** **

**UNITEDSTATESSECURITIES AND EXCHANGE COMMISSION**WASHINGTON, DC 20549

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

**x**                              QUARTERLYREPORT PURSUANT TO SECTION 13 OR 15 OF THE SECURITIES EXCHANGE ACT OF 1934

**For the quarterly period ended March 31, 2007**

**o**                                 TRANSITIONREPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES EXCHANGE ACT OF 1934

# **CommissionFile Number: 333-112325**

**Treaty Oak Bancorp, Inc.**(Exact name of registrant as specified in its charter)

**Texas**(State or other jurisdiction ofcorporation or organization)

**20-0413144**(I.R.S. Employer Identification Number)

**101Westlake Drive, Austin, Texas**(Address of Principal Executive Offices)

**78746**(Zip Code)

**(512)617-3600**(Registrant’s telephone number, including area code)

Indicate by checkmark whether the issuer (1) has filed all reports required to be filed bySection 13 or 15(d) of the Securities Exchange Act of 1934 during the preceding12 months (or for such shorter period that the registrant was required to file****such reports), and (2) has been subject to such filingrequirements for the past 90 days.  **Yes ****x   No****o**

Indicate by check markwhether the registrant is a shell company (as defined in Rule 12b-2 of the Exchange Act).  **Yes****o   No  ****x**

Indicate the number ofshares outstanding of each of the issuer’s classes of common stock as of theclose of business on May 10, 2007.

$0.01 Par ValueCommon Stock                                                                                                          2,748,414shares

Transitional SmallBusiness Disclosure Format (Check one):  **Yes****o   No  ****x**

 

 

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**QUARTERLYREPORT ON FORM 10-QSBFOR THE PERIOD ENDED MARCH 31, 2007**

**TABLE OFCONTENTS**
| **Part I.**   | ** ** | **Financial Information**                                                                                                  |
|---------------|------------|----------------------------------------------------------------------------------------------------------------------------|
|          |       |                                                                                                                       |
| **Item 1.**   | * *   | *Financial Statements*                                                                                                     |
| ** **    | * *   | * *                                                                                                                   |
|          |       | Consolidated Balance Sheets at March 31, 2007  (unaudited) and September 30, 2006 (audited)                                |
|          |       |                                                                                                                       |
|          |       | Consolidated Statements of Operations for the Three  Months and Six Months Ended March 31, 2007, and 2006 (unaudited) |
|          |       |                                                                                                                       |
|          |       | Consolidated Statement of Changes in Shareholders’  Equity for the Six Months Ended March 31, 2007 (unaudited)   |
|          |       |                                                                                                                       |
|          |       | Consolidated Statements of Cash Flows for the Six  Months Ended March 31, 2007 and 2006 (unaudited)                        |
|          |       |                                                                                                                       |
|          |       | Notes to Consolidated Financial Statements (unaudited)                                                                     |
|          |       |                                                                                                                       |
| **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.**   | * *   | *Unregistered Sales of Equity 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*                                                                                                                 |
| ** **    | * *   | * *                                                                                                                   |
|          |       | Signatures                                                                                                                 |

 

This Form 10-QSBcontains forward-looking statements consisting of estimates with respect to thefinancial condition, results of operations, and other business of Treaty OakBancorp, Inc., that are subject to various factors which could cause actualresults to differ materially from those estimates.  Factors that could influence the estimatesinclude changes in the national, regional, and local market conditions,legislative and regulatory conditions, and an adverse interest rateenvironment.

 

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**Treaty Oak Bancorp, Inc.Consolidated Balance Sheets (unaudited)March 31, 2007 and September 30, 2006(Dollars In Thousands, Except Par Value and Share Amounts)**
| ** **                                                                                                   | ** ** | **March 31,** | ** ** | **September 30,** | ** ** |
|--------------------------------------------------------------------------------------------------------------|------------|--------------------|------------|------------------------|------------|
| ** **                                                                                                   | ** ** | **2007**           | ** ** | **2006(1)**            | ** ** |
| ASSETS                                                                                                       |       |               |       |                   |       |
|                                                                                                         |       |               |       |                   |       |
| Cash and cash items                                                                                          |       | $                  | 278        |                   | $          | 267 |   |
| Due from banks                                                                                               |       | 2,563              |       | 2,312                  |       |
| Federal funds sold                                                                                           |       | 8,827              |       | 23,775                 |       |
| Total cash and  cash equivalents                                                                             |       | 11,668             |       | 26,354                 |       |
|                                                                                                         |       |               |       |                   |       |
| Securities available  for sale                                                                               |       | 13                 |       | 16                     |       |
| Securities held to  maturity, fair value of $1,447 and $2,001, respectively                                  |       | 1,448              |       | 2,006                  |       |
| Investment in Federal  Home Loan Bank stock, at cost                                                         |       | 224                |       | 224                    |       |
| Investment in  Independent Banker’s Financial Corporation stock, at cost                                |       | 102                |       | 102                    |       |
| Loans, net                                                                                                   |       | 73,152             |       | 59,620                 |       |
| Premises and equipment,  net                                                                                 |       | 5,543              |       | 5,593                  |       |
| Note receivable from  affiliate                                                                              |       | —             |       | 2,821                  |       |
| Accrued interest  receivable                                                                                 |       | 645                |       | 484                    |       |
| Due from affiliates                                                                                          |       | —             |       | 192                    |       |
| Goodwill and other  intangibles, net                                                                         |       | 1,200              |       | 1,205                  |       |
| Other assets                                                                                                 |       | 767                |       | 474                    |       |
| Total assets                                                                                                 |       | $                  | 94,762     |                   | $          | 99,091 |   |
|                                                                                                         |       |               |       |                   |       |
| LIABILITIES AND  SHAREHOLDERS’ EQUITY                                                                   |       |               |       |                   |       |
|                                                                                                         |       |               |       |                   |       |
| Deposits:                                                                                                    |       |               |       |                   |       |
| Noninterest-bearing  demand                                                                                  |       | $                  | 21,526     |                   | $          | 28,091 |   |
| NOW, money  market and savings                                                                               |       | 24,199             |       | 32,401                 |       |
| Time deposits                                                                                                |       | 27,483             |       | 20,526                 |       |
| Total deposits                                                                                               |       | 73,208             |       | 81,018                 |       |
|                                                                                                         |       |               |       |                   |       |
| Accounts payable and  accrued expenses                                                                       |       | 323                |       | 352                    |       |
| Accrued interest payable                                                                                     |       | 238                |       | 160                    |       |
| Federal funds purchased                                                                                      |       | 5,000              |       | —                 |       |
| Property mortgage                                                                                            |       | 2,636              |       | 2,667                  |       |
| Notes payable                                                                                                |       | —             |       | 2,483                  |       |
| Minority interest - PGI  Equity Partners, LP                                                                 |       | —             |       | 1,106                  |       |
| Other liabilities                                                                                            |       | 31                 |       | 33                     |       |
| Total  liabilities                                                                                           |       | 81,436             |       | 87,819                 |       |
|                                                                                                         |       |               |       |                   |       |
| Shareholders’ equity:                                                                                   |       |               |       |                   |       |
| Preferred stock,  $0.01 par value; 1,000,000 shares authorized; none issued                                  |       | —             |       | —                 |       |
| Common stock,  $0.01 par value; 20,000,000 shares authorized; 2,740,131 and 2,640,226,  respectively, issued |       | 27                 |       | 26                     |       |
| Paid-in capital                                                                                              |       | 16,878             |       | 14,989                 |       |
| Accumulated deficit                                                                                          |       | (3,529             | )          | (3,693                 | )          |
| Less shares held  in treasury, at cost (6,003 shares)                                                        |       | (50                | )          | (50                    | )          |
| Total  shareholders’ equity                                                                             |       | 13,326             |       | 11,272                 |       |
| Total liabilities and  shareholders’ equity                                                             |       | $                  | 94,762     |                   | $          | 99,091 |   |

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(1)             Derivedfrom Audited Consolidated Financial Statements

SeeNotes to Consolidated Financial Statements (unaudited)

 

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**TreatyOak Bancorp, Inc.Consolidated Statements of Operations (unaudited)Three Months and Six Months Ended March 31, 2007 and 2006(Dollars In Thousands, Except Share and Per Share Amounts)**
| ** **                                           | ** ** | **Three Months**         | ** ** | **Three Months**         | ** ** | **Six Months**           | ** ** | **Six Months**           | ** ** |
|------------------------------------------------------|------------|-------------------------------|------------|-------------------------------|------------|-------------------------------|------------|-------------------------------|------------|
| ** **                                           | ** ** | **Ended March 31,** | ** ** | **Ended March 31,** | ** ** | **Ended March 31,** | ** ** | **Ended March 31,** | ** ** |
| ** **                                           | ** ** | **2007**                      | ** ** | **2006**                      | ** ** | **2007**                      | ** ** | **2006**                      | ** ** |
| Interest income:                                     |       |                          |       |                          |       |                          |       |                          |       |
| Loans, including  fees                               |       | $                             | 1,599      |                          | $          | 950                           |       | $                             | 3,144      |   | $ | 1,772 |   |
| Taxable  securities                                  |       | 17                            |       | 25                            |       | 31                            |       | 57                            |       |
| Interest on  deposits with other banks               |       | —                        |       | 20                            |       | —                        |       | 56                            |       |
| Federal funds  sold                                  |       | 82                            |       | 71                            |       | 308                           |       | 107                           |       |
| Total interest  income                               |       | 1,698                         |       | 1,066                         |       | 3,483                         |       | 1,992                         |       |
|                                                 |       |                          |       |                          |       |                          |       |                          |       |
| Interest expense:                                    |       |                          |       |                          |       |                          |       |                          |       |
| Deposits                                             |       | 544                           |       | 207                           |       | 1,109                         |       | 381                           |       |
| Other borrowings                                     |       | 40                            |       | 41                            |       | 107                           |       | 83                            |       |
| Total interest  expense                              |       | 584                           |       | 248                           |       | 1,216                         |       | 464                           |       |
|                                                 |       |                          |       |                          |       |                          |       |                          |       |
| Net interest income                                  |       | 1,114                         |       | 818                           |       | 2,267                         |       | 1,528                         |       |
|                                                 |       |                          |       |                          |       |                          |       |                          |       |
| Provision for loan  losses                           |       | 70                            |       | 45                            |       | 145                           |       | 90                            |       |
| Net interest income  after provision for loan losses |       | 1,044                         |       | 773                           |       | 2,122                         |       | 1,438                         |       |
|                                                 |       |                          |       |                          |       |                          |       |                          |       |
| Noninterest income:                                  |       |                          |       |                          |       |                          |       |                          |       |
| Service charges  on deposit accounts                 |       | 39                            |       | 19                            |       | 72                            |       | 39                            |       |
| Other  noninterest income                            |       | 61                            |       | 102                           |       | 133                           |       | 197                           |       |
| Total  noninterest income                            |       | 100                           |       | 121                           |       | 205                           |       | 236                           |       |
|                                                 |       |                          |       |                          |       |                          |       |                          |       |
| Noninterest expense:                                 |       |                          |       |                          |       |                          |       |                          |       |
| Salaries and  employee benefits                      |       | 615                           |       | 442                           |       | 1,141                         |       | 833                           |       |
| Occupancy and  equipment expenses                    |       | 101                           |       | 114                           |       | 213                           |       | 175                           |       |
| Accounting and  other professional fees              |       | 47                            |       | 52                            |       | 102                           |       | 176                           |       |
| Other  noninterest expense                           |       | 353                           |       | 262                           |       | 707                           |       | 540                           |       |
| Total  noninterest expense                           |       | 1,116                         |       | 870                           |       | 2,163                         |       | 1,724                         |       |
|                                                 |       |                          |       |                          |       |                          |       |                          |       |
| Net income (loss)                                    |       | $                             | 28         |                          | $          | 24                            |       | $                             | 164        |   | $ | (50 | ) |
|                                                 |       |                          |       |                          |       |                          |       |                          |       |
| Earnings (loss) per  common share - basic            |       | $                             | 0.01       |                          | $          | 0.01                          |       | $                             | 0.06       |   | $ | (0.02 | ) |
| Earnings (loss) per  common share - diluted          |       | $                             | 0.01       |                          | $          | 0.01                          |       | $                             | 0.06       |   | $ | (0.02 | ) |
|                                                 |       |                          |       |                          |       |                          |       |                          |       |
| Weighted average shares  outstanding - basic         |       | 2,733,222                     |       | 2,635,887                     |       | 2,707,665                     |       | 2,635,816                     |       |
| Weighted average shares outstanding - diluted        |       | 2,963,399                     |       | 2,637,882                     |       | 2,869,690                     |       | 2,660,599                     |       |

 

SeeNotes to Consolidated Financial Statements (unaudited)

 

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**Treaty Oak Bancorp, Inc.Consolidated Statement of Shareholders’ Equity (unaudited)Six Months Ended March 31, 2007(Dollars In Thousands, Except Share Amounts)**
| ** **                                                   | ** ** | ** **            | ** ** | ** **  | ** ** | **Additional**  | ** ** | ** **   | ** ** | ** ** | ** ** | ** ** | ** ** |
|--------------------------------------------------------------|------------|-----------------------|------------|-------------|------------|-----------------|------------|--------------|------------|------------|------------|------------|------------|
| ** **                                                   | ** ** | **Common Stock** | ** ** | **Paid-In** | ** ** | **Accumulated** | ** ** | **Treasury** | ** ** | ** ** | ** ** |
| ** **                                                   | ** ** | **Shares**            | ** ** | **Amount**  | ** ** | **Capital**     | ** ** | **Deficit**  | ** ** | **Stock**  | ** ** | **Total**  | ** ** |
|                                                         |       |                  |       |        |       |            |       |         |       |       |       |       |       |
| Balances at October 1,  2006                                 |       | 2,640,226             |       | $           | 26         |            | $          | 14,989       |       | $          | (3,693     | )          | $          | (50 | ) | $ | 11,272 |   |
|                                                         |       |                  |       |        |       |            |       |         |       |       |       |       |       |
| Shares issued  from Treaty Oak Holdings merger               |       | 1,094,163             |       | 11          |       | 9,082           |       | —       |       | —     |       | 9,093      |       |
| Shares retired  from Treaty Oak Holdings merger              |       | (1,000,000            | )          | (10         | )          | (8,300          | )          | —       |       | —     |       | (8,310     | )          |
| Warrants and  options from Treaty Oak Holdings merger        |       | —                |       | —      |       | 932             |       | —       |       | —     |       | 932        |       |
| Shares issued  through the exercise of common stock warrants |       | 3,341                 |       | —      |       | 33              |       | —       |       | —     |       | 33         |       |
| Non-cash stock  based compensation                           |       | —                |       | —      |       | 133             |       | —       |       | —     |       | 133        |       |
| Shares issued  for services provided                         |       | 2,401                 |       | —      |       | 9               |       | —       |       | —     |       | 9          |       |
| Net income                                                   |       | —                |       | —      |       | —          |       | 164          |       | —     |       | 164        |       |
|                                                         |       |                  |       |        |       |            |       |         |       |       |       |       |       |
| Balances at March 31, 2007                                   |       | 2,740,131             |       | $           | 27         |            | $          | 16,878       |       | $          | (3,529     | )          | $          | (50 | ) | $ | 13,326 |   |

 

SeeNotes to Consolidated Financial Statements (unaudited)

 

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**Treaty Oak Bancorp, Inc.Consolidated Statements of Cash Flows (unaudited)Six Months Ended March 31, 2007 and 2006(Dollars In Thousands)**
| ** **                                                                                | ** ** | **Six Months**           | ** ** | **Six Months**           | ** ** |
|-------------------------------------------------------------------------------------------|------------|-------------------------------|------------|-------------------------------|------------|
| ** **                                                                                | ** ** | **Ended March 31,** | ** ** | **Ended March 31,** | ** ** |
| ** **                                                                                | ** ** | **2007**                      | ** ** | **2006**                      | ** ** |
| Cash flows from  operating activities:                                                    |       |                          |       |                          |       |
| Net income  (loss)                                                                        |       | $                             | 164        |                          | $          | (50 | ) |
| Adjustments to  reconcile net income (loss) to net cash provided by operating activities: |       |                          |       |                          |       |
| Provision for  loan losses                                                                |       | 145                           |       | 90                            |       |
| Non-cash stock  based compensation                                                        |       | 142                           |       | —                        |       |
| Depreciation and  amortization                                                            |       | 183                           |       | 176                           |       |
| Other                                                                                     |       | (7                            | )          | 9                             |       |
| Changes in other  operating assets and liabilities:                                       |       |                          |       |                          |       |
| Accrued interest  receivable                                                              |       | (118                          | )          | (3                            | )          |
| Other assets                                                                              |       | (229                          | )          | (80                           | )          |
| Accrued interest  payable                                                                 |       | 77                            |       | (5                            | )          |
| Other  liabilities                                                                        |       | (111                          | )          | 96                            |       |
| **Net  cash provided by operating activities**                                            |       | 246                           |       | 233                           |       |
|                                                                                      |       |                          |       |                          |       |
| Cash flows from  investing activities:                                                    |       |                          |       |                          |       |
| Proceeds from  maturities and principal repayments on securities - available for sale     |       | 3                             |       | 10                            |       |
| Proceeds from  maturities and principal repayments on securities - held to maturity       |       | 2,001                         |       | 997                           |       |
| Purchases of  securities - held to maturity                                               |       | (1,443                        | )          | —                        |       |
| Acquistion of  interest in PGI Equity Partners, LP                                        |       | —                        |       | (80                           | )          |
| Purchases of  correspondent bank stock                                                    |       | —                        |       | (7                            | )          |
| Net increase in  loans                                                                    |       | (13,610                       | )          | (12,940                       | )          |
| Cash received  from the acquistion of Treaty Oak Holdings, Inc.                           |       | 515                           |       | —                        |       |
| (Advances to)  repayments from affiliates                                                 |       | 194                           |       | (411                          | )          |
| Collection of  notes receivable from affiliates                                           |       | 2,821                         |       | —                        |       |
| Purchases of  premises and equipment                                                      |       | (122                          | )          | (34                           | )          |
| **Net  cash used in investing activities**                                                |       | (9,641                        | )          | (12,465                       | )          |
|                                                                                      |       |                          |       |                          |       |
| Cash flows from  financing activities:                                                    |       |                          |       |                          |       |
| Net increase  (decrease) in deposits                                                      |       | (7,810                        | )          | 10,768                        |       |
| Increase in  federal funds purchased                                                      |       | 5,000                         |       | —                        |       |
| Payments of  principal on mortgage                                                        |       | (31                           | )          | —                        |       |
| Payments of  principal on notes payable                                                   |       | (2,483                        | )          | (39                           | )          |
| Proceeds from  exercise of warrants                                                       |       | 33                            |       | 2                             |       |
| **Net  cash provided by (used in) in financing activities**                               |       | (5,291                        | )          | 10,731                        |       |
|                                                                                      |       |                          |       |                          |       |
| Net decrease in cash  and cash equivalents                                                |       | (14,686                       | )          | (1,501                        | )          |
| Cash and cash  equivalents at beginning of period                                         |       | 26,354                        |       | 13,107                        |       |
| Cash and cash equivalents at end of period                                                |       | $                             | 11,668     |                          | $          | 11,606 |   |

 

 

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**Treaty Oak Bancorp, Inc.Consolidated Statements of Cash Flows (unaudited)Six Months Ended March 31, 2007 and 2006(Dollars In Thousands)**
| ** **                                          | ** ** | **Six Months**           | ** ** | **Six Months**           | ** ** |
|-----------------------------------------------------|------------|-------------------------------|------------|-------------------------------|------------|
| ** **                                          | ** ** | **Ended March 31,** | ** ** | **Ended March 31,** | ** ** |
| ** **                                          | ** ** | **2007**                      | ** ** | **2006**                      | ** ** |
|                                                |       |                          |       |                          |       |
| Supplemental  disclosures of cash flow information: |       |                          |       |                          |       |
| Non-cash  investing and financing information:      |       |                          |       |                          |       |
| Cash interest  received                             |       | $                             | 3,322      |                          | $          | 1,525 |   |
| Cash interest  paid                                 |       | $                             | 1,138      |                          | $          | 469 |   |
|                                                |       |                          |       |                          |       |
| Acquisition of Treaty  Oak Holdings, Inc.           |       |                          |       |                          |       |
| Assets acquired,  excluding cash acquired           |       | $                             | 1,280      |                          |       |   |
| Liabilities  assumed                                |       | (80                           | )          |                          |       |
| Issuance of  common stock                           |       | (9,093                        | )          |                          |       |
| Retirement of  comon stock                          |       | 8,310                         |       |                          |       |
| Issuance of  warrants and assumption of options     |       | (932                          | )          |                          |       |
| Net cash acquired                                   |       | $                             | (515       | )                             |       |   |

 

SeeNotes to Consolidated Financial Statements (unaudited)

 

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**Treaty Oak Bancorp, Inc.Notes to Consolidated Financial Statements (unaudited)**

**Note1.  Basis of Presentation**

Treaty Oak Bancorp, Inc.(the “Company”) is a bank holding company incorporated on November 18, 2003,and organized December 8, 2003 for the purpose of holding the common stock ofTreaty Oak Bank (formerly Texline State Bank, the “Bank”).  TheCompany, through Treaty Oak Bank, provides a full range of commercial andconsumer banking services to individuals and businesses in the commercialsector in Austin, Texas, and in the agriculture, cattle and commercial sectorsin the community of Texline, Texas.

OnNovember 15, 2006, the Company completed its acquisition of Treaty OakHoldings, Inc. (“TOHI”) pursuant to the Agreement and Plan of Merger, dated October3, 2006 (the “Merger Agreement”).  Themerger was approved by the Company’s Board of Directors and also by the Company’sshareholders at a Special Meeting of Shareholders held on October 24,2006.  Prior to the merger, TOHI operatedas a bank holding company and significant shareholder of the Company, butotherwise had no active operations.  As aresult of the merger, the Company now owns TOHI’s subsidiary companies, TreatyOak Financial Holdings, Inc. (“TOFHI”) and PGI Capital, Inc. These entities havebeen consolidated in the Company’s financial statements since the merger onNovember 15, 2006.  TOFHI is an inactivecorporate entity with assets of cash and a note receivable.  PGI Capital, Inc. is the general partner ofPGI Equity Partners, LP, the entity which owns the Company’s corporateheadquarters.

The Companyacquired a 47.5% interest in PGI Equity Partners, LP (the “Partnership”) onDecember 31, 2004. The Partnership owns and operates the building in which theCompany offices. On February 23, 2006, theCompany acquired additional 2.5% Class A and 1.25% Class B interests in thePartnership from the sole remaining minority shareholder, bringing the Company’stotal ownership interest in the Partnership to 51.25% at September 30,2006.  TOHI owned 43.25% of the limitedpartnership interests, while PGI Capital, Inc. owned the remaining 0.5% limitedpartnership interest.  Thus, followingthe Company’s merger with TOHI on November 15, 2006, the Company now owns100.0% of the limited partnership interests in the Partnership as well as the5.0% general partnership interest held by PGI Capital, Inc., the Partnership’sgeneral partner.  The Partnership hasbeen consolidated in the Company’s financial statements since December 31,2004.  TOHI and PGI Capital, Inc.’sinterests have been accounted for as minority interests until the merger onNovember 15, 2006.

The consolidatedfinancial statements include the accounts of Treaty Oak Bancorp, Inc., itswholly owned subsidiary Treaty Oak Bank, and PGI Equity Partners, LP.  The consolidated financial statements alsoinclude the accounts of PGI Capital, Inc. and TOFHI subsequent to the merger onNovember 15, 2006.

The accompanying unaudited consolidated financial statements have beenprepared in accordance with the instructions to Form 10-QSB and, therefore, donot include all of the disclosures and notes required by accounting principlesgenerally accepted in the United States of America.  In the opinion of management, all materialadjustments (which are of a normal recurring nature) considered necessary for afair presentation have been made.  Theresults for the interim period are not necessarily indicative of the results tobe expected for the entire year or any other interim period.

New AccountingPronouncements

The Companyadopted Financial Accounting Standards Board Statement No. 123R, “Share-BasedPayment”, (“Statement 123R”) on October 1, 2006. Under Statement 123R, the costof employee services received in exchange for an award of equity instruments isbased on the grant-date fair value of the award (with limited exceptions). Thatcost is recognized over the period during which an employee is required toprovide service in exchange for the award — the requisite service period(usually the vesting period).

Prior to October 1, 2006,the Company accounted for stock-based compensation to employees using theintrinsic value method.  Accordingly,compensation costs for employee stock options were measured as the excess, ifany, of the fair value of the Company’s common stock at date of grant over theexercise price.

The Companyaccounts for stock-based compensation to non-employees at fair value.

8

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In June 2006, the FASB issued FASB Interpretation No. 48, “Accounting forUncertainty in Income Taxes” (FIN 48). Fin 48 clarifies the accounting and reporting for income taxesrecognized in accordance with SFAS No. 109, “Accounting for Income Taxes.”  This Interpretation prescribes acomprehensive model for the financial statement recognition, measurement,presentation and disclosure of uncertain tax positions taken or expected to betaken in income tax returns.  The Companyis currently evaluating the impact of FIN 48. The Company will adopt this Interpretation in the first quarter offiscal 2008.

In September 2006,the SEC issued Staff Accounting Bulletin (“SAB”) No. 108, “Considering theEffects of Prior Year Misstatements when Quantifying Misstatements in CurrentYear Financial Statements.” SAB 108 addresses the views of the SEC staffregarding the process of quantifying financial statement misstatements. SECregistrants are expected to reflect the effects of initially applying theguidance in SAB 108 in their annual financial statements covering the firstfiscal year ending after November 15, 2006. The cumulative effect of theinitial application should be reported in the carrying amounts of assets andliabilities as of the beginning of that fiscal year and the offsettingadjustment should be made to the opening balance of retained earnings for thatyear. The Company adopted SAB 108 on October 1, 2006.  The adoption did not have any impact on thefinancial statements.

In September 2006, the FASB issued SFAS No. 157,“Fair Value Measurements”.  ThisStatement defines fair value, establishes a framework for measuring fair valueand expands disclosures about fair value measurements.  It clarifies that fair value is the pricethat would be received to sell an asset or paid to transfer a liability in anorderly transaction between market participants in the market in which the reportingentity transacts.  This Statement doesnot require any new fair value measurements, but rather, it provides enhancedguidance to other pronouncements that require or permit assets or liabilitiesto be measured at fair value.  ThisStatement is effective for fiscal years beginning after November 15, 2007, withearlier adoption permitted.  TheCompany will adopt this standard in the first quarter of fiscal 2008.   The Company does not expect that the adoption ofthis Statement will have a material impact on its financial position, resultsof operation and cash flows.

InFebruary 2007, the FASB issued SFAS No. 159, “The Fair Value Option forFinancial Assets and Financial Liabilities”. This Statement permits entities to choose to measure many financialassets and financial liabilities at fair value. Unrealized gains and losses on items for which the fair value option hasbeen elected will be reported in earnings. SFAS No. 159 is effective for fiscal years beginning after November 15,2007.  The Company will adopt this standard in the first quarter of fiscal2008.  The Company is currentlyevaluating the impact of SFAS No. 159 on its consolidated financial position,results of operations and cash flows.

**Note2.  Merger with Organizing Shareholder**

On November 15,2006, the Company completed the acquisition of TOHI pursuant to the Agreementand Plan of Merger, dated October 3, 2006. TOHI was one of the five organizing shareholders of the Company andoperated as a bank holding company and significant shareholder of the Company,but otherwise had no active operations. The primary purpose of the merger wasto achieve certain operational efficiencies for the Company and its affiliates.The merger was approved by the Company’s Board of Directors and also by theCompany’s shareholders at a Special Meeting of Shareholders held on October 24,2006.  Prior to the consummation of themerger, TOHI held approximately 38% of the issued and outstanding shares of theCompany’s common stock.  Pursuant to theMerger Agreement, (1) each issued and outstanding share of TOHI’s common stock,par value $0.01 per share was converted into the right to receive 0.8121 sharesof the Company’s common stock, par value $0.01 per share, and (2) each issuedand outstanding share of TOHI’s preferred stock, par value $10.00 per share,was converted into the right to receive 1.2034 shares of the Company’s commonstock.

TOHI had issuedoptions to acquire shares of common stock to various individuals, 40,000 ofwhich were outstanding as of the date of the merger.  These options were assumed by the Companyand, pursuant to the conversion ratio, now represent options to acquire 32,484shares of the Company’s common stock. The options were fully vested at the merger date.  Also, at the closing of the merger, certainTOHI warrantholders were issued new warrants to acquire, in the aggregate,450,000 shares of the Company’s common stock. The warrants were fully vested when issued.  The Company granted the TOHI shareholderscertain limited registration rights pursuant to a Registration Rights Agreementexecuted at the closing of the merger. Pursuant to the Registration Rights Agreement these former TOHIshareholders can request that the Company register their shares of the Company’scommon stock on a Registration Statement on Form S-3 if such form is availablefor use by the Company, but only once during any 12-month period. The formerTOHI warrantholders were also granted similar S-3 registration rights.

The TOHIshareholders contributed certain assets and liabilities to the Company inconnection with the merger.  As ofNovember 15, 2006, the assets and liabilities contributed by TOHI were asfollows (in thousands):

9

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|                                                        | ** ** | **As of  November 15,  2006** | ** ** |
|--------------------------------------------------------|------------|-----------------------------------------|------------|
|                                                   |       |                                    |       |
| Cash                                                   |       | $                                       | 441        |   |
| Subscriptions receivable                               |       | 72                                      |       |
| Notes receivable                                       |       | 100                                     |       |
| Accrued interest  receivable                           |       | 5                                       |       |
| Investment in  PGI Equity Partnership, LP              |       | 875                                     |       |
| Investment in  PGI Capital, Inc. (1)                   |       | 54                                      |       |
| Investment in  Treaty Oak Financial Holdings, Inc. (2) |       | 248                                     |       |
|                                                   |       | 1,795                                   |       |
| Accrued expenses                                       |       | (80                                     | )          |
|                                                   |       |                                    |       |
| Net assets contributed  by TOHI                        |       | $                                       | 1,715      |   |

----

(1)             PGICapital, Inc.’s assets were comprised of $31,000 in cash and $224,000 ofgeneral and limited partnership interests in PGI Equity Partners LP.  PGI Capital, Inc. liabilities included a notepayable to the Bank of $200,000 plus accrued interest of $1,000.

(2)             TreatyOak Financial Holdings’ assets were comprised of $43,000 in cash, a $166,500note receivable and related accrued interest of $38,000.

The Company and TOHI weredeemed to be under common control.  Amajority of the directors of the Company also served on TOHI’s board ofdirectors and were shareholders of both entities.  TOHI also owned 1,000,000 shares of theCompany’s common stock, representing approximately 38% of the Company sharesthen outstanding.  Because the Companyand TOHI were deemed to be under common control, purchase accounting was notapplied to the merger.  Instead the netassets contributed by TOHI were recorded at their predecessor basis.  The 1,000,000 shares of Company common stockowned by TOHI were cancelled by the Company and recorded as a reduction of itscommon stock accounts (par value and paid in capital) at their fair marketvalue, as determined by an independent appraisal, of $8.31 per share, or$8,310,000 in the aggregate.  The1,094,163 new shares of Company stock issued to the TOHI shareholders were alsorecorded at the fair market value price of $8.31 per share, or $9,093,000 inthe aggregate.  The warrants issued bythe Company in exchange for the TOHI warrants and the TOHI options assumed bythe Company were valued and recorded at their fair value using a Black-Scholespricing model.****The net effect of thecontribution of assets and the capital stock transactions was a $1,715,000increase to the Company’s equity and a 94,163 net increase in the number ofCompany shares issued.  Although the netassets contributed by TOHI to the Company were not adjusted to their fairvalue, the assets were evaluated for collectibility and/or impairment accordingto generally accepted accounting principles prior to the merger and adjustedaccordingly by TOHI prior to the merger.

**Note3.  Earnings (Loss) Per Share**

Basic earnings(loss) per share is computed by dividing net earnings (loss) by theweighted-average number of common shares outstanding for the period. Diluted earnings per share is computed using the weighted-average number ofcommon shares outstanding plus the number of additional common shares thatwould have been outstanding if dilutive common shares had been issued.  Forthe three months and six months ended March 31, 2007, potentially dilutivesecurities totaled 1,206,432.  Thedilutive securities include 308,603 warrants to purchase common stock at $10.00per share which were issued in connection with the Company’s initial publicoffering, 414,700 options to purchase common stock issued under the Company’sStock Incentive Plan, 645 options to purchase stock issued outside of thePlan,  stock options to purchase 32,484shares of the Company’s common stock 

10

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at an exerciseprice of $6.16 that were assumed in conjunction with the merger with TOHI andwarrants to purchase 450,000 of the Company’s common stock at an exercise priceof the greater of $6.67 per share or the book value of the Company as definedby the warrant agreements.

For the threemonths ended March 31, 2006, all potentially dilutive securities wereanti-dilutive except for stock options to purchase 140,500 shares of theCompany’s common stock at an exercise price of $8.33.  For the six months ended March 31, 2006, allpotentially dilutive securities outstanding were anti-dilutive.

**Note 4.  Securities**

Securities consisted of the following (in thousands):
|                                      | ** ** | **As of  March 31, 2007** | ** ** | **As of  September 30, 2006** | ** ** |
|--------------------------------------|------------|------------------------------------------|------------|----------------------------------------------|------------|
| ** **                           | ** ** | **Amortized  Cost**                      | ** ** | **Fair  Value**                              | ** ** | **Amortized  Cost** | ** ** | **Fair  Value** | ** ** |
|                                 |       |                                     |       |                                         |       |   |   |   |   |
| Securities  Available for Sale:      |       |                                     |       |                                         |       |   |   |   |   |
| U.S. Government Agencies             |       | $                                        | 11         |                                         | $          | 11 |   | $ | 14 |   | $ | 14 |   |
| Other mortgage backed securities     |       | 2                                        |       | 2                                            |       | 2 |   | 2 |   |
|                                 |       |                                     |       |                                         |       |   |   |   |   |
| Total Securities  Available for Sale |       | $                                        | 13         |                                         | $          | 13 |   | $ | 16 |   | $ | 16 |   |
|                                 |       |                                     |       |                                         |       |   |   |   |   |
| Securities Held  to Maturity:        |       |                                     |       |                                         |       |   |   |   |   |
| U.S. Government Agencies             |       | $                                        | 1,448      |                                         | $          | 1,447 |   | $ | 2,000 |   | $ | 1,996 |   |
| Other mortgage backed securities     |       | 0                                        |       | 0                                            |       | 6 |   | 5 |   |
|                                 |       |                                     |       |                                         |       |   |   |   |   |
| Total Securities Held  to Maturity   |       | $                                        | 1,448      |                                         | $          | 1,447 |   | $ | 2,006 |   | $ | 2,001 |   |

 

AtMarch 31, 2007, $612,000 of the Company’s securities were pledged to TexlineIndependent School District, $600,000 to the City of Texline and $249,000 tothe State of Texas.

**Note 5.  Loans and Allowance for Loan Losses**

The Company grants real estate, commercial and agribusiness loans tocustomers primarily in the Austin and Northwest Texas markets.  Loans at March 31, 2007, and September 30,2006 were as follows (in thousands):
|                                  | ** ** | **As of  March 31,  2007** | ** ** | **As of  September 30,  2006** | ** ** |
|----------------------------------|------------|--------------------------------------|------------|------------------------------------------|------------|
|                             |       |                                 |       |                                     |       |
| Agriculture                      |       | $                                    | 3,729      |                                     | $          | 2,989 |   |
| Commercial                       |       | 24,514                               |       | 19,068                                   |       |
| Commercial real  estate          |       | 20,232                               |       | 18,582                                   |       |
| Residential real  estate         |       | 8,484                                |       | 8,221                                    |       |
| Construction  real estate        |       | 9,556                                |       | 4,329                                    |       |
| Consumer and  other              |       | 7,283                                |       | 6,981                                    |       |
| Gross Loans                      |       | 73,798                               |       | 60,170                                   |       |
| Less: allowance  for loan losses |       | (646                                 | )          | (550                                     | )          |
|                             |       |                                 |       |                                     |       |
| Net Loans                        |       | $                                    | 73,152     |                                     | $          | 59,620 |   |

 

 

11

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Activity in the allowance for loan losses for the three months and sixmonths ended March 31, 2007, was as follows (in thousands):
| ** **                                  | ** ** | **Three Months Ended  March 31,** | ** ** | **Six Months Ended  March 31,** | ** ** |
|---------------------------------------------|------------|--------------------------------------------------|------------|------------------------------------------------|------------|
| ** **                                  | ** ** | **2007**                                         | ** ** | **2006**                                       | ** ** | **2007** | ** ** | **2006** | ** ** |
| Balance at beginning of  period             |       | $                                                | 575        |                                           | $          | 317 |   | $ | 550 |   | $ | 277 |   |
| Provision for loan  losses                  |       | 70                                               |       | 45                                             |       | 145 |   | 90 |   |
| Loans charged off                           |       | —                                           |       | (4                                             | )          | (51 | ) | (10 | ) |
| Recoveries on loans  previously charged off |       | 1                                                |       | —                                         |       | 2 |   | 1 |   |
|                                        |       |                                             |       |                                           |       |   |   |   |   |
| Balance at end of period                    |       | $                                                | 646        |                                           | $          | 358 |   | $ | 646 |   | $ | 358 |   |

 

At March 31, 2007and September 30, 2006, the Bank had approximately $109,000 and $123,000,respectively, in nonperforming loans and non accrual loans.  At March 31, 2007 and September 30, 2006 theBank had $5,000 in repossessed assets, and $76,000 and $41,000, respectively,in other real estate owned.

**Note 6.  Premises and Equipment**

Premises and equipment at March 31, 2007, and September 30, 2006, wereas follows (in thousands):
|                                                 | ** ** | **As of  March 31,  2007** | ** ** | **As of  September 30,  2006** | ** ** |
|-------------------------------------------------|------------|--------------------------------------|------------|------------------------------------------|------------|
|                                            |       |                                 |       |                                     |       |
| Land                                            |       | $                                    | 959        |                                     | $          | 959 |   |
| Building and leasehold  improvements            |       | 4,614                                |       | 4,568                                    |       |
| Furniture, fixtures and  equipment              |       | 854                                  |       | 778                                      |       |
|                                            |       | 6,427                                |       | 6,305                                    |       |
| Less accumulated  depreciation and amortization |       | (884                                 | )          | (712                                     | )          |
| Total                                           |       | $                                    | 5,543      |                                     | $          | 5,593 |   |

 

Depreciation andamortization expense for the six months ending March 31, 2007 and 2006 was $172,000and $171,000, respectively.

**Note 7.  Deposits**

Time deposits of $100,000 or more totaled $11,518,000 and $8,989,000 atMarch 31, 2007 and September 30, 2006, respectively. At March 31, 2007 andSeptember 30, 2006, the scheduled maturities of time deposits were as follows(in thousands):

12

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| Years Ending September 30, | ** ** | ** ** | ** ** | **As of March 31,  2007** | ** ** | **As of September 30,  2006** | ** ** |
|-------------------------------------------|------------|------------|------------|------------------------------------------|------------|----------------------------------------------|------------|
|                                      |       |       |       |                                     |       |
| 2007                                      |       | $          | 16,646     |                                     | $          | 20,197                                       |       |
| 2008                                      |       | 10,761     |       | 329                                      |       |
| 2009                                      |       | 76         |       | —                                   |       |
|                                      |       |       |       |                                     |       |
|                                      |       | $          | 27,483     |                                     | $          | 20,526                                       |       |

 

**Note 8.  Goodwill and Other Intangibles**

In conjunctionwith the acquisition of Texline State Bank, the Company recorded goodwill of$1,161,000 and core deposit intangibles of $70,000.  Goodwill is periodically, but at leastannually, reviewed to determine whether adecline in value exists which requires a charge to earnings and a reduction tothe goodwill reflected on the statement of financial condition of the Company.

Core deposit intangiblesare amortized on a straight-line basis over seven years.  The following table reflects the net carryingamount of core deposit intangibles at March 31, 2007 and September 30, 2006 (inthousands):
|                                 | ** ** | **As of March 31,  2007** | ** ** | **As of September 30,  2006** | ** ** |
|---------------------------------|------------|------------------------------------------|------------|----------------------------------------------|------------|
| Gross core deposit  intangibles |       | $                                        | 70         |                                         | $          | 70 |   |
| Less: accumulated  amortization |       | (31                                      | )          | (26                                          | )          |
|                            |       |                                     |       |                                         |       |
| Net core deposit intangibles    |       | $                                        | 39         |                                         | $          | 44 |   |

 

**Note9.  Stock Based Compensation and 2004Stock Incentive Plan**

The Companyadopted Financial Accounting Standards Board Statement No. 123R, “Share-BasedPayment”, (“Statement 123R”) on October 1, 2006. Under Statement 123R, the costof employee services received in exchange for an award of equity instruments isbased on the grant-date fair value of the award (with limited exceptions). Thatcost is recognized over the period during which an employee is required toprovide service in exchange for the award — the requisite service period(usually the vesting period).  TheCompany adopted Statement 123R using the modified prospective application,which was required for public companies. Under the modified prospective application, Statement 123R applies tonew awards and to awards modified, repurchased, or cancelled after October 1,2006.  Additionally, compensation costfor the portion of awards for which the requisite service had not been renderedthat are outstanding as of October 1, 2006 will be recognized as the requisiteservice is rendered subsequent to October 1, 2006.

Prior to October 1, 2006,the Company accounted for stock-based compensation to employees using theintrinsic value method.  Accordingly,compensation costs for employee stock options was measured as the excess, ifany, of the fair value of the Company’s common stock at date of grant over theexercise price.

The Companyaccounts for stock-based compensation to non-employees at fair value.

OnJanuary 19, 2004, the Company and its shareholders approved the Company’s2004 Stock Incentive Plan (the “Plan”).  The Plan authorizes incentivestock option grants, non-statutory stock option grants, direct stock issuances,

13

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stock appreciationrights, salary investment option grants, and director fee option grants. Eligible participants are employees, non-employee board members, andindependent consultants or advisors.  The Company has reserved 500,000shares of common stock under the Plan, and the share reserve increases on the 1st business day in January each year(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 stockappreciation rights for more than 100,000 shares in the aggregate in any calendaryear under the Plan.  Option awards aregenerally granted with an exercise price equal to the market price of theCompany’s stock at the date of the grant; have 10-year contractual terms andvest based on three years of continuous service.  Share awards generally vest over four years.

For the threemonths and six months ended March 31, 2007, the expense related to the stockoptions and restricted stock grant compensation totaled $50,000 and $142,000,respectively, which was comprised of $44,000 and $107,000 for stock optionsgranted to employees and directors and $6,000 and $35,000 for restricted stockgranted to employees and advisory board members.  The remaining expense for the three monthsended March 31, 2007 was related to stock grants outside of the Plan.

For the threemonths and six months ended March 31, 2006, the expense related to stock optioncompensation included in the determination of net income was less than thatwhich would have been recognized if the fair value method had been applied.  The Company’s net income and earnings pershare would have been adjusted to the proforma amounts indicated below for the three months and six months ended March31, 2006, assuming the Company had expensed the fair value of the options (inthousands, except per share amounts):
|                                             | ** ** | **Three Months Ended  March 31, 2006** | ** ** | **Six Months Ended  March 31, 2006** | ** ** |
|---------------------------------------------|------------|------------------------------------------------------------|------------|----------------------------------------------------------|------------|
|                                        |       |                                                       |       |                                                     |       |
| Net income (loss) — as  reported       |       | $                                                          | 24         |                                                     | $          | (50 | ) |
| Net loss — pro forma                   |       | $                                                          | (15        | )                                                        | $          | (123 | ) |
|                                        |       |                                                       |       |                                                     |       |
| Income (loss) per share  — as reported |       |                                                       |       |                                                     |       |
| Basic                                       |       | $                                                          | 0.01       |                                                     | $          | (0.02 | ) |
| Diluted                                     |       | $                                                          | 0.01       |                                                     | $          | (0.02 | ) |
|                                        |       |                                                       |       |                                                     |       |
| Loss per share — pro  forma            |       |                                                       |       |                                                     |       |
| Basic                                       |       | $                                                          | (0.01      | )                                                        | $          | (0.05 | ) |
| Diluted                                     |       | $                                                          | (0.01      | )                                                        | $          | (0.05 | ) |

 

The fair value ofeach option award is estimated on the date of grant using the Black-Scholesoption pricing model.  The Black-Scholesoption pricing model requires the input of highly subjective assumptions.  The Company continues to assess theassumptions and methodologies used to calculate the estimated fair value of thestock-based compensation.  Circumstancesmay change and additional data may become available over time, which couldresult in changes to these assumptions and methodologies.  The risk-free rate for periods within theexpected life of the options is based on the U.S. Treasury yield in effect atthe time of the grant.  The expected lifeof the options is estimated based on the vesting life and contractual life ofthe options. Volatility in the Black-Scholes model is based on historicalvolatility for comparable publicly-traded banks and the Company’s historicalstock prices since inception.

The fair value ofrestricted common stock granted under the Plan is estimated using the mostrecently traded market price of the Company’s common stock at the time of thegrant.

The weightedaverage fair value of the options granted during the three months ended March31, 2007 and 2006, has been estimated using the Black-Scholes option pricingmodel with the following assumptions:

14

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|                         | ** ** | **Three Months Ended  March 31, 2007** | ** ** | **Three Months Ended  March 31, 2006** | ** ** |
|-------------------------|------------|------------------------------------------------------------|------------|------------------------------------------------------------|------------|
| Dividend yield          |       | 0%                                                         |       | 0%                                                         |       |
| Risk-free interest rate |       | 5.08  - 5.12%                                              |       | 4.75%                                                      |       |
| Expected volatility     |       | 3.35%  - 5.12%                                             |       | 22%                                                        |       |
| Expected life in years  |       | 6.85 Years                                                 |       | 6.85 Years                                                 |       |

 

As of March 31,2007, there were outstanding options under the Company’s Stock Incentive Planto purchase an aggregate of 415,200 shares of the Company’s common stock. Each option has an exercise price of between $8.00 and $10.26 per share and maybe exercised in three equal annual installments for each year of service measuredfrom the grant date.  During the three months ended March 31, 2007, theCompany granted stock options to purchase an aggregate of 42,000 shares of itscommon stock with an exercise price of $9.00 per share to eleven (11) officersand directors and 500 shares with an exercise price of $10.26 per share to anemployee. In connection with the execution of his employment agreement with theCompany, Jeffrey L. Nash was awarded 15,000 options to purchase shares of stockat an exercise price of $8.00 per share. On December 31, 2006, the Companygranted 56,750 options to purchase shares of stock at an exercise price of$9.00 per share to thirteen (13) officers and directors.

During the threemonths ended December 31, 2005, the Company granted stock options to purchase82,750 shares of its common stock with an exercise price of $8.50 per share tofifteen (15) officers and directors.  Theoptions become exercisable for the option shares in three equal annualinstallments upon completion of each year of service over the three-year periodof service measured from the date of the grant.

On November 20,2006, the Company awarded 38,006 shares of common stock to six (6)officers.  The stock vests in four equalinstallments upon completion of each year of service over the four-year periodof service measured from the date of the award. On January 1, 2007, 2,401 shares of common stock were issued to the Bank’sadvisory board members.  On February 13,2007, the Company awarded 12,000 shares of common stock to the Company’s ChiefFinancial Officer.  The stock vests infour equal installments upon completion of each year of service over thefour-year period of service measured from the date of the award.

The table belowpresents the summary of stock option and restricted stock activity for the Planduring the six months ended March 31, 2007.
| ** **                            | ** ** | **Six Months Ended March 31, 2007** | ** ** |
|---------------------------------------|------------|--------------------------------------------------------------|------------|
| ** **                            | ** ** | **Restricted Stock**                                    | ** ** | **Options** | ** ** |
| ** **                            | ** ** | **Shares**                                                   | ** ** | **Weighted  Average  Remaining  Contractual  Term in  Years** | ** ** | **Shares** | ** ** | **Weighted  Average  Exercise  Price** | ** ** | **Weighted  Average  Remaining  Contractual  Term in  Years** | ** ** | **Aggregate  Intrinsic  Value** | ** ** |
|                                  |       |                                                         |       |   |   |   |   |   |   |   |   |   |   |
|                                  |       |                                                         |       |   |   |   |   |   |   |   |   |   |   |
| Outstanding, beginning  of the period |       | —                                                       |       |   |   | 301,350 |   | $ | 8.38 |   |   |   |   |   |
| Granted                               |       | 54,207                                                       |       |   |   | 114,250 |   | 8.91 |   |   |   |   |   |
| Forfeited/expired                     |       | —                                                       |       |   |   | (400 | ) | 8.50 |   |   |   |   |   |
| Outstanding, end of the  period       |       | 52,407                                                       |       | 3.5 |   | 415,200 |   | $ | 8.58 |   | 8.4 |   | $ | 697,850 |   |
|                                  |       |                                                         |       |  |   |  |   |   |   |   |   |  |   |
| Exercisable at the end of the period  |       | 2,401                                                        |       | — |   | 154,983 |   | $ | 8.43 |   | 7.5 |   | $ | 284,127 |   |

 

A summary of shares ofour common stock subject to our nonvested shares and options as of March 31,2007 and changes during the six months ended March 31, 2007 is presented below:

15

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|                                     | ** ** | **Six Months Ended March 31, 2007** | ** ** |
|-------------------------------------|------------|--------------------------------------------------------------|------------|
| ** **                          | ** ** | **Restricted Stock**                                    | ** ** | **Options** | ** ** |
| ** **                          | ** ** | **Shares**                                                   | ** ** | **Weighted  Average  Grant Date  Fair Value** | ** ** | **Shares** | ** ** | **Weighted  Average  Grant Date  Fair Value** | ** ** |
|                                |       |                                                         |       |   |   |   |   |   |   |
|                                |       |                                                         |       |   |   |   |   |   |   |
| Nonvested, beginning of  the period |       | —                                                       |       | $ | — |   | 180,400 |   | $ | 1.84 |   |
| Granted                             |       | 52,407                                                       |       | 8.26 |   | 114,250 |   | 2.46 |   |
| Vested                              |       | (2,401                                                       | )          | (8.73 | ) | (34,033 | ) | 1.81 |   |
| Forfeited/expired                   |       | —                                                       |       | — |   | (400 | ) | 1.82 |   |
| Nonvested, end of the period        |       | 50,006                                                       |       | $ | 8.24 |   | 260,217 |   | $ | 2.11 |   |

 

Asof March 31, 2007, there was $671,509 of total unrecognized compensation costsrelated to nonvested share-based compensation arrangements granted under thePlan.  That cost is expected to berecognized over a weighted-average period of 2.84 years.  No options were exercised during the threemonths and six months ended March 31, 2007.

**Note10.  Other Related Party Transactions**

**Transactionswith Former Organizing Shareholder**

On August 30, 2006, TOHI, the Company’s largestshareholder at that time, repurchased shares of its stock owned by certainprincipals of our formerly affiliated services firms, including the Company’sformer CEO Terry W. Hamann. Concurrent with this stock redemption, thoseformerly affiliated firms relocated from the headquarters building.  At that time, Mr. Hamann resigned hisremaining positions with the Company including all committee assignments andhis seat on the board of directors. Mr. Hamann had previously resigned his roleas Chairman, CEO and President of the Company in February 2006.

**Other Transactions**

The Company had no amounts due from affiliates at March 31, 2007.  The Company had a $192,000 due from affiliatebalance as of September 30, 2006 which represented amounts due from TOHI to PGIEquity Partners, LP for occupancy costs.

On October 11, 2005, the Company made a $355,000 loan to TOHI withmonthly interest payments due on the first of each month beginning November 1,2005.  The purpose of the loan was toenable TOHI to pay off certain obligations, and to provide sufficient liquidityto TOHI until the proposed merger with the Company was completed. On April 26,2006, the obligation was renewed and increased to $373,000 at the then currentprime rate. The loan was renewed and increased to $400,000 on September 1,2006. The principal balance ($396,000 as of September 30, 2006), along with anyaccrued interest, was due and payable in full on November 1, 2006.  On November 15, 2006, in connection with themerger of TOHI and the Company, the loan was paid in full.

On August 24, 2006, the Companymade a $2,425,000 loan to TOHI with monthly interest payments at the currentprime rate (8.25% at September 30, 2006) due on the 24th day ofeach month.  The purpose of the loan wasto enable TOHI to redeem shares of common and preferred stock from certain ofits shareholders.  The loan was due andpayable 

16

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on February 24, 2007 but waspaid-off in full on November 15, 2006 in connection with the Company’sacquisition of TOHI.

**Note 11.  Financial Instruments with Off-Balance SheetRisk**

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 creditand standby letters of credit is represented by the contractual amount of thoseinstruments.  The Company uses the samecredit policies in making commitments and conditional obligations as they dofor on-balance sheet instruments.

The following table summarizes the Company’s off-balance sheetfinancial instruments as of March 31, 2007 and September 30, 2006 (inthousands):

|                               | ** ** | **As of March 31,  2007** | ** ** | **As of September 30,  2006** | ** ** |
|-------------------------------|------------|------------------------------------------|------------|----------------------------------------------|------------|
| Commitments to extend  credit |       | $                                        | 27,218     |                                         | $          | 21,277 |   |
| Standby letters of credit     |       | 800                                      |       | 1,935                                        |       |
|                               |            |                                          |            |                                              |            |  |  |

 

Commitments to extendcredit are agreements to lend to a customer as long as there is no violation ofany condition established in the contract. Commitments generally have fixed expiration dates or other terminationclauses and may require payment of a fee. Since many of the commitments are expected to expire without being drawnupon, the total commitment amounts do not necessarily represent future cashrequirements.  The Company evaluates eachcustomer’s creditworthiness on a case-by-case basis.  The amount of collateral obtained if deemednecessary by the Company upon extension of credit is based on management’scredit evaluation of the counterparty. Collateral held varies but may include accounts receivable, inventory,property, plant and equipment and income-producing commercial properties.

Standby letters of credit are written conditionalcommitments used by the Company to guarantee the performance of a customer to athird party.  The Company’s policiesgenerally require that letter of credit arrangements contain security and debtcovenants similar to those contained in loan arrangements.  In the event the customer does not perform inaccordance with the terms of the agreement with the third party, the Companywould be required to fund the commitment. The maximum potential amount of future payments the Company could berequired to make is represented by the contractual amount shown in the tableabove.  If the commitment is funded, theCompany would be entitled to seek recovery from the customer.  As of March 31, 2007, no amounts have beenrecorded as liabilities for the Company’s potential obligations under theseguarantees.

**Note 12.  Dividend Restrictions and Regulatory Matters**

Banks and bankholding companies are subject to regulatory capital requirements administeredby state and federal banking regulatory agencies.  Capital adequacy guidelines and, additionallyfor banks, prompt corrective action 

17

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regulationsinvolve quantitative measures of assets, liabilities, and certain off-balancesheet items calculated under regulatory accounting practices.  Capital amounts and classifications are alsosubject to qualitative judgments by regulators about components, riskweightings and other factors.  Failure tomeet capital requirements can initiate regulatory action.  As of March 31, 2007, management believes theBank is in compliance with all regulatory capital requirements to which it issubject.

The followingtable sets forth the bank only actual capital levels in addition to therequirements under prompt corrective action regulations (in thousands):
| ** **                                | ** ** | **Actual** | ** ** | **For Capital  Adequacy Purposes** | ** ** | **To Be Well  Capitalized Under  Prompt Corrective  Action  Provisions** | ** ** |
|-------------------------------------------|------------|------------|------------|----------------------------------------------|------------|----------------------------------------------------------------------------------------------|------------|
| ** **                                | ** ** | **Amount** | ** ** | **Ratio**                                    | ** ** | **Amount**                                                                                   | ** ** | **Ratio** | ** ** | **Amount** | ** ** | **Ratio** | ** ** |
|                                      |       |       |       |                                         |       |                                                                                         |       |   |   |   |   |   |   |
| As of March 31, 2007                      |       |       |       |                                         |       |                                                                                         |       |   |   |   |   |   |   |
| Tier 1 capital  (to average assets)       |       | $          | 8,669      |                                         | 10.29      | %                                                                                            | $          | 3,370 |   | 4 | % | $ | 4,213 |   | 5 | % |
| Tier 1 capital  (to risk-weighted assets) |       | 8,669      |       | 11.05                                        | %          | 3,139                                                                                        |       | 4 | % | 4,708 |   | 6 | % |
| Total Capital (to risk-weighted  assets)  |       | 9,315      |       | 11.87                                        | %          | 6,278                                                                                        |       | 8 | % | 7,847 |   | 10 | % |
|                                           |            |            |            |                                              |            |                                                                                              |            |  |  |  |  |  |  |  |  |  |

 
| ** **                               | ** ** | **Actual** | ** ** | **For Capital  Adequacy Purposes** | ** ** | **To Be Well  Capitalized Under  Prompt Corrective  Action  Provisions** | ** ** |
|------------------------------------------|------------|------------|------------|----------------------------------------------|------------|----------------------------------------------------------------------------------------------|------------|
|                                     |       |       |       |                                         |       |                                                                                         |       |   |   |   |   |   |   |
| As  of September 30, 2006                |       |       |       |                                         |       |                                                                                         |       |   |   |   |   |   |   |
| Tier 1 capital (to average assets)       |       | $          | 8,213      |                                         | 11.07      | %                                                                                            | $          | 2,967 |   | 4 | % | $ | 3,709 |   | 5 | % |
| Tier 1 capital (to risk-weighted assets) |       | 8,213      |       | 11.39                                        | %          | 2,885                                                                                        |       | 4 | % | 4,328 |   | 6 | % |
| Total  Capital (to risk-weighted assets) |       | 8,763      |       | 12.15                                        | %          | 5,771                                                                                        |       | 8 | % | 7,213 |   | 10 | % |
|                                          |            |            |            |                                              |            |                                                                                              |            |  |  |  |  |  |  |  |  |  |

 

Asof March 31, 2007 and September 30, 2006, the Bank met the level of capitalrequired to be categorized as “well capitalized” under prompt corrective actionregulations.  Management is not aware ofany conditions subsequent to March 31, 2007 that would change the Bank’scapital category.

TheBank is a state chartered banking association and is subject to regulation,supervision and examination by the Texas Department of Banking and the FederalDeposit Insurance Corporation (FDIC).  Inaddition, upon making certain determinations with respect to the condition ofany insured bank, the FDIC may begin proceedings to terminate a bank’s federaldeposit insurance.

Certainrestrictions exist regarding the ability of the Bank to pay cashdividends.  Regulatory approval isrequired in order to pay dividends until such time as the accumulated deficitis eliminated and certain other conditions are met.   Further, the Company has been notified byits banking regulators that no approval will be received in the first threeyears of operations.

18

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

**Introduction**

We are a bank holding company headquartered in Austin,Texas.  We operate a state charteredbank, Treaty Oak Bank (the “Bank”) in Austin, Texas with a branch in Texline,Texas.  We began operations in Austin,Texas on September 10, 2004.  Given itsgreater growth potential, we are focusing the majority of our efforts on growinga community-oriented bank out of our headquarters in Austin, Texas.  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 nosignificant changes to the types of estimates and the manner in which they aredetermined since the filing of our annual report on Form 10-KSB, except asotherwise noted within this discussion and analysis.

**Recent Developments**

OnNovember 15, 2006, the Company completed the acquisition of Treaty OakHoldings, Inc. (“TOHI”) pursuant to the Agreement and Plan of Merger, datedOctober 3, 2006.  TOHI was one of thefive organizing shareholders of the Company and operated as a bank holdingcompany and significant shareholder, but otherwise had no activeoperations.  The merger was approved bythe Company’s Board of Directors and also by the Company’s shareholders at aSpecial Meeting of Shareholders held on October 24, 2006.  Prior to the consummation of the merger, TOHIheld approximately 38% of the issued and outstanding shares of our commonstock.

Theprimary purpose of this merger was to achieve certain operational efficienciesfor the Company and its affiliates.  Thefollowing factors were important to both the Company and TOHI Board’s decisionsto approve the merger and recommend approval to their respective shareholders:

(i)                               The merger would simplify thebookkeeping, financial reporting, and corporate record keeping for the TreatyOak affiliated entities;

(ii)                            The merger would reduce the accountingand other costs for the various Treaty Oak entities, including the costsassociated with the filing of multiple tax returns and regulatory reports;

(iii)                         The merger would eliminate the need totreat TOHI as a separate “bank holding company” and make the various bankingregulatory filings;

(iv)                        The Company and TOHI Boards of Directorsbelieved that it was beneficial for the Company and TOHI shareholders to haveall of the shareholders associated with the Treaty Oak affiliated entitiesinvested in one organization (*i.e*., theCompany) rather than multiple organizations;

(v)                           As part of the exchange, the Companywould receive net assets from TOHI, including cash and limited partnershipinterests in PGI Equity Partners, LP, the entity that owns Treaty Oak Bank’sheadquarters at 101 Westlake Drive, Austin, Texas, which would increase theliquidity and financial strength of the Company;

(vi)                        The merger was anticipated to beaccretive to the Company’s tangible book value per share outstanding;

(vii)                     Net operating losses incurred by TOHI may be availableto offset future earnings of the Company; and

(viii)                  The TOHI Board believed that the exchange of the TOHIshares for the Company shares in connection with the merger would improve theliquidity of such shares since the Company is a public reporting company.

19

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The Company and TOHI were deemed to be under commoncontrol.  A majority of the directors ofthe Company also served on TOHI’s board of directors and were shareholders ofboth entities.  TOHI also owned 1,000,000shares of the Company’s common stock, representing approximately 38% of theCompany shares then outstanding.  Becausethe Company and TOHI were deemed to be under common control, purchaseaccounting was not applied to the merger. Instead the net assets contributed by TOHI were recorded at theirpredecessor cost.  The 1,000,000 sharesof Company common stock owned by TOHI were cancelled by the Company andrecorded as a reduction of its common stock accounts (par value and paid incapital) at their fair market value, as determined by an independent appraisal,of $8.31 per share, or $8,310,000 in the aggregate.  The 1,094,163 new shares of Company stockissued to the TOHI shareholders were also recorded at the fair market valueprice of $8.31 per share, or $9,093,000 in the aggregate.  The warrants issued by the Company inexchange for the TOHI warrants and the TOHI options assumed by the Company werevalued and recorded at their fair value using a Black-Scholes pricing model.****The net effect of the contribution of assets and thecapital stock transactions was a $1,715,000 increase to the Company’s equityand a 94,163 net increase in the number of Company shares issued.  Although the net assets contributed by TOHIto the Company were not adjusted to their fair value, the assets were evaluatedfor collectibility and/or impairment according to generally accepted accountingprinciples prior to the merger and adjusted accordingly by TOHI prior to themerger.

**Results of Operations**

***General***

The following discussion analyzes the results of theCompany for the three months and six months ended March 31, 2007, andMarch 31, 2006.

***Net Income—General***

The Company’s fiscal year ends on September 30.Net income for the three months ended March 31, 2007, was $28,000, compared tonet income of $24,000 for the quarter ended March 31, 2006. Net incomeincreased due to earnings generated at the Bank as a result of growthexperienced at the Austin branch and the elimination of expenses associatedwith the start-up of operations in Austin, Texas.  The increase was offset, in part, due to anincrease in non-cash based stock compensation and an increase in thecompetition for deposits, which in turn, caused a decrease in the Company’s netinterest margin.  The increase innet  income was also offset by anincrease in personnel to support the growth of the Company.

For the six months ended March 31, 2007 the Companyhad net income of $164,000 compared to a net loss of $50,000 for the six monthsended March 31, 2006.  Again, the improvementin operations is attributable to the increase in net interest income, as theCompany grew its earnings assets at a faster pace and at a greater yield thanits interest bearing liabilities, and the elimination of expenses associatedwith the start-up of operations in Austin, Texas.

Our profitability depends primarily on net interestincome, which is defined as the difference between total interest earned oninterest earning assets (investments and loans) and total interest paid oninterest bearing liabilities (deposits, borrowed funds) and non-interestincome. The Company’s net income is affected by its provision for loan losses,as well as other income and other expenses. The provision for loan lossesreflects the amount considered to be adequate to cover probable credit lossesin the loan portfolio. Non-interest income or other income consists of servicecharges on deposits, gain on sale of loans, and other operating income. Otherexpenses include salaries and employee benefits, occupancy expenses, dataprocessing expenses, marketing, supplies, and other operating expenses.

Net interest income is affected by changes in thevolume and mix of interest earning assets, the level of interest rates earnedon those assets, the volume and mix of interest bearing liabilities, and thelevel of interest rates paid on those interest bearing liabilities. Theprovision for loan losses is dependent upon changes in the loan portfolio andmanagement’s assessment of the collectibility of the loan portfolio, as well aseconomic and market conditions. Other income and other expenses are impacted bygrowth of operations and growth in the number of accounts through bothacquisitions and core banking business growth. Growth in operations affectsother expenses as 

20

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a result of additional employees, branch facilities,and promotional marketing expense. Growth in the number of accounts affectsother income including service fees, as well as other expenses such as computerservices, supplies, postage, telecommunications, and other miscellaneousexpenses.

***NetInterest Income***

For the three months ended March31, 2007, our net interest income was $1,114,000 compared to $818,000 for threemonths ended March 31, 2006.  For the sixmonths ended March 31, 2007, our net interest income was $2,267,000 compared to$1,528,000 for the six months ended March 31, 2006.

For the comparative three monthperiods of March 31, 2007, and March 31, 2006, the average rate oninterest-bearing liabilities increased 143 basis points, from 2.92% to4.35%, while the average rate on interest bearing assets increased 119 basispoints from 7.38% to 8.57% during the same period.  For the comparative six month periods ofMarch 31, 2007, and March 31, 2006, the average rate on interest-bearingliabilities increased 149 basis points, from 2.90% to 4.39%, while the averagerate on interest bearing assets increased 112 basis points from 7.29% to 8.41%during the same period. The increase in the average rate on interest-bearingassets and liabilities was due to a general increase in interest rates duringthe period.  Interest rates on depositsalso increased as a result of increased competition for deposits.

The following tables present, forthe periods indicated, the total dollar amount of interest income from averageinterest earning assets, and the resultant yields, as well as the interestexpense on average interest bearing liabilities, and the resultant costs,expressed both in dollars and rates. Yields are reflected on an annualizedbasis (in thousands except for yields).
| ** **                                       | ** ** | **Three Months Ended  March 31, 2007** | ** ** | **Three Months Ended  March 31, 2006** | ** ** |
|--------------------------------------------------|------------|------------------------------------------------------------|------------|------------------------------------------------------------|------------|
| ** **                                       | ** ** | **Average  Balance**                                       | ** ** | **Interest  (2)**                                          | ** ** | **Yield/  Rate** | ** ** | **Average  Balance** | ** ** | **Interest  (2)** | ** ** | **Yield/  Rate** | ** ** |
|                                             |       |                                                       |       |                                                       |       |   |   |   |   |   |   |   |   |
| Interest Earning  Assets:                        |       |                                                       |       |                                                       |       |   |   |   |   |   |   |   |   |
|                                             |       |                                                       |       |                                                       |       |   |   |   |   |   |   |   |   |
| Loans (1)                                        |       | $                                                          | 71,569     |                                                       | $          | 1,599 |   | 8.94 | % | $ | 46,360 |   | $ | 950 |   | 8.20 | % |
| Taxable investment securities                    |       | 1,412                                                      |       | 17                                                         |       | 4.82 | % | 3,328 |   | 25 |   | 3.00 | % |
| Federal funds sold                               |       | 5,971                                                      |       | 82                                                         |       | 5.49 | % | 6,422 |   | 71 |   | 4.42 | % |
| Interest bearing deposits with other Banks       |       | —                                                     |       | —                                                     |       | 0.00 | % | 1,333 |   | 16 |   | 4.80 | % |
| Federal Home Loan Bank Stock                     |       | 326                                                        |       | —                                                     |       | 0.00 | % | 321 |   | 4 |   | 4.98 | % |
|                                             |       |                                                       |       |                                                       |       |   |   |   |   |   |   |   |   |
| Total interest  earning assets                   |       | 79,278                                                     |       | 1,698                                                      |       | 8.57 | % | 57,764 |   | 1,066 |   | 7.38 | % |
| Non-interest earning assets                      |       | 10,858                                                     |       |                                                       |       |   |   | 8,895 |   |   |   |   |   |
|                                             |       |                                                       |       |                                                       |       |   |   |   |   |   |   |   |   |
| Total assets                                     |       | $                                                          | 90,136     |                                                       |       |   |   |   | $ | 66,659 |   |   |   |   |   |
|                                             |       |                                                            |       |                                                       |       |   |   |  |   |   |   |   |   |
| Interest Bearing  Liabilities:                   |       |                                                       |       |                                                       |       |   |   |   |   |   |   |   |   |
| Deposits:                                        |       |                                                       |       |                                                       |       |   |   |   |   |   |   |   |   |
| NOW and money market deposits                    |       | $                                                          | 26,844     |                                                       | $          | 235 |   | 3.50 | % | $ | 18,161 |   | $ | 94 |   | 2.07 | % |
| Savings deposits                                 |       | 545                                                        |       | 2                                                          |       | 1.44 | % | 491 |   | 1 |   | 0.81 | % |
| Time deposits                                    |       | 23,497                                                     |       | 307                                                        |       | 5.22 | % | 12,499 |   | 112 |   | 3.58 | % |
| Short-term borrowings                            |       | 166                                                        |       | 1                                                          |       | 1.85 | % | 67 |   | — |   | 0.00 | % |
| Property mortgage and long term borrowings       |       | 2,663                                                      |       | 39                                                         |       | 5.87 | % | 2,702 |   | 41 |   | 6.07 | % |
| Total interest  bearing liabilities              |       | 53,715                                                     |       | 584                                                        |       | 4.35 | % | 33,920 |   | 248 |   | 2.92 | % |
| Demand deposits—non-interest bearing        |       | 22,565                                                     |       |                                                       |       |   |   | 21,208 |   |   |   |   |   |
| Other non-interest bearing liabilities           |       | 542                                                        |       |                                                       |       |   |   | 314 |   |   |   |   |   |
| Shareholders’  equity                       |       | 13,314                                                     |       |                                                       |       |   |   | 11,217 |   |   |   |   |   |
|                                             |       |                                                       |       |                                                       |       |   |   |   |   |   |   |   |   |
| Total  liabilities and shareholders’ equity |       | $                                                          | 90,136     |                                                       |       |   |   |   | $ | 66,659 |   |   |   |   |   |
|                                             |       |                                                            |       |                                                       |       |   |   |   |   |   |   |   |   |
| Net interest  income                             |       |                                                       |       | $                                                          | 1,114      |   |   |   |   |   | $ | 818 |   |   |   |
|                                             |       |                                                       |       |                                                            |       |   |   |   |   |   |   |   |   |
| Interest rate spread (3)                         |       |                                                       |       |                                                       |       | 4.22 | % |   |   |   |   | 4.46 | % |
| Net interest  margin (4)                         |       |                                                       |       |                                                       |       | 5.62 | % |   |   |   |   | 5.55 | % |

 

 

21

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| ** **                                       | ** ** | **Six Months Ended  March 31, 2007** | ** ** | **Six Months Ended  March 31, 2006** | ** ** |
|--------------------------------------------------|------------|----------------------------------------------------------|------------|----------------------------------------------------------|------------|
| ** **                                       | ** ** | **Average  Balance**                                     | ** ** | **Interest  (2)**                                        | ** ** | **Yield/  Rate** | ** ** | **Average  Balance** | ** ** | **Interest  (2)** | ** ** | **Yield/  Rate** | ** ** |
|                                             |       |                                                     |       |                                                     |       |   |   |   |   |   |   |   |   |
| Interest Earning  Assets:                        |       |                                                     |       |                                                     |       |   |   |   |   |   |   |   |   |
| Loans (1)                                        |       | $                                                        | 69,208     |                                                     | $          | 3,144 |   | 9.09 | % | $ | 43,197 |   | $ | 1,772 |   | 8.20 | % |
| Taxable  investment securities                   |       | 1,561                                                    |       | 31                                                       |       | 3.97 | % | 3,581 |   | 54 |   | 3.02 | % |
| Federal funds  sold                              |       | 11,776                                                   |       | 308                                                      |       | 5.23 | % | 5,105 |   | 107 |   | 4.19 | % |
| Interest bearing  deposits with other Banks      |       | —                                                   |       | —                                                   |       | 0.00 | % | 2,476 |   | 52 |   | 4.20 | % |
| Federal Home  Loan Bank Stock                    |       | 326                                                      |       | —                                                   |       | 0.00 | % | 319 |   | 7 |   | 4.39 | % |
|                                             |       |                                                     |       |                                                     |       |   |   |   |   |   |   |   |   |
| Total interest earning  assets                   |       | 82,871                                                   |       | 3,483                                                    |       | 8.41 | % | 54,678 |   | 1,992 |   | 7.29 | % |
| Non-interest  earning assets                     |       | 10,378                                                   |       |                                                     |       |   |   | 8,916 |   |   |   |   |   |
|                                             |       |                                                     |       |                                                     |       |   |   |   |   |   |   |   |   |
| Total assets                                     |       | $                                                        | 93,249     |                                                     |       |   |   |   | $ | 63,594 |   |   |   |   |   |
|                                             |       |                                                          |       |                                                     |       |   |   |  |   |   |   |   |   |
| Interest Bearing  Liabilities:                   |       |                                                     |       |                                                     |       |   |   |   |   |   |   |   |   |
| Deposits:                                        |       |                                                     |       |                                                     |       |   |   |   |   |   |   |   |   |
| NOW and money  market deposits                   |       | $                                                        | 29,863     |                                                     | $          | 531 |   | 3.56 | % | $ | 16,031 |   | $ | 164 |   | 2.05 | % |
| Savings deposits                                 |       | 527                                                      |       | 4                                                        |       | 1.46 | % | 482 |   | 1 |   | 0.41 | % |
| Time deposits                                    |       | 21,691                                                   |       | 575                                                      |       | 5.30 | % | 12,705 |   | 216 |   | 3.40 | % |
| Short-term  borrowings                           |       | 689                                                      |       | 27                                                       |       | 7.77 | % | 77 |   | 1 |   | 2.60 | % |
| Property  mortgage and long term borrowings      |       | 2,674                                                    |       | 79                                                       |       | 5.99 | % | 2,710 |   | 82 |   | 6.05 | % |
| Total interest bearing  liabilities              |       | 55,444                                                   |       | 1,216                                                    |       | 4.39 | % | 32,005 |   | 464 |   | 2.90 | % |
| Demand  deposits—non-interest bearing       |       | 24,488                                                   |       |                                                     |       |   |   | 19,917 |   |   |   |   |   |
| Other non-interest  bearing liabilities          |       | 539                                                      |       |                                                     |       |   |   | 56 |   |   |   |   |   |
| Shareholders’ equity                        |       | 12,778                                                   |       |                                                     |       |   |   | 11,616 |   |   |   |   |   |
|                                             |       |                                                     |       |                                                     |       |   |   |   |   |   |   |   |   |
| Total liabilities and  shareholders’ equity |       | $                                                        | 93,249     |                                                     |       |   |   |   | $ | 63,594 |   |   |   |   |   |
|                                             |       |                                                          |       |                                                     |       |   |   |   |   |   |   |   |   |
| Net interest income                              |       |                                                     |       | $                                                        | 2,267      |   |   |   |   |   | $ | 1,528 |   |   |   |
|                                             |       |                                                     |       |                                                          |       |   |   |   |   |   |   |   |   |
| Interest rate  spread (3)                        |       |                                                     |       |                                                     |       | 4.02 | % |   |   |   |   | 4.39 | % |
| Net interest margin (4)                          |       |                                                     |       |                                                     |       | 5.47 | % |   |   |   |   | 5.59 | % |

----

(1)             Non-accrualloans are included in average loans.

(2)             Interestincome includes loan fees of $56,000 and $105,000, for the three and six monthsended March 31, 2007, respectively and $26,000 and $56,000 for the three andsix months ended March 31, 2006.

(3)             Interestrate spread represents the difference between the average yield on interestearning assets and the average cost of interest bearing liabilities.

(4)             Netinterest margin represents annualized net interest income as a percentage ofaverage interest earning assets.

***Volume, Mix and Rate Analysis of NetInterest Income***

The following table presents theextent to which changes in volume, changes in interest rates, and changes inthe interest rates times the changes in volume of interest earning assets andinterest bearing liabilities affected the Bank’s interest income and interestexpense during the period indicated. Information is provided on changes in eachcategory due to (1) changes attributable to changes in volume (change involume times the prior period interest rate), (2) changes attributable tochanges in interest rate (changes in rate times the prior period volume), and(3) changes attributable to changes in rate/volume (changes in interestrate times changes in volume). Changes attributable to the combined impact ofvolume and rate have been allocated proportionally to the changes due to volumeand the changes due to rate (in thousands):

22

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|                                             | ** ** | **Three Months Ended March 31, 2007  Compared to  Three Months Ended March 31, 2006** | ** ** |
|---------------------------------------------|------------|----------------------------------------------------------------------------------------------------------------------------------------------|------------|
| ** **                                  | ** ** | **Change Due to  Volume**                                                                                                          | ** ** | **Change Due to  Rate** | ** ** | **Total Change** | ** ** |
|                                        |       |                                                                                                                                         |       |   |   |   |   |
| Interest Earning  Assets:                   |       |                                                                                                                                         |       |   |   |   |   |
| Loans                                       |       | $                                                                                                                                            | 563        |   | $ | 86 |   | $ | 649 |   |
| Taxable investment securities               |       | (23                                                                                                                                          | )          | 15 |   | (8 | ) |
| Federal funds sold                          |       | (6                                                                                                                                           | )          | 17 |   | 11 |   |
| Interest bearing deposits with other Banks  |       | (16                                                                                                                                          | )          | — |   | (16 | ) |
| Increase in  interest income                |       | $                                                                                                                                            | 518        |   | $ | 118 |   | $ | 636 |   |
|                                        |       |                                                                                                                                              |       |  |   |  |   |
| Interest Bearing  Liabilities:              |       |                                                                                                                                         |       |   |   |   |   |
| NOW and money market deposit accounts       |       | $                                                                                                                                            | 76         |   | $ | 65 |   | $ | 141 |   |
| Savings deposits                            |       | 1                                                                                                                                            |       | 1 |   | 1 |   |
| Time deposits                               |       | 144                                                                                                                                          |       | 51 |   | 195 |   |
| Short-term borrowings                       |       | —                                                                                                                                       |       | 1 |   | 1 |   |
| Long term borrowings                        |       | (1                                                                                                                                           | )          | (1 | ) | (2 | ) |
| Increase  (decrease) in interest expense    |       | 220                                                                                                                                          |       | 117 |   | 336 |   |
| Increase (decrease) in  net interest income |       | $                                                                                                                                            | 298        |   | $ | 1 |   | $ | 300 |   |

 
|                                            | ** ** | **Six Months Ended March 31, 2007  Compared to  Six Months Ended March 31, 2006** | ** ** |
|--------------------------------------------|------------|------------------------------------------------------------------------------------------------------------------------------------------|------------|
| ** **                                 | ** ** | **Change Due to  Volume**                                                                                                      | ** ** | **Change Due to  Rate** | ** ** | **Total Change** | ** ** |
|                                       |       |                                                                                                                                     |       |   |   |   |   |
| Interest Earning  Assets:                  |       |                                                                                                                                     |       |   |   |   |   |
| Loans                                      |       | $                                                                                                                                        | 1,182      |   | $ | 191 |   | $ | 1,373 |   |
| Taxable investment securities              |       | (40                                                                                                                                      | )          | 17 |   | (23 | ) |
| Federal funds sold                         |       | 174                                                                                                                                      |       | 27 |   | 201 |   |
| Interest bearing deposits with other Banks |       | (52                                                                                                                                      | )          | — |   | (52 | ) |
| Increase in  interest income               |       | $                                                                                                                                        | 1,264      |   | $ | 235 |   | $ | 1,499 |   |
|                                       |       |                                                                                                                                     |       |   |   |   |   |
| Interest Bearing  Liabilities:             |       |                                                                                                                                     |       |   |   |   |   |
| NOW and money market deposit accounts      |       | $                                                                                                                                        | 246        |   | $ | 121 |   | $ | 367 |   |
| Savings deposits                           |       | —                                                                                                                                   |       | 3 |   | 3 |   |
| Time deposits                              |       | 238                                                                                                                                      |       | 121 |   | 359 |   |
| Short-term borrowings                      |       | 24                                                                                                                                       |       | 2 |   | 26 |   |
| Long term borrowings                       |       | (1                                                                                                                                       | )          | (1 | ) | (2 | ) |
| Increase in  interest expense              |       | 507                                                                                                                                      |       | 245 |   | 752 |   |
| Increase in net  interest income           |       | $                                                                                                                                        | 757        |   | $ | (10 | ) | $ | 747 |   |

 

***Provision for Loan Losses***

The provision for loan losses is an expense determinedby management as the amount necessary to increase the allowance for loan lossesafter net charge-offs have been deducted to a level that, in management’s bestestimate, is necessary to absorb probable losses in the loan portfolio. Theamount of the provision is based on management’s review of the loan portfolioand consideration of such factors as historical loss experience, generalprevailing economic conditions, changes in the size and composition of the loanportfolio and specific borrower considerations, 

23

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including the ability of the borrower to repay theloan and the estimated value of the underlying collateral. The provision iscalculated monthly and a charge or credit to expense is made, as required, toadjust the allowance to the calculated level.

For the three months ended March 31, 2007, the Bankmade $70,000 in provisions for loan losses, compared to $45,000 for the threemonths ended March 31, 2006.  For thethree months ended March 31, 2007, the Bank charged off $0 in commercial andconsumer loans and had recoveries of loans previously charged-off of $1,000 fornet recoveries of $1,000. For the three months ended March 31, 2006, the Bankcharged off $4,000 in commercial and consumer loans and had zero recoveries ofloans previously charged-off for net charge-offs of $4,000. The factorscombined increased the Allowance for Loan Losses to $646,000 or 0.87% of the portfolioat March 31, 2007. This amount represents management’s estimate of probablelosses inherent in the portfolio.  Forthe six months ended March 31, 2007 and March 31, 2006, the provision for loanlosses was $145,000 and $90,000, respectively. For the six months ended March 31, 2007, the Bank charged-off $51,000 incommercial and consumer loans and had recoveries of loans previouslycharged-off of 21,000 for a net charge-off of $49,000.  For the six months ended March 31, 2006, theBank charged-off $10,000 in commercial and consumer loans and had recoveries ofloans previously charged-off of $1,000 for a net charge-off of $9,000.

***OtherIncome***

For the three months ended March31, 2007, other income decreased $21,000 from $121,000 during the three monthsended March 31, 2006, to $100,000. The majority of the decrease wasrelated to the Company’s ownership interest in PGI Equity Partners, LP, whichis the real estate investment company that owns and manages the property wherethe Company’s offices are located.  Forthe six months ended March 31, 2007, other income decreased $31,000 from$236,000 during the six months ended March 31, 2006 to $205,000.  The decrease also related to the Company’sownership interest in PGI Equity Partners, LP.

***Non-InterestExpenses***

For the three months ended March31, 2007, salaries and employee benefits were $615,000 compared to $442,000 forthe three months ended March 31, 2006. Stock based compensation recognized for the three months ended March 31,2007 totaled $92,000.  Occupancy andequipment expenses for the three months ended March 31, 2007 decreased from$114,000 for the three months ended March 31, 2006 to $101,000.  The increase in salaries and employeebenefits and occupancy and equipment expenses was due to the Bank’s continuedgrowth and the corresponding addition of new employees.  Professional fees paid for accounting andlegal services, including regulatory filings and audit services, totaled$47,000 and $52,000, respectively, for the three months ended March 31, 2007and 2006.  The decrease was due to thecompletion of the merger and the corresponding reduction in legal andregulatory fees.  Other expensesincreased from $262,000 for the three months ended March 31, 2006, to $353,000for the three months ended March 31, 2007. This increase in other expenses was also a result of the growth of theBank and the increase in employees.

***Income Taxes***

No federal tax benefit has been recorded for the threemonths ended December 31, 2006, based upon net operating losses incurred andcarried forward in previous years. Because of the Company’s limited operatinghistory, the federal tax benefit of the cumulative losses has been fullyreserved against.  The Company has nowachieved profitability for the previous two quarters and therefore, the Companycontinues to evaluate whether the trend of profitable operations supports therecording of federal tax benefits in a subsequent quarter.

24

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**Financial Condition**

***Loan Portfolio***

Net loans increased $13,532,000 (22.7%) to $73,152,000from $59,620,000 between March 31, 2007 and September 30, 2006. Theconcentration within the portfolio has shifted over time from the previousconcentration of agricultural loans to real estate and commercial loans.

***Loan Portfolio Mix***

The following tables set forth the composition of theloan portfolio (in thousands):
|                                  | ** ** | **As of March 31,  2007** | ** ** | **As of September 30,  2006** | ** ** |
|----------------------------------|------------|------------------------------------------|------------|----------------------------------------------|------------|
|                             |       |                                     |       |                                         |       |
| Agriculture                      |       | $                                        | 3,729      |                                         | $          | 2,989 |   |
| Commercial                       |       | 24,514                                   |       | 19,068                                       |       |
| Commercial real  estate          |       | 20,232                                   |       | 18,582                                       |       |
| Residential real  estate         |       | 8,484                                    |       | 8,221                                        |       |
| Construction  real estate        |       | 9,556                                    |       | 4,329                                        |       |
| Consumer and  other              |       | 7,283                                    |       | 6,981                                        |       |
| Gross Loans                      |       | 73,798                                   |       | 60,170                                       |       |
| Less: allowance  for loan losses |       | (646                                     | )          | (550                                         | )          |
|                             |       |                                     |       |                                         |       |
| Net Loans                        |       | $                                        | 73,152     |                                         | $          | 59,620 |   |

 

Loan concentrations are considered to exist when thereare amounts loaned to a multiple number of borrowers engaged in similaractivities that would cause them to be similarly impacted by economic or otherconditions.

For the three month and six month periods ended March31, 2007, the majority of new loan growth came from the Austin marketreflecting a broader, more diverse mix of industries and borrowers.

Management may renew loans at maturity when requestedby a customer whose financial strength appears to support such a renewal orwhen such a renewal appears to be in the best interest of the Bank. The Bankrequires payment of accrued interest in such instances and may adjust the rateof interest, require a principal reduction, or modify other terms of the loanat the time of renewal.

***Loan Maturities***

The following table presents the contractual maturityranges for agricultural, commercial, real estate and consumer loans outstandingat March 31, 2007, and at September 30, 2006, and also presents for eachmaturity range the portion of loans that have fixed interest rates or interestrates that fluctuate over the life of the loan in accordance with changes inthe interest rate environment as represented by the base rate (in thousands):
| ** **                       | ** ** | **Due in One Year  or Less** | ** ** | **Due after One Year  Through  Five Years** | ** ** | **Due after  Five Years** | ** ** | ** **      | ** ** |
|----------------------------------|------------|--------------------------------------------------|------------|-----------------------------------------------------------------|------------|-------------------------------------|------------|-----------------|------------|
| **March 31, 2007**     | ** ** | ** **                                       | ** ** | **Fixed  Rate**                                                 | ** ** | **Floating  Rate**                  | ** ** | **Fixed  Rate** | ** ** | **Floating  Rate** | ** ** | **Fixed  Rate** | ** ** | **Floating  Rate** | ** ** | **Total** | ** ** |
|                             |       |                                             |       |                                                            |       |                                |       |            |       |   |   |   |   |   |   |
| Agricultural                     |       | $                                                | 830        |                                                            | $          | 1,872                               |       | $               | 9          |   | $ | 517 |   | $ | — |   | $ | 501 |   | $ | 3,729 |   |
| Real estate —  residential  |       | 905                                              |       | 1,642                                                           |       | 2,737                               |       | 1,923           |       | 1,277 |   | — |   | 8,484 |   |
| Real estate —  commercial   |       | 273                                              |       | 7,209                                                           |       | 229                                 |       | 11,232          |       | — |   | 1,289 |   | 20,232 |   |
| Real estate —  construction |       | 2,438                                            |       | 2,881                                                           |       | —                              |       | 3,509           |       | 190 |   | 538 |   | 9,556 |   |
| Commercial                       |       | 919                                              |       | 12,504                                                          |       | 582                                 |       | 10,508          |       | — |   | 1 |   | 24,514 |   |
| Consumer and  other              |       | 694                                              |       | 5,187                                                           |       | 712                                 |       | 669             |       | — |   | 21 |   | 7,283 |   |
| **Total**                        |       | $                                                | 6,059      |                                                            | $          | 31,295                              |       | $               | 4,269      |   | $ | 28,544 |   | $ | 1,467 |   | $ | 2,350 |   | $ | 73,798 |   |
|                                  |            |                                                  |            |                                                                 |            |                                     |            |                 |            |  |  |  |  |  |  |  |  |  |  |  |  |  |  |  |

 

25

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| ** **                       | ** ** | **Due in One Year  or Less** | ** ** | **Due after One Year  Through  Five Years** | ** ** | **Due after  Five Years** | ** ** | ** **      | ** ** |
|----------------------------------|------------|--------------------------------------------------|------------|-----------------------------------------------------------------|------------|-------------------------------------|------------|-----------------|------------|
| **September 30, 2006** | ** ** | ** **                                       | ** ** | **Fixed  Rate**                                                 | ** ** | **Floating  Rate**                  | ** ** | **Fixed  Rate** | ** ** | **Floating  Rate** | ** ** | **Fixed  Rate** | ** ** | **Floating  Rate** | ** ** | **Total** | ** ** |
|                             |       |                                             |       |                                                            |       |                                |       |            |       |   |   |   |   |   |   |
| Agricultural                     |       | $                                                | 6          |                                                            | $          | 2,137                               |       | $               | —     |   | $ | 342 |   | $ | — |   | $ | 504 |   | $ | 2,989 |   |
| Real estate —  residential  |       | 163                                              |       | 2,635                                                           |       | 1,976                               |       | 1,914           |       | 1,533 |   | — |   | 8,221 |   |
| Real estate —  commercial   |       | 323                                              |       | 3,335                                                           |       | 258                                 |       | 9,928           |       | — |   | 4,738 |   | 18,582 |   |
| Real estate —  construction |       | 1,049                                            |       | 202                                                             |       | 1,013                               |       | 2,065           |       | — |   | — |   | 4,329 |   |
| Commercial                       |       | 173                                              |       | 12,118                                                          |       | 1,589                               |       | 5,050           |       | 27 |   | 111 |   | 19,068 |   |
| Consumer and other               |       | 559                                              |       | 5,166                                                           |       | 652                                 |       | 550             |       | 31 |   | 23 |   | 6,981 |   |
| **Total**                        |       | $                                                | 2,273      |                                                            | $          | 25,593                              |       | $               | 5,488      |   | $ | 19,849 |   | $ | 1,591 |   | $ | 5,376 |   | $ | 60,170 |   |
|                                  |            |                                                  |            |                                                                 |            |                                     |            |                 |            |  |  |  |  |  |  |  |  |  |  |  |  |  |  |  |

 

As of March 31, 2007, 50.6% of the loan portfolio, or$37,354,000, matures or re-prices within one year or less and $62,189,000 ofthe loan portfolio, or 84.3%, were variable rate loans.   At September 30, 2006, 46.3% of theloan portfolio or $27,866,000, matured or re-priced within one year or less and$50,818,000 of the loan portfolio, or 84.5%, were variable rate loans.

***Investment Securities***

The primary purposes of the investment portfolio areto provide a source of earnings for liquidity management purposes, to providecollateral to pledge against public deposits, and to control interest raterisk. In managing the portfolio, the Bank seeks to attain the objectives ofsafety of principal, liquidity, diversification, and maximized return oninvestment.

The following tables set forth the amortized cost andfair value of the Bank’s securities portfolio by accounting classificationcategory and by type of security as indicated (in thousands) as of March 31,2007 and September 30, 2006:

|                                      | ** ** | **As of  March 31, 2007** | ** ** | **As of  September 30, 2006** | ** ** |
|--------------------------------------|------------|------------------------------------------|------------|----------------------------------------------|------------|
| ** **                           | ** ** | **Amortized  Cost**                      | ** ** | **Fair  Value**                              | ** ** | **Amortized  Cost** | ** ** | **Fair  Value** | ** ** |
|                                 |       |                                     |       |                                         |       |   |   |   |   |
| Securities Available  for Sale:      |       |                                     |       |                                         |       |   |   |   |   |
| U.S. Government  Agencies            |       | $                                        | 11         |                                         | $          | 11 |   | $ | 14 |   | $ | 14 |   |
| Other mortgage  backed securities    |       | 2                                        |       | 2                                            |       | 2 |   | 2 |   |
|                                 |       |                                     |       |                                         |       |   |   |   |   |
| Total Securities  Available for Sale |       | $                                        | 13         |                                         | $          | 13 |   | $ | 16 |   | $ | 16 |   |
|                                 |       |                                          |       |                                              |       |  |   |  |   |
|  Securities Held to Maturity:   |       |                                     |       |                                         |       |   |   |   |   |
| U.S. Government  Agencies            |       | $                                        | 1,448      |                                         | $          | 1,447 |   | $ | 2,000 |   | $ | 1,996 |   |
| Other mortgage  backed securities    |       | 0                                        |       | 4                                            |       | 6 |   | 5 |   |
|                                 |       |                                     |       |                                         |       |   |   |   |   |
| Total Securities Held to Maturity    |       | $                                        | 1,448      |                                         | $          | 1,447 |   | $ | 2,006 |   | $ | 2,001 |   |

 

U.S. Treasury securities and securities of U.S.Government agencies generally consist of fixed rate securities with maturitiesof three months to five years. Other mortgage backed securities consists offixed rate mortgage pass-through securities with a maturity of five to fifteenyears.

26

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***Asset Quality***

The following table sets forth the amount ofnon-performing loans and non-performing assets as of March 31, 2007, andSeptember 30, 2006 (in thousands except for percentages):
|                                                          | ** ** | **As of  March 31,  2007** | ** ** | **As of  September 30,  2006** | ** ** |
|----------------------------------------------------------|------------|--------------------------------------|------------|------------------------------------------|------------|
|                                                     |       |                                 |       |                                     |       |
| Non-accruing  loans                                      |       | $                                    | 109        |                                     | $          | 123 |   |
| Loans 90 days or more  past due, still accruing interest |       | —                               |       | —                                   |       |
|                                                     |       |                                 |       |                                     |       |
| Total non-performing  loans                              |       | 109                                  |       | 123                                      |       |
| Other real estate owned                                  |       | 76                                   |       | 41                                       |       |
| Other repossessed  assets                                |       | 5                                    |       | 5                                        |       |
|                                                     |       |                                 |       |                                     |       |
| Total non-performing  assets                             |       | $                                    | 190        |                                     | $          | 169 |   |
|                                                     |       |                                      |       |                                          |       |
| Total non-performing  loans to total loans               |       | 0.15                                 | %          | 0.20                                     | %          |
| Allowance for loan  losses to non-performing loans       |       | 593                                  | %          | 447                                      | %          |
| Total non-performing assets to total assets              |       | 0.20                                 | %          | 0.17                                     | %          |

 

***Non-performing Loans***

Non-performing loans include (1) loans accountedfor on a non-accrual basis, (2) accruing loans contractually past due90 days or more as to interest and principal, and (3) troubled debtrestructurings. Management reviews the loan portfolio for problem loans on anongoing basis.

During the ordinary course ofbusiness, management becomes aware of borrowers that may not be able to meetthe contractual requirements of loan agreements. Such loans are placed underclose supervision with consideration given to placing the loan on a non-accrualstatus, increasing the allowance for loan losses, and (if appropriate) partialor full charge-off. After a loan is placed on non-accrual status, any currentyear interest previously accrued but not yet collected is reversed againstcurrent income. When payments are received on non-accrual loans, such paymentsare applied to principal and not taken into income. Loans are not placed backon accrual status unless all back interest and principal payments are made. Ifinterest on non-accrual loans had been accrued, such income would have amountedto approximately $1,400 for the three months ended March 31, 2007 and $2,600for the three months ended March 31, 2006. This amount was not included ininterest income during this period.

Under Federal and Texas law, anyloan 90 or more days past due is required to be placed on non-accrual basisunless specifically identified mitigating circumstances exist. Our policy is toplace loans 90 days past due on non-accrual status. An exception is madewhen management believes the loan is fully secured and in process ofcollection. Non-accrual loans are further classified as impaired whenunderlying collateral is not sufficient to cover the loan balance and it isprobable that we will not fully collect all principal and interest. As of March31, 2007 and September 30, 2006, we had $103,000 and $123,000 in non-accrualloans respectively. There were no loans contractually past due over90 days which continued to accrue interest on March 31, 2007 and September 30,2006, based upon specific information available at that time tomanagement.  In compliance with thesestatutes we have developed pro forma financial statements assuming that noloans will continue to accrue interest if they become 90 days past due,and instead transfer all such loans to non-accruing status.

A “troubled debt restructuring”is a restructured loan upon which interest accrues at a below market rate orupon which certain principal has been forgiven so as to aid the borrower in thefinal repayment of the loan, with any interest previously accrued, but not yetcollected, being reversed against current income. Interest is accrued basedupon the new loan terms.  There were notroubled debt restructurings outstanding as of March 31, 2007 andSeptember 30, 2006*.*

27

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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 of March 31, 2007, and September 30, 2006, we had $76,000and $41,000, respectively, in other real estate owned.  The property consists of three single familydwellings located in Texline and Dalhart, Texas.  Repossessed assets totaled $5,000 at March31, 2007 and September 30, 2006.

***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*

We offer a variety of depositaccounts with a range of interest rates and terms. Core deposits consist ofchecking accounts (non-interest bearing), “NOW” accounts, savings accounts, andnon-public certificates of deposit. These deposits, along with public funddeposits and short-term borrowings, are used to support our asset base.Deposits are obtained predominantly from the geographic trade areas surroundingour office locations. We rely primarily on customer service and long-standingrelationships with customers to attract and retain deposits; however, marketinterest rates and rates offered by competing financial institutionssignificantly affect our ability to attract and retain deposits.  As the competition for deposits hasincreased, we have continued to expand and diversify the Bank’s fundingsources.  For the three months endedMarch 31, 2007, we have increased institutional deposits to ensure adequatefunding of our loan growth.

The following table sets forth the maturities of timedeposits $100,000 and over as of March 31, 2007, and September 30, 2006 (inthousands):

|                                           | ** ** | **As of  March 31,  2007** | ** ** | **As of  September 30,  2006** | ** ** |
|-------------------------------------------|------------|--------------------------------------|------------|------------------------------------------|------------|
|                                      |       |                                 |       |                                     |       |
| Time deposits $100,000  and over:         |       |                                 |       |                                     |       |
| Maturing within three  months             |       | $                                    | 4,046      |                                     | $          | 1,949 |   |
| After three months but  within six months |       | 3,232                                |       | 3,982                                    |       |
| After six months but  within 12 months    |       | 4,240                                |       | 3,058                                    |       |
| After 12 months                           |       | —                               |       | —                                   |       |
|                                      |       |                                 |       |                                     |       |
| Total time deposits $100,000 and over     |       | $                                    | 11,518     |                                     | $          | 8,989 |   |

 

*Returnon Equity and Assets*

The following table sets forth certain informationregarding the Company’s return on equity and assets for the periods indicated:

28

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|                        | ** ** | **For the Three Months  Ended** | ** ** | **For the Six Months  Ended** | ** ** |
|------------------------|------------|------------------------------------------------|------------|----------------------------------------------|------------|
| ** **             | ** ** | **March 31,  2007**                       | ** ** | **March 31,  2006**                     | ** ** | **March 31,  2007** | ** ** | **March 31,  2006** | ** ** |
|                   |       |                                           |       |                                         |       |   |   |   |   |
| Return on assets       |       | 0.03                                           | %          | 0.03                                         | %          | 0.17 | % | -0.07 | % |
| Return on equity       |       | 0.21                                           | %          | 0.21                                         | %          | 1.23 | % | -0.45 | % |
| Dividend payout ratio  |       | 0                                              | %          | 0                                            | %          | 0 | % | 0 | % |
| Equity to assets ratio |       | 14.06                                          | %          | 15.36                                        | %          | 14.06 | % | 15.36 | % |

 

**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 capital requirements more sensitive todifferences in risk profiles among banks, to account for off-balance sheetexposure, and to minimize disincentives for holding liquid assets. Under theregulations, assets and off-balance sheet items are assigned to broad riskcategories, each with appropriate weights. The resulting capital ratiosrepresent capital as a percentage of total risk weighted assets and off-balancesheet items. Under the prompt corrective action regulations, to be adequatelycapitalized a bank must maintain minimum ratios of total capital torisk-weighted assets of 8.00%, Tier 1 capital to risk-weighted assets of 4.00%,and Tier 1 capital to total assets of 4.00%. Failure to meet these capitalrequirements can initiate certain mandatory and possibly additionaldiscretionary actions by regulators that, if undertaken, could have a directmaterial effect on the Bank’s financial statements.

As of March 31, 2007 and as ofSeptember 30, 2006, the most recent notifications from the federal Bankingregulators categorized the Bank as well-capitalized. A well-capitalizedinstitution must maintain a minimum ratio of total capital to risk-weightedassets of at least 10.00%, a minimum ratio of Tier 1 capital to risk weightedassets of at least 6.00%, and a minimum ratio of Tier 1 capital to total assetsof at least 5.00% and must not be subject to any written order, agreement, ordirective requiring it to meet or maintain a specific capital level. There areno conditions or events since that notification that the Bank’s managementbelieves have changed the capital classification.

The Bank was in full compliancewith all applicable capital adequacy requirements as of March 31, 2007 andSeptember 30, 2006. The required and actual amounts and ratios for the Bank asof March 31, 2007 and September 30, 2006, 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 March 31, 2007                      |       |       |       |                                         |       |                                                                                         |       |   |   |   |   |   |   |
| Tier 1 capital  (to average assets)       |       | $          | 8,669      |                                         | 10.29      | %                                                                                            | $          | 3,370 |   | 4 | % | $ | 4,213 |   | 5 | % |
| Tier 1 capital  (to risk-weighted assets) |       | 8,669      |       | 11.05                                        | %          | 3,139                                                                                        |       | 4 | % | 4,708 |   | 6 | % |
| Total Capital (to risk-weighted  assets)  |       | 9,315      |       | 11.87                                        | %          | 6,278                                                                                        |       | 8 | % | 7,847 |   | 10 | % |
|                                           |            |            |            |                                              |            |                                                                                              |            |  |  |  |  |  |  |  |  |  |

 

29

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|                                          | ** ** | **Actual** | ** ** | **For Capital  Adequacy Purposes** | ** ** | **To Be Well  Capitalized Under  Prompt Corrective  Action  Provisions** | ** ** |
|------------------------------------------|------------|------------|------------|----------------------------------------------|------------|----------------------------------------------------------------------------------------------|------------|
|                                     |       |       |       |                                         |       |                                                                                         |       |   |   |   |   |   |   |
| As  of September 30, 2006                |       |       |       |                                         |       |                                                                                         |       |   |   |   |   |   |   |
| Tier 1 capital (to average assets)       |       | $          | 8,213      |                                         | 11.07      | %                                                                                            | $          | 2,967 |   | 4 | % | $ | 3,709 |   | 5 | % |
| Tier 1 capital (to risk-weighted assets) |       | 8,213      |       | 11.39                                        | %          | 2,885                                                                                        |       | 4 | % | 4,328 |   | 6 | % |
| Total  Capital (to risk-weighted assets) |       | 8,763      |       | 12.15                                        | %          | 5,771                                                                                        |       | 8 | % | 7,213 |   | 10 | % |
|                                          |            |            |            |                                              |            |                                                                                              |            |  |  |  |  |  |  |  |  |  |

 

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

With the participation of management, the Company’s chief executiveofficer and chief financial officer reviewed and evaluated the Company’sdisclosure controls and procedures as defined in Rules 13a-14(c) and 15d-14(c)under the Securities Exchange Act of 1934, as amended (the “Exchange Act”), asof the end of the period 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 been no significant changes in the Company’s internal controlsfor financial reporting or in other factors that could significantly affectthese controls, including any significant deficiencies or material weaknessesof internal controls that would require corrective action.  In connection with the new rules, the Companyis currently in the process of further reviewing and documenting its disclosurecontrols and procedures, including its internal accounting controls, and may fromtime to time make changes aimed at enhancing their effectiveness and ensuringthat the Company’s systems evolve with its business.

**PART II.                OtherInformation**

**Item 1.                    *Legal Proceedings***

None

**Item 2.                    *Unregistered Sales ofEquity Securities and Use of Proceeds***

OnMay 7, 2004, the Securities and Exchange Commission declared our RegistrationStatement on Form SB-2 (File No. 333-112325) related to our initial publicoffering effective.  In addition, onOctober 22, 2004, we filed a Form SB-2MEF under Rule 462 registering additionalshares of common stock and warrants to purchase our common stock under ourpublic offering.  We registered a totalof 1,944,000 shares of our common stock, of which 324,000 shares are issuableunder registered common stock warrants. We accepted subscriptions for 1,589,602 shares of our common stock underthe offering and have received net offering proceeds (after deducting offeringexpenses) of approximately $11.9 million.

From the offering proceeds, wepaid our organizing shareholder and affiliate, Treaty Oak Holdings, Inc. (“TOHI”)for reimbursement of expenses and advances on our behalf in connection with ouroffering and repayment of the amount due under a convertible promissory note.TOHI owned approximately 39% of our common stock, but was acquired by us in atransaction that closed on November 15, 2006. We contributed to the capital ofthe Bank and paid 

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operating expenses includingrepayment of certain costs previously paid by TOHI. We also repaid principaland interest under unsecured promissory notes issued in connection with thepurchase price of the Bank, and have paid ongoing operating expenses. Thesepayments are summarized in the table below:

 
| ** **                                                                                                                                                                                | ** ** | **As of**           | ** ** |
|-------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------|------------|--------------------------|------------|
| ** **                                                                                                                                                                                | ** ** | **March 31,  2007** | ** ** |
| Gross proceeds from  sale of shares                                                                                                                                                       |       | $                        | 13,276,271 |   |
| Amounts receivable as  of December 31, 2004                                                                                                                                               |       | —                   |       |
| 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                                                                |       | (1,015,332               | )          |
| Contribution to the  capital of the Bank                                                                                                                                                  |       | (7,500,000               | )          |
| Payments to directors  and officers (bonuses and directors’ fees)                                                                                                                    |       | (194,306                 | )          |
| Payments to officers  (salary and benefits)                                                                                                                                               |       | (326,108                 | )          |
| Other payments to  affiliates for services                                                                                                                                                |       | (149,057                 | )          |
| Limited partnership  investment in affiliated limited partnership                                                                                                                         |       | (1,030,000               | )          |
| Loan to affiliated  company                                                                                                                                                               |       | (46,037                  | )          |
| Repurchase of shares  issued                                                                                                                                                              |       | (50,005                  | )          |
| Payment of additional  operating expenses (estimated)                                                                                                                                     |       | (947,753                 | )          |
| Remaining net proceeds                                                                                                                                                                    |       | $                        | 735,371    |   |

 

In connection with the Company’s acquisition of TOHI, we issued1,094,163 shares of the Company’s common stock to the TOHI shareholders.  We also issued warrants to acquire, in theaggregate, 450,000 shares of the Company’s common stock with an exercise priceof the lesser of the Company’s book value or $6.67 to various TOHIwarrantholders.  We issued the stock andwarrants under an exemption from registration under Section 4(2) of theSecurities Act of 1933.  The Company grantedthe TOHI shareholders certain limited registration rights pursuant to aRegistration Rights Agreement executed at the closing of the merger. Pursuantto the Registration Rights Agreement these former TOHI shareholders can requestthat the Company register their shares of the Company’s stock on a RegistrationStatement on Form S-3 if such form is available for use by the Company, butonly once during any 12-month period. The former TOHI warrantholders were also granted similar S-3registration rights.

## **Item3.**                    ***Defaults Upon Senior Securities***

## None.

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

On February 13, 2007, we held our annual shareholders meeting.  Holders of 1,703,125 of the 2,730,187outstanding shares of our common stock entitled to vote at the meeting werepresent at the meeting in person or by proxy.  The following matters were submitted to avote:

1.             To elect William J.McClellan, Carl J. Stolle and Bill F. Schneider as Class III Directors (toserve terms until the 2010 annual meeting).

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2.             To elect William T.Willis as a Class I Director (to serve for a one-year term ending at the 2008annual meeting)

3.             To ratify McGladrey& Pullen, LLP as auditors.

The above proposals wereapproved and the results of the voting are summarized in the following table:
| **Proposal**                                         | ** ** | ** ** | ** ** | **For** | ** ** | **Against** | ** ** | **Withheld** | ** ** | **Abstain** | ** ** |
|------------------------------------------------------|------------|------------|------------|---------|------------|-------------|------------|--------------|------------|-------------|------------|
| Elect William J.  McLellan to the Board of Directors |       | 1,701,925  |       | —  |       | 1,200       |       | —       |       |
| Elect Carl J. Stolle to  the Board of Directors      |       | 1,703,125  |       | —  |       | —      |       | —       |       |
| Elect Bill F. Schneider  to the Board of Directors   |       | 1,702,525  |       | —  |       | 600         |       | —       |       |
| Elect William T. Willis  to the Board of Directors   |       | 1,694,178  |       | —  |       | 8,947       |       | —       |       |
| Ratify McGladrey & Pullen, LLP as auditors       |       | 1,684,824  |       | 600     |       | —      |       | 17,701       |       |

 

**Item 5.                    *Other Information***

None.

**Item 6.                    *Exhibits***
| Exhibit  Number | ** ** | **Exhibit Title**                                                                                                                 |
|-----------------|------------|-----------------------------------------------------------------------------------------------------------------------------------|
| 2.1(1)          |       | Agreement and Plan of Merger, dated October 3, 2006,  between Treaty Oak Holdings, Inc. and the Company                           |
|            |       |                                                                                                                              |
| 3.1(2)          |       | Amended and Restated Articles of Incorporation                                                                                    |
|            |       |                                                                                                                              |
| 3.2(3)          |       | By-laws                                                                                                                           |
|            |       |                                                                                                                              |
| 4.1(3)          |       | Specimen Common Stock Certificate, $.01 par value  per share                                                                      |
|            |       |                                                                                                                              |
| 4.2(3)          |       | See Exhibits 3.1 and 3.2 for provisions of the  Articles of Incorporation and By-laws defining rights of holders of  Common Stock |
|            |       |                                                                                                                              |
| 10.1(3)         |       | Amended and Restated Building Lease between PGI  Equity Partners, L.P. and Treaty Oak Bank                                        |
|            |       |                                                                                                                              |
| 10.2(3)         |       | Expense Reimbursement Agreement between Treaty Oak  Holdings, Inc. and Treaty Oak Bancorp, Inc.                                   |
|            |       |                                                                                                                              |
| 10.3(3)         |       | Form of Promotional Shares Lock-In Agreement                                                                                      |
|            |       |                                                                                                                              |
| 10.4(3)         |       | Form of Escrow Agreement between Treaty Oak Bancorp,  Inc. and TIB—The Independent Bankers Bank                              |

 

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| 10.5(3)                      |   | Form of Treaty Oak Bancorp Shareholders’ Warrant  Agreement                                                                                  |
|------------------------------|--------|---------------------------------------------------------------------------------------------------------------------------------------------------|
|                         |   |                                                                                                                                              |
|   10.6(2)*              |   | Treaty Oak Bancorp, Inc. 2004 Stock Incentive Plan  (amended and restated as of May 20, 2004)                                                     |
|                         |   |                                                                                                                                              |
|   10.7(3)*              |   | Form of Indemnification Agreement between Treaty Oak  Bancorp, Inc. and its directors and officers, and those of the Bank                         |
|                         |   |                                                                                                                                              |
| 10.8(3)                      |   | Registration Rights Agreement between Treaty Oak  Bancorp, Inc. and Treaty Oak Holdings, Inc.                                                     |
|                         |   |                                                                                                                                              |
|   10.9(4)*              |   | Employment Agreement, dated September 27, 2006,  between Treaty Oak Bancorp, Inc. and Jeffrey L. Nash                                             |
|                         |   |                                                                                                                                              |
|  10.10(5)               |   | Form of Warrant                                                                                                                                   |
|                         |   |                                                                                                                                              |
|  10.11(5)               |   | Form of Registration Rights Agreement with former  shareholders of Treaty Oak Holdings, Inc.                                                      |
|                         |   |                                                                                                                                              |
|  10.12(5)               |   | Form of Registration Rights Agreement with former  warrantholders of Treaty Oak Holdings, Inc.                                                    |
|                         |   |                                                                                                                                              |
| 21(5)         |   | Subsidiaries                                                                                                                                      |
|                         |   |                                                                                                                                              |
| 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** |

----

*      Indicates managementcontract or compensatory plan or arrangement.

(1)   Incorporated by reference tothe Company’s Current Report on Form 8-K filed October 10, 2006.

(2)   Incorporated by reference tothe Company’s Registration Statement on Form S-8 filed October 22, 2004.

(3)   Incorporated by reference tothe same numbered exhibit to the Company’s Registration Statement on Form SB-2.

(4)   Incorporated by reference tothe Company’s Current Report on Form 8-K filed November 1, 2006.

(5)          Incorporated by reference to the Company’ssame numbered exhibit to the Form 10-KSB filed December 29, 2006.

**   Filed herewith.

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**SIGNATURES**

Pursuant to therequirements of the Securities Exchange Act of 1934, the Registrant has dulycaused this report to be signed on its behalf by the undersigned, thereuntoduly authorized.
|                     |   | **TREATY OAK BANCORP, INC.** |
|---------------------|--------|------------------------------|
| ** **          |   | ** **                   |
|                |   |                         |
| Dated: May 15, 2007 |   | By:                          | /s/ Jeffrey L. Nash |
|                |   |                         | Jeffrey L. Nash, President and Chief Executive  Officer |
|                |   |                         |   |
|                |   |                         |   |
|                |   | By:                          | /s/ Coralie S. Pledger |
|                |   |                         | Coralie S. Pledger, Chief Financial Officer |

 

 

 

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