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UNITED STATES

SECURITIES AND EXCHANGE COMMISSION

Washington, D.C. 20549



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FORM 10-Q



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(Mark One)

|x | QUARTERLY REPORT PURSUANT TO SECTION 13 OR 15(D) OF THE SECURITIES EXCHANGE ACT OF 1934
|- | ---------------------------------------------------------------------------------------



FOR THE QUARTERLY PERIOD ENDED SEPTEMBER 30, 2004



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



Commission file number 000-49928



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TEXAS UNITED BANCSHARES, INC.

(Exact name of registrant as specified in its charter)



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|                                                               |  |                                     
|-------------------------------------------------------------- |  | ------------------------------------
|Texas                                                          |  | 75-2768656                          
|(State or other jurisdiction of Incorporation or organization) |  | (I.R.S. Employer Identification No.)



202 W. COLORADO

LA GRANGE, TEXAS 78945

(Address of principal executive offices including zip code)



(979) 968-8451

(Registrants telephone number, including area code)



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Indicate by check mark whether the registrant (1) has filed all reports required to be filed by Section 13 or 15(d) of the Securities Exchange Act of 1934
during the preceding 12 months (or for such shorter period that the registrant was required to file such reports), and (2) has been subject to such filing requirements for the past 90 days.    Yes  x    No ̈.



Indicate by check mark whether the registrant is an accelerated filer (as defined in Rule 12b-2 of the Exchange
Act).    Yes ̈No  x.



As of November 1, 2004, the number of outstanding shares of Common Stock, par
value $1.00 per share was 7,786,372.



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PART I



FINANCIAL INFORMATION



Item 1.Condensed Consolidated Financial Statements.



TEXAS UNITED BANCSHARES, INC. AND SUBSIDIARIES



Consolidated Balance Sheets



(In thousands, except par value and share data)



|                                                                                                                                                                                                               |  |                    |         |   |                   |   |         |  
|-------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------- |  | ------------------ | ------- | - | ----------------- | - | ------- | -
|                                                                                                                                                                                                               |  | September 30, 2004 |         |   | December 31, 2003 |  
|                                                                                                                                                                                                               |  | (Unaudited)        |         |   |                   |  
|ASSETS                                                                                                                                                                                                         |  |                    |         |   |                   |   |         |  
|Cash and cash equivalents:                                                                                                                                                                                     |  |                    |         |   |                   |   |         |  
|Cash and due from banks                                                                                                                                                                                        |  | $                  | 19,196  |   |                   | $ | 17,268  |  
|Federal funds sold and other temporary investments                                                                                                                                                             |  |                    |        |   |                   |   |        |  
|                                                                                                                                                                                                               |  |                    |         |   |                   |   |         |  
|Total cash and cash equivalents                                                                                                                                                                                |  |                    | 19,196  |   |                   |   | 17,268  |  
|Investment securities available-for-sale, at fair value                                                                                                                                                        |  |                    | 255,753 |   |                   |   | 184,547 |  
|Loans, net of allowance for loan losses of $4,535 and $3,893, respectively                                                                                                                                     |  |                    | 476,811 |   |                   |   | 376,628 |  
|Loans held for sale                                                                                                                                                                                            |  |                    | 17,286  |   |                   |   | 3,810   |  
|Premises and equipment, net                                                                                                                                                                                    |  |                    | 29,196  |   |                   |   | 25,802  |  
|Accrued interest receivable                                                                                                                                                                                    |  |                    | 3,559   |   |                   |   | 2,984   |  
|Goodwill                                                                                                                                                                                                       |  |                    | 17,537  |   |                   |   | 9,073   |  
|Core deposit intangibles, net                                                                                                                                                                                  |  |                    | 316     |   |                   |   | 393     |  
|Mortgage servicing rights, net                                                                                                                                                                                 |  |                    | 4,769   |   |                   |   | 4,475   |  
|Other assets                                                                                                                                                                                                   |  |                    | 14,904  |   |                   |   | 12,704  |  
|                                                                                                                                                                                                               |  |                    |         |   |                   |   |         |  
|Total assets                                                                                                                                                                                                   |  | $                  | 839,327 |   |                   | $ | 637,684 |  
|                                                                                                                                                                                                               |  |                    |         |   |                   |   |         |  
|LIABILITIES AND SHAREHOLDERS EQUITY                                                                                                                                                                           |  |                    |         |   |                   |   |         |  
|Deposits:                                                                                                                                                                                                      |  |                    |         |   |                   |   |         |  
|Noninterest-bearing                                                                                                                                                                                            |  | $                  | 126,107 |   |                   | $ | 96,337  |  
|Interest-bearing                                                                                                                                                                                               |  |                    | 562,792 |   |                   |   | 404,799 |  
|                                                                                                                                                                                                               |  |                    |         |   |                   |   |         |  
|Total deposits                                                                                                                                                                                                 |  |                    | 688,899 |   |                   |   | 501,136 |  
|Federal funds purchased                                                                                                                                                                                        |  |                    | 973     |   |                   |   | 6,891   |  
|Other liabilities                                                                                                                                                                                              |  |                    | 9,612   |   |                   |   | 6,646   |  
|Borrowings                                                                                                                                                                                                     |  |                    | 39,925  |   |                   |   | 71,875  |  
|Securities sold under repurchase agreements                                                                                                                                                                    |  |                    | 8,900   |   |                   |   | 784     |  
|Junior subordinated deferrable interest debentures                                                                                                                                                             |  |                    | 12,365  |   |                   |   | 12,365  |  
|                                                                                                                                                                                                               |  |                    |         |   |                   |   |         |  
|Total liabilities                                                                                                                                                                                              |  |                    | 760,674 |   |                   |   | 599,697 |  
|                                                                                                                                                                                                               |  |                    |         |   |                   |   |         |  
|Commitments and contingencies                                                                                                                                                                                  |  |                    |        |   |                   |   |        |  
|Shareholders equity:                                                                                                                                                                                          |  |                    |         |   |                   |   |         |  
|Preferred stock, $1.00 par value, 500,000 shares authorized, none of which are issued and outstanding                                                                                                          |  |                    |        |   |                   |   |        |  
|Common stock, $1.00 par value, 20,000,000 authorized; 6,335,648 shares issued and 6,329,553 outstanding as of September 30, 2004 and 4,008,192
shares issued and 4,002,097 outstanding as of December 31, 2003 |  |                    | 6,336   |   |                   |   | 4,008   |  
|Additional paid-in capital                                                                                                                                                                                     |  |                    | 51,007  |   |                   |   | 16,911  |  
|Retained earnings                                                                                                                                                                                              |  |                    | 21,037  |   |                   |   | 17,422  |  
|Accumulated other comprehensive income (loss)                                                                                                                                                                  |  |                    | 390     |   |                   |   | (237    | )
|Less treasury stock, at cost                                                                                                                                                                                   |  |                    | (117    | ) |                   |   | (117    | )
|                                                                                                                                                                                                               |  |                    |         |   |                   |   |         |  
|Total shareholders equity                                                                                                                                                                                     |  |                    | 78,653  |   |                   |   | 37,987  |  
|                                                                                                                                                                                                               |  |                    |         |   |                   |   |         |  
|Total liabilities and shareholders equity                                                                                                                                                                     |  | $                  | 839,327 |   |                   | $ | 637,684 |  
|                                                                                                                                                                                                               |  |                    |         |   |                   |   |         |  



See accompanying notes
to condensed consolidated financial statements



1



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TEXAS UNITED BANCSHARES, INC. AND SUBSIDIARIES



Consolidated Statements of Earnings



(In thousands, except per share data)

(Unaudited)



|                                                     |  |                                          |        |                                         |   |       |  |      |        |  |   |       
|---------------------------------------------------- |  | ---------------------------------------- | ------ | --------------------------------------- | - | ----- |  | ---- | ------ |  | - | ------
|                                                     |  | For the three months ended September 30, |        | For the nine months ended September 30,
|                                                     |  | 2004                                     |        | 2003                                    |   | 2004  |  | 2003
|Interest income:                                     |  |                                          |        |                                         |   |       |  |      |        |  |   |       
|Loans                                                |  | $                                        | 9,146  |                                         | $ | 7,701 |  | $    | 24,654 |  | $ | 23,006
|Investment securities:                               |  |                                          |        |                                         |   |       |  |      |        |  |   |       
|Taxable                                              |  |                                          | 2,227  |                                         |   | 1,513 |  |      | 5,639  |  |   | 4,143 
|Tax-exempt                                           |  |                                          | 97     |                                         |   | 126   |  |      | 292    |  |   | 424   
|Federal funds sold and other temporary investments   |  |                                          | 7      |                                         |   | 17    |  |      | 14     |  |   | 70    
|                                                     |  |                                          |        |                                         |   |       |  |      |        |  |   |       
|Total interest income                                |  |                                          | 11,477 |                                         |   | 9,357 |  |      | 30,599 |  |   | 27,643
|                                                     |  |                                          |        |                                         |   |       |  |      |        |  |   |       
|Interest expense:                                    |  |                                          |        |                                         |   |       |  |      |        |  |   |       
|Deposits                                             |  |                                          | 2,320  |                                         |   | 1,854 |  |      | 6,144  |  |   | 5,743 
|Federal funds purchased                              |  |                                          | 57     |                                         |   | 30    |  |      | 119    |  |   | 115   
|Borrowings                                           |  |                                          | 643    |                                         |   | 518   |  |      | 1,535  |  |   | 1,542 
|Subordinated notes and debentures                    |  |                                          |       |                                         |   |      |  |      |       |  |   | 87    
|Junior subordinated deferrable interest debentures   |  |                                          | 266    |                                         |   | 185   |  |      | 798    |  |   | 554   
|                                                     |  |                                          |        |                                         |   |       |  |      |        |  |   |       
|Total interest expense                               |  |                                          | 3,286  |                                         |   | 2,587 |  |      | 8,596  |  |   | 8,041 
|                                                     |  |                                          |        |                                         |   |       |  |      |        |  |   |       
|Net interest income                                  |  |                                          | 8,191  |                                         |   | 6,770 |  |      | 22,003 |  |   | 19,602
|Provision for loan losses                            |  |                                          | 700    |                                         |   | 800   |  |      | 1,150  |  |   | 2,100 
|                                                     |  |                                          |        |                                         |   |       |  |      |        |  |   |       
|Net interest income after provision for loan losses  |  |                                          | 7,491  |                                         |   | 5,970 |  |      | 20,853 |  |   | 17,502
|                                                     |  |                                          |        |                                         |   |       |  |      |        |  |   |       
|Noninterest income:                                  |  |                                          |        |                                         |   |       |  |      |        |  |   |       
|Service charges on deposit accounts                  |  |                                          | 1,869  |                                         |   | 1,718 |  |      | 5,196  |  |   | 5,016 
|Mortgage servicing revenue                           |  |                                          | 217    |                                         |   | 636   |  |      | 715    |  |   | 2,040 
|Gain on sale of investment securities, net           |  |                                          | 19     |                                         |   | 376   |  |      | 167    |  |   | 1,291 
|Gain on sale of loans from Community Home Loan, Inc. |  |                                          | 2,364  |                                         |   |      |  |      | 5,506  |  |   |      
|Other noninterest income                             |  |                                          | 539    |                                         |   | 654   |  |      | 1,995  |  |   | 2,259 
|                                                     |  |                                          |        |                                         |   |       |  |      |        |  |   |       
|Total noninterest income                             |  |                                          | 5,008  |                                         |   | 3,384 |  |      | 13,579 |  |   | 10,606
|                                                     |  |                                          |        |                                         |   |       |  |      |        |  |   |       
|Noninterest expense:                                 |  |                                          |        |                                         |   |       |  |      |        |  |   |       
|Employee compensation and benefits                   |  |                                          | 5,664  |                                         |   | 4,509 |  |      | 15,660 |  |   | 12,314
|Occupancy                                            |  |                                          | 1,214  |                                         |   | 1,214 |  |      | 3,419  |  |   | 3,479 
|Other noninterest expense                            |  |                                          | 3,411  |                                         |   | 1,435 |  |      | 8,556  |  |   | 6,535 
|                                                     |  |                                          |        |                                         |   |       |  |      |        |  |   |       
|Total noninterest expense                            |  |                                          | 10,289 |                                         |   | 7,158 |  |      | 27,635 |  |   | 22,328
|                                                     |  |                                          |        |                                         |   |       |  |      |        |  |   |       
|Earnings before provision for income taxes           |  |                                          | 2,210  |                                         |   | 2,196 |  |      | 6,797  |  |   | 5,780 
|Provision for income taxes                           |  |                                          | 649    |                                         |   | 667   |  |      | 2,176  |  |   | 1,728 
|                                                     |  |                                          |        |                                         |   |       |  |      |        |  |   |       
|Net earnings                                         |  | $                                        | 1,561  |                                         | $ | 1,529 |  | $    | 4,621  |  | $ | 4,052 
|                                                     |  |                                          |        |                                         |   |       |  |      |        |  |   |       
|Earnings per common share:                           |  |                                          |        |                                         |   |       |  |      |        |  |   |       
|Basic                                                |  | $                                        | 0.30   |                                         | $ | 0.38  |  | $    | 1.04   |  | $ | 1.02  
|Diluted                                              |  | $                                        | 0.29   |                                         | $ | 0.37  |  | $    | 1.00   |  | $ | 0.98  
|Weighted average shares outstanding:                 |  |                                          |        |                                         |   |       |  |      |        |  |   |       
|Basic                                                |  |                                          | 5,249  |                                         |   | 3,995 |  |      | 4,427  |  |   | 3,979 
|Diluted                                              |  |                                          | 5,421  |                                         |   | 4,163 |  |      | 4,605  |  |   | 4,141 



See accompanying notes
to condensed consolidated financial statements



2



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TEXAS UNITED BANCSHARES, INC. AND SUBSIDIARIES



Consolidated Statements of Comprehensive Income



(In thousands)

(Unaudited)



|                                                                                     |  |                                          |       |      |                                         |        |      |  |      |       |  |   |        |  
|------------------------------------------------------------------------------------ |  | ---------------------------------------- | ----- | ---- | --------------------------------------- | ------ | ---- |  | ---- | ----- |  | - | ------ | -
|                                                                                     |  | For the three months ended September 30, |       |      | For the nine months ended September 30, |       
|                                                                                     |  | 2004                                     |       | 2003 |                                         |        | 2004 |  | 2003 |      
|Net earnings                                                                         |  | $                                        | 1,561 |      | $                                       | 1,529  |      |  | $    | 4,621 |  | $ | 4,052  |  
|                                                                                     |  |                                          |       |      |                                         |        |      |  |      |       |  |   |        |  
|Other comprehensive income (loss), net of tax:                                       |  |                                          |       |      |                                         |        |      |  |      |       |  |   |        |  
|Unrealized holding gains (losses) on investment securities arising during the period |  |                                          | 3,821 |      |                                         | (3,277 | )    |  |      | 737   |  |   | (1,646 | )
|Less: reclassification adjustment for gains included in net income                   |  |                                          | 13    |      |                                         | 248    |      |  |      | 110   |  |   | 852    |  
|                                                                                     |  |                                          |       |      |                                         |        |      |  |      |       |  |   |        |  
|Other comprehensive income (loss)                                                    |  |                                          | 3,808 |      |                                         | (3,525 | )    |  |      | 627   |  |   | (2,498 | )
|                                                                                     |  |                                          |       |      |                                         |        |      |  |      |       |  |   |        |  
|Total comprehensive income (loss)                                                    |  | $                                        | 5,369 |      | $                                       | (1,996 | )    |  | $    | 5,248 |  | $ | 1,554  |  
|                                                                                     |  |                                          |       |      |                                         |        |      |  |      |       |  |   |        |  



See accompanying notes
to condensed consolidated financial statements



3



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TEXAS UNITED BANCSHARES, INC. AND SUBSIDIARIES



Consolidated Statements of Changes in Shareholders Equity



Year Ended December 31, 2003 and

Nine Months Ended September 30, 2004

(Dollars in thousands, except share and per share amounts)



|                                                                          |  |              |  |                          |       |  |                  |        |   |                                            |   |        |                      |  |   |        |   |  |   |      |   |  |   |        |  
|------------------------------------------------------------------------- |  | ------------ |  | ------------------------ | ----- |  | ---------------- | ------ | - | ------------------------------------------ | - | ------ | -------------------- |  | - | ------ | - |  | - | ---- | - |  | - | ------ | -
|                                                                          |  | Common Stock |  | AdditionalPaid-inCapital |       |  | RetainedEarnings |        |   | AccumulatedOtherComprehensiveIncome (loss) |   |        | TreasuryStock atCost |  |   | Total  |  
|                                                                          |  | Shares       |  | Amount                   |       |  |                  |        |  
|Balance at January 1, 2003                                                |  | 2,646,139    |  | $                        | 2,646 |  | $                | 16,683 |   |                                            | $ | 14,594 |                      |  | $ | 1,612  |   |  | $ | (117 | ) |  | $ | 35,418 |  
|Net earnings                                                              |  |             |  |                          |      |  |                  |       |   |                                            |   | 5,241  |                      |  |   |       |   |  |   |     |   |  |   | 5,241  |  
|Unrealized loss on securities, net of tax and reclassification adjustment |  |             |  |                          |      |  |                  |       |   |                                            |   |       |                      |  |   | (1,849 | ) |  |   |     |   |  |   | (1,849 | )
|                                                                          |  |              |  |                          |       |  |                  |        |   |                                            |   |        |                      |  |   |        |   |  |   |      |   |  |   |        |  
|Comprehensive income                                                      |  |              |  |                          |       |  |                  |        |   |                                            |   |        |                      |  |   |        |   |  |   |      |   |  |   | 3,392  |  
|Three-for-two stock split                                                 |  | 1,331,403    |  |                          | 1,331 |  |                  |       |   |                                            |   | (1,331 | )                    |  |   |       |   |  |   |     |   |  |   |       |  
|Issuance of common stock upon exercise of employee stock options          |  | 30,650       |  |                          | 31    |  |                  | 234    |   |                                            |   |       |                      |  |   |       |   |  |   |     |   |  |   | 265    |  
|Cash paid in lieu of fractional shares                                    |  |             |  |                          |      |  |                  | (6     | ) |                                            |   |       |                      |  |   |       |   |  |   |     |   |  |   | (6     | )
|Dividends ($0.28 per share)                                               |  |             |  |                          |      |  |                  |       |   |                                            |   | (1,082 | )                    |  |   |       |   |  |   |     |   |  |   | (1,082 | )
|                                                                          |  |              |  |                          |       |  |                  |        |   |                                            |   |        |                      |  |   |        |   |  |   |      |   |  |   |        |  
|Balance at December 31, 2003                                              |  | 4,008,192    |  | $                        | 4,008 |  | $                | 16,911 |   |                                            | $ | 17,422 |                      |  | $ | (237   | ) |  | $ | (117 | ) |  | $ | 37,987 |  
|                                                                          |  |              |  |                          |       |  |                  |        |   |                                            |   |        |                      |  |   |        |   |  |   |      |   |  |   |        |  



Unaudited



|                                                                                         |  |              |  |                          |       |                  |   |        |                                            |   |        |                      |  |   |       |   |  |   |      |   |  |   |        |  
|---------------------------------------------------------------------------------------- |  | ------------ |  | ------------------------ | ----- | ---------------- | - | ------ | ------------------------------------------ | - | ------ | -------------------- |  | - | ----- | - |  | - | ---- | - |  | - | ------ | -
|                                                                                         |  | Common Stock |  | AdditionalPaid-inCapital |       | RetainedEarnings |   |        | AccumulatedOtherComprehensiveIncome (loss) |   |        | TreasuryStock atCost |  |   | Total |  
|                                                                                         |  | Shares       |  | Amount                   |       |                  |   |        |                                           
|Balance at January 1, 2004                                                               |  | 4,008,192    |  | $                        | 4,008 |                  | $ | 16,911 |                                            | $ | 17,422 |                      |  | $ | (237  | ) |  | $ | (117 | ) |  | $ | 37,987 |  
|Net earnings                                                                             |  |             |  |                          |      |                  |   |       |                                            |   | 4,621  |                      |  |   |      |   |  |   |     |   |  |   | 4,621  |  
|Unrealized gain on securities, net of tax and reclassification adjustment                |  |             |  |                          |      |                  |   |       |                                            |   |       |                      |  |   | 627   |   |  |   |     |   |  |   | 627    |  
|                                                                                         |  |              |  |                          |       |                  |   |        |                                            |   |        |                      |  |   |       |   |  |   |      |   |  |   |        |  
|Comprehensive income                                                                     |  |              |  |                          |       |                  |   |        |                                            |   |        |                      |  |   |       |   |  |   |      |   |  |   | 5,248  |  
|Issuance of common stock upon exercise of employee stock options                         |  | 15,691       |  |                          | 16    |                  |   | 80     |                                            |   |       |                      |  |   |      |   |  |   |     |   |  |   | 96     |  
|Issuance of common stock in connection with the acquisition of Community Home Loan, Inc. |  | 11,765       |  |                          | 12    |                  |   | 188    |                                            |   |       |                      |  |   |      |   |  |   |     |   |  |   | 200    |  
|Issuance of common stock in connection with the public offering                          |  | 2,300,000    |  |                          | 2,300 |                  |   | 33,828 |                                            |   |        |                      |  |   |       |   |  |   |      |   |  |   | 36,128 |  
|Dividends ($0.21 per share)                                                              |  |             |  |                          |      |                  |   |       |                                            |   | (1,006 | )                    |  |   |      |   |  |   |     |   |  |   | (1,006 | )
|                                                                                         |  |              |  |                          |       |                  |   |        |                                            |   |        |                      |  |   |       |   |  |   |      |   |  |   |        |  
|Balance at September 30, 2004                                                            |  | 6,335,648    |  | $                        | 6,336 |                  | $ | 51,007 |                                            | $ | 21,037 |                      |  | $ | 390   |   |  | $ | (117 | ) |  | $ | 78,653 |  
|                                                                                         |  |              |  |                          |       |                  |   |        |                                            |   |        |                      |  |   |       |   |  |   |      |   |  |   |        |  



See accompanying notes
to condensed consolidated financial statements



4



---

TEXAS UNITED BANCSHARES, INC. AND SUBSIDIARIES



Consolidated Statements of Cash Flows



(In thousands)

(Unaudited)



|                                                                                                                   |  |                                         |          |   |      |   |          |  
|------------------------------------------------------------------------------------------------------------------ |  | --------------------------------------- | -------- | - | ---- | - | -------- | -
|                                                                                                                   |  | For the nine months ended September 30, |         
|                                                                                                                   |  | 2004                                    |          |   | 2003 |  
|Cash flows from operating activities:                                                                              |  |                                         |          |   |      |   |          |  
|Net earnings                                                                                                       |  | $                                       | 4,621    |   |      | $ | 4,052    |  
|Adjustments to reconcile net earnings to net cash provided by operating activities net of effects of acquisitions: |  |                                         |          |   |      |   |          |  
|Depreciation and amortization                                                                                      |  |                                         | 2,375    |   |      |   | 2,269    |  
|Reversal of impairment of mortgage servicing rights                                                                |  |                                         | (263     | ) |      |   | (144     | )
|Provision for loan losses                                                                                          |  |                                         | 1,150    |   |      |   | 2,100    |  
|Gain on sales of securities, net                                                                                   |  |                                         | (167     | ) |      |   | (1,291   | )
|Gain on sale of other real estate, loans, premises and equipment                                                   |  |                                         | (651     | ) |      |   | (406     | )
|Amortization of premium, net of discounts on securities                                                            |  |                                         | 975      |   |      |   | 1,186    |  
|Changes in:                                                                                                        |  |                                         |          |   |      |   |          |  
|Loans held for sale                                                                                                |  |                                         | (3,960   | ) |      |   | 31,833   |  
|Other assets                                                                                                       |  |                                         | (3,877   | ) |      |   | (3,485   | )
|Other liabilities                                                                                                  |  |                                         | 1,718    |   |      |   | 721      |  
|                                                                                                                   |  |                                         |          |   |      |   |          |  
|Net cash provided by operating activities                                                                          |  |                                         | 1,921    |   |      |   | 36,835   |  
|                                                                                                                   |  |                                         |          |   |      |   |          |  
|Cash flows from investing activities net of effects of acquisitions:                                               |  |                                         |          |   |      |   |          |  
|Purchases of securities available-for-sale                                                                         |  |                                         | (121,303 | ) |      |   | (175,657 | )
|Proceeds from sales, maturities, and principal paydowns of securities available-for-sale                           |  |                                         | 50,240   |   |      |   | 113,447  |  
|Net change in loans                                                                                                |  |                                         | (72,584  | ) |      |   | (20,011  | )
|Proceeds from sale of other real estate, loans, premises and equipment                                             |  |                                         | 1,044    |   |      |   | 710      |  
|Purchases of premises and equipment                                                                                |  |                                         | (4,035   | ) |      |   | (2,975   | )
|Acquisition of Central Bank branches                                                                               |  |                                         | 62,515   |   |      |   |         |  
|Acquisition of Community Home Loan, Inc.                                                                           |  |                                         | (538     | ) |      |   |         |  
|                                                                                                                   |  |                                         |          |   |      |   |          |  
|Net cash used by investing activities                                                                              |  |                                         | (84,661  | ) |      |   | (84,486  | )
|                                                                                                                   |  |                                         |          |   |      |   |          |  
|Cash flows from financing activities net of effects of acquisitions:                                               |  |                                         |          |   |      |   |          |  
|Net change in:                                                                                                     |  |                                         |          |   |      |   |          |  
|Deposits                                                                                                           |  |                                         | 88,399   |   |      |   | 50,787   |  
|Other borrowings                                                                                                   |  |                                         | (41,314  | ) |      |   | 14,824   |  
|Federal funds purchased                                                                                            |  |                                         | (5,918   | ) |      |   | (19,684  | )
|Subordinated notes and debentures                                                                                  |  |                                         |         |   |      |   | (3,241   | )
|Securities sold under repurchase agreements                                                                        |  |                                         | 8,116    |   |      |   |         |  
|Net proceeds from issuance of common stock upon exercise of employee stock options                                 |  |                                         | 96       |   |      |   | 225      |  
|Net proceeds from issuance of common stock in public offering                                                      |  |                                         | 36,128   |   |      |   |         |  
|Dividends paid                                                                                                     |  |                                         | (839     | ) |      |   | (797     | )
|                                                                                                                   |  |                                         |          |   |      |   |          |  
|Net cash provided by financing activities                                                                          |  |                                         | 84,668   |   |      |   | 42,114   |  
|                                                                                                                   |  |                                         |          |   |      |   |          |  
|Net increase (decrease) in cash and cash equivalents                                                               |  |                                         | 1,928    |   |      |   | (5,537   | )
|Cash and cash equivalents at beginning of period                                                                   |  |                                         | 17,268   |   |      |   | 20,574   |  
|                                                                                                                   |  |                                         |          |   |      |   |          |  
|Cash and cash equivalents at end of period                                                                         |  | $                                       | 19,196   |   |      | $ | 15,037   |  
|                                                                                                                   |  |                                         |          |   |      |   |          |  



See accompanying notes
to condensed consolidated financial statements



5



---

TEXAS UNITED BANCSHARES, INC. AND SUBSIDIARIES



NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS



1. BASIS OF PRESENTATION



The unaudited condensed consolidated financial statements include the
accounts of Texas United Bancshares, Inc. (the Company) and its wholly-owned subsidiaries Texas United Nevada, Inc. (TUNI), State Bank (the Bank), and Community Home Loan, Inc. (CHL). All material
intercompany accounts and transactions have been eliminated in the consolidated report of the Company.



The accompanying unaudited condensed consolidated financial statements were prepared in accordance with generally accepted accounting principles for
interim financial information and with the instructions for Form 10-Q. In the opinion of management, the unaudited condensed consolidated financial statements reflect all adjustments, consisting only of normal and recurring adjustments, necessary to
present fairly the Companys consolidated financial position at September 30, 2004, the Companys consolidated results of operations for the three and nine months ended September 30, 2004 and 2003, respectively, consolidated cash flows for
the nine months ended September 30, 2004 and 2003, and consolidated changes in shareholders equity for the nine months ended September 30, 2004. Interim period results are not necessarily indicative of results of operations or cash flows for a
full-year period. The 2003 year-end consolidated balance sheet and statement of changes in shareholders equity data were derived from audited financial statements, but do not include all disclosures required by generally accepted accounting
principles.



These financial statements and the notes thereto
should be read in conjunction with the Companys audited consolidated financial statements for the year ended December 31, 2003 appearing in the Companys Annual Report on Form 10-K for 2003.



2. EARNINGS PER COMMON SHARE



Basic earnings per share (EPS) is computed by dividing net
income available to common shareholders by the weighted-average number of common shares outstanding during the period. Diluted EPS is computed by dividing net income available to common shareholders by the weighted-average number of common shares
and potentially dilutive common shares outstanding during the period. Potentially dilutive common shares are computed using the treasury stock method.



|                                                                                          |  |                                          |       |                                         |   |       |  |      |       |  |   |      
|----------------------------------------------------------------------------------------- |  | ---------------------------------------- | ----- | --------------------------------------- | - | ----- |  | ---- | ----- |  | - | -----
|                                                                                          |  | For the three months ended September 30, |       | For the nine months ended September 30,
|                                                                                          |  | 2004                                     |       | 2003                                    |   | 2004  |  | 2003
|                                                                                          |  | (In thousands, except per share data)   
|Net earnings available to common shareholders used in basic and diluted EPS               |  | $                                        | 1,561 |                                         | $ | 1,529 |  | $    | 4,621 |  | $ | 4,052
|                                                                                          |  |                                          |       |                                         |   |       |  |      |       |  |   |      
|Weighted-average common shares used in basic EPS                                          |  |                                          | 5,249 |                                         |   | 3,995 |  |      | 4,427 |  |   | 3,979
|Effect of dilutive securities:                                                            |  |                                          |       |                                         |   |       |  |      |       |  |   |      
|Stock options                                                                             |  |                                          | 172   |                                         |   | 168   |  |      | 178   |  |   | 162  
|                                                                                          |  |                                          |       |                                         |   |       |  |      |       |  |   |      
|Weighted-average common shares and potentially dilutive common shares used in diluted EPS |  |                                          | 5,421 |                                         |   | 4,163 |  |      | 4,605 |  |   | 4,141
|                                                                                          |  |                                          |       |                                         |   |       |  |      |       |  |   |      
|Basic EPS                                                                                 |  | $                                        | 0.30  |                                         | $ | 0.38  |  | $    | 1.04  |  | $ | 1.02 
|Diluted EPS                                                                               |  | $                                        | 0.29  |                                         | $ | 0.37  |  | $    | 1.00  |  | $ | 0.98 



The amounts shown
above do not give effect to the additional shares that the Company issued on October 1, 2004 related to the acquisition of GNB Bancshares, Inc. as more fully described in Note 9.



3. INTANGIBLE ASSETS



The gross carrying amount of intangible assets and associated amortization at September 30, 2004 is presented in the following table:



|                             |  |                     |       |                                         |   |      
|---------------------------- |  | ------------------- | ----- | --------------------------------------- | - | -----
|                             |  | GrossCarryingAmount |       | Accumulated Amortization and Impairment
|                             |  | (In thousands)     
|Amortized intangible assets: |  |                     |       |                                         |   |      
|Mortgage servicing rights    |  | $                   | 6,980 |                                         | $ | 2,211
|Core deposit intangibles     |  | $                   | 564   |                                         | $ | 248  



6



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The projections of amortization expense shown below for mortgage servicing rights are based on existing
asset balances and the existing interest rate environment as of September 30, 2004. Future amortization expense may be significantly different depending upon changes in the mortgage servicing portfolio, mortgage interest rates and market conditions.



The following table shows the current period and estimated
future amortization for intangible assets:



|                                                |  |                           |     |                          |   |       |  |   |    
|----------------------------------------------- |  | ------------------------- | --- | ------------------------ | - | ----- |  | - | ---
|                                                |  | Mortgage Servicing Rights |     | Core Deposit Intangibles |   | Total
|                                                |  | (In thousands)           
|Nine months ended September 30, 2004 (actual)   |  | $                         | 678 |                          | $ | 77    |  | $ | 755
|Three months ended December 31, 2004 (estimate) |  |                           | 242 |                          |   | 26    |  |   | 268
|Estimate for the year ended December 31,        |  |                           |     |                          |   |       |  |   |    
|2005                                            |  |                           | 882 |                          |   | 88    |  |   | 970
|2006                                            |  |                           | 835 |                          |   | 72    |  |   | 907
|2007                                            |  |                           | 835 |                          |   | 56    |  |   | 891
|2008                                            |  |                           | 759 |                          |   | 40    |  |   | 799
|2009                                            |  |                           | 757 |                          |   | 25    |  |   | 782



4. STOCK BASED COMPENSATION



The Company accounts for its stock based employee
compensation plans on the intrinsic value method provided in Accounting Principles Board Opinion (APB) No. 25, Accounting for Stock Issued to Employees, and related Interpretations. Because the exercise price of the
Companys employee stock options equals or exceeds the market price of the underlying stock on the date of grant, no compensation expense is recognized on option plans.



Statement of Financial Accounting Standards (SFAS) No. 123, (SFAS 123) Accounting for Stock-Based Compensation,
as amended by SFAS No. 148, Accounting for Stock-Based Compensation  Transition and Disclosure, requires pro forma disclosures of net earnings and earnings per share for companies not adopting its fair value accounting method for
stock-based employee compensation. The pro forma disclosures below use the fair value method of SFAS 123 to measure compensation expense for stock-based compensation plans.



|                                                                                                               |  |                                 |       |      |   |      
|-------------------------------------------------------------------------------------------------------------- |  | ------------------------------- | ----- | ---- | - | -----
|                                                                                                               |  | Nine Months Ended September 30,
|                                                                                                               |  | 2004                            |       | 2003
|                                                                                                               |  | (In thousands)                 
|Net earnings, as reported                                                                                      |  | $                               | 4,621 |      | $ | 4,052
|Less: Total stock-based compensation expense determined under the fair value method for all awards, net of tax |  |                                 | 19    |      |   | 24   
|                                                                                                               |  |                                 |       |      |   |      
|Pro forma net earnings                                                                                         |  | $                               | 4,602 |      | $ | 4,028
|                                                                                                               |  |                                 |       |      |   |      



|                      |  |                                |      |      |   |     
|--------------------- |  | ------------------------------ | ---- | ---- | - | ----
|                      |  | Nine Months EndedSeptember 30,
|                      |  | 2004                           |      | 2003
|Earnings per share:   |  |                                |      |      |   |     
|Basic  as reported   |  | $                              | 1.04 |      | $ | 1.02
|Basic  pro forma     |  |                                | 1.04 |      |   | 1.01
|                      |  |                               
|Diluted  as reported |  |                                | 1.00 |      |   | 0.98
|Diluted  pro forma   |  |                                | 1.00 |      |   | 0.97



5. ACCOUNTING CHANGES



Mortgage Loan Interest Rate Lock Commitments



The Securities and Exchange Commission staff recently released Staff
Accounting Bulletin (SAB) 105, Loan Commitments Accounted for as Derivative Instruments. SAB 105 requires that a lender should not consider the expected future cash flows related to loan servicing or include any internally
developed intangible assets, such as customer-related intangible assets, in determining the fair value of loan commitments accounted for as derivatives.



7



---

Companies were required to adopt SAB 105 for commitments entered into after March 31, 2004. The
requirements of SAB 105 apply to the Companys mortgage loan interest rate lock commitments related to loans held for sale. At September 30, 2004, such commitments with a notional amount of approximately $21.2 million were outstanding at the
Bank. The fair value of these commitments is insignificant. The Company adopted SAB 105 as of April 1, 2004, and application of its guidance had no material impact on the Companys results of operations and financial position.



In March 2004, the EITF reached consensus on Issue 03-01 (EITF 03-01),
The Meaning of Other-Than-Temporary Impairment and Its Application to Certain Investments. EITF 03-01 includes new guidance for evaluating and recording impairment losses on debt and equity investments, as well as new disclosure
requirements for investments that are deemed to be temporarily impaired. This Issue specifically addresses whether an investor has the ability and intent to hold an investment until recovery. In addition, Issue 03-01 contains disclosure requirements
that provide useful information about impairments that have not been recognized as other-than-temporary for investments with in the scope of this Issue. On September 30, 2004, the Financial Accounting Standards Board deferred the effective date of
the Issues guidance on how to evaluate and recognize an impairment loss that is other-than-temporary. This Issues guidance is pending the issuance of a final FASB Staff Position (FSP) relating to the draft FSP EITF Issue
03-01-a, Implementation Guidance for the Application of Paragraph 16 of EITF Issue No. 03-01, The Meaning of Other-Than-Temporary Impairment and its Application to Certain Investments, which the Board may issue as early as
November. This deferral did not change the disclosure guidance which remains effective for fiscal years ending after December 15, 2003. Matters being considered by the FASB which may impact the Companys financial reporting include the
accounting as a component in determining net income for declines in market value of debt securities which are due solely to changes in market interest rates and the effect of sales of available-for-sale securities which have market values below cost
at the time of sale and whether such sale indicates an absence of intent and ability of the investor to hold to a forecasted recovery of the investments value to its original cost.



6. OFF BALANCE SHEET CREDIT COMMITMENTS



In the normal course of business, the Company enters into various transactions, which, in accordance with generally accepted accounting principles, are
not included in its consolidated balance sheet. These transactions are referred to as off balance-sheet commitments. The Company enters into these transactions to meet the financing needs of its customers. These transactions include
commitments to extend credit and standby letters of credit, which involve elements of credit risk in excess of the amounts recognized in the consolidated balance sheet. The Company minimizes its exposure to loss under these commitments by subjecting
them to credit approval and monitoring procedures.



The Company
enters into contractual commitments to extend credit, normally with fixed expiration dates or termination clauses, at specified rates and for specific purposes. Customers use credit commitments to ensure that funds will be available for working
capital purposes, for capital expenditures and to ensure access to funds at specified terms and conditions. Substantially all of the Companys commitments to extend credit are contingent upon customers maintaining specific credit standards at
the time of loan funding. Management assesses the credit risk associated with certain commitments to extend credit in determining the level of the allowance for loan losses. Commitments to extend credit totaled $121.8 million at September 30, 2004
and $58.0 million at December 31, 2003.



Standby letters of
credit are written conditional commitments issued by the Company to guarantee the performance of a customer to a third party. The Companys policies generally require that standby letters of credit arrangements contain collateral and debt
covenants similar to those contained in loan agreements. In the event the customer does not perform in accordance with the terms of the agreement with the third party, the Company would be required to fund the commitment. The maximum potential
amount of future payments the Company could be required to make is represented by the contractual amount of the commitment. If the commitment is funded, the Company would be entitled to seek recovery from the customer. Standby letters of credit
totaled $2.3 million at September 30, 2004 and $695,000 at December 31, 2003. At September 30, 2004, the outstanding standby letters of credit had a weighted average term of approximately one year. As of September 30, 2004 and December 31, 2003, no
liability for the fair value of the Companys potential obligations under these guarantees has been recorded since the amount is deemed immaterial.



7. CRITICAL ACCOUNTING POLICIES



The Companys accounting policies are integral to understanding the results reported. The Companys accounting policies are described in detail
in Note A to its consolidated financial statements included in its Annual Report on Form 10-K. The Company believes that of its significant accounting policies, the allowance for loan losses and mortgage servicing rights assets may involve a higher
degree of judgment and complexity.



The allowance for loan
losses is a valuation allowance for probable losses inherent in the loan portfolio. Loans are charged to the allowance when the loss is confirmed or when a determination is made that a probable loss has occurred on a specific loan. Recoveries are
credited to the allowance at the time of recovery. Throughout the year, management estimates the probable level of losses to determine whether the allowance for loan losses is adequate to absorb losses in the existing portfolio. Based on these
estimates, an amount is charged to the provision for loan losses and credited to the allowance for loan losses in order to adjust the



8



---

allowance to a level determined to be adequate to absorb losses. Managements judgment as to the level of probable
losses on existing loans involves the consideration of current economic conditions and their estimated effects on specific borrowers; an evaluation of the existing relationships among loans, potential loan losses and the present level of the
allowance; results of examinations of the loan portfolio by regulatory agencies; and managements internal review of the loan portfolio. In determining the collectability of certain loans, management also considers the fair value of any
underlying collateral. The amount ultimately realized may differ from the carrying value of these assets because of economic, operating or other conditions beyond the Companys control. Please refer to the subsequent discussion of
Allowance for Loan Losses included in Managements Discussion and Analysis of Financial Condition and Results of Operations for additional insight into managements approach and methodology in estimating the
allowance for loan losses.



Mortgage servicing rights assets
are established and accounted for based on discounted cash flow modeling techniques which require management to make estimates regarding the amount and timing of expected future cash flows, including assumptions about loan repayment rates, loan loss
experience, and costs to service, as well as discount rates that consider the risk involved. Because the values of these assets are sensitive to changes in assumptions, the valuation of mortgage servicing rights is considered a critical accounting
estimate. Please refer to Note 3 to the Condensed Consolidated Financial Statements above and discussion of Noninterest Income included in Managements Discussion and Analysis of Financial Condition and Results of
Operations for additional insight into managements approach in estimating transfers and servicing of financial assets.



8. SEGMENT INFORMATION



Beginning in 2004, the Company has two reportable operating segments; commercial banking and mortgage banking. The mortgage banking activities are
conducted through CHL and the mortgage division of the Bank. The Bank owns 100% of CHL and operates CHL as a subsidiary of the Bank. The Company reports the financial position and the results of operations of each segment on a consolidated basis.
The commercial banking and the mortgage banking segments are managed separately because each business requires distinct marketing strategies and each offers different products and services.



Summarized below is the financial information by operating segment for the
three and nine-month periods ended September 30, 2004:



|                                 |  |                                               |         |   |                                              |   |        |              |  |   |                    |   |  |                  |         |   |              |   |        |   |  |   |         |  
|-------------------------------- |  | --------------------------------------------- | ------- | - | -------------------------------------------- | - | ------ | ------------ |  | - | ------------------ | - |  | ---------------- | ------- | - | ------------ | - | ------ | - |  | - | ------- | -
|                                 |  | For the Three Months Ended September 30, 2004 |         |   | For the Nine Months Ended September 30, 2004 |  
|                                 |  | (In thousands)                                |         |   | (In thousands)                               |  
|                                 |  | Commercial Banking                            |         |   | Mortgage Banking                             |   |        | Consolidated |  |   | Commercial Banking |   |  | Mortgage Banking |         |   | Consolidated |  
|Net interest income              |  | $                                             | 6,218   |   |                                              | $ | 1,973  |              |  | $ | 8,191              |   |  | $                | 17,099  |   |              | $ | 4,904  |   |  | $ | 22,003  |  
|Noninterest income               |  |                                               | 2,210   |   |                                              |   | 2,798  |              |  |   | 5,008              |   |  |                  | 7,098   |   |              |   | 6,481  |   |  |   | 13,579  |  
|                                 |  |                                               |         |   |                                              |   |        |              |  |   |                    |   |  |                  |         |   |              |   |        |   |  |   |         |  
|Revenue                          |  |                                               | 8,428   |   |                                              |   | 4,771  |              |  |   | 13,199             |   |  |                  | 24,197  |   |              |   | 11,385 |   |  |   | 35,582  |  
|Provision for loan losses        |  |                                               | (700    | ) |                                              |   |       |              |  |   | (700               | ) |  |                  | (1,150  | ) |              |   |       |   |  |   | (1,150  | )
|Noninterest expense              |  |                                               | (7,296  | ) |                                              |   | (2,993 | )            |  |   | (10,289            | ) |  |                  | (19,900 | ) |              |   | (7,735 | ) |  |   | (27,635 | )
|                                 |  |                                               |         |   |                                              |   |        |              |  |   |                    |   |  |                  |         |   |              |   |        |   |  |   |         |  
|Earnings before income taxes     |  |                                               | 432     |   |                                              |   | 1,778  |              |  |   | 2,210              |   |  |                  | 3,147   |   |              |   | 3,650  |   |  |   | 6,797   |  
|Provision for income taxes       |  |                                               | (43     | ) |                                              |   | (606   | )            |  |   | (649               | ) |  |                  | (935    | ) |              |   | (1,241 | ) |  |   | (2,176  | )
|                                 |  |                                               |         |   |                                              |   |        |              |  |   |                    |   |  |                  |         |   |              |   |        |   |  |   |         |  
|Net earnings                     |  | $                                             | 389     |   |                                              | $ | 1,172  |              |  | $ | 1,561              |   |  | $                | 2,212   |   |              | $ | 2,409  |   |  | $ | 4,621   |  
|                                 |  |                                               |         |   |                                              |   |        |              |  |   |                    |   |  |                  |         |   |              |   |        |   |  |   |         |  
|Total assets, September 30, 2004 |  | $                                             | 759,731 |   |                                              | $ | 79,596 |              |  | $ | 839,327            |   |  | $                | 759,731 |   |              | $ | 79,596 |   |  | $ | 839,327 |  
|                                 |  |                                               |         |   |                                              |   |        |              |  |   |                    |   |  |                  |         |   |              |   |        |   |  |   |         |  



9. STOCK OFFERING AND ACQUISITIONS



Pursuant to a registration statement on Form S-1 filed
with, and declared effective by, the Securities and Exchange Commission, the Company sold 2,000,000 shares of its common stock at $17.00 per share to the public in an underwritten firm commitment offering which closed on August 10, 2004. The
underwriters exercised their 30-day option on August 26, 2004 to purchase an additional 300,000 shares to cover over-allotments. Of the $36.1 million in net proceeds, after deduction of underwriting discounts and commissions and $788,000 in offering
expenses, approximately $10.0 million was used to repay the Companys outstanding line of credit which was used as additional capital to support the acquisition of the additional assets from the Central Bank branches. In addition, approximately
$18.4 million of the net proceeds will be used to pay the cash portion of the merger consideration to be paid to GNB shareholders and the balance will be used for general corporate purposes, including contributions to the capital of State Bank, the
possible opening of additional branches and the possible acquisition of financial institutions.



On April 29, 2004, the Company entered into a definitive agreement to acquire GNB Bancshares, Inc., Gainesville, Texas. The Company completed the acquisition on October
1, 2004. Pursuant to the terms of the agreement, in exchange for all outstanding shares of GNB capital stock, the Company paid $18.4 million in cash and issued 1,456,819 shares of its common stock. The Company operates GNBs wholly-owned
subsidiary bank, GNB Financial, n.a., as a separate subsidiary. GNB Financial has seven full-service banking centers located in Gainesville, Denton and Ennis, Texas. As of September 30, 2004, on a consolidated basis, GNB had total assets of $223.7
million, total loans of $166.6 million, total deposits of $186.3 million and shareholders equity of $19.2 million.



9



---

On May 3, 2004, the Company entered into a definitive agreement to purchase the loans and premises and
assume the deposit liabilities of the Caldwell, Texas and Lexington, Texas branches of Central Bank, Houston, Texas. Under the terms of the agreement, the Company agreed to pay a premium of 8.02% of total deposits and $800,000 for the related real
property and improvements and the related furniture, fixtures and equipment. The Company completed the acquisition on July 30, 2004. On such date, deposits at both branches totaled $99.2 million and loans totaled $33.1 million. Based on these
totals, the Company paid approximately $8.8 million to acquire these branches. Under the terms of the purchase agreement, on September 23, 2004, the Company put-back approximately $5.3 million in loans. Goodwill of $8.0 million was recognized in
connection with this transaction.



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



Special Cautionary Notice Regarding Forward-looking Statements



Statements and financial discussion and analysis contained in the Form 10-Q that are not historical facts are forward-looking statements within the
meaning of Section 27A of the Securities Act of 1933 and Section 21E of the Securities Exchange Act of 1934. The Company intends such forward-looking statements to be covered by the safe harbor provisions for forward-looking statements contained in
the Private Securities Litigation Reform Act of 1995 and are including this statement for purposes of invoking these safe harbor provisions. These forward-looking statements include information about possible or assumed future results of the
Companys operations or performance. When the Company uses any of the words believe, expect, anticipate, estimate, continue, intend, may, will,
should, or similar expressions, identifies these forward-looking statements. Many possible factors or events could affect the future financial results and performance of the Company and could cause those financial results or performance
to differ materially from those expressed in the forward-looking statement. These possible events or factors include, without limitation:



| |  | general business and economic conditions in the markets the Company serves change or are less favorable than it expected;
| | - | -------------------------------------------------------------------------------------------------------------------------



| |  | deposit attrition, operating costs, customer loss and business disruption are greater than the Company expected;
| | - | ----------------------------------------------------------------------------------------------------------------



| |  | competitive factors including product and pricing pressures among financial services organizations may increase;
| | - | ----------------------------------------------------------------------------------------------------------------



| |  | changes in the interest rate environment reduce the Companys interest margins;
| | - | -------------------------------------------------------------------------------



| |  | changes in market rates and prices may adversely impact securities, loans, deposits, mortgage servicing rights, and other financial instruments;
| | - | ------------------------------------------------------------------------------------------------------------------------------------------------



| |  | legislative or regulatory developments including changes in laws concerning taxes, banking, securities, insurance and other aspects of the financial securities industry may
adversely affect the Companys business;
| | - | ---------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------



| |  | personal or commercial bankruptcies increase;
| | - | ---------------------------------------------



| |  | the Companys ability to expand and grow its business and operations, including the establishment of additional branches and acquisition of additional banks or branches of
banks may be more difficult or costly than the Company expected;
| | - | --------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------



| |  | any future acquisitions may be more difficult to integrate than expected and the Company may be unable to realize any cost savings and revenue enhancements the Company may have
projected in connection with such acquisitions;
| | - | --------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------



| |  | changes in accounting principles, policies or guidelines;
| | - | ---------------------------------------------------------



| |  | changes occur in the securities markets; and
| | - | --------------------------------------------



| |  | technology-related changes may be harder to make or more expensive than the Company anticipated.
| | - | ------------------------------------------------------------------------------------------------



A forward-looking statement may include a statement of the assumptions or bases underlying the forward-looking statement.
The Company believes it has chosen the assumptions or bases in good faith and that they are reasonable. However, the Company cautions you that assumptions or bases almost always vary from actual results, and the differences between assumptions or
bases and actual results can be material. The Company will not update these statements unless the securities laws require us to do so.



Acquisitions. On April 29, 2004, the Company entered into a definitive agreement to acquire GNB Bancshares, Inc., Gainesville, Texas. The Company
completed the acquisition on October 1, 2004. Pursuant to the terms of the agreement, in exchange for all outstanding shares of GNB capital stock, the Company paid $18.4 million in cash and issued 1,456,819 shares of its common stock. The Company
operates GNBs wholly-owned subsidiary bank, GNB Financial, n.a., as a separate subsidiary. GNB Financial has seven full-service banking centers located in Gainesville, Denton and Ennis, Texas. As of September 30, 2004, on a consolidated basis,
GNB had total assets of $223.7 million, total loans of $166.6 million, total deposits of $186.3 million and shareholders equity of $19.2 million.



10



---

On May 3, 2004, the Company entered into a definitive agreement to purchase the loans and premises and
assume the deposit liabilities of the Caldwell, Texas and Lexington, Texas branches of Central Bank, Houston, Texas. Under the terms of the agreement, the Company agreed to pay a premium of 8.02% of total deposits and $800,000 for the related real
property and improvements and the related furniture, fixtures and equipment. The Company completed the acquisition on July 30, 2004. On such date, deposits at both branches totaled $99.2 million and loans totaled $33.1 million. Based on these
totals, the Company paid approximately $8.8 million to acquire these branches. Under the terms of the purchase agreement, on September 23, 2004, the Company put-back approximately $5.3 million in loans. Goodwill of $8.0 million was recognized with
this transaction.



Public Offering. Pursuant to a
registration statement on Form S-1 filed with, and declared effective by, the Securities and Exchange Commission, the Company sold 2,000,000 shares of its common stock at $17.00 per share to the public in an underwritten firm commitment offering
which closed on August 10, 2004. The underwriters exercised their 30-day option on August 26, 2004 to purchase an additional 300,000 shares to cover over-allotments. Of the $36.1 million in net proceeds, after deduction of underwriting discounts and
commissions and $788,000 in offering expenses, approximately $10.0 million was used to repay the Companys outstanding line of credit which was used as additional capital to support the acquisition of the additional assets from the Central Bank
branches. In addition, approximately $18.4 million of the net proceeds will be used to pay the cash portion of the merger consideration to be paid to GNB shareholders and the balance will be used for general corporate purposes, including
contributions to the capital of State Bank, the possible opening of additional branches and the possible acquisition of financial institutions.



General.The Company is a Texas corporation formed in 1995 as a bank holding company for State Bank, which was chartered in 1906. The Company
adopted its current name, Texas United Bancshares, Inc., in June 1998 after the merger of South Central Texas Bancshares, Inc. with and into the Company, which was then named Premier Bancshares, Inc. The Company derives substantially all of its net
income from its wholly-owned subsidiary State Bank. At September 30, 2004, through State Bank, the Company had 20 full service banking centers and three loan production offices serving 11 counties primarily between the Houston, Austin and San
Antonio metropolitan areas in central and south central Texas. In addition, the Company has eight loan production offices of CHL located in Houston and San Antonio.



Net earnings for the three months ended September 30, 2004 were $1.6 million, an increase of 2.1% compared with $1.5 million
for the same period in 2003. The increase in net earnings was a combined result of higher net interest income and increased non-interest income, partially offset by higher non-interest expense. Net earnings for the nine months ended September 30,
2004 were $4.6 million, representing an increase of 14.0% compared with $4.1 million for the same period in 2003. This increase was primarily due to gains on the sale of mortgage loans generated by CHL, a decrease in the provision for loan losses
and an increase in net interest income, partially offset by a decrease in mortgage servicing revenue, a decrease in gains on the sale of securities and higher non-interest expense compared with the same period in 2003. Basic and diluted earnings per
share (EPS) for the three months ended September 30, 2004 were $0.30 and $0.29 compared with $0.38 and $0.37, respectively, for the same period in 2003. For the nine months ended September 30, 2004, basic and diluted EPS were $1.04 and $1.00,
respectively, compared with $1.02 and $0.98, respectively, for the same period in 2003. The decrease in basic and diluted earnings per share for the three months ended September 30, 2004 and the slight increase for the nine months ended September
30, 2004 compared with the same periods in 2003, notwithstanding the increase in net earnings during those periods, is due to the 2,300,000 additional shares of common stock issued in connection with the Companys public offering completed in
August 2004.



At September 30, 2004, total assets were $839.3
million compared with $637.7 million at December 31, 2003. The $201.6 million or 31.6% increase in total assets over December 31, 2003 was primarily attributable to increases in investment securities, net loans and loans held for sale, and the
addition of the Central Bank branches. At September 30, 2004, net loans, including loans held for sale, were $494.1 million compared with $380.4 million at December 31, 2003. The increase is primarily due to internal growth and the acquisitions of
Community Home Loan and the Central Bank branches. Total deposits at September 30, 2004 were $688.9 million compared with $501.1 million at December 31, 2003. The $187.8 million or 37.5% increase in deposits compared with December 31, 2003 is
primarily attributed to internal growth and the addition of the Central Bank branches. Shareholders equity at September 30, 2004 was $78.7 million compared with $38.0 million at December 31, 2003. The $40.7 million or 107.1% increase is
primarily attributed to the $36.1 million in net proceeds from the public offering. The Companys annualized return on average assets was 0.85% for the nine months ended September 30, 2004, compared with 0.90% for the same period in 2003. The
annualized return on average shareholders equity was 13.4% for the nine months ended September 30, 2004, down from 14.6% for the same period in 2003.



Net Interest Income.For the three months ended September 30, 2004, net interest income, before the provision for loan losses, increased by 21.0%
to $8.2 million compared with $6.8 million in the same period in 2003. The increase was primarily due to the increased volumes in loans and investment securities in relation to the decrease in rates on earning assets. For the three months ended
September 30, 2004 and 2003, the net interest margin decreased by 31 basis points to 4.42% from 4.73% and the net interest spread decreased by 39 basis points to 4.06% from 4.45%, respectively.



11



---

For the nine months ended September 30, 2004, net interest income, before the provision for loan losses,
increased by 12.2% to $22.0 million compared with $19.6 million in the same period in 2003. For the nine months ended September 30, 2004 and 2003, the net interest margins and spreads decreased by 38 basis points to 4.49% from 4.87% and by 35 basis
points to 4.22% from 4.57%, respectively. The decrease of the net interest margin was a combined result of lower yields in investments and loan balances, and a decrease in the cost of funds.



Interest income for the three months ended September 30, 2004 was $11.5
million compared with $9.4 million for the same period in 2003. As compared to the three months ended September 30, 2003, the average total loan volumes for the three months ended September 30, 2004 increased by $92.1 million or 23.9%, while the
average yields on average total loan volumes decreased 31 basis points to 7.63%. Average total investment volumes for the three months ended September 30, 2004 increased by $77.2 million or 42.9% compared with the same period in 2003, while the
average yields on average investments decreased by 2 basis points. For the three months ended September 30, 2004, compared to the same period in 2003, the yield on total average earning assets decreased by 33 basis points to 6.2%.



Interest income for the nine months ended September 30, 2004 was $30.6
million compared with $27.6 million for the same period in 2003. This increase was maintained through growth in average earning assets. As compared to the nine months ended September 30, 2003, the average total loan volumes for the nine month period
ended September 30, 2004 increased by $52.0 million or 13.7%, while the average yields on average total loans decreased by 47 basis points to 7.64%. Compared with the nine months ended September 30, 2003, average total investment volumes for the
nine months ended September 30, 2004 increased by $65.7 million or 42.3%, while the average yields on average investment securities decreased by 34 basis points. For the nine months ended September 30, 2004 compared with the same period in 2003, the
yield on total average earning assets decreased by 62 basis points to 6.25%.



Interest expense increased for the three months ended September 30, 2004 by $699,000 or 27.0% to $3.3 million, compared with $2.6 million for the same period in 2003. The increased interest expense was the result of
higher average interest-bearing deposit volumes. Compared with the three month period ended September 30, 2003, average interest bearing deposit volumes for the three months ended September 30, 2004 increased by $128.0 million or 31.7%, while the
average rates paid on interest-bearing deposits decreased by 8 basis points to 1.74%.



For the nine months ended September 30, 2004, interest expense increased by $555,000 or 6.9% to $8.6 million compared with $8.0 million for the same period in 2003. The increased interest expense was the result of
higher interest-bearing deposit volumes coupled with overall lower interest rates paid on those deposits. Compared with the nine months ended September 30, 2003, average interest-bearing deposit volumes increased by $90.0 million or 23.4%, while the
average rates paid on interest-bearing deposits decreased by 27 basis points to 1.73%.



12



---

The following tables set forth for the periods indicated an analysis of net interest income by each major
category of interest-earning assets and interest-bearing liabilities, the average amounts outstanding and the interest earned or paid on such amounts. The tables also set forth the average rate earned on total interest-earning assets, the average
rate paid on total interest-bearing liabilities and the net interest margin on average total interest-earning assets for the same periods. All average balances are daily average balances and nonaccruing loans have been included in the table as loans
carrying a zero yield.



|                                                                |  |                                          |         |                     |      |                       |  |      |                           |  |                     |         |                       |   |       |  |       |  
|--------------------------------------------------------------- |  | ---------------------------------------- | ------- | ------------------- | ---- | --------------------- |  | ---- | ------------------------- |  | ------------------- | ------- | --------------------- | - | ----- |  | ----- | -
|                                                                |  | For the three months ended September 30, |        
|                                                                |  | 2004                                     |         |                     | 2003 |                      
|                                                                |  | AverageOutstandingBalance                |         | InterestEarned/Paid |      | AverageYield/Rate (1) |  |      | AverageOutstandingBalance |  | InterestEarned/Paid |         | AverageYield/Rate (1) |  
|                                                                |  | (Dollars in thousands)                   |        
|Assets                                                          |  |                                          |         |                     |      |                       |  |      |                           |  |                     |         |                       |   |       |  |       |  
|Interest-earning assets:                                        |  |                                          |         |                     |      |                       |  |      |                           |  |                     |         |                       |   |       |  |       |  
|Loans                                                           |  | $                                        | 476,826 |                     |      | 9,146                 |  | 7.63 | %                         |  | $                   | 384,748 |                       | $ | 7,701 |  | 7.94  | %
|Taxable securities                                              |  |                                          | 248,203 |                     |      | 2,227                 |  | 3.57 |                           |  |                     | 168,502 |                       |   | 1,513 |  | 3.56  |  
|Non-taxable securities                                          |  |                                          | 8,687   |                     |      | 97                    |  | 4.44 |                           |  |                     | 11,237  |                       |   | 126   |  | 4.45  |  
|Federal funds sold                                              |  |                                          | 2,800   |                     |      | 7                     |  | 1.00 |                           |  |                     | 3,581   |                       |   | 17    |  | 1.88  |  
|                                                                |  |                                          |         |                     |      |                       |  |      |                           |  |                     |         |                       |   |       |  |       |  
|Total interest-earning assets                                   |  |                                          | 736,516 |                     |      | 11,477                |  | 6.20 |                           |  |                     | 568,068 |                       |   | 9,357 |  | 6.53  |  
|                                                                |  |                                          |         |                     |      |                       |  |      |                           |  |                     |         |                       |   |       |  |       |  
|Less allowance for loan losses                                  |  |                                          | 4,253   |                     |      |                       |  |      |                           |  |                     | 3,663   |                       |   |       |  |       |  
|                                                                |  |                                          |         |                     |      |                       |  |      |                           |  |                     |         |                       |   |       |  |       |  
|Total interest-earning assets, net of allowance for loan losses |  |                                          | 732,263 |                     |      |                       |  |      |                           |  |                     | 564,405 |                       |   |       |  |       |  
|Noninterest-earning assets                                      |  |                                          | 79,571  |                     |      |                       |  |      |                           |  |                     | 66,993  |                       |   |       |  |       |  
|                                                                |  |                                          |         |                     |      |                       |  |      |                           |  |                     |         |                       |   |       |  |       |  
|Total assets                                                    |  | $                                        | 811,834 |                     |      |                       |  |      |                           |  | $                   | 631,398 |                       |   |       |  |       |  
|                                                                |  |                                          |         |                     |      |                       |  |      |                           |  |                     |         |                       |   |       |  |       |  
|Liabilities and shareholders equity                            |  |                                          |         |                     |      |                       |  |      |                           |  |                     |         |                       |   |       |  |       |  
|Interest-bearing liabilities:                                   |  |                                          |         |                     |      |                       |  |      |                           |  |                     |         |                       |   |       |  |       |  
|Interest-bearing demand deposits                                |  | $                                        | 196,222 |                     | $    | 665                   |  | 1.35 | %                         |  | $                   | 126,239 |                       | $ | 297   |  | 0.93  | %
|Savings and money market accounts                               |  |                                          | 115,974 |                     |      | 351                   |  | 1.20 |                           |  |                     | 83,262  |                       |   | 219   |  | 1.04  |  
|Time deposits                                                   |  |                                          | 219,076 |                     |      | 1,304                 |  | 2.37 |                           |  |                     | 193,781 |                       |   | 1,338 |  | 2.74  |  
|Federal funds purchased                                         |  |                                          | 7,568   |                     |      | 57                    |  | 3.00 |                           |  |                     | 7,574   |                       |   | 30    |  | 1.57  |  
|Junior subordinated deferrable interest debentures              |  |                                          | 12,365  |                     |      | 266                   |  | 8.56 |                           |  |                     | 7,000   |                       |   | 185   |  | 10.49 |  
|Other borrowings                                                |  |                                          | 60,126  |                     |      | 643                   |  | 4.25 |                           |  |                     | 74,598  |                       |   | 518   |  | 2.75  |  
|                                                                |  |                                          |         |                     |      |                       |  |      |                           |  |                     |         |                       |   |       |  |       |  
|Total interest-bearing liabilities                              |  |                                          | 611,331 |                     |      | 3,286                 |  | 2.14 |                           |  |                     | 492,454 |                       |   | 2,587 |  | 2.08  |  
|                                                                |  |                                          |         |                     |      |                       |  |      |                           |  |                     |         |                       |   |       |  |       |  
|Noninterest-bearing liabilities:                                |  |                                          |         |                     |      |                       |  |      |                           |  |                     |         |                       |   |       |  |       |  
|Demand deposits                                                 |  |                                          | 133,288 |                     |      |                       |  |      |                           |  |                     | 97,926  |                       |   |       |  |       |  
|Other liabilities                                               |  |                                          | 7,216   |                     |      |                       |  |      |                           |  |                     | 4,397   |                       |   |       |  |       |  
|                                                                |  |                                          |         |                     |      |                       |  |      |                           |  |                     |         |                       |   |       |  |       |  
|Total liabilities                                               |  |                                          | 751,835 |                     |      |                       |  |      |                           |  |                     | 594,777 |                       |   |       |  |       |  
|Shareholders equity                                            |  |                                          | 59,999  |                     |      |                       |  |      |                           |  |                     | 36,621  |                       |   |       |  |       |  
|                                                                |  |                                          |         |                     |      |                       |  |      |                           |  |                     |         |                       |   |       |  |       |  
|Total liabilities and shareholders equity                      |  | $                                        | 811,834 |                     |      |                       |  |      |                           |  | $                   | 631,398 |                       |   |       |  |       |  
|                                                                |  |                                          |         |                     |      |                       |  |      |                           |  |                     |         |                       |   |       |  |       |  
|Net interest income                                             |  |                                          |         |                     | $    | 8,191                 |  |      |                           |  |                     |         |                       | $ | 6,770 |  |       |  
|                                                                |  |                                          |         |                     |      |                       |  |      |                           |  |                     |         |                       |   |       |  |       |  
|Net interest spread                                             |  |                                          |         |                     |      |                       |  | 4.06 | %                         |  |                     |         |                       |   |       |  | 4.45  | %
|Net interest margin                                             |  |                                          |         |                     |      |                       |  | 4.42 | %                         |  |                     |         |                       |   |       |  | 4.73  | %

---

|(1) | Annualized
|--- | ----------



13



---

|                                                                |  |                                         |         |                     |      |                       |  |      |                           |  |                     |         |                       |   |        |  |       |  
|--------------------------------------------------------------- |  | --------------------------------------- | ------- | ------------------- | ---- | --------------------- |  | ---- | ------------------------- |  | ------------------- | ------- | --------------------- | - | ------ |  | ----- | -
|                                                                |  | For the nine months ended September 30, |        
|                                                                |  | 2004                                    |         |                     | 2003 |                      
|                                                                |  | AverageOutstandingBalance               |         | InterestEarned/Paid |      | AverageYield/Rate (1) |  |      | AverageOutstandingBalance |  | InterestEarned/Paid |         | AverageYield/Rate (1) |  
|                                                                |  | (Dollars in thousands)                  |        
|Assets                                                          |  |                                         |         |                     |      |                       |  |      |                           |  |                     |         |                       |   |        |  |       |  
|Interest-earning assets:                                        |  |                                         |         |                     |      |                       |  |      |                           |  |                     |         |                       |   |        |  |       |  
|Loans                                                           |  | $                                       | 431,255 |                     | $    | 24,654                |  | 7.64 | %                         |  | $                   | 379,303 |                       | $ | 23,006 |  | 8.11  | %
|Taxable securities                                              |  |                                         | 212,208 |                     |      | 5,639                 |  | 3.55 |                           |  |                     | 142,561 |                       |   | 4,143  |  | 3.89  |  
|Non-taxable securities                                          |  |                                         | 8,729   |                     |      | 292                   |  | 4.47 |                           |  |                     | 12,655  |                       |   | 424    |  | 4.48  |  
|Federal funds sold                                              |  |                                         | 1,887   |                     |      | 14                    |  | 0.99 |                           |  |                     | 3,427   |                       |   | 70     |  | 2.73  |  
|                                                                |  |                                         |         |                     |      |                       |  |      |                           |  |                     |         |                       |   |        |  |       |  
|Total interest-earning assets                                   |  |                                         | 654,079 |                     |      | 30,599                |  | 6.25 |                           |  |                     | 537,946 |                       |   | 27,643 |  | 6.87  |  
|                                                                |  |                                         |         |                     |      |                       |  |      |                           |  |                     |         |                       |   |        |  |       |  
|Less allowance for loan losses                                  |  |                                         | 4,061   |                     |      |                       |  |      |                           |  |                     | 3,515   |                       |   |        |  |       |  
|                                                                |  |                                         |         |                     |      |                       |  |      |                           |  |                     |         |                       |   |        |  |       |  
|Total interest-earning assets, net of allowance for loan losses |  |                                         | 650,018 |                     |      |                       |  |      |                           |  |                     | 534,431 |                       |   |        |  |       |  
|Noninterest-earning assets                                      |  |                                         | 75,432  |                     |      |                       |  |      |                           |  |                     | 68,502  |                       |   |        |  |       |  
|                                                                |  |                                         |         |                     |      |                       |  |      |                           |  |                     |         |                       |   |        |  |       |  
|Total assets                                                    |  | $                                       | 725,450 |                     |      |                       |  |      |                           |  | $                   | 602,933 |                       |   |        |  |       |  
|                                                                |  |                                         |         |                     |      |                       |  |      |                           |  |                     |         |                       |   |        |  |       |  
|Liabilities and shareholders equity                            |  |                                         |         |                     |      |                       |  |      |                           |  |                     |         |                       |   |        |  |       |  
|Interest-bearing liabilities:                                   |  |                                         |         |                     |      |                       |  |      |                           |  |                     |         |                       |   |        |  |       |  
|Interest-bearing demand deposits                                |  | $                                       | 173,328 |                     | $    | 1,617                 |  | 1.25 | %                         |  | $                   | 122,656 |                       | $ | 957    |  | 1.04  | %
|Savings and money market accounts                               |  |                                         | 100,410 |                     |      | 838                   |  | 1.11 |                           |  |                     | 74,350  |                       |   | 619    |  | 1.11  |  
|Time deposits                                                   |  |                                         | 200,184 |                     |      | 3,689                 |  | 2.46 |                           |  |                     | 186,925 |                       |   | 4,167  |  | 2.98  |  
|Federal funds purchased                                         |  |                                         | 9,887   |                     |      | 119                   |  | 1.61 |                           |  |                     | 9,675   |                       |   | 115    |  | 1.59  |  
|Junior subordinated deferrable interest debentures              |  |                                         | 12,365  |                     |      | 798                   |  | 8.62 |                           |  |                     | 7,000   |                       |   | 554    |  | 10.58 |  
|Subordinated notes and debentures                               |  |                                         |        |                     |      |                      |  |     |                           |  |                     | 1,011   |                       |   | 87     |  | 11.51 |  
|Other borrowings                                                |  |                                         | 69,222  |                     |      | 1,535                 |  | 2.96 |                           |  |                     | 64,806  |                       |   | 1,542  |  | 3.18  |  
|                                                                |  |                                         |         |                     |      |                       |  |      |                           |  |                     |         |                       |   |        |  |       |  
|Total interest-bearing liabilities                              |  |                                         | 565,396 |                     |      | 8,596                 |  | 2.03 |                           |  |                     | 466,423 |                       |   | 8,041  |  | 2.30  |  
|                                                                |  |                                         |         |                     |      |                       |  |      |                           |  |                     |         |                       |   |        |  |       |  
|Noninterest-bearing liabilities:                                |  |                                         |         |                     |      |                       |  |      |                           |  |                     |         |                       |   |        |  |       |  
|Demand deposits                                                 |  |                                         | 112,010 |                     |      |                       |  |      |                           |  |                     | 94,948  |                       |   |        |  |       |  
|Other liabilities                                               |  |                                         | 2,113   |                     |      |                       |  |      |                           |  |                     | 4,403   |                       |   |        |  |       |  
|                                                                |  |                                         |         |                     |      |                       |  |      |                           |  |                     |         |                       |   |        |  |       |  
|Total liabilities                                               |  |                                         | 679,519 |                     |      |                       |  |      |                           |  |                     | 565,774 |                       |   |        |  |       |  
|Shareholders equity                                            |  |                                         | 45,931  |                     |      |                       |  |      |                           |  |                     | 37,159  |                       |   |        |  |       |  
|                                                                |  |                                         |         |                     |      |                       |  |      |                           |  |                     |         |                       |   |        |  |       |  
|Total liabilities and shareholders equity                      |  | $                                       | 725,450 |                     |      |                       |  |      |                           |  | $                   | 602,933 |                       |   |        |  |       |  
|                                                                |  |                                         |         |                     |      |                       |  |      |                           |  |                     |         |                       |   |        |  |       |  
|Net interest income                                             |  |                                         |         |                     | $    | 22,003                |  |      |                           |  |                     |         |                       | $ | 19,602 |  |       |  
|                                                                |  |                                         |         |                     |      |                       |  |      |                           |  |                     |         |                       |   |        |  |       |  
|Net interest spread                                             |  |                                         |         |                     |      |                       |  | 4.22 | %                         |  |                     |         |                       |   |        |  | 4.57  | %
|Net interest margin                                             |  |                                         |         |                     |      |                       |  | 4.49 | %                         |  |                     |         |                       |   |        |  | 4.87  | %

---

|(1) | Annualized
|--- | ----------

|
|



14



---

The following tables present information regarding the dollar amount of changes in
interest income and interest expense for the periods indicated for the major components of interest-earning assets and interest-bearing liabilities and distinguishes between the increase (decrease) attributable to changes in volume and changes in
interest rates. For purposes of these tables, changes attributable to both volume and rate have been allocated proportionately to the change due to volume and rate.



|                                                   |  |                                                        |       |   |      |   |      |       |  |   |       |  
|-------------------------------------------------- |  | ------------------------------------------------------ | ----- | - | ---- | - | ---- | ----- |  | - | ----- | -
|                                                   |  | For the three months ended September 30, 2004 vs. 2003 |      
|                                                   |  | Increase (Decrease)Due to Change in                    |       |   |      |  
|                                                   |  | Volume                                                 |       |   | Rate |   |      | Total | 
|                                                   |  | (Dollars in thousands)                                 |      
|Interest-earning assets:                           |  |                                                        |       |   |      |   |      |       |  |   |       |  
|Total loans                                        |  | $                                                      | 1,843 |   |      | $ | (398 | )     |  | $ | 1,445 |  
|Securities                                         |  |                                                        | 687   |   |      |   | (2   | )     |  |   | 685   |  
|Federal funds sold                                 |  |                                                        | (4    | ) |      |   | (6   | )     |  |   | (10   | )
|                                                   |  |                                                        |       |   |      |   |      |       |  |   |       |  
|Total increase (decrease) in interest income       |  |                                                        | 2,526 |   |      |   | (406 | )     |  |   | 2,120 |  
|Interest-bearing liabilities:                      |  |                                                        |       |   |      |   |      |       |  |   |       |  
|Interest-bearing demand deposits                   |  |                                                        | 165   |   |      |   | 203  |       |  |   | 368   |  
|Savings and money market accounts                  |  |                                                        | 86    |   |      |   | 46   |       |  |   | 132   |  
|Time deposits                                      |  |                                                        | 175   |   |      |   | (209 | )     |  |   | (34   | )
|Federal funds purchased                            |  |                                                        |      |   |      |   | 27   |       |  |   | 27    |  
|Junior subordinated deferrable interest debentures |  |                                                        | 142   |   |      |   | (61  | )     |  |   | 81    |  
|Other borrowings                                   |  |                                                        | (100  | ) |      |   | 225  |       |  |   | 125   |  
|                                                   |  |                                                        |       |   |      |   |      |       |  |   |       |  
|Total increase in interest expense                 |  |                                                        | 468   |   |      |   | 231  |       |  |   | 699   |  
|                                                   |  |                                                        |       |   |      |   |      |       |  |   |       |  
|Increase (decrease) in net interest income         |  | $                                                      | 2,058 |   |      | $ | (637 | )     |  | $ | 1,421 |  
|                                                   |  |                                                        |       |   |      |   |      |       |  |   |       |  



|                                                   |  |                                                       |       |   |      |   |        |       |  |   |       |  
|-------------------------------------------------- |  | ----------------------------------------------------- | ----- | - | ---- | - | ------ | ----- |  | - | ----- | -
|                                                   |  | For the nine months ended September 30, 2004 vs. 2003 |      
|                                                   |  | Increase (Decrease)Due to Change in                   |       |   |      |  
|                                                   |  | Volume                                                |       |   | Rate |   |        | Total | 
|                                                   |  | (Dollars in thousands)                                |      
|Interest-earning assets:                           |  |                                                       |       |   |      |   |        |       |  |   |       |  
|Total loans                                        |  | $                                                     | 3,151 |   |      | $ | (1,503 | )     |  | $ | 1,648 |  
|Securities                                         |  |                                                       | 1,892 |   |      |   | (528   | )     |  |   | 1,364 |  
|Federal funds sold                                 |  |                                                       | (31   | ) |      |   | (25    | )     |  |   | (56   | )
|                                                   |  |                                                       |       |   |      |   |        |       |  |   |       |  
|Total increase (decrease) in interest income       |  |                                                       | 5,012 |   |      |   | (2,056 | )     |  |   | 2,956 |  
|Interest-bearing liabilities:                      |  |                                                       |       |   |      |   |        |       |  |   |       |  
|Interest-bearing demand deposits                   |  |                                                       | 395   |   |      |   | 265    |       |  |   | 660   |  
|Savings and money market accounts                  |  |                                                       | 217   |   |      |   | 2      |       |  |   | 219   |  
|Time deposits                                      |  |                                                       | 296   |   |      |   | (774   | )     |  |   | (478  | )
|Federal funds purchased                            |  |                                                       | 3     |   |      |   | 1      |       |  |   | 4     |  
|Junior subordinated deferrable interest debentures |  |                                                       | 425   |   |      |   | (181   | )     |  |   | 244   |  
|Subordinated notes and debentures                  |  |                                                       | (87   | ) |      |   |       |       |  |   | (87   | )
|Other borrowings                                   |  |                                                       | 105   |   |      |   | (112   | )     |  |   | (7    | )
|                                                   |  |                                                       |       |   |      |   |        |       |  |   |       |  
|Total increase (decrease) in interest expense      |  |                                                       | 1,354 |   |      |   | (799   | )     |  |   | 555   |  
|                                                   |  |                                                       |       |   |      |   |        |       |  |   |       |  
|Increase (decrease) in net interest income         |  | $                                                     | 3,658 |   |      | $ | (1,257 | )     |  | $ | 2,401 |  
|                                                   |  |                                                       |       |   |      |   |        |       |  |   |       |  



Provision for Loan
Losses.Provisions for loan losses are charged to income to bring the Companys allowance for loan losses to a level deemed appropriate by management. For the three and nine month periods ended September 30, 2004 compared with the same
periods in 2003, the provision decreased by $100,000 or 12.5% to $700,000, and decreased by $950,000 or 45.2% to $1.2 million, respectively. The allowance for loan losses at September 30, 2004 was $4.5 million compared with $3.9 million at December
31, 2003. During 2003, management increased its provisions due to growth in the loan portfolio, higher charge-offs and managements perception of changes in the Central Texas economy. At September 30, 2004, the ratio of the allowance for loan
losses to total loans was 0.92% compared with 1.01% at December 31, 2003.



15



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Noninterest Income. Noninterest income for the three months ended September 30, 2004 and 2003 was
$5.0 million and $3.4 million, respectively, an increase of $1.6 million or 48.0%. For the nine months ended September 30, 2004 and 2003, noninterest income was $13.6 million and $10.6 million, respectively, an increase of $3.0 million or 28.0%. The
increase in noninterest income for both periods is primarily attributed to gains on the sale of mortgage loans generated by Community Home Loan, which the Company acquired in February of 2004, partially offset by reduced mortgage servicing revenue
and a decrease in net gains on the sale of securities.



The
following table presents, for the periods indicated, the major categories of noninterest income:



|                                    |  |                                         |       |                                        |   |       |  |      |        |  |   |       
|----------------------------------- |  | --------------------------------------- | ----- | -------------------------------------- | - | ----- |  | ---- | ------ |  | - | ------
|                                    |  | For the three monthsended September 30, |       | For the nine monthsended September 30,
|                                    |  | 2004                                    |       | 2003                                   |   | 2004  |  | 2003
|                                    |  | (Dollars in thousands)                 
|Service charges on deposit accounts |  | $                                       | 1,869 |                                        | $ | 1,718 |  | $    | 5,196  |  | $ | 5,016 
|Mortgage servicing revenue          |  |                                         | 217   |                                        |   | 636   |  |      | 715    |  |   | 2,040 
|Net gain on sale of securities      |  |                                         | 19    |                                        |   | 376   |  |      | 167    |  |   | 1,291 
|Net gain on sale of loans           |  |                                         | 172   |                                        |   | 168   |  |      | 726    |  |   | 446   
|Gain on sale of CHL loans           |  |                                         | 2,364 |                                        |   |      |  |      | 5,506  |  |   |      
|Other noninterest income            |  |                                         | 367   |                                        |   | 486   |  |      | 1,269  |  |   | 1,813 
|                                    |  |                                         |       |                                        |   |       |  |      |        |  |   |       
|Total noninterest income            |  | $                                       | 5,008 |                                        | $ | 3,384 |  | $    | 13,579 |  | $ | 10,606
|                                    |  |                                         |       |                                        |   |       |  |      |        |  |   |       



Noninterest
Expense. For the three months ended September 30, 2004, noninterest expense increased by $3.1 million or 43.7% to $10.3 million, compared with the same period in 2003. For the nine months ended September 30, 2004, noninterest expense increased
by $5.3 million or 23.8% to $27.6 million, compared with the same period in 2003. The increase in noninterest expense for both periods was mainly due to additional employee compensation and benefits and other operating expenses related to Community
Home Loan and additional staff hired to meet loan growth. In addition, in the first quarter of 2003 there was a $1.3 million impairment charge related to mortgage servicing rights which did not recur in the comparable period in 2004. Based on
independent valuations of the mortgage servicing rights, the Company recorded income in the form of a reversal of $1.0 million of the impairment reserve during the third quarter of 2003 and a reversal of $263,000 in the second quarter of 2004, which
were reflected as reductions in mortgage servicing expense.



The following table presents, for the periods indicated, the major categories in noninterest expense:



|                                   |  |                                         |        |      |                                        |       |      |  |      |        |  |   |       
|---------------------------------- |  | --------------------------------------- | ------ | ---- | -------------------------------------- | ----- | ---- |  | ---- | ------ |  | - | ------
|                                   |  | For the three monthsended September 30, |        |      | For the nine monthsended September 30,
|                                   |  | 2004                                    |        | 2003 |                                        |       | 2004 |  | 2003
|                                   |  | (Dollars in thousands)                 
|Employee compensation and benefits |  | $                                       | 5,664  |      | $                                      | 4,509 |      |  | $    | 15,660 |  | $ | 12,314
|Non-staff expenses:                |  |                                         |        |      |                                        |       |      |  |      |        |  |   |       
|Net occupancy expense              |  |                                         | 690    |      |                                        | 492   |      |  |      | 1,877  |  |   | 1,392 
|Depreciation and amortization      |  |                                         | 524    |      |                                        | 468   |      |  |      | 1,961  |  |   | 1,980 
|Data processing                    |  |                                         | 242    |      |                                        | 291   |      |  |      | 758    |  |   | 791   
|Legal and professional fees        |  |                                         | 276    |      |                                        | 242   |      |  |      | 867    |  |   | 777   
|Advertising                        |  |                                         | 100    |      |                                        | 195   |      |  |      | 289    |  |   | 512   
|Printing and supplies              |  |                                         | 172    |      |                                        | 203   |      |  |      | 423    |  |   | 452   
|Telecommunications                 |  |                                         | 228    |      |                                        | 212   |      |  |      | 449    |  |   | 469   
|Mortgage servicing expense         |  |                                         | 236    |      |                                        | (765  | )    |  |      | 414    |  |   | 489   
|Other noninterest expense          |  |                                         | 2,157  |      |                                        | 1,311 |      |  |      | 4,937  |  |   | 3,152 
|                                   |  |                                         |        |      |                                        |       |      |  |      |        |  |   |       
|Total non-staff expenses           |  |                                         | 4,625  |      |                                        | 2,649 |      |  |      | 11,975 |  |   | 10,014
|                                   |  |                                         |        |      |                                        |       |      |  |      |        |  |   |       
|Total noninterest expense          |  | $                                       | 10,289 |      | $                                      | 7,158 |      |  | $    | 27,635 |  | $ | 22,328
|                                   |  |                                         |        |      |                                        |       |      |  |      |        |  |   |       



Employee compensation and benefits expense represented 55.0% and 56.7% of total noninterest expense for the three and nine months periods ended September 30, 2004, respectively. Employee
compensation and benefits expense for the three months ended September 30, 2004 and 2003 was $5.7 million and $4.5 million, respectively, an increase of $1.2 million or 25.6%. For the nine months ended September 30, 2004 and 2003, employee
compensation and benefits expenses was $15.7 million and $12.3 million, respectively, reflecting an increase of $3.3 million or 27.2%. The increases for both periods resulted primarily from the costs associated with the additional staff hired to
meet loan growth and additional staff acquired with the Community Home Loan acquisition. Total full-time equivalent (FTE) employees at September 30, 2004 and 2003 were 409 and 322, respectively.



For the three months ended September 30,
2004, non-staff expenses increased by $2.0 million or 74.6% compared with the same period in 2003. For the nine months ended September 30, 2004, non-staff expenses increased by $2.0 million or 19.6% compared with the same period in 2003. The
increased non-staff expense for both periods was primarily due to higher occupancy expense and the inclusion of Community Home Loan.



16



---

Financial Condition



Loan Portfolio.Total loans, including loans held for sale, increased by $114.3 million or 29.7%, from $384.3 million at December 31, 2003 to
$498.6 million at September 30, 2004. The increases are primarily attributed to the addition of four commercial lenders and the acquisitions of Community Home Loan and the Central Bank branches. At September 30, 2004 and December 31, 2003, the ratio
of total loans to total deposits was 72.4 % and 76.7%, respectively. For the same periods, total loans represented 59.4% and 60.3% of total assets, respectively.



The following table summarizes the loan portfolio of the Company by type of loan at the dates indicated:



|                          |  |                        |         |         |                   |   |        |   |         |  |       |  
|------------------------- |  | ---------------------- | ------- | ------- | ----------------- | - | ------ | - | ------- |  | ----- | -
|                          |  | September 30, 2004     |         |         | December 31, 2003 |  
|                          |  | Amount                 |         | Percent |                   |   | Amount |   | Percent | 
|                          |  | (Dollars in thousands) |        
|Commercial and industrial |  | $                      | 98,332  |         | 19.7              | % |        | $ | 63,793  |  | 16.6  | %
|Real estate mortgage      |  |                        |         |         |                   |   |        |   |         |  |       |  
|1-4 family residential    |  |                        | 158,661 |         | 31.8              |   |        |   | 140,020 |  | 36.4  |  
|Commercial                |  |                        | 150,952 |         | 30.3              |   |        |   | 115,033 |  | 29.9  |  
|Held for sale             |  |                        | 17,286  |         | 3.5               |   |        |   | 3,810   |  | 1.0   |  
|Other                     |  |                        | 12,920  |         | 2.6               |   |        |   | 8,488   |  | 2.2   |  
|Consumer and other, net   |  |                        | 60,481  |         | 12.1              |   |        |   | 53,187  |  | 13.9  |  
|                          |  |                        |         |         |                   |   |        |   |         |  |       |  
|Total loans               |  | $                      | 498,632 |         | 100.0             | % |        | $ | 384,331 |  | 100.0 | %
|                          |  |                        |         |         |                   |   |        |   |         |  |       |  
|Allowance for loan losses |  |                        | 4,535   |         |                   |   |        |   | 3,893   |  |       |  
|                          |  |                        |         |         |                   |   |        |   |         |  |       |  
|Net loans                 |  | $                      | 494,097 |         |                   |   |        | $ | 380,438 |  |       |  
|                          |  |                        |         |         |                   |   |        |   |         |  |       |  



Nonperforming
Assets.Nonperforming assets at September 30, 2004 and December 31, 2003 were $2.6 million and $2.3 million, respectively.



The Company generally places a loan on nonaccrual status and ceases to accrue interest when loan payment performance is deemed unsatisfactory. Loans where
the interest payments jeopardize the collection of principal are placed on nonaccrual status, unless the loan is both well-secured and in the process of collection. Cash payments received while a loan is classified as nonaccrual is recorded as a
reduction of principal as long as doubt exists as to collection.



Accruing loans 90 days or more past due includes $1.1 million in outstanding loans to a borrower that filed Chapter 11 bankruptcy on August 3, 2004. The loan is secured by eight parcels of real property with an aggregate appraised value of
approximately $3.5 million. While management believes that the collateral is adequate security for this loan, there can be no assurance that the Company will be able to sell the real property in a timely manner or for the appraised value.



The following table presents information regarding
nonperforming assets at the dates indicated:



|                                                          |  |                        |       |   |                   |   |       |  
|--------------------------------------------------------- |  | ---------------------- | ----- | - | ----------------- | - | ----- | -
|                                                          |  | September 30, 2004     |       |   | December 31, 2003 |  
|                                                          |  | (Dollars in thousands) |      
|Nonaccrual loans                                          |  | $                      | 193   |   |                   | $ | 1,255 |  
|Accruing loans 90 days or more past due                   |  |                        | 1,785 |   |                   |   | 733   |  
|Other real estate                                         |  |                        | 586   |   |                   |   | 273   |  
|                                                          |  |                        |       |   |                   |   |       |  
|Total nonperforming assets                                |  | $                      | 2,564 |   |                   | $ | 2,261 |  
|                                                          |  |                        |       |   |                   |   |       |  
|Nonperforming assets to total assets                      |  |                        | 0.31  | % |                   |   | 0.35  | %
|Nonperforming assets to total loans and other real estate |  |                        | 0.51  | % |                   |   | 0.59  | %



Allowance for Loan
Losses.The Company has several systems in place to assist in maintaining the overall quality of its loan portfolio. The Company has established underwriting guidelines to be followed by its officers. The Company also monitors its delinquency
levels for any negative or adverse trends and particularly monitors credits that have a total exposure of $75,000 or more. The Company cannot assure you, however, that its loan portfolio will not become subject to increasing pressures from
deteriorating borrower credit due to general economic or other conditions.



The allowance for loan losses is a reserve established through charges to earnings in the form of a provision for loan losses. The Company utilizes a model to determine the specific and general portions of the
allowance for loan losses. Through the loan review



17



---

process, management assigns one of four loan grades to each loan, according to payment history, collateral values and
financial condition of the borrower. Specific reserves are allocated for loans assigned to a grade of watch or below, meaning that management has determined that deterioration in a loan has occurred. The percentage of the specific
allocation for each loan is based on the risk elements attributable to that particular loan. In addition, a general allocation is made for all loans in an amount determined based on general economic condition, historical loan loss experience, loan
growth within a category, amount of past due loans and peer averages. Management maintains the allowance based on the amounts determined using the procedures set forth above.



For the nine months ended September 30, 2004, net loan charge-offs were $508,000 or 0.12% of average loans outstanding
compared with $2.3 million or 0.61% for the year ended December 31, 2003. The decrease in net charge-offs was primarily due to a decrease in the Companys consumer loans in connection with the sale of the Companys credit card portfolio in
the fourth quarter of 2003. Credit card loans generally carry more risk and have historically resulted in larger aggregate charge-offs. At September 30, 2004 and December 31, 2003, the allowance for loan losses aggregated $4.5 million and $3.9
million, or 0.91% and 1.01% of total loans, respectively. At September 30, 2004, the allowance for loan losses as a percentage of nonperforming loans was 229.27% compared with 195.82% at December 31, 2003.



The following table presents for the periods ended an analysis of the
allowance for loan losses and other related data:



|                                                        |  |                                                      |         |   |                                              |   |         |  
|------------------------------------------------------- |  | ---------------------------------------------------- | ------- | - | -------------------------------------------- | - | ------- | -
|                                                        |  | As of and for theNine Months EndedSeptember 30, 2004 |         |   | As of and for theYear EndedDecember 31, 2003 |  
|                                                        |  | (Dollars in thousands)                               |        
|Average total loans outstanding                         |  | $                                                    | 431,255 |   |                                              | $ | 376,988 |  
|                                                        |  |                                                      |         |   |                                              |   |         |  
|Total loans outstanding at end of period                |  | $                                                    | 498,632 |   |                                              | $ | 384,331 |  
|                                                        |  |                                                      |         |   |                                              |   |         |  
|Allowance for loan losses at beginning of period        |  |                                                      | 3,893   |   |                                              |   | 3,296   |  
|Provision for loan losses                               |  |                                                      | 1,150   |   |                                              |   | 2,900   |  
|Charge-offs:                                            |  |                                                      |         |   |                                              |   |         |  
|Commercial and industrial                               |  |                                                      | (68     | ) |                                              |   | (916    | )
|Real estate                                             |  |                                                      | (159    | ) |                                              |   | (321    | )
|Consumer                                                |  |                                                      | (833    | ) |                                              |   | (2,001  | )
|Other                                                   |  |                                                      | (25     | ) |                                              |   |        |  
|                                                        |  |                                                      |         |   |                                              |   |         |  
|Total charge-offs                                       |  |                                                      | (1,085  | ) |                                              |   | (3,238  | )
|                                                        |  |                                                      |         |   |                                              |   |         |  
|Recoveries:                                             |  |                                                      |         |   |                                              |   |         |  
|Commercial and industrial                               |  |                                                      | 166     |   |                                              |   | 153     |  
|Real estate                                             |  |                                                      | 20      |   |                                              |   | 82      |  
|Consumer                                                |  |                                                      | 366     |   |                                              |   | 683     |  
|Other                                                   |  |                                                      | 25      |   |                                              |   | 17      |  
|                                                        |  |                                                      |         |   |                                              |   |         |  
|Total recoveries                                        |  |                                                      | 577     |   |                                              |   | 935     |  
|                                                        |  |                                                      |         |   |                                              |   |         |  
|Net charge-offs                                         |  |                                                      | (508    | ) |                                              |   | (2,303  | )
|                                                        |  |                                                      |         |   |                                              |   |         |  
|Allowance for loan losses at end of period              |  | $                                                    | 4,535   |   |                                              | $ | 3,893   |  
|                                                        |  |                                                      |         |   |                                              |   |         |  
|Ratio of allowance to end of period total loans         |  |                                                      | 0.91    | % |                                              |   | 1.01    | %
|Ratio of net charge-offs to average total loans         |  |                                                      | 0.12    | % |                                              |   | 0.61    | %
|Ratio of allowance to end of period nonperforming loans |  |                                                      | 229.27  | % |                                              |   | 195.82  | %



Securities.At
September 30, 2004, the securities portfolio totaled $255.8 million, reflecting an increase of $71.2 million or 38.6% from $184.5 million at December 31, 2003. During the nine months ended September 30, 2004, the Company purchased $121.3 million in
investment securities. Additionally, the Company sold $31.9 million of investment securities in an effort to reposition the portfolio for current economic conditions and to provide funding for loan growth. The Company also received $18.2 million in
maturities and principal paydowns on investment securities.



Deposits. At September 30, 2004, total deposits were $688.9 million, an increase of $187.8 million or 37.5% from $501.1 million at December 31, 2003. Noninterest-bearing deposits at
September 30, 2004 increased by $29.8 million or 30.9% to $126.1 million from $96.3 million at December 31, 2003. Interest-bearing deposits at September 30, 2004 increased by $158.0 million or 39.0% to $562.8 million from $404.8 million at December
31, 2003. The $187.8 million or 37.5% increase in deposits compared with December 31, 2003 is primarily attributed to internal growth and the addition of the Central Bank branches. The Companys ratios of noninterest-bearing demand deposits to
total deposits at September 30, 2004 and December 31, 2003 were 18.3% and 19.2%, respectively.



Borrowings.The Company utilizes borrowings to supplement deposits in funding its lending and investing activities. Borrowings consist of short-term and long-term advances from the Federal Home Loan Bank (FHLB)
and advances on the revolving



18



---

credit line with a correspondent bank. Federal funds purchased decreased $5.9 million to $973,000 at September 30, 2004
from $6.9 million at December 31, 2003. Borrowings decreased $32.0 million to $39.9 million at September 30, 2004 from $71.9 million at December 31, 2003. The decrease is primarily due to excess funds received in connection with the Central Bank
branch acquisition. The maturity dates for the FHLB borrowings range from the years 2005 to 2024 and have interest rates from 2.75% to 5.91%.



As of September 30, 2004 and December 31, 2003, the Company had $12.4 million outstanding in junior subordinated deferrable interest debentures issued to
its subsidiary trusts.



At September 30, 2004, the Company had
nothing borrowed on its $10.0 million revolving credit line with a correspondent bank. The line of credit bears interest at Federal Funds rate plus 2.25% and expires in March 2005.



Liquidity.Liquidity involves the Companys ability to raise funds to support asset growth or reduce assets to
meet deposit withdrawals and other payment obligations, to maintain reserve requirements and otherwise to operate the Company on an ongoing basis. The Companys liquidity needs are primarily met by growth in core deposits, which excludes time
deposits over $100,000. Although access to purchased funds from correspondent banks is available and has been utilized on occasion to take advantage of investment opportunities, the Company does not rely on these external funding sources. The
Company maintains investments in liquid assets based upon managements assessment of cash needs, expected deposit flows, objectives of its asset/liability management program, availability of federal funds or FHLB advances, and other available
yield on liquid assets. Several options are available to increase liquidity, including the sale of investments and loans, increasing deposit marketing activities, and borrowing from the FHLB or correspondent banks. The cash and federal funds sold
position, supplemented by amortizing investments along with payments and maturities within the loan portfolio, have historically created an adequate liquidity position.



Asset liquidity is provided by cash and assets which are readily marketable or which will mature in the near future. At
September 30, 2004, the Company had cash and cash equivalents of $19.2 million, up from $17.3 million at December 31, 2003. The increase is mainly attributed to the increase in deposits, partially offset by the purchase of investment securities and
loan growth.



Capital Resources. Shareholders
equity was $78.7 million at September 30, 2004 and $38.0 million at December 31, 2003, respectively. The increase is primarily due to the $36.1 million in net proceeds from the sale of 2,300,000 shares of common stock in the public offering, an
addition to undivided profits of $4.6 million in net earnings for the nine months ended September 30, 2004 and $200,000 in common stock issued in connection with the Community Home Loan acquisition, partially offset by dividends declared of $1.0
million.



The following table provides a comparison of the
Companys and the State Banks leverage and risk-weighted capital ratios as of September 30, 2004 to the minimum and well-capitalized regulatory standards:



|                                |  |                                     |      |  |                                                             |   |  |                                    |  
|------------------------------- |  | ----------------------------------- | ---- |  | ----------------------------------------------------------- | - |  | ---------------------------------- | -
|                                |  | MinimumRequired forCapital Purposes |      |  | To be WellCapitalizedUnder PromptCorrectiveActionProvisions |   |  | Actual Ratio at September 30, 2004 |  
|The Company                     |  |                                     |      |  |                                                             |   |  |                                    |  
|Leverage ratio                  |  | 4.00                                | %(1) |  | N/A                                                         |   |  | 9.07                               | %
|Tier 1 risk-based capital ratio |  | 4.00                                | %    |  | N/A                                                         |   |  | 13.53                              | %
|Risk-based capital ratio        |  | 8.00                                | %    |  | N/A                                                         |   |  | 14.39                              | %
|The Bank                        |  |                                     |      |  |                                                             |   |  |                                    |  
|Leverage ratio                  |  | 4.00                                | %(2) |  | 5.00                                                        | % |  | 6.48                               | %
|Tier 1 risk-based capital ratio |  | 4.00                                | %    |  | 6.00                                                        | % |  | 9.68                               | %
|Risk-based capital ratio        |  | 8.00                                | %    |  | 10.00                                                       | % |  | 10.54                              | %

---

|(1) | The Federal Reserve Board may require the Company to maintain a leverage ratio above the required minimum.
|--- | ----------------------------------------------------------------------------------------------------------

|(2) | The FDIC may require the Bank to maintain a leverage ratio above the required minimum.
|--- | --------------------------------------------------------------------------------------



Item 3.Quantitative and Qualitative Disclosures About Market Risk.



There have been no material changes since December 31, 2003. For more
information regarding quantitative and qualitative disclosures about market risk, please refer to the Companys Annual Report on Form 10-K as of and for the year ended December 31, 2003, and in particular, Item 7 Managements
Discussion and Analysis of Financial Condition and Results of Operations - Interest Rate Sensitivity and Market Risk.



19



---

Item 4.Controls and Procedures.



Evaluation of disclosure controls and procedures.The Company carried
out an evaluation, under the supervision and with the participation of our management, including the Chief Executive Officer and Chief Financial Officer, of the effectiveness of the design and operation of the Companys disclosure controls and
procedures as of the end of the period covered by this report. Based on this evaluation, the Companys Chief Executive Officer and Chief Financial Officer concluded that the Companys disclosure controls and procedures (as defined in Rules
13a-15(e) and 15d-15(e) under the Securities Exchange Act of 1934 (the Exchange Act)) are effective to ensure that information required to be disclosed by the Company in reports that it files or submits under the Exchange Act is
recorded, processed, summarized and reported to the Companys management within the time periods specified in the Securities and Exchange Commissions rules and forms.



Changes in internal controls over financial reporting. There were no changes in the Companys internal control
over financial reporting that occurred during the Companys most recent fiscal quarter that have materially affected, or are reasonably likely to materially affect, the Companys internal control over financial reporting.



PART II



OTHER INFORMATION



Item 1.Legal Proceedings



Not applicable



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



(a) Not applicable



(b) Use of Proceeds



Pursuant to a registration statement on Form S-1 (Registration No. 333-116542) filed with, and declared effective on August 4, 2004 by, the Securities and
Exchange Commission, the Company sold 2,000,000 shares of its common stock at $17.00 per share, for an aggregate of $34.0 million, to the public in an underwritten firm commitment offering which closed on August 10, 2004. The underwriters exercised
their 30-day option on August 26, 2004 to purchase an additional 300,000 shares to cover over-allotments. The managing underwriters for the public offering were Stifel, Nicolaus & Company, Incorporated and Hoefer & Arnett, Incorporated.



The Company received $36.1 million in net proceeds, after
deduction of underwriting discounts and commissions of $2.2 million and $788,000 in offering expenses. Of the net proceeds, approximately $10.0 million was used to repay the Companys outstanding line of credit which was used as additional
capital to support the acquisition of the additional assets from the Central Bank branches. In addition, approximately $18.4 million of the net proceeds will be used to pay the cash portion of the merger consideration to be paid to GNB Bancshares
shareholders and the balance will be used for general corporate purposes, including contributions to the capital of State Bank, the possible opening of additional branches and the possible acquisition of financial institutions.



(c) Not applicable



Item 3.Defaults Upon Senior Securities



Not applicable



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



A special meeting of the Companys shareholders was held on September
14, 2004. At the meeting, the shareholders of the Company considered and acted on the following proposals:



| | 1. | A proposal to approve the Amended and Restated Agreement and Plan of Merger, dated April 29, 2004, by and between the Company and GNB Bancshares, Inc. pursuant to which GNB
Bancshares will merge with and into the Company, all on and subject to the terms and conditions contained therein. A total of 3,225,359 shares voted in favor, 3,775 shares voted against and 15,153 shares abstained.
| | -- | ---------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------



20



---

| | 2. | A proposal to adjourn the meeting to a later date or dates, if necessary, to permit further solicitation of proxies in the event there are not sufficient votes at the time of the
meeting to approve the merger agreement. This item was dismissed since enough votes were either represented by presence or proxy.
| | -- | --------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------



| | 3. | A proposal to approve the Companys 2004 Stock Incentive Plan. A total of 2,716,005 shares voted in favor, 498,754 shares voted against and 29,528 shares abstained.
| | -- | --------------------------------------------------------------------------------------------------------------------------------------------------------------------



| | 4. | A proposal to amend the articles of incorporation of the Company to provide that the Companys bylaws may be amended only upon the approval of at least 70% of the
Companys board of directors and to provide that, consistent with the Companys bylaws, the number of directors that serve on the board may be increased or decreased by the board of directors in accordance with Texas law, without first
obtaining shareholder approval. A total of 2,849,338 shares voted in favor, 384,868 shares voted against and 10,081 shares abstained.
| | -- | ----------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------



Item 5.Other Information



Not applicable



Item 6.Exhibits.



|              |  |                                                                                                                                                    
|------------- |  | ---------------------------------------------------------------------------------------------------------------------------------------------------
|ExhibitNumber |  | Identification of Exhibit                                                                                                                          
|31.1          |  | Certification of the Chief Executive Officer pursuant to Rule 13a-14(a) of the Securities Exchange Act of 1934, as amended.                        
|              | 
|31.2          |  | Certification of the Chief Financial Officer pursuant to Rule 13a-14(a) of the Securities Exchange Act of 1934, as amended.                        
|              | 
|32.1          |  | Certification of the Chief Executive Officer pursuant to 18 U.S.C. Section 1350, adopted pursuant to Section 906 of the Sarbanes-Oxley Act of 2002.
|              | 
|32.2          |  | Certification of the Chief Financial Officer pursuant to 18 U.S.C. Section 1350, adopted pursuant to Section 906 of the Sarbanes-Oxley Act of 2002.



SIGNATURES



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



|                        |  |     |  |                                                                    
|----------------------- |  | --- |  | -------------------------------------------------------------------
|Date: November 15, 2004 |  | By: |  | /s/ L. Don Stricklin                                               
|                        |  |     |  | L. Don Stricklin                                                   
|                        |  |     |  | President and Chief Executive Officer (principal executive officer)
|                        |  |    
|Date: November 15, 2004 |  | By: |  | /s/ Thomas N. Adams                                                
|                        |  |     |  | Thomas N. Adams                                                    
|                        |  |     |  | Executive Vice President and                                       
|                        |  |     |  | Chief Financial Officer                                            
|                        |  |     |  | (principal financial officer/ principal accounting officer)        



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