UNITED STATES
SECURITIES AND EXCHANGE COMMISSION

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 SEPTEMBER 30, 2004

Commission File Number 0-27393

CIVITAS BANKGROUP, INC.

(615) 383-6619

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 an accelerated filer (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 outstanding: 17,519,522 shares at October 31, 2004.

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CIVITAS BANKGROUP, INC.
TABLE OF CONTENTS

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CIVITAS BANKGROUP, INC.

See accompanying notes to unaudited consolidated financial statements.

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CIVITAS BANKGROUP, INC.

See accompanying notes to unaudited consolidated financial statements.

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CIVITAS BANKGROUP, INC.
CONSOLIDATED STATEMENTS OF EARNINGS (continued)
THREE AND NINE MONTHS ENDED SEPTEMBER 30, 2004 AND 2003
Dollars in thousands except per share amounts

See accompanying notes to unaudited consolidated financial statements.

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CIVITAS BANKGROUP, INC.

See accompanying notes to unaudited consolidated financial statements.

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CIVITAS BANKGROUP, INC.

See accompanying notes to unaudited consolidated financial statements.

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CIVITAS BANKGROUP, INC. AND SUBSIDIARIES

Note 1. Basis of Presentation

The unaudited consolidated financial statements as of September 30, 2004 and for the nine month periods ended September 30, 2004 and 2003 have been prepared in accordance with accounting principles generally accepted in the United States of America for interim information and in accordance with the instructions to Form 10-Q and Article 10 of Regulation S-X as promulgated by the Securities and Exchange Commission (“SEC”), in the opinion of management, include all adjustments, consisting of normal recurring adjustments, to present fairly the information. They do not include all the information and footnotes required by generally accepted accounting principles for complete financial statements. Operating results for the nine month period ended September 30, 2004 are not necessarily indicative of the results that may be expected for the year ending December 31, 2004. For further information, refer to the 2003 consolidated financial statements and footnotes thereto included in the Company’s Annual Report on Form 10-K.

Note 2. Earnings per Share of Common Stock

Basic earnings per share (EPS) of common stock is computed by dividing net income by the weighted average number of common shares outstanding during the period. Diluted earnings per share of common stock is computed by dividing net income by the weighted average number of common shares and potential common shares outstanding during the period. Stock options are regarded as potential common shares to the extent that the exercise price for the option is less than the fair market value of our common stock. For the three months ended September 30, 2004 the Company included 189,877 shares of common stock issuable upon exercise of stock options in the diluted EPS calculation and 110,773 shares of common stock issuable upon exercise of stock options in the calculation for the nine months ended September 30, 2004.

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Note 3. Stock Compensation

Employee compensation expense under stock options is reported using the intrinsic value method. No stock-based compensation cost is reflected in net income, as all options granted had an exercise price equal to or greater than the market price of the underlying common stock at grant date. The following table illustrates the effect on net income and earning per share for the nine months ended September 30, 2004 and 2003 if expense was measured using the fair value recognition provisions of FASB Statement No. 123, Accounting for Stock-Based Compensation.

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CIVITAS BANKGROUP, INC.
FORM 10-Q, CONTINUED

ITEM 2. MANAGEMENT’S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS OF OPERATIONS

The purpose of this discussion is to provide insight into the financial condition and results of operations of Civitas BankGroup, Inc. and its subsidiaries (the “Company”). This discussion should be read in conjunction with the consolidated financial statements. Reference should also be made to the Company’s Annual Report on Form 10-K, for a more complete discussion of factors that impact liquidity, capital and the results of operations.

FORWARD-LOOKING STATEMENTS

This Form 10-Q contains certain forward-looking statements regarding, among other things, the anticipated financial and operating results of the Company. The words “anticipate,” “could,” “expects,” and “believes” and similar expressions are intended to identify such forward-looking statements but other statements not based on historical information may also be considered forward-looking. Investors are cautioned not to place undue reliance on these forward-looking statements, which speak only as of the date hereof. The Company undertakes no obligation to publicly release any modifications or revisions to these forward-looking statements to reflect events or circumstances occurring after the date hereof or to reflect the occurrence of unanticipated events.

In connection with the “safe harbor” provisions of the Private Securities Litigation Reform Act of 1995, the Company cautions investors that future financial and operating results may differ materially from those projected in forward-looking statements made by, or on behalf of, the Company. Such forward-looking statements involve known and unknown risks and uncertainties, including, but not limited to: (i) increased competition with other financial institutions; (ii) lack of sustained growth in the economy in the Company’s market area; (iii) rapid fluctuations in interest rates; (iv) significant downturns in the businesses of one or more large customers; (v) risks inherent in originating loans, including prepayment risks; (vi) the fluctuations in collateral values, the rate of loan charge-offs and the level for the provision for loan losses; (vii) changes in the legislative and regulatory environment; (viii) the ability to successfully complete the disposition of the Bank of Mason and certain assets of the Bank of Dyer; and (ix) loss of key personnel. These risks and uncertainties may cause the actual results or performance of the Company to be materially different from any future results or performance expressed or implied by such forward-looking statements. The Company’s future operating results depend on a number of factors which were derived utilizing numerous assumptions and other important factors that could cause actual results to differ materially from those projected in forward-looking statements.

CRITICAL ACCOUNTING POLICIES

The accounting principles followed by the Company and the methods of applying these principles conform with accounting principles generally accepted in the United States and with general practices within the banking industry. The preparation of financial statements in conformity with generally accepted accounting principles requires management to make estimates and assumptions that affect the amounts reported in the financial statements and accompanying notes. Critical accounting policies relate to allowance for loan losses. The allowance for loan losses is a valuation allowance for probable incurred credit losses, increased by the provision for loan losses and decreased by charge-offs less recoveries.

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COMPANY OVERVIEW

General. Civitas BankGroup, Inc. is a Tennessee registered bank holding company headquartered in Franklin, Tennessee with $884.8 million in total assets at September 30, 2004. We provide banking and other financial services through the following four (4) bank subsidiaries in eleven (11) markets throughout Middle and West Tennessee:

On July 29, 2004, the Company announced that it had entered into an agreement with the Farmers and Merchants Bank of Dyer pursuant to which the Company would sell certain assets and Farmers and Merchants Bank of Dyer would assume certain liabilities of the Company’s Bank of Dyer bank subsidiary. The transaction is subject to the receipt of regulatory approval and the satisfaction of other customary conditions. The Company expects the transaction to close during the fourth quarter of 2004.

On August 24, 2004, the Company entered into an agreement to sell the Bank of Mason to a group of investors. Pursuant to the terms of the purchase agreement, the investors will purchase all of the outstanding shares of stock in the Bank of Mason from the Company. Consummation of this transaction is subject to receipt of regulatory approval and the satisfaction of certain customary closing conditions. The Company expects this transaction to close prior the December 31, 2004.

Joint Ventures. The Company owns a 50% interest in both The Murray Banc Holding Company, LLC in Murray, Kentucky and Insurors Bank of Tennessee, headquartered in Nashville, Tennessee. Only the Company’s initial investment, adjusted for the pro rata share of operating results of each entity, is included in the consolidated financial statements. The Company’s portion of earnings is recorded in other noninterest income. The Murray Banc Holding Company is a joint venture with BancKentucky, a Kentucky savings and loan holding company. The Murray Banc Holding Company is a single bank holding company owning 100% of The Murray Bank which opened in 1999. The Murray Banc Holding Company had $146.1 million in total assets at September 30, 2004 and for the nine months ended September 30, 2004 contributed income of $351,000 to the Company. The Company also owns 50% of Insurors Bank, which opened November 2000 and had $61.6 million in assets at September 30, 2004. The remaining ownership interest in Insurors Bank is owned by InsCorp, a Tennessee corporation owned predominately by Tennessee insurance agents. Year to date, Insurors Bank has contributed $128,000 of income to the Company.

Description of Business. Our principal operations include traditional banking services incorporating commercial and residential real estate lending, commercial business lending, consumer lending, construction lending and other financial services, including depository services. Net interest income is our principal source of earnings. We serve both metropolitan and rural areas, targeting local consumers, professionals and small businesses.

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PERFORMANCE OVERVIEW

General. Set forth below are significant items that occurred during the nine months ended September 30, 2004:

•

Net income for the nine months ended September 30, 2004, totaled $1.6 million compared to $365,000 for the same period for 2003, a 338.4% increase. For the three month period ended September 30, 2004, net income totaled $253,000 compared to $308,000 for the same period for 2003.

•

Assets increased from $833.3 million at December 31, 2003, to $884.8 million at September 30, 2004, a $51.5 million or 6.2% increase.

•

Loans increased to $567.6 million, up 3.1% from $550.6 million at year end 2003 and up 2.9% from September 30, 2003.

•

Nonperforming assets were $19.0 million at September 30, 2004, up 17.5% from December 31, 2003 but down 4.3% from September 30, 2003.

•

Deposits totaled $734.3 million, up 9.3% from $671.6 million at year end 2003 and 7.1% over September 30, 2003.

•

Cumberland Bank opened a new branch in downtown Franklin, Tennessee and prepared to open a new branch in Spring Hill, Tennessee. Both of these branches are located in Williamson County communities.

•

The merger of two of the Company’s bank subsidiaries, Cumberland Bank and Cumberland Bank South, both of which serve the greater Nashville market, closed on September 1, 2004.

•

The Company announced the sale of certain assets of its Bank of Dyer subsidiary. The transaction is anticipated to close during the fourth quarter of 2004.

•

The Company announced the sale of its Bank of Mason subsidiary. The transaction is anticipated to close during the fourth quarter of 2004.

During a routine internal audit review conducted during August 2004, the Company discovered that its Investment Officer, the son of the Company’s President and Chief Executive Officer, had engaged in apparently fraudulent transactions for which he has been terminated. The Company’s audit committee, along with the Company’s independent auditors, subsequently commenced an investigation into these transactions, which involved less than $500,000. As a result of the investigation, the Company has recorded fraud loss expense totaling $431,000 for the nine months ended September 30, 2004 which amount was offset by income from fraud recovery totaling $431,000 for the same period. This recovery was the result of the Company’s receipt from its President and Chief Executive Officer of a written guarantee of payment of any losses suffered by the Company as a result of these transactions which are not otherwise paid by the Company’s former Investment Officer. In September 2004, the Company received payment of $431,000 from the Company’s former Investment Officer.

EARNINGS HIGHLIGHTS—THIRD QUARTER RESULTS

During the quarter ended September 30, 2004, the Company’s management continued to address improvements in the Company’s performance. Management’s primary short-term objectives continue to be the resolution of problem assets, the creation of operating efficiencies and building for future growth. The ongoing evaluation of its operations and related operational improvements includes the continued centralization of certain backroom operations, reduction of duplicate operational processes and consideration of the disposal of underperforming branches or subsidiaries in markets offering limited growth potential.

Net Income. The Company recorded net income for the third quarter of 2004 of $253,000 compared with net income of $308,000 in the third quarter of 2003. Diluted earnings per share for the third quarter of 2004 were $0.01 as compared $0.02 for third quarter 2003.

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Key performance indicators for the third quarter of 2004 showed annualized return on average assets (ROA) of 0.12% compared to 0.15% in the comparable period of 2003. The annualized return on average shareholders’ equity (ROE) for the third quarter of 2004 was 1.85% compared to 2.43% for the third quarter of 2003.

Net Interest Income. Net interest income for the third quarter of 2004, increased $550,000 or 9.2% as compared to the third quarter of 2003. This increase is primarily attributable to a 3 basis point increase in net interest margin principally due to an 8.3% increase in average earning assets and increases in short-term interest rates by the Federal Reserve Board beginning in the quarter ended September 30, 2004. The changes in net interest income and net interest margin for the three months ended September 30, 2004 as compared to the same period in 2003 were primarily the result of the following:

Rate:

•

The yield on average earning assets increased 5 basis points to 5.37% while the cost of deposits and other borrowed funds increased 2 basis points to 2.14% for third quarter of 2004.

•

The yield on loans dropped 25 basis points as compared to 2003.

•

Investment security yield increased 156 basis points over the 2003 period levels to 4.30%.

Volume:

•

Total average earning assets increased $61.3 million, or 8.3%, with the significant amount of this increase being in the Company’s average securities portfolio, which increased by $58.8 million or 35.1%.

•

Average loans for the third quarter of 2004 decreased $4.8 million, or 0.9%, as compared to the third quarter of 2003.

•

Average Federal Funds sold increased $10.9 million or 159.0%.

•

Average deposits and borrowed funds increased $62.2 million, or 8.4%, as compared to the third quarter of 2003. Average interest-bearing deposits increased $51.0 million while repurchase agreements increased $4.4 million or 27.4%.

•

Average borrowed funds declined $781,000 due to payments made on notes payable.

Net Interest Margin. Net interest margin for the third quarter of 2004 increased 3 basis points to 3.22% from 3.19% in the third quarter of 2003. A greater percentage of new loan originations are short-term real estate loans compared to our existing loan portfolio. Likewise, these loans are funded with short-term deposits. Any new loan production the Company has experienced has been offset by a concentrated effort to remove underperforming and less desirable risk characteristic loans from the portfolio. The resulting effect is a slight decline in average loan balances. Management expects its average loan balances to increase throughout the remainder of 2004 as the Company opens two new branches, takes advantage of recent bank mergers in its markets, and refocuses on managed growth.

The Company increased the volume of its securities portfolio by $58.8 million as a result of a $59.6 million or 9.1% increase in deposit growth. Deposit growth primarily stemmed from the opening of our downtown Franklin office which benefited from the hiring of key personnel from a Williamson County community bank, which was recently merged with a larger regional bank.

The following tables set forth the amount of our average balances, interest income or interest expense for each category of interest-earning assets and interest-bearing liabilities and the average interest rate for total interest-earning assets and total interest-bearing liabilities and net interest margin for the three months ended September 30, 2004 and 2003:

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Average Balances Sheet
(Dollars in thousands, except yields and rates)

		1. Interest income includes loan fees.
		2. Nonaccrual loans are included in average loan balances and the associated income (recognized on a cash basis) is included in interest.
		3. No taxable equivalent adjustments have been made since the effect is insignificant.

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EARNINGS HIGHLIGHTS—NINE MONTHS RESULTS

Net Income. The Company recorded net income for the first nine months of 2004 of $1.6 million compared with net income of $365,000 in the first nine months of 2003. Diluted earnings per share for the first nine months of 2004 were $0.09 as compared to diluted earnings per share of $0.02 for the same period in 2003.

Key performance indicators for the first nine months of 2004 showed annualized return on average assets (ROA) of 0.26% compared to a ROA of 0.06% for the same period in 2003. The annualized return on average shareholders’ equity (ROE) for the first nine months of 2004 was 3.87% compared to a ROE of 1.03% for the first nine months of 2003.

Net Interest Income. Net interest income increased $908,000 or 4.9% for the first nine months of 2004, over the same period in 2003. This increase is attributable to a $71.5 million or 10.1% increase in average earning assets, comprised primarily of a $62.9 million increase in investment securities. This significant increase in securities along with a 57 basis point decrease in loan yield resulted in a 16 basis point decrease in the net interest margin to 3.33%. The changes in net interest income and net interest margin for the nine months ended September 30, 2004 as compared to the same period in 2003 were primarily the result of the following:

Rate:

•

The yield on average earning assets decreased 38 basis points to 5.38% while the cost of deposits and other borrowed funds decreased 18 basis points to 2.07% for the first nine months of 2004 compared to the same period of 2003.

•

The yield on loans dropped 57 basis points as compared to 2003.

Volume:

•

Total average earning assets increased $71.5 million, or 10.1%, as compared to 2003, with a significant amount of this increase being in the Company’s securities portfolio which increased by $62.9 million or 44.0%.

•

Average loans for the first nine months of 2003 increased $1.2 million, or 0.2%, as compared to the first nine months of 2003.

•

Average Federal Funds sold increased $5.4 million due to growth in the deposit liabilities.

•

Average deposits and borrowed funds increased $59.0 million, or 8.3%, as compared to the first nine months of 2003. Average interest-bearing deposits increased $38.2 million.

Net Interest Margin. The $62.9 million increase in the investment portfolio was primarily funded by the increase of $59.8 million in deposits and repurchase agreements. Due to a smaller spread realized when investing in securities as compared to loans, the Company’s net interest margin experienced some compression. In addition, 12.9% of the investment portfolio consists of tax-exempt municipal securities. The tax equivalent yield/income is not included in this analysis.

Additionally, interest income continues to be adversely impacted by the level of nonperforming assets, which totaled $19.0 million at September 30, 2004, a $2.8 million increase since December 31, 2003. This increase was the result of the Company’s continued efforts to identify problem assets. Had such loans been performing, interest income for the first nine months ended September 30, 2004 would have increased by $376,000.

The following tables set forth the amount of our average balances, interest income or interest expense for each category of interest-earning assets and interest-bearing liabilities and the average interest rate for total interest-

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earning assets and total interest-bearing liabilities and net interest margin for the nine months ended September 30, 2004 and 2003:

Average Balances Sheet
(Dollars in thousands, except yields and rates)

		1 Interest income includes loan fees.
		2 Nonaccrual loans are included in average loan balances and the associated income (recognized on a cash basis) is included in interest.
		3 No taxable equivalent adjustments have been made since the effect is insignificant.

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INVESTMENT PORTFOLIO

General. The Company invests primarily in obligations of the United States, obligations of states, counties, and municipalities and mortgage-backed securities. The following table presents, for the periods indicated, the carrying amount of our securities portfolio segregated into available for sale, or AFS, and held to maturity, or HTM, categories:

Composition of Investment Portfolio
Dollars in thousands

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The following table indicates the maturities of securities at September 30, 2004 at the carrying amount and the weighted average yields of such securities:

Maturity of Investment Portfolio
Dollars in thousands

NOTE: Mutual funds are included in other securities AFS over 10 years

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LOANS

General. Loans are the largest category of earning assets and typically provide higher yields than the other types of earning assets. Associated with the higher loan yields are the inherent credit and liquidity risks which management attempts to control and counterbalance. The following table indicates loans outstanding net of unearned income and deferred fees, as of the dates indicated. The segregation used in compiling the following information is based on the collateral of the loan rather than the source of loan payments and is consistent with the method followed for regulatory reporting.

Composition of Loan Portfolio
Dollars in thousands

Totals loans grew $17.0 million since December 31, 2003 even though the Company experienced runoff of loans that do not meet the risk characteristics targeted by management. Additionally the Company’s loan volume increase was partially offset by foreclosed properties of $7.8 million, net charge-offs totaling $2.3 million and $2.6 million in loans sold in connection with the Company’s sale of one of its Bank of Dyer branches.

Management is placing greater emphasis on short-term real estate lending such as construction, acquisition and development, and commercial real estate loans. The Company has established internal targets for real estate secured loans at 75% of total loans, with an emphasis on variable interest rate loans or loans with maturities under five years if at fixed rates.

Provision and Allowance for Loan Losses. The Company has placed a greater emphasis on identifying at-risk borrowers as our banks have experienced a higher than normal amount of borrower bankruptcies which account for a large portion of our loan charge-offs. Additionally, deteriorating economic conditions in some of the markets we serve have resulted in some of our commercial and consumer borrowers experiencing financial difficulty and in some cases the inability to pay their obligations to us. The provision for loan losses is based on past loan experience and other factors, which in management’s judgment deserve current recognition in estimating possible loan losses. Such factors include past loan loss experience, growth and composition of the loan portfolio, review of specific problem loans, trends in past due loans, the relationship of the allowance for loan losses to outstanding loans, and current economic conditions that may affect the borrower’s ability to repay their obligations to the company. Management has in place a risk rating system designed for monitoring its loan portfolio in an effort to identify potential problem loans. Additional provisions will likely be appropriate as a result of ongoing efforts to better assess problem loans. Until the Company can achieve significant reductions in problem assets, it is likely that loan charge-offs will continue to be incurred, resulting in additional provisions for loan losses, which will negatively impact future earnings.

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Loan delinquencies were 3.5% of the total loan portfolio on September 30, 2004, 3.7% on September 30, 2003 and 3.2% at December 31, 2003. Provision expense equaled $577,000 and $583,000 for the three months ended September 30, 2004 and 2003 respectively. The decline in the allowance for loan losses as a percentage of total loans outstanding since September 30, 2003 reflects loan charge-offs taken against specific allocated reserves. A summary of loan loss experience during the three-month and nine-month periods ended September 30, 2004 and 2003 is provided below. Non-performing assets to total loans were 3.4% at September 30, 2004 as compared to 3.6% at September 30, 2003. The following is the activity in the allowance for loan losses:

Summary of Allowance for Loan Losses
Dollars in Thousands

Nonperforming Assets. For financial statement purposes, nonaccrual loans are included in loans outstanding, whereas repossessions and other real estate are included in other assets. Net credit losses include net charge-offs on loans and valuation adjustments.

The following is a summary of nonperforming assets as of September 30, 2004, December 31, 2003 and September 30, 2003:

Summary of Nonperforming Loans
Dollars in thousands

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The increase in nonperforming assets during the nine months ended September 30, 2004 was due primarily to loans becoming 90 days or more past due, bankruptcy filings, and management’s continued efforts in identifying problem credits. It is anticipated that the level of nonperforming loans will gradually improve as management resolves problem loans.

Supplemental Loan Information as of September 30, 2004
Dollars in thousands

In addition to the nonaccrual loans, management has internally identified an additional $20.7 million in loans as potential problem credits. These loans are performing loans but are classified due to payment history, decline in the borrower’s financial position or decline in collateral value. Loans classified as substandard are inadequately protected by the current sound worth and paying capacity of the obligor or the collateral pledged, if any. Loans so classified must have a well-defined weakness or weaknesses that jeopardize the liquidation of the debt. Loans classified as doubtful have all the weaknesses inherent in one classified as substandard, with the added characteristic that the weaknesses make collection or liquidation in full, on the basis of currently existing facts, conditions and values, highly questionable and improbable. Loans classified as loss are considered uncollectible and of such little value that their continuance as bankable assets is not warranted. The following table shows the amount in each classification.

Summary of Performing
Classified Loans
As of September 30, 2004
Dollars in thousands

Management believes the balance of the allowance for loan losses to be adequate as of September 30, 2004 based on its internal evaluation of the allowance for loan losses and loan portfolio. Quarterly, the allowance for loan losses is evaluated under the provision of SFAS 114 and 118. Under these guidelines, specific reserves are allocated for loans considered impaired. A general reserve is also maintained for the Company’s homogenous loans. The level of the allowance and the amount of the provision involve evaluation of uncertainties and matters of judgment. Although management believes the allowance for loan losses at September 30, 2004 to be adequate, further deterioration in problem credits, the results of the loan review process, or the impact of

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deteriorating economic conditions on other businesses, could require increases in the provision for loan losses and could result in future charges to earnings which could have a significant negative impact on net earnings

DEPOSITS

The average daily amounts of deposits and rates paid on such deposits at September 30, 2004 and December 31, 2003 are summarized as follows:

Average Deposit Balance
Dollars in thousands