SECURITIES AND EXCHANGE COMMISSION
Washington, D.C. 20549
Form 10-KSB
(X) Annual Report Pursuant to Section 13 or 15(d) of the Securities Exchange
Act of 1934
For the fiscal year ended December 31, 1997
Commission file number 01-17377
CommonwealthBankshares, Inc.
(Exact name of registrant as specified in its charter)
Virginia 54-1460991
(State or other jurisdiction (I.R.S.Employer
of incorporation or organization) Identification No.)
403 Boush Street
Norfolk, Virginia 23510
(Address of principal executive offices) (Zip Code)
Registrant's telephone number, including area code: (757)446-6900
Securities registered pursuant to Section 12(b) of the Act:
Name of each exchange
Title of each class on which registered
None None
Securities registered pursuant to Section 12(g) of the Act:
Common Stock,$2.50 Par Value
Indicate by a 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, and (2) has been subject to such
filing requirements for the past 90 days. Yes X No Indicate by check mark if
disclosure of delinquent filers pursuant to Item 405 of Regulation S-K is not
contained herein, and will not 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 The aggregate market value of the voting stock held by
non-affiliates of the registrant as of March 15, 1998.
State issuer's revenues for its most recent fiscal year
State the aggregate market value of the voting stock held by
non-affiliates computed by reference to the price at which the stock was
sold, or the average bid and asked prices of such stock, as of a specified
date within the past 60 days. (See definition of affiliate in Rule 12b-2 of
the Exchange Act).
Common Stock, $2.50 Par Value - 1,004,094 shares
DOCUMENTS INCORPORATED BY REFERENCE
Portions of the proxy statement for the annual shareholders meeting to be held
April 28, 1998 are incorporated by reference into Part III.
1997 10-K
Part I
Item 1. Descrpition of Business
The Company and the Bank. The sole business of Commonwealth Bankshares,
Inc. (the "Corporation") is to serve as a holding company for Bank of the
Commonwealth (the "Bank"). The Corporation was incorporated as a Virginia
corporation on June 6, 1988, and on November 7, 1988 it acquired the Bank.
Bank of the Commonwealth was formed on August 28, 1970 under the laws of
Virginia. Since the Bank opened for business on April 14, 1971, its main
banking and administrative office has been located in Norfolk. The Bank opened
two branches in Norfolk in 1979 and four branches in Virginia Beach in 1975,
1982, 1983 and 1996.
Principal Market Area. The Bank concentrates its marketing efforts in
the cities of Norfolk, Virginia Beach, Portsmouth and Chesapeake, Virginia.
The Corporation's present intention is to continue concentrating its banking
activities in its current market, which the Corporation believes is an
attractive area in which to operate.
Banking Service. Through its network of banking facilities, the Bank
provides a wide range of commercial banking services to individuals and small
and medium-sized businesses. The Bank conducts substantially all of the
business operations of a typical independent, commercial bank, including the
acceptance of checking and savings deposits, and the initiating of commercial,
real estate, personal, home improvement, automobile and other installment and
term loans. The Bank also offers other related services, such as home
banking, trust, travelers' checks, safe deposit, lock box, depositor
transfer, customer note payment, collections, notary public, escrow, drive-in
facility and other customary banking services.
Competition
The Bank encounters strong competition for its banking services within its
primary market area. There are twelve commercial banks actively engaged in
business in the cities of Norfolk, Virginia Beach, Portsmouth and Chesapeake,
Virginia, including six major state-wide banking organizations. The Bank is
the oldest independent bank in its market area. Finance companies, mortgage
companies, credit unions and savings and loan associations also compete
with the Bank for loans and deposits. In addition, in some instances, the
Bank must compete for deposits with money market mutual funds that are
marketed nationally. Most of the Bank's competitors have substantially
greater resources than the Bank.
Employees
As of December 31, 1997, the Bank had 67 full-time equivalent employees.
Management of the Corporation and the Bank considers its relations with
employees to be excellent. No employees are represented by a union or any
similar group, and the Bank has never experienced any strike or labor dispute.
Regulation and Supervision
Commonwealth Bankshares, Inc.
In order to acquire the shares of the Bank and thereby become a bank
holding company within the meaning of the Bank Holding Company Act, the
Corporation was required to obtain approval from, and register as a bank
holding company with the Federal Reserve Board (the "Board"), and it is
subject to ongoing regulation, supervision and examination by the Board.
As a condition to its approval, the Board required the Corporation to agree
that it would obtain approval of the Federal Reserve Bank of Richmond prior
to incurring any indebtedness. The Corporation is required to file with
the Board periodic and annual reports and other information concerning its
own business operations and those of its subsidiaries. In addition, the Bank
Holding Company Act requires a bank holding company to obtain Board approval
before it acquires, directly or indirectly, ownership or control of any
voting shares of a second or subsequent bank if, after such acquisition, it
would own or control more than 5% 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%
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.
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% 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.
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 Corporation for all
purchases or redemptions by the Corporation of its equity securities within
the preceding 12 months, will equal 10% or more of the Corporation's
consolidated net worth.
The ability of the Corporation to pay dividends depends upon the amount
of dividends declared by the Bank.
Regulatory restrictions exist with respect to the Bank's ability to pay
dividends. See Note 17 to Consolidated Financial Statements.
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 $100,000 per
depositor.
The commercial banking business is affected by the monetary policies
adopted by the Board. Changes in the discount rate on member bank
borrowing, availability of borrowing at the "discount window," open market
operations, the imposition of any changes in reserve requirements against
member banks' deposits and certain borrowing by banks and their affiliates,
and the limitation of interest rates which member banks may pay on deposits
are some of the instruments of monetary policy available to the Board.
Taken together, these controls give the Board a significant influence over
the growth and profitability of all banks. Management of the Bank is
unable to predict how the Board's monetary policies (or the fiscal policies
or economic controls imposed by Federal or state governments) will affect
the business and earnings of the Bank or the Corporation, or what those
policies or controls will be.
The references in this section to various aspects of supervision and
regulation are brief summaries which do not purport to be complete and
which are qualified in their entirety by reference to applicable laws,
rules and regulations.
<PAGE>
Distribution of Assets, Liabilities and Shareholders' Equity;
Interest Rates and Interest Differential
<TABLE>
<CAPTION>
<S> <C>
Year Ended December 31,
1997 1996 1995
Average Average Average
Balance Interest Yield/Rate Balance Interest Yield/Rate Balance Interest Yield/Rate
(Dollars in Thousands)
ASSETS
Interest earning assets
(taxable-equivalent
basis (1) :
Loans (net of unearned
discount (2) $ 71,481 $ 6,776 9.48% $ 65,710 $ 6,126 9.32% $ 59,459 $ 5,705 9.66%
Securities 24,414 1,560 6.39 23,933 1,197 5.20 16,368 912 5.78
Federal funds sold 4,006 219 5.47 6,614 423 6.40 4,173 246 5.89
Total interest
earning assets 99,901 8,555 8.56 96,257 7,746 8.13 80,000 6,863 8.68
Non-interest earning
assets:
Cash and due from
banks 4,408 4,408 3,785
Premises and equipment 2,415 2,467 2,046
Other assets 2,166 3,002 3,428
TOTAL $108,890 $106,134 $89,259
<FN>
(1) Tax equivalent adjustments (using 34% federal tax rates)
have been made in calculating yields on tax-free loans and
investments. Virginia banks are exempt from state income
tax.
(2) For the purposes of these computations, nonaccruing loans
are included in the daily average loan amounts outstanding.
</TABLE>
<PAGE>
Distribution of Assets, Liabilities and Shareholders' Equity;
Interest Rates and Interest Differential continued. . .
<TABLE>
<CAPTION>
<S> <C>
Year Ended December 31,
1997 1996 1995
Average Average Average
Balance Interest Yield/Rate Balance Interest Yield/Rate Balance Interest Yield/Rate
(Dollars in Thousands)
LIABILITIES &
SHAREHOLDERS'
EQUITY
Interest bearing liabilities:
Savings and time deposits $ 81,580 $ 4,236 5.19% $ 80,037 $ 4,009 5.01% $ 67,419 $ 3,475 5.15%
Federal funds purchased &
securities sold under
agreements to repurchase 3,165 140 4.42 3,142 156 4.96 2,368 117 4.94
Long term debt 583 34 5.83 609 36 5.91 644 40 6.21
Short term debt 0 0 0.00 0 0 0.00 0 0 0.00
Total interest bearing
liabilities 85,328 4,410 5.17 83,788 4,201 5.01 70,431 3,632 5.16
Non-interest bearing
liabilities
Demand deposits 12,204 11,600 9,516
Other 1,399 1,291 1,096
Total liabilities 98,931 96,679 81,043
Common shareholders'
equity 9,959 9,455 8,216
TOTAL $108,890 $106,134 $ 89,259
Net interest earnings $ 4,145 $ 3,545 $ 3,231
Net margin on interest
earning assets on a taxable
equivalent basis 4.21 3.77 4.14
Average interest spread
(taxable equivalent basis) 3.39 3.12 3.52
</TABLE>
<PAGE>
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 changes in
interest due to both rate and volume has been allocated to volume and rate
changes in proportion to the relationship of the absolute dollar amounts of
the change in each.
<TABLE>
<CAPTION>
<S> <C>
1997 Compared to 1996 1996 Compared to 1995
Increase (Decrease) in: Increase Increase
(decrease) due Net (decrease) due Net
to change in: Increase to change in: Increase
Volume Rate (decrease) Volume Rate (decrease)
INTEREST INCOME
Securities $ 25 $ 338 $ 363 $ 366 $ (81) $ 285
Federal funds sold (149) (55) (204) 155 22 177
Loans 546 104 650 576 (155) 421
422 387 809 1,097 (214) 883
INTEREST EXPENSE
Savings and time
deposits 78 149 227 629 (95) 534
Federal funds purchased &
securities sold under
agreement to repurchase 1 (17) (16) 38 1 39
Long term debt (2) 0 (2) (2) (2) (4)
Short term debt 0 0 0 0 0 0
77 132 209 665 (96) 569
Increase (Decrease) in
Net Interest Income $ 345 $ 255 $ 600 $ 432 $ (118) $ 314
</TABLE>
<PAGE>
Investment Portfolio
The following table shows the book value (carrying value) of the
Corporation's investment securities at December 31 of the years indicated below.
<TABLE>
<CAPTION>
<S> <C>
December 31,
1997 1996 1995
(In thousands)
U. S. Government and its Agencies $20,048 $21,483 $15,076
State and Municipals 2,465 2,028 2,038
Other Securities 7 7 0
Federal Reserve Stock 144 144 144
$22,664 $23,662 $17,258
</TABLE>
The maturity distribution, par value, market value, and
yield of the investment portfolio at December 31, 1997, is
presented in
the following table.
December 31, 1997
Par Value Market Value Yield
(In thousands)
Within 3 months $ 300 $ 298 7.86%
After 3 but within 6 months 979 961 5.88
After 6 but within 12 months 755 749 5.32
After 1 but within 5 years 3,147 3,150 5.48
After 5 but within 10 years 8,898 8,824 6.86
After 10 years 8,428 8,419 6.64
Other Securities 7 7 0.00
Federal Reserve Bank Stock 144 144 6.00
$22,658 $22,552 6.49
Loan Portfolio:
The table below classifies loans, net of unearned income, by
major category and percentage distribution at December 31 for
each of the past three years:
<TABLE>
<CAPTION>
<S> <C>
December 31
1997 1996 1995
(In thousands)
Amount % Amount % Amount %
Commercial $13,861 17.67% $11,080 16.83% $ 8,890 14.48%
Commercial mortgage 36,691 46.77 30,664 46.58 27,266 44.43
Residential mortgage 19,836 25.29 17,206 26.13 18,668 30.42
Installment loans to
individuals 4,875 6.21 4,436 6.74 3,739 6.09
Other 3,182 4.06 2,448 3.72 2,810 4.58
TOTAL $78,445 100.00% $65,834 100.00% $61,373 100.00%
</TABLE>
The following table shows the maturity of loans outstanding as of December
31, 1997. Also provided are the amounts due after one year classified
according to the sensitivity to changes in interest rates. Loans are
classified based upon the period in which the final payment is due.
<TABLE>
<CAPTION>
<S> <C>
December 31, 1997
Maturing
After One
Within But Within After
One Year Five Years Five Years Total
(In thousands)
Commercial $4,243 $6,251 $3,367 $13,861
Commercial mortgage 9,055 20,658 6,978 36,691
Residential Mortgage 4,623 9,386 5,827 19,836
Installment loans to
individuals 728 2,885 1,262 4,875
Other 2,775 83 324 3,182
TOTAL $21,424 $39,263 $17,758 $78,445
Loans maturing after one
year with:
Fixed interest rates $11,894 $15,741
Variable interest rates 27,369 2,017
TOTAL $39,263 $17,758
</TABLE>
<PAGE>
Non-performing Loans:
Non-performing loans consist of loans accounted for on a non-accrual
basis (as judgementally determined by management based upon anticipated
realization of interest income) and loans which are contractually past
due 90 days or more as interest and/or principal payments. The following
table presents information concerning non-performing loans for the periods
indicated:
December 31,
1997 1996 1995
(In thousands)
Non-accrual:
Real estate Loans $1,343 $1,869 $1,445
Installment Loans 28 16 62
Credit cards and related plans 0 0 0
Commercial (time and demand) and
all other loans 79 180 148
Lease financing receivables 0 0 0
$1,450 $2,065 $1,655
Contractually past - due
90 days or more:
Real estate Loans $ 0 $ 102 $ 38
Installment Loans 7 9 21
Credit cards and related plans 41 20 37
Commercial (time and demand)
and all other loans 76 49 102
Lease financing receivables 0 0 0
Total Non-performing $1,574 $2,245 $1,853
It is management's practice to cease accruing interest on loans when
payments are 120 days delinquent. However, management may elect to continue
the accrual of interest when the estimated net realizable value of collateral
is sufficient to cover the principal balance and accrued interest, and the
loan is in the process of collection.
If nonaccruing loans had been performing fully, these loans would have
contributed an additional $123.9 thousand to interest income in 1997, $100.5
thousand in 1996, and $115.9 thousand in 1995.
Summary of Loan Loss Experience:
The allowance for loan losses is increased by the provision for loan
losses and reduced by loans charged off, net of recoveries. The allowance
for loan losses is established and maintained at a level judged by management
to be adequate to cover any anticipated loan losses to be incurred in the
collection of outstanding loans. In determining the adequate level of the
allowance for loan losses, management considers the following factors:
(a) loan loss experience; (b) problem loans, including loans judged to
exhibit potential charge-off characteristics, loans on which interest is no
longer being accrued, loans which are past due and loans which have been
classified in the most recent regulatory examination; and (c) anticipated
economic conditions and the potential impact these conditions may have on
individual classifications of borrowers.
The following table presents the Corporation's loan loss experience for
the past five years:
<TABLE>
<CAPTION>
<S> <C>
Year ended December 31,
1997 1996 1995 1994 1993
(In Thousands)
Amount of loans outstanding at end
of year (net of unearned income) $78,251 $65,835 $61,373 $55,463 $49,084
Average amount of loans outstanding
(net of unearned income) $71,481 $65,710 $59,459 $52,592 $47,239
Balance of allowance for loan losses
at beginning of year $932 $1,256 $1,208 $1,129 $1,035
Loans charged off:
Commercial 0 59 0 18 1
Real Estate 0 174 0 0 89
Installment 27 62 7 15 15
Credit Cards and Other Consumer 4 43 6 22 14
Total loans charged off 31 338 13 55 119
Recoveries of loans previously
charged off:
Commercial 1 3 0 9 22
Real Estate 11 1 0 3 1
Installment 3 6 6 12 16
Credit Cards and Other Consumer 3 4 2 8 7
Total recoveries 18 14 8 32 46
Net loans charged off 13 324 5 23 73
Additions to allowance charged
to expense 50 0 53 102 167
Balance at end of year $ 969 $ 932 $1,256 $1,208 $1,129
Ratio of net charge-offs to average
loans outstanding 0.0% 0.5% 0.1% 0.4% 0.2%
</TABLE>
ALLOCATION OF THE ALLOWANCE FOR LOAN LOSSES:
The following table provides an allocation of the allowance for loan losses
as of December 31, 1997:
December 31, 1997
Percent of Loans
on each category
Amount to total loans
(Dollars in Thousands)
Commercial $ 34 6.25%
Commercial Mortgage 222 40.81
Residential Mortgage 211 38.78
Installment Loans to Individuals 36 6.62
Other 41 7.54
Unallocated 425 N/A
Total $969 100.00%
Deposits:
The breakdown of deposits at December 31 for the years indicated is
as follows:
December 31,
1997 1996 1995
(In Thousands)
Non-interest bearing demand deposits $12,083 $10,687 $13,147
Interest-bearing demand deposits 18,011 17,807 15,483
Savings deposits 4,874 4,238 4,196
Certificates of deposit:
Less than $100,000 57,066 52,234 45,024
$100,000 or more 8,726 5,296 4,406
$100,760 $90,262 $82,256
The average daily amount of deposits and rates paid on such deposits
is summarized for the periods indicated in the following table:
December 31,
1997 1996 1995
Amount Rate Amount Rate Amount Rate
(Dollars in Thousands)
Non-interest bearing demand
deposits $12,204 0.00% $11,600 0.00 $9,516 0.00%
Interest bearing demand
deposits 17,416 2.95 17,848 2.96 16,871 2.98
Savings deposits 5,055 2.97 4,673 2.98 4,512 2.97
Certificates of Deposit:
Less than $100,000 52,882 6.13 52,547 6.09 41,847 6.24
$100,000 or more 6,227 5.64 4,969 5.52 4,189 5.34
$93,784 $91,637 $76,935
Remaining maturities of certificates $100,000 or more at
December 31, 1997 as follows:
Maturity
Amount
(In Thousands)
3 months or less $2,287
Over 3 through 12 months 3,676
Over 12 months 2,763
$8,726
Interest Rate Sensitivity Analysis:
The following table provides the maturities of investment securities,
loans, and deposits at December 31, 1997, and measures the interest rate
sensitivity gap for each range of maturity indicated:
<TABLE>
<CAPTION>
<S> <C>
December 31, 1997
Maturing
Non-
Interest
Earning/
After Bearing
one but Assets/
Within Within After Liabili-
One Five Five ties and
Year Years Years Equity Total
(In Thousands)
Assets
Investment Securities $ 6,651 $ 3,189 $12,824 $ 0 $ 22,664
Loans 21,424 39,263 17,758 0 78,445
Other Assets 5,718 0 0 9,279 14,997
Total Assets 33,793 42,452 30,582 9,279 116,106
Liabilities and
Shareholders' Equity
Demand Deposits-Non Interest 0 0 0 12,083 12,083
All Interest-bearing Deposits 56,268 32,409 0 0 88,677
Other Liabilities 2,761 0 0 2,054 4,815
Shareholders' Equity 0 0 0 10,531 10,531
Total Liabilities and
Shareholders' Equity 59,029 32,409 0 24,668 116,106
Interest Rate
Sensitivity Gap ($25,236) $10,043 $30,582 ($15,389) $ 0
</TABLE>
Return on Equity and Assets
The following table highlights certain ratios for the periods indicated:
Year Ended December 31,
1997 1996 1995
Net income to:
Average total assets .85 .79 .94
Average shareholders' equity 9.35 8.85 10.17
Dividend payout ratio (dividends declared per
share divided by net income per share) .00 .00 .00
Average shareholders' equity to average total
assets ratio 9.13 8.91 9.20
Year 2000 Issue
The Corporation has taken steps to ensure that all of our software and
hardware systems are century date compliant and that we will not have problems
as we approach and move into the year 2000. A year 2000 committee has been
established that has the responsibility to review and direct the testing of
our systems for compliance. The Chairman of the Board of Directors is a
member of this committee and updates are periodically provided to the full
Board of Directors.
<PAGE>
Item 2. Description of Properties
The headquarters building (the "Headquarters") of the Corporation and
the Bank, located at the corners of Freemason and Boush Streets, Norfolk,
Virginia, was completed in 1986 and is a three story building of masonry
construction, with approximately 21,000 square feet of floor space. The Bank
utilizes two floors and leases the third floor to others. The office
operates nine teller windows, including two drive-up facilities, one walk-up
facility and a 24 hour teller machine.
The Bank has entered into a lease with Boush Bank Building Associates,
a limited partnership (the "Partnership"), to rent the Headquarters. The
lease requires the Bank to pay all taxes, maintenance and insurance. The
term of the lease is twenty-three years and eleven months, and began on
December 19, 1984. In connection with this property, the lessor has secured
financing in the form of a $1,600,000 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% 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 Crestar 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% 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 $362,201 in 1987. At the time of the 1987 purchase the
Bank assumed $305,744 of the above-mentioned bond. Pursuant to the purchase
option contained in the lease agreement, the Bank recorded an additional
interest of $637,410 (34.7%) in the leased property as of December 31, 1988
by assuming a corresponding portion ($521,888) of the unpaid balance of the
related revenue bond and applying the difference of $115,522 to amounts due
from the lessor.
Accordingly the Bank now owns 54.4%, of the Headquarters property. No
purchases have been made after 1988.
The general partner of the Partnership is Boush Bank Building
Corporation. All of the limited partners of the Partnership, namely Messrs.
Woodard, Burton and Kellam, are directors of the Bank and the Corporation.
The terms of the lease are not less favorable than could be obtained from a
non-related party.
Prior to executing the lease, the shareholders of the Bank owning a
majority of Bank common stock, consented to the foregoing lease.
Additionally, formal shareholder approval of the lease, due to the above
described interest of the Bank's directors, was obtained during the Bank's
1985 Annual Meeting of Shareholders.
The Bank operates a branch office in Norfolk at 4101 Granby Street and
four branches in Virginia Beach at 225 South Rosemont Road, 2712 North Mall
Drive, 1124 First Colonial Road and 1870 Kempsville Road.. One of the
locations is owned by the Bank and the remaining four are leased under
long-term operating leases with renewal options, at total annual rentals of
approximately $103,000 paid to unrelated parties.
<PAGE>
Item 3. Legal Proceedings
None
Item 4. Submission of Matters to a Vote of Securities
Holders
None
PART II
Item 5. Market for Common Equity and Related Stockholder Matters
The Corporation's Articles of Incorporation were amended at the 1996
Annual Meeting of Shareholders to authorize the issuance of up to 5,000,000
shares of Common Stock, par value $2.50 per share, 1,004,094 shares of which
are issued and outstanding. In addition, the Corporation has 300,000 shares
of authorized but unissued preferred stock, par value $25 per share.
The Corporation's Common Stock is not listed on an exchange or traded
through an interdealer quotation system, however, shares are traded in the
over-the-counter market. Anderson & Strudwick, Inc., a member of the
New York Stock Exchange, is an "active market maker" in the Common Stock of
the Corporation. Anderson & Strudwick, Inc. maintains offices in Richmond,
Charlottesville, Fredericksburg, Lynchburg and Norfolk, Virginia. The table
below describes trades quoted by Anderson & Strudwick, Inc. during 1997 and
1996. There may have been other transactions at other prices not known to the
Corporation.
There were no cash dividends declared during the past five years. The
Corporation issued a five (5%) percent stock dividend during the first
quarter of 1994 and six (6%) percent stock dividend during the first quarter
of 1995, 1996 and 1997. In addition, the Board of Directors of the
Corporation declared a eight (8%) stock dividend in February 1998, payable to
shareholders of record on March 31, 1998, which will be distributed April 30,
1998.
The Corporation's Board of Directors determines whether to declared
dividends and the amount of any dividends declared. Such determinations by
the Board take into account the Corporation's financial condition, results of
operations, and other relevant factors. The declaration, amount and timing
of future dividends will be determined by the Board of Directors after a
review of the Corporation's operations and will be dependent upon, among other
factors, the Corporation's income, operating costs, overall financial
condition and capital requirements and upon general business conditions. The
Corporation's only source of funds for cash dividends will be dividends paid
to the Corporation by the Bank, which is subject to regulatory restrictions.
Common Stock Prices
1997 1996
High Low High Low
First Quarter $10.75 $9.91 $9.91 $8.02
Second Quarter 11.25 10.00 10.25 8.75
Third Quarter 11.50 10.50 10.50 9.00
Fourth Quarter 15.25 11.00 11.00 10.00
The foregoing over-the-counter market quotations reflect inter-dealer
prices, without retail mark-up, mark-down or commission, and may not
necessarily represent actual transactions.
At February 28, 1998, there were more than 500 record holders of the
Corporation's common stock (based on the number of record holders as of the
date).
Item 6. Selected Consolidated Financial Data
The following table sets forth certain selected consolidated financial
data for the past five years.
<TABLE>
<CAPTION>
<S> <C>
Years Ended December 31,
1997 1996 1995 1994 1993
(Dollars in thousands, except per share data)
Income Statement Amounts:
Gross interest income $8,553 $7,744 $6,859 $5,831 $5,589
Gross interest expense 4,410 4,201 3,632 2,652 2,744
Net interest income 4,143 3,543 3,227 3,179 2,845
Provision for possible loan
losses (50) (1) (53) (102) (167)
Net interest income after
provision 4,093 3,542 3,174 3,077 2,678
Other operating income 869 871 810 746 824
Other operating expense 3,605 3,213 2,866 2,731 2,636
Income before income
taxes and other item 1,357 1,200 1,118 1,092 866
Income taxes 427 364 282 278 219
Net income $ 930 $ 836 $ 836 $ 814 $ 647
Per Share Data (1):
Net income per share - basic (1) $.93 $.83 $.83 $.81 $.64
Cash dividends per share 0 0 0 0 0
Book value (at year end) 10.49 9.53 8.73 7.76 7.09
Balance Sheet Amounts:
(at year end)
Total assets $116,106 $106,170 $95,037 $81,458 $79,205
Total loans (net of unearned income) 78,251 65,833 61,373 55,463 49,084
Total deposits 100,760 90,262 82,256 71,324 68,805
Long-term debt 583 609 684 662 687
Total equity 10,531 9,568 8,770 7,787 7,117
(1) Adjusted to reflect 1997, 1996, 1995 and 1994 stock
dividends.
</TABLE>
<PAGE>
MANAGEMENT'S DISCUSSION AND ANALYSIS
OF OPERATIONS AND FINANCIAL CONDITION
This section of the Annual Report should be read in conjunction with the
statistical information, Financial Statements and related Notes and the selected
financial data appearing elsewhere in the Report.
In addition to historical information, the following discussion contains
forward looking statements that are subject to risks and uncertainties that
could cause Commonwealth's actual results to differ materially from those
anticipated. These forward looking statements include, but are not limited
to, statements regarding management's expectations that the Bank will
continue to experience growth in core operating earnings, improved credit
quality and increased service fee income, and that Commonwealth may pay cash
dividends in the future. Factors that may cause results to differ materially
from expectations include, among others, adverse changes in the interest rate
environment or economy, resulting in, amount other things, a deterioration in
credit quality, and unanticipated problems with Year 2000 compliance to
effectively correct the Year 2000. Readers are cautioned not to place undue
reliance on these forward looking statements, which reflect management's
analysis only as of the date hereof.
New Accounting Standards
In February 1997 the FASB issued Statement No. 128, "Earnings per Share,"
which establishes standards for computing and presenting earnings per share
information. The Corporation adopted this new accounting standard as of
December 31, 1997 and there was no material impact on the consolidated
financial statements. In June 1997 the FASB issued Statement No. 130,
"Reporting Comprehensive Income," which establishes standards for reporting
and display of comprehensive income and its components. The Corporation will
adopt this new accounting standard as of January 1, 1998 and does not expect
a material impact on the consolidated financial statements.
Financial Condition and Results of Operations-
Commonwealth Bankshares, Inc. and Subsidiary
This commentary provides an overview of Commonwealth Bankshares, Inc.'s
financial condition, changes in financial condition and results of operations
for the years 1995 through 1997. The following discussions should assist
readers in their analysis of the accompanying consolidated financial
statements and supplemental financial information. It should be read in
conjunction with the statistical information.
Earnings Overview
Net income in 1997 of $930.0 thousand represented an 11.18% increase over
the $836.4 thousand reported for the year 1996. This earnings record
reflects the Bank's continued growth in core operating earnings, improved
credit quality and positive trends which are expected to continue into 1998.
Net income for 1996 of $836.4 thousand represented a modest increase over
the $835.5 thousand reported in 1995. This was primarily due to the impact
on earnings created by the establishment of the Bank's Kempsville office and
the implementation of full service Trust activities.
Commonwealth's core earnings, defined by the Corporation as pre-tax
earnings exclusive of the provision for loan losses and nonrecurring items
such as securities gains, have improved steadily since 1993.
The key profitability measures of return on average assets (ROA) and
return on average total shareholders' equity (ROE) reflected improvement in
1997 when compared with 1996 as a result of an improvement in the Bank's net
interest income and a substantial growth in the Bank's loan portfolio. These
improved results followed the decline in 1996 over 1995 brought about by
the impact of the Bank's sixth branch office location and full staffing of
the Bank's newly established Trust Department reported above. Additionally,
the implementation of new technological innovations, the planning for a more
sophisticated customer information system, the implementation of telephone
banking and the expansion of the Bank's home banking system affected 1996's
performance ratios. ROA equaled .85% in 1997 compared with .79% in 1996 and
.94% in 1995. ROE equaled 9.35% in 1997 compared with 8.85% in 1996 and
10.17% in 1995. These ratios, along with other significant earnings and
balance sheet information for each of the years in the five-year period ended
December 31, 1997, are shown in Table 1 as follows:
<TABLE>
<CAPTION>
<S> <C>
Table 1 - Selected Financial Information
(Dollars in thousands, except per share data)
Results of Operations (for the year): 1997 1996 1995 1994 1993
Income From Earning Assets $8,553 $7,744 $6,859 $5,831 $5,590
Net Interest Income 4,143 3,543 3,227 3,179 2,845
Provision For Loan Losses 50 1 53 102 167
Net Income 930 836 836 814 647
Earnings Per Share:
Net Income - basic(1) $0.93 $0.83 $0.83 $0.81 $0.64
Average Shares Outstanding (1) 1,004,094 1,004,094 1,004,094 1,004,094 1,004,094
Financial Condition (at December 31):
Total Assets $116,106 $106,170 $95,037 $81,458 $79,205
Total Equity 10,531 9,568 8,770 7,787 7,117
Selected Ratios (for the year):
Return on Average Assets 0.58% 0.79% 0.94% 1.04% 0.86%
Net Interest Margin 3.99% 3.75% 3.92% 4.53% 4.32%
(1) Adjusted to reflect 1997, 1996, 1995 & 1994 stock dividends
</TABLE>
Earnings per share increased 12.05% during 1997 reaching $.93 per share
or $.10 per share over the $.83 per share reported in both 1996 and 1995.
Significant items affecting the change in earnings per share for 1997, 1996,
and 1995 are summarized as follows:
1997 1996
vs. vs.
1996 1995
Interest on loans and
investments and loan fees 10.4% increase 12.9% increase
Interest on deposits and
funds purchased 4.9% increase 15.7% increase
Net interest income 16.9% increase 9.8% increase
Provision for loan losses $49.2 thousand $52.4 thousand
increase decrease
NET INTEREST INCOME AND NET INTEREST MARGIN
Net interest income, the largest contributor to Commonwealth's earnings,
is defined as the difference between income on assets and the cost of funds
supporting those assets. Earning assets are composed primarily of loans and
securities while deposits and short-term borrowings represent the major
portion of interest-bearing liabilities. Variations in the volume and mix
of these assets and liabilities, as well as changes in the yields earned and
rates paid, are determinants in changes in net interest income.
Net interest income increased $599.9 thousand or 16.93% in 1997 to $4.1
million, compared to an increase of $316 thousand or 9.8% in 1996, or to $3.5
million when compared with the $3.2 million reported in 1995. This improved
performance in 1997 was primarily the result of an increase in interest income
on loans and investments brought about by an increase in the volume of loans
and investment securities outstanding, in spite of the increase in interest
paid on deposits, as deposits grew and repriced during the year. In 1996,
the improved performance over 1995 was also attributable to a similar increase
in interest income on loans and investments. The net interest margin for 1997
was 3.99% compared to 3.75% for 1996. Again, the increase is principally
attributable to the higher volume of loans outstanding. The decline in 1996
was primarily attributable to a 0.5% increase in the cost of deposits for 1996
as compared to 1995. The performance reported herein is reflected in
Commonwealth's earning assets yield which improved 43 basis points to 8.56%
in 1997 compared with a decline of 55 basis points to 8.13% in 1996 following
a 13 basis point increase to 8.68% in 1995. Commonwealth's average cost of
deposits increased 72 basis points in 1995 from 1994 to 4.50%, and 2 basis
points in 1996 from 1995 to 4.52% and decreased 2 basis points in 1997 from
1996. The substantial decreases in nonperforming assets of $1.36 million to
$3.96 million at year end 1996 and $858 thousand to $3.1 million at the end
of 1997 will result in a favorable impact on the net interest margin during
future periods since the major reductions in nonperforming assets occurred at
year end 1996 and 1997 respectively. The increase in nonperforming loans of
$392 thousand to $2.25 million resulted in an unfavorable impact on the net
interest margin during 1995. Without this increase additional income under
the contractual terms of the credits would have been recorded in the amount
of $115.9 thousand on all nonperforming loans during 1995. The level of
nonperforming assets also negatively impacted earnings during 1997 and 1996
in the amounts of $123.9 thousand and $100.5 thousand respectively.
Average interest earning assets increased $3.6 million in 1997 as compared
with an increase of $16.3 million in 1996 and $11 million in 1995. Average
net loans increased $5.8 million in 1997 as compared with increases of $6.3
million in 1996 and $6.9 million in 1995. Average investment securities
increased by $480.4 thousand during 1997, $7.6 million during 1996, and $2.0
million during 1995.
Provision and Allowance for Loan Losses
The provision for loan losses is the annual cost of maintaining an
allowance for inherent credit losses. The amount of the provision each year
and the level of the allowance are matters of judgement and are impacted by
many factors, including actual credit losses during the period,
the prospective view of credit losses, loan performance measures and trends
(such as delinquencies and charge-offs), and other factors, both internal and
external that may affect the quality and future loss experience of the credit
portfolio.
On a quarterly basis, Commonwealth'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 exposures, 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 quarterly.
A continuing strong economy, combined with the Corporation's continued
loan workout activities resulted in a modest contribution to the provision
for loan losses during 1997 and 1996 respectively. The Corporation made
provisions for loan losses of $49.8 thousand in 1997, $0.5 thousand in 1996,
and $52.9 thousand in 1995. Details of the activity in the allowance for
loan losses for the past three years are shown in Note 5 to the Consolidated
Financial Statement.
Net charge-offs during 1997 of $13 thousand represented a substantial
reduction in loan losses when compared with the $324 thousand reported during
1996 and a modest increase over the $5 thousand reported in 1995 The level of
charge-offs during 1996 reflected losses sustained, which were primarily
attributable to the Bank's relationship with one borrower, a relationship
which was in a workout position for an extended period of time. Current
expectations are that total net charge-offs in 1998 will be comparable with
the Bank's experience during 1997.
This expectation is based upon assumptions regarding the general economic
climate in Commonwealth's trade area and the performance characteristics of
the loan portfolio, including Commonwealth's continued success in working out
remaining nonperforming loans. Changes in these conditions could warrant
different results.
The allowance for loan losses at December 31, 1997 was $969 thousand
compared with $932 thousand at year end 1996 and $1.2 million at December 31,
1995. This represented 1.24% of year-end gross loans at December 31, 1997
compared with 1.41% of year-end gross loans at December 31, 1996 and 2.04% of
year end gross loans at December 31, 1995.
The tables on the following pages provide an analysis of the activity in
the Corporation's nonperforming assets and allowance for loan losses for each
of the last three years. Based on current expectations relative to portfolio
characteristics and performance measures including loss projections,
management considers the level of the allowance to be adequate.
Nonperforming loans at December 31, 1997 declined $671 thousand to $1.6
million when compared with the $2.2 million at year-end 1996. During 1996
nonperforming loans increased $392 thousand when compared with 1995.
Nonperforming loans continue to be centered in a relatively small number of
loans with large balances. Based on the Bank's current workout plans, we
expect to return each of these loans to an accrual status during 1998 with
minimum losses to the Bank. Each of the loans are fully secured and
represent minimal risk.
The corporation continues to allocate significant resources to the
expedient disposition and collection of nonperforming and other lower quality
assets. As a part of this workout process, the Corporation routinely
re-evaluates all reasonable alternatives, including the sale of these assets.
Individual action plans have been developed for each nonperforming asset.
The amount of loans past due 90 days or more that were not classified as
nonaccrual loans totaled $124 thousand at December 31, 1997, $180 thousand at
December 31, 1996, and $198 thousand at December 31, 1995.
The following table reflects the trends discussed herein:
Nonperforming Assets
December 31
1997 1996 1995
90 Days delinquent and still accruing $ 124,000 $ 180,000 $ 198,000
Nonaccrual 1,450,000 2,065,000 1,655,000
Foreclosed properties 1,533,000 1,720,000 3,467,000
Total Nonperforming Assets $3,107,000 $3,965,000 $5,320,000
ASSET QUALITY REVIEW AND CREDIT RISK MANAGEMENT
In conducting business activities, the Corporation is exposed to the
possibility that borrowers or counterparties may default on their obligations
to the Corporation. Credit risk arises through the extension of loans,
leases, certain securities, and financial guarantees. To manage this risk,
the Corporation establishes policies and procedures to manage both on and
off-balance sheet risk and communicates and monitors the application of these
policies and procedures throughout the Corporation.
Loan Portfolio
The Corporation's credit risk is centered in its loan portfolio which on
December 31, 1997 totaled $78.4 million, or 72.9% of total earning assets
compared with $66.0 million or 69.2% of total earnings at year end 1996 and
$61.6 or 73.3% total earning assets at year end 1995. The Corporation's
overall objective in managing loan portfolio risk is to minimize the adverse
impact of any single event or set of occurrences. To achieve this objective,
the Corporation strives to maintain a loan portfolio that is diverse in terms
of loan type, industry concentration, geographic distribution and borrower
concentration.
For commercial loans, loan officers prepare proposals supporting the
extension of credit. These proposals contain an analysis of the borrower and
an evaluation of the ability of the borrower to repay the potential credit.
The proposals are subject to varying levels of approval by senior line and
credit policy management prior to the extension of credit. Commercial loans
receive an initial risk rating by the originating loan officer. This rating
is based on the amount of credit risk inherent in the loan and reviewed for
appropriateness by senior line and credit policy personnel for deterioration
in a borrower's financial condition which would impact the borrower's ability
to repay the credit. Risk ratings are adjusted as necessary.
For consumer loans, approval and funding is conducted in various
locations with the majority of loans being approved at the Corporation's
headquarters facility.
An independent credit review group conducts ongoing reviews of the loan
portfolio, reexamining on a regular basis risk assessments for loans and
overall compliance with policy.
To limit credit exposure, the corporation obtains collateral to support
credit extensions and commitments when deemed necessary. The most significant
categories of collateral are real and personal property, cash on deposit and
marketable securities. The corporation obtains real property as security for
some loans that are made on the basis of the general creditworthiness of the
borrower and whose proceeds were not used for real estate related purposes.
Senior level management is devoted to the management and/or collection
of certain nonperforming assets as well as certain performing loans.
Aggressive collection strategies and a proactive approach to managing overall
credit risk has expedited the Corporation's disposition, collection and
renegotiation of nonperforming and other lower-quality assets and allowed loan
officers to concentrate on generating new business.
As the volume of past due loans declines, it is anticipated that the
level of nonaccrual loans will be reduced. It should be noted that of all
loans on nonaccrual, the majority are making regular monthly payments. One
loan is self-liquidating and payments are being received from the assignment
of commissions, one loan is in the process of being purchased by the Small
Business Administration, and the others are for the most part fully secured
with workout arrangements currently in place.
If nonaccruing loans had been performing fully, these loans would have
contributed an additional $123.9 thousand to interest income in 1997, $100.5
thousand in 1996, and $115.9 thousand in 1995.
The Corporation's Other Real Estate Owned (OREO) at December 31, 1997
declined to $1.6 million following a decline in 1996 of $1.7 million from the
$3.5 million reported at December 31, 1995. Of the $1.6 million, three of
the properties representing $761 thousand are generating income under
operating leases. The balance representing $772 thousand are in various
stages of liquidation.
During the last three years, there have been additions to and
liquidations of other real estate owned. There were no additions during 1997,
and properties acquired during 1996 equaled $603 thousand compared with $680
thousand during 1995. Proceeds from the properties disposed of during 1997
equaled $302.5 thousand compared with $2.6 million and $638 thousand in 1996
and 1995 respectively.
During 1997, there was a net loss on the sale of other real estate of
$22.5 thousand compared with $12.7 thousand in 1996 and a net gain equaling
$8.7 thousand in 1995.
The Bank has developed individual action plans for each property for the
ultimate liquidation of these properties. The objectives are diligently
pursued by management and reviewed with the Board of Directors monthly.
Other Income
Total other income was relatively unchanged in 1997 compared with 1996.
Total other income increased 7.5% in 1996 following an 8.5% increase in 1995.
In each of the three years mentioned, income from OREO properties
equaled $88.6, $218.6, and $208.9 thousand, respectively.
The income achieved in service charges and commissions and fees on
deposits, are indicative of the recent trend in commercial banking to
generate additional income from services not related to the lending function.
Other Expense
Total other expense increased to $3.6 million in 1997 or 12.2% following
an increases of 12.1% and 4.9% in 1996 and 1995 respectively. This
represents a moderate increase when compared with the increase in the
Corporation's noninterest income and the Bank's overall growth. These
results reflect management's continued emphasis and commitment to the
management of this area of the Bank's operations. Salaries and employee
benefits, the largest component of other expenses increased by 11.3% in 1997
following increases of 13.3% in 1996 and 6.6% in 1995. The 1997 and 1996
results are attributable to fully staffing the Bank's new branch on
Kempsville Road and the Bank's newly formed Trust Department. Net occupancy
expense increased $120.1 thousand in 1997, $24.3 thousand in 1996, following
a $73.3 thousand increase in 1995. The increases in 1997, 1996 and 1995
reflected necessary modifications and improvements to the Bank's physical
facilities, the opening of the Bank's sixth branch location, as well as the
installation of new ATM equipment at all ATM locations during 1995. Other
operating expenses, which include a grouping of numerous transactions
relating to normal banking operations, increased $59.3 thousand or 6.4% in
1997 compared with an increase of $130 thousand or 16.2% in 1996 which
followed a decrease of $43.7 thousand or 5.1% in 1995. Again, when compared
with the increase in the Corporation's noninterest income during the past
three years, the increase in noninterest expense is considered nominal and
reflects normal increases for outside services.
Liquidity and Interest Sensitivity
Bank liquidity is a measure of the ability to generate and maintain
sufficient cash flows to fund operations and to meet financial obligations to
depositors and borrowers promptly and in a cost-effective manner. Asset
liquidity is provided primarily by maturing loans and investments, and by
cash received from operations. Other sources of asset liquidity include
readily marketable assets, especially short-term investments, and longer-term
investment securities that can serve as collateral for borrowings. On the
liability side, liquidity is affected by the timing of maturing liabilities
and the ability to generate new deposits or borrowings as needed.
Commonwealth's Asset/Liability Management Committee (ALCO) is
responsible for formulating liquidity strategies, monitoring performance
based on established objectives and approving new liquidity initiatives.
ALCO's overall objective is to optimize net interest income within the
constraints of prudent capital adequacy, liquidity needs, the interest rate
and economic outlook, market opportunities, and customer requirements.
General strategies to accomplish this objective include maintaining a strong
balance sheet, achieving solid core deposit growth, taking on manageable
interest rate risk, adhering to conservative financial management on a daily
basis, monitored regularly by ALCO and reviewed periodically with the Board
of Directors.
The Bank's funding requirements are supplied from a wide range of
traditional sources, including various types of demand deposits, money market
accounts, certificates of deposit and short-term borrrowings. Large
certificates of deposit, over $100,000 accounted for 8.1%, 5.5%, and 4.8% of
the Bank's total deposits at December 31, 1997, 1996, and 1995 respectively.
As a percentage of average assets, core deposits decreased from 87.8% in 1995
to 80.1% in 1996 and increased in 1997 to 84.57%. Management seeks to
ensure adequate liquidity to fund loans, deposit withdrawals, and the Bank's
financial requirements and opportunities. To provide liquidity for current,
ongoing and unanticipated needs, the Bank maintains a portfolio of marketable
investment securities, structures and monitors the flow of funds from these
securities and from maturing loans, and maintains access to short-term funding
sources, including a Federal Funds line of credit with its correspondent
banks and the ability to borrow from the Federal Reserve System.
The Corporation's loan portfolio net of unearned income and allowance
for loan losses increased by 19.1% to $77.3 million in 1997 compared with an
8.0% increase in 1996 to $64.9 million from the $60.1 million at year end
1995. Balances in a number of loan categories also increased. Total
commercial loans increased 21.1% to $50.6 million in 1997 compared with an
increase of 15.5% to $41.7 million in 1996, following a 13.1% increase in
1995 to $36.2 million. Consumer loans increased $28.0 thousand or 15.4% in
1997 following a decline of $1.1 million or 4.7% in 1996.
Sources of Funds
Purchased liabilities are composed of certificates of deposit of
$100,000 and over (large CDs) and balances held in "sweep accounts" for
customers. Purchased funds at December 31, 1997 equaled $10.9 million or a
28.6% increase in short-term borrowings during 1997 following a $8.8 million
or 33.3% increase in short-term borrowings in 1996 and a $1.9 million or 40%
increase in short-term borrowings during 1995. At December 31, 1997, 1996
and 1995, approximately 100% of Commonwealth's purchased funds consisted of
funds invested by local customers which, as such, are less volatile than
other categories of purchased funds or brokered deposits. On both an average
and year-end basis, the composition of purchased funds continued to shift in
1997, 1996 and 1995 from the balance sheet category of large CDs to short-
term borrowings. This shift in mix coincided with liquidity needs and balance
sheet management strategies in a low interest rate environment.
Uses of Funds
Total earning assets at December 31,1997 increased 3.8% from year-end
1996 compared with 1996's increase of 13.6% from year-end 1995's increase of
17.2%. The increase of $3.8 million in 1997 and $7 million in 1996 reflected
investments in government securities, Federal Funds sold and the increase in
the Bank's loan portfolio. The increases in 1995 reflected higher levels of
loans.
The composition of long-term investment securities as of December 31,
1997, 1996 and 1995 is presented in Note 3 to the consolidated Financial
Statements.
At year-end 1997, 1996 and 1995, investment securities totaled $22.7
million, $23.7 million, and $17.3 million respectively.
In managing the investment securities portfolio, management's philosophy
has been to provide the maximum return over the long term on funds invested
while giving consideration to risk and other Corporate objectives. During
periods of increasing interest rates, the market value of the investment
portfolio declines in relation to book value.
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
Corporation'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.
On November 15, 1995, the Financial Accounting Standards Board released
their Implementation Guide of Statement 115. As expected, the guide allowed
financial institutions to make a one-time reclassification (between November
15 and December 31, 1995) of investments between the "Available-for-Sale"
(AFS) and "Held-to-Maturity" (HTM) portfolios. During this period (one day
only), transfers between HTM and AFS could be made without the risk of
tainting other securities within the portfolio. As a result of this action,
an adjustment was made in the Bank's securities portfolio. Certain bonds
were sold in anticipation of their "call" in order to prefund their
reinvestment. This partial portfolio restructure enabled the Bank to smooth
out cash flows within its "Investment Ladder". See Note 3 to the
Consolidated Financial Statements for a breakdown of the securities held in
each of these accounts. During 1997 and 1996 it was determined that further
repositioning could enhance yields and smooth cash flows from the investment
portfolio by shifting certain investment funds to different investment
sectors and by moderately lengthening the portfolio's duration. The
liquidation and reinvestment achieved two important management objectives:
To increase the portfolio yield and thus the earnings
contribution from the Bank's investment portfolio, and
To add amortizing investments and thus increase the
regularity of principal
cash flows from the bond portfolio.
Management frequently assesses the performance of the investment
portfolio to ensure its yield and cash flow performances are consistent with
the broad strategic plan of the entire Bank. Flexibility is one of the
hallmarks of the Bank's ability to meet the dynamic banking needs of its
customers.
Year-end total loans net of unearned income increased $12.4 million or
18.9% in 1997 following a $4.4 million or 7.4% increase in 1996, and an
increase of 10.6% or $5.9 million at year end 1995. The results were largely
due to the efforts of the Bank's officers to develop new loan relationships
with customers from the area's regional institutions combined with an improved
economic environment.
Loans represented the largest category of earning assets and the Bank
will continue with its efforts to develop creditable loan relationships in
order to enhance its earnings opportunities while simultaneously
strengthening its underwriting criteria. The policies, procedures and
lending guidelines implemented during the past two years have been reported
to shareholders in detail in previous quarterly and annual reports.
A number of measures have been taken by Commonwealth over the past
several years to reduce overall exposure and earnings vulnerability in the
real estate sectors of the Corporation's trade area, including strengthening
real estate underwriting, management review policies and practices, and
reducing higher risk concentrations within the real estate portfolio.
Commonwealth's real estate portfolio is comprised of loans to customers
located within the Corporation's established marketplace. Diversification of
the loan portfolio continues.
During the past two 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 Commonwealth from
other "regional financial institutions" that are experiencing further
consolidation. This has been an excellent source of new business for the
Bank. We intend to aggressively continue to target these relationships in
future periods.
Further explanations regarding the changes in the volume of outstanding
loans are included in Management's Discussion and Analysis of Financial
Condition and Results Operations under the section entitled "Liquidity".
Dividends and Dividend Policy
The Corporation's Board of Directors determines the amount of and
whether or not to declare dividends. Such determinations by the board take
into account the Corporation's financial condition, results of operations,
and other relevant factors. The Corporation's only source of funds for cash
dividends are dividends paid to the Corporation by the Bank.
Based on the corporation's earnings record for 1997 and 1996, the
Corporation declared a 6% stock dividend in each year. It is anticipated that
this policy will continue to be re-evaluated during 1998. Based on the
corporation's continued improved record of profitability, it is expected that
the payment of cash dividends will be resumed in future periods.
Income Taxes
Corporations are required to pay the greater of the regular corporate
income tax or the alternative minimum tax (AMT).
In 1997, income tax expense was $427.7 thousand, up from $364.3 thousand
in 1996, and $282.1 thousand in 1995. These increases were attributable to
improvements in earnings.
Inflation
The Corporation carefully reviews Federal Reserve monetary policy in
order to insure an appropriate position between the cost and utilization of
funds.
The effect of changing prices on financial institutions is typically
different than on non-banking companies since virtually all of a bank's
assets and liabilities are monetary in nature. In particular, interest rates
are significantly affected by inflation, but neither the timing nor
magnitude of the changes are directly related to price level indices.
Therefore, the Corporation can best counter inflation over the long term by
managing net interest income and controlling net increases in noninterest
income and expenses.
Capital Resources and Adequacy
Average shareholders' equity increased at the rate of 5.3% in 1997
compared with 15.1% in 1996, and 13.4% in 1995. During these periods, the
sole source of capital to the Bank has been internally generated retained
earnings.
The Federal Reserve Board, the Office of the Controller of the Currency,
and the FDIC have issued risk-based capital guidelines for U.S. banking
organizations. These guidelines provide a capital framework that is
sensitive to differences in risk profiles among banking companies.
Risk-based capital ratios are another measure of capital adequacy. At
December 31, 1997, the Bank's risk-adjusted capital ratios were 12.5% for
Tier 1 and 13.7% for total capital, well above the required minimums of 4.0%
and 8.0% respectively, as compared with 13.1% and 14.4% respectively at
December 31, 1996 and 13.1% and 14.4% at December 31, 1995. These ratios are
calculated using regulatory capital (either Tier 1 or total capital) as the
numerator and both on-and off-balance sheet risk-weighted assets as the
denominator. Tier 1 capital consists primarily of common equity less
goodwill and certain other intangible assets. Total capital adds certain
qualifying debt instruments and a portion of the allowance for loan losses
to Tier 1 capital. One of four risk weights, primarily based on credit risk,
is applied to both on-and off-balance sheet assets to determine the asset
denominator. Under Federal Deposit Insurance Corporation (FDIC) rules,
Commonwealth was considered "Well-capitalized", the highest category of
capitalization defined by the regulators allowing the lowest level of FDIC
insurance premium rates, as of December 31, 1997, 1996, and 1995.
The Bank's capital is adequate to support the present level of assets
and to provide for some future growth.
At December 31, 1997, shareholders' equity stood at $10.5 million as
compared with $9.57 million at year-end 1996, and $8.77 million at year-end
1995. These increases were brought about by a net profit of $930.0 thousand
in 1997, a net profit of $836.4 thousand in 1996, and a net profit of $835.1
thousand in 1995, combined with a change in unrealized gains of $149.8
thousand on securities available for sale.
In order to maintain a strong equity capital position, to protect
against the risks of loss, in the investment and loan portfolios and on other
assets, management will continue to monitor the bank's capital position.
Several measures have been or will be employed, to maintain the Bank's
capital position, including but not limited to:
Continuing its efforts to return all nonperforming
assets to performing status,
Monitoring the Bank's growth, and
Continued utilization of its formal
asset/liability policy.
Once again, it should be noted that the Bank's capital position has
always exceeded and continues to exceed the minimum standards established by
the regulatory authorities.
<PAGE>
<TABLE>
<CAPTION>
<S> <C>
FIVE-YEAR SUMMARY CONSOLIDATED BALANCE SHEETS
December 31
1997 1996 1995 1994 1993
ASSETS
Cash and due from banks $4,347,967 $5,655,944 $5,135,875 $4,764,835 $4,603,437
Investment securities 0 0 0 0 0
Investment securities:
Available for sale 11,833,736 9,590,274 5,968,175 6,489,145 0
Held to maturity 10,830,242 14,072,217 11,290,140 8,393 628 0
Federal funds sold 6,440,417 5,718,439 5,131,844 1,056,522 6,360,000
Loans:
Commercial 13,861,467 11,078,914 8,889,880 9,899,880 9,539,927
Commercial construction 1,600,521 1,867,926 1,470,129 988,192 478,214
Commercial mortgage 35,090,563 28,796,673 25,795,631 21,068,295 17,983,733
Residential mortgage 19,836,295 17,206,173 18,668,317 16,376,434 14,315,477
Installemnt loans to individuals 4,874,850 4,600,931 3,970,015 4,103,107 4,075,197
Other 3,181,766 2,448,714 2,809,860 3,272,096 3,006,057
GROSS LOANS 78,445,462 65,999,331 61,603,832 55,708,004 49,398,605
Less: Unearned income (194,100) (164,724) (231,186) (244,930) (314,728)
Allowance for loan losses (969,000) (932,000) (1,256,000) (1,208,000) (1,129,000)
77,282,362 64,902,607 60,116,646 54,255,074 47,954,877
Premises and equipment 2,325,677 2,442,691 2,340,746 1,912,657 1,968,755
Other assets 3,045,336 3,788,054 5,053,931 4,586,250 4,394,932
$116,105,737 $106,170,226 $95,037,357 $81,458,111 $79,205,050
LIABILITIES & SHAREHOLDERS' EQUITY
Deposits:
Noninterest bearing $12,083,459 $10,686,956 $13,147,115 $9,080,263 $11,504,308
Interest bearing 88,676,591 79,575,499 69,109,244 62,243,345 57,300,448
TOTAL DEPOSITS 100,760,050 90,262,455 82,256,359 71,323,608 68,804,756
Securities sold under
agreement to repurchase 2,760,068 3,573,350 2,290,477 744,855 1,616,177
Long-term debt 583,168 609,280 684,019 661,504 687,616
Other liabilities 1,470,963 2,156,671 1,036,116 940,808 979,455
TOTAL LIABILITIES 105,574,249 96,601,756 86,266,971 73,670,775 72,088,004
SHAREHOLDERS' EQUITY
Common stock 2,510,235 2,368,752 2,235,258 2,109,313 2,009,380
Additional paid capital 4,536,468 4,106,361 3,715,666 3,376,454 3,122,226
Unrealized gains (loss) on
securities available for sale 7,436 (28,005) 7,900 (141,900) 0
Retained earnings 3,477,142 3,121,362 2,811,562 2,443,469 1,985,440
10,531,488 9,568,470 8,770,386 7,787,336 7,117,046
$116,106,737 $106,170,226 $95,037,357 $81,458,111 $79,205,050
</TABLE>
<PAGE>
<TABLE>
<CAPTION>
<S> <C>
FIVE-YEAR SUMMARY OF CONSOLIDATED OPERATIONS
Years Ended December 31
1997 1996 1995 1994 1993
Interest on loans and investments and loan fees $8,553,087 $7,744,380 $6,858,537 $5,831,266 $5,589,544
Interest on deposits and federal funds purchased 4,409,992 4,201,221 3,631,792 2,652,383 2,744,515
Net Interest Income 4,143,095 3,543,159 3,226,745 3,178,883 2,845,029
Provision for loan losses (49,762) (529) (52,932) (101,787) (166,869)
Net Interest Income After Provision
for Loan Losses 4,093,333 3,542,630 3,173,813 3,077,096 2,678,160
Other Income
Security gains (loss) 10,077 3,570 28,430 (9,187) 121,775
Gains (loss) on sale of real estate (22,459) (12,744) 8,668 (11,146) (20,661)
Other operating income 881,401 879,795 772,963 766,736 722,647
Total Other Income 869,019 870,621 810,061 746,403 823,761
Other Expenses:
Salaries and employee benefits 1,709,545 1,535,427 1,354,088 1,270,731 1,172,650
Occupancy expenses (net) 420,943 300,844 276,531 203,212 240,329
Furniture and equipment expenses 481,917 443,316 432,693 410,621 388,236
Other operating expenses 992,290 932,974 802,897 846,593 834,672
Total Other Expenses 3,604,695 3,212,561 2,866,209 2,731,157 2,635,887
Income Before Income Taxes 1,357,657 1,200,690 1,117,665 1,092,342 866,034
Applicable Income Tax Expense 427,692 364,264 282,148 278,251 218,714
Net Income for Year $929,965 $836,426 $835,517 $814,091 $647,320
Net Income per share - basic (1) 0.93 0.83 0.83 0.81 0.64
Net Income per share assuming dilution (1) 0.86 0.78 0.80 0.80 0.64
Average shares outstanding (1) 1,004,094 1,004,094 1,004,094 1,004,094 1,004,094
Average shares - assuming dilution (1) 1,084,137 1,066,539 1,041,819 1,020,977 1,012,223
(1) Adjusted to reflect 1997, 1996, 1995 & 1994 Stock Dividends.
</TABLE>
<PAGE>
PART II
Item 7. Financial Statements.
Refer to the index to the Consolidated Financial Statements on Page
F-1 for the required information.
Item 8. Changes In and Disagreements With Accountants on Accounting and
Financial Disclosure.
None.
PART III
Item 9. Directors, Executive Officers, Promoters and Control Persons;
Compliance With Section 16(a) of the Exchange Act.
The following sets forth the names, ages and business experience of
the Corporation's executive officers.
Edward J. Woodard, Jr., 55
Chairman of the Board, President and Chief Executive Officer of the
Corporation and the Bank.
John H. Gayle, 59
Executive Vice President and Secretary of the Corporation and
Executive Vice President and Cashier of the Bank, and Vice President and
Secretary of BOC Title Hampton Roads.
Richard R. Early, 53
Senior Vice President and Senior Trust Officer of the Bank since
September 1996. Prior to accepting the position with the Bank, Mr. Early
was Senior Vice President and Senior Trust Officer at Bank of Lancaster
from May 1990 through September 1996.
Simon Hounslow, 33
Senior Vice President and Commercial Loan Officer of the Bank.
Richard W. Webb, 45
Vice President and Branch Administration Officer of the Bank. Prior to
joining the Bank in August 1993, Mr. Webb was a banker with Home Savings
Bank from 1975 through July 1993.
Item 10. Executive Compensation.
The information called for in this Item is incorporated by reference
from the Corporation's definitive Proxy Statement for its 1998 Annual
Meeting of Shareholders, which will be filed with the Securities and
Exchange Commission no later than 120 days after the end of the
Corporation's fiscal year.
Item 11. Security Ownership of Certain Beneficial Owners and
Management.
The information called for in this Item is incorporated by reference
from the Corporation's definitive Proxy Statement for its 1998 Annual
Meeting of Shareholders, which will be filed with the Securities and
Exchange Commission no later than 120 days after the end of the
Corporation's fiscal year.
Item 12. Certain Relationships and Related Transactions.
The information called for in this item is incorporated by reference
form the Corporation's definitive Proxy Statement for its 1998 Annual
Meeting of Shareholders, which will be filed with the Securities and
Exchange Commission no later than 120 days after the end of the
Corporation's fiscal year.
Item 13. Exhibits and Reports on Form 8-K.
(a) (3) Exhibits
3.1 Articles of Incorporation. Filed June 15, 1988, as
Exhibit 3.1 to the Registrant's Form S-4, and incorporated
herein by reference.
3.2 By laws. 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.
10.1 Lease. Filed June 15, 1988, as Exhibit 10.1 to the
Registrants Form S-4, and incorporated herein by reference.
10.5 Employee Director's Deferred Compensation Plan. Filed March
21, 1989, as Exhibit 10.5 to the Registrant's Form 10-K,
and incorporated herein by reference.
10.6 Non-Employee Director's Deferred Compensation Plan. Filed
March 21, 1989, as Exhibit 10.6 to the Registrant's
Form 10-K, and incorporated herein by reference.
10.7 Deferred Supplemental Compensation Agreement with Edward
J. Woodard, Jr. Filed March 21, 1989, as Exhibit 10.7 to
the Registrant's Form 10-K, and incorporated herein by
reference.
10.8 Employment Agreement with Edward J. Woodard, Jr. Filed
March 20, 1990, as Exhibit 10.8 to Registrant's Form
10-K, and incorporated herein by reference
10.9 Employment Agreement with John H. Gayle. Filed March 28,
1991, as Exhibit 10.9 to Registrant's Form 10-K, and
incorporated herein by reference.
10.10 Amendment to Deferred Supplemental Compensation
Agreement with Edward J. Woodard, Jr. Filed March
30, 1994, as Exhibit 10.10 to Registrant's Form 10-K,
and incorporated herein by reference.
10.11 Amendment to Employment Agreement with Edward J. Woodard,
Jr. Filed March 30, 1994, as Exhibit 10.11 to
Registrant's Form 10-K, and incorporated herein by
reference.
10.12 Amendment to Employment Agreement with John H. Gayle.
Filed March 30, 1994, as Exhibit 10.12 to Registrant's
Form 10-K, and incorporated herein by reference.
10.13 Non-Employee Director Stock Compensation Plan. Filed
March 30, 1996, as Exhibit 10.13 to Registrant's form 10-K,
and incorporated herein by reference.
10.14 Second amendment to deferred supplemental agreement dated
December 27, 1978, with Edward J. Woodard, Jr. Filed herein.
(b) Reports filed on Form 8-K for the quarter ended December
31, 1997.
None
ANNUAL REPORT ON FORM 10-KSB
ITEM 8,
LIST OF FINANCIAL STATEMENTS
FINANCIAL STATEMENTS AND SUPPLEMENTARY DATA
YEAR ENDED DECEMBER 31, 1997
COMMONWEALTH BANKSHARES, INC.
<PAGE>
FORM 10-KSB--ITEM 7
COMMONWEALTH BANKSHARES, INC.
LIST OF FINANCIAL STATEMENTS
The following consolidated financial statements of Commonwealth
Bankshares, Inc. and subsidiary are included:
Consolidated balance sheets--December 31, 1997 and 1996.
Consolidated statements of income--Years ended December 31, 1997,
1996, and 1995.
Consolidated statements of shareholders' equity--Years ended
December 31, 1997, 1996, and 1995.
Consolidated statements of cash flows--Years ended December 31,
1997, 1996 and 1995.
Notes to consolidated financial statements--December 31, 1997.
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.
SIGNATURES
Pursuant to the requirements of Section 13 or 15(d) of the Securities
Act of 1934, the registrant has duly caused this Report to be signed on its
behalf by the undersigned, thereunto duly authorized.
Commonwealth Bankshares, Inc.
(Registrant)
Date: March 30, 1998 By:
E. J. Woodard, Jr., CLBB
Chairman of the Board,
President and CEO
By:
John H. Gayle
Executive Vice President & Cashier
(Principal Financial Officer)
Pursuant to the requirements of the Securities Exchange Act of 1934, this
report has been signed below by the following persons on behalf of the
Registrant and in the capacities indicated.
E. J. Woodard, Jr., CLBB Director and Herbert L. Perlin, Director
Chairman of the Board, President and
Chief Executive Officer
George H. Burton, Jr., Director Richard J. Tavss, Director
Morton Goldmeier, Director Morton M. Zedd, Director
William P. Kellam, Director William D. Payne, MD, Director
<PAGE>
SECOND AMENDMENT TO: DEFERRED SUPPLEMENTAL AGREEMENT DATED DECEMBER 27, 1978
WITH EDWARD J. WOODARD, JR.
This AGREEMENT made this 16th day of December, 1997, between the Bank
of the Commonwealth, a Virginia corporation, Norfolk, Virginia, (hereinafter
called the "Bank") and Edward J. Woodard, Jr. (hereinafter called "Employee").
WHEREAS, the Employee is employed by the Bank, and
WHEREAS, said employment has been beneficial to the Bank, and
WHEREAS, the Bank has determined that certain terms of the December 27,
1978, Deferred Supplemental Compensation Agreement (Exhibit A attached) as
amended by the First Amendment dated April 27, 1993 (Exhibit B attached;
hereinafter, collectively, the "Agreement") with Employee should be amended,
Now, THEREFORE, it is agreed as follows:
1. Paragraph one (1) of the Agreement shall be deleted in its
entirety and the following shall be substituted in liew thereof:
"If the Employee remains and continues in fht full-time employ
of the Bank until he attains the age of sixty-five (65) years,
and if the Employee thereafter retires from the service of the
Bank, then commencing with the first day of the second calendar
month immediately following the said retirement, the Employer
will pay Two Hundred Fifty Thousand Dollars ($250,000.00) in one
hundred twenty (120) equal monthly installments of Two Thousand
Eighty-Three and 33/100 Dollars ($2,083.33) each. Said payments
shall be made to the Employee of he is living on each such
payment date; of if the Employee is not living on any such
payment date, then to the Employee's beneficiary designated by
him in writing and filed with the Cashier of the Bank, and if
no such beneficiary is designated, then to the Employee's
estate. In addition to the monthly installments described in
this paragraph on Employee's death, a lump sum payment of Two
Hundred Fifty Thousand and no/100 Dollars ($250,000.00) shall be
paid by the Bank to Employee's beneficiary designated by him
in writing and filed with the Cashier of the Bank, and if no
such beneficiary is designated, then to the Employee's estate.
2. All other terms and conditions of the Agreement not
amended hereby shall remain in full force and effect.
IN WITNESS WHEREOF, the parties have executed this Second Amendment
in Norfolk, Virginia, on the date first above written.
EMPLOYEE: BANK OF THE COMMONWEALTH
By:
Edward J. Woodard, Jr. E. J. Woodard, Jr.
Chairman of the Board
President and
Chief Executive Officer
ATTEST:
By:
John H. Gayle
Secretary
SEEN AND AGREED TO:
George H. Burton, Jr., Director
Morton M. Goldmeier, Director
William P. Kellam, Director
William D. Payne, MD, Director
Herbert L. Perlin, Director
Richard J. Tavss, Director
Morton M. Zedd, Director
