Company’s financial condition, results of operations, and other relevant factors. The Company’s only source of funds for cash dividends are dividends paid to the Company by the Bank.

In April 1999, the Company’s Board of Directors approved a Dividend Reinvestment and Stock Purchase Plan. Shares purchased from the Company with reinvested dividends are issued at a five percent discount from the market value. 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 Company’s outstanding financial performance for 2003, the Company paid a $0.04 cash dividend on February 28, May 31, August 29, and November 30 of 2003, for a total of $0.16 paid out in 2003 an increase of 52.4% over 2002. The Company paid a $0.035 cash dividend on March 31, June 30, and November 30 of 2002, and on March 31, June 30, September 30, and December 31 of 2001.

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Capital Resources and Adequacy

Total shareholders’ equity at December 31, 2003 increased 24.3% to a record $19.2 million compared to $15.4 million at December 31, 2002. During 2002, shareholders’ equity increased 13.8% from the $13.6 million at December 31, 2001. These increases were brought about by a net profit of $2.5 million in 2003, $1.7 million in 2002 and a net profit of $577.3 thousand in 2001.

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 securities offering. A subsequent funding on August 9, 2001 resulted in $800 thousand of new regulatory capital. At December 31, 2003, the Bank’s risk-adjusted capital ratios were 8.6% for Tier 1 and 9.6% for total capital, well above the required minimums of 4.0% and 8.0%, respectively. These ratios are calculated using regulatory capital (either Tier 1 or total capital) as the numerator and both on and off-balance sheet risk-weighted assets as the denominator. Tier 1 capital consists primarily of common equity less goodwill and certain other intangible assets. Total capital adds certain qualifying debt instruments and a portion of the allowance for loan losses to Tier 1 capital. One of four risk weights, primarily based on credit risk, is applied to both on and off-balance sheet assets to determine the asset denominator.

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 non-performing 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.

Inflation

The Company carefully reviews Federal Reserve monetary policy in order to ensure 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 a Company’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. Accordingly, management believes the Company can best counter inflation over the long-term by managing net interest income and controlling net increases in noninterest income and expenses.

Contractual Obligations

The following table summarized the Company’s significant contractual obligations, contingent obligations, and certain other commitments outstanding as of December 31, 2003:

Table 13: Contractual Obligations

	Payments due by period
(in thousands)	Total		Less than 1 year		1-3 years		3-5 years		More than 5 years
Operating lease obligations	$	2,016	$	297	$	530	$	463	$	726
Other liabilities on balance sheet under GAAP
Federal Home Loan Bank advances		36,992		36,992		—		—		—
Convertible preferred borrowings		6,025		—		—		—		6,025
Federal funds purchased and securities sold under agreements to repurchase		12		12		—		—		—
Long-term debt		426		—		—		—		426
Other commitments
Standby letters of credit		2,674		2,571		103		—		—
Commitments to extend credit		31,300		31,300		—		—		—
Total contractual obligations	$	79,445	$	71,172	$	633	$	463	$	7,177

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Critical Accounting Policies

Certain critical accounting policies affect the more significant judgments and estimates used in the preparation of the consolidated financial statements. The Company’s most critical accounting policy relates to the Company’s allowance for loan losses, which reflects the estimated losses resulting from the inability of the Company’s borrowers to make required loan payments. If the financial condition of the Company’s borrowers were to deteriorate resulting in an impairment of their ability to make payments, the Company’s estimates would be updated and additional provisions for loan losses may be required. Further discussion of the estimates used in determining the allowance for loan losses is contained in Footnote No. 1 in the accompanying Notes to the Consolidated Financial Statements.

Recent Accounting Pronouncements

In January 2003, the FASB issued Interpretation No. 46, Consolidation of Variable Interest Entities (FIN 46) which establishes guidance for determining when an entity should consolidate another entity that meets the definition of a variable interest entity. FIN 46 requires a variable interest entity to be consolidated by a company if that company will absorb a majority of the expected losses, will receive a majority of the expected residual returns, or both. Transferors to qualified special-purpose entities (“QSPEs”) and certain other interests in a QSPE are not subject to the requirements of FIN 46. On December 17, 2003, the FASB deferred the effective date of FIN 46 to no later than the end of the first reporting period that ends after March 15, 2004, however, for special-purpose entities the Company would be required to apply FIN 46 as of December 31, 2003. The Interpretation had no effect on the Company’s consolidated financial statements.

In April 2003, the FASB issued SFAS No. 149, Amendment of Statement 133 on Derivative Instruments and Hedging Activities. This Statement amends SFAS No. 133, Accounting for Derivative Instruments and Hedging Activities and clarifies accounting for derivative instruments, including certain derivative instruments embedded in other contracts, and for hedging activities under SFAS No. 133. This Statement is effective for contracts entered into or modified after June 30, 2003, except in certain circumstances, and for hedging relationships designated after June 30, 2003. This Statement did not have a material effect on the Company’s consolidated financial statements.

In May 2003, the FASB issued SFAS No. 150, Accounting for Certain Financial Instruments with Characteristics of both Liabilities and Equity. This Statement provides new rules on the accounting for certain financial instruments that, under previous guidance, issuers could account for as equity. Such financial instruments include mandatorily redeemable shares, instruments that require the issuer to buy back some of its shares in exchange for cash or other assets, or obligations that can be settled with shares, the monetary value of which is fixed. Most of the guidance in SFAS No. 150 is effective for financial instruments entered into or modified after May 31, 2003, and otherwise is effective at the beginning of the first interim period beginning after June 30, 2003. This Statement had no effect on the Company’s consolidated financial statements.

Item 7. Financial Statements.

The Company’s consolidated financial statements are included with this Form 10-KSB as Exhibit 99.1. Refer to the index to the Consolidated Financial Statements for the required information.

Item 8. Changes In and Disagreements With Accountants on Accounting and Financial Disclosure.

None.

Item 8A. Controls and Procedures

(a) As of December 31, 2003, the Company carried out an evaluation, under the supervision and with the participation of the Company’s management, including the Company’s Chief Executive Officer and Chief Financial Officer, of the effectiveness of the design and operation of the Company’s disclosure controls and procedures pursuant to Rule 13a-15(e) of the Securities Exchange Act of 1934, as amended (the “Exchange Act”). Based on that evaluation, the Chief Executive Officer and the Chief Financial Officer concluded that the Company’s disclosure controls and procedures are effective in timely alerting them to material information relating to the Company (including its consolidated subsidiaries) required to be included in the Company’s Exchange Act filings.

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

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PART III

Item 9. Directors, Executive Officers, Promoters and Control Persons; Compliance With Section 16(a) of the Exchange Act.

The Board of Directors

The Company’s 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 2004, 2005, and 2006. The following table sets forth the composition of the Board of Directors.

Class I (Term Expiring in 2004)	Class II (Term Expiring in 2005)	Class III (Term Expiring in 2006)
Morton Goldmeier	Herbert L. 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, 2003, for each of the 10 directors of Commonwealth Bankshares, Inc.

Class I

(Term Expiring in 2004)

Morton Goldmeier, 80, 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., 68, 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, 64, has served as Senior Counsel of Tavss, Fletcher, Maiden, and Reed, 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, 70, 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 2005)

Herbert L. Perlin, 63, 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, 53, has served as President of the Norfolk Tides Baseball team, and 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., 75, 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 2006)

William P. Kellam, 89, 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 it’s inception in 1971.

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Edward J. Woodard, Jr., CLBB, 61, 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, Inc. and BOC Insurance of Hampton Roads, Inc., President of Boush Bank Building Company 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, 49, is President of Anderson and Strudwick Investment Company. 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, Inc. and Bank of the Commonwealth

In addition to Mr. Woodard, the following individual serves as an executive officer of the Company and the Bank.

John H. Gayle, 65, 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, Secretary, and Treasurer of BOC Insurance Agency of Hampton Roads, Inc.

Audit Committee and Audit Committee Financial Expert

The Company’s Board has a separately-designed standing Audit Committee established in accordance with Section 3(a)(58)(A) of the Securities Exchange Act of 1934 (“Exchange Act”). During 2003, the members of the Audit Committee were Morton Goldmeier, William P. Kellam, Thomas W. Moss, Jr., Kenneth J. Young and Laurence C. Fentriss. Due to committee reassignments, as of January 1, 2004, E. Carlton Bowyer was added to the committee in the place of Kenneth J. Young. The Board has determined that Morton Goldmeier, Chairman of the Audit Committee, is an audit committee financial expert as defined by Item 401(h) of Regulation S-K of the Exchange Act and that each member of the Audit Committee is independent within the meaning of Rule 4200(a)(15) of the National Association of Securities Dealers’ listing standards.

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 Company’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 Company with copies of all Section 16(a) forms they file.

Based solely on a review of the copies of such forms furnished to the Company, the Company believes that all Section 16(a) filing requirements applicable to its directors, officers and greater than 10.0% beneficial owners were complied with in 2003.

Code of Ethics

The Company has adopted a Code of Ethics that applies to the chief executive officer and principal financial officer which is encompassed within the overall “Code of Ethics and Personal Conduct” policy in effect for all employees. The Company will provide a copy of the Code of Ethics without charge upon written request directed to Cynthia A. Sabol, Executive Vice President and Chief Financial Officer, Commonwealth Bankshares, Inc., 403 Boush Street, Norfolk, VA 23510.

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Item 10. Executive Compensation.

Summary Executive Compensation Table

The following table sets forth the annual compensation paid or accrued by the Company and its subsidiaries to Edward J. Woodard, Jr., CLBB, Chairman of the Board, President and Chief Executive Officer, John H Gayle, Executive Vice President and Cashier, and Simon Hounslow, Senior Vice President and Commercial Loan Officer for the past three fiscal years. During these periods, no other executive officer received combined salary and bonus in excess of $100,000.

Summary Compensation Table

Name and Principal Position	Annual Compensation					Other Annual Compensation			Long Term Compensation
	Year	Salary		Bonus					Securities Underlying Options (#)
Edward J. Woodard, Jr., CLBB Chairman of the Board President and Chief Executive Officer	2003 2002 2001	$	230,000 209,000 199,000	$	24,500 5,000 —	$	29,207 32,171 31,300	(1) (1) (1)	4,400 —   5,000
John H. Gayle, Executive Vice President	2003 2002 2001	$	110,800 100,800 93,800	$	12,250 5,000 —	$	5,459 3,236 3,156	(2) (2) (2)	4,000 —   3,000
Simon Hounslow, Senior Vice President	2003 2002 2001	$	91,768 85,797 77,000	$	15,000 5,000 —	$	5,377 4,400 3,580	(2) (2) (2)	4,000 —   2,500

(1) Includes director fees, 401k matching contribution, 401k profit sharing, and deferred compensation.

(2) Includes 401k matching contribution and 401k profit sharing.

Option Grants in Last Fiscal Year

The following table sets forth information for the year ended December 31, 2003 regarding grants of stock options to Mr. Woodard, Mr. Gayle, and Mr. Hounslow.

Option Grants in Year Ended December 31, 2003

Name	Number of Securities Underlying Options Granted	Percent of Total Options Granted to Employees in Fiscal Year		Exercise Price		Expiration Date
Edward J. Woodard, Jr.	4,400	20.3	%	$	19.30	12/31/13
John H. Gayle	4,000	18.5	%	$	19.30	12/31/13
Simon Hounslow	4,000	18.5	%	$	19.30	12/31/13

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Fiscal Year End Option Values

The table below sets forth information for each officer named in the Summary Compensation Table concerning the value of unexercised stock options as of December 31, 2003. None of such officers exercised any stock options during 2003.

Fiscal Year End Option Values

	Number of Securities Underlying Unexercised Options at December 31, 2003 (#)		Value of Unexercised In-The-Money Options at December 31, 2003 ($) (1)
Name	Exercisable	Unexercisable	Exercisable		Unexercisable
E. J. Woodard, Jr.	19,131	14,400	$	233,748	$	—
John H. Gayle	12,915	10,000		155,832		—
Simon Hounslow	8,576	9,000		99,913		—

(1) Under Securities and Exchange Commission rules, an option is only considered in-the-money, for purposes of the chart, if the per share exercise price is less than $19.00, the last reported sales price of the Company’s common stock on the NASDAQ National market on December 31, 2003.

Director Compensation

Each director of the Company was paid $950 for attendance at each board meeting and $400 for attendance at each meeting of a committee of the board of which he or she was a member. Additionally, each director of the Company was paid a quarterly retainer of $500. The Company 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 2003, a total of $81.4 thousand was deferred by directors under this plan. The terms and conditions of the plan are very similar to the terms and conditions of the Bank’s Supplemental Executive Retirement Plan described under the “Stock Option and Employee Benefit Plans” section of this Form 10-KSB.

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, 2006, 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 employment 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.

25

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.

In addition to the Woodard employment agreement, the Bank has entered into an employment agreement with John H. Gayle, dated May 15^th 1990 and Simon Hounslow dated January 2, 2002. The agreements provide for Mr. Gayle’s and Mr. Hounslow’s employment until the earlier of December 31, 2004, their death or disability; provided, however, the employment agreements allows for termination of employment by either Bank of the Commonwealth, Mr. Gayle, or Mr. Hounslow in the event of a “change of control” of Commonwealth Bankshares or Bank of the Commonwealth, or by Mr. Gayle or Mr. Hounslow for “Good Reason”. Mr. Gayle’s and Mr. Hounslow’s employment agreements will be renewed automatically each year unless either party elects not to renew the agreements.

Under the employment agreements, 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. Gayle and Mr. Hounslow will be entitled to receive twelve (12) equal monthly payments, which in total, equal their annual base salary. In the event of a termination of the employment agreement by Mr. Gayle or Mr. Hounslow for “good reason”, by Commonwealth Bankshares or Bank of the Commonwealth subsequent to a “change of control,” but not “for good cause,” Mr. Gayle and Mr. Hounslow will be entitled to receive sixty (60) equal monthly payments, which in total, equal the annual compensation at the time of termination.

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 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 $43.8 thousand and a discretionary profit sharing contribution of $31.2 thousand to the 401(k) plan during 2003.

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.

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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 indicate how the deferred amount is to be invested 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 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. As of December 31, 2003, no money has been funded into this plan.

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Item 11. Security Ownership of Certain Beneficial Owners and Management.

Management

The following table sets forth the beneficial ownership of the Company’s common stock by each of its directors, named executive officer, and named officer as of March 4, 2004. All the Company’s directors, executive and named officers receive mail at the Company’s principal executive office at 403 Boush Street, Norfolk, Virginia 23510.

Name	Number of Shares Beneficially Owned (1)(2)		Percent of Shares Beneficially Owned
Directors:
E. Carlton Bowyer	4,644	(3)	*
Laurence C. Fentriss	168,057	(4)	8.3	%
Morton Goldmeier	85,278	(5)	4.4	%
William P. Kellam	39,075	(6)	2.0	%
Thomas W. Moss, Jr.	5,506	(7)	*
William D. Payne, M.D.	27,277	(8)	1.4	%
Herbert L. Perlin	46,952	(9)	2.4	%
Richard J. Tavss	131,514	(10)	6.7	%
E. J. Woodard, Jr., CLBB	53,598	(11)	2.7	%
Kenneth J. Young	10,792	(12)	*
Non-Director Named Executive Officer and Named Officer:
John H. Gayle	28,575	(13)	1.5	%
Simon Hounslow	20,501	(14)	1.1	%
All Directors, Executive Officer and Named Officer as group (12 persons)	621,769		28.3	%

* Percentage of ownership is less than 1.0% of the outstanding shares of Common Stock of the Company.

(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 1,930,124 issued and outstanding shares of common stock as of March 4, 2004.

(3) Includes 3,000 shares which Dr. Bowyer has the right to acquire through the exercise of stock options.

(4) Includes (i) 3,000 shares which Mr. Fentriss has the right to acquire through the exercise of stock options, (ii)75,000 shares which Mr. Fentriss has the right to acquire through the conversion of convertible preferred securities, and (iii) 8,750 shares which Mr. Fentriss’s wife has the right to acquire through the conversion of convertible preferred securities, for which Mr. Fentriss disclaims beneficial ownership.

(5) Includes (i) 21,000 shares which Mr. Goldmeier has the right to acquire through the exercise of stock options, and (ii) 14,314 shares owned by Mr. Goldmeier’s wife, for which Mr. Goldmeier disclaims beneficial ownership, and (iii) 3,750 shares which Mr. Goldmeier has the right to acquire through the conversion of convertible preferred securities.

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(6) Includes (i) 21,000 shares which Mr. Kellam has the right to acquire through the exercise of stock options, and (ii) 17,286 shares registered in the name of Mr. Kellam’s wife, for which Mr. Kellam disclaims beneficial ownership.

(7) Includes 5,000 shares which Mr. Moss has the right to acquire through the exercise of stock options.

(8) Includes (i) 21,000 shares which Dr. Payne has the right to acquire through the exercise of stock options, (ii) 922 shares registered in the name of Dr. Payne’s wife, for which Dr. Payne disclaims beneficial ownership, and (iii) 3,370 shares registered in the name of Payne Pension and Profit Sharing Plan FBO William D. Payne.

(9) Includes (i) 21,000 shares which Mr. Perlin has the right to acquire through the exercise of stock options, (ii) 19,339 shares registered in the name of Herbert L. Perlin, Profit Sharing Trust, of which Mr. Perlin is Acting Trustee, (iii) 2,350 shares owned jointly by Mr. Perlin and his wife, and (iv) 3,835 shares registered as the Perlin Revocable Living Trust.

(10) Includes (i) 21,000 shares which Mr. Tavss has the right to acquire through the exercise of stock options, (ii) 1,299 shares registered in the name of Richard J. Tavss, Custodian for Bobbie J. Tavss, (iii) 497 shares registered in the name of Richard J. Tavss, Custodian for Sanders T. Schoolar V, (iv) 493 shares registered in the name of Richard J. Tavss, Custodian for Zachary I. Maiden, and (v) 494 shares registered in the name of Richard J. Tavss, Custodian for Taylor Tavss Scholar.

(11) Includes (i) 28,467 shares which Mr. Woodard has the right to acquire through the exercise of stock options, (ii) 673 shares registered in the name of E. J. Woodard, Jr., Custodian for Troy Brandon Woodard, (iii) 1,575 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) 9,145 shares owned jointly by Mr. Woodard and his wife.

(12) Includes (i) 5,000 shares which Mr. Young has the right to acquire through the exercise of stock options, and (ii) 5,250 shares representing the proceeds of a self directed Individual Retirement Account for the benefit of Kenneth J. Young.

(13) Includes 19,877 shares which Mr. Gayle has the right to acquire through the exercise of stock options.

(14) Includes 17,576 shares which Mr. Hounslow has the right to acquire through the exercise of stock options.

Security Ownership of Certain Beneficial Owners

The following table sets forth certain information with respect to beneficial ownership of the Company’s common stock as of March 4, 2004 by each beneficial owner of more than 5.0% of the Company’s common stock based on currently available Schedules 13D and 13G filed with the Security and Exchange Commission.

Name and Address of Holder	Number of Shares Beneficially Owned		Percent of Shares Beneficially Owned
Laurence C. Fentriss P.O. Box 1459 Richmond, VA 23218	168,057		8.3	%
Richard J. Tavss P.O. Box 3747 Norfolk, VA 23514	131,514		6.7	%
The Collective’s Fund 666 5th Avenue, 34th floor New York, NY 10103	99,744	(1)	5.2	%
Hot Creek Capital, LLC P.O. Box 3178 Gardenville, NV 89410	172,300		6.8	%

(1) Includes 13,000 shares which are held by other members of an affiliated group.

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Item 12. Certain Relationships and Related Transactions.

Loans to Officers and Directors

Certain directors and officers of the Company 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 2003, 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, 2003, the amount of loans from the Bank to all officers and directors of the Company and the Bank, and entities in which they are associated, was approximately $3.1 million.

Business Relationships and Transactions with Management

In the ordinary course of its business, the Company 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 Reed, P.C., of which Mr. Tavss, a director of the Company and the Bank, is senior counsel, to perform certain legal services for the Company 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 Company 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 Company. The limited partners of the Partnership are Messrs. Woodard and Kellam, who are directors of the Company 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 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 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 $106.6 thousand. The board of directors of Commonwealth Bankshares received two independent appraisals with respect to this property prior to entering into this lease. The Board and management believe the terms of this lease are no less favorable than could be obtained from a non-related party in an arms-length transaction.

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Item 13. Exhibits and Reports on Form 8-K.

(a) 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 with the Company’s form 10-KSB, and incorporated herein by reference.
4.1	Certificate of Trust of the Trust, included as Exhibit 4.1 to the Registrant’s Registration Statement on form S-1, Registration No. 333-63314, and incorporated herein by reference.
4.2	Declaration of Trust between the Company and the Trust. Included as Exhibit 4.2 to the Registrant’s Registration Statement on Form S-1, Registration No. 333-63314, and incorporated herein by reference.
4.3	Form of Amended and Restated Declaration of Trust of the Trust, included as Exhibit 4.3 to the Registrant’s Registration Statement on Form S-1, Registration No. 333-63314, and incorporated herein by reference.
4.4	Form of Junior Subordinated Indenture between the Company and Wilmington Trust Company, as trustee, included as Exhibit 4.4 to the Registrant’s Registration Statement on Form S-1, Registration No. 333-63314, and incorporated herein by reference.
4.5	Form of Convertible Security certificate, included as Exhibit 4.5 to the Registrant’s Registration Statement on Form S-1, Registration No. 333-63314, and incorporated herein by reference.
4.6	Form of Junior Subordinated Debt Securities, included as Exhibit 4.4 to the Registrant’s Registration Statement on Form S-1, Registration No. 333-63314, and incorporated herein by reference.
4.7	Form of Guarantee Agreement with respect to the Convertible Securities, included as Exhibit 4.7 to the Registrant’s Registration Statement on Form S-1, Registration No. 333-63314, and incorporated herein by reference.
10.1	Lease. Filed June 15, 1988, as Exhibit 10.1 to the Registrant’s 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.

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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	Employment agreement with Simon Hounslow is attached as part of this 10-KSB.
21.1	Subsidiaries of Registrant. *
23.1	Consent of Witt, Mares & Company, PLC. *
24.1	Power of Attorney, included on the signature page herein.
31.1	Certification of CEO pursuant to Rule 13a-14(a). *
31.2	Certification of Principal Financial Officer pursuant to Rule 13a-14(a). *
32.1	Certification of CEO pursuant to Section 906 of the Sarbanes-Oxley Act of 2002. *
32.2	Certification of Principal Financial Officer pursuant to Section 906 of the Sarbanes-Oxley Act of 2002. *
99.1	Consolidated Financial Statements. *

* Filed herewith.

(b) Reports filed on Form 8-K for the quarter ended December 31, 2003.

None

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Item 14. Principal Account Fees and Services

Audit Fees

During 2003, the aggregate amount of fees billed to the Company by Witt Mares Eggleston Smith, PLC rendered by it for the audit of the Company’s financial statements and review of financial statements included in the Company’s reports on Form 10-QSB, and for service normally provided in connection with statutory and regulatory filings was $79,141. In 2002, Witt Mares Eggleston Smith, PLC billed $71,850 for such services. This category includes fees for services necessary to perform the audit of the Company’s financial statements comfort letters and consents in connection with registration statement and other filings with the Securities and Exchange Commission and assistance with and review of documents filed with the Commission.

Audit-Related Fees

During 2003, the aggregate amount of fees billed to the Company by Witt Mares Eggleston Smith, PLC for assurance and related services reasonably related to the performance of the audit services rendered by it was $14,375. In 2002 Witt Mares Eggleston Smith, PLC billed $22,130 for such services. These services were the audit of the Company’s information technology systems, public funds engagements and assistance regarding financial accounting and reporting standards.

Tax Fees

During 2003, the aggregate amount of fees billed to the Company by Witt Mares Eggleston Smith, PLC for tax advice, compliance, and planning services was $3,000. In 2002, Witt Mares Eggleston Smith, PLC billed $3,400 for such services. These services were the preparation of federal and state income tax returns and advice regarding tax compliance issues.

All Other Fees

During 2003 and 2002, Witt Mares Eggleston Smith, PLC billed the Company $32,354 and $3,300, respectively, for all other fees. These services included assistance with the documentation of internal controls and other consulting matters.

None of the engagements of Witt Mares Eggleston Smith, PLC to provide service other than audit services was made pursuant to the de minimus exception to the pre-approval requirement contained in the rules of the Securities and Exchange Commission and the Company’s audit committee charter.

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SIGNATURES

In accordance with Section 13 or 15(d) of the Securities Exchange Act, the registrant caused this Report to be signed on its behalf by the undersigned, thereunto duly authorized.

	Commonwealth Bankshares, Inc.
	(Registrant)
Date: March 29, 2004	by:	/s/ E.J. Woodard, Jr., CLBB
		E. J. Woodard, Jr., CLBB
		Chairman of the Board,
		President and Chief
		Executive Officer
	by:	/s/ John H. Gayle
		John H. Gayle
		Executive Vice President & Cashier (Principal Financial Officer)

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POWER OF ATTORNEY

KNOW ALL MEN BY THESE PRESENTS, that each person whose signature below constitutes and appoints E.J. Woodard, Jr., CLBB and John H. Gayle, and each of them individually, as his true and lawful attorney-in-fact and agent, with full power of substitution and resubstitution, for him and in his name, place and stead, in any and all capacities, to sign any and all amendments to this report, and to file the same, with all exhibits thereto, and other documents in connection therewith, with the Securities and Exchange Commission, granting unto said attorney-in-fact and agent full power and authority to do and perform each and every act and thing requisite and necessary to be done in connection therewith, as fully to all intents and purposes as he might or could do in person, hereby ratifying and confirming all that said attorney-in-fact and agent or his substitute or substitutes, may lawfully do or cause to be done by virtue hereof.

In accordance with Exchange Act, this report has been signed below by the following persons on behalf of the registrant and in the capacities and on the dates indicated.

by:	/s/ E.J. Woodard, Jr., CLBB	Date: March 29, 2004
	E.J. Woodard, Jr., CLBB
	Chairman of the Board
	President and Chief Executive Officer
by:	/s/ E. Carlton Bowyer	Date: March 29, 2004
	E. Carlton Bowyer
	Director
by:	/s/ Laurence C. Fentriss	Date: March 29, 2004
	Laurence C. Fentriss
	Director
by:	/s/ Morton Goldmeier	Date: March 29, 2004
	Morton Goldmeier
	Director
by:	/s/ William P. Kellam	Date: March 29, 2004
	William P. Kellam
	Director
by:	/s/ Thomas W. Moss, Jr.	Date: March 29, 2004
	Thomas W. Moss, Jr.
	Director
by:	/s/ William D. Payne, M.D.	Date: March 29, 2004
	William D. Payne, M.D.
	Director
by:	/s/ Herbert L. Perlin	Date: March 29, 2004
	Herbert L. Perlin
	Director
by:	/s/ Richard J. Tavss	Date: March 29, 2004
	Richard J. Tavss
	Director
by:	/s/ Kenneth J. Young	Date: March 29, 2004
	Kenneth J. Young
	Director

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EX-10.15

Exhibit 10.15

EMPLOYMENT AGREEMENT

THIS EMPLOYMENT AGREEMENT (“Agreement”) is made as of December 15, 1998 by and between BANK OF THE COMMONWEALTH, a banking corporation organized under the laws of Virginia (the “Bank”), COMMONWEALTH BANKSHARES, INC., a Virginia corporation (the “Holding Company”) and SIMON HOUNSLOW (the “Executive”); the Bank being sometimes hereinafter referred to as the “Employer”.

WITNESSETH THAT:

WHEREAS, the Executive is rendering valuable services to the Employer and it is the desire of the Employer to have the benefit of the Executive’s loyalty, service and counsel; and

WHEREAS, the Executive wishes to continue in the employ of the Employer;

NOW, THEREFORE, in consideration of the mutual covenants and agreements herein set forth, the parties covenant and agree as follows:

1. EMPLOYMENT: The Employer agrees to employ the Executive to perform services for the Employer and the Executive agrees to serve the Employer upon the terms and conditions herein provided. The Executive agrees to perform such managerial duties and responsibilities as shall be assigned to him by the Board of Directors of the Employer, which duties and responsibilities shall be of substantially the same character to those required by his assigned office and functions on the date of this Agreement. The Executive shall devote his time and attention on a full-time basis to the discharge of the duties undertaken by him hereunder.

(A) TERM OF EMPLOYMENT. Term of Employment hereunder shall be from January 1, 1999 to and including the first to occur of (I) except as otherwise provided in Section 3 hereof, January 1, 2000 (ii) the Executive’s death, or (iii) except as provided in paragraph (d) of this Section 2, the Executive’s disability; provided further that this Agreement shall automatically be extended for an additional one year period on each January 1 unless prior to January 1, 2000 the Employer or the Employee shall give notice of non-renewal to the other.

(B) COMPENSATION. During the term of employment hereunder, the Executive shall receive for his services a basic salary and incentive or bonus compensation in amounts determined by the Employer’s Board of Directors or an appropriate committee of the Employer in accordance with the salary administration program of the Employer as the same may from time to time be in effect, but in no event shall such base salary be less than the Executive’s base salary at the date hereof.

(C) BENEFITS. The Executive shall be eligible for participation in any additional plans, programs or forms of compensation or benefits that the Employer’s Board of Directors might hereinafter provide to the class of employees that includes the Executive.

(D) DISABILITY. In the event of physical or mental disability of the Executive by reason of which the Executive is unable to perform the duties of his employment hereunder, the Employer shall continue to pay or provide to the Executive the compensation and benefits provided under Paragraphs (b) and (c) of this Section 2 for the first six months of such disability. If, however, the disability continues beyond such six-month period, the employer may, at its election terminate the Executive’s employment under this Agreement, in which case the Executive shall receive any disability benefits payable under the Employer’s plans in effect at that time.

(E) DEATH. In the event that the Executive’s death should occur during the term of this Agreement, this Agreement shall terminate. The Executive and his estate or beneficiaries, as the case may be, shall be entitled only to any and all retirement or death benefits payable under the Employer’s plans in effect at that time and no further compensation will be paid under this Agreement.

2. TERMINATION:

(A) TERMINATION BY THE EMPLOYER. Nothing herein contained shall prevent the Employer from terminating the services of the Executive at any time prior to the expiration of this Agreement.

(i) If such termination is effective prior to the time “a change in control” (as defined in paragraph (b) of this Section 2 occurs with respect to either the Employer or the Holding Company, and prior to the time the Employer or the Holding Company enters into negotiations which result in such change of control, then unless the termination is “for good cause” as hereinafter defined, the Employer shall pay the Executive a termination allowance in 12 equal monthly payments commencing on the last day of the month in which the date of actual termination occurs, the total amount of which will equal the base salary plus director’s fees, if any, but not including any bonuses paid to the Executive by the Employer in the 12 months next preceding the Notice of Termination. Except as provided in this paragraph 2(a)(1), upon the termination herein described, the compensation and benefits of the Executive will cease as of the Date of Termination as defined in paragraph 2(d).

1

(ii) Termination of employment “for good cause” means a dismissal of the Executive because of (I) the material failure of the Executive, after written notice, for reasons other than disability, to render services to the Employer as provided herein, (ii) the Executive’s gross or willful neglect of duty, or (iii) illegal or intentional acts by the Executive demonstrating bad faith toward the Employer. If the Employer shall terminate the Executive’s employment for good cause, the Executive shall be entitled only to receive his base salary in respect of services performed through the Date of Termination.

(B) TERMINATION BY THE EXECUTIVE. The Executive shall be entitled to terminate his employment for good reason, in which event the Employer shall be obligated to pay the Executive and furnish him the benefits provided in Section 3 hereof. By way of illustration and not limitation, the following circumstances shall constitute “good reason” and shall be deemed to be a breach of this Agreement by the Employer:

(i) The Executive is assigned any duties or responsibilities that are inconsistent with his positions, duties, responsibilities and status with Employer in effect at the date of this Agreement; or

(ii) A change of control occurs with respect to either the Bank or the Holding Company:

For the purpose of this Agreement, the term “a change in control” shall mean (a) any “person” (as such term is used in Sections 13(d) and 14(d) of the Securities Exchange Act of 1934) who is, or who has entered into a definitive agreement with either the Holding company or the Bank to become, the beneficial owner, directly or indirectly, of securities of either the Holding Company or the Bank representing more than twenty-five percent (25%) of the combined voting power of the then outstanding securities of either the Holding Company or the Bank, (b) a change in the composition of a majority of the Board of Directors of either the Bank or the Holding Company occurs in any twelve (12) month period, or (c) the Holding Company ceases to be the owner of all of the Bank’s issued and outstanding shares except for director’s qualifying shares.

The right herein conferred upon the Executive to terminate his employment for good reason may be exercised by the Executive at any time during the term of this Agreement at his sole discretion and any failure by the Executive to exercise this right after he has “good reason” to do so shall not be deemed a waiver of the right.

In the event the Executive terminates his employment without “good reason” then he shall be entitled to no termination allowance and no severance allowance and no further compensation after the “Date of Termination” as defined in paragraph (d) of this Section 2.

(C) NOTICE OF TERMINATION. Any termination of the Executive’s employment by the Employer or by the Executive shall be communicated by a written “Notice of Termination” to the other party hereto. For purposes of this Agreement, “Notice of Termination” shall mean a notice which shall indicate the specific termination provision in this Agreement relied upon and shall set forth in reasonable detail the facts and circumstances claimed to provide a basis for termination.

(D) DATE OF TERMINATION. “Date of Termination” shall mean (I) if this Agreement is terminated by the Executive, the date on which the Notice of Termination is delivered, (ii) if this Agreement is terminated by the Employer because of the Executive’s disability, thirty days after the Notice of Termination is given, or (iii) if the Executive’s employment is terminated by the Employer for any reason, the date on which a Notice of Termination is given, unless within thirty days thereafter the Executive notifies the Employer that a dispute exists concerning the termination, in which case the Date of Termination shall be the date on which the dispute is finally determined, whether by mutual written agreement of the parties or by final judgement, order or decree of a court of competent jurisdiction (the time for appeal therefrom having expired and no appeal having been perfected).

3. COMPENSATION UPON TERMINATION. Except as provided in paragraph 2(a)(1) above, if, without good cause, the Employer terminates the services of the Executive prior to the expiration of this Agreement or if the Executive terminates his employment for good reason, then:

(A) ACCRUED BUT UNPAID COMPENSATION. The Employer shall pay the Executive’s full base salary through the date of actual termination at the rate then in effect and the amount, if any, of awards theretofore made which have not yet been paid.

(B) SEVERANCE ALLOWANCE. The Employer shall pay the Executive a severance allowance in 60 equal monthly payments commencing on the last day of the month in which the date of actual termination occurs, the total amount of which will equal and will not exceed the present value of one times the Executive’s base salary amount minus $1.00 plus the present value of any other payment in the nature of compensation within the meaning of Section 280G(b)(2)(A)(ii) of the Internal Revenue Code of 1954, as amended (“Code”). For purposes of this paragraph 3(b), the following definitions shall apply.

(i) Base Amount – The term “base amount” means the Executive’s annualized includible compensation for the base period.

(ii) Annualized Includible compensation for the Base Period – The term “annualized includible compensation for the base period” means the average annual compensation paid by the Bank, which was includible in the gross income of the Executive for federal income tax purposes for the taxable years in the base period.

2

(iii) Base Period – The term “Base Period” means the period consisting of the most recent five taxable years ending before the date on which termination occurs, except for termination as a result of the operation of Paragraph 3(b)(ii) above in which case the date of termination shall be deemed to be the date a change in control occurs as to either the Bank or the Holding Company.

(iv) Present Value – Present value shall be determined in accordance with Section 1274(b)(2) of the code.

(C) EMPLOYEE BENEFITS. The Employer shall maintain in full force and effect, for the Executive’s continued benefit until the earlier of six months subsequent to the Date of Termination or the date the Executive becomes a participant in similar plans, programs or arrangements provided by a subsequent employer, all life, accident, medical and dental insurance benefit plans and programs or arrangements in which the Executive has been entitled to participate immediately prior to the Date of Termination, provided that the Executive’s continued participation is possible under the general terms and provisions of such plans and programs. In the event that the Executive’s participation in any such plan or program is barred, the Employer shall arrange to provide the Executive with benefits substantially similar to those which the Executive is entitled to receive under such plans and programs. At the end of the period of coverage, the Executive shall have the option to have assigned to him at no cost and with no appointment of prepaid premiums, any assignable insurance policy owned by the Employer or the Holding Company and relating specifically to the Executive.

(D) NO DUTY TO MITIGATE. The Executive shall not be required to mitigate the amount of any payment provided for in this Section 4 by seeking other employment or otherwise, nor shall the amount of any payment provided for in this Section 4 be reduced by any compensation earned by the Executive as the result of employment by another employer after the Date of Termination, or otherwise.

4. MISCELLANEOUS:

(A) WAIVER. A waiver by any party of any of the terms and conditions of this Agreement in any instance shall not be deemed or construed to be a waiver of such terms and conditions for the future or any subsequent breach thereof.

(B) SEVERABILITY. If any provision of this Agreement, as applied to any circumstances, shall be adjusted by a court to be void and unenforceable, the same shall in no way affect any other provision of this Agreement or the applicability of such provision to any other circumstances.

(C) AMENDMENT. This Agreement may not be varied, altered, modified, changed, or in any way amended except by an instrument in writing, executed by the parties hereto or their legal representatives.

(D) NON-ASSIGNABILITY. Neither the Executive nor his estate shall have any right to commute, sell, assign, transfer or otherwise convey the right to receive any payments hereunder, which payments and the right thereto, are expressly declared to be non-assignable and non-transferable.

(E) BINDING EFFECT. This Agreement shall be binding upon and inure to the benefit of the Executive (and his personal representative), the Bank and any successor organizations which shall succeed to substantially all of the business and property of the Bank, whether by means of merger, consolidation, acquisition of all or substantially all of the assets of the Bank or otherwise, including by operation of law.

(F) GOVERNING LAW. This Agreement shall be governed by and construed in accordance with the laws of the Commonwealth of Virginia, whether statutory or decisional, applicable to agreements made and entirely to be performed within such state and provisions of federal law as may be applicable.

(G) HOLDING COMPANY JOINDER. The Holding Company executes this Agreement to evidence its consent hereto.

IN WITNESS WHEREOF, the parties have executed this Agreement as of the day and year first above written.

BANK OF THE COMMONWEALTH
By	/s/ John. H. Gayle
	John H. Gayle
	Executive Vice President & Secretary
COMMONWEALTH BANKSHARES, INC.
By	/s/ E. J. Woodard, Jr., CLBB
	E. J. Woodard, Jr., CLBB
	Chairman of the Board, President & CEO
By	/s/ Simon Hounslow
	Simon Hounslow
	Executive

3

EX-21.1

Exhibit 21.1

SUBSIDIARIES

1.	Bank of the Commonwealth, a Virginia Company, is a wholly owned subsidiary of Commonwealth Bankshares, Inc.
2.	Commonwealth Bankshares Capital Trust I, a Delaware Company, is a wholly owned subsidiary of Commonwealth Bankshares, Inc.
3.	BOC Title of Hampton Roads, Inc., a Virginia Corporation, is a wholly owned subsidiary of Bank of the Commonwealth.
4.	BOC Insurance Agencies of Hampton Roads, Inc., a Virginia Corporation, is a wholly owned subsidiary of Bank of the Commonwealth.

EX-23.1

Exhibit 23.1

CONSENT OF INDEPENDENT AUDITORS

We hereby consent to the Incorporation by reference in this Registration Statement on Form S-8 and Form S-3, and the related prospectus, pertaining to the Bank of the Commonwealth Directors’ Deferred Compensation Plan, the Bank of the Commonwealth Supplemental Executive Retirement Plan, and the Dividend Retirement Plan of our report dated February 4, 2004, with respect to Commonwealth Bankshares, Inc. included in its Annual Report on from 10-KSB for the year ended December 31, 2003, as filed with the Securities and Exchange Commission.

/s/ Witt Mares Eggleston Smith, PLC

Norfolk, Virginia

March 29, 2004

EX-31.1

Exhibit 31.1

CERTIFICATION

I, Edward J. Woodard, Jr., CLBB, Chairman of the Board, President, and Chief Executive Officer certify that:

1. I have reviewed this annual report on Form 10-KSB of Commonwealth Bankshares, Inc.;

2. Based on my knowledge, this annual report does not contain any untrue statement of a material fact or omit to state a material fact necessary to make the statements made, in light of the circumstances under which such statements were made, not misleading with respect to the period covered by this annual report;

3. Based on my knowledge, the financial statements, and other financial information included in this annual report, fairly present in all material respects the financial condition, results of operations and cash flows of the registrant as of, and for, the periods presented in this annual report;

4. The registrant’s other certifying officer and I are responsible for establishing and maintaining disclosure controls and procedures (as defined in Exchange Act Rules 13a-15(e) and 15d-15(e)) for the registrant and have:

(A) Designed such disclosure controls and procedures, or caused such disclosure controls and procedures to be designed under our supervision, to ensure that material information relating to the registrant, including its consolidated subsidiaries, is made known to us by others within those entities, particularly during the period in which this annual report is being prepared;

(B) Evaluated the effectiveness of the registrant’s disclosure controls and procedures and presented in this annual report our conclusions about the effectiveness of the disclosure controls and procedures as of the end of the period covered by this report based on such evaluation; and

(C) Disclosed in this annual report any change in the registrant’s internal control over financial reporting that occurred during the registrant’s most recent fiscal quarter that has materially affected, or is reasonably likely to materially affect, the registrant’s internal control over financial reporting; and

5. The registrant’s other certifying officer and I have disclosed, based on our most recent evaluation of internal control over financial reporting, to the registrant’s auditors and the audit committee of the registrant’s board of directors:

(A) All significant deficiencies and material weaknesses in the design or operation of internal control over financial reporting which are reasonably likely to adversely affect the registrant’s ability to record, process, summarize and report financial information; and

(B) Any fraud, whether or not material, that involves management or other employees who have a significant role in the registrant’s internal control over financial reporting.

Date: March 29, 2004	/s/ E. J. Woodard, Jr., CLBB
	E. J. Woodard, Jr., CLBB,
	Chairman of the Board,
	President & CEO

EX-31.2

Exhibit 31.2

CERTIFICATION

I, John H. Gayle, Executive Vice President and Cashier certify that:

1. I have reviewed this annual report on Form 10-KSB of Commonwealth Bankshares, Inc.;

2. Based on my knowledge, this annual report does not contain any untrue statement of a material fact or omit to state a material fact necessary to make the statements made, in light of the circumstances under which such statements were made, not misleading with respect to the period covered by this annual report;

3. Based on my knowledge, the financial statements, and other financial information included in this annual report, fairly present in all material respects the financial condition, results of operations and cash flows of the registrant as of, and for, the periods presented in this annual report;

4. The registrant’s other certifying officer and I are responsible for establishing and maintaining disclosure controls and procedures (as defined in Exchange Act Rules 13a-15(e) and 15d-15(e)) for the registrant and have:

(A) Designed such disclosure controls and procedures, or caused such disclosure controls and procedures to be designed under our supervision, to ensure that material information relating to the registrant, including its consolidated subsidiaries, is made known to us by others within those entities, particularly during the period in which this annual report is being prepared;

(B) Evaluated the effectiveness of the registrant’s disclosure controls and procedures and presented in this annual report our conclusions about the effectiveness of the disclosure controls and procedures as of the end of the period covered by this report based on such evaluation; and

(C) Disclosed in this annual report any change in the registrant’s internal control over financial reporting that occurred during the registrant’s most recent fiscal quarter that has materially affected, or is reasonably likely to materially affect, the registrant’s internal control over financial reporting; and

5. The registrant’s other certifying officer and I have disclosed, based on our most recent evaluation of internal control over financial reporting, to the registrant’s auditors and the audit committee of the registrant’s board of directors:

(A) All significant deficiencies and material weaknesses in the design or operation of internal control over financial reporting which are reasonably likely to adversely affect the registrant’s ability to record, process, summarize and report financial information; and

(B) Any fraud, whether or not material, that involves management or other employees who have a significant role in the registrant’s internal control over financial reporting.

Date: March 29, 2004	/s/ John H. Gayle
	John H. Gayle, Executive Vice President
	& Cashier

EX-32.1

Exhibit 32.1

Certification Pursuant to Section 906 of the Sarbanes-Oxley Act of 2002

Pursuant to Section 906 of the Sarbanes-Oxley Act of 2002, the Company’s Chief Executive Officer certifies as follows:

(a) This report on Form 10-KSB fully complies with the requirements of Section 13(a) or 15(d) of the Securities Exchange Act of 1934.

(b) The information contained in this Report on Form 10-KSB fairly presents, in all material respects, the financial condition and results of operations of the Company.

Date: March 29, 2004	/s/ E. J. Woodard, Jr., CLBB
	E. J. Woodard, Jr., CLBB,
	Chairman of the Board,
	President & CEO

EX-32.2

Exhibit 32.2

Certification Pursuant to Section 906 of the Sarbanes-Oxley Act of 2002

Pursuant to Section 906 of the Sarbanes-Oxley Act of 2002, the Company’s Chief Financial Officer certifies as follows:

(a) This report on Form 10-KSB fully complies with the requirements of Section 13(a) or 15(d) of the Securities Exchange Act of 1934.

(b) The information contained in this Report on Form 10-KSB fairly presents, in all material respects, the financial condition and results of operations of the Company.

Date: March 29, 2004	/s/ John H. Gayle
	John H. Gayle,
	Executive Vice President & Cashier

EX-99.1

Exhibit 99.1

Commonwealth Bankshares, Inc.

List of Financial Statements

The following consolidated financial statements of Commonwealth Bankshares, Inc. and subsidiaries are included:

		Page
•	Independent Auditor’s Report	1
•	Consolidated Balance Sheets-December 31, 2003 and 2002.	2 and 3
•	Consolidated Statements of Income-Years Ended December 31, 2003 and 2002.	4
•	Consolidated Statements of Stockholders’ Equity-Years Ended December 31, 2003 and 2002.	5
•	Consolidated Statements of Cash Flows-Years Ended December 31, 2003 and 2002.	6
•	Notes to Consolidated Financial Statements-December 31, 2003 and 2002.	7 - 21

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.

Independent Auditor’s Report

Board of Directors

Commonwealth Bankshares, Inc.

Norfolk, Virginia

We have audited the accompanying consolidated balance sheets of Commonwealth Bankshares, Inc. and subsidiaries as of December 31, 2003 and 2002, and the related consolidated statements of income, stockholders’ equity and cash flows for the years then ended. 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 subsidiaries as of December 31, 2003 and 2002, and the results of their operations and their cash flows for the years then ended in conformity with accounting principles generally accepted in the United States of America.

/s/ Witt Mares Eggleston Smith, PLC

Norfolk, Virginia

February 4, 2004

1

Commonwealth Bankshares, Inc.

Consolidated Balance Sheets

December 31, 2003 and 2002

	2003			2002
Assets
Cash and cash equivalents:
Cash and due from banks	$	8,116,202		$	7,369,589
Interest bearing deposits in banks		134,300			96,939
Federal funds sold		340,621			59,064
Total cash and cash equivalents		8,591,123			7,525,592
Investment securities:
Available for sale		11,594,084			14,972,915
Held to maturity, at amortized cost (fair market value was $858,850 and $1,080,062, respectively)		836,647			1,047,080
		12,430,731			16,019,995
Equity securities, restricted, at cost		2,397,870			1,180,720
Loans held for sale		56,132,136			27,792,233
Loans receivable:
Commercial		45,583,991			36,278,760
Commercial construction		7,759,122			7,457,813
Commercial mortgage		131,743,596			108,102,933
Residential mortgage		36,268,976			33,995,545
Installment loans to individuals		8,226,346			9,185,951
Other		1,368,563			2,033,225
Gross loans		230,950,594			197,054,227
Unearned income		(900,802	)		(731,446	)
Allowance for loan losses		(2,503,000	)		(2,335,000	)
Loans, net		227,546,792			193,987,781
Premises and equipment, net		5,353,554			5,813,553
Other real estate owned		1,094,637			—
Accrued interest receivable		1,504,761			1,386,057
Other assets		3,243,649			2,807,816
	$	318,295,253		$	256,513,747

See accompanying notes to the consolidated financial statements.

2

Commonwealth Bankshares, Inc.

Consolidated Balance Sheets, continued

December 31, 2003 and 2002

	2003		2002
Liabilities and Stockholders’ Equity
Liabilities:
Deposits:
Noninterest-bearing demand deposits	$	31,974,911	$	25,527,790
Interest-bearing:
Demand deposits		33,730,237		28,793,148
Savings deposits		7,997,386		6,502,390
Time deposits $100,000 and over		47,831,903		43,664,941
Other time deposits		129,123,855		123,598,380
Total deposits		250,658,292		228,086,649
Short-term borrowings:
Securities sold under agreements to repurchase		11,714		288,003
Federal Home Loan Bank		36,992,000		1,600,000
Total short-term borrowings		37,003,714		1,888,003
Long-term debt		426,496		452,608
Convertible preferred securities		6,025,300		7,285,000
Accrued interest payable		740,436		860,989
Other liabilities		4,250,450		2,495,868
Total liabilities		299,104,688		241,069,117
Stockholders’ Equity:
Common stock, par value $2.50, 5,000,000 shares authorized; 1,888,271 and 1,721,621 shares issued and outstanding in 2003 and 2002, respectively		4,720,678		4,304,053
Additional paid-in capital		6,547,479		5,560,051
Retained earnings		7,529,445		5,270,552
Accumulated other comprehensive income		392,963		309,974
Total stockholders’ equity		19,190,565		15,444,630
	$	318,295,253	$	256,513,747

See accompanying notes to the consolidated financial statements.

3

Commonwealth Bankshares, Inc.

Consolidated Statements of Income

Years Ended December 31, 2003 and 2002

	2003		2002
Interest and dividend income:
Loans, including fees	$	18,520,947	$	16,479,632
Investment securities:
Taxable		470,348		638,141
Tax exempt		224,209		251,807
Dividend income, equity securities, restricted		119,009		74,330
Other interest income		29,733		187,647
Total interest income		19,364,246		17,631,557
Interest expense:
Deposits		7,696,596		8,405,605
Federal funds purchased		1,040		830
Securities sold under agreements to repurchase		255		7,114
Federal Home Loan Bank		128,655		52,462
Convertible preferred securities		542,791		579,562
Long-term debt		10,041		12,335
Total interest expense		8,379,378		9,057,908
Net interest income		10,984,868		8,573,649
Provision for loan losses		524,797		419,014
Net interest income after provision for loan losses		10,460,071		8,154,635
Noninterest income:
Service charges on deposit accounts		894,238		835,303
Other service charges and fees		515,164		576,652
Other		268,506		239,360
Total noninterest income		1,677,908		1,651,315
Noninterest expense:
Salaries and employee benefits		4,069,620		3,497,632
Net occupancy expense		919,568		777,510
Furniture and equipment expense		1,151,240		1,002,264
Other operating expense		2,251,732		2,106,447
Total noninterest expense		8,392,160		7,383,853
Income before provision for income taxes		3,745,819		2,422,097
Provision for income taxes		1,203,328		747,910
Net income	$	2,542,491	$	1,674,187
Earnings per share:
Basic	$	1.44	$	0.98
Diluted	$	1.03	$	0.73

See accompanying notes to the consolidated financial statements.

4

Commonwealth Bankshares

Consolidated Statements of Stockholders’ Equity

Years Ended December 31, 2003 and 2002

	Common Shares	Common Amount		Additional Paid-in Capital		Retained Earnings			Accumulated Other Comprehensive Income		Total
Balance, January 1, 2002	1,703,002	$	4,257,506	$	5,477,930	$	3,775,600		$	62,242	$	13,573,278
Comprehensive income:
Net income	—		—		—		1,674,187			—		1,674,187
Change in unrealized gains on securities available for sale, net of tax effect	—		—		—		—			247,732		247,732
Total comprehensive income												1,921,919
Issuance of common stock	18,619		46,547		82,121		—			—		128,668
Cash dividends - $.105 per share	—		—		—		(179,235	)		—		(179,235	)
Balance, December 31, 2002	1,721,621		4,304,053		5,560,051		5,270,552			309,974		15,444,630
Comprehensive income:
Net income	—		—		—		2,542,491			—		2,542,491
Change in unrealized gains on securities available for sale, net of tax effect	—		—		—		—			82,989		82,989
Total comprehensive income												2,625,480
Issuance of common stock	166,650		416,625		987,428		—			—		1,404,053
Cash dividends - $0.16 per share	—		—		—		(283,598	)		—		(283,598	)
Balance, December 31, 2003	1,888,271	$	4,720,678	$	6,547,479	$	7,529,445		$	392,963	$	19,190,565

See accompanying notes to the consolidated financial statements.

5

Commonwealth Bankshares, Inc.

Consolidated Statement of Cash Flows

Years Ended December 31, 2003 and 2002

	2003			2002
Operating Activities:
Net income	$	2,542,491		$	1,674,187
Adjustments to reconcile net income to net cash used in operating activities:
Provision for loan losses		524,797			419,014
Depreciation and amortization		901,592			818,331
Gain on the sale of loans		(23,224	)		—
Gain on the sale of premises and equipment		(2,594	)		(36,203	)
Loss on the sale of other real estate owned		2,991			16,135
Deferred tax assets		(221,351	)		(177,244	)
Net change in:
Loans held for sale		(28,339,903	)		(27,792,233	)
Accrued interest receivable		(118,704	)		(64,294	)
Other assets		(257,234	)		1,430,805
Accrued interest payable		(141,548	)		(177,903	)
Other liabilities		1,775,577			637,280
Net cash used in operating activities		(23,357,110	)		(23,252,125	)
Investing Activities:
Purchase of securities available for sale		(4,041,380	)		(4,671,100	)
Purchase of equity securities, restricted		(4,371,750	)		(632,350	)
Net purchase of premises and equipment		(438,999	)		(1,007,847	)
Net expenditures on other real estate owned		(127,006	)		(28,899	)
Net change in loans		(35,031,206	)		(18,037,357	)
Proceeds from:
Maturities of securities held to maturity		210,433			1,840,235
Sales and maturities of securities available for sale		7,545,952			3,619,800
Sales of equity securities, restricted		3,154,600			368,900
Sale of other real estate owned		—			31,115
Net cash used in investing activities		(33,099,356	)		(18,517,503	)
Financing Activities:
Net change in:
Deposits		22,571,643			23,177,722
Short-term borrowings		35,115,711			463,691
Principal payments on long term-debt		(26,112	)		(26,112	)
Dividends reinvested and sale of stock		144,353			128,668
Dividends paid		(283,598	)		(179,235	)
Net cash provided by financing activities		57,521,997			23,564,734
Net increase (decrease) in cash and cash equivalents		1,065,531			(18,204,894	)
Cash and cash equivalents, January 1		7,525,592			25,730,486
Cash and cash equivalents, December 31	$	8,591,123		$	7,525,592
Supplemental cash flow disclosure:
Interest paid during the year	$	8,499,931		$	9,235,811
Income taxes paid during the year	$	1,581,658		$	695,000
Supplemental noncash disclosure:
Transfer from loans to other real estate owned	$	1,285,376		$	—
Conversion of convertible preferred securities for common stock	$	1,259,700		$	—

See accompanying notes to the consolidated financial statements.

6

Commonwealth Bankshares, Inc.

Notes to Consolidated Financial Statements

December 31, 2003 and 2002

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 by the Virginia State Corporation Commission-Bureau of Financial Institutions and the Federal Reserve System. The Bank serves Norfolk, Virginia Beach, Chesapeake and Portsmouth, Virginia through its nine banking offices.

Cash and Cash Equivalents

For purposes of the consolidated statements of cash flows, cash and cash equivalents includes cash and due from banks, interest bearing deposits in banks and federal funds sold. Interest bearing deposits with maturities extending beyond 90 days are not considered cash equivalents for cash flow reporting purposes. The Company had no such deposits at December 31, 2003 and 2002.

Restrictions on Cash and Due from Bank Accounts

The Company is required to maintain average reserve balances in cash with the Federal Reserve Bank (FRB). Required reserves were $110,000 for December 31, 2003 and 2002.

Investment Securities

Investment securities which the Company 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 Company intends to hold for indefinite periods of time, including investment securities used as part of the Company’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.

Management evaluates securities for other-than-temporary impairment at least on a quarterly basis, and more frequently when economic or market concerns warrant such evaluation. Consideration is given to (1) the length of time and the extent to which the fair value has been less than cost, (2) the financial condition and near-term prospects of the issuer, and (3) the intent and ability of the Company to retain its investment in the issuer for a period of time sufficient to allow for any anticipated recovery in fair value.

Equity Securities, Restricted

The Company, as a member of the Federal Home Loan Bank (“FHLB”) of Atlanta, is required to hold shares of capital stock in the FHLB in an amount equal to at least 1% of the aggregate principal amount of its residential mortgage loans or 5% of its borrowings from the FHLB, whichever is larger.

As a member of the Federal Reserve Bank (“FRB”), the Company is required to hold shares of FRB capital stock, $100 par value, in an amount equal to 6% of the Company’s total common stock and capital surplus.

FRB stock and FHLB stock are carried at cost.

7

Loans Held for Sale

Loans held for sale consist primarily of mortgage loans in the process of being sold to third-party investors. The loans are carried at the lower of aggregate cost or fair value as determined by aggregate outstanding commitments from investors or current investor yield requirements.

Transfers of Financial Assets

Transfers of financial assets are accounted for as sales, when control over the assets has been surrendered. Control over transferred assets is deemed to be surrendered when (1) the assets have been isolated from the Company, (2) the transferee obtains the right (free of conditions that constrain it from taking advantage of that right) to pledge or exchange the transferred assets, and (3) the Company does not maintain effective control over the transferred assets through an agreement to repurchase them before their maturity.

Loans Receivable

Loans that management has the intent and ability to hold for the foreseeable future or until maturity or pay-off generally are stated at their outstanding unpaid principal balance net of any deferred fees or costs on originated loans, or unamortized premiums or discounts on purchased loans. Interest income is accrued on the unpaid principal balance. Discounts and premiums are amortized to income using the interest method. Loan origination fees, net of origination costs, are deferred and recognized as an adjustment to the yield (interest income) of the related loans.

Allowance for Loan Losses

A loan is considered impaired, based on current information and events, if it is probable that the Company will be unable to collect the scheduled payments of principal or interest when due according to the contractual terms of the loan agreement. The measurement of impaired loans is generally based on the present value of expected future cash flows discounted at the historical effective interest rate, except that all collateral-dependent loans are measured for impairment based on the fair value of the collateral.

The adequacy of the allowance for loan losses is periodically evaluated by the Company, in order to maintain the allowance at a level that is sufficient to absorb probable credit losses. Management’s evaluation of the adequacy of the allowance is based on a review of the Company’s historical loss experience, known and inherent risks in the loan portfolio, including adverse circumstances that may affect the ability of the borrower to repay interest and/or principal, the estimated value of collateral, and an analysis of the levels and trends of delinquencies, charge-offs, and the risk ratings of the various loan categories. Such factors as the level and trend of interest rates and the condition of the national and local economies are also considered. In addition, various regulatory agencies, as an integral part of their examination process, periodically review the Company’s allowance for losses on loan. Such agencies may require the Company to recognize additions to the allowance based on their judgments of information available to them at the time of their examination.

The allowance for loan losses is established through charges to earnings in the form of a provision for loan losses. Increases and decreases in the allowance due to changes in the measurement of impaired loans, if applicable, are included in the provision for loan losses. Loans continue to be classified as impaired unless they are brought fully current and the collection of scheduled interest and principal is considered probable.

When a loan or portion of a loan is determined to be uncollectible, the portion deemed uncollectible is charged against the allowance. Subsequent recoveries, if any, are credited to the allowance.

Income Recognition on Impaired and Nonaccrual Loans

Loans, including impaired loans, are generally classified as nonaccrual if they are past due as to maturity or payment of principal or interest for a period of more that 120 days, unless such loans are well-secured and in the process of collection. If a loan or a portion of a loan is adversely classified, or is partially charged off, the loan is generally classified as non-accrual. Loans that are on a current payment status or past due less than 90 days may also be classified as non-accrual, if repayment in full of principal and/or interest is in doubt.

Loans may be returned to accrual status when all principal and interest amounts contractually due (including arrearages) are reasonably assured of repayment within an acceptable period of time, and there is a sustained period of repayment performance by the borrower, in accordance with the contractual terms of interest and principal.

While a loan is classified as nonaccrual and the future collectibility of the recorded loan balance is doubtful, collections of interest and principal are generally applied as a reduction to principal outstanding. When the future collectibility of the recorded loan balance is expected, interest income may be recognized on a cash basis. In the case where a non-accrual loan has been partially charged off, recognition of interest on a cash basis is limited to that which would have been recognized on the recorded loan balance at the contractual interest rate. Cash interest receipts in excess of that amount are recorded as recoveries to the allowance for loan losses until prior charge-offs have been fully recovered.

8

Premises and Equipment

Premises and equipment are stated at cost less accumulated depreciation. Depreciation 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

Other Real Estate Owned

Other real estate owned 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. Development and improvement costs relating to property are capitalized. Net operating income or expenses of such properties are included in other expenses.

Advertising Costs

Advertising costs are expensed as incurred.

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.

Stock Compensation Plans

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

Fair Value of Financial Instruments

The carrying value of cash and cash equivalents, interest bearing deposits in banks, loans held for sale, 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.

9

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:

	2003		2002
Earnings available to common shareholders	$	2,542,491	$	1,674,187
Weighted average shares outstanding		1,771,556		1,708,698
Basic earnings per common share	$	1.44	$	0.98
Effect of dilutive securities:
Earnings available to common shareholders	$	2,542,491	$	1,674,187
Convertible preferred securities interest net of tax effect		358,242		384,648
Earnings available to common plus assumed conversions	$	2,900,733	$	2,058,835
Effect of dilutive securities on EPS:
Weighted average shares outstanding		1,771,556		1,708,698
Effect of stock options		188,126		197,645
Effect of convertible preferred securities		865,020		910,625
Diluted average shares outstanding		2,824,703		2,816,968
Diluted earnings per common share	$	1.03	$	0.73

Segment Information

The Company has determined that it has one significant operating segment, the providing of general commercial financial services to customers located in the single geographic area of Hampton Roads, Virginia, and surrounding communities.

Comprehensive Income

SFAS No. 130, Reporting Comprehensive Income, establishes standards for the reporting and presentation of comprehensive income and its components (revenues, expenses, gains, and losses) within the Company’s consolidated financial statements. Although certain changes in assets and liabilities, such as unrealized gains and losses on available for sale securities, are reported as a separate component of the equity section of the balance sheet, such items, along with net income, are components of comprehensive income.

Off-Balance Sheet Financial Instruments

In the ordinary course of business, the Company has entered into off-balance sheet financial instruments consisting of commitments to extend credit, commercial letters of credit, and standby letters of credit. Such financial instruments are recorded in the financial statements when they become payable.

Use of Estimates

The preparation of financial statements in conformity with generally accepted accounting principles requires management to make estimates and assumptions that affect the reported amounts of assets and liabilities and disclosure of contingent assets and liabilities at the date of the financial statements and the reported amounts of revenues and expenses during the periods presented. 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.

10

Recent Accounting Pronouncements

In January 2003, the FASB issued Interpretation No. 46, Consolidation of Variable Interest Entities (FIN 46) which establishes guidance for determining when an entity should consolidate another entity that meets the definition of a variable interest entity. FIN 46 requires a variable interest entity to be consolidated by a company if that company will absorb a majority of the expected losses, will receive a majority of the expected residual returns, or both. Transferors to qualified special-purpose entities (“QSPEs”) and certain other interests in a QSPE are not subject to the requirements of FIN 46. On December 17, 2003, the FASB deferred the effective date of FIN 46 to no later than the end of the first reporting period that ends after March 15, 2004, however, for special-purpose entities the Company would be required to apply FIN 46 as of December 31, 2003. The Interpretation had no effect on the Company’s consolidated financial statements.

In April 2003, the FASB issued SFAS No. 149, Amendment of Statement 133 on Derivative Instruments and Hedging Activities. This Statement amends SFAS No. 133, Accounting for Derivative Instruments and Hedging Activities and clarifies accounting for derivative instruments, including certain derivative instruments embedded in other contracts, and for hedging activities under SFAS No. 133. This Statement is effective for contracts entered into or modified after June 30, 2003, except in certain circumstances, and for hedging relationships designated after June 30, 2003. This Statement did not have a material effect on the Company’s consolidated financial statements.

In May 2003, the FASB issued SFAS No. 150, Accounting for Certain Financial Instruments with Characteristics of both Liabilities and Equity. This Statement provides new rules on the accounting for certain financial instruments that, under previous guidance, issuers could account for as equity. Such financial instruments include mandatorily redeemable shares, instruments that require the issuer to buy back some of its shares in exchange for cash or other assets, or obligations that can be settled with shares, the monetary value of which is fixed. Most of the guidance in SFAS No. 150 is effective for financial instruments entered into or modified after May 31, 2003, and otherwise is effective at the beginning of the first interim period beginning after June 30, 2003. This Statement had no effect on the Company’s consolidated financial statements.

Reclassifications

Certain prior year amounts have been reclassified to conform to the 2003 presentation. These reclassifications have no effect on previously reported net income.

Note 2. Concentrations of Credit Risk

At December 31, 2003, the Company’s cash and due from banks included two commercial bank deposit accounts aggregating $5,513,344 in excess of the Federal Deposit Insurance Corporation (FDIC) insured limit of $100,000 per institution. Interest bearing deposits in banks are not subject to FDIC coverage.

11

Note 3. Investment Securities

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

	Amortized Cost		Unrealized Gains		Unrealized Losses			Fair Value
December 31, 2003
Available for sale:
U.S. Government and agency securities	$	809,125	$	65	$	—		$	809,190
Mortgage-backed securities		2,147,959		36,592		(3,418	)		2,181,133
State and municipal securities		4,352,146		295,343		—			4,647,489
Equities and other bonds		3,689,458		278,089		(11,275	)		3,956,272
	$	10,998,688	$	610,089	$	(14,693	)	$	11,594,084
Held to maturity:
Mortgage-backed securities	$	582,399	$	3,957	$	(3,407	)	$	582,949
State and municipal securities		254,248		21,653		—			275,901
	$	836,647	$	25,610	$	(3,407	)	$	858,850
December 31, 2002
Available for sale:
U.S. Government and agency securities	$	1,299,501	$	4,944	$	—		$	1,304,445
Mortgage-backed securities		4,759,265		119,602		(1,474	)		4,877,393
State and municipal securities		4,767,839		204,509		(2,665	)		4,969,683
Equities and other bonds		3,676,652		194,900		(50,158	)		3,821,394
	$	14,503,257	$	523,955	$	(54,297	)	$	14,972,915
Held to maturity:
Mortgage-backed securities	$	800,919	$	12,632	$	(6,284	)	$	807,267
State and municipal securities		246,161		26,634		—			272,795
	$	1,047,080	$	39,266	$	(6,284	)	$	1,080,062

A maturity schedule of investment securities as of December 31, 2003 is as follows:

	Available for Sale				Held to Maturity
	Amortized Cost		Fair Value		Amortized Cost		Fair Value
Due:
In one year or less	$	809,125	$	809,190	$	—	$	—
After one year through five years		1,495,202		1,577,072		254,248		275,901
After five years through ten years		2,474,028		2,623,682		—		—
After ten years		1,938,163		2,070,599		—		—
		6,716,518		7,080,543		254,248		275,901
Mortgage-backed securities		2,147,959		2,181,133		582,399		582,949
Equity securities		2,134,211		2,332,408		—		—
	$	10,998,688	$	11,594,084	$	836,647	$	858,850

Securities with an amortized cost of $7,837,684 and $10,408,543 and market value of $8,183,678 and $10,743,842 at December 31, 2003 and 2002, respectively, were pledged as collateral to secure public deposits and for other purposes.

12

Note 4. Loans Receivable

Although the Company 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 on these sectors are as follows:

	December 31,
	2003		2002
Commercial real estate operators	$	19,500,000	$	20,200,000
Hotel/motel	$	24,400,000	$	21,500,000

A summary of transactions in the allowance for loan losses follows:

	2003			2002
Balance at beginning of year	$	2,335,000		$	1,988,000
Provision charged to operating expense		524,797			419,014
Loans charged-off		(369,892	)		(86,753	)
Recoveries of loans previously charged-off		13,095			14,739
Balance at end of year	$	2,503,000		$	2,335,000

Accounting standards require certain disclosures concerning impaired loans, as defined by generally accepted accounting principles, regardless of whether or not an impairment loss exists. Impaired loans amount to $2,845,100 and $1,710,388, with specific reserves allocated from the allowance for loan losses of $1,259,382 and $710,442, as of December 31, 2003 and 2002, respectively. The Company recognized $192,788 and $63,494 of interest income on impaired loans during 2003 and 2002, respectively.

Note 5. Premises and Equipment

Premises and equipment are summarized as follows:

	December 31,
	2003		2002
Land	$	345,403	$	345,403
Buildings and improvements		2,943,032		2,858,609
Leasehold improvements		696,226		618,188
Furniture and equipment		6,160,615		5,887,204
Construction in progress		29,510		82,741
		10,174,786		9,792,145
Less accumulated depreciation		4,821,232		3,978,592
	$	5,353,554	$	5,813,553

Note 6. Deposits

At December 31, 2003, the scheduled maturities of certificates of deposit included in other time deposits on the balance sheet are as follows:

2004	$	58,046,715
2005		29,261,754
2006		26,655,591
2007		3,845,597
2008		35,583,909
Thereafter		8,530,663
	$	161,924,229

13

Note 7. Other Operating Expenses

A summary of other expenses for the years ended December 31, 2003 and 2002 is as follows:

	2003		2002
Stationary and office supplies	$	188,138	$	201,220
Advertising and marketing		187,408		144,350
Telephone and postage		250,189		236,852
Professional		244,797		173,213
Bank franchise tax		182,932		163,473
Other outside services		341,290		311,662
Directors’ and advisory board fees		232,276		251,115
Other		624,702		624,562
	$	2,251,732	$	2,106,447

Note 8. 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 2004, the Bank can initiate dividend payments without said regulatory approvals of approximately $3,986,444 plus an additional amount equal to the Bank’s net earnings for 2004 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 9. Short-Term Borrowings

Included in short-term borrowing are securities sold under agreements to repurchase which generally mature within one to three days from the transaction date. The securities underlying these agreements were under the Company’s control.

	2003			2002
Weighted average rate		0.19	%		0.76	%
Average balance	$	132,564		$	941,575
Maximum outstanding at a month-end	$	319,763		$	1,144,220
Balance at December 31,	$	11,714		$	288,003

The Company has a line of credit with the Federal Home Loan Bank with a maximum value of fifteen percent of the Bank’s current assets, using a daily rate credit and due on demand. The advances from this line are collateralized by a blanket lien on residential mortgage and commercial mortgage loans, and securities pledged with a book value of $2,480,943.

	2003			2002
Weighted average rate		1.32	%		1.87	%
Average balance	$	9,731,395		$	2,807,710
Maximum outstanding at a month-end	$	36,992,000		$	20,638,000
Balance at December 31,	$	36,992,000		$	1,600,000

The Company has an unsecured line of credit with Bank of America and Suntrust for the purchase of federal funds in the amount of $3,000,000 and $3,500,000, respectively. Each separate line of credit has a variable rate based on the lending bank’s daily federal funds sold and is due on demand.

	2003			2002
Weighted average rate		0.75	%		2.69	%
Average balance	$	139,164		$	30,877
Maximum outstanding at a month-end	$	725,000		$	—
Balance at December 31,	$	—		$	—

14

Note 10. Income Taxes

The current and deferred components of income tax expense are as follows:

	2003			2002
Current	$	1,467,832		$	925,154
Deferred		(264,504	)		(177,244	)
Provision for income taxes	$	1,203,328		$	747,910

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:

	2003			2002
Income tax expense at statutory rates	$	1,273,578		$	823,513
Increase (decrease) due to:
Tax exempt income		(85,802	)		(93,416	)
Other		15,552			17,813
Provision for income taxes	$	1,203,328		$	747,910

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.

A cumulative net deferred tax asset is included in other assets at December 31, 2003 and 2002. The components of the asset are as follows:

	December 31,
	2003			2002
Deferred tax assets:
Allowance for loan losses	$	748,703		$	719,573
Deferred compensation		596,669			437,747
Accrued compensated absences		288,380			240,203
Deferred loan fees		303,912			237,751
Other		4,056			1,877
Total deferred tax assets		1,941,720			1,637,151
Deferred tax liabilities:
Depreciation		(436,807	)		(396,214	)
Unrealized gains on securities		(202,436	)		(159,684	)
Other		(588	)		(1,116	)
Total deferred tax liabilities		(639,831	)		(557,014	)
Net deferred tax asset	$	1,301,889		$	1,080,137

Note 11. Related Parties Loans

During the year, officers, directors, principal stockholders, and their affiliates (related parties) were customers of and had transactions with the Company 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:

	2003			2002
Beginning of year	$	3,714,800		$	2,796,930
Additional borrowings		1,930,683			1,516,892
Curtailments		(2,499,171	)		(599,022	)
End of year	$	3,146,312		$	3,714,800

Deposits from related parties held by the Company at December 31, 2003 and 2002 amounted to $13,477,941 and $7,935,625, respectively.

15

Note 12. 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 common stock at $8.00 per share may occur at any time prior to maturity. During the second half of 2003, 251,940 shares of the 8.0% cumulative preferred securities were converted to 157,449 shares of the Parent’s common stock. There were no conversions in 2002.

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.

Note 13. Regulatory Matters

The Company 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 Company’s and the Bank’s financial statements. Under capital adequacy guidelines and the regulatory framework for prompt corrective action, the Company 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 Company 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, 2003 and 2002, that the Company and the Bank met all capital adequacy requirements to which they are subject.

As of December 31, 2003, the most recent notification from the Federal Reserve Bank categorized the Bank as adequately 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 Company’s and the Bank’s actual capital amounts and ratios as of December 31, 2003 and 2002 are also presented in the table.

	Actual		Minimum Capital Requirement		Minimum To Be Well Capitalized Under Prompt Corrective Action Provisions
(in thousands)	Amount	Ratio	Amount	Ratio	Amount	Ratio
As of December 31, 2003:
Total capital to risk weighted assets:
Consolidated	$27,415	10.2%	$21,442	8.0%	N/A	N/A
Bank	25,692	9.6%	21,390	8.0%	$26,737	10.0%
Tier I capital to risk weighted assets:
Consolidated	24,823	9.3%	10,721	4.0%	N/A	N/A
Bank	23,100	8.6%	10,695	4.0%	16,042	6.0%
Tier I capital to average assets:
Consolidated	24,823	8.7%	11,429	4.0%	N/A	N/A
Bank	23,100	8.1%	11,403	4.0%	14,254	5.0%
As of December 31, 2002:
Total capital to risk weighted assets:
Consolidated	$24,822	11.4%	$17,493	8.0%	N/A	N/A
Bank	23,233	10.7%	17,441	8.0%	$21,801	10.0%
Tier I capital to risk weighted assets:
Consolidated	20,180	9.2%	8,746	4.0%	N/A	N/A
Bank	20,831	9.6%	8,720	4.0%	13,080	6.0%
Tier I capital to average assets:
Consolidated	20,180	7.8%	10,302	4.0%	N/A	N/A
Bank	20,831	8.1%	10,241	4.0%	12,801	5.0%

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Note 14. Disclosures About Fair Value of Financial Instruments

The fair value of a financial instrument is the current amount that would be exchanged between willing parties, other than in a forced liquidation. Fair value is best determined based upon quoted market prices. However, in many instances, there are no quoted market prices for the Company’s various financial instruments. In cases where quoted market prices are not available, fair values are based on estimates using present value or other valuation techniques. Those techniques are significantly affected by the assumptions used, including the discount rate and estimates of future cash flows. Accordingly, the fair value estimates may not be realized in an immediate settlement of the instrument. SFAS No. 107 excludes certain financial instruments and all non-financial instruments from its disclosure requirements. Accordingly, the aggregate fair value amounts presented may not necessarily represent the underlying fair value of the Company.

The following methods and assumptions were used by the Company in estimating fair value disclosures for financial instruments:

Cash and Cash Equivalents

The carrying amounts of cash and short-term instruments approximate fair values.

Equity Securities

The carrying amount approximates fair value.

Investment Securities

Fair values are based on published market prices or dealer quotes. Available-for-sale securities are carried at their aggregate fair value.

Loans Held for Sale and Loans Receivable, Net

For loans receivables with short-term and/or variable characteristics, the total receivables outstanding approximate fair value. The fair value of other loans is estimated by discounting the future cash flows using the build up approach to discount rate construction. Components of the discount rate include a risk free rate, credit quality component, and a service charge component.

Accrued Interest Receivable and Accrued Interest Payable

The carrying amount approximates fair value.

Deposits

The fair value of noninterest bearing deposits and deposits with no defined maturity, by SFAS No. 107 definition, is the amount payable on demand at the reporting date. The fair value of time deposits is estimated by discounting the future cash flows using the build up approach to discount rate construction. Components of the discount rate include a risk free rate, credit quality component, and a service charge component.

Short-term Borrowings

The carrying amounts of federal funds purchased, borrowings under repurchase agreements, and other short-term borrowings maturing within 90 days approximate their fair values.

Long-term Debt

The fair values of the Company’s long-term debt are estimated using discounted cash flow analysis based on the Company’s current incremental borrowing rates for similar types of borrowing arrangements.

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The estimated fair value and the carrying value of the Company’s recorded financial instruments are as follows:

	December 31, 2003				December 31, 2002
(in thousands)	Carrying Amount		Estimated Fair Value		Carrying Amount		Estimated Fair Value
Cash and cash equivalents	$	8,591	$	8,591	$	7,526	$	7,526
Investment securities		12,431		12,453		16,020		15,153
Equity securities		2,398		2,398		1,181		1,181
Loans held for sale and loans receivable, net		283,679		300,350		221,780		241,359
Accrued interest receivable		1,505		1,505		1,386		1,386
Deposits		250,658		257,057		228,087		239,268
Short-term borrowings		37,004		37,004		1,888		1,888
Long-term debt		426		400		453		443
Accrued interest payable		741		741		861		861

Note 15. Dividend Reinvestment and Stock Purchase Plan

In April 1999, the Company’s Board of Directors approved a Dividend Reinvestment and Stock Purchase Plan (the “Plan”). Under this Plan, shares purchased from the Company with reinvested dividends are issued at a five percent (5.0%) discount from market value. The Plan also permits participants to make optional cash payments of up to $20,000 per quarter for the purchase of additional shares of the Company’s common stock. The shares are issued at market value without incurring brokerage commissions.

Note 16. Stock Options

The Company has a Stock Option Plan under which the Company may grant options to its directors and employees for shares of common stock.

A summary of the Company’s stock option activity and related information is as follows.

	Options Outstanding	Weighted Average Exercise Price
Balance at January 1, 2002:	196,872	$	6.68
Granted	—		—
Exercised	8,746		5.59
Expired	—		—
Balance at December 31, 2002:	188,126		6.73
Granted (currently unexercisable)	48,650		19.30
Exercised	—		—
Expired	—		—
Balance at December 31, 2003:	236,776	$	9.31

Exercise prices for options outstanding and exercisable as of December 31, 2003 were as follows:

Range of Exercise Prices	Number of Options	Remaining Contractual Life (in Months)	Weighted Average Exercise Price
$4.30 - $4.81	42,109	17.50	$	4.3219
$5.04 - $6.11	55,757	39.13		5.4288
$6.33 - $9.04	51,510	71.97		8.0002
$9.30 - $10.02	38,750	76.68		9.5090
$4.30 - $10.02	188,126	51.02	$	6.7256

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Note 17. Related Party Leases

In 1984, the Bank entered into a lease with Boush Bank Building Associates, a limited partnership owned by several stockholders of the Company (the Partnership), to rent the Headquarters Building. The lease requires the Bank to pay all taxes, maintenance and insurance. The term of the lease is twenty-three years and eleven months. In connection with this property, the lessor has secured financing in the form of a $1,600,000 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. Under this provision the Bank purchased 19.7% of this property for $362,200 in 1987. At the time of the 1987 purchase the Bank assumed $305,700 of the above-mentioned bond. Pursuant to the purchase option contained in the lease agreement, the Bank recorded an additional interest of $637,400 (34.7%) in the leased property as of December 31, 1988 by assuming a corresponding portion ($521,900) of the unpaid balance of the related revenue bond and applying the difference of $115,500 to amounts due from the lessor. Accordingly the Bank now owns 54.4%, of the Headquarters property. No purchases have been made after 1988. Total lease expense was $66,100 and $72,480 for the years 2003 and 2002.

In addition, the Bank subleases approximately 4,000 square feet of third floor office space to outside parties. Total sublease rental income was $60,614 for the years ended December 31, 2003 and 2002.

The Bank has also entered into a long-term lease with a related party to provide space for one branch located in Chesapeake, Virginia. This lease has been classified as an operating lease for financial reporting purposes. Future minimum lease payments of $107,016 are required each year for five years under the long-term non-cancelable lease agreement as of October 20, 1998, which expires in October 2007. Total lease expense was $106,642 and $104,821 for the years 2003 and 2002, respectively.

Note 18. Lease Commitments

The Company leases office space in Hampton Roads. The leases provide for options to renew for various periods. Pursuant to the terms of these leases, the following is a schedule, by year, of future minimum lease payments required under these non-cancelable operating lease agreements.

	Lease Payments
2004	$	297,428
2005		282,232
2006		247,946
2007		236,825
2008		225,704
Thereafter		726,307
	$	2,016,442

Total rental expense was $295,504 and $291,170 for 2003 and 2002, respectively.

Note 19. Financial Instruments with Off-Balance Sheet Risk

In the normal course of business, the Company is a party to financial instruments with off-balance sheet risk. These financial instruments include commitments to extend credit, standby letters of credit and financial guarantees and involve, to varying degrees, elements of credit and interest rate risk in excess of the amount recognized in the balance sheet. The contract or notional amounts of these instruments reflect the extent of the Company’s involvement in particular classes of financial instruments.

The Company’s exposure to credit loss in the event of nonperformance by the other party to the financial instrument for commitments to extend credit, standby letters of credit, and financial guarantees written is represented by the contractual notional amount of those instruments. The Company uses the same credit policies in making commitments and conditional obligations as it does for on-balance sheet instruments.

Unless otherwise noted, the Company does not require collateral or other security to support financial instruments with credit risk.

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Commitments to extend credit are agreements to lend to a customer as long as there is no violation of any condition established in the contract. Commitments generally have fixed expiration dates or other termination clauses and may require payment of a fee. Since many of the commitments are expected to expire without being drawn upon, the total commitment amounts do not necessarily represent future cash requirements. The Company’s experience has been that approximately 90% of loan commitments are drawn upon by customers. The Company evaluates each customer’s credit worthiness on a case-by-case basis. The amount of collateral obtained, if deemed necessary by the Company upon extension of credit, is based on management’s credit evaluation of the counterparty. Collateral held varies but may include property, plant and equipment, and income-producing commercial properties.

Standby letters of credit and financial guarantees written are conditional commitments issued by the Company to guarantee the performance of a customer to a third party. Those guarantees are primarily issued to support public and private borrowing arrangements. The credit risk involved in issuing letters of credit is essentially the same as that involved in extending loan facilities to customers. The Company has not been required to perform on any financial guarantees during the past two years. The Company has not incurred any losses on its commitments in either 2003 or 2002.

The amounts of loan commitments, guarantees and standby letters of credit are set out in the following table as of December 31, 2003 and 2002.

	Variable Rate Commitments		Fixed Rate Commitments
December 31, 2003:
Loan commitments	$	19,757,151	$	11,542,464
Standby letters of credit and guarantees written	$	2,434,220	$	240,147
December 31, 2002:
Loan commitments	$	22,373,139	$	8,713,975
Standby letters of credit and guarantees written	$	153,050	$	704,789

Note 20. Subsequent Events

On January 20, 2004, the Company declared a cash dividend of $0.05 payable February 27, 2004, to shareholders of record on February 23, 2004.

Subsequent to December 31, 2003 through February 4, 2004, 21,775 shares of the 8.0% cumulative preferred securities were converted to 13,607 shares of the Parent’s common stock.

Note 21. Parent Company Only Financial Information

Balance Sheets

December 31, 2003 and 2002

Assets

	2003		2002
Cash on deposit with subsidiary	$	831,709	$	624,923
Investment in subsidiaries		23,648,975		21,323,185
Due from subsidiary		751,315		763,494
Premises		104,421		107,807
Prepaid expense		14,692		37,069
Other assets		248,235		252,497
	$	25,599,347	$	23,108,975

Liabilities and Stockholders’ Equity

Accrued expenses	$	53,917	$	26,715
Accrued interest payable		104,177		126,841
Junior subordinated debentures		6,250,615		7,510,315
Other liabilities		73		474
Total stockholders’ equity		19,190,565		15,444,630
	$	25,599,347	$	23,108,975

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Statements of Income

For the Years Ended December 31, 2003 and 2002

	2003		2002
Income:
Dividends from subsidiaries	$	774,527	$	393,776
Rental income		6,000		6,000
Interest income		309		1,746
Total income		780,836		401,522
Expenses:
Interest expense		559,147		599,158
Professional fees		160,895		90,104
Other		6,324		5,612
Total expenses		726,366		694,874
Income (loss) before income taxes and equity in undistributed net income of subsidiaries		54,470		(293,352	)
Income tax benefits		245,220		233,965
Income (loss) before equity in undistributed net income of subsidiaries		299,690		(59,387	)
Equity in undistributed net income of subsidiaries		2,242,801		1,733,574
Net income	$	2,542,491	$	1,674,187

Statements of Cash Flows

For the Years Ended December 31, 2003 and 2002

	2003			2002
Operating activities:
Net income	$	2,542,491		$	1,674,187
Adjustments to reconcile net income to net cash provided by (used in) operating activities:
Depreciation		3,386			3,385
Equity in undistributed net income of subsidiaries		(2,242,801	)		(1,733,574	)
Net change in:
Amount due to subsidiaries		—			(11,089	)
Prepaid expense		22,377			4,405
Other assets		16,441			(107,149	)
Accrued expenses		27,202			17,838
Accrued interest payable		(22,664	)		(1,667	)
Deferred tax liability		(401	)		(341	)
Net cash provided by (used in) operating activities		346,031			(154,005	)
Financing activities:
Proceeds from issuance of common stock		144,353			128,668
Dividends paid		(283,598	)		(179,235	)
Net cash used in financing activities		(139,245	)		(50,567	)
Net increase (decrease) in cash on deposit with subsidiary		206,786			(204,572	)
Cash on deposit with subsidiary, January 1		624,923			829,495
Cash on deposit with subsidiary, December 31	$	831,709		$	624,923

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