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 June 30, 2004 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 (2) 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 Rule 12b-2 of the Exchange Act)
 
 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: 6,734,049 shares as of August 5, 2004 .
  
 
 CAVALRY BANCORP, INC.
 
 Table of Contents
 
 Part I
Financial Information
PageItem 1.
Financial StatementsConsolidated Balance Sheets at June 30, 2004 (unaudited)
and December 31, 2003
1-2Consolidated Statements of Income (unaudited) for the Three Months and Six Months Ended
June 30, 2004 and 2003
3Consolidated Statements of Comprehensive Income (unaudited) for the
Three Months and Six Months Ended June 30, 2004 and 2003
4Consolidated Statements of Cash Flows (unaudited) for the Six MonthsEnded June 30, 2004 and 2003
5Notes to Consolidated Financial Statements (unaudited)
6-9Item 2.
Managements Discussion and Analysis of Financial
Condition and Results of Operations
9-14Item 3.
Quantitative and Qualitative Disclosures About Market Risk
14-15Item 4.
Controls and Procedures
15-16Part II
Other Information
17Item 2.
Changes in Securities, Use of Proceeds and Issuer Purchases of Equity Securities
17Item 3.
Defaults Upon Senior Securities
17Item 4.
Submission of Matters to a Vote of Security Holders
17Item 5.
Other Information
17Item 6.
Exhibits and Reports on Form 8-K
18Signatures

19 
 
    
 
    Part I.  Financial Information
 
 ITEM 1.  FINANCIAL STATEMENTS
 
 CAVALRY BANCORP, INC.
 CONSOLIDATED BALANCE SHEETS
 JUNE 30, 2004 (UNAUDITED) AND DECEMBER 31, 2003
 (DOLLARS IN THOUSANDS)
 
 
 June 30,
December 31,Assets

2004
2003(Unaudited)Cash

$
13,629


32,946Interest-bearing deposits with other financial institutions


19,136


37,967Cash and cash equivalents


32,765


70,913Investment securities available-for-sale at fair value (amortized cost: $41,970and $55,136 at June 30, 2004 and December 31, 2003, respectively)


41,268


55,123Loans held for sale, at estimated fair value


3,922


2,648Loans receivable, net of allowances for loan losses of $4,600 at June 30, 2004 and $4,525 at December 31, 2003


409,383


350,412Accrued interest receivable


1,599


1,668Office properties and equipment, net


18,005


18,431Required investments in stock of Federal Home Loan Bank and Federal Reserve Bank, at cost


3,057


2,992Foreclosed assets


8


-Bank owned life insurance


8,426


8,308Goodwill


1,772


1,772Other assets


3,376


2,905Total assets

$
523,581


515,172Liabilities and Shareholders EquityLiabilities:Deposits:Non-interest-bearing

$
88,575


72,443Interest-bearing


372,364


381,814Total deposits


460,939


454,257Advances from Federal Home Loan Bank of Cincinnati


2,862


2,889Accrued expenses and other liabilities


5,022


3,599Total liabilities


468,823


460,745Shareholders equity:Preferred stock, no par valueAuthorized- 250,000 shares; none issued or outstanding at June 30, 2004 and December 31, 2003


-


-Common stock, no par valueAuthorized- 49,750,000 shares; issued and outstanding 6,734,049 and 6,834,873 at June 30, 2004 and December 31, 2003, respectively


9,172


10,175Retained earnings


48,045


46,633Unallocated ESOP shares


(2,017
)

(2,373
)Accumulated other comprehensive loss, net of tax


(442
)

(8
)Total shareholders equity


54,758


54,427Total liabilities and shareholders equity

$
523,581


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.
  CAVALRY BANCORP, INC.
 CONSOLIDATED STATEMENTS OF INCOME
 (DOLLARS IN THOUSANDS, EXCEPT PER SHARE DATA)
 (UNAUDITED)
 
 Three Months Ended
Six Months EndedJune 30,
June 30,2004
2003
2004
2003Interest income:Loans

$
5,572


5,045


10,844


10,069Investment securities:Taxable


305


306


647


589Non-taxable


31


-


38


-Other


52


101


142


227Total interest income


5,960


5,452


11,671


10,885Interest expense  deposits


1,245


1,399


2,514


2,918Interest expense  borrowings


24


25


48


49Total interest expense


1,269


1,424


2,562


2,967Net interest income


4,691


4,028


9,109


7,918Provision for loan losses


75


45


176


101Net interest income after provision for loan losses


4,616


3,983


8,933


7,817Non-interest income:Servicing income


47


60


93


131Gain on sale of loans, net


816


1,702


1,402


3,024Gain on sale of other assets


-


-


53


-Gain on sale of investment securities, net


12


-


78


11Deposit servicing fees and charges


1,310


1,192


2,535


2,247Trust service fees


274


248


566


494Commissions and other non-banking fees


594


650


1,249


1,350Other operating income


198


163


462


377Total non-interest income


3,251


4,015


6,438


7,634Non-interest expenses:Salaries and employee benefits


3,659


3,877


7,232


7,536Occupancy expense


329


344


655


659Supplies, communications and other office expenses


265


252


483


505Advertising expense


165


122


316


223Equipment and service bureau expense


845


736


1,661


1,431Professional fees


210


130


398


235Other taxes


115


104


230


208Other operating expense


358


344


732


670Total non-interest expenses


5,946


5,909


11,707


11,467Income before income taxes


1,921


2,089


3,664


3,984Income tax expense


754


811


1,481


1,538Net income

$
1,167


1,278


2,183


2,446Basic earnings per share

$
0.18


0.20


0.34


0.38Diluted earnings per share

$
0.17


0.19


0.33


0.37Weighted average shares outstanding - Basic


6,463,543


6,392,100


6,475,265


6,379,006Weighted average shares outstanding - Diluted


6,691,848


6,694,136


6,713,153


6,640,591 
 Dividends declared $0.06 per share payable July 9, 2004 for shareholders of record date June 30, 2004.
 
 See accompanying notes to consolidated financial statements.
  CAVALRY BANCORP, INC.
 CONSOLIDATED STATEMENTS OF COMPREHENSIVE INCOME
 (DOLLARS IN THOUSANDS)
 (UNAUDITED)
 
 Three Months Ended
Six Months EndedJune 30,
June 30,2004
2003
2004
2003Net income

$
1,167


1,278


2,183


2,446Other comprehensive income, net of tax:Unrealized gains (losses) on investment securities available-for-sale


(513
)

5


(386
)

(25
)Reclassification adjustment for gains included in net income


(7
)

-


(48
)

(7
)Comprehensive income

$
647


1,283


1,749


2,414 
 See accompanying notes to consolidated financial statements.
  CAVALRY BANCORP, INC.
 CONSOLIDATED STATEMENTS OF CASH FLOWS
 SIX MONTHS ENDED JUNE 30, 2004 AND 2003
 (DOLLARS IN THOUSANDS)
 (UNAUDITED)
 
 
 2004
2003Operating activities:Net cash provided by operating activities

$
4,093


10,106Investing activities:Increase in loans receivable, net


(59,277
)

(21,585
)Principal payments on investment securities


1,451


4,556Purchase of investment securities available-for-sale


(38,704
)

(52,457
)Proceeds from maturities of investment securities


13,900


29,750Proceeds from sales of investment securities available-for-sale


36,510


2,511Purchase of Federal Reserve Stock


(18
)

-Purchase of office properties and equipment


(439
)

(1,669
)Proceeds from sale of assets


11


378Net cash used in investing activities


(46,566
)

(38,516
)Financing activities:Net increase in deposits


6,682


7,577Retirement of common stock


(1,651
)

(137
)Proceeds from exercise of stock options


98


-Dividends paid


(777
)

(636
)Net decrease in borrowings


(27
)

(28
)Net cash provided by financing activities


4,325


6,776Decrease in cash and cash equivalents


(38,148
)

(21,634
)Cash and cash equivalents, beginning of period


70,913


73,162Cash and cash equivalents, end of period

$
32,765


51,528Supplemental Disclosures of Cash Flow Information:Payments during the period for:Interest

$
2,550


2,982Income taxes

$
1,405


1,750Supplemental Disclosures of Noncash Investing and Financing Activities:Increase in deferred tax asset related to unrealized losses on investments

$
255


18Net unrealized losses on investment securities available for sale

$
(689
)

(50
)Dividends declared and payable

$
404


341 
 See accompanying notes to consolidated financial statements.
  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 six months ended June 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 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 Opinion No. 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
Six Months EndedJune 30,
June 30,2004
2003
2004
2003(Dollars in thousands, except per share data)Net income:As reported

$
1,167


1,278


2,183


2,446Deduct: Total stock-based employee compensation expense determined under fair value methods for all awards granted, net of related tax effects


(98
)

(32
)

(201
)

(63
)Pro forma net income

$
1,069


1,246


1,982


2,383Earnings per share:Basic  as reported

$
0.18


0.20


0.34


0.38Basic  pro forma

$
0.17


0.19


0.31


0.37Diluted  as reported

$
0.17


0.19


0.33


0.37Diluted  pro forma

$
0.16


0.19


0.30


0.36 
 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 six months ended June 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
June 30,
Six Months Ended
June 30,2004
2003
2004
2003Basic EPS:Net income

$
1,167,000


1,278,000


2,183,000


2,446,000Average common shares outstanding


6,463,543


6,392,100


6,475,265


6,379,006Earnings per share - basic

$
0.18


0.20


0.34


0.38Diluted EPS:Net income

$
1,167,000


1,278,000


2,183,000


2,446,000Average common shares outstanding


6,463,543


6,392,100


6,475,265


6,379,006Dilutive effect of stock options


228,305


302,036


237,888


261,585Average dilutive shares outstanding


6,691,848


6,694,136


6,713,153


6,640,591Earnings per share - diluted

$
0.17


0.19


0.33


0.37 
 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.
  
 
 Banking
Mortgage Banking
Trust
Insurance
Eliminations
ConsolidatedFor the three months endedJune 30, 2004:Interest revenue

$
5,960


-


-


-


-


5,960Other income-external customers


1,606


47


274


496


-


2,423Interest expense


1,269


-


-


-


-


1,269Depreciation and amortization


341


42


18


7


-


408Other significant items:Provision for loan losses


75


-


-


-


-


75Gain on sales of assets


12


816


-


-


-


828Segment profit


1,849


-


47


42


(17
)

1,921Segment assets


517,840


4,054


396


3,215


(1,924
)

523,581 
 
 Banking
Mortgage Banking
Trust
Insurance
Eliminations
ConsolidatedFor the three months endedJune 30, 2003:Interest revenue

$
5,452


-


-


-


-


5,452Other income-external customers


1,483


60


248


522


-


2,313Interest expense


1,424


-


-


-


-


1,424Depreciation and amortization


313


91


17


15


-


436Other significant items:Provision for loan losses


45


-


-


-


-


45Gain on sales of assets


-


1,702


-


-


-


1,702Segment profit


1,771


360


40


15


(97
)

2,089Segment assets


461,580


11,809


351


2,842


(2,281
)

474,301 
 
 Banking
Mortgage Banking
Trust
Insurance
Eliminations
ConsolidatedFor the six months endedJune 30, 2004:Interest revenue

$
11,671


-


-


-


-


11,671Other income-external customers


3,232


93


566


1,014


-


4,905Interest expense


2,562


-


-


-


-


2,562Depreciation and amortization


701


87


35


17


-


840Other significant items:Provision for loan losses


176


-


-


-


-


176Gain on sales of assets


131


1,402


-


-


-


1,533Segment profit (loss)


3,641


(154
)

114


94


(31
)

3,664Segment assets


517,840


4,054


396


3,215


(1,924
)

523,581 
 
 Banking
Mortgage Banking
Trust
Insurance
Eliminations
ConsolidatedFor the six months endedJune 30, 2003:Interest revenue

$
10,885


-


-


-


-


10,885Other income-external customers


2,861


131


494


1,113


-


4,599Interest expense


2,967


-


-


-


-


2,967Depreciation and amortization


614


181


33


30


-


858Other significant items:Provision for loan losses


101


-


-


-


-


101Gain on sales of assets


11


3,024


-


-


-


3,035Segment profit


3,470


449


65


115


(115
)

3,984Segment assets


461,580


11,809


351


2,842


(2,281
)

474,301 
 
  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, 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.
 
 Overview of Operating Results for the Three Months Ended June 30, 2004 and June 30, 2003
 
 Net income decreased from $1.3 million or $0.19 per diluted share for the quarter ended June 30, 2003 to $1.2 million or $0.17 per diluted share for the quarter ended June 30, 2004. The decrease in earnings 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 non-interest income excluding gain on sale of loans, and a decline in interest expense. These items are discussed in further detail below.
 
 Overview of Operating Results for the Six Months Ended June 30, 2004 and June 30, 2003
 
 Net income decreased from $2.4 million or $0.37 per diluted share for the six months ended June 30, 2003 to $2.2 million or $0.33 per diluted share for the same period ended June 30, 2004. The decrease in earnings 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 non-interest income excluding gain on sale of loans, 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 considerations, both quantitative and qualitative, in establishing an allowance that management believes to be appropriate for each reporting date. Quantitative factors include the Companys historical loss experience, delinquency and charge-off trends, collateral values, and changes in non-performing loans. The Company also incorporates known information about individual loans, including borrowers sensitivity to interest rate movements and other relevant factors. Qualitative factors include 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.
 
 
  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.
 
 Comparison of Financial Condition at June 30, 2004 and December 31, 2003
 
 Total Assets . Total assets increased 1.63%, from $515.2 million at December 31, 2003 to $523.6 million at June 30, 2004. This overall increase reflects a $59.0 million or 16.83% increase in net loans receivable and a $1.3 million or 48.11% increase in loans held for sale. The increase in net loans receivable is primarily due to a 40.59% increase in commercial lending, a 21.68% increase in construction lending, and an 11.48% increase in consumer lending. These increases were partially offset by a $38.1 million or 53.80% decrease in cash and cash equivalents and a $13.9 million or 25.13% decrease in available-for-sale investment securities. The decrease in investment securities available-for-sale is primarily due to several calls, maturities, and sales of agency securities. These decreases were partially offset by the purchase of municipal securities, collateralized mortgage obligations (CMOs), and mortgage-backed securities.
 
 Deposits . Total deposits increased $6.6 million or 1.45%, from $454.3 million at December 31, 2003 to $460.9 million at June 30, 2004. Non-interest-bearing deposits increased $16.1 million or 22.27%, primarily due to a $14.6 million or 21.57% increase in demand deposit accounts. Interest-bearing deposits decreased $9.5 million or 2.48%, primarily due to a $15.8 million or 16.58% decrease in NOW accounts, which was partially offset by a $6.8 million or 31.14% increase in non-personal money market accounts. Transaction accounts, which include both interest-bearing and non-interest-bearing accounts, increased $4.3 million, from $280.5 million at December 31, 2003 to $284.8 million at June 30, 2004. Savings accounts increased $900,000, from $21.0 million at December 31, 2003 to $21.9 million at June 30, 2004. Certificates of deposit increased $1.4 million, from $152.8 million at December 31, 2003 to $154.2 million at June 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 $54.8 million at June 30, 2004. This increase was primarily the result of net income of $2.2 million and the allocation of shares under the Bank's Employee Stock Ownership Plan (ESOP) that totaled $906,000. Additionally, the Company issued common stock as a result of options exercised in the amount of $98,000, inclusive of the related tax benefit. These increases were partially offset by a $434,000 decrease in the valuation allowance for available-for-sale investment securities, dividends of $771,000, and the repurchase of $1.6 million of Company common stock.
 
 Non-Performing Assets . Non-performing assets totaled $950,000 and $859,000 at June 30, 2004 and December 31, 2003, respectively. The allowance for loan losses increased 2.22%, from $4.5 million at December 31, 2003 to $4.6 million at June 30, 2004. Although the non-performing asset balance reflects an increase of $91,000 or 10.59%, non-performing assets have continued to be a relatively small portion of the Banks portfolio, with the balance equal to 0.23% of total loans and 0.18% of total assets. Therefore, management feels that the increase in the allowance for loan losses is adequate as of June 30, 2004.
 
 Comparison of Operating Results for the Three Months Ended June 30, 2004 and June 30, 2003.
 
 Net Income . Net income was $1.2 million for the three months ended June 30, 2004 compared to $1.3 million for the three months ended June 30, 2003. Diluted earnings per share decreased $0.02, from $0.19 for the three months ended June 30, 2003 to $0.17 for the same period in 2004. Return on average assets decreased from 1.12% for the three months ended June 30, 2003 to 0.92% for the same period in 2004. Return on average equity also decreased, from 9.91% for the three months ended June 30, 2003 to 8.48% for the same period in 2004. These declines are mainly attributable to a decline in mortgage banking activity during the three months ended June 30, 2004 compared to the same period in 2003. The Company also had increased costs during 2004 due to a new branch opening during the latter part of the second quarter of 2003. Additionally, the Company experienced an increase in professional fees related to the Companys internal control compliance. These changes are discussed in more detail in the following sections.
 
 
  Net Interest Income . Net interest income increased 17.50%, from $4.0 million for the three months ended June 30, 2003 to $4.7 million for the same period in 2004. Although there was, in general, an overall decline in both yields and costs when comparing the quarter ended June 30, 2003 to the same period ended June 30, 2004, the Company experienced increased volume in both average interest-earning assets and average interest-bearing liabilities. Average interest-earning assets increased $54.4 million or 13.44%, while average interest-bearing liabilities increased $35.2 million or 10.28%. Interest rate spread increased 0.13%, from 3.74% for the three months ended June 30, 2003 to 3.87% for the same period in 2004. Net interest margin increased 0.12%, from 3.99% for the three months ended June 30, 2003 to 4.11% for the same period in 2004. The ratio of average interest-earning assets to average interest-bearing liabilities increased 3.39%, from 118.00% for the three months ended June 30, 2003 to 121.39% for the same period in 2004.
 
 Interest Income . Interest income increased $508,000 or 9.32%, primarily due to an increase of $527,000 or 10.45% in loan interest income. This increase is the result of an increase of $69.9 million or 21.62% in average loans receivable, net. The average yield on these loans decreased, from 6.26% for the three months ended June 30, 2003 to 5.70% 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, decreased by $19,000 or 4.67%. The average yield for these investments increased 0.36%, from 2.01% for the three months ended June 30, 2003 to 2.37% for the same period in 2004. This increase is the result of a restructuring of the Companys investment portfolio. The Company disposed of shorter-term agency bonds and purchased longer-term CMOs, mortgage-backed securities, and municipal securities, resulting in increased yields.
 
 Interest Expense . Total interest expense decreased $155,000 or 10.88%. This decrease is primarily due to a decrease in the average cost of deposits, which declined from 1.65% for the three months ended June 30, 2003 to 1.33% for the same period in 2004. Average deposits increased $35.3 million or 10.39%, from $339.8 million for the three months ended June 30, 2003 to $375.1 million for the same period in 2004. The total cost of funds decreased 0.32%, from 1.67% for the three months ended June 30, 2003 to 1.35% for the same period in 2004.
 
 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 borrowers sensitivity to interest rate movements and other relevant factors.
 
 The provision for loan losses totaled $75,000 for the three months ended June 30, 2004 compared to $45,000 for the same period ended June 30, 2003. This 66.67% increase is primarily due to the increase in the amount of the loan portfolio. Net charge-offs declined $13,000, from $64,000 for the quarter ended June 30, 2003 to $51,000 for the same period ended June 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 June 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 $764,000 or 17.50%, from $4.0 million for the three months ended June 30, 2003 to $3.3 million for the same period in 2004. This overall decrease is primarily due to a $886,000 or 52.06% decrease in net gain on sale of loans. The decrease in net gain on sale of loans is the result of a decline in loans sold during the three month period ended June 30, 2004, compared to the same period ended June 30, 2003. The decline is partially attributable to the Company retaining more adjustable rate loans in its portfolio during the second quarter of 2004. In addition, the overall level of mortgage loans originated by the Company has declined significantly as a result of higher mortgage rates. The decrease in net gain on sale of loans is offset by an increase of $118,000 or 9.90% in deposit-related service fees and charges. This is 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 $26,000 or 10.48% due to an increase in the assets under management.
 
 
  Non-Interest Expense . Non-interest expense increased $40,000 or 0.68%, from $5.91 million for the three months ended June 30, 2003 to $5.95 million for the same period in 2004. Many factors contributed to this change. Equipment and service bureau expense increased $109,000 or 14.81%, which primarily is a result of increased equipment maintenance expense, equipment rental and lease expense, and computer expense. These increases are partially attributable to the opening of the Banks Sam Ridley branch late in the second quarter of 2003. In addition, professional fees increased $80,000 or 61.54%. 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. The Company also experienced an increase of $43,000 or 35.25% 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 $218,000 or 5.62% in salaries and employee benefits, which was primarily due to decreased commission expense and overtime compensation expense.
 
 Comparison of Operating Results for the Six Months Ended June 30, 2004 and June 30, 2003.
 
 Net Income . Net income was $2.2 million for the six months ended June 30, 2004 compared to $2.4 million for the six months ended June 30, 2003. Diluted earnings per share decreased $0.04, from $0.37 for the six months ended June 30, 2003 to $0.33 for the same period in 2004. Return on average assets decreased from 1.09% for the six months ended June 30, 2003 to 0.86% for the same period in 2004. Return on average equity also decreased, from 9.66% for the six months ended June 30, 2003 to 7.94% for the same period in 2004. These declines are mainly attributable to lower fees collected for mortgage banking, as refinancing slowed considerably during the first six months of 2004 compared to high levels experienced during the same period ended June 30, 2003. The Company also had increased costs during 2004 due to a new branch opening during the latter part of the second quarter of 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 15.19%, from $7.9 million for the six months ended June 30, 2003 to $9.1 million for the same period in 2004. Although there was, in general, an overall decline in both yields and costs when comparing the six months ended June 30, 2003 to the same period ended June 30, 2004, the Company experienced increased volume in both average interest-earning assets and average interest-bearing liabilities. Average interest-earning assets increased $54.6 million or 13.64%, while average interest-bearing liabilities increased $38.7 million or 11.30%. Interest rate spread increased 0.08%, from 3.73% for the six months ended June 30, 2003 to 3.81% for the same period in 2004. Net interest margin increased 0.03%, from 3.99% for the six months ended June 30, 2003 to 4.02% for the same period in 2004. The ratio of average interest-earning assets to average interest-bearing liabilities increased 2.45%, from 116.96% for the six months ended June 30, 2003 to 119.41% for the same period in 2004.
 
 Interest Income . Interest income increased $786,000 or 7.22%, primarily due to an increase of $775,000 or 7.70% in loan interest income. This increase is the result of an increase of $59.5 million or 18.65% in average loans receivable, net. The average yield on these loans decreased, from 6.36% for the six months ended June 30, 2003 to 5.76% 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 $11,000 or 1.35%. The average yield for these investments increased 0.16%, from 2.01% for the six months ended June 30, 2003 to 2.17% for the same period in 2004.
 
 Interest Expense . Total interest expense decreased $405,000 or 13.65%. This decrease is primarily due to a decrease in the average cost of deposits, which declined from 1.73% for the six months ended June 30, 2003 to 1.34% for the same period in 2004. Average deposits increased $38.7 million or 11.40%, from $339.6 million for the six months ended June 30, 2003 to $378.3 million for the same period in 2004. The total cost of funds decreased 0.40%, from 1.75% for the six months ended June 30, 2003 to 1.35% 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 June 30, 2004 and June 30, 2003 - Provision for Loan Losses for a discussion as to how the Company derives the provision for loan losses.
 
 The provision for loan losses totaled $176,000 for the six months ended June 30, 2004 compared to $101,000 for the same period ended June 30, 2003. This 74.26% increase is primarily due to an increase in the amount of the loan portfolio. Net charge-offs declined $42,000, from $143,000 for the six months ended June 30, 2003 to $101,000 for the same period ended June 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 June 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 $1.2 million or 15.79%, from $7.6 million for the six months ended June 30, 2003 to $6.4 million for the same period in 2004. This overall decrease is primarily due to a $1.6 million or 53.64% decrease in net gain on sale of loans. The decrease in net gain on sale of loans is the result of a decline in loans sold during the six month period ended June 30, 2004, compared to the same period ended June 30, 2003. The decline is partially attributable to the Company retaining more adjustable rate loans in its portfolio during the first six months of 2004. In addition, there was a decrease in the volume of loans closed during the first six months of 2004 when compared to the first six months of 2003, primarily due to the large refinancing activity that occurred during the first three months of 2003. The decrease in net gain on sale of loans is offset by an increase of $288,000 or 12.82% in deposit-related service fees and charges. This is 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 $72,000 or 14.57% due to an increase in the assets under management.
 
 Non-Interest Expense . Non-interest expense increased $240,000 or 1.74%, from $11.5 million for the six months ended June 30, 2003 to $11.7 million for the same period in 2004. Many factors contributed to this change. Equipment and service bureau expense increased $230,000 or 16.07%, which primarily is a result of increased equipment maintenance expense, equipment rental and lease expense, and computer expense. These increases are partially attributable to the opening of the Banks Sam Ridley branch late in the second quarter of 2003. In addition, professional fees increased $163,000 or 69.36%. 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. The Company also experienced an increase of $93,000 or 41.70% 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 $304,000 or 4.03% in salaries and employee benefits, which was primarily due to decreased commission expense, overtime compensation expense, and other retirement expense.
 
 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 June 30, 2004, cash and cash equivalents totaled $32.8 million or 6.26% of total assets, and investment securities availableforsale totaled $41.3 million. At June 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 June 30, 2004, the Company and the Banks regulatory capital ratios were in excess of all applicable regulatory requirements. At June 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 9.47%, 11.56% and 12.68%, respectively, compared to requirements of 3.0%, 4.0% and 8.0%, respectively. At June 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  10.46%, 12.98%, and 14.10%, respectively. The Company is currently involved in a share repurchase program. The Company has repurchased 108,900 shares this year at an average price of $15.16. The maximum number of shares that may yet be repurchased under the plan is 298,404 shares.
  
 At June 30, 2004, the Bank had off-balance sheet loan commitments of approximately $52.7 million. In addition, at June 30, 2004, the unused portion of lines of credit extended by the Bank was approximately $8.3 million for consumer loans and $30.0 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 June 30, 2004, the Bank had $8.6 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 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 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.
 
 The following table presents the Company's repricing gap at June 30, 2004. The table indicates that at June 30, 2004 the Company was asset sensitive up to six months. 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

$
135,125


48,707


62,404


149,196


17,873


413,305FHLB and FRB stock


3,057


-


-


-


-


3,057Investment securities available-for-sale


10,615


3,901


5,578


4,060


17,114


41,268Interest-bearing deposits with other financial institutions


19,136


-


-


-


-


19,136Total rate sensitive assets

$
167,933


52,608


67,982


153,256


34,987


476,766Interest-bearing liabilities:Deposits:Savings deposits

$
2,272


2,272


8,704


8,703


-


21,951Demand deposits


66,334


65,562


32,172


32,173


-


196,241Certificates of deposit


56,789


43,498


40,979


12,873


33


154,172Borrowings


27


27


2,109


109


590


2,862Total rate sensitive liabilities

$
125,422


111,359


83,964


53,858


623


375,226Excess (deficiency) of interest sensitive assets over interest sensitive liabilities

$
42,511


(58,751
)

(15,982
)

99,398


34,364


101,540Cumulative excess (deficiency) of interest sensitive assets

$
42,511


(16,240
)

(32,222
)

67,176


101,540


101,540Cumulative ratio of interest-earning assets to interest-bearing liabilities


133.89
%

93.14
%

89.95
%

117.93
%

127.06
%

127.06
%Interest sensitivity gap to total rate sensitive assets


8.92
%

(12.32)
%

(3.35)
%

20.85
%

7.21
%

21.30
%Ratio of interest-earning assets to interest -bearing liabilities


133.89
%

47.24
%

80.97
%

284.56
%

5,615.89
%

127.06
%Ratio of cumulative gap to total rate sensitive assets


8.92
%

(3.41)
%

(6.76)
%

14.09
%

21.30
%

21.30
% 
 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 18 basis points. The magnitude of potential gain for a 100 basis point increase under projected growth conditions would be an increase of 12 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 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.
 
 
  Part II. Other Information
 
 Item 1. Legal Proceedings
 
 None.
 
 Item 2. Changes in Securities, Use of Proceeds and Issuer Purchases of Equity Securities
 (a)  Not applicable.
 (b)  Not applicable.
 (c)  Not applicable.
 (d)  Not applicable.
 (e)  The following table provides information about purchases by the Company during the quarter ended June 30, 2004 of equity securities that are registered by the Company pursuant to Section 12 of the Exchange Act:
 
 ISSUER PURCHASES OF EQUITY SECURITIESPeriod
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 programsApril 1, 2004 through April 30, 2004
5,000
$15.60
5,000
400,904May 1, 2004 through May 31, 2004
81,500
15.08
81,500
319,404June 1, 2004 through June 30, 2004
21,000
15.33
21,000
298,404Total
107,500
15.15
107,500 
 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
 
 On April 22, 2004 at the annual meeting of shareholders of Cavalry Bancorp, Inc. the following Directors were elected for three-year terms:
 
 Name
For
WithholdEd C. Loughry, Jr.
5,383,103
119,699William Kent Coleman
5,377,299
125,503James C. Cope
5,376,923
125,879
 
 Item 5. Other Information
 
 None.
 
  
 Item 6. Exhibits and Reports on Form 8-K
 
 (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
 
 (b) Reports on Form 8-K
 
 The Company furnished a report on Form 8-K under Item 7, Item 9 and Item 12 dated April 30, 2004, reporting the announcement of the Companys earnings for the first quarter of 2004.
 
 The Company furnished a report on Form 8 K under Item 5 and Item 7 dated April 30, 2004, announcing the re-election of directors William Kent Coleman, James C. Cope and Ed C. Loughry, Jr., each for three-year terms, at the Annual Stockholders Meeting held on April 22, 2004.
 
 Notwithstanding the foregoing, information furnished under Item 9 and Item 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.
 
  
 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:August 5, 2004
byEd C. Loughry, Jr.Chairman of the Board and Chief Executive Officer 
 Date:August 5, 2004
byHillard C. GardnerSenior Vice President and Chief Financial Officer(Principal Financial and Accounting Officer)