SECURITIES AND EXCHANGE COMMISSION

Washington, D.C. 20549

FORM 10-K

[X]

ANNUAL REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES EXCHANGE ACT OF 1934

For the Fiscal Year Ended December 31, 2002                       OR

[  ]

TRANSITION REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES EXCHANGE ACT OF 1934

Commission File Number: 0-23605

(Exact name of registrant as specified in its charter)

Tennessee

 62-1721072

(State or other jurisdiction of incorporation or organization)

(I.R.S. Employer I.D. Number)

114 West College Street, Murfreesboro, Tennessee

37130

(Address of principal executive offices)

(Zip Code)

Registrant's telephone number, including area code:

(615) 893-1234

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

None

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

Common Stock, no par value per share

(Title of Class)

          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 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 Registrant's knowledge, in definitive proxy or information statements incorporated by reference in Part III of this Form 10-K or any amendments to this Form 10-K.X

          Indicate by check mark whether the registrant is an accelerated filer (as defined in Exchange Act Rule 12b-2)

                    YES   X    NO      

          The aggregate market value of the voting stock held by non-affiliates of the Registrant, based on the closing sales price of the Registrant's Common Stock as quoted on the NASDAQ National Market System under the symbol "CAVB" on June 28, 2002, was $82,346,949 (6,310,111 shares at $13.05 per share).  It is assumed for purposes of this calculation that the Registrant's directors are its affiliates.

          The number of shares outstanding of Registrant’s common stock as of March 25, 2003 was 6,820,179.

DOCUMENTS INCORPORATED BY REFERENCE

          1.   Portions of Annual Report to Stockholders for the Fiscal Year Ended December 31, 2002 ("Annual Report") (Parts I and II).

          2.   Portions of Definitive Proxy Statement for the 2003 Annual Meeting of Stockholders (Part III).

PART I

Item 1.  Business

Safe Harbor Statement under the Private Securities Litigation Reform Act of 1995

          This report contains certain forward-looking statements within the meaning of Section 27A of the Securities Act of 1933, as amended, and Section 21E of the Securities Exchange Act of 1934, as amended.  The Company intends such forward-looking statements to be covered by the safe harbor provisions for forward-looking statements contained in the Private Securities Litigation Reform Act of 1995, and is including this statement for purposes of this safe harbor.  Forward-looking statements, which are based on certain assumptions and describe future plans, strategies and expectations of the Company, are generally identifiable by use of the words “believe,” “expect,” “intend,” “anticipate,” “estimate,” “project” or similar expressions.  The Company’s ability to predict results or the actual effect of future plans or strategies is inherently uncertain.& nbsp; Factors which could have a material adverse affect on the operations and future prospects of the Company and its subsidiaries include, but are not limited to, changes in: interest rates, general economic conditions, legislative/regulatory changes, monetary and fiscal policies of the U. S. Government, including policies of the U. S. Treasury and the Federal Reserve Board, the quality or composition of the loan or investment portfolios, demand for loan products, deposit flows, competition, demand for financial services in the Company’s market area, implementation of new technologies, the Company’s ability to develop and maintain secure and reliable electronic systems and accounting principles, policies and guidelines.  These risks and uncertainties should be considered in evaluating forward-looking statements and undue reliance should not be placed on such statements.

General

          Cavalry Bancorp, Inc. ("Company"), a Tennessee corporation, was organized on November 5, 1997 for the purpose of becoming the holding company for Cavalry Banking ("Bank") upon the Bank's conversion from a federally chartered mutual to a federally chartered stock savings bank ("Conversion").  The Conversion was completed on March 16, 1998.  In January 2002, the Bank converted to a state chartered commercial bank and became a member of the Federal Reserve System.  As of that date, the Company became a bank holding company registered with the Board of Governors of the Federal Reserve System (“FRB”).  At December 31, 2002, the Company had total assets of $464.4 million, total deposits of $407.8 million and shareholders' equity of $49.7 million.  The Company has not engaged in any significant activity other than holding the stock of the Bank.  Accordingly, the information se t forth in this report, including financial statement and related data, relates primarily to the Bank.

          Prior to its conversion to a state bank, the Bank’s primary federal regulator was the Office of Thrift Supervision ("OTS").  The Bank's deposits have been federally insured since 1936 and are currently insured by the Federal Deposit Insurance Corporation (“FDIC”) under the Savings Association Insurance Fund ("SAIF").  The Bank has been a member of the Federal Home Loan Bank ("FHLB") system since 1936.  As result of its conversion to a state chartered bank effective January 2002, the Bank’s primary regulators are the Tennessee Department of Financial Institutions (“TDFI”) and FRB.

          The Bank is a community-oriented financial institution whose primary business is attracting deposits from the general public and using those funds to originate a variety of loans to individuals residing within its primary market area, and to businesses owned and operated by such individuals.  The Bank originates both adjustable rate mortgage ("ARM") loans and fixed-rate mortgage loans.  Generally, ARM loans are retained in the Bank's portfolio and long-term fixed-rate mortgage loans are sold in the secondary market.  In addition, the Bank actively makes construction and acquisition and development loans, commercial real estate loans, commercial business loans, and consumer and other non-real estate loans.  The Bank also provides trust and investment services through its trust division and brokerage and investment products through its brokerage division, Cavalry Investment Services.  The Ba nk’s subsidiary Miller & Loughry Insurance and Services, Inc., an independent insurance agency, offers a full line of insurance products and services and human resources management services to customers in Rutherford County.

Market Area

          The Bank considers Rutherford, Davidson, Bedford and Williamson Counties in Central Tennessee to be its primary market area.  A large number of the Bank's depositors reside, and a substantial portion of its loan portfolio is secured by properties located, in Rutherford and Bedford Counties.  With the mortgage loan origination division, Cavalry Mortgage, the Bank has a presence in the Nashville-Davidson county market for residential mortgage originations.

          The economy of Rutherford and Bedford Counties are diverse and generally stable.  According to the Rutherford and Bedford Area Chambers of Commerce, major employers include Nissan Motor Manufacturing Corp.  USA, Rutherford County Government, Whirlpool Corp., Bridgestone/Firestone Inc., Middle Tennessee State University, Alvin C. York Veterans Administration Medical Center and Ingram Distribution, among others.

Lending Activities

          General.   At December 31, 2002, the Bank's loans receivable portfolio amounted to $318.3 million, or 68.5% of total assets at that date. Real estate loans including mortgage and construction loans collectively constituted $192.1million or 60.4% of the loan portfolio at December 31, 2002.  A substantial portion of the Bank's loan portfolio is secured by real estate, either as primary or secondary collateral, located in its primary market area.

          Loan Portfolio Analysis.   The following table sets forth the composition of the Bank's loan portfolio by type of loan as of the dates indicated.

­­­­­­­­­­­­­­­­

(1) Includes loans held for sale.

As a result of the change in charter certain loans that were classified as commercial and consumer loans in prior years are now classified as real estate mortgage.  For the year ended December 31, 2002, approximately $27.4 million classified as mortgage loans would have been classified as commercial and $19.3 million classified as mortgage loans would have been classified as installment and other consumer loans.

          Real Estate - Lending  Mortgage.   Historically, the Bank has concentrated its lending activities on the origination of loans secured by first mortgage loans on residences located in its primary market area.  At December 31, 2002, $125.3 million, or 38.7% of the Bank's total loan portfolio, consisted of such loans.

          Generally, the Bank's fixed-rate loans have maturities ranging from 15 to 30 years and are fully amortizing with monthly payments sufficient to repay the total amount of the loan with interest by the end of the loan term.  Generally, they are originated under terms, conditions and documentation that permit them to be sold to U.S. Government sponsored agencies such as the Federal Home Loan Mortgage Corporation ("FHLMC").  The Bank's fixed-rate loans customarily include "due on sale" clauses, which give the Bank the right to declare a loan immediately due and payable in the event the borrower sells or otherwise disposes of the real property subject to the mortgage and the loan is not paid.

          The Bank also originates ARM loans secured by residences at rates and terms competitive with market conditions.  At December 31, 2002, $44.0 million of these loans, or 13.59% of the Bank's gross loan portfolio, were subject to periodic interest rate adjustments.  The Bank originates for its portfolio ARM loans which provide for an interest rate which adjusts every year or which is fixed for one, three or five years and then adjusts every year after the initial period.  Most of the Bank's one-year, three-year and five-year ARMs adjust every year after the initial fixed rate period based on the one year Treasury constant maturity index.  The Bank's ARMs are typically based on a 30-year amortization schedule.  The Bank's ARM loans generally provide for annual and lifetime interest rate adjustment limits of 2% and 5% to 6%, respectively.

          Borrower demand for ARM loans versus fixed-rate mortgage loans is a function of the level of interest rates, the expectations of changes in the level of interest rates and the difference between the initial interest rates and fees charged for each type of loan.  The relative amount of fixed-rate mortgage loans and ARM loans that can be originated at any time is largely determined by the demand for each in a competitive environment.

          Construction Lending.   The Bank actively originates three types of residential construction loans: (i) speculative construction loans, (ii) pre-sold construction loans and (iii) construction/permanent loans.   The Bank also originates construction loans for the development of multi-family and commercial properties as well as acquisition and land development loans.

At December 31, 2002, the composition of the Bank's construction loan portfolio was as follows:

          Speculative construction loans are made to home builders and are termed "speculative" because the home builder does not have, at the time of loan origination, a signed contract with a home buyer who has a commitment for permanent financing with either the Bank or another lender for the finished home.  The home buyer may be identified either during or after the construction period, with the risk that the builder will have to pay debt service on the speculative construction loan and finance real estate taxes and other carrying costs of the completed home for a significant time after the completion of construction until the home buyer is identified.

          Unlike speculative construction loans, pre-sold construction loans are made to homebuilders who, at the time of construction, have a signed contract with a homebuyer who has a commitment for permanent financing for the finished home with the Bank or another lender.

          Construction/permanent loans are originated to the homeowner rather than the homebuilder.  The construction phase of a construction/permanent loan generally lasts 12 months and the interest rate charged is generally a fixed rate.

          The Bank also provides construction financing for non-residential properties (i.e., multi-family and commercial properties).

          Construction lending affords the Bank the opportunity to achieve higher interest rates and fees with shorter terms to maturity than does its single-family permanent mortgage lending.  Construction lending, however, is generally considered to involve a higher degree of risk than single-family permanent mortgage lending because of the inherent difficulty in estimating both a property's value at completion of the project and the estimated cost of the project.  The nature of these loans is such that they are generally more difficult to evaluate and monitor.  If the estimate of construction cost proves to be inaccurate, the Bank may be required to advance funds beyond the amount originally committed to permit completion of the project.  If the estimate of value upon completion proves to be inaccurate, the Bank may be confronted with a project whose value is insufficient to assure full repayment. &nb sp;Projects may also be jeopardized by disagreements between borrowers and builders and by the failure of builders to pay subcontractors.  Loans to builders to construct homes for which no purchaser has been identified carry more risk because the payoff for the loan depends on the builder's ability to sell the property prior to the time that the construction loan is due.  The Bank has sought to address these risks by adhering to strict underwriting policies, disbursement procedures, and monitoring practices.  In addition, because the Bank's construction lending is in its primary market area, changes in the local economy and real estate market could adversely affect the Bank's construction loan portfolio.

          The Bank originates acquisition and development (“A&D”) loans for the purpose of developing the land (i.e., installing roads, sewers, water and other utilities) for sale for residential housing construction.  All of the Bank’s A&D loans are secured by properties located in the Bank's primary market area.  A&D loans are usually repaid through the sale of the developed land.  However, the Bank believes that its A&D loans are made to individuals with, or to entities the principals/guarantors of which possess, sufficient personal financial resources out of which the loans could be repaid, if necessary.

          Loans secured by undeveloped land or improved lots involve greater risks than residential mortgage loans because such loans are more difficult to monitor and foreclose as the Bank may be confronted with a property the value of which is insufficient to assure full repayment.  Furthermore, if the borrower defaults the Bank may have to expend its own funds to complete development and also incur costs associated with marketing and holding the building lots pending sale.  A&D loans are generally considered to involve a higher degree of risk than single-family permanent mortgage loans because of the concentration of principal among relatively few borrowers and development projects, the increased difficulty at the time the loan is originated of estimating the development building costs, the increased difficulty and costs of monitoring the loan, the higher degree of sensitivity to increases in market rates of interest, and the increased difficulty of working out problem loans.  A concentration of loans secured by properties in any single area presents the risk that any adverse change in regional economic or employment conditions may result in increased delinquencies and loan losses.

          Commercial Lending.   Commercial loans include commercial real estate, commercial business loans, and to a lesser extent loans secured by farmland, and agricultural loans to finance agricultural production.  The following table indicates the amounts of each classification of commercial loans at December 31, 2002 and 2001.

          The Bank originates mortgage loans for the acquisition and refinancing of commercial real estate properties.  The majority of the Bank's commercial real estate properties are secured by small businesses, retail properties and churches located in the Bank's primary market area.  The average size of a commercial real estate loan in the Bank's portfolio is approximately $100,000 to $200,000.

          Commercial real estate lending affords the Bank an opportunity to receive interest at rates higher than those generally available from residential lending.  However, loans secured by such properties usually are greater in amount, more difficult to evaluate and monitor and, therefore, involve a greater degree of risk than residential mortgage loans.  Because payments on loans secured by multi-family and commercial properties are often dependent on the successful operation and management of the properties, repayment of such loans may be affected by adverse conditions in the real estate market or the economy.  The Bank seeks to minimize these risks by limiting the maximum loan-to-value ratio to 80% and strictly scrutinizing the financial condition of the borrower, the quality of the collateral and the management of the property securing the loan.  The Bank also obtains loan guarantees from financially capable parties based on a review of personal financial statements.

          The Bank's commercial business lending activities focus primarily on small to medium size businesses owned by individuals who reside in the Bank's primary market area.  Commercial business loans may be unsecured loans, but generally are secured by various types of business collateral other than real estate (i.e., inventory, equipment, etc.).   In many instances, however, such loans are often also secured by junior liens on real estate.  Commercial business loans are generally made in amounts between $50,000 to $75,000 and may be either lines of credit or term loans.

          Commercial business lending generally involves greater risk than residential mortgage lending and involves risks that are different from those associated with residential, commercial and multi-family real estate lending.  Real estate lending is generally considered to be collateral based lending with loan amounts based on predetermined loan to collateral values and liquidation of the underlying real estate collateral is viewed as the primary source of repayment in the event of borrower default.  Although commercial business loans are often collateralized by equipment, inventory, accounts receivable or other business assets, the liquidation of collateral in the event of a borrower default is often not a sufficient source of repayment because accounts receivable may be uncollectible and inventories and equipment may be obsolete or of limited use, among other things.  Accordingly, the repayment of a commercial b usiness loan depends primarily on the cash flows from the business or the creditworthiness of guarantors, while liquidation of collateral is a secondary and often insufficient source of repayment.

          As part of its commercial business lending activities, the Bank issues standby letters of credit or performance bonds as an accommodation to its borrowers.  See "Loan Commitments and Letters of Credit."

          Consumer Lending.   The Bank originates a variety of consumer loans that generally have shorter terms to maturity and higher interest rates than residential mortgage loans.  The Bank's consumer loans consist primarily of home equity lines of credit, automobile loans, and a variety of other secured loans, a substantial portion of which are secured by junior mortgages on real estate.  To a substantially lesser extent, the Bank also originates unsecured consumer loans.

          Consumer loans entail greater risk than do residential mortgage loans, particularly in the case of loans that are unsecured or secured by rapidly depreciating assets such as automobiles and other vehicles.  In such cases, any repossessed collateral for a defaulted consumer loan may not provide an adequate source of repayment of the outstanding loan balance as a result of the greater likelihood of damage, loss or depreciation.  The remaining deficiency often does not warrant further substantial collection efforts against the borrower beyond obtaining a deficiency judgment.  In addition, consumer loan collections are dependent on the borrower's continuing financial stability, and thus are more likely to be adversely affected by job loss, divorce, illness or personal bankruptcy.   Furthermore, the application of various federal and state laws, including federal and state bankruptcy and insolvency laws, may limit the amount that can be recovered on such loans.

          Maturity of Loan Portfolio.   The following table sets forth certain information at December 31, 2002 regarding the dollar amount of loans maturing in the Bank's loan portfolio based on their contractual terms to maturity, but does not include scheduled payments or potential prepayments.  Demand loans, loans having no stated schedule of repayments and no stated maturity, and overdrafts are reported as due in one year or less. 

          The following table sets forth the dollar amount of all loans due after December 31, 2003, which have fixed interest rates or floating or adjustable interest rates.

          Scheduled contractual principal repayments of loans do not reflect the actual life of such assets.  The actual life of a loan may be substantially less than its contractual terms because of prepayments.  In addition, due-on-sale clauses on loans generally give the Bank the right to declare loans immediately due and payable in the event, among other things, that the borrower sells the real property subject to the mortgage.  The average life of mortgage loans tends to increase, however, when current mortgage loan market rates are substantially higher than rates on existing mortgage loans and, conversely, decrease when rates on existing mortgage loans are substantially higher than current mortgage loan market rates.

          Loan Originations, Sales and Purchases.  While the Bank originates both adjustable-rate and fixed-rate loans, its ability to generate each type of loan depends upon relative customer demand for loans in its primary market area.

          The Bank sells most loans originated under FHA and VA programs, including related servicing rights, including those originated for the THDA.  The Bank originated $183.0 million mortgage loans in 2002.   The Bank sold approximately $179.0 million mortgage loans, and had approximately $17.8 million which were “held for sale” at December 31, 2002.  Approximately 90.0% of the one-to-four family mortgage loans sold were fixed rate loans.  The Bank also periodically sells conventional one-to-four family loans (i.e., non-FHA/VA loans) with servicing retained and without recourse.  These sales generally involve fixed-rate loans that help to reduce the Bank’s exposure to interest rate risk, and the proceeds of sale are used to fund continuing operations.  The Bank occasionally may also sell ARM loans to satisfy liquidity needs.

          Sellers of loans are exposed to various degrees of "pipeline risk," which is the risk that the value of the loan will decline during the period between the time the loan is originated and the time of sale because of changes in market interest rates.  The Bank believes it is exposed to a relatively low degree of pipeline risk because it generally does not fix the loan interest rate until shortly before or on the closing date and loans are generally closed against a mandatory purchase commitment by the FHLMC or other purchaser.

          When conventional loans are sold, the Bank may retain the responsibility for servicing the loans for the buyer, including collection and remitting mortgage loan payments, accounting for principal and interest and holding and disbursing escrow or impound funds for real estate taxes and insurance premiums.  The Bank receives a servicing fee for performing these services for others.  The Bank's servicing portfolio amounted to $64.9 million at December 31, 2002.  The Bank is generally paid a fee equal to 0.25% of the outstanding principal balance for servicing sold loans.  Loan servicing income totaled $75,000, $85,000 and $129,000 for the years ended December 31, 2002, 2001 and 2000, respectively.  The Bank earns late charges collected from delinquent customers whose loans are serviced by the Bank.  The Bank is allowed to invest escrow impounds (funds collected from mortgage custome rs for the payment of property taxes and insurance premiums on mortgaged real estate) until they are disbursed on behalf of mortgage customers, but is not required to pay interest on these funds.  At December 31, 2002, borrowers' escrow funds amounted to $177,000.

          Historically, the Bank has not been an active purchaser of loans or participation interests in loans.

          Loan Commitments and Letters of Credit.   The Bank issues commitments for mortgage loans that are conditioned upon the occurrence of certain events.  Such commitments are made in writing on specified terms and conditions and are honored for up to 45 days from approval, depending on the type of transaction.  At December 31, 2002, the Bank had commitments to originate mortgage loans of $34.0 million and had unused lines of credit of $29.5 million.  Loan commitments are agreements to provide a specific amount of credit to a borrower normally on a one-time basis.  Lines of credit are commitments to borrowers that revolve allowing the borrower to continue withdrawing and paying from time to time up to a pre-approved credit limit.   See Note 17 of Notes to the Consolidated Financial Statements contained in the Annual Report.

          As an accommodation to its commercial business borrowers, the Bank issues standby letters of credit or performance bonds in favor of entities, usually municipalities, for whom the Bank's borrowers are performing work or other services.  At December 31, 2002, the Bank had outstanding standby letters of credit of $6.1 million that were issued primarily to municipalities as performance bonds.  See Note 17 of Notes to the Consolidated Financial Statements contained in the Annual Report.

          Loan Fees.   In addition to interest earned on loans, the Bank receives income from fees in connection with loan originations, loan modifications, late payments and for miscellaneous services related to its loan portfolio.  Income from these activities varies from period to period depending upon the volume and type of loans made and competitive conditions.

          The Bank charges loan origination fees that are calculated as a percentage of the amount borrowed.  In accordance with applicable accounting procedures, loan origination fees and discount points in excess of loan origination costs are deferred and recognized over the contractual remaining lives of the related loans on a level yield basis.  Discounts and premiums on loans purchased are accreted and amortized in the same manner.  The Bank recognized $898,000, $882,000 and $837,000 of deferred loan fees during the years ended December 31, 2002, 2001, and 2000, respectively, in connection with loan refinancings, payoffs, sales and ongoing amortization of outstanding loans.

          Non-performing Assets and Delinquencies.   Loans are placed on non-accrual status generally if, in the opinion of management, principal or interest payments are not likely in accordance with the terms of the loan agreement, or when principal or interest is past due 90 days or more.  Interest accrued but not collected at the date the loan is placed on non-accrual status is reversed against income in the current period.  Loans may be reinstated to accrual status when payments are under 90 days past due and, in the opinion of management, collection of the remaining past due balances can be reasonably expected.

          The following table sets forth information with respect to the Bank's non-performing assets at the dates indicated.

          Interest income that would have been recorded for the year ended December 31, 2002 had non-accruing loans been current in accordance with their original terms was not significant.  No interest income was included in net interest income on such loans for the year ended December 31, 2002.

          Potential problem assets, which are not included in non-performing assets, amounted to $3.4 million or 1.07% of total loans at December 31, 2002 and $4.0 million or 1.38% of total loans at December 31, 2001.  Potential problem assets represent those assets where information about possible credit problems of borrowers has caused management to have serious doubts about the borrower’s ability to comply with present repayment terms.  This definition is believed to be substantially consistent with the standards established by the Bank and its regulators for loans classified as substandard.

          Foreclosed Assets.   Foreclosed assets (“ORE”) include property acquired through foreclosure and deeds in lieu of foreclosure.  Property acquired by deed in lieu of foreclosure results when a borrower voluntarily transfers title to the company in settlement of the related debt in an attempt to avoid foreclosure.  Foreclosed assets also include other collateral acquired by the Company in an attempt to recover the debt owed by the borrower.  See Note 1 of Notes to the Consolidated Financial Statements contained in the Annual Report for a discussion of the accounting treatment of foreclosed assets.

          Restructured Loans.  Under U.S. GAAP, the Bank is required to account for certain loan modifications or restructuring as a "troubled debt restructuring".  In general, the modification or restructuring of a debt constitutes a troubled debt restructuring if the Bank for economic or legal reasons related to the borrower's financial difficulties grants a concession to the borrowers that the Bank would not otherwise consider.  Debt restructurings or loan modifications for a borrower do not necessarily always constitute troubled debt restructurings, however, and troubled debt restructurings do not necessarily result in non-accrual loans.  The Bank did not have any restructured loans at December 31, 2002.

          Asset Classification.   Generally, bank regulators have adopted various regulations or guidelines regarding problem assets of financial institutions.  The regulations or guidelines require that each institution review and classify its assets on a regular basis.  In addition, in connection with examinations of insured institutions, examiners have authority to identify problem assets and, if appropriate, require them to be classified.  There are three classifications for problem assets: substandard, doubtful and loss.  Substandard assets have one or more defined weaknesses and are characterized by the distinct possibility that the insured institution will sustain some loss if the deficiencies are not corrected.  Doubtful assets have the weaknesses of substandard assets with the additional characteristic that the weaknesses make collection or liquidation in full on the basis of currently existing facts, conditions and values questionable, and there is a high possibility of loss.  An asset classified as loss is considered uncollectible and of such little value that continuance as an asset of the institution is not warranted.  If an asset or portion thereof is classified as loss, the insured institution establishes specific allowances for loan losses for the full amount of the portion of the asset classified as loss.  All or a portion of general loan loss allowances established to cover possible losses related to assets classified substandard or doubtful can be included in determining an institution's regulatory capital, while specific valuation allowances for loan losses generally do not qualify as regulatory capital.  Assets that do not currently expose the insured institution to sufficient risk to warrant classification in one of the aforementioned categories but possess weaknesses are designated "special mention" and monitored by the Bank.

          The aggregate amounts of the Bank's classified and special mention assets were as follows:

          Provision for Loan Losses.    The Bank has established a systematic methodology for the determination of provisions for loan losses.  The methodology is set forth in a formal policy and takes into consideration the need for an overall general valuation allowance as well as specific allowances that are tied to individual loans.

          Provisions for loan losses are charges to earnings to bring the total allowance for loan losses to a level considered by management as adequate to provide for estimated losses based on concentrations, trends in historical loss experience, specific impaired loans and economic conditions.  In determining the adequacy of the allowance for loan losses, management periodically reviews the loan portfolio and considers such factors as delinquency status, past performance problems, historical loss experience, adverse situations that may affect the ability of the borrowers to repay, known and inherent risks in the portfolio, assessments of economic conditions, regulatory policies, and the estimated value of underlying collateral.  The Bank’s credit management systems have resulted in low loan loss experience, however there can be no assurances that such experience will continue.  The allowance for loan losses is based principally on the risks associated with the type of loans in the portfolio with greater emphasis placed on higher risk assets.  This requires a heavier weight assigned to internally identified problem assets, repossessed assets, and non-performing assets that otherwise exhibit, in management’s judgment, potential credit weaknesses.  The required level of the allowance for loan losses is then calculated based upon the outstanding balances in each loan category and the risk weight assigned to each category.

          At December 31, 2002, the Bank had an allowance for loan losses of $4.7 million.  Management believes that the amount maintained in the allowance at December 31, 2002 will be adequate to absorb losses inherent in the portfolio.  Although management believes that it uses the best information available to make such determinations, future adjustments to the allowance for loan losses may be necessary and results of operations could be significantly and adversely affected if circumstances differ substantially from the assumptions used in making the determinations.  Furthermore, while the Bank believes it has established its existing allowance for loan losses in accordance with U.S. GAAP, there can be no assurance that regulators, in reviewing the Bank's loan portfolio, will not request the Bank to increase significantly its allowance for loan losses.  In addition, because future events affecting borrower s and collateral cannot be predicted with certainty, there can be no assurance that the existing allowance for loan losses is adequate or that substantial increases will not be necessary should the quality of any loans deteriorate as a result of the factors discussed above.  Any material increase in the allowance for loan losses may adversely affect the Bank's financial condition and results of operations.

          The following table sets forth an analysis of the Bank's gross allowance for loan losses for the periods indicated.

The following table sets forth the breakdown of the allowance for loan losses by loan category at the dates indicated.  Management believes that the allowance for loan losses can be allocated by category only on an approximate basis.  The allocation of the allowance for loan losses to each category is not necessarily indicative of future losses and does not restrict the use of the allowance for loan losses to absorb losses in any other category.

At December 31,

2002

2001 

2000 

1999 

1998

Percent

Percent

Percent

Percent

Percent

of Loans

of Loans

of Loans

of Loans

of Loans

in Category

in Category

in Category

in Category

in Category

to Total

to Total

to Total

to Total

to Total

Amount

Loans

Amount

Loans

Amount

Loans

Amount

Loans

Amount

Loans

(Dollars in thousands)

 Commercial

$1,833

32.2%

$2,209

44.1%

$2,024

41.0%

$1,994

38.3%

$1,357

32.8%

 Real estate - construction

1,107

20.7

844

16.4

840

17.7

740

20.9

492

19.1

 Real estate - mortgage

1,017

38.7

388

24.1

406

23.3

305

21.7

384

30.3

 Installment and other consumer

612

8.4

734

15.4

777

18.0

874

19.1

635

17.8

Unallocated

88

N/A

 295

N/A

 188

N/A

 223

N/A

363

 N/A

    Total allowance

         for loan losses

$4,657

100.0%

$4,470

100.0%

$4,235

100.0%

$4,136

100.0%

$3,231

100.0%

Investment Activities

          The Bank is permitted under federal law to invest in various types of liquid assets, including U.S. Treasury obligations, securities of various federal agencies and state and municipal governments, deposits at the FHLB-Cincinnati, certificates of deposit of federally insured institutions, certain bankers' acceptances and federal funds.  Subject to various restrictions, the Bank may also invest a portion of its assets in commercial paper and corporate debt securities.  The Bank as a member of the Federal Home Loan Bank and the Federal Reserve Bank are also required to maintain an investment in FHLB and FRB stock.  The Bank as a matter of safety and soundness is required to maintain adequate levels of liquid assets.  See "Management's Discussion and Analysis of Financial Condition and Results of Operations  Liquidity and Capital Resources," contained in the Annual Report.

          The Bank purchases investment securities with excess liquidity arising when investable funds exceed loan demand.  The Bank's investment securities purchases generally have been limited to U.S. Government and agency securities with contractual maturities of between one and five years.

          The Bank's investment policies generally limit investments to U.S. Government and agency securities, municipal bonds, certificates of deposit, marketable corporate debt obligations, and mortgage-backed securities.  The Bank's investment policy does not permit hedging activities or the purchase of high-risk mortgage derivative products or non-investment grade corporate bonds.  Investments are made based on certain considerations, which include the interest rate, yield, settlement date and maturity of the investment, the Bank's liquidity position, and anticipated cash needs and sources (which in turn include outstanding commitments, upcoming maturities, estimated deposits and anticipated loan amortization and repayments).   The effect that the proposed investment would have on the Bank's credit and interest rate risk and risk-based capital is also considered.

          The following table sets forth the amortized cost and fair value of the Bank's debt, mortgage-backed and other securities, by accounting classification and by type of security, at the dates indicated.

(footnotes on following page)

(1)

The market value of the investment portfolio amounted to $40.8 million, $44.6 million and $34.9 million at December 31, 2002, 2001 and 2000, respectively.  At December 31, 2002, the market value of the principal components of the Bank's investment securities portfolio was as follows: U.S. Government securities, $26.7 million; collateralized mortgage obligations and mortgage-backed securities, $10.8 million; other securities $425,000, and FHLB and FRB stock, $2.9 million.

          The following table sets forth the maturities and weighted average yields of the investment securities in the Bank's portfolio at December 31, 2002.

Less Than 

One to

Over Five to

 Over Ten

Amount

Yield

Amount

Yield

Amount

Yield

Amount

Yield

Held to Maturity:

FHLB & FRB stock

$2,874

4.82%

$        - 

        -% 

$        - 

        -% 

$        - 

        -% 

   Total held to maturity

       securities

2,874

4.82

-

-

-

-

-

-

Available for Sale:

Debt Securities: