** **

**UNITEDSTATESSECURITIES AND EXCHANGE COMMISSION**

###### **WASHINGTON, DC 20549**

###### ** **

###### **FORM 10-QSB**

###### ** **

| **ý**                                            | ** ** | **QUARTERLY REPORT PURSUANT TO  SECTION 13 OR 15 OF THE SECURITIES EXCHANGE ACT OF 1934**     |
|-------------------------------------------------------|------------|-----------------------------------------------------------------------------------------------|
|                                                  |       |                                                                                          |
| **For the quarterly period ended December 31,  2004** |
|                                                  |       |                                                                                          |
| **o**                                                 | ** ** | **TRANSITION REPORT PURSUANT TO  SECTION 13 OR 15(d) OF THE SECURITIES EXCHANGE ACT OF 1934** |
|                                                  |       |                                                                                          |
| **Commission File Number:  333-112325**               |

 

**Treaty Oak Bancorp, Inc.**

(Exact name of registrant as specified in itscharter)

 

**Texas**

(State or other jurisdiction ofcorporation or organization)

 

**20-0413144**

(I.R.S. Employer Identification Number)

 

**101 Westlake Drive, Austin, Texas**

(Address of Principal Executive Offices)

 

**78746**

(Zip Code)

 

**(512) 617-3600**

(Registrant’s telephone number, includingarea code)

 

Indicate by check mark whether the issuer (1) has filed all reportsrequired to be filed by Section 13 or 15(d) of the Securities Exchange Act of1934 during the preceding 12 months (or for such shorter period that theregistrant was required to file****such reports),and (2) has been subject to such filing requirements for the past 90 days.

**Yes   ****ý       No   ****o**

 

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

**Yes   ****o       No   ****ý**

 

Indicate thenumber of shares outstanding of each of the issuer’s classes of common stock asof the close of business on Feburary 10, 2005.

 
| $0.01 Par Value Common  Stock |   | 2,608,882 shares |
|-------------------------------|--------|------------------|

 

Transitional Small Business Disclosure Format (Check one):                     **Yes   ****o   No  ****ý**

 

 

----

 

**QUARTERLY REPORT ON FORM 10-QSB**

**FOR THE PERIOD ENDED DECEMBER 31, 2004**

 

**TABLE OF CONTENTS**

 
| **Part I.**  | ** ** | **Financial Information**                                                                                                       |   |
|--------------|------------|---------------------------------------------------------------------------------------------------------------------------------|--------|
|         |       |                                                                                                                            |   |
| **Item 1.**  | ** ** | *Financial  Statements*                                                                                                         |   |
|         |       |                                                                                                                            |   |
|         |       | Consolidated Balance Sheets at September 30, 2004 and December 31,  2004 (unaudited)                                            |   |
|         |       |                                                                                                                            |   |
|         |       | Consolidated Statements of Operations for  the Three-Month Periods ended December 31, 2004, and 2003 (unaudited)                |   |
|         |       |                                                                                                                            |   |
|         |       | Consolidated Statement of Changes in  Shareholders’ Equity for the Three-Month Period ended December 31, 2004  (unaudited) |   |
|         |       |                                                                                                                            |   |
|         |       | Consolidated Statements of Cash Flows for the Three Month Periods  ended December 31, 2004, and 2003 (unaudited)                |   |
|         |       |                                                                                                                            |   |
|         |       | Notes to Consolidated Financial Statements                                                                                      |   |
|         |       |                                                                                                                            |   |
| **Item 2.**  | ** ** | *Management’s Discussion and Analysis of  Financial Condition and*                                                         |   |
|         |       | *Results of Operations*                                                                                                         |   |
|         |       |                                                                                                                            |   |
| **Item 3.**  | ** ** | *Controls and Procedures*                                                                                                       |   |
|         |       |                                                                                                                            |   |
| **Part II.** | ** ** | **Other Information**                                                                                                           |   |
|         |       |                                                                                                                            |   |
| **Item 1.**  | ** ** | *Legal Proceedings*                                                                                                             |   |
|         |       |                                                                                                                            |   |
| **Item 2.**  | ** ** | *Changes in Securities and Use of Proceeds*                                                                                     |   |
|         |       |                                                                                                                            |   |
| **Item 3.**  | ** ** | *Defaults Upon Senior Securities*                                                                                               |   |
|         |       |                                                                                                                            |   |
| **Item 4.**  | ** ** | *Submission of Matters to a Vote of Security  Holders*                                                                          |   |
|         |       |                                                                                                                            |   |
| **Item 5.**  | ** ** | *Other Information*                                                                                                             |   |
|         |       |                                                                                                                            |   |
| **Item 6.**  | ** ** | *Exhibits and Reports on Form 8-K*                                                                                              |   |
|         |       |                                                                                                                            |   |
|         |       | Signatures                                                                                                                      |   |

 

This Form 10-QSB contains forward-looking statements consisting ofestimates with respect to the financial condition, results of operations, andother business of Treaty Oak Bancorp, Inc., that are subject to various factorswhich could cause actual results to differ materially from thoseestimates.  Factors that could influencethe estimates include changes in the national, regional, and local marketconditions, legislative and regulatory conditions, and an adverse interest rateenvironment.

 

i

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**Treaty OakBancorp, Inc.**

**ConsolidatedBalance Sheets**

**December31, 2004, and September 30, 2004**

**(Dollars InThousands, Except Par Value Amounts)**

 
| ** **                                                                                                   | ** ** | **December 31,  2004** | ** ** | **September 30,  2004 (1)** | ** ** |
|--------------------------------------------------------------------------------------------------------------|------------|------------------------|------------|-----------------------------|------------|
| ** **                                                                                                   | ** ** | **(Unaudited)**        | ** ** | ** **                  | ** ** |
| **ASSETS**                                                                                                   | ** ** | ** **             | ** ** | ** **                  | ** ** |
| Cash and due from banks                                                                                      | ** ** | **$**                  | **1,623**  | ** **                  | **$**      | **3,562** | ** ** |
| Interest bearing deposits in banks                                                                           | ** ** | **1,080**              | ** ** | **1,272**                   | ** ** |
| Federal funds sold                                                                                           | ** ** | **11,990**             | ** ** | **4,450**                   | ** ** |
| ** **                                                                                                   | ** ** | ** **             | ** ** | ** **                  | ** ** |
| **Total cash and cash equivalents**                                                                          | ** ** | **14,693**             | ** ** | **9,284**                   | ** ** |
| ** **                                                                                                   | ** ** | ** **             | ** ** | ** **                  | ** ** |
| Stock subscriptions receivable                                                                               | ** ** | **52**                 | ** ** | **3,379**                   | ** ** |
| Securities available for sale                                                                                | ** ** | **455**                | ** ** | **464**                     | ** ** |
| Securities held to maturity, fair value of  $4,992 and 6, respectively                                       | ** ** | **5,001**              | ** ** | **7**                       | ** ** |
| Investment in Federal Home Loan Bank stock,  at cost                                                         | ** ** | **211**                | ** ** | **211**                     | ** ** |
| Loans, net                                                                                                   | ** ** | **15,145**             | ** ** | **9,953**                   | ** ** |
| Premises and equipment, net                                                                                  | ** ** | **5,963**              | ** ** | **1,227**                   | ** ** |
| Accrued interest receivable                                                                                  | ** ** | **187**                | ** ** | **144**                     | ** ** |
| Due from affiliates                                                                                          | ** ** | **—**             | ** ** | **69**                      | ** ** |
| Goodwill                                                                                                     | ** ** | **1,161**              | ** ** | **1,161**                   | ** ** |
| Core deposit intangibles, net                                                                                | ** ** | **62**                 | ** ** | **64**                      | ** ** |
| Other assets                                                                                                 | ** ** | **382**                | ** ** | **205**                     | ** ** |
| ** **                                                                                                   | ** ** | ** **             | ** ** | ** **                  | ** ** |
| **Total assets**                                                                                             | ** ** | **$**                  | **43,312** | ** **                  | **$**      | **26,168** | ** ** |
| ** **                                                                                                   | ** ** | ** **             | ** ** | ** **                  | ** ** |
| **LIABILITIES AND SHAREHOLDERS’ EQUITY**                                                                | ** ** | ** **             | ** ** | ** **                  | ** ** |
| ** **                                                                                                   | ** ** | ** **             | ** ** | ** **                  | ** ** |
| Deposits:                                                                                                    | ** ** | ** **             | ** ** | ** **                  | ** ** |
| Noninterest-bearing demand                                                                                   | ** ** | **$**                  | **4,853**  | ** **                  | **$**      | **2,579** | ** ** |
| NOW, money market and savings                                                                                | ** ** | **14,552**             | ** ** | **2,391**                   | ** ** |
| Time deposits                                                                                                | ** ** | **7,363**              | ** ** | **8,223**                   | ** ** |
| ** **                                                                                                   | ** ** | ** **             | ** ** | ** **                  | ** ** |
| **Total deposits**                                                                                           | ** ** | **26,768**             | ** ** | **13,193**                  | ** ** |
| ** **                                                                                                   | ** ** | ** **             | ** ** | ** **                  | ** ** |
| Accrued interest payable                                                                                     | ** ** | **39**                 | ** ** | **15**                      | ** ** |
| Capital lease obligation                                                                                     | ** ** | **509**                | ** ** | **509**                     | ** ** |
| Mortgage payable                                                                                             | ** ** | **2,919**              | ** ** | **—**                  | ** ** |
| Minority interests - PGI Equity Partners,  LP                                                                | ** ** | **1,002**              | ** ** | **—**                  | ** ** |
| Other liabilities                                                                                            | ** ** | **135**                | ** ** | **132**                     | ** ** |
| ** **                                                                                                   | ** ** | ** **             | ** ** | ** **                  | ** ** |
| **Total liabilities**                                                                                        | ** ** | **31,372**             | ** ** | **13,849**                  | ** ** |
| ** **                                                                                                   | ** ** | ** **             | ** ** | ** **                  | ** ** |
| Commitments and Contingencies                                                                                | ** ** | **—**             | ** ** | **—**                  | ** ** |
| ** **                                                                                                   | ** ** | ** **             | ** ** | ** **                  | ** ** |
| Shareholders’ equity:                                                                                   | ** ** | ** **             | ** ** | ** **                  | ** ** |
| Common stock, $0.01 par value, 20,000,000  shares authorized, 2,614,885 and 2,169,814, respectively, issued  | ** ** | **26**                 | ** ** | **22**                      | ** ** |
| Paid-in capital                                                                                              | ** ** | **14,764**             | ** ** | **11,067**                  | ** ** |
| Accumulated deficit                                                                                          | ** ** | **(2,851**             | **)**      | **(2,151**                  | **)**      |
| Common stock subscribed for but not paid  for and not issued - 6,302 shares and 405,663 shares, respectively | ** ** | **52**                 | ** ** | **3,379**                   | ** ** |
| Accumulated other comprehensive income  (loss)                                                               | ** ** | **(1**                 | **)**      | **2**                       | ** ** |
| Less shares held in treasury, at cost  (6,003 shares)                                                        | ** ** | **(50**                | **)**      | **—**                  | ** ** |
| ** **                                                                                                   | ** ** | ** **             | ** ** | ** **                  | ** ** |
| **Total shareholders’ equity**                                                                          | ** ** | **11,940**             | ** ** | **12,319**                  | ** ** |
| ** **                                                                                                   | ** ** | ** **             | ** ** | ** **                  | ** ** |
| **Total liabilities and shareholders’ equity**                                                          | ** ** | **$**                  | **43,312** | ** **                  | **$**      | **26,168** | ** ** |

 

See Notes to Consolidated FinancialStatements.

 

----

(1) Derived from audited financialstatements.

 

3

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**Treaty OakBancorp, Inc.**

**ThreeMonths Ended December 31, 2004, and 2003**

**Consolidated Statements of Operations**

**(Dollars InThousands, Except Per Share Amounts)**

 
| ** **                                               | ** ** | **Three Months**

**Ended  December 31,  2004** | ** ** | **Three Months**

**Ended  December 31,  2003** | ** ** |
|----------------------------------------------------------|------------|-------------------------------------------------|------------|-------------------------------------------------|------------|
| ** **                                               | ** ** | **(Unaudited)**                                 | ** ** | **(Unaudited)**                                 | ** ** |
| Interest income:                                         | ** ** | ** **                                      | ** ** | ** **                                      | ** ** |
| Loans, including fees                                    | ** ** | **$**                                           | **233**    | ** **                                      | **$**      | **—** | ** ** |
| Taxable securities                                       | ** ** | **20**                                          | ** ** | **—**                                      | ** ** |
| Interest on deposits with other banks                    | ** ** | **6**                                           | ** ** | **—**                                      | ** ** |
| Federal funds sold                                       | ** ** | **66**                                          | ** ** | **—**                                      | ** ** |
| ** **                                               | ** ** | ** **                                      | ** ** | ** **                                      | ** ** |
| **Total interest income**                                | ** ** | **325**                                         | ** ** | **—**                                      | ** ** |
| ** **                                               | ** ** | ** **                                      | ** ** | ** **                                      | ** ** |
| Interest expense:                                        | ** ** | ** **                                      | ** ** | ** **                                      | ** ** |
| Deposits                                                 | ** ** | **86**                                          | ** ** | **—**                                      | ** ** |
| ** **                                               | ** ** | ** **                                      | ** ** | ** **                                      | ** ** |
| **Total interest expense**                               | ** ** | **86**                                          | ** ** | **—**                                      | ** ** |
| ** **                                               | ** ** | ** **                                      | ** ** | ** **                                      | ** ** |
| **Net interest income**                                  | ** ** | **239**                                         | ** ** | **—**                                      | ** ** |
| ** **                                               | ** ** | ** **                                      | ** ** | ** **                                      | ** ** |
| Provision for loan losses                                | ** ** | **—**                                      | ** ** | **—**                                      | ** ** |
| ** **                                               | ** ** | ** **                                      | ** ** | ** **                                      | ** ** |
| **Net interest income after provision for  loan losses** | ** ** | **239**                                         | ** ** | **—**                                      | ** ** |
| Noninterest income:                                      | ** ** | ** **                                      | ** ** | ** **                                      | ** ** |
| Service charges on deposit accounts                      | ** ** | **16**                                          | ** ** | **—**                                      | ** ** |
| ** **                                               | ** ** | ** **                                      | ** ** | ** **                                      | ** ** |
| **Total noninterest income**                             | ** ** | **16**                                          | ** ** | **—**                                      | ** ** |
| Noninterest expense:                                     | ** ** | ** **                                      | ** ** | ** **                                      | ** ** |
| Salaries and employee benefits                           | ** ** | **583**                                         | ** ** | **333**                                         | ** ** |
| Occupancy and equipment expenses                         | ** ** | **111**                                         | ** ** | **—**                                      | ** ** |
| Accounting, legal and other professional  fees           | ** ** | **93**                                          | ** ** | **64**                                          | ** ** |
| Acquistion related costs                                 | ** ** | **—**                                      | ** ** | **72**                                          | ** ** |
| Other noninterest expense                                | ** ** | **168**                                         | ** ** | **44**                                          | ** ** |
| ** **                                               | ** ** | ** **                                      | ** ** | ** **                                      | ** ** |
| **Total noninterest expense**                            | ** ** | **955**                                         | ** ** | **513**                                         | ** ** |
| ** **                                               | ** ** | ** **                                      | ** ** | ** **                                      | ** ** |
| **Net loss**                                             | ** ** | **$**                                           | **(700**   | **)**                                           | **$**      | **(513** | **)** |
| ** **                                               | ** ** | ** **                                      | ** ** | ** **                                      | ** ** |
| **Loss per common share - basic**                        |       | $                                               | (0.27      | )                                               | $          | (0.51 | ) |
| **Loss per common share - diluted**                      |       | $                                               | (0.27      | )                                               | $          | (0.51 | ) |
| **Weighted average shares outstanding - basic**          | ** ** | **2,584,246**                                   | ** ** | **1,000,579**                                   | ** ** |
| **Weighted average shares outstanding -  diluted**       | ** ** | **2,584,246**                                   | ** ** | **1,000,579**                                   | ** ** |

 

See Notes to Consolidated FinancialStatements.

 

4

----

 

 
| **Treaty  Oak Bancorp, Inc.**                                       |   |   |   |   |   |   |   |   |
|---------------------------------------------------------------------|--------|--------|--------|--------|--------|--------|--------|--------|
| **Consolidated Statement  Of Changes In Shareholders’ Equity** |   |   |   |   |   |
| **Three  Months Ended December 31, 2004**                           |   |   |   |   |   |
| **(Amounts  In  Thousands, Except Share Amounts)**             |   |   |   |   |   |

 

 
| ** **                                                                              | ** ** | ** **        | ** ** | ** ** | ** ** | **Additional paid-in capital** | ** ** | **Subscribed for but not paid for and  not issued** | ** ** | **Accumulated Deficit** | ** ** | **Accumulated**

**other comprehensive income (loss)** | ** ** | ** ** | ** ** | ** ** |
|-----------------------------------------------------------------------------------------|------------|-------------------|------------|------------|------------|--------------------------------|------------|-----------------------------------------------------|------------|-------------------------|------------|--------------------------------------------------------|------------|------------|------------|------------|
| ** **                                                                              | ** ** | **Common  Stock** | ** ** | ** ** | ** ** | ** **                     | ** ** | **Treasury  Stock**                                 | ** ** | ** **              |
| ** **                                                                              | ** ** | **Shares**        | ** ** | **Amount** | ** ** | ** **                     | ** ** | ** **                                          | ** ** | ** **              | **Total**  |
| ** **                                                                              | ** ** | ** **        | ** ** | ** ** | ** ** | ** **                     | ** ** | ** **                                          | ** ** | ** **              | ** ** | ** **                                             | ** ** | ** ** | ** ** | ** ** |
| Balances at October 1,  2004                                                            |       | 2,169,814         |       | $          | 22         |                           | $          | 11,067                                              |       | $                       | 3,379      |                                                   | $          | (2,151)    |       | $          | 2 |   | $ | — |   | $ | 12,319 |
| —                                                                                  |       |              |       |       |       |                           |       |                                                |       |                    |       |                                                   |       |       |       |       |
| Sale on common stock subscribed as of September 30, 2004 - unaudited                    |       | 405,663           |       | 4          |       | 3,375                          |       | (3,379)                                             |       | —                  |       | —                                                 |       | —     |       | —     |
| Sale of common stock, net of costs of issuance - unaudited                              |       | 39,408            |       | —     |       | 322                            |       | —                                              |       | —                  |       | —                                                 |       | —     |       | 322        |
| Common shares subscribed for but not paid for and not issued - 6302  shares - unaudited |       | —            |       | —     |       | —                         |       | 52                                                  |       | —                  |       | —                                                 |       | —     |       | 52         |
| Shares repurchased and held in treasury-unaudited                                       |       | —            |       | —     |       | —                         |       | —                                              |       | —                  |       | —                                                 |       | (50)       |       | (50)       |
| Comprehensive loss:                                                                     |       |              |       |       |       |                           |       |                                                |       |                    |       |                                                   |       |       |       |       |
| Net loss - unaudited                                                                    |       |              |       |       |       |                           |       |                                                |       | (700)                   |       |                                                   |       | —     |       | (700)      |
| Change in unrealized income (loss) on securities available for sale -  unaudited        |       | —            |       | —     |       | —                         |       | —                                              |       | —                  |       | (3)                                                    |       | —     |       | (3)        |
|                                                                                    |       |              |       |       |       |                           |       |                                                |       |                    |       |                                                   |       |       |       |       |
| Total comprehensive loss - unaudited                                               |       | —            |       | —     |       | —                         |       | —                                              |       | —                  |       | —                                                 |       | —     |       | (703)      |
|                                                                                    |       |              |       |       |       |                           |       |                                                |       |                    |       |                                                   |       |       |       |       |
| Balances at December 31,  2004 - unaudited                                              |       | 2,614,885         |       | $          | 26         |                           | $          | 14,764                                              |       | $                       | 52         |                                                   | $          | (2,851)    |       | $          | (1) |   | $ | (50) |   | $ | 11,940 |

 
| See Notes to Consolidated  Financial Statements. |
|--------------------------------------------------|

 

 

5

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| **Treaty  Oak Bancorp, Inc.**                      | ** ** | ** ** | ** ** | ** ** |
|----------------------------------------------------|------------|------------|------------|------------|
| **Consolidated Statements  Of Cash Flows**         | ** ** | ** ** | ** ** | ** ** |
| **Three  Months Ended December 31, 2004 And 2003** | ** ** | ** ** | ** ** | ** ** |
| **(Dollars  In Thousands)**                        | ** ** | ** ** | ** ** | ** ** |

 
| ** **                                                                               | ** ** | **Three  Months Ended** | ** **       | **Three  Months Ended** |
|------------------------------------------------------------------------------------------|------------|-------------------------|------------------|-------------------------|
| ** **                                                                               | ** ** | **December  31,**       | ** **       | **December  31,**       |
| ** **                                                                               | ** ** | **2004**                | ** **       | **2003**                |
| ** **                                                                               | ** ** | **(Unaudited)**         | ** **       | **(Unaudited)**         |
| Cash  flows from operating activities:                                                   | ** ** | ** **              | ** **       | ** **              |
| Net loss                                                                                 | ** ** | **$**                   | **(700)**        | ** **              | **$** | **(513)** |
| Adjustments to reconcile net loss to net cash used  in operating activities:             | ** ** | ** **              | ** **       | ** **              |
| Provision for loan losses                                                                | ** ** | **—**              | ** **       | **—**              |
| Non-cash stock based compensation                                                        | ** ** | **—**              | ** **       | **333**                 |
| Non-cash pre-opening expenses incurred by majority shareholder on  behalf of the Company | ** ** | **—**              | ** **       | **180**                 |
| Depreciation and amortization                                                            | ** ** | **42 **            | ** **       | **—**              |
| Changes in other operating assets and liabilities:                                       | ** ** | ** **              | ** **       | ** **              |
| Accrued interest receivable                                                              | ** ** | **(43)**                | ** **       | **—**              |
| Other assets                                                                             | ** ** | **(1)**                 | ** **       | **—**              |
| Accrued interest payable                                                                 | ** ** | **2 **             | ** **       | **—**              |
| Other liabilities                                                                        | ** ** | **(71)**                | ** **       | **—**              |
| ** **                                                                               | ** ** | ** **              | ** **       | ** **              |
| **Net cash used in operating activities**                                                | ** ** | **(771)**               | ** **       | **—**              |
| ** **                                                                               | ** ** | ** **              | ** **       | ** **              |
| Cash flows from investing  activities:                                                   | ** ** | ** **              | ** **       | ** **              |
| Proceeds from maturities and principal repayments on securities -  available for sale    | ** ** | **6 **             | ** **       | **—**              |
| Acquisition of interest in PGI Equity Partners, LP, net of cash  received of $24         | ** ** | **(926)**               | ** **       | ** **              |
| Purchase of securities - held to maturity                                                | ** ** | **(4,994)**             | ** **       | **—**              |
| Net increase in loans                                                                    | ** ** | **(5,192)**             | ** **       | **—**              |
| Purchases of premises and equipment                                                      | ** ** | **(9)**                 | ** **       | **—**              |
| ** **                                                                               | ** ** | ** **              | ** **       | ** **              |
| **Net cash used in investing activities**                                                | ** ** | **(11,115)**            | ** **       | **—**              |
| ** **                                                                               | ** ** | ** **              | ** **       | ** **              |
| Cash flows from financing  activities:                                                   | ** ** | ** **              | ** **       | ** **              |
| Net increase in deposits                                                                 | ** ** | **13,575 **        | ** **       | **—**              |
| Initial capital contribution of majority shareholder                                     | ** ** | **—**              | ** **       | **1,200**               |
| Proceeds from the sale of common stock, net of issuance costs                            | ** ** | **3,701 **         | ** **       | **1**                   |
| Advances to affiliates                                                                   | ** ** | **(50)**                | ** **       | **—**              |
| Repayments of advances to affiliates                                                     | ** ** | **119 **           | ** **       | **—**              |
| Repurchase of common stock                                                               | ** ** | **(50)**                | ** **       | **—**              |
| ** **                                                                               | ** ** | ** **              | ** **       | ** **              |
| **Net cash provided by financing activities**                                            | ** ** | **17,295 **        | ** **       | **1,201**               |
| ** **                                                                               | ** ** | ** **              | ** **       | ** **              |
| Net increase in cash and  cash equivalents                                               | ** ** | **5,409 **         | ** **       | **1,201**               |
| ** **                                                                               | ** ** | ** **              | ** **       | ** **              |
| Cash and cash equivalents  at beginning of period                                        | ** ** | **9,284 **         | ** **       | **—**              |
| ** **                                                                               | ** ** | ** **              | ** **       | ** **              |
| Cash and cash equivalents  at end of period                                              | ** ** | **$**                   | **14,693 ** | ** **              | **$** | **1,201** |
| ** **                                                                               | ** ** | ** **              | ** **       | ** **              |
| Supplemental dislclosures  of cash flow information:                                     |       |                    |             |                    |
| Non-cash investing and financing information                                             |       |                    |             |                    |
| Contribution of deferred stock issuance costs                                            |       | $                       | —           |                    | $ | 384 |
| Contribution of direct acquisition costs - Texline State Bank                            |       | $                       | —           |                    | $ | 150 |
| Contribution of deposit on Texline State Bank                                            |       | $                       | —           |                    | $ | 50 |
|                                                                                     |       |                    |             |                    |
| Assets acquired - investment in PGI Equity Partners, LP                                  |       | $                       | 4,943       |                    |   |
| Liabilities assumed - investment in PGI Equity Partners, LP                              |       | (3,015)                 |             |                    |
| Minority interest - PGI Equity Partners, LP                                              |       | (1,002)                 |             |                    |
| Cash paid, net of cash acquired                                                          |       | $                       | 926         |                    |   |
|                                                                                     |       |                    |             |                    |
| Cash interest paid                                                                       |       | $                       | 62          |                    | $ | — |

 
| See Notes to Consolidated  Financial Statements. | ** ** | ** ** | ** ** | ** ** |
|--------------------------------------------------|------------|------------|------------|------------|

** **

 

6

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**Treaty OakBancorp, Inc.**

**Notes to Consolidated Financial Statements****- unaudited**

**ThreeMonths Ended December 31, 2004, and 2003**

 

**Note1.  Basis of Presentation**

 

Treaty OakBancorp, Inc. (the “Company”) is a bank holding company incorporated onNovember 18, 2003, and organized December 8, 2003 for the purpose of holdingthe common stock of Treaty Oak Bank (formerly Texline State Bank, the “Bank”).  The Company acquired the Bank on March 9,2004, and began conducting banking operations in Texline, Texas.  On September 10, 2004, the Company receivedfinal approval to relocate the main office of the Bank to Austin, Texas, and torename the Bank “Treaty Oak Bank.”  TheBank commenced operations in Austin, Texas, on September 10, 2004, and prior tothe commencement of operations in Austin, the Company was considered to be inthe development stage.

 

The Company, through Treaty Oak Bank, provides a full range ofcommercial and consumer banking services to individuals and businesses in thecommercial sector in Austin, Texas, and in the agriculture, cattle andcommercial sectors in the community of Texline, Texas.

 

Theaccompanying unaudited consolidated financial statements have been prepared inaccordance with the instructions to Form 10-QSB and, therefore, do not includeall of the disclosures and notes required by generally accepted accountingprinciples.  In the opinion of management, all material adjustments (whichare of a normal recurring nature) considered necessary for a fair presentationhave been made.  The results for the interim period are not necessarilyindicative of the results to be expected for the entire year or any other interimperiod.

 

Stock-BasedCompensation

 

The Companyaccounts for stock-based compensation to employees using the intrinsic valuemethod.  Accordingly, compensation costsfor employee stock options is measured as the excess, if any, of the fair valueof the Company’s common stock at date of grant over the exercise price.

 

The Company accounts for stock-based compensation to non-employees atfair value.

 

As of December 31, 2004, there were outstanding options to purchase anaggregate of 165,500 shares of the Company’s common stock.  Each option has an exercise price of $8.33per share and may be exercised in three equal annual installments for each yearof service measured from the grant date. No options were issued during the three months ended December 31, 2004.

 

Accordingly, the expense related to stock option compensation includedin the determination of net income for the three months ended December 31,2004, is less than that which would have been recognized if the fair valuemethod had been applied.  The Company’snet income and earnings per share would have been adjusted to the proformaamounts indicated below.

 

The weighted average fair value of the options granted during the yearended September 30, 2004, has been estimated using the Black-Scholes option pricingmodel with the following assumptions:

 

| Dividend yield          |   | 0    | %      |
|-------------------------|--------|------|--------|
| Risk-free interest rate |   | 4.75 | %      |
| Expected volatility     |   | 22   | %      |
| Expected life in years  |   | 10   |   |

 

7

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The table below presents the pro forma effecton the Company’s loss from operations assuming the Company had expensed thefair value of the options (in thousands, except per share amounts):

 
| ** **                   | ** ** | **Three Months Ended  December 31,  2004** | ** ** | **Three Months Ended  December 31,  2003** | ** ** |
|------------------------------|------------|--------------------------------------------|------------|--------------------------------------------|------------|
| ** **                   | ** ** | ** **                                 | ** ** | ** **                                 | ** ** |
| Net loss - as reported       |       | $                                          | (700       | )                                          | $          | (513 | ) |
| Net loss - pro forma         |       | (752                                       | )          | (513                                       | )          |
|                         |       |                                       |       |                                       |       |
| Loss per share - as reported |       |                                       |       |                                       |       |
| basic                        |       | $                                          | (0.27      | )                                          | $          | (0.51 | ) |
| diluted                      |       | $                                          | (0.27      | )                                          | $          | (0.51 | ) |
|                         |       |                                       |       |                                       |       |
| Loss per share - pro forma   |       |                                       |       |                                       |       |
| basic                        |       | $                                          | (0.29      | )                                          | $          | (0.51 | ) |
| diluted                      |       | $                                          | (0.29      | )                                          | $          | (0.51 | ) |

 

**Note2.  Common Stock Offering**

 

The Company issued1,581,187 shares of its common stock at $8.33 per share, resulting in grossproceeds of approximately $13,171,287 and incurred offering costs of $910,000in an offering that closed on September 30, 2004.  As of September 30, 2004, 1,129,814 of theseshares had been issued and 405,663 were subscribed.  All of the subscribed shares as of September30, 2004, plus an additional 39,408 shares, had been issued as of December 31,2004.  Subscriptions receivable as of theend of the period, representing 6,302 shares, was $52,500. The Company used theproceeds to pay the costs of the offering, pay the balance of the acquisitionindebtedness for the purchase of Texline State Bank, and paid off certain othershort-term borrowings, including advances and a note payable to the organizingshareholder.  The balance of the proceedsof the offering will be held and invested.

 

The stocksubscription receivable at September 30, 2004 (the date the offering closed),represents stock subscription agreements that were received on or beforeSeptember 30, 2004, and collected during the period from October 1, 2004 toDecember 3, 2004.  The stock subscriptionreceivable as of December 31, 2004, represents stock subscription agreementsthat were received on or before September 30, 2004, and collected betweenJanuary 1, 2005, and January 31, 2005.

 

**Note3.  Adoption of FASB Interpretation No.46(R): Consolidation of Variable Interest Entities (FIN 46(R))**

 

On November 30, 2004, the Company approved the acquisition of a 47.5%Class D limited partnership interest in PGI Equity Partners, L.P, (the “Partnership”)for a cash investment of $950,000.  TheCompany paid $150,000 as an investment deposit on November 18, 2004, and theremaining $800,000 on December 30, 2004 in conjunction with the closing of thepurchase.

 

The Partnership owns and operates the premises located at 101 WestlakeDrive where the Company leases its Austin, Texas, bank location and Companyoffices.  The Partnership has no othersignificant activities.

 

The Company has analyzed its relationship with the Partnership inaccordance with FIN 46(R) and has determined that the Company is theconsolidating parent of the Partnership for financial reporting purposes basedupon its investment in the Partnership combined with its lessee relationshipwith the Partnership.

 

8

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The assets and liabilities of the Partnership have been included in theconsolidated balance sheet of the Company at December 31, 2004.  The balance sheet of the Partnership as ofDecember 31, 2004, was as follows (in thousands):

 
| Cash                                      |   | $      | 24     |   |
|-------------------------------------------|--------|--------|--------|--------|
| Premises and equipment, net               |   | 4,767  |   |
| Other assets                              |   | 176    |   |
|                                      |   |   |   |
| Total Assets                              |   | $      | 4,967  |   |
|                                      |   |   |   |
| Mortgage payable                          |   | $      | 2,919  |   |
| Other liabilities                         |   | 96     |   |
| Partners’ capital                    |   | 1,952  |   |
|                                      |   |   |   |
| Total Liabilities and Owners’ Equity |   | $      | 4,967  |   |

 

Because of the timing of the closing date, any results of operations tobe included in the consolidated statements of operations were immaterial andhave not been included.

 

Because of theCompany’s status as a limited partner of the Partnership, the creditors of thePartnership do not have recourse against the Company with respect to theobligations of the Partnership in excess of the Company’s investment in thePartnership.

 

**Note 4.  Earnings Per Share**

 

Basic earnings (loss) per share is computed by dividing net earnings(loss) by the weighted average number of common shares outstanding for theperiod.  Diluted earnings per share is computed using the weighted-averagenumber of common shares outstanding plus the number of additional common sharesthat would have been outstanding if dilutive common shares had beenissued.  For all periods presented all potentially dilutive securitiesoutstanding were anti-dilutive.

 

For purposes of calculating weighted-average shares outstanding, the1,000,000 common shares issued to Treaty Oak Holdings, Inc., in the Company’sinitial capitalization are assumed to be outstanding for all periods presented.

 

9

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**Note5.  Securities**

 

  Securities consisted of thefollowing (in thousands):

 
| ** **                                                                               | ** ** | **Amortized  Cost** | ** ** | **Gross  Unrealized  Gains** | ** ** | **Gross  Unrealized  Losses** | ** ** | **Estimated  Fair  Value** | ** ** |
|------------------------------------------------------------------------------------------|------------|---------------------|------------|------------------------------|------------|-------------------------------|------------|----------------------------|------------|
|                                                                                     |       |                |       |                         |       |                          |       |                       |       |
| September 30, 2004:                                                                      | ** ** | ** **          | ** ** | ** **                   | ** ** | ** **                    | ** ** | ** **                 | ** ** |
| Mortgage-backed securities and  collateralized mortgage obligations - held to maturity   | ** ** | **$**               | **7**      | ** **                   | **$**      | **—**                    | ** ** | **$**                      | **(1**     | **)** | **$** | **6** | ** ** |
| ** **                                                                               | ** ** | ** **          | ** ** | ** **                   | ** ** | ** **                    | ** ** | ** **                 | ** ** |
| **Total held to maturity**                                                               | ** ** | **7**               | ** ** | **—**                   | ** ** | **(1**                        | **)**      | **6**                      | ** ** |
| ** **                                                                               | ** ** | ** **          | ** ** | ** **                   | ** ** | ** **                    | ** ** | ** **                 | ** ** |
| Agency notes and bonds - available for sale                                              | ** ** | **404**             | ** ** | **—**                   | ** ** | **—**                    | ** ** | **404**                    | ** ** |
| Mortgage-backed securities and  collateralized mortgage obligations - available for sale | ** ** | **58**              | ** ** | **2**                        | ** ** | **—**                    | ** ** | **60**                     | ** ** |
| **Total available for sale**                                                             | ** ** | **462**             | ** ** | **2**                        | ** ** | **—**                    | ** ** | **464**                    | ** ** |
| ** **                                                                               | ** ** | ** **          | ** ** | ** **                   | ** ** | ** **                    | ** ** | ** **                 | ** ** |
| **Total**                                                                                | ** ** | **$**               | **469**    | ** **                   | **$**      | **2**                         | ** ** | **$**                      | **(1**     | **)** | **$** | **470** | ** ** |
|                                                                                     |       |                |       |                         |       |                          |       |                       |       |
| December 31, 2004:                                                                       | ** ** | ** **          | ** ** | ** **                   | ** ** | ** **                    | ** ** | ** **                 | ** ** |
| Agency notes and bonds - held to maturity                                                | ** ** | **$**               | **4,994**  | ** **                   | **$**      | **—**                    | ** ** | **$**                      | **(8**     | **)** | **$** | **4,986** | ** ** |
| Mortgage-backed securities and  collateralized mortgage obligations - held to maturity   | ** ** | **7**               | ** ** | **$**                        | **—** | ** **                    | **$**      | **(1**                     | **)**      | **6** | ** ** |
| ** **                                                                               | ** ** | ** **          | ** ** | ** **                   | ** ** | ** **                    | ** ** | ** **                 | ** ** |
| **Total held to maturiity**                                                              | ** ** | **5,001**           | ** ** | **—**                   | ** ** | **(9**                        | **)**      | **4,992**                  | ** ** |
| ** **                                                                               | ** ** | ** **          | ** ** | ** **                   | ** ** | ** **                    | ** ** | ** **                 | ** ** |
| Agency notes and bonds - available for sale                                              | ** ** | **402**             | ** ** | **—**                   | ** ** | **(3**                        | **)**      | **399**                    | ** ** |
| Mortgage-backed securities and  collateralized mortgage obligations - available for sale | ** ** | **54**              | ** ** | **2**                        | ** ** | **—**                    | ** ** | **56**                     | ** ** |
| **Total available for sale**                                                             | ** ** | **456**             | ** ** | **2**                        | ** ** | **(3**                        | **)**      | **455**                    | ** ** |
| ** **                                                                               | ** ** | ** **          | ** ** | ** **                   | ** ** | ** **                    | ** ** | ** **                 | ** ** |
| **Total**                                                                                | ** ** | **$**               | **5,457**  | ** **                   | **$**      | **2**                         | ** ** | **$**                      | **(12**    | **)** | **$** | **5,447** | ** ** |

 

Mortgage-backed securities are backed by pools of mortgages most ofwhich are insured or guaranteed by the Federal Home Loan Mortgage Corporation(FHLMC), the Federal National Mortgage Association (FNMA) or the GovernmentNational Mortgage Association (GNMA).

 

Agency notes and bonds - available for sale mature within one year.Expected maturities of mortgage-backed securities may differ from contractualmaturities because issuers may have the right to call or prepay obligations.  Therefore maturities of mortgage-backedsecurities are not presented.

 

At December 31, 2004, $1,260,000 of the Company’ssecurities were pledged to Texline Independent School District ($1,054,000) andto the City of Texline ($206,000).

 

**Note6.  Loans and Allowance for Loan Losses**

 

The Company grantsagribusiness, real estate, and commercial loans to customers primarily in theAustin and Northwest Texas markets.  Loansat December 31, 2004, and September 30, 2004 were as follows (in thousands):

10

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| ** **                      | ** ** | **December 31, 2004** | ** ** | **September 30, 2004** | ** ** |
|---------------------------------|------------|-----------------------|------------|------------------------|------------|
| Agriculture                     | ** ** | **$**                 | **2,602**  | ** **             | **$**      | **3,444** | ** ** |
| Commercial                      | ** ** | **6,630**             | ** ** | **2,316**              | ** ** |
| Commerical real estate          | ** ** | **1,684**             | ** ** | **1,030**              | ** ** |
| Residential real estate         | ** ** | **3,308**             | ** ** | **2,627**              | ** ** |
| Construction real estate        | ** ** | **270**               | ** ** | **33**                 | ** ** |
| Consumer                        | ** ** | **878**               | ** ** | **720**                | ** ** |
| ** **                      | ** ** | ** **            | ** ** | ** **             | ** ** |
| ** **                      | ** ** | **15,372**            | ** ** | **10,170**             | ** ** |
| ** **                      | ** ** | ** **            | ** ** | ** **             | ** ** |
| Less: allowance for loan losses | ** ** | **(227**              | **)**      | **(217**               | **)**      |
| ** **                      | ** ** | ** **            | ** ** | ** **             | ** ** |
| ** **                      | ** ** | **$**                 | **15,145** | ** **             | **$**      | **9,953** | ** ** |

 

Activity in the allowance for loan losses for the three months endedDecember 31, 2004, and the year ended September 30, 2004, was as follows (inthousands):

 
| ** **                                 | ** ** | **December 31, 2004** | ** ** | **September 30, 2004** | ** ** |
|--------------------------------------------|------------|-----------------------|------------|------------------------|------------|
| ** **                                 | ** ** | ** **            | ** ** | ** **             | ** ** |
| Balance on date of acquisition             | ** ** | **$**                 | **—** | ** **             | **$**      | **166** | ** ** |
| Balance at beginning of the period         | ** ** | **217**               | ** ** | **—**             | ** ** |
| Provision for loan losses                  | ** ** | **—**            | ** ** | **95**                 | ** ** |
| Loans charged off                          | ** ** | **(1**                | **)**      | **(65**                | **)**      |
| Recoveries on loans previously charged-off | ** ** | **11**                | ** ** | **21**                 | ** ** |
| ** **                                 | ** ** | ** **            | ** ** | ** **             | ** ** |
| Balance at the end of the period           | ** ** | **$**                 | **227**    | ** **             | **$**      | **217** | ** ** |

 

The Company had no impaired loans at December 31, 2004, or September30, 2004.  At December 31, 2004 andSeptember 30, 2004, the Bank had approximately $61,000 and $152,000,respectively, in nonperforming loans including nonaccrual loans and loans pastdue over 90 days and still accruing interest.

 

**Note7.  Premises and Equipment**

 

Premises and equipment at December 31, 2004, and September 30, 2004,were as follows (in thousands):

 
| ** **                                      | ** ** | **December 31, 2004** | ** ** | **September 30, 2004** | ** ** |
|-------------------------------------------------|------------|-----------------------|------------|------------------------|------------|
| ** **                                      | ** ** | ** **            | ** ** | ** **             | ** ** |
| Land                                            | ** ** | **$**                 | **949**    | ** **             | **$**      | **4** | ** ** |
| Building and leasehold improvements             | ** ** | **4,489**             | ** ** | **615**                | ** ** |
| Furniture, fixtures and equipment               | ** ** | **644**               | ** ** | **635**                | ** ** |
| ** **                                      | ** ** | ** **            | ** ** | ** **             | ** ** |
| ** **                                      | ** ** | **6,082**             | ** ** | **1,254**              | ** ** |
| ** **                                      | ** ** | ** **            | ** ** | ** **             | ** ** |
| Less accumulated depreciation and  amortization | ** ** | **(119**              | **)**      | **(27**                | **)**      |
| ** **                                      | ** ** | ** **            | ** ** | ** **             | ** ** |
| ** **                                      | ** ** | **$**                 | **5,963**  | ** **             | **$**      | **1,227** | ** ** |

 

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**Note8.  Leases**

 

Effective September 28, 2004, the Company entered into a three yearlease for certain furniture, fixtures and equipment.  The first payment under this lease is due onJanuary 1, 2005, though the Company had already accepted delivery of theequipment on September 30, 2004.  Thelease had a renewal option for two additional years.  Due to certain financing provided by the Bankto the lessor, the lease was treated as a capital lease and the lease wouldhave been amortized over the maximum 60 month term.  The lease was paid-in-full and the equipmentpurchased in January 2005.

 

**Note9.  Deposits**

 

Time deposits of $100,000 or more totaled $1,745,233 and $1,597,064 atDecember 31, 2004 and September 30, 2004, respectively. At December 31, 2004,and September 30, 2004, the scheduled maturities of time deposits were asfollows (in thousands):

 

Time deposits maturing in the fiscal year ending:

 
| ** ** | ** ** | **As of  December 31, 2004** | ** ** | **As of  September 30, 2004** | ** ** |
|------------|------------|------------------------------|------------|-------------------------------|------------|
|       |       |                         |       |                          |       |
| 2005       |       | $                            | 6,977      |                          | $          | 7,860 |   |
| 2006       |       | 386                          |       | 363                           |       |
|       |       |                         |       |                          |       |
|       |       | $                            | 7,363      |                          | $          | 8,223 |   |

 

**Note10.  Goodwill and Other Intangibles**

 

In conjunction with the acquisition of Texline State Bank, the Companyrecorded Goodwill of $1,161,000 and core deposit intangibles of $70,000.  Goodwill is periodically, but at leastannually, reviewed to determine whether a decline in value exists whichrequires a charge to earnings and a reduction to the net goodwill reflected onthe statement of financial condition of the Company.

 

Core deposit intangibles are amortized on a straight-line basis overseven years.  The following tablereflects the net carrying amount of core deposit intangibles at December 31,2004, and September 30, 2004 (in thousands):

 

| ** **                     | ** ** | **December 31, 2004** | ** ** | **September 30, 2004** | ** ** |
|--------------------------------|------------|-----------------------|------------|------------------------|------------|
| Gross core deposit intangibles |       | $                     | 70         |                   | $          | 70 |   |
| Less accumulated amortization  |       | (8                    | )          | (6                     | )          |
| Net core deposit intangibles   |       | $                     | 62         |                   | $          | 64 |   |

 

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**Note11.  Stock Based Compensation and 2004Stock Incentive Plan**

 

On December 8,2003, in conjunction with the issuance of 40,000 shares of the Company’s commonstock to four individual organizers the Company recognized compensation expenseof $332,400.  The Company has notrecognized any other stock-based compensation in conjunction with the issuanceof its stock.

 

On January 19, 2004, the Company and its shareholders approved theCompany’s 2004 Stock Incentive Plan (the “Plan”).  The Plan authorizesincentive stock option grants, non-statutory stock option grants, direct stockissuances, stock appreciation rights, salary investment option grants, anddirector fee option grants.  Eligible participants are employees,non-employee board members, and independent consultants or advisors.  TheCompany has reserved 500,000 shares of common stock under the Plan, and theshare reserve increases on the 1st business day in January eachyear (beginning in 2005) by an amount equal to 2% of the number of outstandingshares of the Company on the last business day in December of thepreceding year, subject to a maximum annual increase of 100,000 shares. No person may receive stock option grants, stock issuances, or stock appreciationrights for more than 100,000 shares in the aggregate in any calendar year underthe Plan.

 

The table below presents the weighted average number of options issuedand outstanding during the three months ended December 31, 2004 and the fiscalyear ended September 30, 2004.

 
| ** **                                                        | ** ** | **Three Months Ended  December 31, 2004** | ** ** | **Year Ended  September 30, 2004**    | ** ** |
|-------------------------------------------------------------------|------------|-------------------------------------------|------------|---------------------------------------|------------|
| ** **                                                        | ** ** | **Shares**                                | ** ** | **Weighted  Average  Exercise Price** | ** ** | **Shares** | ** ** | **Weighted  Average  Exercise Price** | ** ** |
|                                                              |       |                                      |       |                                  |       |   |   |   |   |
| Outstanding, beginning of the period                              |       | 166,500                                   |       | $                                     | 8.33       |   | — |   | $ | — |   |
| Granted                                                           |       | —                                    |       | —                                |       | 175,500 |   | 8.33 |   |
| Exercised                                                         |       | —                                    |       | —                                |       | — |   | — |   |
| Forfeited/expired                                                 |       | —                                    |       | —                                |       | (10,000 | ) | 8.33 |   |
| Outstanding, end of the period                                    |       | 166,500                                   |       | $                                     | 8.33       |   | 165,500 |   | $ | 8.33 |   |
|                                                              |       |                                      |       |                                  |       |   |   |   |   |
| Exercisable at the end of the period                              |       | —                                    |       |                                  |       | — |   |   |   |
| Weighted-average fair value of options  granted during the period |       | $                                         | —     |                                  |       |   | $ | 3.80 |   |   |   |
| Weighted-average remaining contractural  life (months)            |       | 115                                       |       |                                  |       | 118 |   |   |   |
|                                                                   |            |                                           |            |                                       |            |  |  |  |  |  |  |  |  |

 

 

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**Note12.  Other Related Party Transactions**

 

**PGI Equity Partners, L.P.**

 

The Company has made an investment in the entity that owns the Company’spremises.  On November 18, 2004, theindependent, disinterested directors and members of the Company’s AuditCommittee, Mr. Watson and Mr. Coleman, approved the terms whereby the Companywould purchase a Class D limited partnership interest in PGI Equity Partners,L.P. of 47.5% for a cash investment of $950,000.  The Company paid $150,000 as an investmentdeposit on November 18, 2004, and paid the remaining $800,000 upon closing ofthe investment on December 30, 2004.  Asa result of this transaction and the previously existing lease of the premises,the Company is required to consolidate the operations PGI Equity Partners,L.P., for financial reporting purposes.

 

**Accounting and Tax Services**

 

The Company receives tax planning advice and general tax and accountingservices from Hamann & Associates, P.C. (“Hamann & Associates”),a professional corporation of certified public accountants. For the threemonths ended December 31, 2004, and December 31, 2003, the Company paidapproximately $18,750 and $50,000, respectively, for these services primarilywith respect to assistance in the preparation of the Company’s registrationstatement and related accounting support. Mr. Hamann owns an 80% interest in Hamann & Associates andserves as the chairman of its board of directors but has a limitedparticipation in the ongoing delivery of services to its clients in an advisorycapacity.  None of the fees paid forservices during the three months ended December 31, 2004, and 2003, wererelated to the efforts of Mr. Hamann. Hamann & Associates is a firm focused on tax planning andadvisory work and does not provide auditing services to clients.

 

**Note 13. Financial Instruments with Off-Balance Sheet Risk**

 

In the normal course of business, the Company is a party to financialinstruments with off-balance sheet risk to meet the financing needs of itscustomers, through the use of commitments to extend credit.  Those instruments involve, to varyingdegrees, elements of credit and interest-rate risk in excess of the amountrecognized in the consolidated balance sheet. The contract or notional amounts of those instruments reflect the extentof the Company’s involvement in particular classes of financial instruments.

 

The Company’s exposure to credit loss in the event of nonperformance bythe other party to the financial instrument for commitments to extend credit isrepresented by the contractual amount of those instruments.  The Company uses the same credit policies inmaking commitments and conditional obligations as they do for on-balance sheetinstruments.

 

The following table summarizes the Company’s off-balance sheetfinancial instruments as of December 31, 2004, and September 30, 2004 (inthousands):

 
| ** **                   | ** ** | **December 31,  2004** | ** ** | **September 30,  2004** | ** ** |
|------------------------------|------------|------------------------|------------|-------------------------|------------|
| ** **                   | ** ** | ** **             | ** ** | ** **              | ** ** |
| Commitments to extend credit | ** ** | **$**                  | **4,785**  | ** **              | **$**      | **1,264** | ** ** |
| Standby letters of credit    | ** ** | **$**                  | **97**     | ** **              | **$**      | **97** | ** ** |

 

Commitments to extend credit are agreements to lend to a customer aslong as there is no violation of any condition established in thecontract.  Commitments generally havefixed expiration dates or other termination clauses and may require payment ofa fee.  Since many of the commitments areexpected to expire without being drawn upon, the total commitment amounts donot necessarily represent future cash requirements.  The Company evaluates each customer’screditworthiness on a case-by-case basis. The amount of collateral obtained if deemed necessary by the Companyupon extension of credit is based on management’s credit evaluation of thecounterparty.  Collateral held

 

14

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varies but may include accounts receivable, inventory, property, plantand equipment and income-producing commercial properties.

 

Standby letters of credit are written conditional commitments used bythe Company to guarantee the performance of a customer to a third party. TheCompany’s policies generally require that letter of credit arrangements containsecurity and debt covenants similar to those contained in loan arrangements. Inthe event the customer does not perform in accordance with the terms of theagreement with the third party, the Company would be required to fund thecommitment. The maximum potential amount of future payments the Company couldbe required to make is represented by the contractual amount shown in the tableabove. If the commitment is funded, the Company would be entitled to seekrecovery from the customer. As of December 31, 2004, no amounts have beenrecorded as liabilities for the Company’s potential obligations under theseguarantees.

 

**Note 14. DividendRestrictions and Regulatory Matters**

 

Banks and bank holdingcompanies are subject to regulatory capital requirements administered by stateand federal banking regulatory agencies. Capital adequacy guidelines and,additionally for banks, prompt corrective action regulations involvequantitative measures of assets, liabilities, and certain off-balance sheetitems calculated under regulatory accounting practices. Capital amounts andclassifications are also subject to qualitative judgments by regulators aboutcomponents, risk weightings and other factors. Failure to meet capitalrequirements can initiate regulatory action. As of December 31, 2004,management believes the Bank is in compliance with all regulatory capitalrequirements to which it is subject.

 

The following table sets forth the bank only actual capital levels inaddition to the requirements under prompt corrective action regulations (inthousands):

 
| ** **                              | ** ** | **Actual** | ** ** | **For Capital  Adequacy Purposes** | ** ** | **To Be Well  Capitalized Under  Prompt Corrective  Action Provisions** | ** ** |
|-----------------------------------------|------------|------------|------------|------------------------------------|------------|-------------------------------------------------------------------------|------------|
| ** **                              | ** ** | **Amount** | ** ** | **Ratio**                          | ** ** | **Amount**                                                              | ** ** | **Ratio** | ** ** | **Amount** | ** ** | **Ratio** | ** ** |
|                                    |       |       |       |                               |       |                                                                    |       |   |   |   |   |   |   |
| December 31,  2004                 |       |       |       |                               |       |                                                                    |       |   |   |   |   |   |   |
| Total  capital to risk weighted assets  |       | **$**      | **8,311**  | ** **                         | **39.96**  | **%**                                                                   | ** ** | **1,664** | ** ** | **4.0** | **%** | **$** | **2,080** | ** ** | **5.0** | **%** |
| Tier I  capital to risk weighted assets |       | **8,083**  | ** ** | **38.87**                          | **%**      | **832**                                                                 | ** ** | **4.0** | **%** | **1,248** | ** ** | **6.0** | **%** |
| Tier I  capital to average assets       |       | **8,083**  | ** ** | **26.12**                          | **%**      | **1,238**                                                               | ** ** | **8.0** | **%** | **1,547** | ** ** | **10.0** | **%** |
|                                    |       | ** ** | ** ** | ** **                         | ** ** | ** **                                                              | ** ** | ** ** | ** ** | ** ** | ** ** | ** ** | ** ** |
| September 30,  2004                |       | ** ** | ** ** | ** **                         | ** ** | ** **                                                              | ** ** | ** ** | ** ** | ** ** | ** ** | ** ** | ** ** |
| Total  capital to risk weighted assets  |       | **$**      | **6,582**  | ** **                         | **57.77**  | **%**                                                                   | **$**      | **736** | ** ** | **8.0** | **%** | **$** | **921** | ** ** | **10.0** | **%** |
| Tier I  capital to risk weighted assets |       | **6,439**  | ** ** | **56.51**                          | **%**      | **368**                                                                 | ** ** | **4.0** | **%** | **553** | ** ** | **6.0** | **%** |
| Tier I  capital to average assets       |       | **6,439**  | ** ** | **42.68**                          | **%**      | **463**                                                                 | ** ** | **4.0** | **%** | **580** | ** ** | **5.0** | **%** |

 

As of December 31, 2004,the Bank met the level of capital required to be categorized as “wellcapitalized” under prompt corrective action regulations. Management is notaware of any conditions subsequent to December 31, 2004 that would changethe Bank’s capital category.

 

The Bank is a statechartered banking association and is subject to regulation, supervision andexamination by the Texas Department of Banking and the Federal DepositInsurance Corporation (FDIC). In addition, upon making certain determinationswith respect to the condition of any insured bank, the FDIC may beginproceedings to terminate a bank’s federal deposit insurance. The Bank iscurrently operating under a Memorandum of

 

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Understanding with theFDIC to ensure that management takes certain corrective actions to bringoperational activities within the parameters of FDIC recommendations, and theCompany believes that the Bank has conformed and complied with the Memorandumof Understanding. In addition, the FDIC examined the Bank in November 2004and issued its final report for such examination on January 31, 2005. TheFDIC has proposed a new Memorandum of Understanding to replace the currentMemorandum of Understanding, which proposed terms require the Bank to takecertain corrective actions with respect to internal compliance procedures andtraining.

 

Certain restrictions exist regarding the ability of the Bank to paycash dividends. Regulatory approval is required in order to pay dividends untilsuch time as the accumulated deficit is eliminated and certain other conditionsare met.  Nonetheless, the Bank will notpay dividends for at least three years, regardless of its total capitalizationas part of its agreement with banking regulations for approval of therelocation of the Bank's main office to Austin. The Company experienced losses both in the current and the two precedingyears.

 

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**Item 2.****           *Management’s Discussion and Analysis of FinancialCondition and Results Of Operations***

 

**Introduction**

 

We are a bank holdingcompany headquartered in Austin, Texas. We acquired 99.92% of Texline StateBank (the “Bank”), a state chartered bank with a single business location inTexline, Dalham County, Texas, on March 9, 2004.  Following thepurchase of additional shares from shareholders of the Bank and the completionof a reverse stock split, we acquired all of the outstanding stock of theBank.  On September 10, 2004, the name of the Bank was changed to “TreatyOak Bank” and we began banking operations in Austin, Texas, retaining a branchin Texline, Texas.  As a result, our operating history, as it relates tothe banking industry, is limited. In the course of preparing our consolidatedfinancial statements, we use certain estimates with respect to loans,intangibles, the allowance for loan losses and other estimates necessary forfinancial reporting. We have made no significant changes to the types ofestimates and the manner in which they are determined since the filing of ourannual report on Form 10-KSB, except as otherwise noted within this discussionand analysis.

 

**Plan of Operation**

 

***General***

 

Financial performance in ourTexline branch has continued to improve over the prior year. Additionally,given the greater growth potential in Austin, we expect to focus our efforts onestablishing a community-oriented bank out of our headquarters in the leasedfacility that we occupy at 101 Westlake Drive (at Bee Cave Road), Austin,Texas, 78746. The Bank occupies approximately 7,000 square feet in a buildingand has executed, effective June 1, 2004, a 15-year lease with options torenew for up to an additional 10 years.  Further, we have subleased anadditional 700 square feet in the same building, effective October 1,2004, under the same terms, for the offices of the Company.  We have atotal of 24 employees, 19 of whom are full-time employees and 21 of whom areemployees of the Bank.  Of those, 14 are employed at the Austinheadquarters and 7 are employed in Texline.

 

On December 30, 2004,the Company closed on the purchase of a 47.5% Class D limited partnershipinterest in PGI Equity Partners, L.P., a Texas limited partnership, which ownsand operates the building and premises in which the Company has its Austin,Texas, headquarters. As a result of this investment, the Company has includedPGI Equity Partners, L.P., in its consolidated financial statements, inaccordance with FIN 46(R), An Interpretation of ARB No. 51.

 

***Holding Company Liquidity***

 

We closed our stock offeringon September 30, 2004 with 1,581,187 shares subscribed representing$13,171,288 in gross total capital raised.  As of December 31, 2004,we had 1,574,885 ($13,118,792) of these shares of common stock  deemed issued.  As of December 31, 2004, the Companystill had funds in transit as to 6,302 shares ($52,500) of common stock, whichare reported as a receivable on December 31, 2004.  Of this sum $5,500,000, in addition to the$500,000 injected on the date of acquisition, was injected into the Bank. An additional $2,000,000 was injected into the Bank on December 23, 2004,bringing the total additional paid in capital to $8,000,000. After payment ofoffering and start-up costs under the Expense Reimbursement Agreement to TreatyOak Holdings, Inc., (“TOHI”) of $775,000, repayment of other start-up costsaccumulated prior to the closing of the offering of approximately $303,000,repayment of the $500,000 note plus accumulated interest to TOHI, which wasused to make the $500,000 capital injection to the Bank upon acquisition,payment of the outstanding notes, of $1,019,000 plus accumulated interest,arising from the acquisition of Texline State Bank, the investment of $950,000in PGI Equity Partners, L.P., and the payment of other operating expenses, theCompany (excluding the Bank) had approximately $1,650,000 in remaining cashproceeds.  The Company had approximately $1,700,000 of liquidity. These funds are being used for Company operations, investment and for laterinfusion into the Bank and other corporate activities.  The primary sourceof liquidity for the Company will be dividends paid by the Bank.  The Bankis currently restricted from paying dividends without regulatory approval whichwill not be granted until the accumulated deficit has been eliminated.

 

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***Bank Liquidity***

 

The Bank’s liquidity ismonitored by its staff, the Asset/Liability Management Committee and the Boardof Directors, who review historical funding requirements, current liquidityposition, sources and stability of funding, marketability of assets, optionsfor attracting additional funds, and anticipated future funding needs,including the level of unfunded commitments.

 

The Bank’s primary sourcesof funds will be retail and commercial deposits, loan and securitiesrepayments, other short-term borrowings, and other funds provided by operations.While scheduled loan repayments and maturing investments are relativelypredictable, deposit flows and early loan prepayments are more influenced byinterest rates, general economic conditions, and competition. The Bank willmaintain investments in liquid assets based upon management’s assessment of(1) the need for funds, (2) expected deposit flows, (3) yieldsavailable on short-term liquid assets, and (4) objectives of theasset/liability management program. We anticipate eliminating the need for borrowedfunds upon infusion of additional cash and cash equivalents.

 

We haveretained the facility in Texline, Texas, as a branch of Treaty Oak Bank. Because this facility has both a concentration and an expertise in agriculturallending, we will continue to service the existing loans and make newagricultural loans when possible in the Texline market. Since loan growth hasbeen flat for a number of years in Texline, and since a greater opportunity forand expertise in commercial lending exists in Austin, it is our expectationthat the majority of new loan growth, particularly commercial and executive andprofessional loan demand, will come from the Austin market.

 

Greater loan demand willresult in greater pressure on the Bank’s liquidity; however, it is ourintention to maintain a conservative loan to deposit ratio in the range of 80%over time. Consequently, we will not aggressively pursue lending opportunitiesif sufficient funding sources (i.e. deposits, Fed Funds, etc.) are notavailable, nor will we seek to attract transient, volatile non-local depositswith above market interest rates. As of December 31, 2004, theloan-to-deposit ratio was 57.43%.

 

Managementbelieves the Bank is in compliance with its current Memorandum ofUnderstanding.  We believe we have met the liquidity requirements byinjecting $8,000,000 of capital into the Bank, which increased totalcapitalization of the Bank to $9,305,000 as of December 31, 2004. Inaddition, the FDIC examined the Bank in November 2004 and issued its finalreport for such examination on January 31, 2005. The FDIC has proposed anew Memorandum of Understanding to replace the current Memorandum ofUnderstanding, which proposed terms require the Bank to take certain correctiveactions with respect to internal compliance procedures and training.

 

In the event that additionalshort-term liquidity is needed, the Bank will retain established relationshipscreated by Texline State Bank with several large regional banks in addition toestablishing new correspondent relationships through the main office in Austin.Texline has utilized such relationships as a source of liquidity in the past,and we expect to continue to utilize these going forward if needed. Also,Texline State Bank has been a frequent borrower of Federal Funds in the past.In the current rate environment, where rates on Federal Funds are at historicallows, Texline State Bank has relied upon this source as an alternative toattracting more expensive deposit funds that would carry a slightly higherinterest cost. While we do not intend to rely as heavily on Federal Funds ashas Texline State Bank, the source will remain available to the Bank goingforward.  As of December 31, 2004, the Bank had not borrowed anyFederal Funds.

 

The Bank had cash and cashequivalents of $13,019,000 or 35.53% of the Bank’s total assets, at December 31,2004, and had available $20.3 million of rate-sensitive assets which maturewithin one year or less as of December 31, 2004. At December 31,2004, the Bank had approximately $7 million of excess deposits that weanticipate will be drawn down early in the next calendar quarter. With theadditional capital injection from the proceeds of the offering, the Bank shouldhave more than adequate liquidity to meet anticipated future funding needs.

 

The Bank is subject tovarious regulatory capital requirements administered by federal and statebanking agencies, which could affect its ability to pay dividends to theCompany. Failure to meet minimum capital

 

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requirements can initiate certain mandatory anddiscretionary actions by regulators that, if undertaken, could have a materialadverse effect on our financial statements. The minimum ratios required for theBank to be considered “well capitalized” for regulatory purposes, and thereforeeligible to consider the payment of dividends to the Company, are 10% totalcapital to risk weighted assets, 6% tier 1 capital to risk weighted assetsand 5% tier 1 capital to average assets. At December 31, 2004, theBank was considered “well capitalized” by regulatory standards. Nonetheless,the Bank will not pay dividends for at least three years, regardless of itstotal capitalization as part of its agreement with banking regulators forapproval of the relocation of the Bank’s main office to Austin.

 

***Capital Resources***

 

As of December 31,2004, the Company’s shareholder’s equity was $11,940,000 ($11,990,000 net of$50,000 in treasury stock), or 27.68% of total assets. The increase inshareholders’ equity results from capital raised in our offering, net of costs,reduced by the operating losses of approximately $2,854,000 arising during thestart-up phase of operations in Austin, including charges of $332,400 fornon-cash, stock-based compensation expense from the initial issuances of theCompany’s common stock to certain affiliated parties.

 

The equity capital base ofthe Bank increased from $1,066,000 to $9,305,000 between March 9, 2004(the date of acquisition) and December 31, 2004, due primarily to the capitalinjections of $8,000,000 net of operating losses of $1,137,000 attributable tothe start-up activities in Austin, Texas.  Total assets of the Bankincreased from $10,663,000 to $36,638,000 for the same period.

 

The Bank will be subject tothe risk-based capital regulations administered by the banking regulatoryagencies. The risk-based capital guidelines are designed to make regulatorycapital requirements more sensitive to differences in risk profiles among banksto account for off-balance sheet exposure and to minimize disincentives forholding liquid assets. Under the regulations, assets and off-balance sheetitems are assigned to broad risk categories, each with appropriate weights. Theresulting capital ratios represent capital as a percentage of total riskweighted assets and off-balance sheet items. Under the prompt corrective actionregulations, to be adequately capitalized a bank must maintain minimum ratiosof total capital to risk-weighted assets of 8.00%, Tier 1 capital torisk-weighted assets of 4.00%, and Tier 1 capital to total assets of 4.00%.Further, the Bank is currently required to maintain an 8% Tier 1 leverageratio, under the Memorandum of Understanding. Failure to meet these capitalrequirements may initiate certain mandatory, and possibly additionaldiscretionary actions by regulators that if undertaken could have a materialadverse effect on the Bank’s financial statements. At December 31, 2004,management believed that the Bank was in full compliance with all capitaladequacy requirements.

 

**Results of Operations**

 

***General***

 

The following discussionanalyzes the results of the Company for the three-month periods ended December 31,2004, and December 31, 2003. References to the “Bank” in this reviewconcern the operating performance of Treaty Oak Bank (formerly Texline StateBank) since its acquisition on March 9, 2004.

 

***Net Income—General***

 

The Company’s fiscal yearends on September 30. The net loss for the quarter ended December 31,2004, was $700,000, compared to a net loss of $513,000 for the quarter ended December 31,2003. The expenses associated with the start-up of operations in Austin, Texas,and the high concentration of cash and cash equivalents earning atsignificantly lower rates than if a higher concentration of these assets werein the form of loans, accounted for substantially all of the losses for thequarter ended December 31, 2004, while start-up activities accounted forsubstantially all of the loss for the three months ended December 31,2003.

 

The profitability of theCompany’s consolidated operations depends primarily on net interest income,which is defined as the difference between total interest earned on interestearning assets (investments and loans) and total interest paid on interestbearing liabilities (deposits, borrowed funds). The Company’s net income isaffected by its provision for loan losses, as well as other income and otherexpenses. The provision for loan losses reflects the

 

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amount considered to be adequate to cover probablecredit losses in the loan portfolio. Non-interest income or other incomeconsists of service charges on deposits, gain on sale of loans, and otheroperating income. Other expenses include salaries and employee benefits, occupancyexpenses, data processing expenses, marketing, supplies, and other operatingexpenses.

 

Net interest income isaffected by changes in the volume and mix of interest earning assets, the levelof interest rates earned on those assets, the volume and mix of interestbearing liabilities, and the level of interest rates paid on those interestbearing liabilities. The provision for loan losses is dependent upon changes inthe loan portfolio and management’s assessment of the collectibility of theloan portfolio, as well as economic and market conditions. Other income andother expenses are impacted by growth of operations and growth in the number ofaccounts through both acquisitions and core banking business growth. Growth inoperations affects other expenses as a result of additional employees, branchfacilities, and promotional marketing expense. Growth in the number of accountsaffects other income including service fees, as well as other expenses such ascomputer services, supplies, postage, telecommunications, and othermiscellaneous expenses.

 

***Provision for Loan Losses***

 

The provision for loanlosses is an expense determined by management as the amount necessary toincrease the allowance for loan losses after net charge-offs have been deductedto a level that, in management’s best estimate, is necessary to absorb probablelosses in the loan portfolio. The amount of the provision is based onmanagement’s review of the loan portfolio and consideration of such factors ashistorical loss experience, general prevailing economic conditions, changes inthe size and composition of the loan portfolio and specific borrowerconsiderations, including the ability of the borrower to repay the loan and theestimated value of the underlying collateral. The provision is calculatedmonthly and a charge to expense is made, as required, to increase the allowanceto the calculated level. For any particular month, in the event the requiredallowance is less than or equal to the current allowance, no expense is chargedor reversed.

 

For the quarter ended December 31,2004, the Bank made no additional provision for loan losses. The Bank chargedoff $1,000 in commercial and consumer loans and had recoveries of loanspreviously charged-off of $11,000 for net charge-offs of $10,000. The factorscombined increased the Allowance for Loan Losses to $227,000 or 1.48% of theportfolio. This amount represents management’s estimate of potential lossesinherent in the portfolio.

 

***Income Taxes***

 

No federal tax expense hasbeen recorded for the quarter ended December 31, 2004, based upon netoperating losses incurred and carried forward in previous years. Based upon theCompany’s limited operating history, the federal tax benefit of these losseshas been fully reserved.

 

**Financial Condition**

 

***Loan Portfolio***

 

Net loans increased$5,192,000 (52.17%) to $15,145,000 from $9,953,000 between December 31,2004 and September 30, 2004. The increase was due primarily to the openingof the Austin office and subsequent funding of pending loan requests. It isanticipated that the concentration within the portfolio will shift over timefrom the current concentration of agricultural loans to real estate andcommercial loans.

 

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***Loan Portfolio Mix***

 

The following tables setforth the composition of the loan portfolio:

 
| ** **                 | ** ** | **At December 31,  2004** | ** ** | **At September 30,  2004** | ** ** |
|----------------------------|------------|--------------------------------|------------|---------------------------------|------------|
| ** **                 | ** ** | **Amount**                     | ** ** | **Percent**                     | ** ** | **Amount** | ** ** | **Percent** | ** ** |
|                       |       |                           |       |                            |       |   |   |   |   |
| Agriculture                |       | $                              | 2,602,000  |                            | 17.0       | % | $ | 3,444,000 |   | 33.9 | % |
| Commercial                 |       | 6,630,000                      |       | 43.1                            | %          | 2,316,000 |   | 22.8 | % |
| Commercial  real estate    |       | 1,684,000                      |       | 10.9                            | %          | 1,030,000 |   | 10.1 | % |
| Residential  real estate   |       | 3,308,000                      |       | 21.5                            | %          | 2,627,000 |   | 25.8 | % |
| Construction  real estate  |       | 270,000                        |       | 1.8                             | %          | 33,000 |   | 0.3 | % |
| Consumer                   |       | 878,000                        |       | 5.7                             | %          | 720,000 |   | 7.1 | % |
|                       |       |                           |       |                            |       |   |   |   |   |
| Total Loans                |       | 15,372,000                     |       | 100                             | %          | 10,170,000 |   | 100 | % |
| Allowance  for Loan Losses |       | (227,000                       | )          |                            |       | (217,000 | ) |   |   |
|                       |       |                           |       |                            |       |   |   |   |   |
| Net Loans                  |       | $                              | 15,145,000 |                            |       |   | $ | 9,953,000 |   |   |   |
|                            |            |                                |            |                                 |            |  |  |  |  |  |  |  |  |

 

Loan concentrations areconsidered to exist when there are amounts loaned to a multiple number ofborrowers engaged in similar activities that would cause them to be similarlyimpacted by economic or other conditions.

 

Prior to its acquisition byus, the Bank operated a branch office in Houston, Texas (which was closed in2002), and a second portfolio concentration developed with loans of one-to-fourfamily residential real estate. Approximately $1,780,000 of the Bank’sresidential real estate portfolio is comprised of single family residences inHouston. The majority of these loans originated between 1996 and 1998 for15-year terms with fixed rates of 8.75% or greater. These loans additionallyhave five-year call provisions exercisable at the Bank’s discretion.

 

These residential realestate loans are expected to remain flat or possibly trend down slightly. Themajority of new loan growth is expected to originate from the Austin market. Managementbelieves that loans originated from the Austin market will reflect a broader,more diverse mix of industries and borrowers. As new loans are generated fornon-agricultural and non residential real estate purposes, the percentage ofthe total loan portfolio creating the concentrations described above will bereduced thereby diminishing undue risk associated with industry concentration.

 

Management may renew loansat maturity when requested by a customer whose financial strength appears tosupport such a renewal or when such a renewal appears to be in the bestinterest of the Bank. The Bank requires payment of accrued interest in suchinstances and may adjust the rate of interest, require a principal reduction,or modify other terms of the loan at the time of renewal.

 

***Loan Maturities***

 

As of December 31,2004, 27.57% of the loan portfolio consisting of agricultural, commercial, andreal estate loans, or $4,238,000, matures or reprices within one year or less.$2,480,000 of these loans, or 16.13%, are variable rate loans. The followingtable presents the contractual maturity ranges for agricultural, commercial,and real estate loans outstanding at December 31, 2004, and also presentsfor each maturity range the portion of loans

 

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that have fixed interest rates or interest ratesthat fluctuate over the life of the loan in accordance with changes in theinterest rate environment as represented by the base rate:

 
| ** **                  | ** ** | **Due in One Year  or Less** | ** ** | **Due after One Year  Through  Five Years** | ** ** | **Due after  Five Years** | ** ** | ** **         | ** ** |
|-----------------------------|------------|------------------------------|------------|---------------------------------------------|------------|---------------------------|------------|--------------------|------------|
| **September 30, 2004** | ** ** | **Fixed  Rate**              | ** ** | **Floating  Rate**                          | ** ** | **Fixed  Rate**           | ** ** | **Floating  Rate** | ** ** | **Fixed  Rate** | ** ** | **Floating  Rate** | ** ** | **Total** | ** ** |
| Agricultural                |       | $                            | 108,000    |                                        | 1,200,000  |                      | 8,000      |               | 580,000    |   | 1,000 |   | 705,000 |   | $ | 2,602,000 |   |
| Commercial                  |       | 938,000                      |       | 1,057,000                                   |       | 2,219,000                 |       | 1,827,000          |       | — |   | 589,000 |   | 6,630,000 |   |
| Real Estate                 |       | 713,000                      |       | 222,000                                     |       | 1,496,000                 |       | 359,000            |       | 1,612,000 |   | 880,000 |   | 5,262,000 |   |
|                             |            |                              |            |                                             |            |                           |            |                    |            |  |  |  |  |  |  |  |  |

 

***Investment Securities***

 

The primary purposes of theinvestment portfolio are to provide a source of earnings for liquiditymanagement purposes, to provide collateral to pledge against public deposits,and to control interest rate risk. In managing the portfolio, the Bank seeks toattain the objectives of safety of principal, liquidity, diversification, andmaximized return on investment.

 

The following tables setforth the amortized cost and fair value of the Bank’s securities portfolio byaccounting classification category and by type of security as indicated:

 

| ** **                           | ** ** | **As of  December 31, 2004** | ** ** |
|--------------------------------------|------------|-----------------------------------|------------|
| ** **                           | ** ** | **Amortized  Cost**               | ** ** | **Fair  Value** | ** ** |
| Securities  Available for Sale:      |       |                              |       |   |   |
| U.S.  Government Agencies            |       | $                                 | 402,000    |   | $ | 399,000 |   |
| Other  mortgage backed securities    |       | 54,000                            |       | 56,000 |   |
|                                 |       |                              |       |   |   |
| Total  Securities Available for Sale |       | $                                 | 456,000    |   | $ | 455,000 |   |
|                                 |       |                              |       |   |   |
| Securities  Held to Maturity:        |       |                              |       |   |   |
| U.S.  Government agencies            |       | $                                 | 4,994,000  |   | $ | 4,986,000 |   |
| Other  mortgage backed securities    |       | 7,000                             |       | 6,000 |   |
|                                 |       |                              |       |   |   |
| Total  Securities Held to Maturity   |       | $                                 | 5,001,000  |   | $ | 4,992,000 |   |
|                                      |            |                                   |            |  |  |  |  |  |

 

U.S. Treasury securities andsecurities of U.S. Government agencies generally consist of fixed ratesecurities with maturities of three months to five years. Other mortgage backedsecurities consists of fixed rate mortgage pass-through securities with amaturity of five to fifteen years.

 

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***Asset Quality***

 

The following table setsforth the amount of non-performing loans and non-performing assets as of December 31,2004:

 

| ** **                                               | ** ** | **December 31,  2004** | ** ** |
|----------------------------------------------------------|------------|-----------------------------|------------|
| Non-accruing  loans                                      |       | $                           | 61,000     |   |
| Loans 90  days or more past due, still accruing interest |       | —                      |       |
| Total  non-performing loans                              |       | 61,000                      |       |
| Other real  estate owned                                 |       | —                      |       |
| Other  repossessed assets                                |       | 17,000                      |       |
| Total  non-performing assets                             |       | $                           | 78,000     |   |
|                                                     |       |                        |       |
| Total  non-performing loans to total loans               |       | 0.40                        | %          |
| Allowance  for loan losses to non-performing loans       |       | 373.77                      | %          |
| Total  non-performing assets to total assets             |       | 0.18                        | %          |

 

***Non-performing Loans***

 

Non-performing loans include(1) loans accounted for on a non-accrual basis, (2) accruing loanscontractually past due 90 days or more as to interest and principal, and(3) troubled debt restructurings. Management reviews the loan portfoliofor problem loans on an ongoing basis.

 

If interest on non-accrualloans had been accrued, such income would have amounted to approximately $3,000for the quarter ended December 31, 2004. This amount was not included ininterest income during this period.

 

Any loan 90 or more dayspast due is required to be placed on non-accrual basis unless specificallyidentified mitigating circumstances exist. The Bank’s policy is to place loans90 days past due on non-accrual status. An exception is made whenmanagement believes the loan is fully secured and in process of collection. Non-accrualloans are further classified as impaired when underlying collateral is notsufficient to cover the loan balance and it is probable that the Bank will notfully collect all principal and interest. As of December 31, 2004, theBank had $61,000 in non-accrual loans. There were no loans contractually pastdue over 90 days and continuing to accrue interest on December 31,2004, based upon specific information available at that time to management. Incompliance with these statutes we have developed pro forma financial statementsassuming that no loans will continue to accrue interest if the loan become90 days past due, and instead transfer all such loans to non-accruingstatus.

 

A “troubled debtrestructuring” is a restructured loan upon which interest accrues at a belowmarket rate or upon which certain principal has been forgiven so as to aid theborrower in the final repayment of the loan, with any interest previouslyaccrued, but not yet collected, being reversed against current income. Interestis accrued based upon the new loan terms. There were no troubled debtrestructurings outstanding as of December 31, 2004*.*

 

Non-performing assets alsoconsist of other repossessed assets and other real estate owned (“OREO”). OREOrepresents properties acquired through foreclosure or other proceedings and isrecorded at the lower of cost or fair market value less the estimated cost ofdisposal. OREO is evaluated regularly to ensure that the recorded amount issupported by its current fair market value. Valuation allowances to reduce thecarrying amount to fair market value less estimated costs of disposal arerecorded as necessary. Revenues and expenses from the operations of OREO andchanges in the valuation are included in other income and other expenses on theincome statement. As

 

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of December 31, 2004, the Bank had no otherreal estate owned. Repossessed assets totaled $17,000 at December 31,2004.

 

***Sources of Funds***

 

*General*

 

Deposits, short-term andlong-term borrowings, loan and investment security repayments and prepayments,proceeds from the sale of securities, and cash flows generated from operationsare the primary sources of our funds for lending, investing, and other generalpurposes. Loan repayments are a relatively predictable source of funds exceptduring periods of significant interest rate declines, while deposit flows tendto fluctuate with prevailing interests rates, money markets conditions, generaleconomic conditions, and competition.

 

*Deposits*

 

The Bank offers a variety ofdeposit accounts with a range of interest rates and terms. Core depositsconsist of checking accounts (non-interest bearing), “NOW” accounts, savingsaccounts, and non-public certificates of deposit. These deposits, along withpublic fund deposits and short-term borrowings, are used to support the Bank’sasset base. Deposits are obtained predominantly from the geographic trade areassurrounding the Bank’s office location. The Bank relies primarily on customerservice and long-standing relationships with customers to attract and retaindeposits; however, market interest rates and rates offered by competingfinancial institutions significantly affect the Bank’s ability to attract andretain deposits.

 

The following table setsforth the maturities of time deposits $100,000 and over as of December 31,2004:

 
| ** **                                | ** ** | **At December 31,  2004** | ** ** |
|-------------------------------------------|------------|--------------------------------|------------|
| Time  deposits $100,000 and over:         |       |                           |       |
| Maturing  within three months             |       | $                              | 627,000    |   |
| After three  months but within six months |       | 313,000                        |       |
| After six  months but within 12 months    |       | 705,000                        |       |
| After 12  months                          |       | 100,000                        |       |
|                                      |       |                           |       |
| Total time  deposits $100,000 and over:   |       | $                              | 1,745,000  |   |

 

*Return onEquity and Assets*

 

The following table setsforth certain information regarding the Company’s return on equity and assetsfor the periods indicated:

 
| ** **              | ** ** | **For the  Three Months Ended  December 31,  2004** | ** ** |
|-------------------------|------------|----------------------------------------------------------|------------|
| Return on  assets       |       | -3.72                                                    | %          |
| Return on  equity       |       | -14.57                                                   | %          |
| Dividend  payout ratio  |       | 0                                                        | %          |
| Equity to  assets ratio |       | 25.40                                                    | %          |

 

**Capital Resources**

 

The risk-based capitalregulations established and administered by the banking regulatory agenciesdiscussed previously are applicable to the Bank. Risk-based capital guidelinesare designed to make regulatory

 

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capital requirements more sensitive to differencesin risk profiles among banks, to account for off-balance sheet exposure, and tominimize disincentives for holding liquid assets. Under the regulations, assetsand off-balance sheet items are assigned to broad risk categories, each withappropriate weights. The resulting capital ratios represent capital as apercentage of total risk weighted assets and off-balance sheet items. Under theprompt corrective action regulations, to be adequately capitalized a bank mustmaintain minimum ratios of total capital to risk-weighted assets of 8.00%, Tier1 capital to risk-weighted assets of 4.00%, and Tier 1 capital to total assetsof 4.00%. Failure to meet these capital requirements can initiate certainmandatory, and possibly additional discretionary, actions by regulators that,if undertaken, could have a material adverse effect on the Bank’s financialstatements.

 

As of December 31,2004, the most recent notification from the federal banking regulatorscategorized the Bank as well-capitalized. A well-capitalized institution mustmaintain a minimum ratio of total capital to risk-weighted assets of at least10.00%, a minimum ratio of Tier 1 capital to risk weighted assets of at least6.00%, and a minimum ratio of Tier 1 capital to total assets of at least 5.00%and must not be subject to any written order, agreement, or directive requiringit to meet or maintain a specific capital level. We believe that there are noconditions or events since that notification that have changed the capitalclassification.

 

The Bank was in fullcompliance with all applicable capital adequacy requirements as of December 31,2004. The required and actual amounts and ratios for the Bank as of December 31,2004, are presented below:

 
| ** **                                | ** ** | **Actual** | ** ** | **For Capital Adequacy  Purposes** | ** ** | **To Be Well Capitalized  Under  Prompt Corrective  Action  Provisions** | ** ** |
|-------------------------------------------|------------|------------|------------|------------------------------------|------------|--------------------------------------------------------------------------|------------|
| ** **                                | ** ** | **Amount** | ** ** | **Ratio**                          | ** ** | **Amount**                                                               | ** ** | **Ratio** | ** ** | **Amount** | ** ** | **Ratio** | ** ** |
| As of December 31,  2004             |       |       |       |                               |       |                                                                     |       |   |   |   |   |   |   |
| Tier 1  capital (to average assets)       |       | $          | 8,083,000  |                               | 26.12      | %                                                                        | $          | 1,238,000 |   | 4 | % | $ | 1,547,000 |   | 5 | % |
| Tier 1 capital  (to risk-weighted assets) |       | 8,083,000  |       | 38.87                              | %          | 832,000                                                                  |       | 4 | % | 1,248,000 |   | 6 | % |
| Total  capital (to risk-weighted assets)  |       | 8,311,000  |       | 39.96                              | %          | 1,664000                                                                 |       | 8 | % | 2,080,000 |   | 10 | % |
|                                           |            |            |            |                                    |            |                                                                          |            |  |  |  |  |  |  |  |  |  |

 

**Item 3.****                                                           *Controls and Procedures***

 

With theparticipation of management, the Company’s chief executive officer and chieffinancial officer reviewed and evaluated the Company’s disclosure controls andprocedures as defined in Rules 13a-14(c) and 15d-14(c) under the SecuritiesExchange Act of 1934, as amended (the “Exchange Act”), as of the end of theperiod covered by this report. Based on this evaluation, the chief executiveofficer and chief financial officer concluded that the disclosure controls andprocedures are effective to ensure that the information required to bedisclosed by the Company in reports that it files or submits under the ExchangeAct is recorded, processed, summarized and reported to the Company’s managementwithin the time periods specified in the Securities and Exchange Commission’srules and forms.

 

There have beenno significant changes in the Company’s internal controls for financialreporting or in other factors that could significantly affect these controls,including any significant deficiencies or material weaknesses of internalcontrols that would require corrective action. In connection with the newrules, the Company is currently in the process of further reviewing anddocumenting its disclosure controls and procedures, including its internalaccounting controls, and may from time to time make changes aimed at enhancingtheir effectiveness and ensuring that the Company’s systems evolve with itsbusiness.

 

**PART II.****                                                OtherInformation**

 

**Item 1.****                                                            *Legal Proceedings***

 

The Company has nopending legal proceedings as of December 31, 2004. From time to time, theCompany’s subsidiary is involved in various legal proceedings arising in theordinary course of business. These

 

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actions are notbelieved to be material either individually or collectively to the consolidatedfinancial condition of the Company or its subsidiary.

 

**Item 2.****                                                            *Changes in Securities and Use of Proceeds***

 

On May 7, 2004, the Securities and ExchangeCommission declared our Registration Statement on Form SB-2 (File No.333-112325) related to our initial public offering effective. In addition, on October 22,2004, we filed a Form SB-2MEF under Rule 462 registering additional shares ofcommon stock and warrants to purchase our common stock under our publicoffering. We registered a total of 1,944,000 shares of our common stock, ofwhich 324,000 shares are issuable under registered common stock warrants. Weaccepted subscriptions for 1,589,602 shares of our common stock under theoffering and have received net offering proceeds (after deducting offeringexpenses) of approximately $11.9 million.

 

As of December 31, 2004, we had paid ourorganizing shareholder and affiliate, Treaty Oak Holdings for reimbursement ofexpenses and advances on our behalf in connection with our offering andrepayment of the amount due under a convertible promissory note. Treaty OakHoldings owns approximately 39% of our common stock. We contributed to thecapital of the Bank and paid operating expenses including repayment of certaincosts previously paid by Treaty Oak Holdings. We also repaid principal andinterest under unsecured promissory notes issued in connection with thepurchase price of the Bank. The table below summarizes the use of net offeringproceeds through December 31, 2004:

 
| Gross  proceeds from sale of shares                                                                                                                                                      |   | 13,171,288 |   |
|------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------|--------|------------|--------|
| Amounts  receivable as of December 31, 2004                                                                                                                                         |   | (52,500    | )      |
| Repayment of offering and start-up costs  under Expense Reimbursement Agreement to Treaty Oak Holdings, Inc., including  offering costs of $500,000 and pre-opening expenses of $275,000 |   | (775,000   | )      |
| Repayment of note payable to Treaty Oak  Holdings, Inc., including accrued interest of approximately $7,000                                                                              |   | (507,302   | )      |
| Repayment of notes payable for the  acquisition of Texline State Bank including accrued interest of approximately  $29,000                                                               |   | (1,034,115 | )      |
| Contribution  to the capital of the Bank                                                                                                                                                 |   | (7,500,000 | )      |
| Payments to  directors and officers (bonuses and directors’ fees)                                                                                                                   |   | (140,000   | )      |
| Payments to  officers (salary and benefits)                                                                                                                                              |   | (73,000    | )      |
| Other  payments to affiliates for services                                                                                                                                               |   | (19,000    | )      |
| Limited  partnership investment in affiliated limited partnership                                                                                                                        |   | (950,000   | )      |
| Repurchase  of shares issued                                                                                                                                                             |   | (50,000    | )      |
| Payment of  additional operating expenses (estimated)                                                                                                                                    |   | (424,000   | )      |
| Remaining  net proceeds                                                                                                                                                                  |   | 1,646,371  |   |

 

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$679,691 of the amount referenced as “Repaymentof notes payable for the acquisition of Texline State Bank was paid to CharlesT. Meeks, a member of our Board of Directors and Chairman of the Board of theBank. An additional amount due to Mr. Meeks from the acquisition of the Bank inthe amount of $18,783 previously held in escrow is also included in thisamount. On November 18, 2004, we approved the purchase of a 47.5%preferential limited partnership interest in PGI Equity Partners, L.P., whichowns and operates the building premises we lease, for $950,000. A deposit of$150,000 was paid on November 18, 2004 and the balance of the purchaseprice of $800,000 was paid on December 30, 2004, at closing. We hadoriginally anticipated these funds would be used for capital of the Bank, butwe believe the investment in premises will allow us the opportunity to realizemore value from appreciation in the real property.  These proceeds represent a portion of thefunds raised above original maximum offering. Accordingly, we believe this investment will have little or no impactupon the capital necessary to support our banking operations at this time. Theremaining net proceeds have been invested in short-term interest bearing, moneymarket accounts.

 

**Item 3.****           *DefaultsUpon Senior Securities***

 

None.

 

**Item 4.****           *Submissionof Matters to a Vote of Security Holders***

 

None.

 

**Item 5.****           *OtherInformation***

 

Charles T. Meeks, one of our directors, who also serves as chairman of Treaty Oak Bank, is the father of M. Randy Meeks, Treaty Oak Bank’s senior vice president – Chief Loan Officer.

 

**Item 6.****           *Exhibits andReports on Form 8-K***

 

a.       Exhibits
|   |   |   |                                                                                                                                                                                                                                      |
|--------|--------|--------|-------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------|
|   | 3.1    |   | Amended and Restated Articles of  Incorporation (filed as Exhibit 4.1 to Registration Statement on Form S-8  filed with the Commission on October 22, 2004 (File No. 333-119914,  which exhibit is incorporated herein by reference) |
|   |   |   |                                                                                                                                                                                                                                      |
|   | 3.2*   |   | By-laws                                                                                                                                                                                                                                   |
|   |   |   |                                                                                                                                                                                                                                      |
|   | 4.1*   |   | Specimen Common Stock Certificate, $.01 par  value per share                                                                                                                                                                              |
|   |   |   |                                                                                                                                                                                                                                      |
|   | 4.2*   |   | See Exhibits 3.1 and 3.2 for provisions of  the Articles of Incorporation and By-laws defining rights of holders of  Common Stock                                                                                                         |
|   |   |   |                                                                                                                                                                                                                                      |
|   | 31.1   |   | Certification of Chief Executive Officer  required by Rule 13a-14(a)/15d-14(a) under the Exchange Act                                                                                                                                     |
|   |   |   |                                                                                                                                                                                                                                      |
|   | 31.2   |   | Certification of Chief Financial Officer  required by Rule 13a-14(a)/15d-14(a) under the Exchange Act                                                                                                                                     |
|   |   |   |                                                                                                                                                                                                                                      |
|   | 32.1   |   | Certification of Chief Executive Officer  pursuant to 18 U.S.C. Section 1350, as adopted pursuant to  Section 906 of Sarbanes-Oxley Act of 2002                                                                                 |
|   |   |   |                                                                                                                                                                                                                                      |
|   | 32.2   |   | Certification of Chief Financial Officer  pursuant to 18 U.S.C. Section 1350, as adopted pursuant to  Section 906 of Sarbanes-Oxley Act of 2002                                                                                 |

 

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*                                         Incorporatedby reference to the same numbered exhibit filed with the Company’s RegistrationStatement on Form SB-2 (File No. 333-112325).

 

b.              Current Reports onForm 8-K

 

We filed two current reports on Form 8-Kduring the reporting period. On October 6, 2004, we reported the close ofour public offering and acceptance of subscriptions for an aggregate of1,593,094 shares at a price of $8.33 per share for a total offering of$13,270,473.02. On December 28, 2004, we reported the resignation ofSandra Ellsworth as our chief financial officer and the appointment of JeffreyL. Nash as our new chief financial officer.

 

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**SIGNATURES**

 

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

 

 
|                     | **TREATY OAK BANCORP, INC.** |
|--------------------------|------------------------------|
|                     |                         |   |
|                     |                         |   |
| Dated: February 14, 2005 | By:                          | /s/ Terry W. Hamann |   |
|                     |                         | Terry W. Hamann, President and Chief  Executive Officer |
|                     |                         |   |
|                     |                         |   |
|                     | By:                          | /s/ Jeffrey L. Nash |   |
|                     |                         | Jeffrey L. Nash, Chief Financial Officer |

 

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