** **

**UNITEDSTATES**

**SECURITIESAND EXCHANGE COMMISSION**

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

###### ** **

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

###### ** **

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

# ** **

**Treaty OakBancorp, Inc.**

(Exact name of registrant as specified in itscharter)

 

| **Texas**                                                                                                                                                                                    |
|----------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------|
| (State or other jurisdiction of  corporation or organization)                                                                                                                                |
|                                                                                                                                                                                         |
| **20-0413144**                                                                                                                                                                               |
| (I.R.S. Employer Identification Number)                                                                                                                                                      |
|                                                                                                                                                                                         |   |   |
| **3811 Bee Cave Road, Suite 209, Austin, Texas                78746**                                                  |
| (Address of Principal Executive Offices) **                      **(Zip  Code) |
|                                                                                                                                                                                         |   |   |   |   |
| **(512) 617-3600**                                                                                                                                                                           |
| (Registrant’s telephone number, including  area code)                                                                                                                                   |
|                                                                                                                                                                                              |  |  |  |  |

 

Indicate by check mark whether the issuer (1) has filed all reportsrequired to be filed by Section 13 or 15(d) of the Securities Exchange Actof 1934 during the preceding 12 months (or for such shorter period that theregistrant was required to file****such reports), and (2) has been subject tosuch filing requirements for the past 90 days.

| **Yes ****o** |   | **No****ý** |
|--------------------|--------|------------------|

 

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

| **Yes ****o** |   | **No****ý** |
|--------------------|--------|------------------|

 

Indicate thenumber of shares outstanding of each of the issuer’s classes of common stock asof the close of business of May 1, 2004.

 
| $0.01 Par Value Common Stock |   | 1,040,000 shares |
|------------------------------|--------|------------------|

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

 

 

----

 

**QUARTERLYREPORT ON FORM 10-QSB**

**FORTHE PERIOD ENDED MARCH 31, 2004**

 

**TABLEOF CONTENTS**

 

 
| **Part I.**   | **Financial  Information** |                                                                                                                                                                     |
|---------------|----------------------------|--------------------------------------------------------------------------------------------------------------------------------------------------------------------------|
|          |                       |                                                                                                                                                                     |   |
|          | **Item 1.**                | *Financial Statements*                                                                                                                                                   |   |
|          |                       |                                                                                                                                                                     |   |
|          |                       | Consolidated  Balance Sheets at March 31, 2004 and September 30, 2003(unaudited)                                                                               |   |
|          |                       |                                                                                                                                                                     |   |
|          |                       | Consolidated  Statements of Operations for the Three-Month and Six-Month Periods ended  March 31, 2003, and 2004 (unaudited)                                        |   |
|          |                       |                                                                                                                                                                     |   |
|          |                       | Consolidated Statements of Changes in Shareholders’ Equity for the  Six-Month Periods ended March 31, 2003, and 2004 (unaudited)                               |   |
|          |                       |                                                                                                                                                                     |   |
|          |                       | Consolidated Statements of Cash Flows for  the Period from November 1, 2002 to March 31, 2003, and the  Six-Month Period ended March 31, 2004 (unaudited) |   |
|          |                       |                                                                                                                                                                     |   |
|          |                       | Notes to Consolidated Financial Statements                                                                                                                               |   |
|          |                       |                                                                                                                                                                     |   |
|          | **Item 2.**                | *Management’s Discussion and Analysis of Financial Condition and  Results of Operations*                                                                            |   |
|          |                       |                                                                                                                                                                     |   |
|          | **Item 3.**                | *Controls and Procedures*                                                                                                                                                |   |
|          |                       |                                                                                                                                                                     |   |
| **Part  II.** | **Other  Information**     |                                                                                                                                                                     |
|          |                       |                                                                                                                                                                     |   |
|          | **Item  1.**               | *Legal Proceedings*                                                                                                                                                      |   |
|          |                       |                                                                                                                                                                     |   |
|          | **Item 2.**                | *Changes in Securities and Use of Proceeds*                                                                                                                              |   |
|          |                       |                                                                                                                                                                     |   |
|          | **Item 3.**                | *Defaults Upon Senior Securities*                                                                                                                                        |   |
|          |                       |                                                                                                                                                                     |   |
|          | **Item 4.**                | *Submission of Matters to a Vote of Security  Holders*                                                                                                                   |   |
|          |                       |                                                                                                                                                                     |   |
|          | **Item 5.**                | *Other Information*                                                                                                                                                      |   |
|          |                       |                                                                                                                                                                     |   |
|          | **Item 6.**                | *Exhibits and Reports on Form 8-K*                                                                                                                                       |   |
|          |                       |                                                                                                                                                                     |   |
|          |                       | Signatures                                                                                                                                                               |   |

 

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

 

i

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| **Part I**  |   | **Financial  Information** |
|-------------|--------|----------------------------|
| **Item 1.** |   | *Financial  Statements*    |

 

 

1

----

 

**Treaty Oak Bancorp, Inc., and Subsidiaries**

**(A Development Stage Enterprise)**

**ConsolidatedBalance Sheets**

**(Dollars in Thousands, except share amounts)**

 
|                                                                                           |   | **March 31,  2004** |   | **September 30,  2003** |   |
|------------------------------------------------------------------------------------------------|--------|---------------------|--------|------------------------------|--------|
|                                                                                           |   | **(Unaudited)**     |   | **(Unaudited)**              |   |
| **ASSETS**                                                                                     |   |                |   |                         |   |
| Cash and due from banks                                                                        |   | $                   | 648    |                         | $      | — |   |
| Interest bearing deposits in banks                                                             |   | 4                   |   | —                       |   |
| Federal funds sold                                                                             |   | 1,100               |   | —                       |   |
| Total cash and cash equivalents                                                                |   | 1,752               |   | —                       |   |
|                                                                                           |   |                |   |                         |   |
| Securities available for sale, at fair  value                                                  |   | 89                  |   | —                       |   |
| Securities held to maturity                                                                    |   | 411                 |   | —                       |   |
| Investment in Federal Home Loan Bank stock                                                     |   | 209                 |   | —                       |   |
| Loans receivable, net of allowance for loan  losses                                            |   | 8,409               |   | —                       |   |
| Premises and equipment, net                                                                    |   | 471                 |   | —                       |   |
| Accrued interest receivable                                                                    |   | 187                 |   | —                       |   |
| Deferred stock issuance costs                                                                  |   | 691                 |   | —                       |   |
| Goodwill                                                                                       |   | 1,161               |   | —                       |   |
| Other assets                                                                                   |   | 172                 |   | —                       |   |
|                                                                                           |   |                |   |                         |   |
| Total Assets                                                                                   |   | $                   | 13,552 |                         | $      | — |   |
|                                                                                           |   |                |   |                         |   |
| **LIABILITIES AND  SHAREHOLDERS’ EQUITY**                                                 |   |                |   |                         |   |
| Non-interest bearing deposits                                                                  |   | $                   | 2,257  |                         | $      | — |   |
| NOW, money market and savings deposits                                                         |   | 1,535               |   | —                       |   |
| Time deposits                                                                                  |   | 5,325               |   | —                       |   |
| Total Deposits                                                                                 |   | 9,117               |   | —                       |   |
|                                                                                           |   |                |   |                         |   |
| Federal Home Loan Bank borrowings                                                              |   | 700                 |   | —                       |   |
| Accrued interest payable                                                                       |   | 14                  |   | —                       |   |
| Due to related party                                                                           |   | 631                 |   | —                       |   |
| Notes payable - acquisition of Texline  State Bank                                             |   | 1,019               |   | —                       |   |
| Note payable to related party                                                                  |   | 500                 |   | —                       |   |
| Other liabilities                                                                              |   | 186                 |   | —                       |   |
| Total Liabilities                                                                              |   | 12,167              |   | —                       |   |
|                                                                                           |   |                |   |                         |   |
| **SHAREHOLDERS’  EQUITY**                                                                 |   |                |   |                         |   |
|                                                                                           |   |                |   |                         |   |
| Common stock, $0.01 par value; 20,000,000  shares authorized; 1,040,000 issued and outstanding |   | 10                  |   | —                       |   |
| Additional paid-in capital                                                                     |   | 2,352               |   | 218                          |   |
| Deficit accumulated during development  stage                                                  |   | (977                | )      | (218                         | )      |
| Total shareholders’ equity                                                                |   | 1,385               |   | —                       |   |
|                                                                                           |   |                |   |                         |   |
| Total liabilities and shareholders’ equity                                                |   | $                   | 13,552 |                         | $      | — |   |

 

2

----

 

**Treaty Oak Bancorp, Inc., and Subsidiaries**

**(A Development Stage Enterprise)**

**Consolidated Statements ofOperations**

**(Dollars in Thousands, except per share amounts)**

 
|                                                            |   | **Three  Months Ended  March 31,** |   | **Six Months  Ended  March 31,** |   |            |   |
|-----------------------------------------------------------------|--------|-----------------------------------------|--------|---------------------------------------|--------|-----------------|--------|
|                                                            |   | **2004**                                |   | **2003**                              |   | **2004**        |   | **2003** |   | **Cumulative  Since Inception** |   |
|                                                            |   | **(Unaudited)**                         |   | **(Unaudited)**                       |   | **(Unaudited)** |   | **(Unaudited)** |   | **(Unaudited)** |   |
| **Interest Income:**                                            |   |                                    |   |                                  |   |            |   |   |   |   |   |
| Interest and fees on loans                                      |   | $                                       | 46     |                                  | $      | —          |   | $ | 46 |   | $ | — |   | $ | 46 |   |
| Interest on securities:                                         |   |                                    |   |                                  |   |            |   |   |   |   |   |
| U.S. government and agencies                                    |   | 1                                       |   | —                                |   | 1               |   | — |   | 1 |   |
| State and political subdivisions                                |   |                                    |   |                                  |   |            |   |   |   |   |   |
| Interest on federal funds sold                                  |   | —                                  |   | —                                |   | —          |   | — |   | — |   |
| Interest on deposits in other financial  institutions and other |   | 2                                       |   | —                                |   | 2               |   | — |   | 2 |   |
|                                                            |   |                                    |   |                                  |   |            |   |   |   |   |   |
| Total interest income                                           |   | 49                                      |   | —                                |   | 49              |   | — |   | 49 |   |
|                                                            |   |                                    |   |                                  |   |            |   |   |   |   |   |
| **Interest Expense:**                                           |   |                                    |   |                                  |   |            |   |   |   |   |   |
| Savings and interest-bearing demand  deposits                   |   | 1                                       |   | —                                |   | 1               |   | — |   | 1 |   |
| Time deposits                                                   |   | 6                                       |   | —                                |   | 6               |   | — |   | 6 |   |
| Federal funds purchased and other  borrowings                   |   | 5                                       |   | —                                |   | 5               |   | — |   | 5 |   |
|                                                            |   |                                    |   |                                  |   |            |   |   |   |   |   |
| Total interest expense                                          |   | 12                                      |   | —                                |   | 12              |   | — |   | 12 |   |
|                                                            |   |                                    |   |                                  |   |            |   |   |   |   |   |
| Net interest income                                             |   | 37                                      |   | —                                |   | 37              |   | — |   | 37 |   |
|                                                            |   |                                    |   |                                  |   |            |   |   |   |   |   |
| Provision for loan losses                                       |   | —                                  |   | —                                |   | —          |   | — |   | — |   |
|                                                            |   |                                    |   |                                  |   |            |   |   |   |   |   |
| Net interest income after provision for  loan losses            |   |                                    |   |                                  |   |            |   |   |   |   |   |
|                                                            |   | 37                                      |   | —                                |   | 37              |   | — |   | 37 |   |
|                                                            |   |                                    |   |                                  |   |            |   |   |   |   |   |
| **Noninterest Income**                                          |   |                                    |   |                                  |   |            |   |   |   |   |   |
| Service charges on deposit accounts                             |   | 5                                       |   | —                                |   | 5               |   | — |   | 5 |   |
| Other operating income                                          |   | —                                  |   | —                                |   | —          |   | — |   | — |   |
|                                                            |   |                                    |   |                                  |   |            |   |   |   |   |   |
| Total noninterest income                                        |   | 5                                       |   | —                                |   | 5               |   | — |   | 5 |   |
|                                                            |   |                                    |   |                                  |   |            |   |   |   |   |   |
| **Noninterest Expense**                                         |   |                                    |   |                                  |   |            |   |   |   |   |   |
| Salaries and benefits                                           |   | 110                                     |   | —                                |   | 443             |   | — |   | 443 |   |
| Occupancy expense                                               |   | 3                                       |   | —                                |   | 3               |   | — |   | 3 |   |
| Acquisition related costs                                       |   | 84                                      |   | 30                                    |   | 156             |   | 100 |   | 345 |   |
| Other operating expense                                         |   | 91                                      |   | —                                |   | 199             |   | — |   | 228 |   |
|                                                            |   |                                    |   |                                  |   |            |   |   |   |   |   |
| Total noninterest expense                                       |   | 288                                     |   | 30                                    |   | 801             |   | 100 |   | 1,019 |   |
|                                                            |   |                                    |   |                                  |   |            |   |   |   |   |   |
|                                                            |   |                                    |   |                                  |   |            |   |   |   |   |   |
| **Net Loss**                                                    |   | $                                       | (246   | )                                     | $      | (30             | )      | $ | (759 | ) | $ | (100 | ) | $ | (977 | ) |
|                                                            |   |                                    |   |                                  |   |            |   |   |   |   |   |
| **Loss Per Share -  basic and diluted**                         |   | $                                       | (0.24  | )                                     | $      | (0.03           | )      | $ | (0.74 | ) | $ | (0.10 | ) | $ | (0.98 | ) |
|                                                            |   |                                    |   |                                  |   |            |   |   |   |   |   |
| Weighted average shares outstanding - basic  and diluted        |   | 1,040,000                               |   | 1,000,000                             |   | 1,020,290       |   | 1,000,000 |   | 1,000,000 |   |

 

3

----

 

**Treaty Oak Bancorp, Inc.,****and Subsidiaries**

**(A Development Stage Enterprise)**

**Statement of Changes inShareholders’ Equity (unaudited)**

**(Dollars in Thousands, except share amounts)**

 
|                                                                                                        |   |       |   | **Additional  paid-in  capital** |   | **Deficit  accumulated  during  development stage** |   | **Total** |   |
|-------------------------------------------------------------------------------------------------------------|--------|------------|--------|----------------------------------|--------|-----------------------------------------------------|--------|-----------|--------|
|                                                                                                        |
| **Common  Stock**                                                                                           |
| **Shares**                                                                                                  |   | **Amount** |
|                                                                                                        |   |       |   |                             |   |                                                |   |      |   |   |   |
| Contribution of pre-opening expenses  incurred by organizing shareholder on behalf of the Company           |   | —     |   | $                                | — |                                                | $      | 218       |   | $ | — |   | $ | 218 |   |
|                                                                                                        |   |       |   |                             |   |                                                |   |      |   | — |   |
| Net loss                                                                                                    |   |       |   |                             |   |                                                |   | (218      | )      | (218 | ) |
|                                                                                                        |   |       |   |                             |   |                                                |   |      |   | — |   |
| Balances at September 30, 2003                                                                         |   | —     |   | $                                | — |                                                | $      | 218       |   | $ | (218 | ) | $ | — |   |
|                                                                                                        |   |       |   |                             |   |                                                |   |      |   | — |   |
| Initial capital contribution from  organizing shareholder - unaudited                                       |   | 1,000,000  |   | 10                               |   | 1,677                                               |   | —    |   | 1,687 |   |
| Sale of Common stock - unaudited                                                                            |   | 40,000     |   | —                           |   | —                                              |   |      |   | — |   |
| Contribution of pre-opening expenses  incurred by organizing shareholder on behalf of the Company unaudited |   |       |   |                             |   | 124                                                 |   |      |   | 124 |   |
| Non-cash stock-based compensation -  unaudited                                                              |   |       |   |                             |   | 333                                                 |   |      |   | 333 |   |
|                                                                                                        |   |       |   |                             |   |                                                |   |      |   | — |   |
| Net loss - unaudited                                                                                        |   |       |   |                             |   |                                                |   | (759      | )      | (759 | ) |
|                                                                                                        |   |       |   |                             |   |                                                |   |      |   |   |   |
| Balances at March 31, 2004 (unaudited)                                                                 |   | 1,040,000  |   | $                                | 10     |                                                | $      | 2,352     |   | $ | (977 | ) | $ | 1,385 |   |

 

See Notes to Financial Statements.

 

4

----

 

**Treaty Oak Bancorp, Inc.****,****and Subsidiaries**

**(A Development Stage Enterprise)**

**Consolidated Statements Of Cash Flows**

**(Dollars In Thousands)**

 
|                                                                                     |   | **Six months  ended  March 31, 2004** |   | **Period  from  November 1, 2002 to  March 31, 2003** |   |
|------------------------------------------------------------------------------------------|--------|--------------------------------------------|--------|-----------------------------------------------------------------|--------|
|                                                                                     |   | **(unaudited)**                            |   | **(unaudited)**                                                 |   |
| Cash flows from operating activities:                                                    |   |                                       |   |                                                            |   |
| Net loss                                                                                 |   | $                                          | (759   | )                                                               | $      | (100 | ) |
| Adjustments to reconcile net loss to net  cash used in operating activities:             |   |                                       |   |                                                            |   |
| Non-cash stock based compensation                                                        |   | 332                                        |   |                                                            |   |
| Non-cash pre-opening expenses incurred by  majority shareholder on behalf of the Company |   | 320                                        |   | 100                                                             |   |
| Depreciation and amortization                                                            |   | 3                                          |   |                                                            |   |
| Net amortization on securities                                                           |   | 3                                          |   |                                                            |   |
| Changes in operating assets and  liabilities, net of acquisition                         |   |                                       |   |                                                            |   |
| Accrued interest receivable                                                              |   | (1                                         | )      |                                                            |   |
| Other assets                                                                             |   | (83                                        | )      |                                                            |   |
| Accrued interest payable                                                                 |   | 1                                          |   |                                                            |   |
| Other liabilities                                                                        |   | 184                                        |   |                                                            |   |
|                                                                                     |   |                                       |   |                                                            |   |
| **Net cash used in  operating activities**                                               |   | —                                     |   | —                                                          |   |
|                                                                                     |   |                                       |   |                                                            |   |
| Cash flows from investing activities:                                                    |   |                                       |   |                                                            |   |
| Initial capital contribution of majority  shareholder                                    |   | 1,200                                      |   |                                                            |   |
| Proceeds from sale of common stock                                                       |   | 1                                          |   |                                                            |   |
| Cash paid for acquisition of Texline State  Bank, net of cash received                   |   | (324                                       | )      |                                                            |   |
| Proceeds from sale of other real estate                                                  |   | 10                                         |   |                                                            |   |
| Net decrease in loans                                                                    |   | 131                                        |   |                                                            |   |
| Purchases of premises and equipment                                                      |   | —                                     |   |                                                            |   |
| Purchase of Federal Home Loan Bank stock                                                 |   | (1                                         | )      |                                                            |   |
|                                                                                     |   |                                       |   |                                                            |   |
| **Net cash provided  by investing activities**                                           |   | 1,017                                      |   | —                                                          |   |
|                                                                                     |   |                                       |   |                                                            |   |
| Cash flows from financing activities:                                                    |   |                                       |   |                                                            |   |
| Net increase in deposits                                                                 |   | 235                                        |   |                                                            |   |
| Net increase in notes payable                                                            |   | 500                                        |   |                                                            |   |
|                                                                                     |   |                                       |   |                                                            |   |
| **Net cash provided  by financing activities**                                           |   | 735                                        |   | —                                                          |   |
|                                                                                     |   |                                       |   |                                                            |   |
| Net increase in cash and cash equivalents                                                |   | 1,752                                      |   | —                                                          |   |
|                                                                                     |   |                                       |   |                                                            |   |
| Cash and cash equivalents at beginning of  period                                        |   | —                                     |   | —                                                          |   |
|                                                                                     |   |                                       |   |                                                            |   |
| Cash and cash equivalents at end of period                                               |   | $                                          | 1,752  |                                                            | $      | — |   |
|                                                                                     |   |                                       |   |                                                            |   |
| Supplemental disclosures of cash flow  information:                                      |   |                                       |   |                                                            |   |
| Contribution of deferred stock issuance  costs                                           |   | $                                          | 690    |                                                            | $      | — |   |
| Contribution of direct acquisition costs -  Texline State Bank                           |   | $                                          | 217    |                                                            | $      | — |   |
| Contribution of deposit on Texline State  Bank                                           |   | $                                          | 50     |                                                            | $      | — |   |
| Cash interest paid                                                                       |   | $                                          | 6      |                                                            | $      | — |   |
|                                                                                     |   |                                       |   |                                                            |   |
| Acquisition of Texline State Bank                                                        |   |                                       |   |                                                            |   |
| Assets acquired                                                                          |   | 10,940                                     |   | —                                                          |   |
| Liabilities assumed                                                                      |   | (9,597                                     | )      | —                                                          |   |
| Notes payable on acquisition                                                             |   | (1,019                                     | )      | —                                                          |   |
| Cash paid, net of cash received                                                          |   | 324                                        |   | —                                                          |   |

 

5

----

 

**Treaty Oak Bancorp,Inc.****,****and Subsidiaries**

**Notesto the Consolid****ated Financial Statements (Unaudited)**

 

**Note 1: Descriptionof Business**

 

General.  Treaty Oak Bancorp,Inc., (the “Holding Company”) is a bank holding company which owns 97.97% ofthe outstanding stock of Texline State Bank (the “Bank”), which was acquired bythe Holding Company on March 9, 2004. The Bank is a state-chartered commercial bank and its deposits areinsured by the Federal Deposit Insurance Corporation.  The Bank provides a variety of banking services to individualsand business located primarily in Dallham County, Texas.  The Holding Company’s primary businessactivity is the operation of the Bank, and currently operates only onereportable industry segment: banking; however, the Bank owns a currentlyinactive subsidiary insurance agency. Collectively the entities are referred to as the “Company”.

 

The Company’s fiscal year end is September 30.

 

**Note 2:  Basis of Presentation**

 

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 generally acceptedaccounting principles.  In the opinionof management, all material adjustments (which are of a normal recurringnature) considered necessary for a fair presentation have been made.  The results for the interim periods are notnecessarily indicative of the results to be expected for the entire year or anyother interim period.

 

**Note 3.  Initial Capitalization**

 

On December 8, 2003, Treaty Oak Holdings, Inc. (“Treaty OakHoldings”) contributed cash of $250,000, a receivable of $950,000 (which waspaid on December 22, 2003) and other assets of $486,688 in exchange for1,000,000 shares of the Company’s common stock, which represented 96% of theissued and outstanding shares of the Company’s common stock.

 

Prior to the formation of the Company, certain pre-opening expenseswere incurred by its organizing shareholder for the Company’s benefit.  These costs, which amounted to $123,896 and$218,350 for the period from October 1, 2003, to December 8, 2003,and the year ended September 30, 2003, respectively, and have beenreflected in the Company’s statements of operations for the respective periodsand as contributions to additional paid-in capital.

 

On December 8, 2003, the Company issued 40,000 shares of itscommon stock to four individuals for $0.02 per share, in cash, and otherconsideration and recognized compensation expense in the amount of $332,400during the period from October 1, 2003, to December 8, 2003.

 

**Note4.  Summary of Significant AccountingPolicies**

 

*Cash and Cash Equivalents*

 

Cash and cash equivalents include cash onhand and held in banks, money-market funds and other investments withmaturities of three months or less, when purchased.

 

*IncomeTaxes*

 

The Company utilizes the liability method of accounting for deferredincome taxes.  Under the liabilitymethod, deferred income tax assets and liabilities are calculated based on thedifference between the financial statements and tax basis of assets andliabilities as measured by the currently enacted tax rates in effect for theyears in which these differences are expected to reverse.  Deferred tax expense or benefit is theresult of changes in deferred tax assets and liabilities.  An allowance against deferred tax assets isrecorded in whole or in part when it is more likely than not that such taxbenefits will not be realized.

 

6

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*Use ofEstimates*

 

The preparation of the financial statements in conformity withaccounting principles generally accepted in the United States of Americarequires management to make estimates and assumptions that affect the reportedamounts of assets and liabilities and the disclosure of contingent assets andliabilities at the date of the financial statements and revenues and expensesduring the reporting period.  Actualresults could differ from those estimates.

 

*Stock-BasedCompensation*

 

The Company accounts for stock-based compensation to employees usingthe intrinsic value method. Accordingly, compensation costs for employee stock options is measuredas the excess, if any, of the fair value of the Company’s common stock at dateof grant over the exercise price.

 

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

 

*DeferredStock Issuance Costs*

 

Deferred stock issuance costs represent costs incurred in connectionwith the Company’s proposed offering. Proceeds from the offering will be reduced by these costs.  In the event the offering is notconsummated, these costs will be reflected as expenses.

 

*Securities Available forSale*

 

Securities classified asavailable for sale are those that the Company intends to hold for an indefiniteperiod of time, but not necessarily to maturity.  Any decision to sell a security classified as available for salewould be based on various factors, including significant movements in interestrates, changes in the maturity mix of the Company’s assets and liabilities,liquidity needs, regulatory capital considerations, and other similar factors.

 

Securities available forsale are reported at fair value with unrealized gains or losses reported as aseparate component of other comprehensive income, net of income taxes.

 

Realized gains or losses,determined on the basis of the cost of specific securities sold, are includedin earnings.

 

*Securities Held to Maturity*

 

Securities classified ashold to maturity are those that the Company intends to hold until theinstrument matures under the terms of its issuance and are reported atamortized cost.  The amortization ofpremiums and accretion of discounts, computed by the interest method over theircontractual lives, is recognized in interest income.

 

*Loans*

 

Loans that management hasthe intent and ability to hold for the foreseeable future or until maturity orpay-off are reported at their outstanding principal balance adjusted for theallowance for loan losses. Interest is accrued daily on the outstandingbalances.

 

A loan is consideredimpaired when it is probable, based upon current information and events, theCompany will be unable to collect all contractual principal and interestpayments due in accordance with the terms of the loan agreement.  Impaired loans are accounted for at the netpresent value of expected future cash flows, discounted at the loan’s effectiveinterest rate, the observable market price of the loan or at the fair value ofthe collateral if the loan is collateral dependent.

 

The accrual of interest onimpaired loans is discontinued when, in management’s opinion, the borrower maybe unable to meet payments as they become due. When interest accrual is discontinued, all unpaid accrued interest isreversed.  Interest income issubsequently recognized only to the extent cash payments are received.

 

Loan fees and direct loanorigination costs are immaterial.

 

*Allowance for Loan Losses*

 

The allowancefor loan losses is established through a provision for loan losses charged toexpense.  Loans are charged against theallowance for loan losses when management believes that collectibility of theprincipal is unlikely.  The allowance isan amount that management believes will be adequate to absorb estimated losseson existing loans, based on an evaluation of the collectibility of loans andprior loss experience.  This evaluationalso takes into consideration such factors as changes in the nature and volumeof the loan portfolio, overall portfolio quality, review of specific problemloans, and current economic conditions that may affect the borrower’s abilityto pay.  While management uses the bestinformation available to make its evaluation, future adjustments to theallowance may be necessary if there are significant changes in economicconditions.  In addition, regulatoryagencies, as an integral part of their examination process, periodically reviewthe Company’s allowance for loan losses, and may require the Company to makeadditions to the allowance based on their judgment about information availableto them at the time of their examinations.

 

7

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*Premises and Equipment*

 

Land is carried atcost.  Premises and equipment arecarried at cost, less accumulated depreciation which is computed on thestraight line method over the following estimated useful lives:

 

| Building  and improvements |   | 10  – 25 years |
|----------------------------|--------|---------------------|
| Furniture  and equipment   |   | 3  – 10 years  |

 

*Other Real Estate andRepossessed Assets*

 

Assets acquired through orinstead of loan foreclosures are initially recorded at fair value whenacquired, establishing a new cost basis. If fair value declines, an impairment charge is recorded throughexpense.  Costs after acquisition areexpensed.

 

*Off-Balance Sheet FinancialInstruments*

 

In the ordinary course ofbusiness, the Company has entered into off-balance sheet financial instrumentsconsisting of commitments to extend credit and standby letters of credit.  Such financial instruments are recorded inthe financial statements when they are funded or related fees are incurred orreceived.

 

*Goodwill*

 

Management periodicallyreviews goodwill (and other similar intangibles) to determine whether a declinein value exists which requires a charge to earnings and a reduction to the netgoodwill reflected on the statement of financial condition of the Company.Under SFAS 142, an intangible asset with an indefinite useful life istested for impairment at least annually and more frequently if circumstancesindicate that the asset could be impaired. To test for impairment, the fairvalue of the asset is compared to its carrying amount and if the fair value isless than its carrying value, the company will recognize an impairment loss. Ifthe fair value exceeds the carrying amount, no increase in the carrying amountis recorded. In addition, if following the recognition of an impairment loss, thefair value increases back to or in excess of the carrying amount prior to therecognition of the loss, no reversal of the impairment is recorded.  As of March 31, 2004, management hasdetermined that there has been no impairment to goodwill.

 

*New Accounting Pronouncements*

 

In January 2003, the Financial Accounting Standards Board (“FASB”)issued FIN 46, which clarifies the application of Accounting Research Bulletin(“ARB”) 51, Consolidated Financial Statements, to certain entities (calledvariable interest entities) in which equity investors do not have thecharacteristics of a controlling financial interest or do not have sufficientequity at risk for the entity to finance its activities without additionalsubordinated financial support from other parties.  The disclosure requirements of this Interpretation are effectivefor all financial statements issued after December 31, 2003.  The consolidation requirements apply to allvariable interest entities created after January 31, 2003.  In addition, public companies must apply theconsolidation requirements to variable interest entities that existed prior toDecember 31, 2003, and remain in existence as of the beginning of annualor interim periods beginning after December 15, 2003.  Management is currently assessing the impactof FIN 46, and does not expect this Interpretation to have a material impact tothe Consolidated Financial Statements.

 

In April 2003, the FASB issued Statement of Financial AccountingStandards (“SFAS”) No. 149, Amendment of Statement 133 on DerivativeInstruments and Hedging Activities.  Theprovisions of this Statement are effective for contracts entered into ormodified after June 20, 2003, and hedging relationships designated afterJune 30, 2003, and generally require that contracts with comparablecharacteristics be accounted for similarly. Except for the provisions related to FASB Statement No. 133, Accountingfor Derivative Instruments and Hedging Activities, all provisions of thisStatement should be applied prospectively. The provisions of the Statement related to Statement 133 ImplementationIssues that have been effective for fiscal quarters that begin prior toJune 15, 2003, should continue to be applied in accordance with theirrespective effective dates.  We do notexpect the adoption of the provisions of this Statement to have a materialeffect on the Company’s operating results or financial position.

 

8

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In May 2003, the FASB issued SFAS No. 150, Accounting for Certain FinancialInstruments with Characteristics of both Liabilities and Equity.  This Statement establishes standards for howan issuer classifies and measures certain financial instruments withcharacteristics of both liabilities and equity.  It requires liability treatment for certain financial instrumentswhich had previously been recognized as equity.  The provisions of this Statement are effective for financialinstruments entered into or modified after May 31, 2003, and otherwise areeffective at the beginning of the first interim period beginning afterJune 15, 2003.  It is to beimplemented by reporting the cumulative effect of a change in accountingprinciple for financial instruments created before May 15, 2003 and stillexisting at the beginning of the interim period of adoption.  Restatement is not permitted.  We do not expect the adoption of theprovisions of this Statement to have a material effect on the Company’soperating results or financial position.

 

The foregoing may not constitute a comprehensive summary of allmaterial changes or developments affecting the manner in which the Companykeeps its books and records or performs its financial accountingresponsibilities.  It is intended onlyas a summary of the most recent accounting pronouncements made which are ofparticular interest to financial institutions.

 

**Note 5.  Acquisitionof Texline State Bank**

 

On March 9, 2004,the Company purchased, 99.97% of the outstanding shares of Texline State Bank’scommon stock, the only stock currently outstanding, for a total purchase priceof approximately $2,225,000.  TexlineState Bank was acquired as the first phase of the Company’s business plan toacquire a small Texas chartered bank and then relocate the charter to Austin,Texas.  This second phase is currentlyin process.  The purchase price was paidapproximately $1,260,000 in cash and notes payable of $1,019,000.  The notes bear interest at 5% per annum andare currently amortized over 10 years. These notes accelerate and become immediately payable when and if theCompany sells at least $7,000,000 of its common stock in a publicoffering.  The Company intends torelocate the charter and begin operations in Austin, Texas as a significantelement of its business plan.  Theoperating results of Texline State Bank are included in the Company's FinancialStatements since the date of acquisition.

 

The purchase price andpreliminary allocation of the purchase price for Texline State Bank, was asfollows (in thousands):

 

 
| Contract price                          |   | $      | 2,225  |   |
|-----------------------------------------|--------|--------|--------|--------|
| Acquisition costs                       |   | 218    |   |
| Total purchase                          |   | $      | 2,443  |   |
|                                    |   |   |   |
| Adjustment to fixed assets              |   | $      | 145    |   |
| Adjustment to securities, net           |   | — |   |
| Adjustment for core deposit intangibles |   | 70     |   |
| Common stock                            |   | 248    |   |
| Additional paid-in-capital              |   | 1,371  |   |
| Accumulated deficit                     |   | (555   | )      |
| Cumulative other comprehensive income   |   | 3      |   |
| Balance charged to goodwill             |   | 1,161  |   |
| Total purchase allocated                |   | $      | 2,443  |   |

 

Immediately following theacquisition, Texline condensed balance sheet was as follows:

 
| Cash and cash equivalents                       |   | $      | 869    |   |
|-------------------------------------------------|--------|--------|--------|--------|
| Securities                                      |   | 503    |   |
| Loans, net                                      |   | 8,540  |   |
| Core deposit intangibles                        |   | 70     |   |
| Goodwill                                        |   | 1,161  |   |
| Other assets                                    |   | 897    |   |
| Total Assets                                    |   | $      | 12,040 |   |
|                                            |   |   |   |
| Deposits                                        |   | $      | 8,882  |   |
| Other liabilities                               |   | 715    |   |
| Shareholders’ equity                       |   | 2,443  |   |
| Total Liabilities and Shareholders’ Equity |   | $      | 12,040 |   |

 

The table belowshows the pro forma results of operations assuming the acquisition of TexlineState Bank as of the first day of each period. The results of actual operations over the same period could materiallydiffer from those reported here.

 
|                |   | **Three  Months Ended** |   | **Six Months  Ended** |   |
|---------------------|--------|-------------------------|--------|-----------------------|--------|
|                |   | **March 31,  2004**     |   | **March 31,  2003**   |   | **March 31,  2004** |   | **March 31,  2003** |   |
| Interest income     |   | $                       | 224    |                  | $      | 212 |   | $ | 428 |   | $ | 433 |   |
| Net interest income |   | $                       | 174    |                  | $      | 148 |   | $ | 329 |   | $ | 299 |   |
| Net loss            |   | $                       | (109   | )                     | $      | (49 | ) | $ | (688 | ) | $ | (104 | ) |
| Loss per share      |   | $                       | (0.11  | )                     | (0.05  | ) | $ | (0.67 | ) | $ | (0.10 | ) |

 

**Note 6.  Earnings Per Share**

 

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

 

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

 

**Note 7.  Common Stock Offering**

 

The Company intends to offer for sale up to 1,440,000 shares of itscommon stock at an offering price of $8.33 per share.  In addition, the Company will issue one stock purchase warrantfor every five shares of common stock purchased, up to a maximum of 288,000warrants.  The warrants are exercisableat a price of $10.00 per share and will remain exercisable until June 30,2007.  The Holding Company’s registration statement on Form SB-2was declared effective by the Securities and Exchange Commission on May 7,2004. No shares have been sold under the offering as of the date of filing ofthis report.

 

**Note8.  Advances from Organizers**

 

Treaty Oak Holdings has and will continue to advance funds fororganizational, acquisition, offering and other pre-operating expenses.  These advances are being made under anexpense reimbursement agreement pursuant to which our organizing shareholderhas advanced funds on behalf of the Company subsequent to December 8,2003, up to an aggregate of $775,000. Unless and until the Company raises at least $4,000,000 from theissuance of its common stock, the Company will not be obligated to reimbursethese costs.

 

The Company will record the payment or accrual of these costs as aliability as incurred and such amounts will be reflected in the appropriatebalance sheet or expense accounts.  Inthe event the Company does not raise at least $4,000,000 from the issuance ofcommon stock, they will be accounted for by the Company as a contribution to capital.

 

When the Company has raised the required $4,000,000 from the issuanceof common stock, the Company will reimburse Treaty Oak Holdings based uponinvoices or other support submitted to the Company for reimbursement.

 

9

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**Note9.  2004 Stock Incentive Plan**

 

On January 19, 2004, the Company and its shareholders approved theCompany’s 2004 Stock Incentive Plan (the “Plan”).  The Plan authorizesincentive stock option grants, non-statutory stock option grants, direct stockissuances, stock appreciation rights, salary investment option grants, anddirector fee option grants.  Eligible participants are employees,non-employee board members, and independent consultants or advisors. 500,000 shares of common stock have been initially reserved under the Plan, andthe share reserve increases on the 1st business day inJanuary each year (beginning in 2005) by an amount equal to 2% of thenumber of outstanding shares of the Company on the last business day in December ofthe preceding year, subject to a maximum annual increase of 100,000shares.  No person may receive stock option grants, stock issuances, orstock appreciation rights for more than 100,000 shares in the aggregate in anycalendar year under the Plan.

 

As of March 31, 2004, there were no outstanding stock options,awards of stock appreciation rights, or shares issued under the Plan.

 

**Note10.  Related Party Transactions**

 

The Company engages the services of certain affiliated companies toprovide management, administrative and other support services.  These fees incurred by the Company’smajority shareholder through September 30, 2003 totaled $218,350, relatedto the acquisition of Texline State Bank and to the proposed offering of theCompany’s common stock.

 

The Company receives certain accounting services from a firm in whichone of the firm’s partners is also a director of the Company.  The fees incurred by the Company’sorganizing shareholder through September 30, 2003 amounted toapproximately $20,700.

 

The Company intends to lease its office premises from a partnership inwhich our organizing shareholder owns a 15% interest and in which, as of thecompletion of the proposed offering, the Company’s directors and officers willcollectively own a 62.5% interest. However, in connection with the Company's approval from the FederalDeposit Insurance Corporation (“FDIC”) to relocate the main office of the Bank,the Company’s directors and officers will divest themselves of thisownership  interest.  Annual minimum lease payments under thelease are anticipated to be approximately $150,000 per year over the 15-yearlease term.

 

Treaty Oak Holdings is entitled to certain registration rightsrequiring the Company to register the sale of its shares under the SecuritiesAct of 1933, as amended.  Treaty OakHoldings may make two demands for registration and has piggyback rights,subject to limitations.  Theseregistration rights may be exercised beginning January 1, 2005, and ending10 years from the completion of the Company’s proposed stock offering.

 

In March 2004,the organizing shareholder, Treaty Oak Holdings, advanced $500,000 to theCompany in connection with the acquisition of Texline State Bank.  The $500,000 was advanced  to make a contribution to the capital ofTexline State Bank in addition to the new capital we intend to contribute fromthe proceeds of this offering.  Thisobligation is currently represented by a promissory note bearing interest at2.00% and payable in 12 months, with no penalty for prepayment.  This note, including accrued interest, willautomatically convert to 61,342 shares of common stock on March 9, 2005, basedupon a conversion price of $8.33 per share.

 

**Note11.  Commitments**

 

In connection with its capital raising activities, the Company receivescertain services from an unrelated party. These services are provided under an agreement entered into by TreatyOak Holdings.  These services aresubject to an Expense Reimbursement Agreement (Note 8) and will not be payableby the Company unless and until it has raised at least $4,000,000 from the saleof common stock under the proposed offering. Certain costs under this agreement have already been incurred by TreatyOak Holdings and are included in the initial capital contribution to theCompany as accumulated deficit.  Costsincluded in the capitalized costs of funding were approximately $210,000 andcosts currently expensed as pre-operating costs were approximately $33,000.  Additional costs to be incurred under thisagreement in the fiscal year ending September 30, 2004, are expected to beapproximately $300,000.

 

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**Note12.  Loans and Allowance for Loan Losses**

 

The Company grants agribusiness, real estate, and commercial loans tocustomers located primarily in Northwest Texas.  The Company has a diversified loan portfolio; however, asignificant number of loans made by the Company are agriculture in nature.  As a result, the ability of many of theCompany’s borrowers will, to a certain extent, be dependant on the generaleconomic conditions of the Company’s geographic location.

 

Loans at March 31, 2004 were as follows (in thousands):

 
|                            |   | **March 31,  2004 (unaudited)** |       |
|---------------------------------|--------|--------------------------------------|------------|
|                            |   |                                 |       |
| Agriculture                     |   | **$**                                | **2,886**  | ** ** |
| Real estate                     |   | **4,154**                            | ** ** |
| Commercial                      |   | **1,015**                            | ** ** |
| Consumer                        |   | **520**                              | ** ** |
|                            |   |                                 | ** ** |
|                            |   | **8,575**                            |       |
|                            |   |                                 | ** ** |
| Less: allowance for loan losses |   | **(166**                             | **)**      |
|                            |   |                                 | ** ** |
|                            |   | **$**                                | **8 ,409** |   |

 

**Note 13.  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 credit isrepresented by the contractual amount of those instruments.  The Company uses the same credit policies inmaking commitments and conditional obligations as they do for on-balance sheetinstruments.

 

The following table summarizes the Company’s off-balance sheetfinancial instruments (in thousands):

 
|                          |   | **March 31,  2004 (unaudited)** |        |
|-------------------------------|--------|--------------------------------------|-------------|
|                          |   |                                 |        |
| Commitments to extend  credit |   | **$**                                | **681,000** |   |
| Standby letters of credit     |   | **90,000**                           |        |
|                               |        |                                      |             |  |

 

Commitments to extend credit are agreements to lend to a customer aslong as there is no violation of any condition established in thecontract.  Commitments generally havefixed expiration dates or other termination clauses and may require payment ofa fee.  Since many of the commitmentsare expected to expire without being drawn upon, the total commitment amountsdo not necessarily represent future cash requirements.  The Company evaluates each customer’screditworthiness on a case-by-case basis. The amount of collateral obtained if deemed necessary by the Companyupon extension of credit is based on management’s credit evaluation of thecounterparty.  Collateral held variesbut may include accounts receivable, inventory, property, plant and equipmentand income-producing commercial properties.

 

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Standby letters of credit are writtenconditional commitments used by the Company to guarantee the performance of acustomer to a third party.  TheCompany’s policies generally require that letter of credit arrangements containsecurity and debt covenants similar to those contained in loanarrangements.  In the event the customerdoes not perform in accordance with the terms of the agreement with the thirdparty, the Company would be required to fund the commitment.  The maximum potential amount of futurepayments the Company could be required to make is represented by thecontractual amount shown in the table above. If the commitment is funded, the Company would be entitled to seekrecovery from the customer.

 

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

 

Treaty Oak Bancorp, Inc., (the “Holding Company”), a Texas corporation,is a bank holding company headquartered in Austin, Texas.  The Holding Company serves the marketplaceprimarily through is 99.97% owned banking subsidiary, Texline State Bank (the“Bank”), a Texas chartered commercial bank. The Bank’s deposits are insured by the FDIC to the extent provided bylaw.  The Bank is supervised andexamined by the Texas Department of Banking. At March 31, 2004, the Bank operated a single branch located inTexline, Dalham County, Texas. Collectively the Holding Company and the Bank are referred to as the“Company.”

 

Through the Bank, the Holding Company offers a variety of commercialbanking services to individuals and business located in the area surroundingTexline, Texas, which is a primarily agricultural area. The services offeredinclude agricultural, real estate and commercial lending services, checking andsavings deposits, time deposits and other customary banking services.  The Bank does not offer trust services.

 

The Holding Company acquired the Bank on March 9, 2004, bypurchasing 99.97% of the then outstanding common stock of the Bank.  The Holding Company currently has no otheroperating history.  The Holding Companyreceived notification from the Securities and Exchange Commission on May 7,2004, as to the effectiveness of its registration statement to sell shares ofcommon stock, at $8.33 per share, to raise up to $12,000,000.  The proceeds of the offering are intendedprimarily to increase the capital of the Bank to permit the relocation of theBank’s charter to Austin, Texas.  As aresult, the Holding Company is currently incurring substantial pre-openingcosts related to the future relocation.

 

The following discussion provides information about the majorcomponents of the financial condition, results of operations, asset quality,liquidity and capital resources of Treaty Oak Bancorp.  The discussion and analysis should be readin conjunction with the Consolidated Financial Statements included in thisreport.

 

**Plan of Operation**

 

***General***

 

We intend to support the existing and remaining management team inTexline in continuing the improvement of that branch’s financial performance.Additionally, given the greater growth potential in Austin, we expect to focusour efforts on establishing a community-oriented effort out of our headquartersin the leased facility that we will occupy at 101 Westlake Drive (at Bee CaveRoad), Austin, Texas, 78746. The Bank will occupy approximately 7,000 squarefeet in a building that is currently under renovation and expects to execute a15-year lease. The Bank’s budget for leasehold improvements, furniture,fixtures, and technology infrastructure and equipment is approximately$400,000. We anticipate that the Bank will open with 10 full-time employees inAustin and that we will retain a staff of approximately seven in Texline.

 

To mitigate the inconvenience and potential competitive disadvantage ofa single location in Austin, we intend to offer a courier service to pick-upnon-cash deposits from our customers and will reimburse customers for a setnumber of ATM transactions per month. Our proposed plan anticipates theestablishment of a second branch late in our second year of operation, twobranches in the third year, and a fifth branch in the fourth year. Alldecisions to add branches will be dependent upon the demands of our market, thegrowth and profitability of the Bank, and our capital adequacy.

 

Assuming we raise the maximum funds under our public offering, weintend to immediately infuse an additional $5,500,000 into the Bank from theproceeds of the offering, the majority of which will be used for bank customerloans, investments, and other general business purposes. The remainder of thecapital raised in our public offering will be retained with the Holding Companyfor later infusion into the Bank as capital requirements necessitate. We havenot fully developed the products and services that the Bank will initiallyoffer its customers and anticipate engaging in additional product research anddevelopment during the 12-month period following the offering, but we believethat the initial offering proceeds will adequately fund our business operationsfor at least the first three years of

 

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operations. Accordingly, we do not anticipate raising additionalcapital in the next three years. However, we cannot assure you that we will notneed to raise additional capital in the next three years.

 

Where required in the preparation of the Bank’s financial statements inaccordance with generally accepted accounting principles estimates are made bymanagement to present fairly the financial condition of the Company. The notesto the Consolidated Financial Statements of Texline State Bank included as apart of this prospectus describe the Bank’s significant accounting policiesincluding the use of estimates by noting that “the preparation of financialstatements in conformity with accounting principles generally accepted in theUnited States of America requires management to make estimates and assumptionsthat affect certain reported amounts of assets and liabilities and disclosuresof contingent assets and liabilities at the date of the financial statementsand the reported amounts of revenue and expenses for the period. Accordingly,actual results could differ from those estimates.”

 

Estimates made in preparation of the financial statements includedherein are the estimates of the current management of the Bank. Although webelieve that the estimates used lead to the fair presentation, in all materialrespects, of the financial statements for the Bank, accounting estimates couldhave a material effect on the financial results of the Bank. While managementuses estimates to record items such as prepaid expenses, accrued expenses,accrued taxes and similar items, we do not believe that any of these estimatesare material, or that they could lead to a material misstatement in thefinancial statements.

 

The critical estimates of the Bank are centered in three areas: thetreatment of certain loans, the allowance for loan losses, and goodwill.

 

*Estimates as they relate to loans*

 

When a loan is considered to be “impaired,” management has concludedthat based upon current information and events, the Bank will be unable tocollect all contractual principal and interest payments due in accordance withthe terms of the loan agreement. Management’s conclusions regarding the statusof a loan are estimates. Management then chooses the method by which this loanwill be accounted for from one of three methods: (1) The loan is accountedfor at the net present value of expected future cash flows, discounted at theloan’s effective interest rate, (2) the observable market price of theloan or (3) at the fair value of the collateral if the loan is collateraldependent. The impact of such method and the underlying estimate ofclassification, varies dependent upon which of these approaches is deemed to beappropriate for the loan. Each of these methods essentially revalues theunderlying loan and the difference between the carrying value and thecalculated loan value is reflected as a charge to the Allowance for LoanLosses. Depending upon the number of loans subject to revaluing and the amountcharged-off, this could create a material additional charge to the Provisionfor Loan Loss expense. In each case, management uses its best efforts toevaluate problem loans and provide adequately for their collectibility based onall the facts available. However, the under or over valuing of loans couldmaterially affect the performance and financial condition of the Bank. Theactual results of collection efforts, regardless of the method selected, couldvary significantly, thereby impacting reported earnings, reserves and assetvalues.

 

*Estimates as they relate to the allowance forloan losses*

 

The “allowance for loan losses” for the Bank is established through aprovision for loan losses charged to expense. Loans are charged against theallowance for loan losses when management believes that collectibility of theprincipal is unlikely. The allowance is an amount that management, in its bestestimate, believes will be adequate to absorb estimated losses on existingloans. There are generally two components utilized to determine the allowancefor loan losses; the first is a charge determined in the evaluation of specificloans identified by management and deemed to be “impaired” or “troubled,” withthe second being an estimate generally based upon the overall size of the loanportfolio and the bank’s recent loan loss experience. If for example, as aresult of changes in economic conditions, collateral valuations or otherfactors that could impact a borrower’s ability to repay or the underlying valueof collateral securing loans, actual losses that occur could be greater or lessthan the allowance for losses established by management, in turn resulting inadditional charges against earnings or a recovery that would positively impactearnings.

 

Failure of management to adequately reserve against future losses couldmaterially affect the Bank’s condition and performance. Likewise, an excessivereserve could also materially affect the Bank’s performance and condition.

 

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Management does not believe that they have selected any methods thatwould result in a material difference in the presentation of the financialstatements over the methods employed in the current periods. Further,management does not believe that the use of any alternative estimates in thefinancial statements would have differed materially from financial statementsas presented.

 

*Estimates as they relate to goodwill*

 

In addition to the two critical estimates discussed above, the Bankalso used estimates in evaluating certain intangible assets including thegoodwill recorded as part of the acquisition transaction. Goodwill is no longeramortizable under generally accepted accounting principles, instead managementperiodically reviews goodwill (and other similar intangibles) to determinewhether a decline in value exists which requires a charge to earnings and areduction to the net goodwill reflected on the statement of financial conditionof the Bank. Under SFAS 142, an intangible asset with an indefinite usefullife is tested for impairment at least annually and more frequently ifcircumstances indicate that the asset could be impaired. To test forimpairment, the fair value of the asset is compared to its carrying amount andif the fair value is less than its carrying value, the company will recognizean impairment loss. If the fair value exceeds the carrying amount, no increasein the carrying amount is recorded. In addition, if following the recognitionof an impairment loss, the fair value increases back to or in excess of thecarrying amount prior to the recognition of the loss, no reversal of the impairmentis recorded.

 

*Other Estimates*

 

In addition to the three critical estimates discussed above, the Bankalso uses estimates in the valuation of Other Real Estate Owned (“OREO”) andother repossessed assets. While in larger banks this estimate could besignificant, the Bank does not generally have material amounts of these assets.When the Bank forecloses on real estate, it seeks a third party assessment ofthe asset value, and if available, an appraisal, generally from a real estatebroker familiar with the area. In addition, the Bank uses its best efforts tovalue other foreclosed assets. While the Bank has experienced write-downs ofthese values, these adjustments have not been material and do not materiallyimpact the Bank’s financial performance. As of March 31, 2004, and 2003, theCompany held no OREO.

 

**Financial Condition**

 

Total assets as of March 31, 2004, were $13.6 million up from $0from the year ended September 30, 2003. Total loans decreased between the date of acquisition and March 31,2004, by $131,000 to $8.57 million due to normal principal payments and adecrease in lending activity in conjunction with the Bank’s transition to newmanagement. The Bank’s investment securities decrease nominally by $3,000 dueto principal payments received between the date of acquisition andMarch 31, 2004.  The Bank increasedits Federal Funds sold from $350,000 to $1,100,000 between the date ofacquisition and March 31, 2004, as excess funds held for future lendingneeds.

 

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Net loans were $8,409,000 as of March 31, 2004.  The following tables set forth thecomposition of the loan portfolio:

 
|                      |   | **March 31,  2004** |      |
|---------------------------|--------|--------------------------|-----------|
|                      |   | **Amount**               |      | **Percent** |   |
|                      |   |                     |      |   |   |
| Agriculture               |   | $                        | 2,886,000 |   | 33.7 | % |
| Commercial                |   | 983,000                  |      | 11.5 | % |
| Commercial real estate    |   | 1,077,000                |      | 12.6 | % |
| Residential real estate   |   | 3,077,000                |      | 35.8 | % |
| Construction real estate  |   |                     |      |   |   |
| Installment and other     |   | 552,000                  |      | 6.4 | % |
| Total Loans               |   | 8,575,000                |      | 100 | % |
| Unearned Income           |   |                     |      |   |   |
| Gross Loans               |   | 8,575,000                |      |   |   |
| Allowance for Loan Losses |   | (166,000                 | )         |   |   |
| Net Loans                 |   | $                        | 8,409,000 |   |   |   |

 

Loan concentrations are considered to exist when there are amountsloaned to a multiple number of borrowers engaged in similar activities thatwould cause them to be similarly impacted by economic or other conditions.

 

Given its location in a heavily agricultural section of the state,the Bank has been predominantly an agricultural lender. Accordingly, atpresent, a concentration in agricultural loans exists in the Bank’s portfolio.Recent years have produced increasing trends in agricultural lending as areafarmers have enjoyed several years of adequate rainfall and growing conditionsand as more land has come under irrigation. Despite the increased prevalence ofirrigation farming, weather can have a significant impact on farming yields,and accordingly no assurances can be offered regarding future farmingproduction.

 

When the Bank opened its branch office in Houston, Texas, a secondportfolio concentration developed with loans of one-to-four family residentialreal estate. Approximately $2,100,000 of the Bank’s residential real estateportfolio is comprised of single family residences in Houston. The majority ofthese loans originated between 1996 and 1998 for 15-year terms with fixed ratesof 8.75% or greater. These loans additionally have five-year call provisionsexercisable at the Bank’s discretion.

 

This “book of business” is expected to remain flat or possibly trenddown slightly. The majority of new loan growth is expected to originate fromthe Austin market and reflect a broader, more diverse mix of industries andborrowers. As new loans are generated for non-agricultural and non residentialreal estate purposes, the percentage of the total loan portfolio creating theconcentrations described above will be reduced thereby diminishing undue riskassociated with industry concentration.

 

Management may renew loans at maturity when requested by a customerwhose financial strength appears to support such a renewal or when such arenewal appears to be in the best interest of the Bank. The Bank requirespayment of accrued interest in such instances and may adjust the rate ofinterest, require a principal reduction, or modify other terms of the loan atthe time of renewal.

 

***Loan Maturities***

 

As of March 31, 2004, 33.8% of the represented loan portfolioconsisting of agricultural, commercial, and real estate loans, or $2,718,000matures or reprices within one year or less. $3,916,000 of the represented loanportfolio, or 48.8% are variable rate loans. The following table presents thecontractual maturity ranges for agricultural, commercial, and real estate loansoutstanding at March 31, 2004, and also presents for each maturity rangethe portion of loans that have fixed

 

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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:

 
|                       |   | **Due in One  Year  or Less** |   | **Due after  One Year  Through  Five Years** |      | **Due after  Five Years** |   |               |    |
|----------------------------|--------|-------------------------------|--------|----------------------------------------------|-----------|---------------------------|--------|--------------------|---------|
| **December 31, 2003** |   | **Fixed  Rate**               |   | **Floating  Rate**                           |      | **Fixed  Rate**           |   | **Floating  Rate** |    | **Fixed  Rate** |   | **Floating  Rate** |   | **Total** |   |
| Agricultural               |   | $                             | 91,134 |                                         | 1,372,692 |                      | 52,055 |               | 748,165 |   | — |   | 621,884 |   | $ | 2,885,930 |   |
| Commercial                 |   | 347,730                       |   | 339,169                                      |      | 54,152                    |   | 242,279            |    | — |   | — |   | 983,330 |   |
| Real Estate                |   | 326,123                       |   | 241,683                                      |      | 1,815,556                 |   | 192,863            |    | 1,419,724 |   | 157,663 |   | 4,153,612 |   |
|                            |        |                               |        |                                              |           |                           |        |                    |         |  |  |  |  |  |  |  |  |

 

As of March 31, 2004, total deposits were $9.1 million whichreflected a net increase of $235,000 from the date of acquisition.  Non-interest bearing deposits increased by$386,000 while time deposits and other interest bearing deposits decreased by$151,000, accounting for the change. The Holding Company incurred debt associated with the purchase of theBank in the amount of $1,019,000.  Thesenotes, payable to the two largest former shareholders of the Bank bear interestat 5% and accelerate to become due and payable if and when the Holding Companysells at least $7 million in shares of its common stock under the publicoffering.

 

The Bank offers a variety of deposit accounts with a range of interestrates and terms. Core deposits consist of checking accounts (non-interestbearing), “NOW” accounts, savings accounts, and non-public certificates ofdeposit. These deposits, along with public fund deposits and short-termborrowings, are used to support the Bank’s asset base. Deposits are obtainedpredominantly from the geographic trade areas surrounding the Bank’s officelocation. The Bank relies 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 the Bank’s ability to attract and retain deposits.

 

The following table sets forth the maturities of time deposits $100,000and over at March 31, 2004:

 
|                                     |   | **At  March 31, 2004** |      |
|------------------------------------------|--------|-----------------------------|-----------|
|                                     |   |                        |      |
| Time deposits $100,000 and over:         |   |                        |      |
| Maturing within three months             |   | $                           | 410,000   |   |
| After three months but within six months |   | 302,000                     |      |
| After six months but within 12 months    |   | 484,000                     |      |
| After 12 months                          |   | —                      |      |
| Total time deposits $100,000 and over:   |   | $                           | 1,196,000 |   |

 

The Holding Company borrowed $500,000 from its organizing shareholderon March 9, 2004, in conjunction with the acquisition of the Bank.  This amount is represented by a promissorynote bearing interest at a rate of 2.00% per annum.  Any unpaid principal and interest on this note will automaticallyconvert to shares of common stock at a price of $8.33 per share on March 9,2005.  The cash proceeds of this notewere used as a capital injection, in cash, to the Bank.

 

The Holding Company entered into an Expense Reimbursement Agreement onDecember 8, 2004, with its organizing shareholder with respect to theanticipated costs of the public offering and the pre-opening expenses for theAustin location of the Bank.  Under thisagreement, the organizing shareholder has agreed to pay up to $775,000 of thecosts of the public offering and certain pre-opening expenses incurred afterDecember 8, 2003, and until the termination of the offering.  If and when the Company sells 480,000 sharesof its common stock, the balance incurred under the Agreement will becomepayable.  As of March 31, 2004,costs incurred subject to this agreement were $631,000.

 

Shareholders’ equity was $1.4 million on March 31, 2004, comparedto $0 on September 30, 2003.  Theincrease in equity is due to the initial capitalization of the Company ofapproximately $2.3 million net of the

 

17

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cumulative deficit since inception of $977,000.  Of the $977,000 accumulated deficit,$332,400 was non-cash, stock-based compensation recognized in conjunction withthe organization of the Holding Company. An additional, $342,000 was incurred prior to organization of theHolding Company by its organizing shareholder, primarily in conjunction withthe acquisition of the Bank.  Thesecosts were included in the initial capital contribution of the organizingshareholder to the Holding Company.

 

**Results of Operations**

 

The Holding Company acquired the Bank on March 9, 2004, bypurchasing 99.97% of the then outstanding common stock of the Bank.  The Holding Company currently has no otheroperating history.  The Holding Companyreceived notification from the Securities and Exchange Commission on May 7,2004, as to the effectiveness of its registration to sell shares of commonstock, at $8.33 per share, to raise up to $12,000,000.  The proceeds of the public offering areintended primarily to increase the capital of the Bank to permit the relocationof the Bank’s charter to Austin, Texas. As a result, the Holding Company is currently incurring substantialpre-opening costs related to the future relocation.

 

The following discussion provides information about the majorcomponents of the financial condition, results of operations, asset quality,liquidity and capital resources of Treaty Oak Bancorp.  The discussion and analysis should be readin conjunction with the Consolidated Financial Statements included in thisreport.

 

Net loss for the three months ended March 31, 2004, was $247,000compared to $30,000 for the three months ended March 31, 2003.  Net loss for the six months endedMarch 31, 2004, were $759,000 compared to $100,000 for the six monthsended March 31, 2003.  These lossesare directly attributable to various phases of development.  The charge to earnings of $332,400 fornon-cash stock based compensation in conjunction with the organization of theCompany in December 2003, accounts for the majority of the disparity inthe loss incurred in the six months ended March 31, 2004.  Excluding this charge, the Company wouldhave reported a net loss of $427,000 for the six months ended March 31,2004.

 

Total interest income for the three and six months ended March 31,2004, was $49,000, which is primarily attributable to the acquisition of theBank and its operations since acquisition on March 9, 2004.  Interest expense for the same periods was$12,000 resulting in net interest income of $37,000 (or  75.5% of total interest income).  There was no interest income earned orinterest expense incurred for the three and six months ended March 31,2003.

 

Non-interest income for the three and six months ended March 31,2004, was $5,000 and resulted primarily from services fees and charges ondeposit accounts.  Noninterest expensesfor the three months ended March 31, 2004, were $288,000 and includedsalaries and payroll related expenses of $110,000 and internally generatedacquisition costs of $84,000. Pre-opening costs, in addition to certain pre-opening salaries, were$64,000.  For the six months endedMarch 31, 2004, the non-cash stock based compensation expense of $342,000and internally generated acquisition costs of $72,000 accounted forsubstantially all of the additional loss incurred over the three month periodended March 31, 2004.  For thethree and six months ended March 31, 2003, the Holding Company incurred$30,000 and $100,000 of acquisition related costs accounting for the net lossesfor those periods.

 

The provision for loan losses is an expense determined by management asthe amount necessary to increase the allowance for loan losses after netcharge-offs have been deducted to a level that, in management’s best estimate,is necessary to absorb probable losses in the loan portfolio. The amount of theprovision is based on management’s review of the loan portfolio andconsideration of such factors as historical loss experience, general prevailingeconomic conditions, changes in the size and composition of the loan portfolio andspecific borrower considerations, including the ability of the borrower torepay the loan and the estimated value of the underlying collateral. Theprovision is calculated monthly and a charge to expense is made, as required,to increase the allowance to the calculated level. For any particular month, inthe event the required allowance is less than or equal to the currentallowance, no expense is charged or reversed.

 

Our management does not have specific experience with the loanportfolio of Texline State Bank, although we have thoroughly analyzed such loanportfolio in connection with the acquisition of Texline State Bank. Further,given

 

18

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that we will be establishing the primary location of the Bank inAustin, rather than Texline, we anticipate the majority of new loan growth tocome from this new market where the Bank does not have the benefit of specificloan performance from which to base future forecasts or projections. Managementwill continue to calculate the monthly provision to the loan loss reserve usingcurrent methods employed by Texline State Bank.

 

**Asset Quality**

 

The allowance for loan losses is a reserve against losses in the loanportfolio that is calculated monthly based upon a specific reserve and ageneral allocation as described herein. Increases to the allowance are made bycharging the expense, Provision for Loan Losses.  We believe the accounting policies governing the allowance forloan losses are critical to the portrayal and understanding of the Bank’sfinancial condition and its results of operations.

 

Loans subject to specific allocations to the allowance for loan lossesare loans that have generally first been placed on the Bank’s “WatchList.”  The fact that a loan is placedon the Watch List does not necessarily indicate that the Bank has experienced aproblem with the loan but indicates that the Bank has had some indication thatthe loan may become a problem loan.  TheBank and the regulators each, independently, perform review of the Bank’sloans.  The regulators (the TexasDepartment of Banking and the FDIC) will generally specifically review eachloan on the Bank’s Watch List and a random sampling of other loans as well.  As a result of these examinations, theregulators may place additional loans on the Watch List.  There are a variety of factors influencingthe Bank’s decision to place a loan on the Watch List. Factors other than afailure to make one or more payments, which may result in a loan being includedon the Watch List include a general economic trend impacting a concentration ofloans such as adverse trends in agriculture, a declining trend in a particular banking customer’s deposits, negativetrends in financial statements which are provided on a routine basis forbusiness loans, and in a rural community such as Texline, Texas, personalknowledge of the existence of a financial hardship to a customer by one of theBank’s officers is not uncommon.  Thusto some degree, a category of loans, such as agricultural loans, may beseparately reviewed based upon known additional risks to which the category maybe subject.  Placement of a loan on theWatch List from any of these factors may be the result of a determination bythe board of directors, bank management, the servicing officer, or by thebanking regulators during their periodic examinations of the Bank.

 

Through this process the Bank addresses the particular risks inherentin different concentrations of loans. Historically, the Bank’s allowance has been adequate to absorb thelosses experienced by the Bank.

 

Once a loan is placed on the Watch List it may be classified as“Watch,” “Substandard,” “Doubtful,” or “Loss.” These classifications are also based on numerous factors but these aregeneral groupings of the loans that receive different levels of scrutiny andhave different methods for determining whether a specific reserve should bemade for each loan applied to them. If a loan is classified as a “Watch,” thenit merely indicates that circumstances exist that may, but have not yet,jeopardized the collection of the loan. These loans generally do not have a specific reserve charged againstthem but are instead subject to the historical loss percentage discussed below.

 

Substandard loans are those loans that are considered to have somedeficiency relative to loans generally considered to be of acceptable loanquality (be it cash flow, collateral value, or otherwise) but that are notspecifically considered to have loss exposure. Each such loan is considered separately, and allocations range from 15%to 0% on some loans within the classification. Factors such as collectibility,collateral values, borrower strength, and past due status may influence theamount of reserve to be specifically allocated. A 0% specific reserve may occurwhen a loan is classified as substandard but is fully collateralized withcollateral such as a certificate of deposit held by the Bank.

 

As of March  31, 2004, and September 30, 2003, the Bank had$938,000 and $997,000, respectively, in Substandard or Doubtful loans withspecific reserves of $45,000 and $93,000, respectively.  Loss loans were immaterial but totaled $0and $2,934 as of March 31, 2004, and September 30, 2003,respectively. Loans classified as “loss” also have specific allocations of 100%of loan principal balance.

 

A historical loss percentage is applied to the balance of the loanportfolio, including those loans on the Watch List for which there has been nospecific reserve and excluding loans secured by cash on deposit and loans thatare guaranteed by governmental agencies. At September 30, 2003, thispercentage was 1.208% which is based upon the

 

19

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actual historical loss experience of the bank over the past five (5)years and was mandated by the regulators. This percentage was still in effectas of December 31, 2003.

 

After the required reserve has been calculated by adding together thespecific reserves and the general allocation discussed above, the currentbalance in the allowance for loan losses is compared to the calculated requiredallowance and to the extent an addition is necessary, the allowance isincreased by a charge to expense through the provision for loan losses.

 

The amount of the allowance represents the cumulative total of theprovisions made from time to time, reduced by loan charge-offs and increased byrecoveries of loans previously charged-off.

 

Credit and loan decisions are made by management and the board ofdirectors in conformity with loan policies established by the board ofdirectors. The Bank’s practice is to charge-off any loan or portion of a loanwhen the loan is determined by management to be uncollectible due to theborrower’s failure to meet repayment terms, the borrower’s deteriorating or deterioratedfinancial condition, the depreciation of the underlying collateral, the loan’sclassification as a loss by regulatory examiners, or other reasons.

 

The allowance for loan losses as of March 31, 2004, was $166,000or 1.9% of outstanding loans.  Therewere no net charge-offs for the period from the date of acquisition toMarch 31, 2004.  While managementuses all available information to recognize losses on loans, future additionsto the allowance may be necessary based on changes in economic conditions.  The regulatory agencies (the FDIC and theTexas Department of Banking), as part of their regular examinations of theBank, periodically review the allowance for loan losses and the Bank’s loanportfolio in general.  These agenciesmay require the Company to recognize additions to the allowance based upontheir judgments about information available at the time of their examinations.

 

Nonperformingassets, which consist of nonaccrual loans, loans 90 days or more past due, andother real estate owned, were $295,000 as of March 31, 2004.  Management does not expect to incur anymaterial losses related to nonperforming assets.

 

The following table sets forth the amount of non-performing loans andnon-performing assets at the date indicated:

 
|                                                     |   | **March 31,** |    | **September  30,** |   |
|----------------------------------------------------------|--------|--------------------|---------|--------------------|--------|
|                                                     |   | **2004**           |    | **2003**           |   |
| Non-accruing loans                                       |   | $                  | 93,000  |               |   |   |
| Loans 90 days or more past due, still  accruing interest |   | 51,000             |    |               |   |
| Total non-performing loans                               |   | 144,000            |    |               |   |
| Other real estate owned                                  |   | —             |    |               |   |
| Other repossessed assets                                 |   | 7,000              |    |               |   |
| Total non-performing assets                              |   | $                  | 151,000 |               |   |   |
|                                                     |   |               |    |               |   |
| Total non-performing loans to total loans                |   | 1.68               | %       |               |   |
| Allowance for loan losses to non-performing  loans       |   | 115.28             | %       |               |   |
| Total non-performing assets to total assets              |   | 2.31               | %       |               |   |

 

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**Liquidity**

 

In determining the Company’s liquidity requirements, management reviewsboth sides of the balance sheet to ensure that adequate funding sources areavailable to support loan growth, deposit withdrawals and unanticipated needsfor funds.

 

The Bank’s liquidity management will be monitored by theAsset/Liability Management Committee and the board of directors, who willreview historical funding requirements, current liquidity position, sources andstability of funding, marketability of assets, options for attractingadditional funds, and anticipated future funding needs, including the level ofunfunded commitments.

 

The Bank’s primary sources of funds will be retail and commercialdeposits, loan and securities repayments, other short-term borrowings, andother funds provided by operations. While scheduled loan repayments andmaturing investments are relatively predictable, deposit flows and early loanprepayments are more influenced by interest rates, general economic conditions,and competition. The Bank will maintain investments in liquid assets based uponmanagement’s assessment of (1) the need for funds, (2) expecteddeposit flows, (3) yields available on short-term liquid assets, and(4) objectives of the asset/liability management program. We anticipateeliminating the need for borrowed funds upon infusion of additional cash andcash equivalents.

 

In the event that additional short-term liquidity is needed, the Bankwill retain established relationships created by Texline State Bank with severallarge regional banks. For example, Texline State Bank has an existingcorrespondent banking relationship with Plains Capital Bank in Lubbock, Texas.Texline has utilized this relationship as a source of liquidity in the past,and we expect to utilize the facility going forward if needed. Also, TexlineState Bank has been a frequent borrower from the Federal Home Loan Bank in thepast and at present. In the current rate environment where rates on these fundsare at historical lows, the Bank has relied upon this source as an alternativeto attracting more expensive deposit funds that would carry a slightly higherinterest cost. While we do not intend to rely as heavily on Fed Funds as hasTexline State Bank (we intend to repay these funds from the capital raised fromthe public offering assuming we raise at least $6,000,000), the source willremain available to the Bank going forward.

 

Through Treaty Oak Holdings, Inc., the Company’s organizingshareholder, the Bank has an existing line of credit with The IndependentBanker’sBank (TIB) in the amount of $950,000, and $75,000 of this line ofcredit remains available.

 

**Capital Resources**

 

The Company’s capital position provides support for anticipated assetgrowth and for the absorption of the anticipated losses.

 

The Bank, Tier 1 capital position as of March 31, 2004, was$1,539,000 or 20% of risk weighted assets. Total risk based capital was $1,638,000 or 21.4% of risk weightedassets.

 

Tier 1 capital consists primarily of common shareholders’ equity, whilerisk-based capital includes the allowance for loan losses.  Risk weighted assets are determined byassigning various levels of risk to different categories of assets andoff-balance sheet activities.  Undercurrent risk-based capital standards, all banks are required to have Tier 1capital of at least 4% and total capital of 8%.

 

In addition, to the risk based capital guidelines, banking regulatoryagencies have adopted leverage capital ratio requirements.  The leverage ratio – or core capital toassets ratio – works in conjunction with the risk capital guidelines.  The minimum leverage ratios range from threeto five percent.  At March 31,2004, the Bank, leverage capital ratio was 14.64%.

 

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**A Warning AboutForward-Looking Statements**

 

This Form 10-QSB contains forward-looking statements.  The Company may also make writtenforward-looking statements in periodic reports to the Securities and ExchangeCommission, proxy statements, offering circulars and prospectuses, pressreleases and other written materials and oral statements made by Treaty OakBancorp’s officers, directors or employees to third parties.  Statements that are not historical facts,including statements about the companies beliefs and expectations, areforward-looking statements.  Thesestatements are based on beliefs and assumptions of the Company’s management andupon the information currently available to management.  Forward-looking statements includestatements preceded or followed by, or that include, the words “believes,”“expects,” “estimates,” “anticipates,” “plans,” or other similar words orexpressions.  Forward-looking statementsspeak only as of the date they are made and the Company does not actively seekto update these statements for new information or future events.

 

Forward-looking statements involve inherent risks anduncertainties.  Management cautionsreaders that many factors could cause actual results to materially differ fromthose contained in any forward-looking statement.  Such factors include, but are not limited to, the following:changes in the interest rate environment may reduce interest margins; generaleconomic or business conditions can cause fluctuations in credit demand or adeterioration in credit quality; legislative or regulatory changes, includingchanges in accounting standards can adversely affect the banking industry;competition in the banking industry or in the market in which the Company doesnow or intends to operate may increase significantly; competitors may havegreater financial resources to develop new products or services than theCompany.

 

Management believes that these forward looking statements arereasonable; however, undue reliance should not be placed on theseforward-looking statements, which are based upon current expectation.

Forward-looking statements are not guarantees of performance.  They involve risks, uncertainties andassumptions.  The future results andshareholder values may differ materially from those expressed in forward-lookingstatements.  Many of the factors thatwill determine these results and values are beyond the Company’s ability tocontrol or predict.

 

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

 

With the participation of management, ourchief executive officer and chief financial officer reviewed and evaluated ourdisclosure 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”),as of a date within 90 days prior to the filing of this report.  Based on this evaluation, the chief executiveofficer and chief financial officer concluded that the disclosure controls andprocedures are effective in bringing to their attention on a timely basisinformation relating to the Holding Company and its consolidated subsidiariesin connection with our filing of this quarterly report on Form 10-QSB for theperiod ended March 31, 2004.  Therehave been no significant changes in our internal controls for financial reportingor in other factors that could significantly affect these controls, includingany significant deficiencies or material weaknesses of internal controls thatwould require corrective action.  Inconnection with the new rules, we are currently in the process of furtherreviewing and documenting its disclosure controls and procedures, including ourinternal accounting controls, and may from time to time make changes aimed atenhancing their effectiveness and ensuring that our systems evolve with ourbusiness.

 

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

 

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

 

We have no pending legal proceedings as ofMarch 31, 2004.  From time to time,our subsidiary is involved in various legal proceedings arising in the ordinarycourse of business.  These actions arenot believed to be material either individually or collectively to theconsolidated financial condition of the Company.

 

22

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

 

None.

 

**Item 3.****                                                           *Defaults Upon Senior Securities***

## ** **

## **None.**

## ** **

## **Item4.**                                                           *Submission of Matters to**a Vote of Security Holders*

## ** **

## **OnJanuary 19, 2004, our shareholders acted via written consent to approveour 2004 Stock Incentive Plan (the “Plan”).  Holders of 1,030,000 of the 1,040,000 outstanding shares of ourcommon stock, $0.01 par value per share (“Common Stock”), joined in theconsent.  The remaining holder of 10,000shares of Common Stock did not join in the consent.**

 

## **OnApril 12, 2004, our shareholdersacted via written consent to (i) approve our Amended and Restated Articles ofIncorporation to modify certain provisions relating to our ability to takeactions without a meeting and change our registered office and agent; and (ii)amend the Plan in order for us to proceed with approvals in connection with ourbanking regulatory applications. Holders of 1,030,000 of the 1,040,000 outstanding shares of Common Stockjoined in the consent.  The remainingholder of 10,000 shares of Common Stock did not join in the consent.**

## ** **

**Item 5.****                                                           *Other Infor**mation***

 

On May 7, 2004, the Securities and Exchange Commission declared ourRegistration Statement on Form SB-2 (File No. 333-112325) effective under theSecurities Act of 1933, as amended.  Weare offering to sell up to a maximum of 1,440,000 shares of our Common Stock ata purchase price of $8.33 per share with a minimum offering of 360,000shares.  The offering will expire onJune 30, 2004, unless extended until not later than September 30,2004.  No shares have been sold underthe offering as of the date of this report.

 

**Item 6.****                                                           *Exhibits and Reports**on Form 8-K***

 

a.               Exhibits

 
| 3.1*   |   | Amended and Restated Articles of Incorporation                                                                                   |
|--------|--------|----------------------------------------------------------------------------------------------------------------------------------|
|   |   |                                                                                                                             |
| 3.2*   |   | By-laws                                                                                                                          |
|   |   |                                                                                                                             |
| 4.1*   |   | Specimen Common Stock Certificate, $.01 par value per share                                                                      |
|   |   |                                                                                                                             |
| 4.2*   |   | See Exhibits 3.1 and 3.2 for provisions of the Articles of  Incorporation and By-laws defining rights of holders of Common Stock |
|   |   |                                                                                                                             |
| 10.1*  |   | Form of Building Lease between PGI Equity Partners, L.P., and Treaty  Oak Bank (Approval Pending)                                |
|   |   |                                                                                                                             |
| 10.2*  |   | Expense Reimbursement Agreement between Treaty Oak Holdings, Inc.,  and Treaty Oak Bancorp, Inc.                                 |
|   |   |                                                                                                                             |
| 10.3*  |   | Form of Promotional Shares Lock-In Agreement                                                                                     |
|   |   |                                                                                                                             |
| 10.4*  |   | Form of Escrow Agreement between Treaty Oak Bancorp, Inc., and  TIB—The Independent BankersBank                             |
|   |   |                                                                                                                             |
| 10.5*  |   | Form of Treaty Oak Bancorp Shareholders’ Warrant Agreement                                                                  |

 

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| 10.6*  |   | Treaty Oak Bancorp, Inc., 2004 Stock Incentive Plan (Amended and  Restated as of April 12, 2004)                                                                                                                                                               |
|--------|--------|---------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------|
|   |   |                                                                                                                                                                                                                                                                |
| 10.7*  |   | Form of Indemnification Agreement between Treaty Oak Bancorp, Inc.,  and its Directors and Officers, and those of the Bank                                                                                                                                          |
|   |   |                                                                                                                                                                                                                                                                |
| 10.8*  |   | Registration Rights Agreement between Treaty Oak Bancorp, Inc., and  Treaty Oak Holdings, Inc.                                                                                                                                                                      |
|   |   |                                                                                                                                                                                                                                                                |
| 10.9*  |   | Stock Purchase Agreement dated June 20, 2003 (as amended on  November 26, 2003), by and among Texline State Bank, Charles T. Meeks,  certain shareholders of Texline State Bank, and Treaty Oak Bancorp, Inc. (as  assignee of Treaty Oak Holdings, Inc.) |
|   |   |                                                                                                                                                                                                                                                                |
| 10.10* |   | Promissory Note dated March 9, 2004, between Treaty Oak  Holdings, Inc., and Treaty Oak Bancorp, Inc.                                                                                                                                                          |
|   |   |                                                                                                                                                                                                                                                                |
| 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                                                                                                           |
|   |   |                                                                                                                                                                                                                                                                |
| 99     |   | Subsidiaries                                                                                                                                                                                                                                                        |

 

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

 

b.              Current Reports on Form 8-K

 

There were no reports on Form 8-K filed during the three months endedMarch 31, 2004.

 

24

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**SIGNATURE****S**

 

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

 

 
|                | **TREATY OAK BANCORP,  INC.** |
|---------------------|-------------------------------|
|                |                          |
|                |                          |
| Dated: May 18, 2004 | By:                           | /s/ Terry W. Hamann |   |
|                |                          | Terry W. Hamann, President and Chief Executive Officer |
|                |                          |   |
|                |                          |   |
|                | By:                           | /s/ Sandra L. Ellsworth |   |
|                |                          | Sandra L. Ellsworth, Chief Financial Officer |

 

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