**UNITED STATES**

**SECURITIES AND EXCHANGE COMMISSION**

**WASHINGTON, DC 20549**

** **

**FORM 10-QSB**

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

 

**For the quarterly periodended December 31, 2006**

** **

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

 

**Commission File Number:333-112325**

** **

**Treaty Oak Bancorp, Inc.**

(Exact name ofregistrant as specified in its charter)

**Texas**

(State or otherjurisdiction of

corporation ororganization)

**20-0413144**

(I.R.S. EmployerIdentification Number)

**101 Westlake Drive, Austin, Texas**

(Address ofPrincipal Executive Offices)

**78746**

(Zip Code)

**(512)617-3600**

(Registrant’stelephone number, including area code)

Indicate by checkmark whether the issuer (1) has filed all reports required to be filed bySection 13 or 15(d) of the Securities Exchange Act of 1934 during the preceding12 months (or for such shorter period that the registrant was required to file suchreports), and (2) has been subject to such filing requirements for the past 90days.

Yes  x          No o

Indicate by check markwhether the registrant is a shell company (as defined in Rule 12b-2 of the Exchange Act).

Yes o           No  x

Indicate the number ofshares outstanding of each of the issuer’s classes of common stock as of theclose of business on February 14, 2007.

| $0.01 Par Value Common Stock |   | 2,730,187 shares |
|------------------------------|--------|------------------|

 

Transitional SmallBusiness Disclosure Format (Check one):                      Yeso   No   x

 

 

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**QUARTERLY REPORT ON FORM 10-QSBFOR THE PERIOD ENDED DECEMBER 31, 2006**

**TABLE OF CONTENTS**
| **Part I.**  | **Financial Information** |
|--------------|---------------------------|
| ** **   | ** **                | ** ** |
| ** **   | **Item 1.**               | *Financial Statements* |
| ** **   | ** **                | * * |
|         |                      | Consolidated Balance Sheets at December 31, 2006 and  September 30, 2006 (unaudited) |
|         |                      |   |
|         |                      | Consolidated Statements of Operations for the Three  Month Periods ended December 31, 2006, and 2005 (unaudited) |
|         |                      |   |
|         |                      | Consolidated Statement of Changes in Shareholders’  Equity for the Three Month Period ended December 31, 2006 (unaudited) |
|         |                      |   |
|         |                      | Consolidated Statements of Cash Flows for the Three  Month Periods ended December 31, 2006, and 2005 (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.**               | *Unregistered  Sales of Equity Securities and Use  of Proceeds* |
| ** **   | ** **                | * * |
| ** **   | **Item 3.**               | *Defaults Upon  Senior Securities* |
| ** **   | ** **                | * * |
| ** **   | **Item 4.**               | *Submission of  Matters to a Vote of Security Holders* |
| ** **   | ** **                | * * |
| ** **   | **Item 5.**               | *Other Information* |
| ** **   | ** **                | * * |
| ** **   | **Item  6.**              | *Exhibits* |
| ** **   | ** **                | * * |
|         |                      | Signatures |

 

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

i

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**Treaty Oak Bancorp, Inc.**

**ConsolidatedBalance Sheets (unaudited)**

**December 31, 2006 and September 30,2006**

**(Dollars In Thousands, Except ParValue and Share Amounts)**

 

 
| ** **                                                                                                   | ** ** | **December 31,** | ** ** | **September 30,** | ** ** |
|--------------------------------------------------------------------------------------------------------------|------------|-----------------------|------------|------------------------|------------|
| ** **                                                                                                   | ** ** | **2006**              | ** ** | **2006(1)**            | ** ** |
| ASSETS                                                                                                       |       |                  |       |                   |       |
| ** **                                                                                                   |       |                  |       |                   |       |
| Cash and cash items                                                                                          |       | $                     | 260        |                   | $          | 267 |   |
| Due from banks                                                                                               |       | 2,835                 |       | 2,312                  |       |
| Federal funds sold                                                                                           |       | 13,599                |       | 23,775                 |       |
| Total cash and  cash equivalents                                                                             |       | 16,694                |       | 26,354                 |       |
|                                                                                                         |       |                  |       |                   |       |
| Securities available  for sale                                                                               |       | 15                    |       | 16                     |       |
| Securities held to  maturity, fair value of $1,344 and $2,001, respectively                                  |       | 1,347                 |       | 2,006                  |       |
| Investment in Federal  Home Loan Bank stock, at cost                                                         |       | 224                   |       | 224                    |       |
| Investment in  Independent Banker’s Financial Corporation stock, at cost                                |       | 102                   |       | 102                    |       |
| Loans, net                                                                                                   |       | 68,360                |       | 59,620                 |       |
| Premises and equipment,  net                                                                                 |       | 5,545                 |       | 5,593                  |       |
| Note receivable from  affiliate                                                                              |       | —                |       | 2,821                  |       |
| Accrued interest  receivable                                                                                 |       | 584                   |       | 484                    |       |
| Due from affiliates                                                                                          |       | —                |       | 192                    |       |
| Goodwill and other  intangibles, net                                                                         |       | 1,203                 |       | 1,205                  |       |
| Other assets                                                                                                 |       | 667                   |       | 474                    |       |
| Total assets                                                                                                 |       | $                     | 94,741     |                   | $          | 99,091 |   |
|                                                                                                         |       |                  |       |                   |       |
| LIABILITIES AND  SHAREHOLDERS’ EQUITY                                                                   |       |                  |       |                   |       |
|                                                                                                         |       |                  |       |                   |       |
| Deposits:                                                                                                    |       |                  |       |                   |       |
| Noninterest-bearing  demand                                                                                  |       | $                     | 26,338     |                   | $          | 28,091 |   |
| NOW, money  market and savings                                                                               |       | 31,773                |       | 32,401                 |       |
| Time deposits                                                                                                |       | 20,295                |       | 20,526                 |       |
| Total deposits                                                                                               |       | 78,406                |       | 81,018                 |       |
|                                                                                                         |       |                  |       |                   |       |
| Accounts payable and  accrued expenses                                                                       |       | 277                   |       | 352                    |       |
| Accrued interest  payable                                                                                    |       | 185                   |       | 160                    |       |
| Property mortgage                                                                                            |       | 2,652                 |       | 2,667                  |       |
| Notes payable                                                                                                |       | —                |       | 2,483                  |       |
| Minority interest - PGI  Equity Partners, LP                                                                 |       | —                |       | 1,106                  |       |
| Other liabilities                                                                                            |       | 30                    |       | 33                     |       |
| Total  liabilities                                                                                           |       | 81,550                |       | 87,819                 |       |
|                                                                                                         |       |                  |       |                   |       |
| Shareholders’ equity:                                                                                   |       |                  |       |                   |       |
| Preferred stock,  $0.01 par value; 1,000,000 shares authorized; none issued                                  |       | —                |       | —                 |       |
| Common stock,  $0.01 par value; 20,000,000 shares authorized; 2,736,190 and 2,640,226,  respectively, issued |       | 27                    |       | 26                     |       |
| Paid-in capital                                                                                              |       | 16,771                |       | 14,989                 |       |
| Accumulated  deficit                                                                                         |       | (3,557                | )          | (3,693                 | )          |
| Less shares held  in treasury, at cost (6,003 shares)                                                        |       | (50                   | )          | (50                    | )          |
| Total  shareholders’ equity                                                                             |       | 13,191                |       | 11,272                 |       |
| Total liabilities and  shareholders’ equity                                                             |       | $                     | 94,741     |                   | $          | 99,091 |   |

 

See Notes to Consolidated Financial Statements (unaudited)

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(1) Derived from Audited Consolidated Financial Statements

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**Treaty Oak Bancorp, Inc.**

**ConsolidatedStatements of Operations (unaudited)**

**Three Months Ended December 31, 2006and 2005**

**(Dollars In Thousands, Except Shareand Per Share Amounts)**

 

 
| ** **                                           | ** ** | **Three Months  Ended December  31, 2006** | ** ** | **Three Months  Ended December  31, 2005** | ** ** |
|------------------------------------------------------|------------|-----------------------------------------------------------|------------|-----------------------------------------------------------|------------|
|                                                 |       |                                                      |       |                                                      |       |
| Interest income:                                     |       |                                                      |       |                                                      |       |
| Loans, including fees                                |       | $                                                         | 1,545      |                                                      | $          | 822 |   |
| Taxable securities                                   |       | 14                                                        |       | 32                                                        |       |
| Interest on deposits with other banks                |       | —                                                    |       | 36                                                        |       |
| Federal funds sold                                   |       | 226                                                       |       | 36                                                        |       |
| Total interest income                                |       | 1,785                                                     |       | 926                                                       |       |
|                                                 |       |                                                      |       |                                                      |       |
| Interest  expense:                                   |       |                                                      |       |                                                      |       |
| Deposits                                             |       | 565                                                       |       | 174                                                       |       |
| Other borrowings                                     |       | 67                                                        |       | 42                                                        |       |
| Total interest expense                               |       | 632                                                       |       | 216                                                       |       |
|                                                 |       |                                                      |       |                                                      |       |
| Net interest  income                                 |       | 1,153                                                     |       | 710                                                       |       |
|                                                 |       |                                                      |       |                                                      |       |
| Provision for  loan losses                           |       | 75                                                        |       | 45                                                        |       |
| Net interest  income after provision for loan losses |       | 1,078                                                     |       | 665                                                       |       |
|                                                 |       |                                                      |       |                                                      |       |
| Noninterest  income:                                 |       |                                                      |       |                                                      |       |
| Service charges on deposit accounts                  |       | 33                                                        |       | 20                                                        |       |
| Other noninterest income                             |       | 72                                                        |       | 95                                                        |       |
| Total noninterest income                             |       | 105                                                       |       | 115                                                       |       |
|                                                 |       |                                                      |       |                                                      |       |
| Noninterest  expense:                                |       |                                                      |       |                                                      |       |
| Salaries and employee benefits                       |       | 526                                                       |       | 391                                                       |       |
| Occupancy and equipment expenses                     |       | 112                                                       |       | 61                                                        |       |
| Accounting and other professional fees               |       | 55                                                        |       | 124                                                       |       |
| Other noninterest expense                            |       | 354                                                       |       | 278                                                       |       |
| Total noninterest expense                            |       | 1,047                                                     |       | 854                                                       |       |
|                                                 |       |                                                      |       |                                                      |       |
| Net income  (loss)                                   |       | $                                                         | 136        |                                                      | $          | (74 | ) |
|                                                 |       |                                                      |       |                                                      |       |
|                                                 |       |                                                      |       |                                                      |       |
|                                                 |       |                                                      |       |                                                      |       |
| Earnings (loss)  per common share - basic            |       | $                                                         | 0.05       |                                                      | $          | (0.03 | ) |
| Earnings (loss)  per common share - diluted          |       | $                                                         | 0.05       |                                                      | $          | (0.03 | ) |
|                                                 |       |                                                      |       |                                                      |       |
| Weighted average  shares outstanding - basic         |       | 2,682,664                                                 |       | 2,635,746                                                 |       |
| Weighted average shares  outstanding - diluted       |       | 2,778,017                                                 |       | 2,635,746                                                 |       |

 

See Notes to Consolidated Financial Statements(unaudited)

4

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**TreatyOak Bancorp, Inc.**

**ConsolidatedStatement Of Changes In Shareholders’ Equity (unaudited)**

**Forthe Three Months Ended December 31, 2006**

**(DollarsIn  Thousands Except for Share Amounts)**

 

 
|                                                              | ** ** | **Common Stock** | ** ** | **Additional  paid-in** | ** ** | **Accumulated** | ** ** | **Treasury** | ** ** | ** ** | ** ** |
|--------------------------------------------------------------|------------|-----------------------|------------|-------------------------|------------|-----------------|------------|--------------|------------|------------|------------|
| ** **                                                   | ** ** | **Shares**            | ** ** | **Amount**              | ** ** | **capital**     | ** ** | **Deficit**  | ** ** | **Stock**  | ** ** | **Total** | ** ** |
|                                                         |       |                  |       |                    |       |            |       |         |       |       |       |   |   |
| Balances at October 1, 2006                                  |       | 2,640,226             |       | $                       | 26         |            | $          | 14,989       |       | $          | (3,693     | ) | $ | (50 | ) | $ | 11,272 |   |
|                                                         |       |                  |       |                    |       |            |       |         |       |       |       |   |   |
| Shares issued from Treaty  Oak                               |       |                  |       |                    |       |            |       |         |       |       |       |   |   |
| Holdings merger                                              |       | 1,094,163             |       | 11                      |       | 9,082           |       | —       |       | —     |       | 9,093 |   |
| Shares retired from Treaty Oak                               |       |                  |       |                    |       |            |       |         |       |       |       |   |   |
| Holdings merger                                              |       | (1,000,000            | )          | (10                     | )          | (8,300          | )          | —       |       | —     |       | (8,310 | ) |
| Warrants and options from  Treaty                            |       |                  |       |                    |       |            |       |         |       |       |       |   |   |
| Oak Holdings merger                                          |       | —                |       | —                  |       | 932             |       | —       |       | —     |       | 932 |   |
| Shares issued through the exercise of common stock  warrants |       | 1,801                 |       | —                  |       | 18              |       | —       |       | —     |       | 18 |   |
| Non-cash stock based compensation                            |       | —                |       | —                  |       | 50              |       | —       |       | —     |       | 50 |   |
| Net income                                                   |       | —                |       | —                  |       | —          |       | 136          |       | —     |       | 136 |   |
|                                                         |       |                  |       |                    |       |            |       |         |       |       |       |   |   |
| Balances at December 31,  2006                               |       | 2,736,190             |       | $                       | 27         |            | $          | 16,771       |       | $          | (3,557     | ) | $ | (50 | ) | $ | 13,191 |   |

 

See Notes toConsolidated Financial Statements (unaudited)

 

5

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**TreatyOak Bancorp, Inc.**

**ConsolidatedStatements of Cash Flows (unaudited)**

**Three Months Ended December 30, 2006,and 2005**

**(Dollars In Thousands)**

 

 
| ** **                                                                                | ** ** | **Three Months**   | ** ** | **Three Months**   | ** ** |
|-------------------------------------------------------------------------------------------|------------|-------------------------|------------|-------------------------|------------|
| ** **                                                                                | ** ** | **Ended December** | ** ** | **Ended December** | ** ** |
| ** **                                                                                | ** ** | **31, 2006**       | ** ** | **31, 2005**       | ** ** |
| Cash flows from operating activities:                                                     |       |                    |       |                    |       |
| Net income (loss)                                                                         |       | $                       | 136        |                    | $          | (74 | ) |
| Adjustments to reconcile net income (loss) to net  cash provided by operating activities: |       |                    |       |                    |       |
| Minority interests in partnership income (loss)                                           |       | (7                      | )          | 3                       |       |
| Provision for loan losses                                                                 |       | 75                      |       | 45                      |       |
| Non-cash stock based compensation                                                         |       | 50                      |       | 1                       |       |
| Depreciation and amortization                                                             |       | 90                      |       | 89                      |       |
| Changes in other operating assets and liabilities:                                        |       |                    |       |                    |       |
| Accrued interest receivable                                                               |       | (57                     | )          | (4                      | )          |
| Other assets                                                                              |       | (124                    | )          | (25                     | )          |
| Accrued interest payable                                                                  |       | 24                      | ** ** | (30                     | )          |
| Other liabilities                                                                         |       | (158                    | )          | 83                      |       |
| **Net cash provided by operating activities**                                             |       | 29                      |       | 88                      |       |
|                                                                                      |       |                    |       |                    |       |
| Cash flows from investing activities:                                                     |       |                    |       |                    |       |
| Proceeds from maturities and principal repayments on  securities - available for sale     |       | 1                       |       | 3                       |       |
| Proceeds from maturities and principal repayments on  securities - held to maturity       |       | 2,000                   |       | 498                     |       |
| Purchases of securities - held to maturity                                                |       | (1,340                  | )          | —                  |       |
| Purchases of correspondent bank stock                                                     |       | —                  | ** ** | (2                      | )          |
| Net increase in loans                                                                     |       | (8,748                  | )          | (9,265                  | )          |
| Cash received from the acquistion of Treaty Oak  Holdings, Inc.                           |       | 515                     |       | —                  |       |
| Advances to affiliates                                                                    |       | —                  | ** ** | (20                     | )          |
| Repayments of advances to affiliates                                                      |       | 192                     | ** ** | —                  |       |
| Collection of notes receivable from affiliates                                            |       | 2,821                   |       | —                  |       |
| Purchases of premises and equipment                                                       |       | (38                     | )          | (6                      | )          |
| **Net cash used in investing activities**                                                 |       | (4,597                  | )          | (8,792                  | )          |
|                                                                                      |       |                    |       |                    |       |
| Cash flows from financing activities:                                                     |       |                    |       |                    |       |
| Net increase (decrease) in deposits                                                       |       | (2,612                  | )          | 355                     |       |
| Payments of principal on mortgage                                                         |       | (15                     | )          | (19                     | )          |
| Payments of principal on notes payable                                                    |       | (2,483                  | )          | —                  |       |
| Proceeds from exercise of warrants                                                        |       | 18                      |       | —                  |       |
| Note payable to affiliates                                                                |       | —                  |       | (337                    | )          |
| **Net cash used in financing activities**                                                 |       | (5,092                  | )          | (1                      | )          |
|                                                                                      |       |                    |       |                    |       |
| Net decrease in cash and cash equivalents                                                 |       | (9,660                  | )          | (8,705                  | )          |
| Cash and cash equivalents at beginning of period                                          |       | 26,354                  |       | 13,107                  |       |
| Cash and cash equivalents at end of period                                                |       | $                       | 16,694     |                    | $          | 4,402 |   |
|                                                                                      |       |                    |       |                    |       |
| Supplemental  disclosures of cash flow information:                                       |       |                    |       |                    |       |
| Non-cash investing and financing information:                                             |       |                    |       |                    |       |
| Cash interest received                                                                    |       | $                       | 1,685      |                    | $          | 922 |   |
| Cash interest paid                                                                        |       | $                       | 606        |                    | $          | 246 |   |
|                                                                                      |       |                    |       |                    |       |
| Acquisition of  Treaty Oak Holdings, Inc.                                                 |       |                    |       |                    |       |
| Assets acquired, net of cash                                                              |       | $                       | 1,280      |                    |       |   |
| Liabilities assumed                                                                       |       | (80                     | )          |                    |       |
| Issuance of common stock                                                                  |       | (9,093                  | )          |                    |       |
| Retirement of comon stock                                                                 |       | 8,310                   |       |                    |       |
| Issuance of warrants and assumption of options                                            |       | (932                    | )          |                    |       |
| Net cash  acquired                                                                        |       | $                       | (515       | )                       |       |   |

 

See Notes to Consolidated Financial Statements(unaudited)

6

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

** **

**Note1. Basis of Presentation**

Treaty OakBancorp, Inc. (the “Company”) is a bank holding company incorporated onNovember 18, 2003, and organized December 8, 2003 for the purpose of holdingthe common stock of Treaty Oak Bank (formerly Texline State Bank, the “Bank”). The Company, through Treaty Oak Bank, provides afull range of commercial and consumer banking services to individuals andbusinesses in the commercial sector in Austin, Texas, and in the agriculture,cattle and commercial sectors in the community of Texline, Texas.

On November 15,2006, the Company completed its acquisition of Treaty Oak Holdings, Inc. (“TOHI”)pursuant to the Agreement and Plan of Merger, dated October 3, 2006 (the “MergerAgreement”). The merger was approved by the Company’s Board of Directors andalso by the Company’s shareholders at a Special Meeting of Shareholders held onOctober 24, 2006. Prior to the merger, TOHI operated as a bank holding companyand significant shareholder of the Company, but otherwise had no activeoperations. As a result of the merger, the Company now owns TOHI’s subsidiarycompanies, Treaty Oak Financial Holdings, Inc. (“TOFHI”) and PGI Capital, Inc.These entities have been consolidated in the Company’s financial statementssince the merger on November 15, 2006. TOFHI is an inactive corporate entitywith assets of cash and a note receivable. PGI Capital, Inc. is the generalpartner of PGI Equity Partners, LP, the entity which owns the Company’scorporate headquarters.

The Company acquired a47.5% interest in PGI Equity Partners, LP (the “Partnership”) on December 31,2004. The Partnership owns and operates the building in which the Companyoffices. On February 23, 2006, the Companyacquired additional 2.5% Class A and 1.25% Class B interests in the Partnershipfrom the sole remaining minority shareholder, bringing the Company’s totalownership interest in the Partnership to 51.25% at September 30, 2006. TOHIowned 43.25% of the limited partnership interests, while PGI Capital, Inc.owned the remaining 0.5% limited partnership interest. Thus, following theCompany’s merger with TOHI on November 15, 2006, the Company now owns 100.0% ofthe limited partnership interests in the Partnership as well as the 5.0%general partnership interest held by PGI Capital, Inc., the Partnership’sgeneral partner. The Partnership has been consolidated in the Company’sfinancial statements since December 31, 2004. TOHI and PGI Capital, Inc.’s interestshave been accounted for as minority interests until the merger on November 15,2006.

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

Theaccompanying unaudited consolidated financial statements have been prepared inaccordance with the instructions to Form 10-QSB and, therefore, do not includeall of the disclosures and notes required by accounting principles generallyaccepted in the United States of America. In the opinion of management, allmaterial adjustments (which are of a normal recurring nature) considerednecessary for a fair presentation have been made. The results for the interimperiod are not necessarily indicative of the results to be expected for theentire year or any other interim period.

New AccountingPronouncements

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

Prior to October1, 2006, the Company accounted for stock-based compensation to employees usingthe intrinsic value method. Accordingly, compensation costs for employee stockoptions was measured as the excess, if any, of the fair value of the Company’scommon stock at date of grant over the exercise price.

The Company accounts forstock-based compensation to non-employees at fair value.

7

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In June 2006, theFASB issued FASB Interpretation No. 48, “Accounting for Uncertainty in IncomeTaxes” (FIN 48). Fin 48 clarifies the accounting and reporting for income taxesrecognized in accordance with SFAS No. 109, “Accounting for Income Taxes.” ThisInterpretation prescribes a comprehensive model for the financial statementrecognition, measurement, presentation and disclosure of uncertain taxpositions taken or expected to be taken in income tax returns. The Company iscurrently evaluating the impact of FIN 48. The Company will adopt thisInterpretation in the first quarter of fiscal 2008.

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

**Note2. Merger with Organizing Shareholder**

On November 15,2006, the Company completed the acquisition of TOHI pursuant to the Agreementand Plan of Merger, dated October 3, 2006. TOHI was one of the five organizingshareholders of the Company and operated as a bank holding company andsignificant shareholder of the Company, but otherwise had no active operations.The primary purpose of the merger was to achieve certain operationalefficiencies for the Company and its affiliates. The merger was approved by theCompany’s Board of Directors and also by the Company’s shareholders at aSpecial Meeting of Shareholders held on October 24, 2006. Prior to theconsummation of the merger, TOHI held approximately 38% of the issued andoutstanding shares of our common stock. Pursuant to the Merger Agreement, (1)each issued and outstanding share of TOHI’s common stock, par value $0.01 pershare was converted into the right to receive 0.8121 shares of the Company’scommon stock, par value $0.01 per share, and (2) each issued and outstandingshare of TOHI’s preferred stock, par value $10.00 per share, was converted intothe right to receive 1.2034 shares of the Company’s common stock.

TOHI had options toacquire 40,000 shares of common stock outstanding as of the date of the merger,which options were assumed by the Company and, pursuant to the conversionratio, now represent options to acquire 32,484 shares of the Company’s common stock.The options were fully vested at the merger date. Also, at the closing of themerger, certain TOHI warrantholders were issued new warrants to acquire, in theaggregate, 450,000 shares of the Company’s common stock. The warrants werefully vested when issued. The Company granted the TOHI shareholders certainlimited registration rights pursuant to a Registration Rights Agreementexecuted at the closing of the merger. Pursuant to the Registration RightsAgreement these former TOHI shareholders can request that the Company registertheir shares of the Company’s common stock on a Registration Statement on FormS-3 if such form is available for use by the Company, but only once during any12-month period. The former TOHI warrantholders were also granted similar S-3registration rights.

The TOHI shareholderscontributed certain assets and liabilities to the Company in connection withthe merger. As of November 15, 2006, the assets and liabilities contributed byTOHI were as follows (in thousands):

8

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

 

----

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

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

Themerger of TOHI and the Company did not constitute a change of control. Amajority of the directors of the Company also served on TOHI’s board ofdirectors and were shareholders of both entities. TOHI also owned 1,000,000shares of the Company’s common stock, representing approximately 38% of theCompany shares then outstanding. Because a change of control did not occur,purchase accounting was not applied to the merger. Instead the net assetscontributed by TOHI were recorded at their carrying book value. The 1,000,000shares of Company common stock owned by TOHI were cancelled by the Company andrecorded as a reduction of its common stock accounts (par value and paid incapital) at their fair market value, as determined by an independent appraisal,of $8.31 per share, or $8,310,000 in the aggregate. The 1,094,163 new shares ofCompany stock issued to the TOHI shareholders were also recorded at the fairmarket value price of $8.31 per share, or $9,093,000 in the aggregate. Thewarrants issued by the Company in exchange for the TOHI warrants and the TOHIoptions assumed by the Company were valued and recorded at their fair valueusing a Black-Scholes pricing model.****The net effectof the contribution of assets and the capital stock transactions was a$1,715,000 increase to the Company’s equity and a 94,163 net increase in thenumber of Company shares issued. Although the net assets contributed by TOHI tothe Company were not adjusted to their fair value, the assets were evaluatedfor collectibility and/or impairment according to generally accepted accountingprinciples prior to the merger and adjusted accordingly by TOHI prior to themerger.

**Note 3. Earnings (Loss) Per Share**

Basic earnings (loss) pershare is computed by dividing net earnings (loss) by the weighted averagenumber of common shares outstanding for the period.  Diluted earnings pershare is computed using the weighted-average number of common sharesoutstanding plus the number of additional common shares that would have been outstandingif dilutive common shares had been issued.  For the three months endedDecember 31, 2006, all potentially dilutive securities were anti-dilutiveexcept for stock options to purchase 15,000 shares of the Company’s commonstock at an exercise price of $8.00, stock options to purchase 32,484 shares ofthe Company’s common stock at an exercise price of $6.16 that were assumed inconjunction with the merger with TOHI and warrants to purchase 450,000 of theCompany’s common stock at an exercise price of the greater of $6.67 per shareor the book

9

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value of theCompany as defined by the warrant agreements. For the three months endedDecember 31, 2005, all potentially dilutive securities outstanding wereanti-dilutive.

**Note 4. Securities**

Securitiesconsisted of the following (in thousands):

|                                      | ** ** | **As of  December 31, 2006** | ** ** | **As of  September 30, 2006** | ** ** |
|--------------------------------------|------------|---------------------------------------------|------------|----------------------------------------------|------------|
| ** **                           | ** ** | **Amortized  Cost**                         | ** ** | **Fair  Value**                              | ** ** | **Amortized  Cost** | ** ** | **Fair  Value** | ** ** |
| Securities  Available for Sale:      |       |                                        |       |                                         |       |   |   |   |   |
| U.S. Government Agencies             |       | $                                           | 13         |                                         | $          | 13 |   | $ | 14 |   | $ | 14 |   |
| Other mortgage backed securities     |       | 2                                           |       | 2                                            |       | 2 |   | 2 |   |
|                                 |       |                                        |       |                                         |       |   |   |   |   |
| Total Securities  Available for Sale |       | $                                           | 15         |                                         | $          | 15 |   | $ | 16 |   | $ | 16 |   |
|                                 |       |                                        |       |                                         |       |   |   |   |   |
|  Securities Held to Maturity:   |       |                                        |       |                                         |       |   |   |   |   |
| U.S. Government Agencies             |       | $                                           | 1,342      |                                         | $          | 1,340 |   | $ | 2,000 |   | $ | 1,996 |   |
| Other mortgage backed securities     |       | 5                                           |       | 4                                            |       | 6 |   | 5 |   |
|                                 |       |                                        |       |                                         |       |   |   |   |   |
| Total Securities Held  to Maturity   |       | $                                           | 1,347      |                                         | $          | 1,344 |   | $ | 2,006 |   | $ | 2,001 |   |

 

At December 31, 2006, $1,110,000 of the Company’s securities werepledged to Texline Independent School District , $2,000 to the City of Texlineand $249,000 to the State of Texas.

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

TheCompany grants agribusiness, real estate, and commercial loans to customersprimarily in the Austin and Northwest Texas markets.

Loansat December 31, 2006, and September 30, 2006 were as follows (in thousands):

|                                  | ** ** | **As of December  31, 2006** | ** ** | **As of September  30, 2006** | ** ** |
|----------------------------------|------------|---------------------------------------------|------------|----------------------------------------------|------------|
| Agriculture                      |       | $                                           | 3,006      |                                         | $          | 2,989 |   |
| Commercial                       |       | 23,929                                      |       | 19,068                                       |       |
| Commercial real  estate          |       | 19,891                                      |       | 18,582                                       |       |
| Residential real  estate         |       | 11,377                                      |       | 8,221                                        |       |
| Construction  real estate        |       | 4,053                                       |       | 4,329                                        |       |
| Consumer and  other              |       | 6,679                                       |       | 6,981                                        |       |
| Gross Loans                      |       | 68,935                                      |       | 60,170                                       |       |
| Less: allowance  for loan losses |       | (575                                        | )          | (550                                         | )          |
|                             |       |                                        |       |                                         |       |
| Net Loans                        |       | $                                           | 68,360     |                                         | $          | 59,620 |   |

 

10

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Activity in theallowance for loan losses for the three months ended December 31, 2006 and theyear ended September 30, 2006, was as follows (in thousands):

|                                             | ** ** | **As of December  31, 2006** | ** ** | **As of September  30, 2006** | ** ** |
|---------------------------------------------|------------|---------------------------------------------|------------|----------------------------------------------|------------|
| Balance at  beginning of period             |       | $                                           | 550        |                                         | $          | 277 |   |
| Provisions for loan  losses                 |       | 75                                          |       | 295                                          |       |
| Loans charged  off                          |       | (51                                         | )          | (29                                          | )          |
| Recoveries on  loans previously charged off |       | 1                                           |       | 7                                            |       |
|                                        |       |                                        |       |                                         |       |
| Balance at end of  period                   |       | $                                           | 575        |                                         | $          | 550 |   |

 

At December 31, 2006 andSeptember 30, 2006, the Bank had approximately $104,000 and $123,000, respectively,in nonperforming loans including non accrual loans of $104,000 and $123,000. AtDecember 31, 2006 and September 30, 2006 the Bank had $5,000 in repossessedassets, and $55,000 and $41,000, respectively, in other real estate owned.

**Note 6. Premises and Equipment**

Premisesand equipment at December 31, 2006, and September 30, 2006, were as follows (inthousands):

|                                                 | ** ** | **As of December  31, 2006** | ** ** | **As of September  30, 2006** | ** ** |
|-------------------------------------------------|------------|---------------------------------------------|------------|----------------------------------------------|------------|
| Land                                            |       | $                                           | 959        |                                         | $          | 959 |   |
| Building and  leasehold improvements            |       | 4,590                                       |       | 4,568                                        |       |
| Furniture,  fixtures and equipment              |       | 794                                         |       | 778                                          |       |
|                                            |       | 6,343                                       |       | 6,305                                        |       |
| Less accumulated  depreciation and amortization |       | (798                                        | )          | (712                                         | )          |
| Total                                           |       | $                                           | 5,545      |                                         | $          | 5,593 |   |

 

Depreciation andamortization expense for the three months ending December 31, 2006 and 2005 was$86,000 and $87,000, respectively.

**Note 7. Deposits**

Timedeposits of $100,000 or more totaled $8,638,000 and $8,989,000 at December 31,2006 and September 30, 2006, respectively. At December 31, 2006 and September30, 2006, the scheduled maturities of time deposits were as follows (inthousands):

11

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| Years Ending September 30, | ** ** | **As of December  31, 2006** | ** ** | **As of September  30, 2006** | ** ** |
|-------------------------------------------|------------|---------------------------------------------|------------|----------------------------------------------|------------|
| 2007                                      |       | $                                           | 18,290     |                                         | $          | 20,197 |   |
| 2008                                      |       | 1,813                                       |       | 329                                          |       |
| 2009                                      |       | 192                                         |       | —                                       |       |
|                                      |       |                                        |       |                                         |       |
|                                      |       | $                                           | 20,295     |                                         | $          | 20,526 |   |

 

**Note 8. Goodwill and Other Intangibles**

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

Core deposit intangibles are amortized on astraight-line basis over seven years. The following table reflects the netcarrying amount of core deposit intangibles at December 31, 2006 and September30, 2006 (in thousands):

|                                 | ** ** | **As of December  31, 2006** | ** ** | **As of September  30, 2006** | ** ** |
|---------------------------------|------------|---------------------------------------------|------------|----------------------------------------------|------------|
| Gross core  deposit intangibles |       | $                                           | 70         |                                         | $          | 70 |   |
| Less accumulated  amortization  |       | (28                                         | )          | (26                                          | )          |
|                            |       |                                        |       |                                         |       |
| Net core deposit  intangibles   |       | $                                           | 42         |                                         | $          | 44 |   |

 

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

The Company adoptedFinancial Accounting Standards Board Statement No. 123R, “Share-Based Payment”,(“Statement 123R”) on October 1, 2006. Under Statement 123R, the cost ofemployee services received in exchange for an award of equity instruments isbased on the grant-date fair value of the award (with limited exceptions). Thatcost is recognized over the period during which an employee is required toprovide service in exchange for the award — the requisite service period(usually the vesting period). The Company adopted Statement 123R using themodified prospective application, which was required for public companies. Underthe modified prospective application, Statement 123R applies to new awards andto awards modified, repurchased, or cancelled after October 1, 2006. Additionally,compensation cost for the portion of awards for which the requisite service hadnot been rendered that are outstanding as of October 1, 2006 will be recognizedas the requisite service is rendered subsequent to October 1, 2006.

Prior to October1, 2006, the Company accounted for stock-based compensation to employees usingthe intrinsic value method. Accordingly, compensation costs for employee stockoptions was measured as the excess, if any, of the fair value of the Company’scommon stock at date of grant over the exercise price.

The Company accounts forstock-based compensation to non-employees at fair value.

On January 19, 2004,the Company and its shareholders approved the Company’s 2004 Stock IncentivePlan (the “Plan”).  The Plan authorizes incentive stock option grants,non-statutory stock option grants, direct stock issuances, stock appreciationrights, salary investment option grants, and director fee option grants. Eligible participants are

12

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employees,non-employee board members, and independent consultants or advisors.  TheCompany has reserved 500,000 shares of common stock under the Plan, and theshare reserve increases on the 1st business day in January each year(beginning in 2005) by an amount equal to 2% of the number of outstandingshares of the Company on the last business day in December of thepreceding year, subject to a maximum annual increase of 100,000 shares. No person may receive stock option grants, stock issuances, or stockappreciation rights for more than 100,000 shares in the aggregate in anycalendar year under the Plan. Option awards are generally granted with anexercise price equal to the market price of the Company’s stock at the date ofthe grant; have 10-year contractual terms and vest based on three years ofcontinuous service. Share awards generally vest over four years.

For the three months endedDecember 31, 2006, the expense related to the stock options and restrictedstock grant compensation totaled $50,000, which was comprised of $44,000 forstock options granted to employees and directors and $6,000 for restrictedstock granted to employees. For the three months ended December 31, 2005, theexpense related to stock option compensation included in the determination ofnet income was less than that which would have been recognized if the fairvalue method had been applied. The Company’s net income and earnings per sharewould have been adjusted to the proforma amounts indicated below.

Thetable below presents the pro forma effect on the Company’s loss from operationsfor the three months ended December 31, 2005, assuming the Company had expensedthe fair value of the options (in thousands, except per share amounts):

|                                    | ** ** | **Three Months Ended  December 31, 2005** | ** ** |
|------------------------------------|------------|---------------------------------------------------------------|------------|
| Net loss — as  reported       |       | $                                                             | (74        | ) |
| Net loss — pro  forma         |       | $                                                             | (112       | ) |
|                               |       |                                                          |       |
| Loss per share —  as reported |       |                                                          |       |
| Basic                              |       | $                                                             | (0.03      | ) |
| Diluted                            |       | $                                                             | (0.03      | ) |
|                               |       |                                                          |       |
| Loss per share —  pro forma   |       |                                                          |       |
| Basic                              |       | $                                                             | (0.04      | ) |
| Diluted                            |       | $                                                             | (0.04      | ) |

 

The fair value of eachoption award is estimated on the date of grant using the Black-Scholes optionpricing model. The Black-Scholes option pricing model requires the input ofhighly subjective assumptions. The Company continues to assess the assumptionsand methodologies used to calculate the estimated fair value of the stock-basedcompensation. Circumstances may change and additional data may become availableover time, which could result in changes to these assumptions andmethodologies. The risk-free rate for periods within the expected life of theoptions is based on the U.S. Treasury yield in effect at the time of the grant.The expected life of the options is estimated based on the vesting life andcontractual life of the options. Volatility in the Black-Scholes model is basedon historical volatility for comparable publicly-traded banks and the Company’shistorical stock prices since inception. 

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

The weighted average fairvalue of the options granted during the three months ended December 31, 2006,and December 31, 2005 has been estimated using the Black-Scholes option pricingmodel with the following assumptions:

13

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|                          | ** ** | **Three Months Ended  December 31, 2006** | ** ** | **Three Months Ended  December 31, 2005** | ** ** |
|--------------------------|------------|---------------------------------------------------------------|------------|---------------------------------------------------------------|------------|
| Dividend yield           |       | 0                                                             | %          | 0                                                             | %          |
| Risk-free  interest rate |       | 4.70 — 4.75                                              | %          | 4.25                                                          | %          |
| Expected  volatility     |       | 3.35                                                          | %          | 22                                                            | %          |
| Expected life in years   |       | 6.85 Years                                                    |       | 6.85 Years                                                    |       |

 

As of December 31, 2006,there were outstanding options under the Company’s Stock Incentive Plan topurchase an aggregate of 373,100 shares of the Company’s common stock. Each option has an exercise price of between $8.00 and $9.00 per share and maybe exercised in three equal annual installments for each year of servicemeasured from the grant date.  During the three months ended December 31,2006, the Company granted stock options to purchase an aggregate of 71,750shares of its common stock with exercise prices ranging from $8.00 to $9.00 pershare. In connection with the execution of his employment agreement with theCompany, Jeffrey L. Nash was awarded 15,000 options to purchase shares of stockat an exercise price of $8.00 per share. On December 31, 2006, the Companygranted 56,750 options to purchase shares of stock at an exercise price of$9.00 per share to thirteen (13) officers and directors.

During the three monthsended December 31, 2005, the Company granted stock options to purchase 82,750shares of its common stock with an exercise price of $8.50 per share to fifteen(15) officers and directors. The options become exercisable for the optionshares in three equal annual installments upon completion of each year ofservice over the three-year period of service measured from the date of thegrant.

.On November 20, 2006,the Company awarded 38,006 shares of restricted stock to six (6) officers. Thestock vests in four equal installments upon completion of each year of serviceover the four-year period of service measured from the date of the award.

The table below presentsthe summary of stock option and restricted stock activity for the Plan duringthe three months ended December 31, 2006.
| ** **                            | ** ** | **Three Months Ended December 31, 2006** | ** ** |
|---------------------------------------|------------|-------------------------------------------------------------------|------------|
| ** **                            | ** ** | **Restricted Stock**                                         | ** ** | **Options** | ** ** |
| ** **                            | ** ** | **Shares**                                                        | ** ** | **Weighted  Average  Remaining  Contractual Term  (years)** | ** ** | **Shares** | ** ** | **Weighted  Average  Exercise  Price** | ** ** | **Weighted  Average  Remaining  Contractual  Term  (years)** | ** ** | **Aggregate  Intrinsic  Value** | ** ** |
| Outstanding,  beginning of the period |       | —                                                            |       |   |   | 301,350 |   | $ | 8.38 |   |   |   |   |   |
| Granted                               |       | 38,006                                                            |       |   |   | 71,750 |   | 8.79 |   |   |   |   |   |
| Forfeited/expired                     |       | —                                                            |       |   |   | — |   | — |   |   |   |   |   |
| Outstanding, end  of the period       |       | 38,006                                                            |       | 3.9 |   | 373,100 |   | $ | 8.53 |   | 8.5 |   | $ | 175,528 |   |
|                                  |       |                                                                   |       |  |   |  |   |   |   |   |   |   |   |
| Exercisable at  the end of the period |       | —                                                            |       | — |   | 146,867 |   | $ | 8.40 |   | 7.7 |   | $ | 87,430 |   |

 

A summary of shares ofour common stock subject to our nonvested shares and options as of December 31,2006 and changes during the three months ended December 31, 2006 is presentedbelow:

14

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|                                     | ** ** | **Three Months Ended December 31, 2006** | ** ** |
|-------------------------------------|------------|-------------------------------------------------------------------|------------|
| ** **                          | ** ** | **Restricted Stock**                                         | ** ** | **Options** | ** ** |
| ** **                          | ** ** | **Shares**                                                        | ** ** | **Weighted  Average  Grant Date  Fair Value** | ** ** | **Shares** | ** ** | **Weighted  Average  Grant Date  Fair Value** | ** ** |
| Nonvested,  beginning of the period |       | —                                                            |       | $ | — |   | 180,400 |   | $ | 1.84 |   |
| Granted                             |       | 38,006                                                            |       | 9.00 |   | 71,750 |   | 2.43 |   |
| Vested                              |       | —                                                            |       | — |   | (25,917 | ) | 1.82 |   |
| Forfeited/expired                   |       | —                                                            |       | — |   | — |   | — |   |
| Nonvested, end  of the period       |       | 38,006                                                            |       | $ | 9.00 |   | 226,233 |   | $ | 2.03 |   |

 

As of December 31, 2006, there was $602,673 of total unrecognizedcompensation costs related to nonvested share-based compensation arrangementsgranted under the Plan. That cost is expected to be recognized over aweighted-average period of 2.87 years. No options were exercised during thethree months ended December 31, 2006.

**Note10. Other Related Party Transactions**

**Transactions with Former OrganizingShareholder**

OnAugust 30, 2006, TOHI, the Company’s largest shareholder at that time,repurchased shares of its stock owned by certain principals of our formerlyaffiliated services firms, including the Company’s former CEO Terry W. Hamann.Concurrent with this stock redemption, those formerly affiliated firmsrelocated from the headquarters building. At that time, Mr. Hamann resigned hisremaining positions with the Company including all committee assignments andhis seat on the board of directors. Mr. Hamann had previously resigned his roleas Chairman, CEO and President of the Company in February 2006.

**OtherTransactions**

TheCompany had no amounts due from affiliates at December 31, 2006. The Company hada $192,000 due from affiliate balance as of September 30, 2006 whichrepresented amounts due from TOHI to PGI Equity Partners, LP for occupancycosts.

OnOctober 11, 2005, the Company made a $355,000 loan to TOHI with monthlyinterest payments due on the first of each month beginning November 1, 2005. Thepurpose of the loan was to enable TOHI to pay off certain obligations, and toprovide sufficient liquidity to TOHI until the proposed merger with the Companywas completed. On April 26, 2006, the obligation was renewed and increased to$373,000 at the then current prime rate. The loan was renewed and increased to$400,000 on September 1, 2006. The principal balance ($396,000 as of September30, 2006), along with any accrued interest, was due and payable in full onNovember 1, 2006. On November 15, 2006, in connection with the merger of TOHIand the Company, the loan was paid in full.

On August 24, 2006, the Company made a $2,425,000 loanto TOHI with monthly interest payments at the current prime rate (8.25% atSeptember 30, 2006) due on the 24th day ofeach month. The purpose of the loan was to enable TOHI to redeem shares ofcommon and preferred stock from certain of its shareholders. The loan was dueand payable on February 24, 2007 but was paid-off in full on November 15, 2006in connection with the Company’s acquisition of TOHI.

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**Note 11. FinancialInstruments with Off-Balance Sheet Risk**

Inthe normal course of business, the Company is a party to financial instrumentswith off-balance sheet risk to meet the financing needs of its customers,through the use of commitments to extend credit. Those instruments involve, tovarying degrees, elements of credit and interest-rate risk in excess of theamount recognized in the consolidated balance sheet. The contract or notionalamounts of those instruments reflect the extent of the Company’s involvement inparticular classes of financial instruments.

TheCompany’s exposure to credit loss in the event of nonperformance by the otherparty to the financial instrument for commitments to extend credit and standbyletters of credit is represented by the contractual amount of thoseinstruments. The Company uses the same credit policies in making commitmentsand conditional obligations as they do for on-balance sheet instruments.

Thefollowing table summarizes the Company’s off-balance sheet financialinstruments as of December 31, 2006 and September 30, 2006 (in thousands):

|                               | ** ** | **As of December  31, 2006** | ** ** | **As of September  30, 2006** | ** ** |
|-------------------------------|------------|---------------------------------------------|------------|----------------------------------------------|------------|
| Commitments to  extend credit |       | $                                           | 22,628     |                                         | $          | 21,277 |   |
| Standby letters of  credit    |       | $                                           | 533        |                                         | $          | 1,935 |   |

 

Commitments to extend credit are agreements to lend toa customer as long as there is no violation of any condition established in thecontract. Commitments generally have fixed expiration dates or othertermination clauses and may require payment of a fee. Since many of thecommitments are expected to expire without being drawn upon, the totalcommitment amounts do not necessarily represent future cash requirements. TheCompany evaluates each customer’s creditworthiness on a case-by-case basis. Theamount of collateral obtained if deemed necessary by the Company upon extensionof credit is based on management’s credit evaluation of the counterparty. Collateralheld varies but may include accounts receivable, inventory, property, plant andequipment and income-producing commercial properties.

Standby letters of credit are written conditional commitments used bythe Company to guarantee the performance of a customer to a third party. TheCompany’s policies generally require that letter of credit arrangements containsecurity and debt covenants similar to those contained in loan arrangements. Inthe event the customer does not perform in accordance with the terms of theagreement with the third party, the Company would be required to fund thecommitment. The maximum potential amount of future payments the Company couldbe required to make is represented by the contractual amount shown in the tableabove. If the commitment is funded, the Company would be entitled to seekrecovery from the customer. As of December 31, 2006, no amounts have beenrecorded as liabilities for the Company’s potential obligations under theseguarantees.

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

Banks and bankholding companies are subject to regulatory capital requirements administeredby state and federal banking regulatory agencies. Capital adequacy guidelinesand, additionally for banks, prompt corrective action regulations involvequantitative measures of assets, liabilities, and certain off-balance sheetitems calculated under regulatory accounting practices. Capital amounts andclassifications are also subject to qualitative judgments by regulators aboutcomponents, risk weightings and other factors. Failure to meet capitalrequirements can initiate regulatory action. As of December 31, 2006,management believes the Bank is in compliance with all regulatory capitalrequirements to which it is subject.

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

The followingtable sets forth the bank only actual capital levels in addition to therequirements under prompt corrective action regulations (in thousands):
| ** **                                | ** ** | **Actual** | ** ** | **For Capital  Adequacy Purposes** | ** ** | **To Be Well  Capitalized Under  Prompt Corrective  Action  Provisions** | ** ** |
|-------------------------------------------|------------|------------|------------|----------------------------------------------|------------|----------------------------------------------------------------------------------------------|------------|
| ** **                                | ** ** | **Amount** | ** ** | **Ratio**                                    | ** ** | **Amount**                                                                                   | ** ** | **Ratio** | ** ** | **Amount** | ** ** | **Ratio** | ** ** |
| As of December 31, 2006                   |       |       |       |                                         |       |                                                                                         |       |   |   |   |   |   |   |
| Tier 1 capital  (to average assets)       |       | $          | 8,474      |                                         | 9.44       | %                                                                                            | $          | 3,591 |   | 4 | % | $ | 4,489 |   | 5 | % |
| Tier 1 capital  (to risk-weighted assets) |       | 8,474      |       | 11.16                                        | %          | 3,037                                                                                        |       | 4 | % | 4,555 |   | 6 | % |
| Total Capital (to risk-weighted  assets)  |       | 9,049      |       | 11.92                                        | %          | 6,074                                                                                        |       | 8 | % | 7,592 |   | 10 | % |
|                                           |            |            |            |                                              |            |                                                                                              |            |  |  |  |  |  |  |  |  |  |

 

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

 

 

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

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

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

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

**Introduction**

We are a bank holding company headquartered in Austin,Texas.  We operate a state charteredbank, Treaty Oak Bank (the “Bank”) in Austin, Texas with a branch in Texline,Texas.  We began operations in Austin,Texas on September 10, 2004.  Given itsgreater growth potential, we are focusing the majority of our efforts ongrowing a community-oriented bank out of our headquarters in Austin,Texas.  In the course of preparing ourconsolidated financial statements, we use certain estimates with respect toloans, intangibles, the allowance for loan losses and other estimates necessaryfor financial reporting.  We have made nosignificant changes to the types of estimates and the manner in which they aredetermined since the filing of our annual report on Form 10-KSB, except asotherwise noted within this discussion and analysis.

**Recent Developments**

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

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

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

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

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

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

(v)                           As part of the exchange, the Companywould receive net assets from TOHI, including cash and limited partnership interestsin PGI Equity Partners, LP, the entity that owns Treaty Oak Bank’s headquartersat 101 Westlake Drive, Austin, Texas, which would increase the liquidity andfinancial strength of the Company;

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

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

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

The merger of TOHI and the Company did not constitutea change of control.  A majority of thedirectors of the Company also served on TOHI’s board of directors and wereshareholders of both entities.  TOHI alsoowned 1,000,000 shares of the Company’s common stock, representingapproximately 38% of the Company shares then outstanding.  Because a change of control did not occur,purchase accounting was not applied to the merger.  Instead the net assets contributed by TOHIwere recorded at their carrying book value. The 1,000,000 shares of Company common stock owned by TOHI werecancelled by the Company and recorded as a reduction of its common stockaccounts (par value and paid in capital) at their fair market value, asdetermined by an independent appraisal, of $8.31 per share, or $8,310,000 inthe aggregate.  The 1,094,163 new sharesof Company stock issued to the TOHI shareholders were also recorded at the fairmarket value price of $8.31 per share, or $9,093,000 in the aggregate.  The warrants issued by the Company inexchange for the TOHI warrants and the TOHI options assumed by the Company werevalued and recorded at their fair value using a Black-Scholes pricing model.****The net effect of the contribution of assets and thecapital stock transactions was a $1,715,000 increase to the Company’s equityand a 94,163 net increase in the number of Company shares issued.  Although the net assets contributed by TOHIto the Company were not adjusted to their fair value, the assets were evaluatedfor collectibility and/or impairment according to generally accepted accountingprinciples prior to the merger and adjusted accordingly by TOHI prior to the merger.

**Results of Operations**

***General***

The following discussion analyzes the results of theCompany for the three months ended December 31, 2006, and December 31,2005.

***Net Income—General***

The Company’s fiscal year ends on September 30.Net income for the quarter ended December 31, 2006, was $136,000, compared to anet loss of $74,000 for the quarter ended December 31, 2005. Theimprovement is due to earnings generated at the Bank as a result of growthexperienced at the Austin branch and the elimination of expenses associatedwith the start-up of operations in Austin, Texas.

Our profitability depends primarily on net interestincome, which is defined as the difference between total interest earned oninterest earning assets (investments and loans) and total interest paid oninterest bearing liabilities (deposits, borrowed funds). The Company’s netincome is affected by its provision for loan losses, as well as other incomeand other expenses. The provision for loan losses reflects the amountconsidered to be adequate to cover probable credit losses in the loanportfolio. Non-interest income or other income consists of service charges ondeposits, gain on sale of loans, and other operating income. Other expensesinclude salaries and employee benefits, occupancy expenses, data processingexpenses, marketing, supplies, and other operating expenses.

Net interest income is affected by changes in thevolume and mix of interest earning assets, the level of interest rates earnedon those assets, the volume and mix of interest bearing liabilities, and thelevel of interest rates paid on those interest bearing liabilities. Theprovision for loan losses is dependent upon changes in the loan portfolio andmanagement’s assessment of the collectibility of the loan portfolio, as well aseconomic and market conditions. Other income and other expenses are impacted bygrowth of operations and growth in the number of accounts through bothacquisitions and core banking business growth. Growth in operations affectsother expenses as a result of additional employees, branch facilities, andpromotional marketing expense. Growth in the number of accounts affects otherincome including service fees, as well as other expenses such as computerservices, supplies, postage, telecommunications, and other miscellaneousexpenses.

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***Net Interest Income***

For the quarter ended December31, 2006, our net interest income was $1,153,000 compared to $710,000 forquarter ended December 31, 2005.  Netinterest income for the quarters ended December 31, 2006 and December 31, 2005was reduced by the amortization of direct loan origination costs ofapproximately $13,400 and $9,000, respectively.

For the comparative periods ofDecember 31, 2006, and December 31, 2005, the average rate on interest-bearingliabilities increased 140 basis points, from 2.98% to 4.38%, while the averagerate on interest bearing assets increased 106 basis points from 7.18% to 8.24%during the same period.  The increase inthe average rate on interest-bearing assets and liabilities was due to ageneral increase in interest rates during the period.  Interest rates on deposits also increased asa result of competition for deposits.

The following table presents, forthe periods indicated, the total dollar amount of interest income from averageinterest earning assets, and the resultant yields, as well as the interestexpense on average interest bearing liabilities, and the resultant costs,expressed both in dollars and rates. Yields are reflected on an annualizedbasis (in thousands except for yields).
| ** **                                       | ** ** | **Three Months Ended December 31,  2006** | ** ** | **Three Months Ended December 31,  2005** | ** ** |
|--------------------------------------------------|------------|---------------------------------------------------------------|------------|---------------------------------------------------------------|------------|
| ** **                                       | ** ** | **Average  Balance**                                          | ** ** | **Interest  (2)**                                             | ** ** | **Yield/  Rate** | ** ** | **Average  Balance** | ** ** | **Interest  (2)** | ** ** | **Yield/  Rate** | ** ** |
| Interest Earning  Assets:                        |       |                                                          |       |                                                          |       |   |   |   |   |   |   |   |   |
|                                             |       |                                                          |       |                                                          |       |   |   |   |   |   |   |   |   |
|                                             |       |                                                          |       |                                                          |       |   |   |   |   |   |   |   |   |
| Loans (1)                                        |       | $                                                             | 66,980     |                                                          | $          | 1,545 |   | 9.23 | % | $ | 40,033 |   | $ | 822 |   | 8.21 | % |
| Taxable investment securities                    |       | 1,711                                                         |       | 14                                                            |       | 3.27 | % | 3,834 |   | 29 |   | 3.03 | % |
| Federal funds sold                               |       | 17,581                                                        |       | 226                                                           |       | 5.14 | % | 3,787 |   | 36 |   | 3.80 | % |
| Interest bearing deposits with other Banks       |       | —                                                        |       | —                                                        |       | 0.00 | % | 3,619 |   | 36 |   | 3.98 | % |
| Federal Home Loan Bank Stock                     |       | 326                                                           |       | —                                                        |       | 0.00 | % | 317 |   | 3 |   | 3.79 | % |
| Total interest  earning assets                   |       | 86,598                                                        |       | 1,785                                                         |       | 8.24 | % | 51,590 |   | 926 |   | 7.18 | % |
| Non-interest earning assets                      |       | 10,301                                                        |       |                                                          |       |   |   | 8,938 |   |   |   |   |   |
| Total assets                                     |       | $                                                             | 96,899     |                                                          |       |   |   |   | $ | 60,528 |   |   |   |   |   |
|                                             |       |                                                               |       |                                                          |       |   |   |  |   |   |   |   |   |
| Interest Bearing  Liabilities:                   |       |                                                          |       |                                                          |       |   |   |   |   |   |   |   |   |
| Deposits:                                        |       |                                                          |       |                                                          |       |   |   |   |   |   |   |   |   |
| NOW and money market deposits                    |       | $                                                             | 33,417     |                                                          | $          | 296 |   | 3.54 | % | $ | 12,995 |   | $ | 70 |   | 2.15 | % |
| Savings deposits                                 |       | 510                                                           |       | 2                                                             |       | 1.57 | % | 472 |   | — |   | 0.00 | % |
| Time deposits                                    |       | 19,884                                                        |       | 267                                                           |       | 5.37 | % | 12,710 |   | 104 |   | 3.27 | % |
| Short-term borrowings                            |       | 1,213                                                         |       | 26                                                            |       | 8.58 | % | 87 |   | 1 |   | 4.60 | % |
| Property mortgage and long term borrowings       |       | 2,685                                                         |       | 41                                                            |       | 6.11 | % | 2,717 |   | 41 |   | 6.04 | % |
| Total interest  bearing liabilities              |       | 57,709                                                        |       | 632                                                           |       | 4.38 | % | 28,981 |   | 216 |   | 2.98 | % |
| Demand deposits—non-interest bearing        |       | 26,411                                                        |       |                                                          |       |   |   | 19,026 |   |   |   |   |   |
| Other non-interest bearing liabilities           |       | 537                                                           |       |                                                          |       |   |   | 507 |   |   |   |   |   |
| Shareholders’  equity                       |       | 12,242                                                        |       |                                                          |       |   |   | 12,014 |   |   |   |   |   |
| Total  liabilities and shareholders’ equity |       | $                                                             | 96,899     |                                                          |       |   |   |   | $ | 60,528 |   |   |   |   |   |
|                                             |       |                                                               |       |                                                          |       |   |   |   |   |   |   |   |   |
| Net interest  income                             |       |                                                          |       | $                                                             | 1,153      |   |   |   |   |   | $ | 710 |   |   |   |
|                                             |       |                                                          |       |                                                               |       |   |   |   |   |   |   |   |   |
| Interest rate spread (3)                         |       |                                                          |       |                                                          |       | 3.86 | % |   |   |   |   | 4.20 | % |
| Net interest  margin (4)                         |       |                                                          |       |                                                          |       | 5.33 | % |   |   |   |   | 5.50 | % |

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(1)                                  Non-accrual loans areincluded in average loans.

(2)                                  Interest income includesloan fees of $49,000 for the three months ended December 31, 2006 and $30,000for the three months ended December 31, 2005.

(3)                                  Interest rate spreadrepresents the difference between the average yield on interest earning assetsand the average cost of interest bearing liabilities.

(4)                                  Net interest marginrepresents annualized net interest income as a percentage of average interestearning assets.

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

The following table presents theextent to which changes in volume, changes in interest rates, and changes inthe interest rates times the changes in volume of interest earning assets andinterest bearing liabilities affected the Bank’s interest income and interestexpense during the period indicated. Information is provided on changes in eachcategory due to (1) changes attributable to changes in volume (change involume times the prior period interest rate), (2) changes attributable tochanges in interest rate (changes in rate times the prior period volume), and(3) changes attributable to changes in rate/volume (changes in interestrate times changes in volume). Changes attributable to the combined impact ofvolume and rate have been allocated proportionally to the changes due to volumeand the changes due to rate (in thousands):
| ** **                                 | ** ** | **Three Months Ended December 31, 2006  Compared to  Three Months Ended December 31, 2005** | ** ** |
|--------------------------------------------|------------|----------------------------------------------------------------------------------------------------------------------------------------------------|------------|
| ** **                                 | ** ** | **Change Due to Volume**                                                                                                            | ** ** | **Change Due to Rate** | ** ** | **Total Change** | ** ** |
| Interest Earning  Assets:                  |       |                                                                                                                                               |       |   |   |   |   |
| Loans                                      |       | $                                                                                                                                                  | 621        |   | $ | 102 |   | $ | 723 |   |
| Taxable investment securities              |       | (17                                                                                                                                                | )          | 2 |   | (15 | ) |
| Federal funds sold                         |       | 177                                                                                                                                                |       | 13 |   | 190 |   |
| Interest bearing deposits with other Banks |       | (36                                                                                                                                                | )          | — |   | (36 | ) |
| Increase in  interest income               |       | $                                                                                                                                                  | 745        |   | $ | 117 |   | $ | 862 |   |
|                                       |       |                                                                                                                                                    |       |  |   |  |   |
| Interest Bearing  Liabilities:             |       |                                                                                                                                               |       |   |   |   |   |
| NOW and money market deposit accounts      |       | $                                                                                                                                                  | 181        |   | $ | 45 |   | $ | 226 |   |
| Savings deposits                           |       | —                                                                                                                                             |       | 2 |   | 2 |   |
| Time deposits                              |       | 96                                                                                                                                                 |       | 67 |   | 163 |   |
| Short-term borrowings                      |       | 24                                                                                                                                                 |       | 1 |   | 25 |   |
| Long term borrowings                       |       | —                                                                                                                                             |       | — |   | — |   |
| Increase in  interest expense              |       | 301                                                                                                                                                |       | 115 |   | 416 |   |
| Increase in net  interest income           |       | $                                                                                                                                                  | 444        |   | $ | 2 |   | $ | 446 |   |

 

***Provision for Loan Losses***

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

For the three months ended December 31, 2006, the Bankmade $75,000 in provisions for loan losses, compared to $45,000 for the threemonths ended December 31, 2005. The Bank charged off $51,000 in commercial andconsumer loans and had recoveries of loans previously charged-off of $1,000 fornet charge-offs of $50,000. The factors combined increased the Allowance forLoan Losses to $575,000 or 0.83% of the portfolio at December 31, 2006. Thisamount represents management’s estimate of probable losses inherent in theportfolio.

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***OtherIncome***

For the three months endedDecember 31, 2006, other income decreased $5,000 from $115,000 during the threemonths ended December 31, 2005, to $105,000. The majority of the decreasewas related to the Company’s ownership interest in PGI Equity Partners, LP,which is the real estate investment company that owns and manages the propertywhere the Company’s offices are located.

***Non-InterestExpenses***

For the three months endedDecember 31, 2006, salaries and employee benefits were $526,000 compared to$391,000 for the three months ended December 31, 2005.  Stock based compensation recognized for thethree months ended December 31, 2006 totaled $50,000.  Occupancy and equipment expenses for thethree months ended December 31, 2006 increased from $61,000 for the threemonths ended December 31, 2005 to $112,000. The increase in salaries and employee benefits and occupancy andequipment expenses was due to the Bank’s continued growth and the correspondingaddition of new employees.  Professionalfees paid for accounting and legal services, including regulatory filings andaudit services, totaled $55,000 and $124,000, respectively, for the threemonths ended December 31, 2006 and 2005. The decrease was due to the completion of the merger and thecorresponding reduction in legal and regulatory fees.  Other expenses increased from $278,000 forthe three months ended December 31, 2005, to $354,000 for the three monthsended December 31, 2006.  This increasein other expenses was also a result of the growth of the Bank and the increasein employees.

***Income Taxes***

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

**Financial Condition**

***Loan Portfolio***

Net loans increased $8,740,000 (14.7%) to $68,360,000from $59,620,000 between December 31, 2006 and September 30, 2006. Theconcentration within the portfolio has shifted over time from the previousconcentration of agricultural loans to real estate and commercial loans.

***Loan Portfolio Mix***

The following tables set forth the composition of theloan portfolio (in thousands):

|                                  | ** ** | **As of December 31,  2006** | ** ** | **As of September 30,  2006** | ** ** |
|----------------------------------|------------|---------------------------------------------|------------|----------------------------------------------|------------|
| Agriculture                      |       | $                                           | 3,006      |                                         | $          | 2,989 |   |
| Commercial                       |       | 23,929                                      |       | 19,068                                       |       |
| Commercial real  estate          |       | 19,891                                      |       | 18,582                                       |       |
| Residential real  estate         |       | 11,377                                      |       | 8,221                                        |       |
| Construction  real estate        |       | 4,053                                       |       | 4,329                                        |       |
| Consumer and  other              |       | 6,679                                       |       | 6,981                                        |       |
| Gross Loans                      |       | 68,935                                      |       | 60,170                                       |       |
| Less: allowance  for loan losses |       | (575                                        | )          | (550                                         | )          |
|                             |       |                                        |       |                                         |       |
| Net Loans                        |       | $                                           | 68,360     |                                         | $          | 59,620 |   |

 

 

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

For the three month period ended December 31, 2006,the majority of new loan growth came from the Austin market reflecting a broader,more diverse mix of industries and borrowers.

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

***Loan Maturities***

The following table presents the contractual maturityranges for agricultural, commercial, real estate and consumer loans outstandingat December 31, 2006, and at September 30, 2006, and also presents for eachmaturity range the portion of loans that have fixed interest rates or interestrates that fluctuate over the life of the loan in accordance with changes inthe interest rate environment as represented by the base rate (in thousands):
| ** **                       | ** ** | **Due in One Year  or Less** | ** ** | **Due after One Year  Through  Five Years** | ** ** | **Due after  Five Years** | ** ** | ** **         | ** ** |
|----------------------------------|------------|--------------------------------------------------|------------|-----------------------------------------------------------------|------------|-------------------------------------|------------|--------------------|------------|
| **December 31, 2006**  | ** ** | **Fixed  Rate**                                  | ** ** | **Floating  Rate**                                              | ** ** | **Fixed  Rate**                     | ** ** | **Floating  Rate** | ** ** | **Fixed  Rate** | ** ** | **Floating  Rate** | ** ** | **Total** | ** ** |
| Agricultural                     |       | $                                                | 312        |                                                            | $          | 1,874                               |       | $                  | 10         |   | $ | 309 |   | $ | — |   | $ | 501 |   | $ | 3,006 |   |
| Real estate —  residential  |       | 2,533                                            |       | 2,845                                                           |       | 2,498                               |       | 1,976              |       | 1,525 |   | — |   | 11,377 |   |
| Real estate —  commercial   |       | 338                                              |       | 3,510                                                           |       | 223                                 |       | 13,152             |       | — |   | 2,668 |   | 19,891 |   |
| Real estate —  construction |       | 517                                              |       | 630                                                             |       | —                              |       | 2,581              |       | — |   | 295 |   | 4,023 |   |
| Commercial                       |       | 884                                              |       | 13,416                                                          |       | 1,051                               |       | 8,500              |       | — |   | 108 |   | 23,959 |   |
| Consumer and  other              |       | 483                                              |       | 4,952                                                           |       | 648                                 |       | 543                |       | 30 |   | 23 |   | 6,679 |   |
| **Total**                        |       | $                                                | 5,067      |                                                            | $          | 27,227                              |       | $                  | 4,430      |   | $ | 27,061 |   | $ | 1,555 |   | $ | 3,595 |   | $ | 68,935 |   |

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

 

As of December 31, 2006, 46.8% of the loan portfolio,or $32,294,000, matured or re-priced within one year or less and $57,883,000 ofthe loan portfolio, or 84.0%, were variable rate loans.   At September 30, 2006, 46.31% of the loanportfolio or $27,866,000, matured or re-priced within one year or less and$50,818,000 of these loans, or 84.5%, were variable rate loans.

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***Investment Securities***

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

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

|                                      | ** ** | **As of  December 31, 2006** | ** ** | **As of  September 30, 2006** | ** ** |
|--------------------------------------|------------|---------------------------------------------|------------|----------------------------------------------|------------|
| ** **                           | ** ** | **Amortized  Cost**                         | ** ** | **Fair  Value**                              | ** ** | **Amortized  Cost** | ** ** | **Fair  Value** | ** ** |
| Securities Available  for Sale:      |       |                                        |       |                                         |       |   |   |   |   |
| U.S. Government Agencies             |       | $                                           | 13         |                                         | $          | 16 |   | $ | 14 |   | $ | 14 |   |
| Other mortgage backed securities     |       | 2                                           |       | 2                                            |       | 2 |   | 2 |   |
|                                 |       |                                        |       |                                         |       |   |   |   |   |
| Total Securities  Available for Sale |       | $                                           | 15         |                                         | $          | 15 |   | $ | 16 |   | $ | 16 |   |
|                                 |       |                                             |       |                                              |       |  |   |  |   |
|                                 |       |                                        |       |                                         |       |   |   |   |   |
| Securities Held  to Maturity:        |       |                                        |       |                                         |       |   |   |   |   |
| U.S. Government Agencies             |       | $                                           | 1,342      |                                         | $          | 1,340 |   | $ | 2,000 |   | $ | 1,996 |   |
| Other mortgage backed securities     |       | 5                                           |       | 4                                            |       | 6 |   | 5 |   |
|                                 |       |                                        |       |                                         |       |   |   |   |   |
| Total Securities  Held to Maturity   |       | $                                           | 1,347      |                                         | $          | 1,344 |   | $ | 2,006 |   | $ | 2,001 |   |

 

U.S. Treasury securities and securities of U.S. Governmentagencies generally consist of fixed rate securities with maturities of threemonths to five years. Other mortgage backed securities consists of fixed ratemortgage pass-through securities with a maturity of five to fifteen years.

***Asset Quality***

The following table sets forth the amount of non-performingloans and non-performing assets as of December 31, 2006, and September 30, 2006(in thousands except for percentages):

|                                                          | ** ** | **As of  December 31,  2006** | ** ** | **As of  September 30,  2006** | ** ** |
|----------------------------------------------------------|------------|-----------------------------------------|------------|------------------------------------------|------------|
| Non-accruing  loans                                      |       | $                                       | 104        |                                     | $          | 123 |   |
| Loans 90 days or  more past due, still accruing interest |       | —                                  |       | —                                   |       |
|                                                     |       |                                    |       |                                     |       |
| Total non-performing  loans                              |       | 104                                     |       | 123                                      |       |
| Other real  estate owned                                 |       | 55                                      |       | 41                                       |       |
| Other  repossessed assets                                |       | 5                                       |       | 5                                        |       |
|                                                     |       |                                    |       |                                     |       |
| Total non-performing  assets                             |       | $                                       | 164        |                                     | $          | 169 |   |
|                                                     |       |                                         |       |                                          |       |
| Total non-performing  loans to total loans               |       | 0.24                                    | %          | 0.20                                     | %          |
| Allowance for  loan losses to non-performing loans       |       | 553                                     | %          | 447                                      | %          |
| Total non-performing  assets to total assets             |       | 0.17                                    | %          | 0.17                                     | %          |

 

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***Non-performing Loans***

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

During the ordinary course ofbusiness, management becomes aware of borrowers that may not be able to meetthe contractual requirements of loan agreements. Such loans are placed underclose supervision with consideration given to placing the loan on a non-accrualstatus, increasing the allowance for loan losses, and (if appropriate) partialor full charge-off. After a loan is placed on non-accrual status, any currentyear interest previously accrued but not yet collected is reversed againstcurrent income. When payments are received on non-accrual loans, such paymentsare applied to principal and not taken into income. Loans are not placed backon accrual status unless all back interest and principal payments are made. Ifinterest on non-accrual loans had been accrued, such income would have amountedto approximately $2,600 for the three months ended December 31, 2006 and $1,400for the three months ended December 31, 2005. This amount was not includedin interest income during this period.

Under Federal and Texas law, anyloan 90 or more days past due is required to be placed on non-accrual basisunless specifically identified mitigating circumstances exist. Our policy is toplace loans 90 days past due on non-accrual status. An exception is madewhen management believes the loan is fully secured and in process ofcollection. Non-accrual loans are further classified as impaired whenunderlying collateral is not sufficient to cover the loan balance and it isprobable that we will not fully collect all principal and interest. As ofDecember 31, 2006 and September 30, 2006, we had $104,000 and $123,000 innon-accrual loans respectively. Loans contractually past due over 90 dayswhich continued to accrue interest totaled $0 on December 31, 2006 and $0 onSeptember 30, 2006, based upon specific information available at that timeto management.  In compliance with thesestatutes we have developed pro forma financial statements assuming that noloans will continue to accrue interest if they become 90 days past due,and instead transfer all such loans to non-accruing status.

A “troubled debt restructuring”is a restructured loan upon which interest accrues at a below market rate orupon which certain principal has been forgiven so as to aid the borrower in thefinal repayment of the loan, with any interest previously accrued, but not yetcollected, being reversed against current income. Interest is accrued basedupon the new loan terms. There were no troubled debt restructurings outstandingas of December 31, 2006 and September 30, 2006*.*

Non-performing assets alsoconsist of other repossessed assets and other real estate owned (“OREO”). OREOrepresents properties acquired through foreclosure or other proceedings and isrecorded at the lower of cost or fair market value less the estimated cost ofdisposal. OREO is evaluated regularly to ensure that the recorded amount issupported by its current fair market value. Valuation allowances to reduce thecarrying amount to fair market value less estimated costs of disposal arerecorded as necessary. Revenues and expenses from the operations of OREO andchanges in the valuation are included in other income and other expenses on theincome statement. As of December 31, 2006, and September 30, 2006, we had$55,000 and $41,000, respectively, in other real estate owned.  The property consists of two single familydwellings located in Dalhart, Texas. Repossessed assets totaled $5,000 at December 31, 2006 and September 30,2006.

***Sources of Funds***

*General*

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

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*Deposits*

We offer a variety of depositaccounts with a range of interest rates and terms. Core deposits consist ofchecking accounts (non-interest bearing), “NOW” accounts, savings accounts, andnon-public certificates of deposit. These deposits, along with public funddeposits and short-term borrowings, are used to support our asset base.Deposits are obtained predominantly from the geographic trade areas surroundingour office locations. We rely primarily on customer service and long-standingrelationships with customers to attract and retain deposits; however, marketinterest rates and rates offered by competing financial institutionssignificantly affect our ability to attract and retain deposits.

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

|                                           | ** ** | **As of December 31, 2006** | ** ** | **As of September 30, 2006** | ** ** |
|-------------------------------------------|------------|-------------------------------------------------|------------|--------------------------------------------------|------------|
| Time deposits $100,000  and over:         |       |                                            |       |                                             |       |
| Maturing within  three months             |       | $                                               | 4,036      |                                             | $          | 1,949 |   |
| After three  months but within six months |       | 1,397                                           |       | 3,982                                            |       |
| After six months  but within 12 months    |       | 3,205                                           |       | 3,058                                            |       |
| After 12 months                           |       | —                                          |       | —                                           |       |
|                                      |       |                                            |       |                                             |       |
| Total time deposits  $100,000 and over    |       | $                                               | 8,638      |                                             | $          | 8,989 |   |

 

*Returnon Equity and Assets*

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

|                        | ** ** | **For the Three Months  Ended December 31, 2006** | ** ** | **For the Three Months  Ended December 31, 2005** | ** ** |
|------------------------|------------|---------------------------------------------------------------------------------|------------|---------------------------------------------------------------------------------|------------|
| Return on assets       |       | 0.57                                                                            | %          | -0.13                                                                           | %          |
| Return on equity       |       | 4.12                                                                            | %          | -0.68                                                                           | %          |
| Dividend payout ratio  |       | 0                                                                               | %          | 0                                                                               | %          |
| Equity to assets ratio |       | 13.92                                                                           | %          | 17.92                                                                           | %          |

 

**Capital Resources**

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

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

The Bank was in full compliancewith all applicable capital adequacy requirements as of December 31, 2006 andSeptember 30, 2006. The required and actual amounts and ratios for the Bank asof December 31, 2006 and September 30, 2006, are presented below:
| ** **                                | ** ** | **Actual** | ** ** | **For Capital  Adequacy Purposes** | ** ** | **To Be Well  Capitalized Under  Prompt Corrective  Action Provisions** | ** ** |
|-------------------------------------------|------------|------------|------------|----------------------------------------------|------------|--------------------------------------------------------------------------------------------------|------------|
| ** **                                | ** ** | **Amount** | ** ** | **Ratio**                                    | ** ** | **Amount**                                                                                       | ** ** | **Ratio** | ** ** | **Amount** | ** ** | **Ratio** | ** ** |
| As of December 31, 2006                   |       |       |       |                                         |       |                                                                                             |       |   |   |   |   |   |   |
| Tier 1 capital  (to average assets)       |       | $          | 8,474      |                                         | 9.44       | %                                                                                                | $          | 3,591 |   | 4 | % | $ | 4,489 |   | 5 | % |
| Tier 1 capital  (to risk-weighted assets) |       | 8,474      |       | 11.16                                        | %          | 3,037                                                                                            |       | 4 | % | 4,555 |   | 6 | % |
| Total Capital  (to risk-weighted assets)  |       | 9,049      |       | 11.92                                        | %          | 6,074                                                                                            |       | 8 | % | 7,592 |   | 10 | % |
|                                           |            |            |            |                                              |            |                                                                                                  |            |  |  |  |  |  |  |  |  |  |

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

 

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

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

There have been no significant changes in the Company’s internal controlsfor financial reporting or in other factors that could significantly affectthese controls, including any significant deficiencies or material weaknessesof internal controls that would require corrective action.  In connection with the new rules, the Companyis currently in the process of further reviewing and documenting its disclosurecontrols and procedures, including its internal accounting controls, and may fromtime to time make changes aimed at enhancing their effectiveness and ensuringthat the Company’s systems evolve with its business.

27

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**PART II.                OtherInformation**

**Item 1.                    *Legal Proceedings***

None

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

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

From the offering proceeds, wepaid our organizing shareholder and affiliate, Treaty Oak Holdings, Inc. (“TOHI”)for reimbursement of expenses and advances on our behalf in connection with ouroffering and repayment of the amount due under a convertible promissory note.TOHI owned approximately 39% of our common stock, but was acquired by us in atransaction that closed on November 15, 2006. We contributed to the capital ofthe Bank and paid operating expenses including repayment of certain costspreviously paid by TOHI. We also repaid principal and interest under unsecuredpromissory notes issued in connection with the purchase price of the Bank, andhave paid ongoing operating expenses. These payments are summarized in thetable below:

 

|                                                                                                                                                                                           | ** ** | **As of**                  | ** ** |
|-------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------|------------|---------------------------------|------------|
| ** **                                                                                                                                                                                | ** ** | **December 31, 2006** | ** ** |
| Gross proceeds from  sale of shares                                                                                                                                                       |       | $                               | 13,276,271 |   |
| Amounts receivable as  of December 31, 2004                                                                                                                                               |       | —                          |       |
| Repayment  of offering and start-up costs under Expense Reimbursement Agreement to  Treaty Oak Holdings, Inc., including offering costs of $500,000 and  pre-opening expenses of $275,000 |       | (775,000                        | )          |
| Repayment  of note payable to Treaty Oak Holdings, Inc., including accrued interest of  approximately $7,000                                                                              |       | (507,302                        | )          |
| Repayment  of notes payable for the acquisition of Texline State Bank including accrued  interest of approximately $29,000                                                                |       | (1,015,332                      | )          |
| Contribution to the  capital of the Bank                                                                                                                                                  |       | (7,500,000                      | )          |
| Payments to directors  and officers (bonuses and directors’ fees)                                                                                                                    |       | (194,306                        | )          |
| Payments to officers  (salary and benefits)                                                                                                                                               |       | (322,108                        | )          |
| Other payments to  affiliates for services                                                                                                                                                |       | (149,057                        | )          |
| Limited partnership  investment in affiliated limited partnership                                                                                                                         |       | (1,030,000                      | )          |
| Loan to affiliated  company                                                                                                                                                               |       | (46,037                         | )          |
| Repurchase of shares  issued                                                                                                                                                              |       | (50,005                         | )          |
| Payment of additional  operating expenses (estimated)                                                                                                                                     |       | (944,000                        | )          |
| Remaining net proceeds                                                                                                                                                                    |       | $                               | 743,124    |   |

 

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

## None.

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

A Special Meeting of Shareholders was held on October 24, 2006.  Of the 2,636,926 shares of common stockoutstanding and entitled to vote at the meeting, 1,838,685 shares were present,either in person or by proxy.  Thefollowing proposals were submitted to a vote of the shareholders at themeeting:

1.             To approve andadopt an Agreement and Plan of Merger between the Company and Treaty OakHoldings, Inc.

2.             To elect Bill F.Schneider to serve on the Company’s Board of Directors as a Class II directoruntil his successor is duly elected and qualified.

The above proposals wereapproved and the results of the voting are summarized in the following table:
| Proposal                                           | ** ** | **For**   | ** ** | **Against** | ** ** | **Withheld** | ** ** | **Abstain** |
|----------------------------------------------------|------------|-----------|------------|-------------|------------|--------------|------------|-------------|
| Approve the merger                                 |       | 1,823,379 |       | 12,005      |       | —       |       | 3,301       |
|                                               |       |      |       |        |       |         |       |        |
| Elect Bill F. Schneider to  the Board of Directors |       | 1,835,384 |       | —      |       | 3,301        |       | —      |

 

**Item 5.                    *Other Information***

None.

**Item 6.                    *Exhibits***
| Exhibit  Number | ** ** | **Exhibit Title**                                                                                                                 |
|-----------------|------------|-----------------------------------------------------------------------------------------------------------------------------------|
| 2.1(1)          |       | Agreement and Plan of Merger, dated October 3, 2006,  between Treaty Oak Holdings, Inc. and the Company                           |
|            |       |                                                                                                                              |
| 3.1(2)          |       | Amended and Restated Articles of Incorporation                                                                                    |
|            |       |                                                                                                                              |
| 3.2(3)          |       | By-laws                                                                                                                           |
|            |       |                                                                                                                              |
| 4.1(3)          |       | Specimen Common Stock Certificate, $.01 par value  per share                                                                      |
|            |       |                                                                                                                              |
| 4.2(3)          |       | See Exhibits 3.1 and 3.2 for provisions of the  Articles of Incorporation and By-laws defining rights of holders of  Common Stock |
|            |       |                                                                                                                              |
| 10.1(3)         |       | Amended and Restated Building Lease between PGI  Equity Partners, L.P. and Treaty Oak Bank                                        |
|            |       |                                                                                                                              |
| 10.2(3)         |       | Expense Reimbursement Agreement between Treaty Oak  Holdings, Inc. and Treaty Oak Bancorp, Inc.                                   |
|            |       |                                                                                                                              |
| 10.3(3)         |       | Form of Promotional Shares Lock-In Agreement                                                                                      |
|            |       |                                                                                                                              |
| 10.4(3)         |       | Form of Escrow Agreement between Treaty Oak Bancorp,  Inc. and TIB—The Independent Bankers Bank                              |
|            |       |                                                                                                                              |
| 10.5(3)         |       | Form of Treaty Oak Bancorp Shareholders’ Warrant  Agreement                                                                  |
|            |       |                                                                                                                              |

 

29

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| 10.6(2)* |   | Treaty Oak Bancorp, Inc. 2004 Stock Incentive Plan  (amended and restated as of May 20, 2004)                                                     |
|----------|--------|---------------------------------------------------------------------------------------------------------------------------------------------------|
|     |   |                                                                                                                                              |
| 10.7(3)* |   | Form of Indemnification Agreement between Treaty Oak  Bancorp, Inc. and its directors and officers, and those of the Bank                         |
|     |   |                                                                                                                                              |
| 10.8(3)  |   | Registration Rights Agreement between Treaty Oak Bancorp,  Inc. and Treaty Oak Holdings, Inc.                                                     |
|     |   |                                                                                                                                              |
| 10.9(4)* |   | Employment Agreement, dated September 27, 2006,  between Treaty Oak Bancorp, Inc. and Jeffrey L. Nash                                             |
|     |   |                                                                                                                                              |
| 10.10(5) |   | Form of Warrant                                                                                                                                   |
|     |   |                                                                                                                                              |
| 10.11(5) |   | Form of Registration Rights Agreement with former shareholders  of Treaty Oak Holdings, Inc.                                                      |
|     |   |                                                                                                                                              |
| 10.12(5) |   | Form of Registration Rights Agreement with former  warrantholders of Treaty Oak Holdings, Inc.                                                    |
|     |   |                                                                                                                                              |
| 21(5)    |   | Subsidiaries                                                                                                                                      |
|     |   |                                                                                                                                              |
| 31.1     |   | Certification of Chief Executive Officer required by  Rule 13a-14(a)/15d-14(a) under the Exchange Act**                                           |
|     |   |                                                                                                                                              |
| 31.2     |   | Certification of Chief Financial Officer required by  Rule 13a-14(a)/15d-14(a) under the Exchange Act**                                           |
|     |   |                                                                                                                                              |
| 32.1     |   | Certification of Chief Executive Officer pursuant to  18 U.S.C. Section 1350, as adopted pursuant to Section 906 of Sarbanes-Oxley  Act of 2002** |
|     |   |                                                                                                                                              |
| 32.2     |   | Certification of Chief Financial Officer pursuant to  18 U.S.C. Section 1350, as adopted pursuant to Section 906 of Sarbanes-Oxley  Act of 2002** |

----

*      Indicates management contract or compensatory plan orarrangement.

(1)   Incorporated by reference to the Company’sCurrent Report on Form 8-K filed October 10, 2006.

(2)   Incorporated by reference to the Company’sRegistration Statement on Form S-8 filed October 22, 2004.

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

(4)   Incorporated by reference to the Company’sCurrent Report on Form 8-K filed November 1, 2006.

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

**   Filed herewith.

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**SIGNATURES**

Pursuant to therequirements of the Securities Exchange Act of 1934, the Registrant has dulycaused this report to be signed on its behalf by the undersigned, thereuntoduly authorized.
|                          | **TREATY OAK BANCORP, INC.** |
|--------------------------|------------------------------|
|                     |                         |   |
| Dated: February 14, 2007 | By:                          | /s/ Jeffrey L. Nash |
|                     |                         | Jeffrey L. Nash, President and Chief Executive  Officer |
|                     |                         |   |
|                     | By:                          | /s/ Coralie S. Pledger |
|                     |                         | Coralie S. Pledger, Acting Chief Financial Officer |

 

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