UNITED STATES
 SECURITIES AND EXCHANGE COMMISSION
 WASHINGTON, D.C. 20549
 
 FORM 10-Q
 
 (Mark One )
 
 x
Quarterly Report Under Section 13 or 15(d) of the Securities Exchange Act of 1934 For the Quarterly Period Ended September 30, 2003 oro
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) 893-1234Registrant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 has been subject to such filing requirements for the past 90 days.
 
 Yesx
Noo Indicate by check mark whether the registrant is an accelerated filer (as defined in Exchange Act Rule 12b-2)
 
 Yesx
Noo 
 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: 6,820,179 shares as of November 7, 2003.
  
 
 CAVALRY BANCORP, INC.
 
 Table of Contents
 
 
 Part I
Financial Information
PageItem 1.
Financial StatementsConsolidated Balance Sheets at September 30, 2003 (unaudited)and December 31, 2002
1Consolidated Statements of Income (unaudited) for the Three Months and Nine MonthsEnded September 30, 2003 and 2002
2Consolidated Statements of Comprehensive Income (unaudited) for theThree and Nine Months Ended September 30, 2003 and 2002
3Consolidated Statements of Cash Flows (unaudited) for the Nine MonthsEnded September 30, 2003 and 2002
4Notes to Consolidated Financial Statements (unaudited)
5-8Item 2.
Managements Discussion and Analysis of FinancialCondition and Results of Operations
8-11Item 3.
Quantitative and Qualitative Disclosures About Market Risk
11-12Item 4.
Controls and Procedures
12Part II
Other Information
13Item 6.
Exhibits, Financial Statement Schedules and Reports on Form 8-K
13Signatures

14
 
 
    Part I. Financial Information
 
 ITEM 1. FINANCIAL STATEMENTS
 
 CAVALRY BANCORP, INC.
 CONSOLIDATED BALANCE SHEETS
 SEPTEMBER 30, 2003 (UNAUDITED) AND DECEMBER 31, 2002
 (DOLLARS IN THOUSANDS)
 
 
 September 30,
December 31,Assets

2003
2002(Unaudited)Cash

$
19,714


21,200Interest-bearing deposits with other financial institutions


20,935


51,962Cash and cash equivalents


40,649


73,162Investment securities available-for-sale at fair value (amortized
cost: $61,698 and $37,728 at September 30, 2003 and December
31, 2002, respectively)


61,893


37,926Loans held for sale, at estimated fair value


5,502


17,800Loans receivable, net of allowances for loan losses of $4,570 at
September 30, 2003 and $4,657 at December 31, 2002


331,200


300,524Accrued interest receivable


1,525


1,577Office properties and equipment, net


18,763


18,108Required investments in stock of Federal Home Loan Bankand Federal Reserve Bank, at cost


2,968


2,874Foreclosed assets, net


98


203Bank owned life insurance


8,211


7,921Goodwill


1,772


1,772Other assets


3,122


2,498Total assets

$
475,703


464,365Liabilities and Shareholders EquityLiabilities:Deposits:Non-interest-bearing

$
64,402


57,343Interest-bearing


349,711


350,409Total deposits


414,113


407,752Advances from Federal Home Loan Bank of Cincinnati


2,903


2,944Accrued expenses and other liabilities


5,103


3,923Total liabilities


422,119


414,619Shareholders equity:Preferred stock, no par valueAuthorized- 250,000 shares; none issued or outstanding atSeptember 30, 2003 and December 31, 2002


-


-Common stock, no par valueAuthorized- 49,750,000 shares; issued and outstanding6,820,179 and 6,830,679 at September 30, 2003and December 31, 2002, respectively


9,850


9,138Retained earnings


46,161


43,543Unallocated ESOP Shares


(2,547
)

(3,057
)Accumulated other comprehensive income, net of tax


120


122Total shareholders equity


53,584


49,746Total liabilities and shareholders equity

$
475,703


464,365 
 Note: The balance sheet presented above at December 31, 2002 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 EndedSeptember 30,
September 30,2003
2002
2003
2002Interest and dividend income:Loans

$
5,055


5,224


15,124


15,754Investment securities


307


340


896


1,286Other


82


174


309


503Total interest and dividend income


5,444


5,738


16,329


17,543Interest expense  deposits


1,303


1,777


4,221


5,473Interest expense  borrowings


25


12


74


23Total interest expense


1,328


1,789


4,295


5,496Net interest income


4,116


3,949


12,034


12,047Provision for loan losses


-


115


101


278Net interest income after provisionfor loan losses


4,116


3,834


11,933


11,769Non-interest income:Servicing income


45


65


176


190Gain on sale of loans, net


1,687


974


4,711


2,124Gain on sale of investment securities, net


-


-


11


-Deposit servicing fees and charges


1,208


971


3,455


2,772Trust service fees


246


280


740


832Commissions and other non-banking fees


676


602


1,995


1,694Other operating income


196


239


579


700Total non-interest income


4,058


3,131


11,667


8,312Non-interest expenses:Salaries and employee benefits


3,962


3,186


11,498


8,995Occupancy expense


346


333


979


906Supplies, communications and otheroffice expenses


286


322


791


844Federal insurance premiums


15


15


47


48Advertising expense


107


101


330


364Equipment and service bureau expense


780


650


2,211


1,980Other operating expense


563


585


1,645


1,475Total non-interest expenses


6,059


5,192


17,501


14,612Income before income taxes


2,115


1,773


6,099


5,469Income tax expense


835


713


2,373


2,167Net income

$
1,280


1,060


3,726


3,302Basic earnings per share

$
0.20


0.17


0.58


0.51Diluted earnings per share

$
0.19


0.16


0.56


0.50Weighted average shares outstanding -Basic


6,418,261


6,396,215


6,392,235


6,442,389Weighted average shares outstanding -Diluted


6,713,772


6,568,172


6,666,276


6,604,630 
 Dividends declared $0.06 per share payable October 10, 2003 for shareholders of record date September 30, 2003.
 
 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 EndedSeptember 30,
September 30,2003
2002
2003
2002Net income

$
1,280


1,060


3,726


3,302Other comprehensive income, net of tax:Unrealized gains (losses) on investment securitiesavailable-for-sale


30


34


5


(37
)Reclassification adjustment for gains included in net income


-


-


(7
)

-Comprehensive income

$
1,310


1,094


3,724


3,265 
 See accompanying notes to consolidated financial statements.
 3 CAVALRY BANCORP, INC.
 CONSOLIDATED STATEMENTS OF CASH FLOWS
 NINE MONTHS ENDED SEPTEMBER 30, 2003 AND 2002
 (DOLLARS IN THOUSANDS)
 (UNAUDITED)
 
 
 2003
2002Operating activities:Net cash provided by operating activities

$
19,658


10,864Investing activities:Increase in loans receivable, net


(31,849
)

(19,043
)Principal payments on investment securities


5,572


3,042Purchase of investment securitiesavailable-for-sale


(76,080
)

(40,889
)Purchase of Federal Reserve Stock


-


(1,240
)Proceeds from maturities of investment securities


43,789


34,510Proceeds from sales of investment securitiesAvailable-for-sale


2,500


-Purchase of office properties and equipment


(1,984
)

(3,535
)Proceeds from sale of foreclosed assets


743


340Cash paid in acquisition of Miller & Loughry


-


(1,944
)Net cash used in investing activities


(57,309
)

(28,759
)Financing activities:Net increase (decrease) in deposits


6,361


(1,051
)Retirement of common stock


(137
)

(2,423
)Proceeds from the exercise of stock options


-


12Dividends paid


(1,045
)

(913
)Net increase (decrease) in borrowings


(41
)

1,959Net cash provided by (used in)financing activities


5,138


(2,416
)Decrease in cash and cash equivalents


(32,513
)

(20,311
)Cash and cash equivalents, beginning of period


73,162


69,281Cash and cash equivalents, end of period

$
40,649


48,970Supplement Disclosures of CashFlow Information:Payments during the period for:Interest

$
4,365


5,498Income taxes

$
2,700


2,200Supplemental Disclosures of NoncashInvesting and Financing Activities :Increase in deferred tax asset relatedto unrealized loss on investments

$
1


24Net unrealized losses on investmentsecurities available for sale

$
(3
)

(61
)Dividends declared and payable

$
409


317 
 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 and nine months ended September 30, 2003, are not necessarily indicative of the results to be expected for the year ending December 31, 2003. 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, 2002.
 
 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 Opinion No. 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 of 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 opinion No. 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 of SFAS 123, as amended:
 
 
 Three Months Ended
Nine Months EndedSeptember 30,
September 30,2003
2002
2003
2002Net income:As reported

$
1,280


1,060


3,726


3,302Deduct: Total stock-based employee compensation expense determined under fair value methods for all awards granted, net of related tax effects


(32
)

(33
)

(95
)

(99
)Pro forma net income

$
1,248


1,027


3,631


3,203Earnings per share:Basic - as reported

$
0.20


0.17


0.58


0.51Basic  pro forma

$
0.19


0.16


0.57


0.50Diluted  as reported

$
0.19


0.16


0.56


0.50Diluted  pro forma

$
0.19


0.16


0.54


0.49 
 5
  
 3. Acquisitions
 
 On January 4, 2002, Cavalry Banking, a wholly owned subsidiary of Cavalry Bancorp, Inc., completed the acquisition of 100% of the capital stock issued and outstanding of Miller & Loughry Insurances and Services, Inc., for a cash purchase price of approximately $2.0 million.
 
 
 4. Earnings Per Share
 
 The following schedule reconciles the numerators and denominators of the basic and diluted earnings per share ("EPS") computations for the three and nine months ended September 30, 2003 and 2002. Diluted common shares arise from the potentially dilutive effect of the Companys stock options outstanding.
 
 Three Months Ended
September 30,
Nine Months Ended
September 30,2003
2002
2003
2002Basic EPS:Net income

$
1,280,000


1,060,000


3,726,000


3,302,000Average common shares outstanding


6,418,261


6,396,215


6,392,235


6,442,389Earnings per share - basic

$
0.20


0.17


0.58


0.51Diluted EPS:Net income

$
1,280,000


1,060,000


3,726,000


3,302,000Average common shares outstanding


6,418,261


6,396,215


6,392,235


6,442,389Dilutive effect of stock options


295,511


171,957


274,041


162,241Average dilutive shares outstanding


6,713,772


6,568,172


6,666,276


6,604,630Earnings per share - diluted

$
0.19


0.16


0.56


0.50 
 5. 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 2002 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


ConsolidatedSeptember 30, 2003:Interest revenue

$
5,444


-


-


-


-


5,444Other income-external customers


1,539


45


246


541


-


2,371Interest expense


1,328


-


-


-


-


1,328Depreciation and amortization


329


92


16


15


-


452Other significant items:Provision for loan losses


-


-


-


-


-


-Gain on sales of assets


-


1,687


-


-


-


1,687Segment profit


1,836


264


37


75


(97
)

2,115Segment assets


469,050


5,733


335


2,855


(2,270
)

475,703 
 
 For the three months ended


Banking


Mortgage Banking


Trust


Insurance


Eliminations


ConsolidatedSeptember 30, 2002:Interest revenue

$
5,738


-


-


-


-


5,738Other income-external customers


1,295


65


280


530


(37
)

2,133Interest expense


1,789


-


-


-


-


1,789Depreciation and amortization


330


52


29


16


-


427Other significant items:Provision for loan losses


115


-


-


-


-


115Gain on sales of assets


24


974


-


-


-


998Segment profit


1,740


-


52


83


(102
)

1,773Segment assets


427,664


8,408


395


2,454


(2,265
)

436,656 
 
 
 For the nine months ended


Banking


Mortgage Banking


Trust


Insurance


Eliminations


ConsolidatedSeptember 30, 2003:Interest revenue

$
16,329


-


-


-


-


16,329Other income-external customers


4,360


176


740


1,669


-


6,945Interest expense


4,295


-


-


-


-


4,295Depreciation and amortization


942


274


50


45


-


1,311Other significant items:Provision for loan losses


101


-


-


-


-


101Gain on sales of assets


11


4,711


-


-


-


4,722Segment profit


5,380


713


102


191


(287
)

6,099Segment assets


469,050


5,733


335


2,855


(2,270
)

475,703 
 
 For the nine months ended


Banking


Mortgage Banking


Trust


Insurance


Eliminations


ConsolidatedSeptember 30, 2002:Interest revenue

$
17,543


-


-


-


-


17,543Other income-external customers


3,802


190


832


1,352


(37
)

6,139Interest expense


5,496


-


-


-


-


5,496Depreciation and amortization


845


143


41


34


-


1,063Other significant items:Provision for loan losses


278


-


-


-


-


278Gain on sales of assets


49


2,124


-


-


-


2,173Segment profit (loss)


5,359


(5
)

168


168


(221
)

5,469Segment assets


427,664


8,408


395


2,454


(2,265
)

436,656 7
 6. New Accounting Standards Pronouncements
 
 Statement of Financial Accounting Standards No. 148.
 
 Statement of Financial Accounting Standards No. 148, "Accounting for Stock-Based Compensation  Transition and Disclosure" ("SFAS 148"), amends SFAS 123, "Accounting for Stock-Based Compensation" to provide alternative methods of transition for an entity that voluntarily changes to the fair value method of accounting for stock-based employee compensation. SFAS 148 also amends the disclosure provisions of SFAS 123 to require prominent disclosure about the effects on reported net income of the Companys accounting policy decisions with respect to stock-based employee compensation. Finally, SFAS 148 amends APB Opinion No. 28, "Interim Financial Reporting," to require disclosure about those effects in interim financial information. Presently the Company does not intend to adopt the fair value method. For further information regarding the Companys accounting for stock options, See Note 2 on page 6.
 
 Statement of Financial Accounting Standards No. 149.
 
 Statement of Financial Accounting Standards No. 149 "Amendment of Statement 133 on Derivative Instruments and Hedging Activities" ("SFAS 149"), clarifies and amends financial accounting and reporting for derivative instruments, including certain derivative instruments embedded in other contracts and for hedging activities under Statement of Financial Accounting Standards No. 133, "Accounting for Derivative and Hedging Activities" ("SFAS 133"). In general, SFAS 149 is effective for contracts entered into or modified after June 30, 2003 and for hedging relationships designated after June 30, 2003. It is anticipated that the financial impact of SFAS 149 will not have a material effect on the Company.
 
 Statement of Financial Accounting Standards No. 150.
 
 Statement of Financial Accounting Standards No. 150, "Accounting for Certain Financial Instruments with Characteristics of both Liabilities and Equity" ("SFAS 150"), establishes standards for how an issuer classifies and measures certain financial instruments with characteristics of both liabilities and equity that have been presented either entirely as equity or between the liabilities section and the equity section of the statement of financial position. SFAS 150 is effective for financial instruments entered into or modified after May 31, 2003, and otherwise is effective at the beginning of the first interim period beginning after June 15, 2003. It is anticipated that the financial impact of SFAS 150 will not have a material effect on the Company.
 
 Financial Accounting Standards Board Interpretation 46.
 
 Financial Accounting Standards Board Interpretation 46, "Consolidation of Variable Interest Entities, an interpretation of ARB No. 51" ("FIN 46"), requires a variable interest entity to be consolidated by a company if that company is subject to a majority of the risk of loss from the variable interest entitys activities or is entitled to receive a majority of the entitys residual returns or both. Prior to FIN 46, a company included another entity in its consolidated financial statements only if it controlled the entity through voting interests. FIN 46 also requires disclosures about variable interest entities that the company is not required to consolidate but in which it has a significant variable interest. The consolidated requirements of FIN 46 apply immediately to variable interest entities created after January 31, 2003. The consolidated requirements apply to older entities in the first fiscal year or interim period after June 15, 2003. Certain disclosure requirements apply in all financial statements issued after January 31, 2003, regardless of when the variable interest entities established. It is anticipated that the financial impact of FIN 46 will not have a material effect on the Company.
 
 
 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, general 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.
 
 Critical Accounting Policies
 
 The Companys critical accounting policies are set forth in the "Managements Discussion and Analysis of Financial Condition and Results of Operations" contained in the Companys Annual Report on Form 10-K, which is incorporated herein by reference.
 
 8
  Comparison of Financial Condition at September 30, 2003 and December 31, 2002
 
 Total assets were $475.7 million at September 30, 2003, compared to $464.4 million at December 31, 2002, an increase of $11.3 million or 2.43%. This increase was primarily funded by net income and an increase in total deposits. Cash and cash equivalents decreased from $73.2 million at December 31, 2002, to $40.6 million at September 30, 2003. Investment securities available-for-sale increased from $37.9 million at December 31, 2002, to $61.9 million at September 30, 2003. Loans receivable, net increased $30.7 million from $300.5 million at December 31, 2002, to $331.2 million at September 30, 2003 as a result of continued overall loan demand. Loans held-for-sale declined from $17.8 million at December 31, 2002 to $5.5 million at September 30, 2003. This decline was a result of slowing mortgage activity. Office properties and equipment increased from $18.1 million at December 31, 2002 to $18.8 million at September 30, 2003. This increase was primarily a result of construction of the branch office on Sam Ridley Parkway in Smyrna, Tennessee in Rutherford County. This location opened for business in June of 2003.
 
 Deposit accounts increased $6.3 million from $407.8 million at December 31, 2002, to $414.1 million at September 30, 2003. Certificates of deposit decreased $800,000 from $151.8 million at December 31, 2002 to $151.0 million at September 30, 2003. Savings deposits increased $5.0 million from $16.6 million at December 31, 2002 to $21.6 million at September 30, 2003. Interest-bearing demand deposits decreased $4.7 million from $181.9 million at December 31, 2002 to $177.2 million at September 30, 2003. Non-interest bearing deposit accounts increased $7.1 million from $57.3 million at December 31, 2002 to $64.4 million at September 30, 2003.
 
 Shareholders equity increased by $3.9 million from $49.7 million at December 31, 2002, to $53.6 million at September 30, 2003. This increase was a result of net income of $3.7 million and the release of ESOP shares of $1.4 million. These increases were partially offset by common stock repurchases of $137,000 in Company common stock, a decrease in unrealized gains on available-for-sale securities of $2,000, net of taxes, and dividends of $1.1 million.
 
 Non-performing assets were $733,000 at December 31, 2002 and $873,000 million at September 30, 2003. The allowance for loan losses was $4.6 million at September 30, 2003, down slightly from $4.7 million at December 31, 2002.
 
 Comparison of Operating Results for the Three Months Ended September 30, 2003 and September 30, 2002.
 
 Net Income. Net income was $1.3 million for the three months ended September 30, 2003 compared to $1.1 million for the three months ended September 30, 2002. Return on average assets increased from 0.99% for the three months ended September 30, 2002, to 1.07% for the same period in 2003. Return on average equity increased from 8.46% for the three months ended September 30, 2002, to 9.60% for the same period in 2003. Earnings per diluted share increased from $0.16 per diluted share for the three months ended September 30, 2002, to $0.19 per diluted share for the same period in 2003. This increase was primarily a result of increased net interest income, higher non-interest income and a lower provision for loan losses. These increases were partially offset by higher non-interest expenses.
 
 Net Interest Income. Net interest income increased $200,000 from $3.9 million for the three months ended September 30, 2002, to $4.1 million for the same period in 2003. Interest rate spread decreased from 3.88% for the three months ended September 30, 2002, to 3.65% for the same period in 2003. Net interest margin decreased from 4.17% for the three months ended September 30, 2002, to 3.88% for the same period in 2003. The ratio of average interest-earning assets to average interest-bearing liabilities increased from 115.22% for the three months ended September 30, 2002, to 118.57% for the same period in 2003.
 
 Interest income decreased 5.26% to $5.4 million for the three months ended September 30, 2003, from $5.7 million for the same period in 2002 as a result of lower interest rates. Interest on loans decreased from $5.2 million for the three months ended September 30, 2002, to $5.1 million for the same period in 2003. Average loans outstanding increased from $296.5 million for the three months ended September 30, 2002, to $332.8 million for the same period in 2003. The average yield decreased from 6.99% for the three months ended September 30, 2002, to 6.03% for the same period in 2003. Income on all other investments consisting of mortgage backed securities, other investments, Federal Home Loan Bank and Federal Reserve Bank stock, bank deposits and federal funds decreased from $514,000 for the three months ended September 30, 2002, to $389,000 for the same period in 2003. Average investments increased from $79.1 million for the three months ended September 30, 2002, to $87.9 million for the same period in 2003. The average yield decreased from 2.58% for the three months ended September 30, 2002, to 1.76% for the same period in 2003. Average interest earning assets increased from $375.6 million for the three months ended September 30, 2002 to $420.7 million for the same period in 2003. Yield on total interest earning assets decreased from 6.06% for the three months ended September 30, 2002 to 5.13% for the same period in 2003.
 
 Interest expense decreased from $1.8 million for the three months ended September 30, 2002, to $1.3 million for the same period in 2003 as a result of lower interest rates. Average interest-bearing deposits increased from $324.4 million for the three months ended September 30, 2002, to $351.9 million for the same period in 2003. The average cost of deposits decreased from 2.17% for the three months ended September 30, 2002, to 1.47% for the same period in 2003. Average borrowings increased from $1.6 million at an average cost of 2.91% for the three months ended September 30, 2002 to $2.9 million at an average cost of 3.41% for the same period in 2003. The total cost of funds decreased from 2.18% for the three months ended September 30, 2002, to 1.48% for the same period in 2003. Average interest-bearing liabilities increased from $326.0 million for the three months ended September 30, 2002, to $354.8 million for the same period in 2003.
 
 Provision for Loan Losses. Provision 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 loan losses based on managements evaluation of the collectibility of the loan portfolio, including the nature of the portfolio, credit concentrations, trends in historical loss experience, specific impaired loans and economic conditions.
 
 The provision for loan losses decreased from $115,000 for the three months ended September 30, 2002 to no provision for the same period in 2003. Management deemed the allowance for loan losses adequate at September 30, 2003.
 
 Non-interest Income. Non-interest income increased from $3.1 million for the three months ended September 30, 2002, to $4.1 million for the same period in 2003. In the mortgage banking segment, net gain on sale of loans increased from $974,000 for the three months ended September 30, 2002, to $1.7 million for the same period in 2003. This increase in gains in 2003 was a result of increased volume. Loan servicing fees decreased from $65,000 for the three months ended September 30, 2002, to $45,000 for the same period in 2003. In the banking segment, deposit fees and other operating incomes increased from $1.2 million for the three months ended September 30, 2002, to $1.4 million for the same period in 2003. This increase was a result of growth in the number of transaction accounts and increased charges. In the trust segment, trust fees decreased from $280,000 for the three months ended September 30, 2002, to $246,000 for the same period in 2003 as a result of declines in market values of trust assets under management. Commissions and other non-banking fees increased from $602,000 for the three months ended September 30, 2002 to $676,000 for the same period in 2003.
 
 The Companys non-interest income is composed of several components, some of which vary significantly between quarterly periods. Service charges on deposit accounts and other non- interest income generally reflect the Companys growth, while fees for origination of mortgage loans, trust fees and commissions and other non banking fees will often reflect stock and home mortgage market conditions and fluctuate more widely from period to period.
 
 Non-interest Expense. Non-interest expense increased from $5.2 million for the three months ended September 30, 2002, to $6.1 million for the same period in 2003. Salaries and employee benefits increased from $3.2 million for the three months ended September 30, 2002 to $4.0 million for the same period in 2003 primarily as a result of increased staffing. Increased mortgage loan production and insurance sales resulted in increased commissions and related benefits. The increases in other expenses were primarily due to increased loan and deposit activity.
 
 Income taxes. The provision for income taxes was $835,000 for the three months ended September 30, 2003, compared to $713,000 for the same period in 2002.
 
 9
  Comparison of Operating Results for the Nine Months Ended September 30, 2003 and September 30, 2002.
 
 Net Income. Net income was $3.7 million for the nine months ended September 30, 2003 compared to $3.3 million for the nine months ended September 30, 2002. Return on average assets increased from 1.06% for the nine months ended September 30, 2002 to 1.10% for the same period in 2003. Return on average equity increased from 9.01% for the nine months ended September 30, 2002, to 9.76% for the same period in 2003. Earnings per share increased from $0.50 per diluted share for the nine months ended September 30, 2002, to $0.56 per diluted share for the same period in 2003. This increase was primarily a result of higher non-interest income and a lower provision for loan losses. These increases were partially offset by higher non-interest expenses and a lower net interest income.
 
 Net Interest Income. Net interest income was $12.0 million for the nine months ended September 30, 2002 and 2003. Interest rate spread decreased from 4.07% for the nine months ended September 30, 2002, to 3.83% for the same period in 2003. Net interest margin decreased from 4.35% for the nine months ended September 30, 2002, to 4.05% for the same period in 2003. The ratio of average interest-earning assets to average interest-bearing liabilities increased from 114.25% for the nine months ended September 30, 2002, to 114.70% for the same period in 2003.
 
 Interest income decreased 6.86% to $16.3 million for the nine months ended September 30, 2003, from $17.5 million for the same period in 2002 as a result of lower interest rates. Interest on loans decreased from $15.8 million for the nine months ended September 30, 2002, to $15.1 million for the same period in 2003. Average loans outstanding increased from $291.5 million for the nine months ended September 30, 2002, to $319.0 million for the same period in 2003. The average yield decreased from 7.22% for the nine months ended September 30, 2002, to 6.34% for the same period in 2003. Income on all other investments consisting of mortgage backed securities, other investments, Federal Home Loan Bank and Federal Reserve Bank stock, bank deposits and federal funds decreased from $1.8 million for the nine months ended September 30, 2002, to $1.2 million for the same period in 2003. Average investments decreased from $78.7 million for the nine months ended September 30, 2002, to $78.6 million for the same period in 2003. The average yield decreased from 2.94% for the nine months ended September 30, 2002, to 2.05% for the same period in 2003. Average interest earning assets increased from $370.3 million for the nine months ended September 30, 2002 to $397.6 million for the same period in 2003. This increase was offset by a decline in yields on earning assets from 6.33% for the nine months ended September 30, 2002 to 5.49% for the same period in 2003.
 
 Interest expense decreased from $5.5 million for the nine months ended September 30, 2002, to $4.3 million for the same period in 2003. Average interest-bearing deposits increased from $322.9 million for the nine months ended September 30, 2002, to $343.7 million for the same period in 2003. The average cost of deposits decreased from 2.27% for the nine months ended September 30, 2002, to 1.64% for the same period in 2003. Average borrowings increased from $1.2 million at an average cost of 2.56% for the nine months ended September 30, 2002 to $2.9 million at an average cost of 3.39% for the same period in 2003. The total cost of funds decreased from 2.27% for the nine months ended September 30, 2002, to 1.66% for the same period in 2003. Average interest-bearing liabilities increased from $324.1 million for the nine months ended September 30, 2002, to $346.7 million for the same period in 2003.
 
 Provision for Loan Losses. Provision 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 loan losses based on managements evaluation of the collectibility of the loan portfolio, including the nature of the portfolio, credit concentrations, trends in historical loss experience, specific impaired loans and economic conditions.
 
 The provision for loan losses decreased from $278,000 for the nine months ended September 30, 2002 to $101,000 for the same period in 2003. Management deemed the allowance for loan losses adequate at September 30, 2003.
 
 Non-interest Income. Non-interest income increased from $8.3 million for the nine months ended September 30, 2002, to $11.7 million for the same period in 2003. In the mortgage banking segment, net gain on sale of loans increased from $2.1 million for the nine months ended September 30, 2002, to $4.7 million for the same period in 2003. The higher gain in 2003 was a result of increased volume. Loan servicing fees decreased from $190,000 for the nine months ended September 30, 2002, to $176,000 for the same period in 2003. In the banking segment, deposit fees and other operating incomes increased from $3.5 million for the nine months ended September 30, 2002, to $4.0 million for the same period in 2003. This increase was a result of growth in the number of transaction accounts and increased charges. In the trust segment, trust fees decreased from $832,000 for the nine months ended September 30, 2002, to $740,000 for the same period in 2003 as a result of declines in market values of trust assets under management. Commissions and other non-banking fees were $2.0 million for the nine months ended September 30, 2003 compared to $1.7 million for the same period in 2002
 
 The Companys non-interest income is composed of several components, some of which vary significantly between quarterly periods. Service charges on deposit accounts and other non- interest income generally reflect the Companys growth, while fees for origination of mortgage loans, trust fees and commissions and other non banking fees will often reflect stock and home mortgage market conditions and fluctuate more widely from period to period.
 
 Non-interest Expense. Non-interest expense increased from $14.6 million for the nine months ended September 30, 2002, to $17.5 million for the same period in 2003. Salaries and employee benefits increased from $9.0 million for the nine months ended September 30, 2002 to $11.5 million for the same period in 2003 primarily as a result of increased staffing. Increased mortgage loan production and insurance sales resulted in increased commissions and related benefits. The increases in other expenses were primarily due to increased loan and deposit activity.
 
 Income taxes. The provision for income taxes was $2.4 million for the nine months ended September 30, 2003 compared to $2.2 million for the same period in 2002.
 
 10
  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, 2003, cash and cash equivalents totaled $40.6 million or 8.53% of total assets, and investment securities availableforsale totaled $61.9 million. At September 30, 2003, the Bank also maintained, but did not draw upon, a line of credit with the FHLB of Cincinnati in the amount of $10.0 million.
 
 As of September 30, 2003, the Company and the Banks regulatory capital ratios were in excess of all applicable regulatory requirements. At September 30, 2003, under the regulations of the Federal Reserve Board, the Banks actual leverage, Tier 1 risk-based, and risked-based capital ratios were 9.34%, 12.92% and 14.17%, respectively,  compared to requirements of 3.0%, 4.0% and 8.0%, respectively.  At September 30, 2003, under the regulations of the Federal Reserve Board, the Companys actual leverage, Tier 1 risk-based, and risked-based capital ratios were  10.88%, 15.24%, and 16.50%, respectively.
 
 At September 30, 2003, the Bank had loan commitments of approximately $51.8 million. In addition, at September 30, 2003, the unused portion of lines of credit extended by the Bank was approximately $7.3 million for consumer loans and $24.9 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, 2003, the Bank had $7.2 million of letters of credit outstanding. The adoption of the requirements of FASB Interpretation No. 45, Guarantor's Accounting and Disclosure Requirements for Guarantees, Including Indirect Guarantees of Indebtedness of Others, did not have a material impact on the consolidated financial statements as of or for the three and nine months ended September 30, 2003.
 
 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 U.S. GAAP, 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 extent 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 by management 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-earning assets and interest-bearing liabilities to manage interest rate risk.
 
 11
  The following table presents the Company's repricing gap at September 30, 2003. The table indicates that at September 30, 2003 the Company was asset sensitive up to one year and had a positive cumulative GAP for all time periods. This would indicate an increase in earnings in a rising rate environment.
 
 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

$
113,210


45,462


52,875


108,620


16,535


336,702FHLB & FRB stock


2,968


-


-


-


-


2,968Investment securities available-for-sale


41,825


11,144


4,511


4,386


27


61,893Interest-bearing deposits with otherfinancial institutions


20,935


-


-


-


-


20,935Total rate sensitive assets

$
178,938


56,606


57,386


113,006


16,562


422,498Interest-bearing liabilities:Deposits:Savings deposits

$
2,157


2,157


8,628


8,634


-


21,576Demand deposits


112,286


7,210


28,841


28,841


-


177,178Certificates of deposit


52,856


46,992


31,499


19,600


10


150,957Borrowings


27


27


1,109


1,109


631


2,903Total rate sensitive liabilities

$
167,326


56,386


70,077


58,184


641


352,614Excess (deficiency) of interest sensitive assets over interest sensitive liabilities

$
11,612


220


(12,691
)

54,822


15,921


69,884Cumulative excess (deficiency) ofinterest sensitive assets

$
11,612


11,832


(859
)

53,963


69,884


69,884Cumulative ratio of interest-earning assetsto interest-bearing liabilities


106.94
%

105.29
%

99.71
%

115.33
%

119.82
%

119.82
%Interest sensitivity gap to total rate sensitive
assets


2.75
%

0.05
%

(3.00)
%

12.98
%

3.77
%

16.54
%Ratio of interest-earning assets tointerest -bearing liabilities


106.94
%

100.39
%

81.89
%

194.22
%

2,583.78
%

119.82
%Ratio of cumulative gap to total rate sensitive assets


2.75
%

2.80
%

(0.20)
%

12.77
%

16.54
%

16.54
% 
 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 13 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 15 d-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 consolidated 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.
 
 
 12 
 Part II. Other Information
 
 Item 1. Legal Proceedings
 
 None
 
 Item 2. Changes in Securities and use of Proceeds
 
 Not applicable
 
 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, Financial Statement Schedules, and Reports on Form 8-K
 
 (a) Exhibits
 
 31.1 CEO Certification Pursuant to Section 302 of the Sarbanes-Oxley Act of 2002
 31.2 CFO Certification Pursuant to Section 302 of the Sarbanes-Oxley Act of 2002
 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
 
 
 (b) Reports on Form 8-K
 
 The Company furnished a report on Form 8-K under Item 9 and Item 12 dated July 25, 2003, reporting the announcement of the Companys earnings for the second quarter of 2003.
 
 Notwithstanding the foregoing, information furnished under Items 9 and 12 of our current Reports on Form 8-K, including the related Exhibits, shall not be deemed to be filed for the purpose of Section 18 of the Securities Exchange Act of 1934.
 
 13 
 
 Pursuant to the requirements of section 13 or 15(d) of the Securities Act of 1934, the registrant has duly caused this report to be signed on its behalf by the undersigned, thereunto duly authorized.
 
 
 
 CAVALRY BANCORP, INC.Date: November 7, 2003
byEd C. Loughry, Jr.Chairman of the Board and Chief Executive Officer 
 
 
 Date: November 7, 2003
byHillard C. GardnerSenior Vice President and Chief Financial Officer(Principal Financial and Accounting Officer) 
 14