CAVALRY BANCORP INC - 10-Q Quarterly Report

UNITED STATES

SECURITIES AND EXCHANGE COMMISSION

WASHINGTON, D.C. 20549

FORM 10-Q

(Mark One)

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 or

o	Transition Report Pursuant to Section 13 or 15(d) of the Securities Exchange Act of 1934 For the Transition period from___________ to ___________

Commission File Number: 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)

(615) 893-1234

Registrant’s telephone number, including area code

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 o

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

Yes x

No o

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

Common Stock Issued and Outstanding: 6,729,752 shares as of November 5, 2004.

CAVALRY BANCORP, INC.

Table of Contents

Part I	Financial Information	Page

Item 1.	Financial Statements

	Consolidated Balance Sheets at September 30, 2004 (unaudited) and December 31, 2003 (audited)	1

	Consolidated Statements of Income (unaudited) for the Three Months and Nine Months Ended September 30, 2004 and 2003	2

	Consolidated Statements of Comprehensive Income (unaudited) for the Three Months and Nine Months Ended September 30, 2004 and 2003	3

	Consolidated Statements of Cash Flows (unaudited) for the Nine Months Ended September 30, 2004 and 2003	4

	Notes to Consolidated Financial Statements (unaudited)	5-8

Item 2.	Management’s Discussion and Analysis of Financial Condition and Results of Operations	8-13

Item 3.	Quantitative and Qualitative Disclosures About Market Risk	13-14

Item 4.	Controls and Procedures	14

Part II	Other Information	15

Item 1.	Legal Proceedings	15

Item 2.	Unregistered Sales of Equity Securities and Use of Proceeds	15

Item 3.	Defaults Upon Senior Securities	15

Item 4.	Submission of Matters to a Vote of Security Holders	15

Item 5.	Other Information	15

Item 6.	Exhibits	15

Signatures		16

Part I. Financial Information

Item 1. FINANCIAL STATEMENTS

CAVALRY BANCORP, INC.

CONSOLIDATED BALANCE SHEETS

SEPTEMBER 30, 2004 (UNAUDITED) AND DECEMBER 31, 2003 (AUDITED)

(DOLLARS IN THOUSANDS)

	September 30,			December 31,
Assets	2004			2003
	(Unaudited)
Cash	$	20,674			32,946
Interest-bearing deposits with other financial institutions		35,366			37,967
Cash and cash equivalents		56,040			70,913
Investment securities available-for-sale at fair value (amortized cost: $43,865 and $55,136 at September 30, 2004 and December 31, 2003, respectively)		43,707			55,123
Loans held for sale, at estimated fair value		2,438			2,648
Loans receivable, net of allowances for loan losses of $4,728 at September 30, 2004 and $4,525 at December 31, 2003		413,788			350,412
Accrued interest receivable		1,813			1,668
Office properties and equipment, net		17,822			18,431
Required investments in stock of Federal Home Loan Bank and Federal Reserve Bank, at cost		3,099			2,992
Foreclosed assets		13			-
Bank owned life insurance		8,499			8,308
Goodwill		1,772			1,772
Other assets		2,911			2,905
Total assets	$	551,902			515,172

Liabilities and Shareholders’ Equity
Liabilities:
Deposits:
Non-interest-bearing	$	90,212			72,443
Interest-bearing		396,134			381,814
Total deposits		486,346			454,257
Advances from Federal Home Loan Bank of Cincinnati		2,848			2,889
Accrued expenses and other liabilities		6,072			3,599
Total liabilities		495,266			460,745
Shareholders’ equity:
Preferred stock, no par value
Authorized- 250,000 shares; none issued or outstanding at September 30, 2004 and December 31, 2003		-			-
Common stock, no par value
Authorized- 49,750,000 shares; issued and outstanding 6,741,752 and 6,834,873 at September 30, 2004 and December 31, 2003, respectively		9,439			10,175
Retained earnings		49,142			46,633
Unallocated ESOP shares		(1,839	)		(2,373	)
Accumulated other comprehensive loss, net of tax		(106	)		(8	)
Total shareholders’ equity		56,636			54,427
Total liabilities and shareholders’ equity	$	551,902			515,172

Note: The balance sheet presented above at December 31, 2003 has been derived from the audited financial statements at that date but does not include all of the information and footnotes required by accounting principles generally accepted in the United States of America for complete financial statements.

See accompanying notes to consolidated financial statements.


	1

CAVALRY BANCORP, INC.

CONSOLIDATED STATEMENTS OF INCOME

(DOLLARS IN THOUSANDS, EXCEPT PER SHARE DATA)

(UNAUDITED)

	Three Months Ended				Nine Months Ended
	September 30,				September 30,
	2004		2003		2004		2003
Interest income:
Loans	$	5,994		5,055		16,839		15,124
Investment securities:
Taxable		332		307		979		896
Non-taxable		36		-		74		-
Other		120		82		261		309
Total interest income		6,482		5,444		18,153		16,329
Interest expense - deposits		1,367		1,303		3,880		4,221
Interest expense - borrowings		24		25		73		74
Total interest expense		1,391		1,328		3,953		4,295
Net interest income		5,091		4,116		14,200		12,034
Provision for loan losses		176		-		352		101
Net interest income after provision for loan losses		4,915		4,116		13,848		11,933
Non-interest income:
Servicing income		47		45		140		176
Gain on sale of loans, net		879		1,687		2,281		4,711
Gain on sale of other assets		-		-		53		-
Gain on sale of investment securities, net		-		-		-		11
Deposit servicing fees and charges		1,457		1,208		3,992		3,455
Trust service fees		266		246		832		740
Commissions and other non-banking fees		649		676		1,899		1,995
Other operating income		221		196		701		579
Total non-interest income		3,519		4,058		9,898		11,667
Non-interest expenses:
Salaries and employee benefits		3,603		3,962		10,834		11,498
Occupancy expense		329		346		984		979
Supplies, communications and other office expenses		223		286		706		791
Advertising expense		87		107		404		330
Equipment and service bureau expense		890		780		2,557		2,211
Professional fees		257		130		656		365
Other taxes		114		116		344		324
Loss on sale of investment securities, net		81		-		3		-
Other operating expense		377		332		1,120		1,003
Total non-interest expenses		5,961		6,059		17,608		17,501
Income before income taxes		2,473		2,115		6,138		6,099
Income tax expense		994		835		2,475		2,373
Net income	$	1,479		1,280		3,663		3,726

Basic earnings per share	$	0.23		0.20		0.57		0.58

Diluted earnings per share	$	0.22		0.19		0.55		0.56

Weighted average shares outstanding - Basic		6,441,148		6,418,261		6,463,810		6,392,235

Weighted average shares outstanding - Diluted		6,675,920		6,713,772		6,700,546		6,666,276

Dividends declared $0.06 per share payable October 8, 2004 for shareholders of record date September 30, 2004.

See accompanying notes to consolidated financial statements.


	2

CAVALRY BANCORP, INC.

CONSOLIDATED STATEMENTS OF COMPREHENSIVE INCOME

(DOLLARS IN THOUSANDS)

(UNAUDITED)

	Three Months Ended			Nine Months Ended
	September 30,			September 30,
		2004	2003		2004		2003

Net income	$	1,479	1,280		3,663		3,726
Other comprehensive income, net of tax:
Unrealized gains (losses) on investment securities available-for-sale		286	30		(100	)	5
Reclassification adjustment for (gains) losses included in net income		50	-		2		(7	)
Comprehensive income	$	1,815	1,310		3,565		3,724

See accompanying notes to consolidated financial statements.


	3

CAVALRY BANCORP, INC.

CONSOLIDATED STATEMENTS OF CASH FLOWS

NINE MONTHS ENDED SEPTEMBER 30, 2004 AND 2003

(DOLLARS IN THOUSANDS)

(UNAUDITED)

	2004			2003

Operating activities:
Net cash provided by operating activities	$	9,144			19,658
Investing activities:
Increase in loans receivable, net		(63,770	)		(31,849	)
Principal payments on investment securities		2,406			5,572
Purchase of investment securities available-for-sale		(47,746	)		(76,080	)
Proceeds from maturities of investment securities		14,030			43,789
Proceeds from sales of investment securities available-for-sale		42,429			2,500
Purchase of Federal Reserve Stock		(35	)		-
Purchase of office properties and equipment		(681	)		(1,984	)
Proceeds from sale of assets		30			743
Net cash used in investing activities		(53,337	)		(57,309	)
Financing activities:
Net increase in deposits		32,089			6,361
Retirement of common stock		(1,840	)		(137	)
Proceeds from exercise of stock options		271			-
Dividends paid		(1,159	)		(1,045	)
Net decrease in borrowings		(41	)		(41	)
Net cash provided by financing activities		29,320			5,138
Decrease in cash and cash equivalents		(14,873	)		(32,513	)
Cash and cash equivalents, beginning of period		70,913			73,162

Cash and cash equivalents, end of period	$	56,040			40,649

Supplemental Disclosures of Cash Flow Information:
Payments during the period for:
Interest	$	3,919			4,365
Income taxes	$	2,195			2,700

Supplemental Disclosures of Noncash Investing and Financing Activities:

Increase in deferred tax asset related to unrealized losses on investments	$	145			1
Net unrealized losses on investment securities available for sale	$	(47	)		(3	)
Dividends declared and payable	$	405			409

See accompanying notes to consolidated financial statements.


	4

Cavalry Bancorp, Inc.

Notes to Consolidated Financial Statements

1. Basis of Presentation

Cavalry Bancorp, Inc. (the "Company"), a Tennessee corporation, is the holding company for Cavalry Banking (the "Bank") a state chartered Federal Reserve member commercial bank. Miller & Loughry Insurance and Services, Inc. ("Miller & Loughry"), an independent insurance agency, is a wholly-owned subsidiary of the Bank.

The unaudited consolidated financial statements include the accounts of Miller & Loughry, the Bank and the Company. All material intercompany accounts and transactions have been eliminated in consolidation.

The accompanying consolidated financial statements of the Company have been prepared in accordance with Instructions to Form 10-Q. Accordingly, they do not include all of the information and footnotes required by accounting principles generally accepted in the United States of America for complete financial statements. However, such information reflects all adjustments (consisting solely of normal recurring adjustments), which are, in the opinion of management, necessary for a fair statement of results for the interim periods.

The results of operations for the three months and nine months ended September 30, 2004, are not necessarily indicative of the results to be expected for the year ending December 31, 2004. The consolidated financial statements and notes thereto should be read in conjunction with the audited consolidated financial statements and notes thereto for the year ended December 31, 2003.

2. Stock Options

The Company accounts for its stock option plan in accordance with the provisions of Accounting Principles Board (APB) Opinion No. 25, "Accounting for Stock Issued to Employees," and related interpretations, as permitted by Statement of Financial Accounting Standard (SFAS) No. 123, "Accounting for Stock-Based Compensation." As such, compensation expense is recorded on the date of grant only if the current market price of the underlying stock exceeds the exercise price. SFAS 123 requires entities which continue to apply the provisions of APB 25 to provide pro-forma earnings per share disclosure for stock option grants made in 1995 and subsequent years as if the fair value based method defined in SFAS 123 had been applied. SFAS 148, "Accounting for Stock-Based Compensation - Transition and Disclosure - an amendment o f FASB No. 123," provides that an entity that has transitioned to the accounting treatment prescribed by SFAS 123 may use the intrinsic value method in lieu of the fair value based method for determining the fair value of stock options at the date of grant. SFAS 148 requires disclosure in addition to SFAS 123 if APB 25 is currently being applied.

The Company applies APB 25 and related interpretations in accounting for the stock option plan. No compensation cost has been recognized for the plan because the stock option price is equal to or greater than the fair value at the grant date. Following is a reconciliation of reported and pro forma net income and earnings per share had compensation cost for the plan been determined based on the fair value method of SFAS 123, as amended:

	Three Months Ended						Nine Months Ended
	September 30,						September 30,
	2004			2003			2004			2003
	(Dollars in thousands, except per share data)
Net income:
As reported	$	1,479			1,280			3,663			3,726
Deduct: Total stock-based employee compensation expense determined under fair value methods for all awards granted, net of related tax effects		(110	)		(32	)		(311	)		(95	)
Pro forma net income	$	1,369			1,248			3,352			3,631
Earnings per share:
Basic - as reported	$	0.23			0.20			0.57			0.58
Basic - pro forma	$	0.21			0.19			0.52			0.57
Diluted - as reported	$	0.22			0.19			0.55			0.56
Diluted - pro forma	$	0.21			0.19			0.50			0.54


	5

3. Earnings Per Share

The following schedule reconciles the numerators and denominators of the basic and diluted earnings per share (EPS) computations for the three months and nine months ended September 30, 2004 and 2003. Diluted common shares arise from the potentially dilutive effect of the Company’s stock options outstanding that have exercise prices less than the fair market value of the Company’s common stock.

	Three Months Ended September 30,				Nine Months Ended September 30,
	2004		2003		2004		2003
Basic EPS:
Net income	$	1,479,000		1,280,000		3,663,000		3,726,000
Average common shares outstanding		6,441,148		6,418,261		6,463,810		6,392,235

Earnings per share - basic	$	0.23		0.20		0.57		0.58

Diluted EPS:
Net income	$	1,479,000		1,280,000		3,663,000		3,726,000

Average common shares outstanding		6,441,148		6,418,261		6,463,810		6,392,235
Dilutive effect of stock options		234,772		295,511		236,736		274,041

Average dilutive shares outstanding		6,675,920		6,713,772		6,700,546		6,666,276

Earnings per share - diluted	$	0.22		0.19		0.55		0.56

4. Business Segments

The Company and its subsidiaries provide community oriented financial services to individuals and businesses primarily within Davidson, Rutherford and Bedford counties in Middle Tennessee.

The Company’s segments are identified by the products and services offered, principally distinguished as banking, trust, insurance, and mortgage banking operations. The majority of loans originated for sale are sold with the servicing rights attached.

Segment information is derived from the internal reporting system utilized by management with accounting policies and procedures consistent with those described in Note 1 of the financial statements included in the Company’s 2003 Annual Report to Shareholders. Segment performance is evaluated by the Company based on profit or loss before income taxes. Revenue, expense, and asset levels reflect those which can be specifically identified and those assigned based on internally developed allocation methods. These methods have been consistently applied.


	6

For the three months ended	Banking		Mortgage Banking		Trust		Insurance		Eliminations			Consolidated
September 30, 2004:
Interest income	$	6,482		-		-		-		-			6,482
Other income-external customers		1,789		47		266		538		-			2,640
Interest expense		1,391		-		-		-		-			1,391
Depreciation and amortization		361		36		17		2		-			416
Other significant items:
Provision for loan losses		176		-		-		-		-			176
Gain on sales of assets		-		879		-		-		-			879
Segment profit		2,344		27		33		86		(17	)		2,473
Segment assets		547,928		2,576		324		2,991		(1,917	)		551,902

For the three months ended	Banking		Mortgage Banking		Trust		Insurance		Eliminations			Consolidated
September 30, 2003:
Interest income	$	5,444		-		-		-		-			5,444
Other income-external customers		1,539		45		246		541		-			2,371
Interest expense		1,328		-		-		-		-			1,328
Depreciation and amortization		329		92		16		15		-			452
Other significant items:
Provision for loan losses		-		-		-		-		-			-
Gain on sales of assets		-		1,687		-		-		-			1,687
Segment profit		1,836		264		37		75		(97	)		2,115
Segment assets		469,050		5,733		335		2,855		(2,270	)		475,703

For the nine months ended	Banking		Mortgage Banking			Trust		Insurance		Eliminations			Consolidated
September 30, 2004:
Interest income	$	18,153		-			-		-		-			18,153
Other income-external customers		5,040		140			832		1,552		-			7,564
Interest expense		3,953		-			-		-		-			3,953
Depreciation and amortization		1,062		123			52		19		-			1,256
Other significant items:
Provision for loan losses		352		-			-		-		-			352
Gain on sales of assets		53		2,281			-		-		-			2,334
Segment profit (loss)		5,985		(127	)		147		180		(47	)		6,138
Segment assets		547,928		2,576			324		2,991		(1,917	)		551,902

For the nine months ended	Banking		Mortgage Banking		Trust		Insurance		Eliminations			Consolidated
September 30, 2003:
Interest income	$	16,329		-		-		-		-			16,329
Other income-external customers		4,360		176		740		1,669		-			6,945
Interest expense		4,295		-		-		-		-			4,295
Depreciation and amortization		942		274		50		45		-			1,311
Other significant items:
Provision for loan losses		101		-		-		-		-			101
Gain on sales of assets		11		4,711		-		-		-			4,722
Segment profit		5,380		713		102		191		(287	)		6,099
Segment assets		469,050		5,733		335		2,855		(2,270	)		475,703


	7

5. New Accounting Standards

On March 9, 2004, the SEC staff issued Staff Accounting Bulletin No. 105, "Application of Accounting Principles to Loan Commitments", which provides guidance regarding mortgage loan interest rate lock commitments related to loans held for sale as written options, effective for commitments entered into after March 31, 2004. The Company enters into such commitments with customers in connection with residential mortgage loan applications, however, the amount of these commitments is not material to the Company’s consolidated financial statements. The impact of implementing this guidance did not have a significant impact on the consolidated financial statements.

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

This Quarterly Report contains forward-looking statements within the meaning of the federal securities laws. These statements are not historical facts, but rather are statements based on the Company's current expectations regarding its business strategies and their intended results and its future performance. Forward-looking statements are preceded by terms such as "expects," "feels," "believes," "anticipates," "intends," and similar expressions. Forward-looking statements are not guarantees of future performance. Numerous risks and uncertainties could cause the Company's actual results, performance, and achievements to be materially different from those expressed or implied by the forward-looking statements. Factors that may cause or contribute to these differences include, without limitation, gen eral economic conditions, including changes in market interest rates and changes in monetary and fiscal policies of the federal government; changes in market conditions in the Company’s principal market area; adverse changes in the financial condition of the loan loss reserves; competitive pressures on loan or deposit terms; legislative and regulatory changes; and other factors disclosed periodically in the Company's filings with the Securities and Exchange Commission. Because of the risks and uncertainties inherent in forward-looking statements, readers are cautioned not to place undue reliance on them, whether included in this report or made elsewhere from time to time by the Company or on its behalf. The Company assumes no obligation to update any forward-looking statements.

Overview of Operating Results for the Three Months Ended September 30, 2004 and September 30, 2003

Net income increased from $1.3 million or $0.19 per diluted share for the quarter ended September 30, 2003 to $1.5 million or $0.22 per diluted share for the quarter ended September 30, 2004. The increase in earnings for the quarter was a result of increased net interest income, increased deposit servicing fees and decreased non-interest expense. These factors were partially offset by increased provision for loan losses and decreased gain on sale of loans. These items are discussed in further detail below.

Overview of Operating Results for the Nine Months Ended September 30, 2004 and September 30, 2003

Net income was $3.7 million or $0.56 per diluted share for the nine months ended September 30, 2003 and $3.7 million or $0.55 per diluted share for the same period ended September 30, 2004. The decrease in diluted earnings per share was a result of decreased gain on sale of loans, increased provision for loan losses and increased non-interest expense. These factors were partially offset by increased interest income, increased deposit servicing fees, and a decline in interest expense. These items are discussed in further detail below.

Critical Accounting Policies

The Company’s consolidated financial statements are prepared in conformity with accounting principles generally accepted in the United States of America and follow general practices within the industries in which it operates. The Company’s accounting policies are fundamental to understanding these financial statements. Certain accounting policies involve significant judgments and complex assumptions by management which may have a material impact on the carrying value of certain assets and liabilities; management considers these accounting policies to be critical accounting policies. Based on this definition, management considers the allowance for loan losses to be its most critical accounting policy. The Company’s allowance for loan loss methodology incorporates a variety of risk con siderations, both quantitative and qualitative, in establishing an allowance that management believes to be appropriate for each reporting date. Quantitative and qualitative factors include the Company’s historical loss experience, delinquency and charge-off trends, collateral values, and changes in non-performing loans. Additionally, the Company considers the general economic environment in the Company’s markets, including economic conditions throughout the Southeast and the state of industries predominant in the Middle Tennessee area. The Company also incorporates known information about individual loans, including borrower’s sensitivity to interest rate movements and other relevant factors.

Management also considers its policy on non-accrual loans to be a critical accounting policy. Loans are classified as non-accrual loans when principal or interest is delinquent for 90 days or more. Once a loan is categorized as non-accrual, all previously recorded earned income is reversed and income is no longer accrued on an on-going basis. When the deficiency is cured, the loan is taken out of non-accrual status, the related income is recorded on the books, and interest income will start accruing again as usual.

The final critical accounting policy identified by management relates to the sale of loans. The Bank sells mortgage loans for cash proceeds equal to the principal amount of the loans sold but with yield rates which reflect the current market rate. Gain or loss is recorded at the time of sale in an amount reflecting the difference between the contractual interest rates of the loans sold and the current market rate. The gain (or loss) on sales includes any fees received for release of servicing.


	8

Comparison of Financial Condition at September 30, 2004 and December 31, 2003

Total Assets. Total assets increased 7.12%, from $515.2 million at December 31, 2003 to $551.9 million at September 30, 2004. This overall increase reflects a $63.4 million or 18.09% increase in net loans receivable. The increase in net loans receivable is primarily due to a 30.13% increase in commercial lending, a 37.33% increase in construction lending, and an 9.50% increase in consumer lending. This increase in loans was partially offset by a $14.9 million or 20.97% decrease in cash and cash equivalents and an $11.4 million or 20.71% decrease in available-for-sale investment securities. The decrease in investment securities available-for-sale is primarily due to investments being c alled, investments maturing, and sales of investments. These decreases were partially offset by the purchase of municipal securities, collateralized mortgage obligations ("CMOs"), and mortgage-backed securities.

Deposits. Total deposits increased $32.0 million or 7.04%, from $454.3 million at December 31, 2003 to $486.3 million at September 30, 2004. Non-interest-bearing deposits increased $17.8 million or 24.53%, primarily due to a $16.0 million or 23.61% increase in demand deposit accounts. Interest-bearing deposits increased $14.3 million or 3.75%, primarily due to an $11.6 million or 53.24% increase in non-personal money market accounts and a $6.8 million or 12.41% increase in certificates of deposit greater than $100,000. These increases were partially offset by a $4.0 million or 4.18% decrease in NOW accounts. Transaction accounts, which include both interest-bearing and non-interest-be aring accounts, increased $23.3 million, from $280.5 million at December 31, 2003 to $303.8 million at September 30, 2004. Savings accounts increased $1.1 million, from $21.0 million at December 31, 2003 to $22.1 million at September 30, 2004. Certificates of deposit increased $7.6 million, from $152.8 million at December 31, 2003 to $160.4 million at September 30, 2004. The overall increase in deposits is due to increased marketing strategies focused on gaining and retaining deposit accounts.

Shareholders’ Equity. Shareholders’ equity increased from $54.4 million at December 31, 2003 to $56.6 million at September 30, 2004. This increase was primarily the result of net income of $3.7 million and the allocation of shares under the Bank's Employee Stock Ownership Plan (ESOP) that totaled $1.4 million. Additionally, the Company issued common stock as a result of options exercised in the amount of $287,000, inclusive of the related tax benefit. These increases were partially offset by a $98,000 decrease in the valuation allowance for available-for-sale investment securities, dividends of $1.2 million and the repurchase of $1.9 million of Company common stock.

Non-Performing Assets. Non-performing assets totaled $1.2 million and $859,000 at September 30, 2004 and December 31, 2003, respectively. The allowance for loan losses increased 4.44%, from $4.5 million at December 31, 2003 to $4.7 million at September 30, 2004. Although the non-performing asset balance reflects an increase of $341,000 or 39.70%, non-performing assets have continued to be a relatively small portion of the Bank’s portfolio, with the balance equal to 0.29% of total loans and 0.22% of total assets. Therefore, management feels that the increase in the allowance for loan losses is adequate as of September 30, 2004.

Comparison of Operating Results for the Three Months Ended September 30, 2004 and September 30, 2003.

Net Income. Net income was $1.5 million for the three months ended September 30, 2004 compared to $1.3 million for the three months ended September 30, 2003. Diluted earnings per share increased $0.03, from $0.19 for the three months ended September 30, 2003 to $0.22 for the same period in 2004. Annualized return on average assets increased from 1.07% for the three months ended September 30, 2003 to 1.10% for the same period in 2004. Annualized return on average equity also increased, from 9.60% for the three months ended September 30, 2003 to 10.51% for the same period in 2004. These increases are mainly attributable to an increase in consumer, commercial, and construction lending activity as well as an increase in deposit fees during the three months ended September 30, 2004 compared to the same period in 2003, net of a decline in sale of loans. These changes are discussed in more detail in the following sections.


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Net Interest Income. Net interest income increased 24.39%, from $4.1 million for the three months ended September 30, 2003 to $5.1 million for the same period in 2004. When comparing the three months ended September 30, 2004 and 2003, the Company experienced increased volume in both average interest-earning assets and average interest-bearing liabilities, while yields and costs varied. Average interest-earning assets increased $65.3 million or 15.51%, while average interest-bearing liabilities increased $32.9 million or 9.27%. Interest rate spread increased 0.24%, from 3.65% for the three months ended September 30, 2003 to 3.89% for the same period in 2004. Net interest margin increased 29 basis points, from 3.88% f or the three months ended September 30, 2003 to 4.17% for the same period in 2004. The ratio of average interest-earning assets to average interest-bearing liabilities increased from 118.57% for the three months ended September 30, 2003 to 125.35% for the same period in 2004.

Interest Income. Interest income increased $1.0 million or 19.07%, primarily due to an increase of $939,000 or 18.58% in loan interest income. This increase is the result of an increase of $75.5 million or 22.68% in average loans receivable, net. The average yield on these loans decreased, from 6.03% for the three months ended September 30, 2003 to 5.84% for the same period in 2004. Interest income on all other investments, including Federal Home Loan Bank stock, Federal Reserve Bank stock, and interest-bearing deposits with other financial institutions, increased by $99,000 or 25.45%. The average yield for these investments increased 84 basis points, from 1.76% for the three months ended September 30, 2003 to 2.60% for the same period in 2004. This increase is the result of a restructuring of the Company’s investment portfolio. The Company replaced shorter-term agency bonds with longer-term CMOs, mortgage-backed securities, and municipal securities, resulting in increased yields.

Interest Expense. Total interest expense increased $63,000 or 4.74%. Although the average cost of deposits declined from 1.47% for the three months ended September 30, 2003 to 1.41% for the same period in 2004, the average deposit balance increased, resulting in increased expense. Average deposits increased $33.0 million or 9.38%, from $351.9 million for the three months ended September 30, 2003 to $384.9 million for the same period in 2004. The total cost of funds decreased 5 basis points, from 1.48% for the three months ended September 30, 2003 to 1.43% for the same period in 2004, primarily as a result of a lower cost of funds for certificates of deposit.

Provision for Loan Losses. The provision for loan losses is a charge to earnings to bring the total allowance for loan losses to a level management considers adequate to provide for inherent losses in the loan portfolio. Management examines a variety of factors on a monthly basis to determine the estimated charge or credit necessary to bring the allowance to an acceptable level. These factors include the nature of the portfolio, collateral values, credit concentrations, historical loss experience along with delinquency and charge-off trends, and economic conditions. Management also identifies specific impaired loans by incorporating known information about individual loans, including borrowers’ sensitivity to i nterest rate movements and other relevant factors.

The provision for loan losses totaled $176,000 for the three months ended September 30, 2004 compared to no provision for the same period ended September 30, 2003. This increase is primarily due to the increase in the amount of the loan portfolio. Net charge-offs increased $3,000, from $45,000 for the quarter ended September 30, 2003 to $48,000 for the same period ended September 30, 2004. Management feels that their evaluations and estimations were reasonable for determining the provision, and the allowance for loan losses is deemed to be adequate as of September 30, 2004. However, a decline in economic conditions or other factors beyond management’s control could significantly affect the amount of losses the Company recognizes in the future.

Non-Interest Income. Non-interest income decreased $600,000 or 14.63%, from $4.1 million for the three months ended September 30, 2003 to $3.5 million for the same period in 2004. This decrease is primarily due to an $808,000 or 47.90% decrease in net gain on sale of loans. The overall volume of mortgage loans originated by the Company has declined significantly as a result of decreased refinancing activity. There has therefore been a decline in loans sold during the three month period ended September 30, 2004, compared to the same period ended September 30, 2003. The decrease in net gain on sale of loans is offset by an increase of $249,000 or 20.61% in deposit-related service fees and charges. This is due to an in crease in the Bank’s service fee schedule as well as an increase in the number of deposit accounts. In the trust segment, trust service fees increased by $20,000 or 8.13% due to an increase in the assets under management. In the insurance segment, commission revenue declined slightly while overall segment profit increased by 14.67%, primarily due to expense management.


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Non-Interest Expense. Non-interest expense decreased $100,000 or 1.64%, from $6.1 million for the three months ended September 30, 2003 to $6.0 million for the same period in 2004. Many factors contributed to this change. Salaries and employee benefits expense decreased $359,000 or 9.06%, which primarily is a result of decreased commission expense due to the closing of a mortgage origination location during the third quarter of 2004 as well as an overall decline in mortgage originations for the three months ended September 30, 2004 compared to the same period ended 2003. This decrease was partially offset by an increase of $110,000 or 14.10% in equipment and service bureau expense, which primarily is a result of inc reased processing costs. In addition, professional fees increased $127,000 or 97.69%. This increase is due to an increase in internal audit fees as well as an increase in consulting fees as a result of the internal control requirement of the Sarbanes-Oxley Act of 2002. Management anticipates that its professional fees will continue to exceed historical levels as the Company continues to address the internal control requirements of the Sarbanes-Oxley Act of 2002.

Comparison of Operating Results for the Nine Months Ended September 30, 2004 and September 30, 2003.

Net Income. Net income was $3.7 million for the nine months ended September 30, 2004 compared to $3.7 million for the nine months ended September 30, 2003. Diluted earnings per share decreased $0.01, from $0.56 for the nine months ended September 30, 2003 to $0.55 for the same period in 2004. Annualized return on average assets decreased from 1.10% for the nine months ended September 30, 2003 to 0.95% for the same period in 2004. Annualized return on average equity also decreased, from 9.76% for the nine months ended September 30, 2003 to 8.82% for the same period in 2004. These declines are mainly attributable to lower fees collected for mortgage banking as well as decreased gain on sale of loans, as refinancing sl owed considerably during the first nine months of 2004 compared to high levels experienced during the same period ended September 30, 2003. Additionally, the Company experienced an increase in professional fees due to the Company’s implementation of its compliance program related to the internal control requirement of the Sarbanes-Oxley Act of 2002. These changes are discussed in more detail in the following sections.

Net Interest Income. Net interest income increased 18.33%, from $12.0 million for the nine months ended September 30, 2003 to $14.2 million for the same period in 2004. When comparing the nine months ended September 30, 2004 and 2003, the Company experienced increased volume in both average interest-earning assets and average interest-bearing liabilities, while yields and costs varied. Average interest-earning assets increased $67.9 million or 17.08%, while average interest-bearing liabilities increased $36.7 million or 10.60%. Interest rate spread increased 0.01%, from 3.83% for the nine months ended September 30, 2003 to 3.84% for the same period in 2004. Net interest margin increased 2 basis points, from 4.05% fo r the nine months ended September 30, 2003 to 4.07% for the same period in 2004. The ratio of average interest-earning assets to average interest-bearing liabilities increased from 114.70% for the nine months ended September 30, 2003 to 121.43% for the same period in 2004.

Interest Income. Interest income increased $1.8 million or 11.17%, primarily due to an increase of $1.7 million or 11.34% in loan interest income. This increase is the result of an increase of $69.5 million or 21.78% in average loans receivable, net. The average yield on these loans decreased, from 6.34% for the nine months ended September 30, 2003 to 5.79% for the same period in 2004. Interest income on all other investments, including Federal Home Loan Bank stock, Federal Reserve Bank stock, and interest-bearing deposits with other financial institutions, increased by $109,000 or 9.05%. The average yield for these investments increased 29 basis points, from 2.05% for the nine months ended September 30, 2003 to 2.3 4% for the same period in 2004.

Interest Expense. Total interest expense decreased $342,000 or 7.96%. This decrease is primarily due to a decrease in the average cost of deposits, which declined from 1.64% for the nine months ended September 30, 2003 to 1.36% for the same period in 2004. Average deposits increased $36.8 million or 10.71%, from $343.7 million for the nine months ended September 30, 2003 to $380.5 million for the same period in 2004. The total cost of funds decreased 28 basis points, from 1.66% for the nine months ended September 30, 2003 to 1.38% for the same period in 2004.

Provision for Loan Losses. Please see the above section entitled "Comparison of Operating Results for the Three Months Ended September 30, 2004 and September 30, 2003 - Provision for Loan Losses" for a discussion as to how the Company derives the provision for loan losses.


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The provision for loan losses totaled $352,000 for the nine months ended September 30, 2004 compared to $101,000 for the same period ended September 30, 2003. This increase is primarily due to an increase in the amount of the loan portfolio. Net charge-offs declined $39,000, from $188,000 for the nine months ended September 30, 2003 to $149,000 for the same period ended September 30, 2004. Management feels that their evaluations and estimations were reasonable for determining the provision, and the allowance for loan losses is deemed to be adequate as of September 30, 2004. However, a decline in economic conditions or other factors beyond management’s control could significantly alter the amount of losses the Company recognizes in the future.

Non-Interest Income. Non-interest income decreased $1.8 million or 15.38%, from $11.7 million for the nine months ended September 30, 2003 to $9.9 million for the same period in 2004. This overall decrease is primarily due to a $2.4 million or 51.58% decrease in net gain on sale of loans. The overall volume of mortgage loans originated by the Company has declined significantly as a result of decreased refinancing activity. There has therefore been a decline in loans sold during the nine month period ended September 30, 2004, compared to the same period ended September 30, 2003. The decrease in net gain on sale of loans is offset by an increase of $537,000 or 15.54% in deposit-related service fees and charges. This i s due to an increase in the Bank’s service fee schedule as well as an increase in the number of deposit accounts. In the trust segment, trust service fees increased by $92,000 or 12.43% due to an increase in the assets under management. In the insurance segment, commission revenue decreased 7.01% and overall segment profit decreased 5.76% for the nine months ended September 30, 2004 compared to the same period ended 2003. These decreases are primarily due to a decrease in contingency commission, which is a result of increased claims paid during 2003 due to significant storm damage suffered by the middle Tennessee area during the spring and summer seasons of 2003.

Non-Interest Expense. Non-interest expense increased $107,000 or 0.61%, from $17.5 million for the nine months ended September 30, 2003 to $17.6 million for the same period in 2004. Many factors contributed to this change. Equipment and service bureau expense increased $346,000 or 15.65%, which primarily is a result of increased equipment maintenance expense and increased processing expense. In addition, professional fees increased $291,000 or 79.73%. This increase is due to an increase in internal audit fees as well as an increase in consulting fees as a result of the internal control requirement of the Sarbanes-Oxley Act of 2002. Management anticipates that its professional fees will continue to exceed historical levels as the Company continues to address the internal control requirements of the Sarbanes-Oxley Act of 2002. The Company also experienced an increase of $74,000 or 22.42% in advertising expenses, due to the Bank celebrating its 75^th anniversary during the second quarter of 2004. This celebration resulted in numerous promotional activities aimed at recognizing current customers and attracting new prospects. These increases were partially offset by a decrease of $664,000 or 5.77% in salaries and employee benefits, which was primarily attributable to decreased commission expense due to the closing of a mortgage origination location during the third quarter of 2004, as well as an overall decline in mortgage originations during 2004.

Liquidity and Capital Resources

The Company’s primary sources of funds are customer deposits, proceeds from loan principal and interest payments, sale of loans, maturing securities and Federal Home Loan Bank (FHLB) of Cincinnati advances. While maturities and scheduled amortization of loans are a predictable source of funds, deposit flows and mortgage prepayments are influenced greatly by general interest rates, other economic conditions, and competition. The Company and the Bank generally maintain sufficient cash and short-term investments to meet short-term liquidity needs. At September 30, 2004, cash and cash equivalents totaled $56.0 million or 10.15% of total assets, and investment securities available-for-sale totaled $43.7 million. At September 30, 2004, the Bank also maintained, but did not draw upon, a line of credit with the FHLB of Cincinnati in the amount of $50.0 million.

As of September 30, 2004, the Company and the Bank’s regulatory capital ratios were in excess of all applicable regulatory requirements. At September 30, 2004, under the regulations of the Federal Reserve Board, the Bank’s actual leverage, Tier 1 risk-based, and risked-based capital ratios were 9.40%, 11.60% and 12.74%, respectively, compared to requirements of 3.0%, 4.0% and 8.0%, respectively. At September 30, 2004, under the regulations of the Federal Reserve Board, the Company’s actual leverage, Tier 1, risk-based, and risked-based capital ratios were 10.33%, 12.93%, and 14.07%, respectively. The Comp any is currently involved in a share repurchase program. The Company has repurchased 120,043 shares this year at an average price of $15.33. The maximum number of shares that may yet be repurchased under the plan is 287,261 shares.


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At September 30, 2004, the Bank had off-balance sheet loan commitments of approximately $57.1 million. In addition, at September 30, 2004, the unused portion of lines of credit extended by the Bank was approximately $8.7 million for consumer loans and $35.0 million for commercial loans. Standby letters of credit and financial guarantees are conditional commitments issued by the Bank to guarantee the performance of a customer to a third party. Those guarantees are primarily issued to support public and private borrowing arrangements, including commercial paper, bond financing, and similar transactions. Most guarantees extend from one to two years. The credit risk involved in issuing letters of credit is essentially the same as that involved in extending loan facilities to customers. At September 30, 2004, the Bank had $8.1 million of letters of credit outstanding.

Impact of Inflation and Changing Prices

The consolidated financial statements of the Company and notes thereto, presented elsewhere herein, have been prepared in accordance with accounting principles generally accepted in the United States of America, which require the measurement of financial condition and operating results in terms of historical dollars without considering the change in relative purchasing power of money over time due to inflation. The impact of inflation is reflected in the increased cost of the Company’s operations. Unlike most industrial companies, nearly all the assets and liabilities of the Company are financial. As a result, interest rates have a greater impact on the Company’s performance than do the effects of general levels of inflation. Interest rates do not necessarily move in the same direction or to the same ext ent as the prices of goods and services.

Item 3. Quantitative and Qualitative Disclosures About Market Risk

As a financial institution, the Company’s primary component of market risk is interest rate risk. Ultimately, fluctuations in interest rates will impact liquidity, the level of income and expense recorded on most of the Company’s assets and liabilities, and the market value of interest-earning assets and interest-bearing liabilities. The Company is not subject to foreign exchange or commodity price risk. The Company does not own any trading assets.

Interest rate risk is managed in accordance with policies approved by the Bank’s Board of Directors. Management formulates strategies based on appropriate levels of interest rate risk. In determining the appropriate level of interest rate risk, management considers the impact on earnings and capital of the current outlook on interest rates, potential changes in interest rates, regional economy, liquidity, business strategies and other factors. Management meets regularly to review, among other things, the sensitivity of assets and liabilities to interest rate changes, the book and market value of assets and liabilities, unrealized gains and losses, purchase and sales activities, commitments to originate loans and the maturities of investments. Management uses an analysis of relationships between interest-earni ng assets and interest-bearing liabilities to manage interest rate risk.

The following table presents the Company's repricing gap at September 30, 2004. The table indicates that at September 30, 2004 the Company was asset sensitive up to six months. This would indicate an increase in earnings in a rising rate environment.


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	Within Six Months			Six Months to One Year			After One to Three Years			After Three to Five Years			Over Ten Years			Total
	(in thousands)
Interest-earning assets:
Loans receivable, net	$	139,730			45,203			59,709			153,141			18,443			416,226
FHLB and FRB stock		3,099			-			-			-			-			3,099
Investment securities available-for-sale		11,213			2,675			6,316			5,105			18,398			43,707
Interest-bearing deposits with other financial institutions		35,366			-			-			-			-			35,366
Total rate sensitive assets	$	189,408			47,878			66,025			158,246			36,841			498,398

Interest-bearing liabilities:
Deposits:
Savings deposits	$	2,212			2,212			8,848			8,847			-			22,119
Demand deposits		70,290			70,290			36,512			36,512			-			213,604
Certificates of deposit		56,104			36,095			49,645			18,533			34			160,411
Borrowings		27			27			2,109			109			576			2,848
Total rate sensitive liabilities	$	128,633			108,624			97,114			64,001			610			398,982
Excess (deficiency) of interest sensitive assets over interest sensitive liabilities	$	60,775			(60,746	)		(31,089	)		94,245			36,231			99,416
Cumulative excess (deficiency) of interest sensitive assets	$	60,775			29			(31,060	)		63,185			99,416			99,416
Cumulative ratio of interest-earning assets to interest-bearing liabilities		147.25	%		100.01	%		90.71	%		115.86	%		124.92	%		124.92	%
Interest sensitivity gap to total rate sensitive assets		12.19	%		(12.19	)%		(6.24	)%		18.91	%		7.27	%		19.95	%
Ratio of interest-earning assets to interest -bearing liabilities		147.25	%		44.08	%		67.99	%		247.26	%		6,039.51	%		124.92	%
Ratio of cumulative gap to total rate sensitive assets		12.19	%		0.01	%		(6.23	)%		12.68	%		19.95	%		19.95	%

The gap analysis provides the basis for more detailed analysis in a simulation model. Also gap results are popular rate risk indicators. However, to truly evaluate the impact of rate change on income, simulation is the best technique because variables are changed for various rate conditions. Each category’s interest change is calculated as rates ramp up and down. In addition, the prepayment speeds and repricing speeds are changed.

Rate shock is a method for stress testing the net interest margin (NIM) over the next four quarters under several rate change levels. These levels span four 100 basis point increments up and down, as applicable, from the current interest rates. In order to simulate activity, maturing balances are replaced with new balances at the new rate level and repricing balances are adjusted to the new rate shock level. The interest is recalculated for each level along with the new average yield. NIM is then calculated and a margin risk profile is developed. This simulation reveals that the Bank will experience a loss in net interest income if rates decline in the next year. The magnitude and severity of potential loss for a 100 basis point decline in rates under projected growth conditions would be a decline of 21 basis poin ts. The magnitude of potential gain for a 100 basis point increase under projected growth conditions would be an increase of 18 basis points.

Item 4. Controls and Procedures

Evaluation of disclosure controls and procedures.

In accordance with Rule 13a-15(b) of the Securities Exchange Act of 1934(the "Exchange Act"), an evaluation was carried out with the participation of the Company’s management, including the Company’s Chief Executive Officer and Chief Financial Officer, of the effectiveness of the design and operation of the Company’s disclosure controls and procedures (as defined in Rule 13a-15(e) and 15d-15(e) under the Exchange Act) as of the end of the period covered by this report. Based upon their evaluation of these disclosure controls and procedures, the Chief Executive Officer and the Chief Financial Officer concluded that the disclosure controls and procedures were effective as of the end of the period covered by this report to ensure that material information relating to the Company, including its consolid ated subsidiaries, was made known to them by others within those entities, particularly during the period in which this quarterly report on Form 10-Q was being prepared.


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Part II. Other Information

Item 1. Legal Proceedings

None.

Item 2. Unregistered Sales of Equity Securities and Use of Proceeds

(a) Not applicable.

(b) Not applicable.

(c) The following table provides information about purchases by the Company during the quarter ended September 30, 2004 of equity securities that are registered by the Company pursuant to Section 12 of the Exchange Act:

ISSUER PURCHASES OF EQUITY SECURITIES
Period	Total number of shares purchased	Average price paid per share	Total number of shares purchased as part of publicly announced plans or programs	Maximum number of shares that may yet be purchased under the plans or programs
July 1, 2004 through July 31, 2004	-	$ -	-	298,404
August 1, 2004 through August 31, 2004	-	-	-	298,404
September 1, 2004 through September 30, 2004	11,143	16.97	11,143	287,261
Total	11,143	16.97	11,143

On September 26, 2001, the Company announced its plans to implement a program to repurchase 710,480 shares of its common stock outstanding ("stock repurchase program"). The stock repurchase program does not have an expiration date and unless terminated earlier by resolution of the Company’s board of directors, will expire when the Company has repurchased all shares authorized for repurchase thereunder. The Company has no other programs to repurchase common stock at this time.

Item 3. Defaults Upon Senior Securities

Not applicable.

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

None.

Item 5. Other Information

None.

Item 6. Exhibits

(a) Exhibits

31.1 CEO Certification Pursuant Rule 13a-14(a)/15d-14(a)

31.2 CFO Certification Pursuant Rule 13a-14(a)/15d-14(a)

32.1 CEO Certification Pursuant 18 U.S.C. Section 1350, Sarbanes - Oxley Act 2002

32.2 CFO Certification Pursuant 18 U.S.C. Section 1350, Sarbanes - Oxley Act 2002


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SIGNATURES

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

		CAVALRY BANCORP, INC.

Date: November 4, 2004	by
		Ed C. Loughry, Jr.
		Chairman of the Board and Chief Executive Officer

Date: November 4, 2004	by
		Hillard C. Gardner
		Senior Vice President and Chief Financial Officer
		(Principal Financial and Accounting Officer)


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