10-Q

UNITED STATES

SECURITIES AND EXCHANGE COMMISSION

Washington, D. C. 20549

FORM 10-Q

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

For the quarterly period ended June 30, 2008

or

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

For the transition period from              to             

Commission file number: 01-17377

COMMONWEALTH BANKSHARES, INC.

(Exact name of registrant as specified in its charter)

VIRGINIA	54-1460991
(State or other jurisdiction of incorporation or organization)	(I.R.S. Employer Identification No.)
403 Boush Street Norfolk, Virginia	23510
(Address of principal executive offices)	(Zip Code)

(757) 446-6900

(Registrant’s telephone number, including area code)

Not Applicable

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

Indicate by check mark whether the registrant (1) has filed all reports required to be filed by Section 13 or 15(d) of the Securities Exchange Act of 1934 during the preceding 12 months (or for such shorter period that the registrant was required to file such reports), and (2) has been subject to such filing requirements for the past 90 days.    Yes  x    No  ¨

Indicate by check mark whether the registrant is a large accelerated filer, an accelerated filer, a non-accelerated filer, or a smaller reporting company. See the definitions of “large accelerated filer”, “accelerated filer” and “smaller reporting company” in Rule 12b-2 of the Exchange Act. (Check one):

Large Accelerated Filer  ¨    Accelerated Filer  x    Non-Accelerated Filer  ¨    Smaller Reporting Company  ¨

Indicate by check mark whether the registrant is a shell company (as defined in Rule 12b-2 of the Exchange Act).    Yes  ¨    No  x

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

Common Stock, $2.066 Par Value – 6,816,751 shares as of July 24, 2008

Commonwealth Bankshares, Inc.

Table of Contents

	Page
PART I – FINANCIAL INFORMATION
ITEM 1 – FINANCIAL STATEMENTS (unaudited)
Consolidated Balance Sheets	3
June 30, 2008
December 31, 2007
Consolidated Statements of Income	4
Three months ended June 30, 2008
Three months ended June 30, 2007
Six months ended June 30, 2008
Six months ended June 30, 2007
Consolidated Statements of Comprehensive Income	5
Six months ended June 30, 2008
Six months ended June 30, 2007
Consolidated Statements of Stockholders’ Equity	6
Six months ended June 30, 2008
Year ended December 31, 2007
Year ended December 31, 2006
Consolidated Statements of Cash Flows	7
Six months ended June 30, 2008
Six months ended June 30, 2007
Notes to Consolidated Financial Statements	8 - 12
ITEM 2 – MANAGEMENT’S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS OF OPERATIONS	12 - 22
ITEM 3 – QUANTITATIVE AND QUALITATIVE DISCLOSURES ABOUT MARKET RISK	23
ITEM 4 – CONTROLS AND PROCEDURES	23
PART II – OTHER INFORMATION
ITEM 1 – LEGAL PROCEEDINGS	24
ITEM 1A – RISK FACTORS	24
ITEM 2 – UNREGISTERED SALES OF EQUITY SECURITIES AND USE OF PROCEEDS	24
ITEM 3 – DEFAULTS UPON SENIOR SECURITIES	24
ITEM 4 – SUBMISSION OF MATTERS TO A VOTE OF SECURITY HOLDERS	24 - 25
ITEM 5 – OTHER INFORMATION	25
ITEM 6 – EXHIBITS	25
SIGNATURES	26

2

Commonwealth Bankshares, Inc.

Consolidated Balance Sheets

	June 30, 2008 (Unaudited)			December 31, 2007 (Audited)
Assets
Cash and cash equivalents:
Cash and due from banks	$	6,196,543		$	8,577,180
Interest bearing deposits in banks		530,720			601,823
Federal funds sold		606,342			158,395
Total cash and cash equivalents		7,333,605			9,337,398
Investment securities:
Available for sale, at fair market value		6,853,841			6,943,449
Held to maturity, at amortized cost (fair market value was $426,467 and $436,252, respectively)		425,143			431,992
Total investment securities		7,278,984			7,375,441
Equity securities, restricted, at cost		9,289,250			8,759,350
Loans		895,562,297			786,986,539
Allowance for loan losses		(10,185,038	)		(9,423,647	)
Loans, net		885,377,259			777,562,892
Premises and equipment, net		31,630,521			24,287,350
Deferred tax assets		5,433,473			4,909,698
Accrued interest receivable		6,009,743			6,171,517
Other assets		7,380,411			4,734,453
Total assets	$	959,733,246		$	843,138,099
Liabilities and Stockholders’ Equity
Liabilities:
Deposits:
Noninterest-bearing demand deposits	$	57,829,660		$	41,232,448
Interest-bearing		622,925,954			531,063,126
Total deposits		680,755,614			572,295,574
Short-term borrowings		75,852,860			69,227,660
Long-term debt		55,295,936			55,322,048
Trust preferred capital notes		20,619,000			20,619,000
Accrued interest payable		2,258,884			2,459,589
Other liabilities		9,377,219			9,800,054
Total liabilities		844,159,513			729,723,925
Stockholders’ Equity:
Common stock, par value $2.066, 18,150,000 shares authorized; 6,816,751 and 6,915,587 shares issued and outstanding in 2008 and 2007, respectively		14,083,407			14,287,602
Additional paid-in capital		63,482,189			64,742,520
Retained earnings		38,010,737			34,361,972
Accumulated other comprehensive income (loss)		(2,600	)		22,080
Total stockholders’ equity		115,573,733			113,414,174
Total liabilities and stockholders’ equity	$	959,733,246		$	843,138,099

See notes to unaudited consolidated financial statements.

3

Commonwealth Bankshares, Inc.

Consolidated Statements of Income (Unaudited)

	Three months ended					Six months ended
	June 30, 2008		June 30, 2007			June 30, 2008		June 30, 2007
Interest and dividend income:
Loans, including fees	$	15,323,415	$	15,340,443		$	30,470,620	$	29,671,152
Investment securities:
Taxable		87,104		88,813			175,484		177,675
Tax exempt		11,434		11,297			22,807		23,621
Dividend income, equity securities, restricted		132,385		119,769			266,862		227,256
Other interest income		3,797		26,096			9,900		64,078
Total interest and dividend income		15,558,135		15,586,418			30,945,673		30,163,782
Interest expense:
Deposits		5,821,727		5,202,654			11,612,782		10,148,743
Federal funds purchased		6,481		—			7,705		—
Federal Home Loan Bank		436,518		1,206,653			1,085,182		2,436,707
Trust preferred capital notes		326,534		326,534			656,655		649,479
Long-term debt		534,783		185,672			1,070,137		238,903
Total interest expense		7,126,043		6,921,513			14,432,461		13,473,832
Net interest income		8,432,092		8,664,905			16,513,212		16,689,950
Provision for loan losses		800,000		285,000			1,255,000		715,000
Net interest income after provision for loan losses		7,632,092		8,379,905			15,258,212		15,974,950
Noninterest income:
Service charges on deposit accounts		363,721		252,679			663,233		477,362
Other service charges and fees		218,391		173,048			404,528		320,590
Mortgage brokerage income		297,067		376,569			593,742		726,972
Title insurance income		210,055		228,180			442,711		445,076
Investment service income		74,881		214,950			185,472		416,419
Other		77,501		55,820			173,898		110,792
Total noninterest income		1,241,616		1,301,246			2,463,584		2,497,211
Noninterest expense:
Salaries and employee benefits		2,592,412		2,728,597			5,381,740		5,222,840
Net occupancy expense		841,824		568,646			1,656,894		1,025,711
Furniture and equipment expense		449,067		384,845			870,689		764,280
Other operating expense		1,321,568		1,453,208			2,544,336		2,695,944
Total noninterest expense		5,204,871		5,135,296			10,453,659		9,708,775
Income before provision for income taxes and noncontrolling interest		3,668,837		4,545,855			7,268,137		8,763,386
Provision for income taxes		1,272,308		1,613,502			2,519,295		3,064,930
Income before noncontrolling interest		2,396,529		2,932,353			4,748,842		5,698,456
Noncontrolling interest in subsidiaries		5,995		(4,695	)		9,815		(9,787	)
Net income	$	2,402,524	$	2,927,658		$	4,758,657	$	5,688,669
Basic earnings per share	$	0.35	$	0.43		$	0.69	$	0.83
Diluted earnings per share	$	0.35	$	0.42		$	0.68	$	0.82
Dividends paid per share	$	0.08	$	0.06		$	0.16	$	0.12
Basic weighted average shares outstanding		6,935,206		6,884,048			6,935,192		6,875,935
Diluted weighted average shares outstanding		6,953,464		6,957,823			6,961,386		6,968,782

See notes to unaudited consolidated financial statements.

4

Commonwealth Bankshares, Inc.

Consolidated Statements of Comprehensive Income (Unaudited)

	Six months ended
	June 30, 2008			June 30, 2007
Net income	$	4,758,657		$	5,688,669
Other comprehensive income, net of income tax:
Net change in unrealized loss on securities available for sale		(24,680	)		(10,705	)
Comprehensive income	$	4,733,977		$	5,677,964

See notes to unaudited consolidated financial statements.

5

Commonwealth Bankshares, Inc.

Consolidated Statements of Stockholders’ Equity

Six Months Ended June 30, 2008, and Years Ended December 31, 2007 and 2006

	Common Shares		Common Amount			Additional Paid-in Capital			Retained Earnings			Accumulated Other Comprehensive Income (loss)			Total
Balance, January 1, 2006	4,928,992		$	10,183,868		$	36,479,909		$	16,071,813		$	(5,571	)	$	62,730,019
Comprehensive income:
Net income	—			—			—			10,091,629			—			10,091,629
Change in unrealized gain on securities available for sale, net of tax effect	—			—			—			—			251			251
Total comprehensive income																10,091,880
Issuance of common stock	752,522			1,553,717			3,523,022			—			—			5,076,739
Issuance of common stock through private placement	1,163,461			2,404,134			23,867,509			—			—			26,271,643
Stock based compensation expense-options issued	—			—			95,400			—			—			95,400
Cash dividends - $0.1991 per share	—			—			—			(1,040,302	)		—			(1,040,302	)
Balance, December 31, 2006	6,844,975		$	14,141,719		$	63,965,840		$	25,123,140		$	(5,320	)	$	103,225,379
Comprehensive income:
Net income	—			—			—			11,166,911			—			11,166,911
Change in unrealized gain on securities available for sale, net of tax effect	—			—			—			—			27,400			27,400
Total comprehensive income																11,194,311
Issuance of common stock	86,012			177,699			1,048,005			—			—			1,225,704
Common stock repurchased	(15,400	)		(31,816	)		(293,375	)		—			—			(325,191	)
Stock based compensation expense-options issued	—			—			22,050			—			—			22,050
Cash dividends - $0.28 per share	—			—			—			(1,928,079	)		—			(1,928,079	)
Balance, December 31, 2007	6,915,587		$	14,287,602		$	64,742,520		$	34,361,972		$	22,080		$	113,414,174
Comprehensive income:
Net income	—			—			—			4,758,657			—			4,758,657
Change in unrealized loss on securities available for sale, net of tax effect	—			—			—			—			(24,680	)		(24,680	)
Total comprehensive income																4,733,977
Issuance of common stock	42,490			87,785			507,915			—			—			595,700
Common stock repurchased	(141,326	)		(291,980	)		(1,768,246	)								(2,060,226	)
Cash dividends - $0.16 per share	—			—			—			(1,109,892	)		—			(1,109,892	)
Balance, June 30, 2008	6,816,751		$	14,083,407		$	63,482,189		$	38,010,737		$	(2,600	)	$	115,573,733

See notes to unaudited consolidated financial statements.

6

Commonwealth Bankshares, Inc.

Consolidated Statements of Cash Flows (Unaudited)

	Six months ended
	June 30, 2008			June 30, 2007
Operating activities:
Net income	$	4,758,657		$	5,688,669
Adjustments to reconcile net income to net cash provided by operating activities:
Provision for loan losses		1,255,000			715,000
Depreciation and amortization		980,847			706,685
Gain on the sale of premises and equipment		(3,720	)		(861	)
Loss on the sale of other real estate owned		59,374			—
Net amortization of premiums and accretion of discounts on investments securities		(4,777	)		(4,277	)
Deferred tax assets		(511,061	)		(324,431	)
Net change in:
Accrued interest receivable		161,774			(427,305	)
Other assets		(3,602,297	)		(651,227	)
Accrued interest payable		(200,705	)		642,019
Other liabilities		(379,688	)		265,299
Net cash provided by operating activities		2,513,404			6,609,571
Investing activities:
Purchase of investment securities available for sale		(1,519,719	)		(21,730	)
Purchase of equity securities, restricted		(5,619,900	)		(4,652,200	)
Net purchase of premises and equipment		(8,324,298	)		(6,426,839	)
Net change in loans		(108,996,151	)		(51,439,708	)
Proceeds from:
Calls and maturities of investment securities held to maturity		12,563			32,587
Sales and maturities of investment securities available for sale		1,570,996			744,887
Sales of equity securities, restricted		5,090,000			3,817,600
Sale of premises and equipment		4,000			10,500
Sale of other real estate owned		896,965			—
Net cash used in investing activities		(116,885,544	)		(57,934,903	)
Financing activities:
Net change in:
Demand, interest-bearing demand and savings deposits		7,693,599			8,627,686
Time deposits		10,952,441			6,664,660
Brokered time deposits		89,814,000			23,277,840
Short-term borrowings		6,625,200			(5,681,700	)
Increase in long-term debt		—			20,000,000
Principal payments on long-term debt		(26,112	)		(26,112	)
Dividends reinvested and issuance of stock		479,337			453,048
Dividends paid		(1,109,892	)		(824,956	)
Common stock repurchased		(2,060,226	)		—
Net cash provided by financing activities		112,368,347			52,490,466
Net increase(decrease) in cash and cash equivalents		(2,003,793	)		1,165,134
Cash and cash equivalents, January 1		9,337,398			13,026,137
Cash and cash equivalents, June 30	$	7,333,605		$	14,191,271
Supplemental cash flow disclosure:
Interest paid during the period	$	14,633,166		$	12,831,813
Income taxes paid during the period	$	2,820,000		$	3,505,000
Supplemental noncash disclosure:
Transfer between loans and other real estate owned	$	2,195,585		$	—
Sale of other real estate owned financed by bank loans	$	910,000		$	—

See notes to unaudited consolidated financial statements.

7

Commonwealth Bankshares, Inc.

Notes to Consolidated Financial Statements (Unaudited)

June 30, 2008

Note A – Basis of Presentation

The accounting and reporting policies of Commonwealth Bankshares, Inc. (the “Parent”) and its subsidiary, Bank of the Commonwealth (the “Bank”) and its subsidiaries, BOC Title of Hampton Roads, Inc., T/A Executive Title Center, BOC Insurance Agencies of Hampton Roads, Inc., Community Home Mortgage of Virginia, Inc., T/A Bank of the Commonwealth Mortgage, Commonwealth Financial Advisors, LLC and Commonwealth Property Associates, LLC, are in accordance with accounting principles generally accepted in the United States of America and conform to accepted practices within the banking industry. The accompanying consolidated financial statements include the accounts of the Parent, the Bank and its subsidiaries, collectively referred to as “the Company.” All significant intercompany balances and transactions have been eliminated in consolidation.

The accompanying unaudited consolidated financial statements have been prepared in accordance with accounting principles generally accepted in the United States of America for interim financial reporting and with the instructions to Form 10-Q. Accordingly, they do not include all of the information and footnotes required by generally accepted accounting principles for complete financial statements. In the opinion of management, all adjustments (consisting of normal recurring accruals) considered necessary for a fair presentation have been included. For further information, refer to the financial statements and footnotes thereto included in the Company’s annual report on Form 10-K for the year ended December 31, 2007. The results of operations for the six months ended June 30, 2008 are not necessarily indicative of the results to be expected for the full year.

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

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

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

Certain 2007 amounts have been reclassified to conform to the 2008 presentation.

8

Note B – Earnings Per Share

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:

	Three months ended				Six months ended
	June 30, 2008		June 30, 2007		June 30, 2008		June 30, 2007
Earnings available to common shareholders	$	2,402,524	$	2,927,658	$	4,758,657	$	5,688,669
Weighted average shares outstanding		6,935,206		6,884,048		6,935,192		6,875,935
Basic earnings per common share	$	0.35	$	0.43	$	0.69	$	0.83
Effect of dilutive securities on EPS:
Weighted average shares outstanding		6,935,206		6,884,048		6,935,192		6,875,935
Effect of dilutive securities, stock options		18,258		73,775		26,194		92,847
Diluted average shares outstanding		6,953,464		6,957,823		6,961,386		6,968,782
Diluted earnings per common share	$	0.35	$	0.42	$	0.68	$	0.82

Options to acquire 420,474 and 296,570 shares of common stock were not included in computing diluted earnings per common share for the three and six months ended June 30, 2008, respectively, because their effects were anti-dilutive.

Note C – Investment Securities

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

	Amortized Cost		Unrealized Gains		Unrealized Losses			Fair Value
June 30, 2008
Available for sale:
U.S. Government and agency securities	$	5,508,726	$	31,760	$	(39,279	)	$	5,501,207
Mortgage-backed securities		574,778		3,245		(4,947	)		573,076
State and municipal securities		774,276		5,282		—			779,558
	$	6,857,780	$	40,287	$	(44,226	)	$	6,853,841
Held to maturity:
Mortgage-backed securities	$	228,673	$	58	$	(654	)	$	228,077
State and municipal securities		196,470		1,920		—			198,390
	$	425,143	$	1,978	$	(654	)	$	426,467
December 31, 2007
Available for sale:
U.S. Government and agency securities	$	5,511,011	$	28,229	$	(724	)	$	5,538,516
Mortgage-backed securities		624,733		4,774		(5,061	)		624,446
State and municipal securities		774,249		6,238		—			780,487
	$	6,909,993	$	39,241	$	(5,785	)	$	6,943,449
Held to maturity:
Mortgage-backed securities	$	240,664	$	1,300	$	(267	)	$	241,697
State and municipal securities		191,328		3,227		—			194,555
	$	431,992	$	4,527	$	(267	)	$	436,252

9

Note D – Loans

Major classifications of loans are summarized as follows:

	June 30, 2008			December 31, 2007
Construction and development	$	248,385,676		$	222,971,794
Commercial		79,617,225			71,171,982
Commercial mortgage		409,962,654			361,658,553
Residential mortgage		144,511,700			118,180,418
Installment loans to individuals		14,189,644			13,781,545
Other		1,054,590			1,033,248
Gross loans		897,721,489			788,797,540
Unearned income		(2,159,192	)		(1,811,001	)
Allowance for loan losses		(10,185,038	)		(9,423,647	)
Loans, net	$	885,377,259		$	777,562,892

Non-performing assets are as follows:

	June 30, 2008			December 31, 2007
Non-accrual loans:
Construction and development	$	375,000		$	—
Commercial		65,378			256,390
Commercial mortgage		962,314			130,228
Residential mortgage		1,482,647			1,945,835
Installment loans to individuals		51,707			54,476
		2,937,046			2,386,929
Loans contractually past-due 90 days or more:
Construction and development		3,744,912			437,045
Commercial		1,142,831			588,246
Residential mortgage		2,270,838			1,519,629
Installment loans to individuals		27,047			31,972
Other		19,725			721
		7,205,353			2,577,613
Total non-performing loans		10,142,399			4,964,542
Other real estate owned		2,081,785			717,377
Total non-performing assets	$	12,224,184		$	5,681,919
Allowance as a percentage of non-performing assets		83.32	%		165.85	%
Non-performing assets as a percentage of total assets		1.27	%		0.67	%

Note E – Allowance For Loan Losses

A summary of transactions in the allowance for loan losses for the six months ended June 30, 2008 and 2007 were as follows:

	June 30, 2008			June 30, 2007
Balance at beginning of year	$	9,423,647		$	8,144,265
Provision charged to operating expense		1,255,000			715,000
Loans charged-off		(496,536	)		(85,467	)
Recoveries of loans previously charged-off		2,927			8,449
Balance at end of period	$	10,185,038		$	8,782,247

10

Note F – Premises and Equipment

Premises and equipment are summarized as follows:

	June 30, 2008			December 31, 2007
Land	$	1,753,908		$	345,403
Building and improvements		3,434,579			3,398,940
Leasehold improvements		15,145,825			14,593,683
Furniture and equipment		14,954,997			14,136,798
Construction in progress		6,543,963			1,203,635
		41,833,272			33,678,459
Less accumulated depreciation		(10,202,751	)		(9,391,109	)
	$	31,630,521		$	24,287,350

Note G – Fair Value Measurements

Effective January 1, 2008, the Company adopted Statement of Financial Accounting Standards (“SFAS”) No. 157—Fair Value Measurements (“SFAS 157”). SFAS 157 defines fair value, establishes a framework for measuring fair value, establishes a three-level valuation hierarchy for disclosure of fair value measurement and enhances disclosure requirements for fair value measurements. SFAS 157 has been applied prospectively as of the beginning of the year. In February 2008, Staff Position No. 157-2 (“FSP 157-2”) was issued. FSP 157-2 delayed the effective date of SFAS 157 for certain nonfinancial assets and nonfinancial liabilities except for those items that are recognized or disclosed at fair value in the financial statements on a recurring basis. FSP 157-2 defers the effective date of SFAS 157 for such nonfinancial assets and nonfinancial liabilities to fiscal years beginning after November 15, 2008, and interim periods within those fiscal years.

SFAS 157 defines fair value as the price that would be received to sell an asset or paid to transfer a liability in an orderly transaction between market participants at the measurement date. SFAS 157 also establishes a fair value hierarchy which requires the use of observable inputs and minimize the use of unobservable inputs when measuring fair value. The standard describes the three levels of inputs that may be used to measure fair value as follows:

•     Level 1	inputs to the valuation methodology are quoted prices (unadjusted) for identical assets or liabilities in active markets.
•     Level 2	inputs to the valuation methodology include quoted prices for similar assets and liabilities in active markets, and inputs that are observable for the asset or liability, either directly or indirectly, for substantially the full term of the financial instrument.
•     Level 3	inputs to the valuation methodology are unobservable and significant to the fair value measurement.

Following is a description of the valuation methodologies used for instruments measured at fair value on a recurring basis and recognized in the accompanying balance sheet, as well as the general classification of such instruments pursuant to the valuation hierarchy:

Available for sale securities

Available for sale securities are recorded at fair value on a recurring basis. Where quoted prices are available in an active market, securities are classified within level 1 of the valuation hierarchy. Level 1 securities would include highly liquid government bonds, mortgage products and exchange traded equities. If quoted market prices are not available, then fair values are estimated by using pricing models, quoted prices of securities with similar characteristics, or discounted cash flow. Level 2 securities would include U.S. agency securities, mortgage-backed agency securities, obligations of states and political subdivisions and certain corporate, asset backed and other securities. In certain cases where there is limited activity or less transparency around inputs to the valuation, securities are classified within level 3 of the valuation hierarchy. Currently, all of the Company’s available for sale securities are considered to be Level 2 securities.

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Following is a description of the valuation methodologies used for instruments measured at fair value on a non-recurring basis and recognized in the accompanying balance sheet, as well as the general classification of such instruments pursuant to the valuation hierarchy:

Impaired loans

SFAS 157 applies to loans measured for impairment using the practical expedients permitted by SFAS 114—Accounting by Creditors for Impairment of a Loan, including impaired loans measured at an observable market price (if available), or at the fair value of the loan’s collateral (if the loan is collateral dependent). Fair value of the loan’s collateral, when the loan is dependent on collateral, is determined by appraisals or independent valuation which is then adjusted for the cost related to liquidation of the collateral. This valuation would be considered Level 3.

Other Real Estate Owned

Certain assets such as other real estate owned (OREO) are measured at fair value less cost to sell. We believe that the fair value component in its valuation follows the provisions of SFAS 157.

Note H – Subsequent Events

On July 15, 2008, the Company declared a $0.08 per share cash dividend payable August 29, 2008, to shareholders of record on August 18, 2008.

On July 21, 2008, the Company opened its 19^th retail branch location in the Redmill section of Virginia Beach, Virginia.

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

General

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

Bank of the Commonwealth was formed on August 28, 1970 under the laws of Virginia. Since the Bank opened for business on April 14, 1971, its main banking and administrative offices have been located in Norfolk, Virginia. The Bank currently operates four branches in Norfolk, six branches in Virginia Beach, four branches in Chesapeake, two branches in Portsmouth, one branch in Powells Point, North Carolina, one branch in Waves, North Carolina and one branch in Moyock, North Carolina. Bank of the Commonwealth Mortgage currently operates one mortgage branch office in Virginia Beach, one mortgage branch office in Gloucester and one mortgage branch office in Richmond, Virginia. Executive Title Center currently operates one title insurance branch office in Norfolk and one title insurance branch office in Suffolk, Virginia. Commonwealth Financial Advisors currently has two locations, one in Virginia Beach and one in Norfolk, Virginia.

The Company concentrates its marketing efforts in the cities of Norfolk, Virginia Beach, Portsmouth and Chesapeake, Virginia and Northeastern North Carolina. The Company intends to continue concentrating its banking activities in its current markets, which the Company believes are attractive areas in which to operate.

The following discussion provides information about the important factors affecting the consolidated results of operations, financial condition, capital resources and liquidity of the Company. This report identifies trends and material changes that occurred during the reporting period and should be read in conjunction with the Company’s annual report on Form 10-K for the year ended December 31, 2007.

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Forward-Looking Statements

Some of the matters discussed below and elsewhere in this report include forward-looking statements. These forward-looking statements include statements regarding profitability, liquidity, adequacy of the allowance for loan losses, interest rate sensitivity, market risk and financial and other goals. Forward-looking statements often use words such as “believes,” “expects,” “plans,” “may,” “will,” “should,” “projects,” “contemplates,” “anticipates,” “forecasts,” “intends” or other words of similar meaning. You can also identify them by the fact that they do not relate strictly to historical or current facts. The forward-looking statements we use in this report are subject to significant risks, assumptions and uncertainties, including among other things, the following important factors that could affect the actual outcome of future events:

• Our dependence on key personnel;

• The high level of competition within the banking industry;

• Our dependence on commercial real estate loans that could be negatively affected by a downturn in the real estate market;

• Adverse changes in the overall national economy as well as adverse economic conditions in our specific market areas within Hampton Roads, Virginia and Northeastern North Carolina;

• Risks inherent in making loans such as repayment risks and fluctuating collateral values;

• The adequacy of our estimate for known and inherent losses in our loan portfolio;

• Changes in interest rates;

• Our ability to manage our growth;

• Impacts of implementing various accounting standards;

• Governmental and regulatory changes that may adversely affect our expenses and cost structure; and

• Other factors described from time to time in our Securities and Exchange Commission filings.

Because of these and other uncertainties, our actual results and performance may be materially different from results indicated by these forward-looking statements. In addition, our past results of operations are not necessarily indicative of future performance.

We caution you that the above list of important factors is not all inclusive. These forward-looking statements are made as of the date of this report, and we may not undertake steps to update these forward-looking statements to reflect the impact of any circumstances or events that arise after the date the forward-looking statements are made.

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. See Note 1 – Summary of Significant Accounting Policies, of the Notes to Consolidated Financial Statements contained in our Annual Report on Form 10-K for the year ended December 31, 2007, for further information related to the allowance for loan losses.

New Accounting Pronouncements

On February 15, 2007, the Financial Accounting Standards Board (“FASB”) issued SFAS No. 159 – The Fair Value Option for Financial Assets and Financial Liabilities, including an amendment of FASB Statement No. 115 (“SFAS 159”), which permits companies to choose to measure many financial instruments and certain other items at fair value. The objective of SFAS 159 is to improve financial reporting by providing companies with the opportunity to mitigate volatility in reported earnings caused by measuring related assets and liabilities differently. The Company adopted SFAS 159 effective January 1, 2008, as required, but has not elected to measure any permissible items at fair value. As a result, the adoption of SFAS 159 did not have any impact on the Companys’ financial statements.

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In December 2007, the FASB issued SFAS No. 141 (revised 2007) – Business Combinations (“Statement 141R”). Statement 141R significantly changes the way companies account for business combinations and will generally require more assets acquired and liabilities assumed to be measured at their acquisition-date fair value. Under Statement 141R, legal fees and other transaction-related costs are expensed as incurred and are no longer included in goodwill as a cost of acquiring the business. Statement 141R also requires, among other things, acquirers to estimate the acquisition-date fair value of any contingent consideration and to recognize any subsequent changes in the fair value of contingent consideration in earnings. In addition, restructuring costs the acquirer expected, but was not obligated to incur, will be recognized separately from the business acquisition. This accounting standard is effective for fiscal years beginning on or after December 15, 2008. The Company is currently evaluating the impact of Statement 141R on its financial statements.

In December 2007, the FASB issued SFAS No. 160 – Noncontrolling Interests in Consolidated Financial Statements, an amendment of ARB No. 51 (“Statement 160”). Statement 160 requires all entities to report noncontrolling interests in subsidiaries as a separate component of equity in the consolidated financial statements. Statement 160 establishes a single method of accounting for changes in a parent’s ownership interest in a subsidiary that do not result in deconsolidation. Companies will no longer recognize a gain or loss on partial disposals of a subsidiary where control is retained. In addition, in partial acquisitions, where control is obtained, the acquiring company will recognize and measure at fair value 100 percent of the assets and liabilities, including goodwill, as if the entire target company had been acquired. This accounting standard is effective for fiscal years beginning on or after December 15, 2008. The Company is currently evaluating the impact of Statement 160 on its financial statements.

In March 2008, the FASB issued SFAS No. 161 – Disclosures about Derivative Instruments and Hedging Activities – an amendment of FASB Statement No. 133 (“Statement 161”). Statement 161 is intended to improve financial reporting about derivative instruments and hedging activities by requiring enhanced disclosures to enable investors to better understand their effects on an entity’s financial position, financial performance, and cash flows. The statement also improves transparency about the location and amounts of derivative instruments in an entity’s financial statements; how derivative instruments and related hedged items are accounted for under Statement 133; and how derivative instruments and related hedged items affect its financial position, financial performance, and cash flows. This accounting standard is effective for fiscal years and interim periods beginning after November 15, 2008, with early application encouraged. The Company is currently evaluating the impact of Statement 161 on its financial statements.

In April 2008, the FASB issued FASB Staff Position No. 142-3 – Determination of the Useful Life of Intangible Assets (“FSP No. 142-3”) to improve the consistency between the useful life of a recognized intangible asset (under SFAS No. 142) and the period of expected cash flows used to measure the fair value of the intangible asset (under SFAS No. 141(R)). FSP No. 142-3 amends the factors to be considered when developing renewal or extension assumptions that are used to estimate an intangible asset’s useful life under SFAS No. 142. The guidance in the new staff position is to be applied prospectively to intangible assets acquired after December 31, 2008. In addition, FSP No. 142-3 increases the disclosure requirements related to renewal or extension assumptions. The Company is currently evaluating the impact of FSP No. 142-3 on its financial statements.

In May 2008, the FASB issued SFAS No. 162 – The Hierarchy of Generally Accepted Accounting Principles (“Statement 162”). Statement 162 identifies the sources of accounting principles and the framework for selecting the principles to be used in the preparation of financial statements of nongovernmental entities that are presented in conformity with generally accepted accounting principles (GAAP) in the United States (the GAAP hierarchy). This statement is effective 60 days following the SEC’s approval of the Public Company Accounting Oversight Board amendments to AU Section 411—The Meaning of Present Fairly in Conformity With Generally Accepted Accounting Principles. The Company is currently evaluating the impact of Statement 162 on its financial statements.

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In May 2008, the FASB issued SFAS No. 163 – Accounting for Financial Guarantee Insurance Contracts—an interpretation of FASB Statement No. 60 (“Statement 163”). Statement 163 requires that an insurance enterprise recognize a claim liability prior to an event of default (insured event) when there is evidence that credit deterioration has occurred in an insured financial obligation. This Statement also clarifies how Statement 60 applies to financial guarantee insurance contracts, including the recognition and measurement to be used to account for premium revenue and claim liabilities. This statement is effective for financial statements issued for fiscal years and interim periods beginning after December 15, 2008. The Company is currently evaluating the impact of Statement 163 on its financial statements.

Stock Compensation Plans

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

Stock option compensation expense is the estimated fair value of options granted on the date of grant using the Black-Scholes option-pricing model. Substantially, all employee stock options are awarded at the end of the year as part of an employees overall compensation, based on the individual’s performance during the year, and either vest immediately or over a nominal vesting period. There were no options granted during the six months ended June 30, 2008 and 2007, respectively. There have been no significant changes in the assumptions for the Black-Scholes option-pricing model previously disclosed in the Company’s Annual Report on Form 10-K for the year ended December 31, 2007. A summary of the Company’s stock option activity and related information for the six months ended June 30, 2008 is as follows:

	Stock Options Outstanding	Weighted Average Exercise Price		Remaining Contractual Life ( in months)	Aggregate Intrinsic Value
Balance at December 31, 2007	489,396	$	16.86
Granted	—		—
Forfeited	—		—
Exercised	15,682		7.47
Expired	—		—
Balance at June 30, 2008	473,714	$	17.17	77.42	$	(2,153,433	)
Balance exercisable at June 30, 2008	473,714	$	17.17	77.42	$	(2,153,433	)

See Note 20 - Stock Based Compensation Plans, of the Notes to Consolidated Financial Statements contained in our Annual Report on Form 10-K for the year ended December 31, 2007, for further information related to stock based compensation.

Financial Condition

Total assets at June 30, 2008 reached a new high of $959.7 million, up 13.8% or $116.6 million from $843.1 million at December 31, 2007. Total loans, the Company’s largest and most profitable asset, ended the quarter at a record $895.6 million, up $108.6 million or 13.8% from December 31, 2007. The expansion of our footprint into new markets, the low interest rate environment, our solid local economy and the efforts of our experienced loan officers to develop new loan relationships combined with the support of existing customers continue to generate record loan demand for the Company.

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As of June 30, 2008, 82.2% of the Company’s loan portfolio consisted of commercial loans, which are considered to provide higher yields, but also generally carry a greater risk. It should be noted that 55.6% of these commercial loans are collateralized with real estate, and accordingly do not represent an unfavorable risk. At June 30, 2008, 61.8% of the Bank’s total loan portfolio consisted of loans collateralized with real estate.

Deposits are the most significant source of the Company’s funds for use in lending and general business purposes. The Company’s strong growth in deposits continued into the second quarter of 2008 with deposits at June 30, 2008 reaching a record $680.8 million, an increase of $108.5 million from December 31, 2007. Noninterest-bearing demand deposits increased by $16.6 million or 40.3% and interest-bearing deposits increased by $91.9 million or 17.3%. Included in time deposits less than $100,000 as of June 30, 2008 and December 31, 2007 are $250.3 million and $160.5 million, respectively in broker certificates of deposits. The interest rates paid on these deposits are consistent, if not lower, than the market rates offered in our local area. Management believes the growth in deposits is a result of the Company’s competitive interest rates on all deposit products, new branch locations, special promotions and product enhancements, as well as the Company’s marketing efforts. The Company’s deposits are predominantly provided by individuals and businesses located within communities served.

As of June 30, 2008, short-term borrowings (advances from FHLB) were $75.9 million, compared to $69.2 million outstanding on December 31, 2007. The increase in short-term borrowings was primarily a result of our loan demand continuing to increase at a faster pace than our deposit growth.

Results of Operation

During the first six months of 2008, the Company had net income of $4.8 million, a decrease of 16.4% over the $5.7 million reported in the first six months of 2007. On a per share basis, diluted earnings was $0.68 for the six months ended June 30, 2008, down $0.14 or 17.1% from the $0.82 reported in the comparable period of 2007. The expansion cost associated with the addition of six new branch facilities in 2007 and one new branch facility in 2008, coupled with the compression of our margins due to the rapid interest rate decline contributed to our decrease in earnings for the first six months of 2008. Net income for the quarter ended June 30, 2008 totaled $2.4 million, a decrease of 17.9% or $525.1 thousand over the amount reported in the second quarter of 2007. Diluted earnings per share equaled $0.35 for the three months ended June 30, 2008 compared to $0.42 for the same period in 2007.

Profitability as measured by the Company’s return on average assets (ROA) was 1.08% and 1.54% for the six months ended June 30, 2008 and 2007, respectively. ROA was impacted by the decrease in net income of 16.4% and by the increase in year to date average assets of $146.1 million or 19.6% from June 30, 2007 to June 30, 2008. The return on average equity (ROE) was 8.31% and 10.87% for the six months ended June 30, 2008 and 2007, respectively. The decrease in ROE is the result of the decrease in net income and the growth in year to date average equity of $9.6 million or 9.1% from June 30, 2007 to June 30, 2008. The growth in year to date average equity is the primary result of the 10.7% increase in net income for the year ended December 31, 2007. For the quarter ended June 30, 2008, ROA was 1.05% and ROE was 8.33%.

A fundamental source of the Company’s earnings, net interest income, is defined as the difference between income on earning assets and the cost of funds supporting those assets. Significant categories of earning assets are loans and securities, while deposits and short-term borrowings represent the major portion of interest- bearing liabilities. The level of net interest income is impacted primarily by variations in the volume and mix of these assets and liabilities, as well as changes in interest rates when compared to previous periods of operations. Net interest income was $16.5 million for the six months ended June 30, 2008, a decrease of $176.7 thousand or 1.1% over the $16.7 million for the six months ended June 30, 2007. For the quarter ended June 30, 2008, net interest income was $8.4 million, a decrease of $232.8 thousand or 2.7% over the comparable period in 2007.

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Total interest and dividend income was $31.0 million for the six months ended June 30, 2008, an increase of $781.9 thousand or 2.6% over the same period of 2007. Interest income on loans, including fees, increased $799.5 thousand or 2.7% to $30.5 million for the six months ended June 30, 2008. For the quarter ended June 30, 2008, total interest and dividend income was $15.6 million and interest income on loans, including fees, was $15.3 million, a decrease of 0.2% and 0.1%, respectively over the comparable period in 2007.

Interest expense of $14.4 million for the six months ended June 30, 2008 represented a $958.6 thousand or 7.1% increase from the comparable period in 2007. Interest expense for the second quarter of 2008 was $7.1 million, up $204.5 thousand from the quarter ended June 30, 2007. The increase was primarily attributable to the substantial increase in the Company’s average interest bearing liabilities as a result of the $155.0 million increase in total deposits as of June 30, 2008 as compared to 2007. Average interest bearing liabilities increased $133.6 million or 22.9% from June 30, 2007 to June 30, 2008, while the overall rate paid on these liabilities decreased 61 basis points as a result of the rapid declining interest rate environment.

The net interest margin, calculated by expressing net interest income as a percentage of average interest earning assets, is an indicator of the Company’s effectiveness in generating income from earning assets. The net interest margin is affected by the structure of the balance sheet as well as by competition and the economy. The Company’s net interest margin (tax equivalent basis) was 3.92% during the first six months of 2008, as compared to 4.71% for the same period in 2007. The compression of our margins can be attributed to the Federal Reserve lowering the Federal Funds rate 100 basis points in the last four months of 2007 and 225 basis points in the first six months of 2008, along with the continued pressure on deposit pricing and the pricing of some deposit products, which lag the decrease in the prime rate, which has an immediate affect on variable loans. For the quarter ended June 30, 2008, the net interest margin was 3.88% compared to 4.77% for the second quarter in 2007.

The provision for loan losses is the annual cost of maintaining an allowance for inherent credit losses. The amount of the provision each year and the level of the allowance are matters of judgment and are impacted by many factors, including actual credit losses during the period, the prospective view of credit losses, loan performance measures and trends (such as delinquencies and charge-offs), loan growth, and other factors, both internal and external that may affect the quality and future loss experience of the credit portfolio. At June 30, 2008, the Company had total allowance for loan losses of $10.2 million or 1.14% of total loans. As a result of the growth in the loan portfolio as well as current expectations relative to the portfolio characteristics and management’s comprehensive allowance analysis, the Company made provisions for loan losses of $1.3 million during the first six months of 2008, an increase of 75.5% over the same period of 2007. Loan charge-offs for the six months ended June 30, 2008 totaled $496.5 thousand and recoveries for the same period totaled $2.9 thousand. Net charge-offs as a percentage of year to date average loans outstanding was relatively low at 0.06% and 0.01% for the period ended June 30, 2008 and 2007, respectively.

Despite the growth in the Company’s loan portfolio, asset quality remains sound. Non-performing assets were $12.2 million or 1.27% of total assets at June 30, 2008 compared to $3.8 million or 0.49% of total assets at June 30, 2007. Non-performing loans increased $5.2 million in the first six months of 2008 to $10.1 million. Non-performing loans at June 30, 2008 consist of sixty-five (65) loans. $9.1 million or 89.6% of the total consists of forty-one (41) loans which are secured by real estate and management does not anticipate any material losses associated with these credits. The remaining $1.0 million in non-performing loans represents twenty-four (24) loans, with the majority making monthly payments and in most cases are secured with workout arrangements currently in place. Other real estate owned (“OREO”) is included in other assets and totaled $2.1 million and $717.4 thousand at June 30, 2008 and December 31, 2007, respectively. The balance at June 30, 2008 includes three residential properties, one commercial property and one construction & development property. During the quarter ended June 30, 2008, one construction and development OREO property was sold and resulted in a net loss of $59.4 thousand. All other real estate owned properties are being actively marketed with two of the five properties under contract to be sold with closings anticipated early in the third quarter. Management does not anticipate any material losses associated with these properties. Asset quality remains a top priority for the Company. We continue to allocate significant resources to the expedient disposition and collection of non-performing and other lower quality assets. Individual action plans have been developed for each non- performing asset. Based on current expectations relative to portfolio characteristics and performance measures including loss projections, management considers the level of the allowance to be adequate.

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Noninterest income for the six months ended June 30, 2008 equaled $2.5 million, a slight decrease of $33.6 thousand from the amount reported for the same period in 2007. Revenues generated from the Bank’s mortgage, title and investment subsidiaries for the six months ended June 30, 2008 was $1.2 million as compared to $1.6 million for the same period in 2007, a net decrease of $366.5 thousand or 23.1%. Offsetting the reduction in subsidiary revenues for the six months ended June 30, 2008 was a 38.9% and 26.2% increase in service charges on deposit accounts and other service charges and fees, respectively. Included in service charges on deposit accounts for the six months ended June 30, 2008 and 2007 were $549.9 thousand and $339.8 thousand, respectively, in non-sufficient funds (“NSF”) fees. Included in other service charges and fees for the six months ended June 30, 2008 and 2007 were $197.2 thousand and $157.8 thousand, respectively in ATM fee income. The increases are the result of the expansion of our branch and ATM networks as well as the record increases in deposits and the corresponding number of deposit accounts. For the three months ended June 30, 2008, noninterest income was $1.2 million, down $59.6 thousand or 4.6% over the comparable period in 2007. Revenues generated by the Bank’s mortgage, title and investment subsidiaries for the three months ended June 30, 2008 was $582.0 thousand, down $237.7 thousand or 29.0% from the same period in 2007. Offsetting the reduction in subsidiary revenues for the three months ended June 30, 2008 was a 44.0% and 26.2% increase in service charges on deposit accounts and other service charges and fees, respectively. Included in service charges on deposit accounts for the three months ended June 30, 2008 and 2007 were $310.8 thousand and $182.6 thousand, respectively, in NSF fees. Included in other service charges and fees for the three months ended June 30, 2008 and 2007 were $107.2 thousand and $90.3 thousand, respectively in ATM fee income.

Noninterest expense represents the overhead expenses of the Company. Costs associated with handling our substantial asset and liability growth, including the expansion of our branch network, resulted in increases to almost every component of noninterest expense. Noninterest expense for the six months ended June 30, 2008 totaled $10.5 million, an increase of $744.9 thousand over the $9.7 million recorded during the comparable period in 2007. For the quarter ended June 30, 2008, noninterest expense was $5.2 million, up $69.6 thousand or 1.4% from the same period in 2007. The increase in noninterest expense is in line when compared to the Bank’s overall growth. The ratio of annualized noninterest expense to year to date average total assets was 2.36% and 2.63% for the six months ended June 30, 2008 and 2007, respectively. The ratio of annualized noninterest expense to quarter to date average total assets was 2.28% and 2.71% for the three months ended June 30, 2008 and 2007, respectively.

A key measure of overhead is the operating efficiency ratio. The operating efficiency ratio is calculated by dividing noninterest expense by net bank revenue on a tax equivalent basis. Efficiency gains can be achieved by controlling costs and generating more diverse and higher levels of noninterest income along with increasing our margins. The Company’s efficiency ratio (tax equivalent basis) was 54.97% and 53.58% for the six months and three months ended June 30, 2008, as compared to 50.54% and the 51.47% for the comparable periods in 2007.

Salaries and employee benefits, the largest component of noninterest expense, increased by $158.9 thousand or 3.0% over the $5.2 million reported during the first six months of 2007. For the quarter ended June 30, 2008, salaries and employee benefits decreased $136.2 thousand to $2.6 million as compared to $2.7 million for the quarter ended June 30, 2007. The year to date increase was the result of annual merit increases, the addition of several new positions, including the staff needed to operate the Bank’s four new branches, which opened subsequent to June 30, 2007 and an increase in certain employee benefit costs. Occupancy expense increased $631.2 thousand for the six months ended June 30, 2008 as compared to same period in 2007. For the quarter ended June 30, 2008, occupancy expense increased $273.2 thousand or 48.0% over the $568.6 thousand reported in the second quarter of 2007. This increase is primarily due to the addition of four new branch locations subsequent to June 30, 2007 and the improvements to several branch facilities, the cost of which qualified for capitalization. Other noninterest operating expenses, which includes a grouping of numerous transactions relating to normal banking operations, decreased $151.6 thousand for the six months ended June 30, 2008, a 5.6% reduction over the comparable period for 2007. The decrease was comprised of a $472.6 thousand reduction in advertising and marketing expense, which was offset by increases of $62.5 thousand and $151.5 thousand in Bank Franchise taxes and FDIC

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insurance, respectively. For the three months ended June 30, 2008, other noninterest operating expenses decreased $131.6 thousand or 9.1% over the $1.5 million reported in the second quarter of 2007. The decrease was comprised of a $246.3 thousand reduction in advertising and marketing expense, which was offset by increases of $48.3 thousand and $76.8 thousand in Bank Franchise taxes and FDIC insurance, respectively.

Income tax expense for the six months ended June 30, 2008 and 2007 was $2.5 million and $3.1 million, respectively. For the three months ended June 30, 2008 and 2007, income tax expense was $1.3 million and $1.6 million, respectively. The Company’s effective tax rate was 34.7% for the six months and three months ended June 30, 2008, compared to 35.0% and 35.5% for the comparable periods in 2007.

Capital Resources

Total stockholders’ equity for the Company increased $2.2 million, or 1.9%, to $115.6 million at June 30, 2008 compared to $113.4 million at December 31, 2007. Contributing to the overall increase in total stockholders’ equity was our earnings of $4.8 million for the first six months of 2008, which was offset by the $2.1 million of common stock repurchased by the Company in June 2008.

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

Risk-based capital ratios are another measure of capital adequacy. At June 30, 2008, the Bank’s risk-adjusted capital ratios were 12.63% for Tier 1 and 13.76% for total capital, well above the required minimums of 4% and 8%, respectively. These ratios are calculated using regulatory capital (either Tier 1 or total capital) as the numerator and both on and off-balance sheet risk-weighted assets as the denominator. Tier 1 capital consists primarily of common equity less goodwill and certain other intangible assets. Total capital adds certain qualifying debt instruments and a portion of the allowance for loan losses to Tier 1 capital. One of four risk weights, primarily based on credit risk, is applied to both on and off-balance sheet assets to determine the asset denominator. Under Federal Reserve Bank rules, the Bank was considered “well capitalized,” the highest category of capitalization defined by the regulators, as of June 30, 2008.

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

Cash Dividends

In compliance with the Company’s dividend payout policy, on February 29, 2008, the Company paid a cash dividend of 8.0 cents per share, totaling $554.5 thousand. On May 30, 2008, the Company paid a cash dividend of 8.0 cents per share, totaling $555.4 thousand. Total dividends of 16 cents per share paid during the six months ended June 30, 2008 are up 33.3% from the 12 cents per share paid during the same period in 2007.

Off-Balance Sheet Arrangements

The Company is a party to financial instruments with off-balance sheet risk in the normal course of business to meet the financing needs of its customers. For more information on the Company’s off-balance sheet arrangements, see Note 23 of the Notes to Consolidated Financial Statements in our Annual Report on Form 10-K for the year ended December 31, 2007.

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Contractual Obligations

The Company’s contractual obligations consist of operating lease obligations, FHLB borrowings, trust preferred capital notes, industrial development revenue bond borrowings, standby letters of credit and commitments to extend credit. There have been no material changes to the contractual obligations disclosed in the 2007 Form 10-K.

Interest Sensitivity and Liquidity

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

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

The primary goal of the Company’s asset/liability management strategy is to maximize its net interest income over time while keeping interest rate risk exposure within levels established by the Company’s management. The Company’s ability to manage its interest rate risk depends generally on the Company’s ability to match the maturities and re-pricing characteristics of its assets and liabilities while taking into account the separate goals of maintaining asset quality and liquidity and achieving the desired level of net interest income. The principal variables that affect the Company’s management of its interest rate risk include the Company’s existing interest rate gap position, management’s assessment of future interest rates and the withdrawal of liabilities over time. In addition, the Company uses simulation modeling to forecast future balance sheet and income statement behavior. By studying the effects on net interest income of rising, stable and falling interest rate scenarios, the Company can position itself to take advantage of anticipated interest rate movements, and protect itself from unanticipated interest rate movements, by understanding the dynamic nature of its balance sheet components.

One technique the Company uses in managing its interest rate risk exposure is the management of the Company’s interest sensitivity gap. The interest sensitivity gap is defined as the difference between the amount of interest earning assets anticipated, based upon certain assumptions, to mature or re-price within a specific time period and the amount of interest bearing liabilities anticipated, based upon certain assumptions, to mature or re-price within that time period. At June 30, 2008, the Company’s one year “negative gap” (interest bearing liabilities maturing or re-pricing within the same period exceed interest earning assets maturing or re-pricing within the same period) was approximately ($41.8) million, or (4.35%) of total assets. Thus, during periods of rising interest rates, this implies that the Company’s net interest income would be negatively affected because the cost of the Company’s interest bearing liabilities is likely to rise more quickly than the yield on its interest earning assets. In periods of falling interest rates, the opposite effect on net interest income is likely to occur. At December 31, 2007, the Company’s one year “positive gap” was approximately $3.8 million, or 0.45% of total assets.

The following tables set forth the amount of interest earning assets and interest bearing liabilities outstanding at June 30, 2008 and December 31, 2007 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. Long-term debt (advances from Federal Home Loan Bank of Atlanta) is included in the period in which they contractually mature. Each contains certain conversion options that may cause the advances to mature or convert prior to final maturity. The trust preferred capital notes are included in the period in which they may first be redeemed. Except as stated above, the amount of assets and liabilities shown that re-price or mature

20

during a particular period were determined in accordance with the contractual terms of the asset or liability. In making the gap computations, none of the assumptions sometimes made regarding prepayment rates and deposit decay rates have been used for any interest-earning assets or interest-bearing liabilities. In addition, the table does not reflect scheduled principal payments which will be received throughout the lives of the loans.

Interest Rate Sensitivity Analysis

	June 30, 2008
(dollars 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	$	3,269		$	2,569		$	842		$	599		$	7,279
Equity securities, restricted, at cost		—			—			—			9,289			9,289
Loans		327,517			102,681			360,777			106,746			897,721
Interest bearing deposits in banks		531			—			—			—			531
Federal funds sold		606			—			—			—			606
Total	$	331,923		$	105,250		$	361,619		$	116,634		$	915,426
Cumulative totals		331,923			437,173			798,792			915,426
Interest Bearing Liabilities:
Deposits:
Demand	$	68,581		$	—		$	—		$	—		$	68,581
Savings		6,570			—			—			—			6,570
Time deposits, $100,000 and over		33,137			42,033			44,788			1,042			121,000
Other time deposits		59,994			192,474			168,896			5,411			426,775
Short-term borrowings		75,853			—			—			—			75,853
Long-term debt		296			—			5,000			50,000			55,296
Trust preferred capital notes		—			—			20,619			—			20,619
Total	$	244,431		$	234,507		$	239,303		$	56,453		$	774,694
Cumulative totals		244,431			478,938			718,241			774,694
Interest sensitivity gap	$	87,492		$	(129,257	)	$	122,316		$	60,181		$	140,732
Cumulative interest sensitivity gap	$	87,492		$	(41,765	)	$	80,551		$	140,732
Cumulative interest sensitivity gap as a percentage of total assets		9.12	%		-4.35	%		8.39	%		14.66	%

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Interest Rate Sensitivity Analysis

	December 31, 2007
(dollars in thousands)	Within 90 Days			91 Days to One Year			After One but Within Five Years			After Five Years			Total
Interest Earning Assets:
Investment securities	$	1,037		$	4,946		$	832		$	560		$	7,375
Equity securities, restricted, at cost		—			—			—			8,759			8,759
Loans		372,712			46,073			276,920			93,093			788,798
Interest bearing deposits in banks		602			—			—			—			602
Federal funds sold		158			—			—			—			158
Total	$	374,509		$	51,019		$	277,752		$	102,412		$	805,692
Cumulative totals		374,509			425,528			703,280			805,692
Interest Bearing Liabilities:
Deposits:
Demand	$	77,750		$	—		$	—		$	—		$	77,750
Savings		6,304			—			—			—			6,304
Time deposits, $100,000 and over		31,650			50,393			34,047			—			116,090
Other time deposits		58,489			127,634			140,435			4,361			330,919
Short-term borrowings		69,228			—			—			—			69,228
Long-term debt		322			—			5,000			50,000			55,322
Trust preferred capital notes		—			—			20,619			—			20,619
Total	$	243,743		$	178,027		$	200,101		$	54,361		$	676,232
Cumulative totals		243,743			421,770			621,871			676,232
Interest sensitivity gap	$	130,766		$	(127,008	)	$	77,651		$	48,051		$	129,460
Cumulative interest sensitivity gap	$	130,766		$	3,758		$	81,409		$	129,460
Cumulative interest sensitivity gap as a percentage of total assets		15.51	%		0.45	%		9.66	%		15.35	%

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Item 3. Quantitative and Qualitative Disclosures about Market Risk

There have been no significant changes from the quantitative and qualitative disclosures made in the Company’s Annual Report on Form 10-K for the year ended December 31, 2007.

Item 4. Controls and Procedures

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

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

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

Management assessed the effectiveness of the Company’s internal control over financial reporting as of June 30, 2008. In making this assessment, management used the criteria set forth by the Committee of Sponsoring Organizations of the Treadway Commission in Internal Control – Integrated Framework. Based on this assessment, management believes that, as of June 30, 2008, the Company’s internal control over financial reporting is effective based on those criteria.

Management’s assessment of the effectiveness of internal control over financial reporting as of December 31, 2007 has been audited by PKF Witt Mares, PLC, the independent registered public accounting firm who also audited the Company’s consolidated financial statements included in the Annual Report on Form 10-K for the year ended December 31, 2007.

Changes in Internal Control over Financial Reporting. There was no change in the internal control over financial reporting that occurred during the quarter ended June 30, 2008 that has materially affected, or is reasonably likely to materially affect, the internal control over financial reporting.

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Part II. OTHER INFORMATION

Item 1. Legal proceedings

As of June 30, 2008, there were no legal proceedings against the Company.

Item 1A. Risk factors

There have been no material changes from the risk factors previously disclosed in the Company’s Annual Report on Form 10-K for the year ended December 31, 2007.

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

We announced an open ended program in May 2007 by which management was authorized to repurchase an unlimited number of our own shares of common stock in open market and privately negotiated transactions. During the first six months of 2008, the Company repurchased 141,326 shares of its common stock in open market and privately negotiated transactions. Detail for the shares repurchase transactions conducted during the second quarter of 2008 appears below.

Period	Total Number of Shares Purchased	Average Price Paid Per Share		Total Number of Shares Purchased as Part of Publicly Announced Plans or Programs	Maximum Number of Shares that May Yet to be Purchased Under the Plans or Programs
Month #1
April 1, 2008 - April 30, 2008	—	$	—	—	—
Month #2
May 1, 2008 - May 31, 2008	—	$	—	—	—
Month #3
June 1, 2008 - June 30, 2008	141,326	$	14.53	141,326	—
Total	141,326	$	14.53	141,326	—

Item 3. Defaults upon senior securities

There were no defaults upon senior securities during the quarter.

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

The Annual Meeting of Shareholders was held on July 15, 2008. Of the 6,942,385 shares entitled to vote at the meeting, 5,574,463 voted. The following matters were voted on at the meeting.

Proposal I: The Shareholders of the Company elected three members of the Board of Directors for three year terms as Class II directors until the Annual Meeting of Shareholders in 2011. Votes for each nominee were as follows:

	For	Withheld
Herbert L. Perlin	5,193,941	380,522
Kenneth J. Young	5,193,649	380,814
Thomas W. Moss, Jr.	5,179,587	394,875

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The following Class III and Class I directors whose terms expire in 2009 and 2010 continued in office: Laurence C. Fentriss, Edward J. Woodard, Jr., CLBB, Raju V. Uppalapati, E. Carlton Bowyer, Ph.D., Morton Goldmeier, William D. Payne, M.D. and Richard J. Tavss.

Proposal II: The Shareholders of the Company defeated a shareholder proposal relating to the declassification of the Board of Directors. The vote was as follows:

For	Against	Abstain
1,682,206	2,827,454	36,828

Item 5. Other information

None.

Item 6. Exhibits

(a) Exhibits

31.1	Certification of Chief Executive Officer pursuant to Rule 13a-14(a).
31.2	Certification of Chief Financial Officer pursuant to Rule 13a-14(a).
32.1	Certification of CEO and CFO pursuant to 18 U.S.C. Section 1350.

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SIGNATURES

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

	Commonwealth Bankshares, Inc.
	(Registrant)
Date: August 11, 2008	by:	/s/ Edward J. Woodard, Jr., CLBB
		Edward J. Woodard, Jr., CLBB
		Chairman of the Board, President and Chief Executive Officer
Date: August 11, 2008	by:	/s/ Cynthia A. Sabol, CPA
		Cynthia A. Sabol, CPA
		Executive Vice President & Chief Financial Officer

26

EX-31.1

Exhibit 31.1

CERTIFICATION

I, Edward J. Woodard, Jr., CLBB certify that:

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

2. Based on my knowledge, this 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 report;

3. Based on my knowledge, the financial statements, and other financial information included in this 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 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)) and internal control over financial reporting (as defined in Exchange Act Rules 13a-15(f) and 15d-15(f)) 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 report is being prepared;

b) Designed such internal control over financial reporting, or caused such internal control over financial reporting to be designed under our supervision, to provide reasonable assurance regarding the reliability of financial reporting and the preparation of financial statements for external purposes in accordance with generally accepted accounting principles;

c) Evaluated the effectiveness of the registrant’s disclosure controls and procedures and presented in this 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

d) Disclosed in this report any change in the registrant’s internal control over financial reporting that occurred during the registrant’s most recent fiscal quarter (the registrant’s fourth fiscal quarter in the case of an annual report) 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 (or persons performing the equivalent functions):

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: August 11, 2008	/s/ Edward J. Woodard, Jr., CLBB
	Edward J. Woodard, Jr., CLBB
	Chairman, President and Chief Executive Officer

EX-31.2

Exhibit 31.2

CERTIFICATION

I, Cynthia A. Sabol, CPA certify that:

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

2. Based on my knowledge, this 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 report;

3. Based on my knowledge, the financial statements, and other financial information included in this 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 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)) and internal control over financial reporting (as defined in Exchange Act Rules 13a-15(f) and 15d-15(f)) 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 report is being prepared;

b) Designed such internal control over financial reporting, or caused such internal control over financial reporting to be designed under our supervision, to provide reasonable assurance regarding the reliability of financial reporting and the preparation of financial statements for external purposes in accordance with generally accepted accounting principles;

c) Evaluated the effectiveness of the registrant’s disclosure controls and procedures and presented in this 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

d) Disclosed in this report any change in the registrant’s internal control over financial reporting that occurred during the registrant’s most recent fiscal quarter (the registrant’s fourth fiscal quarter in the case of an annual report) 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 (or persons performing the equivalent functions):

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: August 11, 2008	/s/ Cynthia A. Sabol, CPA
	Cynthia A. Sabol, CPA
	Executive Vice President and Chief Financial Officer

EX-32.1

Exhibit 32.1

CERTIFICATION

The undersigned, as the Chief Executive Officer and the Chief Financial Officer of Commonwealth Bankshares, Inc., certify that to the best of their knowledge and belief the Quarterly Report on Form 10-Q for the period ended June 30, 2008, which accompanies this certification, fully complies with the requirements of Section 13(a) of the Securities Exchange Act of 1934 and the information contained in the periodic report fairly presents, in all material respects, the financial condition and results of operations of Commonwealth Bankshares, Inc. at the dates and for the periods indicated. The foregoing certification is made pursuant to §906 of the Sarbanes-Oxley Act of 2002 (18 U.S.C. §1350), and shall not be relied upon for any other purpose. The undersigned expressly disclaim any obligation to update the foregoing certification except as required by law.

Date: August 11, 2008	/s/ Edward J. Woodard, Jr., CLBB
	Edward J. Woodard, Jr., CLBB
	Chairman, President and Chief Executive Officer
Date: August 11, 2008	/s/ Cynthia A. Sabol, CPA
	Cynthia A. Sabol, CPA
	Executive Vice President and Chief Financial Officer