** **

**UNITEDSTATES**

**SECURITIES AND EXCHANGE COMMISSION**

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

###### ** **

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

###### ** **

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

 

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

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

 

# **Commission File Number: 333-112325**

# ** **

**Treaty Oak Bancorp, Inc.**

(Exact name ofregistrant as specified in its charter)

 

**Texas**

(State or otherjurisdiction of

corporation ororganization)

 

**20-0413144**

(I.R.S. EmployerIdentification Number)

 

**101Westlake Drive, Austin, Texas**

(Address ofPrincipal Executive Offices)

 

**78746**

(Zip Code)

 

**(512)617-3600**

(Registrant’stelephone number, including area code)

 

Indicate by check markwhether the issuer (1) has filed all reports required to be filed by Section 13or 15(d) of the Securities Exchange Act of 1934 during the preceding 12months (or for such shorter period that the registrant was required to file****such reports), and (2) has been subject to such filingrequirements for the past 90 days.

**Yes****x      No.****o**

 

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

**Yes****o      No.****x**

 

Indicate thenumber of shares outstanding of each of the issuer’s classes of common stock asof the close of business on February 14, 2008.

 
| $0.01 Par Value Common Stock |   | 2,969,739 shares |
|------------------------------|--------|------------------|

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

 

 

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**QUARTERLYREPORT ON FORM 10-QSB**

**FOR THEPERIOD ENDED DECEMBER 31, 2007**

**TABLE OFCONTENTS**

 
| ** **        | ** ** | ** **                                                                                                                     | ** ** |
|-------------------|------------|--------------------------------------------------------------------------------------------------------------------------------|------------|
| **Part I.**  | ** ** | **Financial Information**                                                                                                      |       |
|              |       |                                                                                                                           |       |
| **Item 1.**       | ** ** | *Financial Statements*                                                                                                         |       |
|              |       |                                                                                                                           |       |
|              |       | Consolidated  Balance Sheets at December 31, 2007 (unaudited) and September 30,  2007 (audited)                      |       |
|              |       |                                                                                                                           |       |
|              |       | Consolidated  Statements of Operations for the Three Months Ended December 31, 2007  and 2006 (unaudited)                 |       |
|              |       |                                                                                                                           |       |
|              |       | Consolidated  Statement of Changes in Shareholders’ Equity for the Three Months Ended  December 31, 2007 (unaudited) |       |
|              |       |                                                                                                                           |       |
|              |       | Consolidated  Statements of Cash Flows for the Three Months Ended December 31, 2007  and 2006 (unaudited)                 |       |
|              |       |                                                                                                                           |       |
|              |       | Notes to Consolidated Financial  Statements (unaudited)                                                                        |       |
|              |       |                                                                                                                           |       |
| **Item 2.**       | ** ** | *Management’s Discussion and  Analysis of Financial Condition and Results of Operations*                                  |       |
|              |       |                                                                                                                           |       |
| **Item 3.**       | ** ** | *Controls and Procedures*                                                                                                      |       |
|              |       |                                                                                                                           |       |
| **Part II.** | ** ** | **Other  Information**                                                                                                         |       |
|              |       |                                                                                                                           |       |
| **Item 1.**       | ** ** | *Legal Proceedings*                                                                                                            |       |
|              |       |                                                                                                                           |       |
| **Item 2.**       | ** ** | *Unregistered Sales of Equity  Securities and Use of Proceeds*                                                                 |       |
|              |       |                                                                                                                           |       |
| **Item 3.**       | ** ** | *Defaults Upon Senior  Securities*                                                                                             |       |
|              |       |                                                                                                                           |       |
| **Item 4.**       | ** ** | *Submission of Matters to a  Vote of Security Holders*                                                                         |       |
|              |       |                                                                                                                           |       |
| **Item 5.**       | ** ** | *Other Information*                                                                                                            |       |
|              |       |                                                                                                                           |       |
| **Item 6.**       | ** ** | *Exhibits*                                                                                                                     |       |
|              |       |                                                                                                                           |       |
|              |       | Signatures                                                                                                                     |       |

 

This Form 10-QSBcontains forward-looking statements consisting of estimates with respect to thefinancial condition, results of operations, and other business of Treaty OakBancorp, Inc., that are subject to various factors which could causeactual results to differ materially from those estimates. Factors that couldinfluence the estimates include changes in the national, regional, and localmarket conditions, legislative and regulatory conditions, and an adverseinterest rate environment.

 

i

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**Treaty Oak Bancorp, Inc.**

**Consolidated Balance Sheets (unaudited)**

**December 31, 2007 and September 30, 2007**

**(Dollars In Thousands, Except Par Value and ShareAmounts)**

** **
| ** **                                                                                                   | ** ** | **December 31,** | ** ** | **September 30,** | ** ** |
|--------------------------------------------------------------------------------------------------------------|------------|-----------------------|------------|------------------------|------------|
| **ASSETS**                                                                                                   | ** ** | **2007**              | ** ** | **2007 (1)**      | ** ** |
|                                                                                                         |       |                  |       |                   |       |
| Cash and cash  items                                                                                         |       | $                     | 337        |                   | $          | 435 |   |
| Due from banks                                                                                               |       | 5,079                 |       | 2,670                  |       |
| Federal funds  sold                                                                                          |       | 14,190                |       | 19,224                 |       |
| Total cash and  cash equivalents                                                                             |       | 19,606                |       | 22,329                 |       |
|                                                                                                         |       |                  |       |                   |       |
| Securities  available for sale                                                                               |       | 6                     |       | 7                      |       |
| Securities held  to maturity, fair value of $1,214 and $354, respectively                                    |       | 1,209                 |       | 354                    |       |
| Investment in  Federal Home Loan Bank stock, at cost                                                         |       | 242                   |       | 224                    |       |
| Investment in  Independent Banker’s Financial Corporation stock, at cost                                |       | 102                   |       | 102                    |       |
| Due from time  deposits                                                                                      |       | 1,198                 |       | 198                    |       |
| Loans, net                                                                                                   |       | 85,071                |       | 83,333                 |       |
| Premises and  equipment, net                                                                                 |       | 6,229                 |       | 6,044                  |       |
| Accrued interest  receivable                                                                                 |       | 637                   |       | 686                    |       |
| Goodwill and  other intangibles, net                                                                         |       | 1,193                 |       | 1,195                  |       |
| Other assets                                                                                                 |       | 692                   |       | 814                    |       |
| Total assets                                                                                                 |       | $                     | 116,185    |                   | $          | 115,286 |   |
|                                                                                                         |       |                  |       |                   |       |
| LIABILITIES AND  SHAREHOLDERS’ EQUITY                                                                   |       |                  |       |                   |       |
|                                                                                                         |       |                  |       |                   |       |
| Deposits:                                                                                                    |       |                  |       |                   |       |
| Noninterest-bearing  demand                                                                                  |       | $                     | 21,743     |                   | $          | 30,158 |   |
| NOW, money  market and savings                                                                               |       | 46,492                |       | 36,371                 |       |
| Time deposits                                                                                                |       | 29,613                |       | 30,188                 |       |
| Total deposits                                                                                               |       | 97,848                |       | 96,717                 |       |
|                                                                                                         |       |                  |       |                   |       |
| Accounts payable  and accrued expenses                                                                       |       | 305                   |       | 413                    |       |
| Accrued interest  payable                                                                                    |       | 269                   |       | 214                    |       |
| Notes payable                                                                                                |       | 2,588                 |       | 2,604                  |       |
| Other  liabilities                                                                                           |       | 31                    |       | 28                     |       |
| Total  liabilities                                                                                           |       | 101,041               |       | 99,976                 |       |
|                                                                                                         |       |                  |       |                   |       |
| 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; 2,980,948 and 2,962,484,  respectively, issued |       | 30                    |       | 30                     |       |
| Paid-in capital                                                                                              |       | 18,873                |       | 18,758                 |       |
| Accumulated  deficit                                                                                         |       | (3,654                | )          | (3,428                 | )          |
| Less shares held  in treasury, at cost (11,209 and 6,003 shares, respectively)                               |       | (105                  | )          | (50                    | )          |
| Total  shareholders’ equity                                                                             |       | 15,144                |       | 15,310                 |       |
| Total  liabilities and shareholders’ equity                                                             |       | $                     | 116,185    |                   | $          | 115,286 |   |

 

See Notes toConsolidated Financial Statements (unaudited)

 

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(1)  Derivedfrom Audited Consolidated Financial Statement

 

3

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**TreatyOak Bancorp, Inc.**

**ConsolidatedStatements of Operations (unaudited)**

**ThreeMonths Ended December 31, 2007 and 2006**

**(DollarsIn Thousands, Except Share and Per Share Amounts)**

 
| ** **                                           | ** ** | **Three Months Ended** | ** ** | **Three Months Ended** | ** ** |
|------------------------------------------------------|------------|----------------------------------|------------|----------------------------------|------------|
| ** **                                           | ** ** | **December**                     | ** ** | **December**                     | ** ** |
|                                                 |       | **31, 2007**                     | ** ** | **31, 2006**                     |       |
| Interest income:                                     |       |                             |       |                             |       |
| Loans, including  fees                               |       | $                                | 1,816      |                             | $          | 1,545 |   |
| Taxable  securities                                  |       | 33                               |       | 14                               |       |
| Interest on  deposits with other banks               |       | 30                               |       | —                           |       |
| Federal funds  sold                                  |       | 182                              |       | 226                              |       |
| Total interest  income                               |       | 2,061                            |       | 1,785                            |       |
|                                                 |       |                             |       |                             |       |
| Interest  expense:                                   |       |                             |       |                             |       |
| Deposits                                             |       | 722                              |       | 565                              |       |
| Other borrowings                                     |       | 39                               |       | 67                               |       |
| Total interest  expense                              |       | 761                              |       | 632                              |       |
|                                                 |       |                             |       |                             |       |
| Net interest  income                                 |       | 1,300                            |       | 1,153                            |       |
|                                                 |       |                             |       |                             |       |
| Provision for  loan losses                           |       | 86                               |       | 75                               |       |
| Net interest  income after provision for loan losses |       | 1,214                            |       | 1,078                            |       |
|                                                 |       |                             |       |                             |       |
| Noninterest  income:                                 |       |                             |       |                             |       |
| Service charges  on deposit accounts                 |       | 68                               |       | 33                               |       |
| Other  noninterest income                            |       | 39                               |       | 72                               |       |
| Total  noninterest income                            |       | 107                              |       | 105                              |       |
|                                                 |       |                             |       |                             |       |
| Noninterest  expense:                                |       |                             |       |                             |       |
| Salaries and  employee benefits                      |       | 762                              |       | 526                              |       |
| Occupancy and  equipment expenses                    |       | 151                              |       | 112                              |       |
| Accounting and  other professional fees              |       | 196                              |       | 55                               |       |
| Other  noninterest expense                           |       | 438                              |       | 354                              |       |
| Total noninterest  expense                           |       | 1,547                            |       | 1,047                            |       |
|                                                 |       |                             |       |                             |       |
| Net income  (loss)                                   |       | $                                | (226       | )                                | $          | 136 |   |
|                                                 |       |                             |       |                             |       |
| Earnings (loss)  per common share - basic            |       | $                                | (0.08      | )                                | $          | 0.05 |   |
| Earnings (loss)  per common share - diluted          |       | $                                | (0.08      | )                                | $          | 0.05 |   |
|                                                 |       |                             |       |                             |       |
| Weighted average  shares outstanding - basic         |       | 2,964,470                        |       | 2,682,664                        |       |
| Weighted average  shares outstanding - diluted       |       | 2,964,470                        |       | 2,778,017                        |       |

 

See Notes toConsolidated Financial Statements (unaudited)

 

4

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**Treaty Oak Bancorp, Inc.**

**Consolidated Statement of Shareholders’ Equity(unaudited)**

**Three Months Ended December 31, 2007**

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

 
| ** **                                                   | ** ** | ** **            | ** ** | ** **  | ** ** | **Additional**  | ** ** | ** **   | ** ** | ** ** | ** ** | ** ** | ** ** |
|--------------------------------------------------------------|------------|-----------------------|------------|-------------|------------|-----------------|------------|--------------|------------|------------|------------|------------|------------|
| ** **                                                   | ** ** | **Common Stock** | ** ** | **Paid-In** | ** ** | **Accumulated** | ** ** | **Treasury** | ** ** | ** ** | ** ** |
| ** **                                                   | ** ** | **Shares**            | ** ** | **Amount**  | ** ** | **Capital**     | ** ** | **Deficit**  | ** ** | **Stock**  | ** ** | **Total**  | ** ** |
|                                                         |       |                  |       |        |       |            |       |         |       |       |       |       |       |
| Balances at  October 1, 2007                            |       | 2,962,484             |       | 30          |       | 18,758          |       | (3,428       | )          | (50        | )          | 15,310     |       |
|                                                         |       |                  |       |        |       |            |       |         |       | —     |       | —     |       |
| Shares issued  through the exercise of common stock options  |       | 5,000                 |       | —      |       | 41              |       | —       |       | —     |       | 41         |       |
| Shares issued  through the exercise of common stock warrants |       | 140                   |       | —      |       | 1               |       | —       |       | —     |       | 1          |       |
| Purchase of  treasury shares (5,206)                         |       |                  |       | —      |       | —          |       | —       |       | (55        | )          | (55        | )          |
| Non-cash stock  based compensation                           |       | 13,324                |       | —      |       | 73              |       | —       |       | —     |       | 73         |       |
| Net loss                                                     |       | —                |       | —      |       | —          |       | (226         | )          | —     |       | (226       | )          |
|                                                         |       |                  |       |        |       |            |       |         |       |       |       |       |       |
| Balances at December 31,  2007                          |       | 2,980,948             |       | $           | 30         |            | $          | 18,873       |       | $          | (3,654     | )          | $          | (105 | ) | $ | 15,144 |   |
|                                                              |            |                       |            |             |            |                 |            |              |            |            |            |            |            |  |  |  |  |  |

 

See Notes toConsolidated Financial Statements (unaudited)

 

5

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**Treaty Oak Bancorp, Inc.**

**Consolidated Statements of Cash Flows (unaudited)**

**Three Months Ended December 31, 2007 and 2006**

**(Dollars In Thousands)**

 
| ** **                                                                                | ** ** | **Three Months Ended** | ** ** | **Three Months Ended** | ** ** |
|-------------------------------------------------------------------------------------------|------------|----------------------------------|------------|----------------------------------|------------|
| ** **                                                                                | ** ** | **December**                     | ** ** | **December**                     | ** ** |
| ** **                                                                                | ** ** | **31, 2007**                | ** ** | **31, 2006**                | ** ** |
| Cash flows from  operating activities:                                                    |       |                             |       |                             |       |
| Net income  (loss)                                                                        |       | $                                | (226       | )                                | $          | 136 |   |
| Adjustments to  reconcile net income (loss) to net cash provided by operating activities: |       |                             |       |                             |       |
| Provision for  loan losses                                                                |       | 86                               |       | 75                               |       |
| Non-cash stock  based compensation                                                        |       | 73                               |       | 50                               |       |
| Depreciation and  amortization                                                            |       | 112                              |       | 90                               |       |
| Other                                                                                     |       | —                           |       | (7                               | )          |
| Changes in other  operating assets and liabilities:                                       |       |                             |       |                             |       |
| Accrued interest  receivable                                                              |       | 49                               |       | (57                              | )          |
| Other assets                                                                              |       | 122                              |       | (124                             | )          |
| Accrued interest  payable                                                                 |       | 55                               |       | 24                               |       |
| Other  liabilities                                                                        |       | (105                             | )          | (158                             | )          |
| **Net  cash provided by operating activities**                                            |       | 166                              |       | 29                               |       |
|                                                                                      |       |                             |       |                             |       |
| Cash flows from  investing activities:                                                    |       |                             |       |                             |       |
| Proceeds from  maturities and principal repayments on securities - available for sale     |       | 1                                |       | 1                                |       |
| Proceeds from  maturities and principal repayments on securities - held to maturity       |       | 250                              |       | 2,000                            |       |
| Purchases of  securities - held to maturity                                               |       | (1,106                           | )          | (1,340                           | )          |
| Purchases of  time deposits                                                               |       | (1,000                           | )          | —                           |       |
| Net increase in  loans                                                                    |       | (1,824                           | )          | (8,748                           | )          |
| Cash received  from the acquistion of Treaty Oak Holdings, Inc.                      |       | —                           |       | 515                              |       |
| Advances to  affiliates                                                                   |       | —                           |       | 192                              |       |
| Collection of  notes receivable from affiliates                                           |       | —                           |       | 2,821                            |       |
| Purchases of  premises and equipment                                                      |       | (294                             | )          | (38                              | )          |
| Purchases of  correspondent bank stock                                                    |       | (18                              | )          | —                           |       |
| **Net  cash used in investing activities**                                                |       | (3,991                           | )          | (4,597                           | )          |
|                                                                                      |       |                             |       |                             |       |
| Cash flows from  financing activities:                                                    |       |                             |       |                             |       |
| Net increase  (decrease) in deposits                                                      |       | 1,131                            |       | (2,612                           | )          |
| Payments of  principal on mortgage                                                        |       | (16                              | )          | (15                              | )          |
| Payments of  principal on notes payable                                                   |       | —                           |       | (2,483                           | )          |
| Purchases of  treasury shares                                                             |       | (55                              | )          | —                           |       |
| Proceeds from  exercise of warrants                                                       |       | 1                                |       | 18                               |       |
| Proceeds from  exercise of options                                                        |       | 41                               |       | —                           |       |
| **Net  cash provided by (used in) financing activities**                                  |       | 1,102                            |       | (5,092                           | )          |
|                                                                                      |       |                             |       |                             |       |
| Net decrease in  cash and cash equivalents                                                |       | (2,723                           | )          | (9,660                           | )          |
| Cash and cash  equivalents at beginning of period                                         |       | 22,329                           |       | 26,354                           |       |
| Cash and cash  equivalents at end of period                                               |       | $                                | 19,606     |                             | $          | 16,694 |   |

 

SeeNotes to Consolidated Financial Statements (unaudited)

 

6

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**TreatyOak Bancorp, Inc.**

**ConsolidatedStatements of Cash Flows (unaudited)**

**ThreeMonths Ended December 31, 2007 and 2006**

**(DollarsIn Thousands)**

 
| ** **                                          | ** ** | **Three Months Ended** | ** ** | **Three Months Ended** | ** ** |
|-----------------------------------------------------|------------|----------------------------------|------------|----------------------------------|------------|
| ** **                                          | ** ** | **December**                     | ** ** | **December**                     | ** ** |
| ** **                                          | ** ** | **31, 2007**                | ** ** | **31, 2006**                | ** ** |
|                                                |       |                             |       |                             |       |
| Supplemental  disclosures of cash flow information: |       |                             |       |                             |       |
| Non-cash  investing and financing information:      |       |                             |       |                             |       |
| Cash interest  received                             |       | $                                | 2,110      |                             | $          | 1,685 |   |
| Cash interest  paid                                 |       | $                                | 706        |                             | $          | 606 |   |
|                                                |       |                             |       |                             |       |
| Acquisition of  Treaty Oak Holdings, Inc.      |       |                             |       |                             |       |
| Assets acquired,  excluding cash acquired           |       |                             |       | $                                | 1,280      |   |
| Liabilities  assumed                                |       |                             |       | (80                              | )          |
| Issuance of  common stock                           |       |                             |       | (9,093                           | )          |
| Retirement of  comon stock                          |       |                             |       | 8,310                            |       |
| Issuance of  warrants and assumption of options     |       |                             |       | (932                             | )     |
| Net cash  acquired                                  |       |                             |       | $                                | (515       | )  |

 

See Notes toConsolidated Financial Statements (unaudited)

 

7

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**Note 1. Basis of Presentation**

 

Treaty Oak Bancorp, Inc.(the “Company”) is a bank holding company incorporated on November 18,2003, and organized December 8, 2003 for the purpose of holding the commonstock 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, Marble Falls, Texas andin 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 holdingcompany and 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 corporateentity with assets of cash and a note receivable. PGI Capital, Inc. is thegeneral partner 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, theCompany acquired additional 2.5% Class A and 1.25% Class B interestsin the Partnership from the sole remaining minority shareholder, bringing theCompany’s total ownership interest in the Partnership to 51.25% at September 30,2006. TOHI owned 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 owns100.0% of the limited partnership interests in the Partnership as well as the5.0% general partnership interest held by PGI Capital, Inc., thePartnership’s general partner. The Partnership has been consolidated in theCompany’s financial statements since December 31, 2004. TOHI and PGICapital, Inc.’s interests have been accounted for as minority interestsuntil 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.

 

The accompanying unaudited consolidated financial statements have beenprepared in accordance with the instructions to Form 10-QSB and,therefore, do not include all of the disclosures and notes required byaccounting principles generally accepted in the United States of America. Inthe opinion of management, all material adjustments (which are of a normalrecurring nature) considered necessary for a fair presentation have been made. Theresults for the interim period are not necessarily indicative of the results tobe expected for the entire year or any other interim period.

 

New AccountingPronouncements

 

In June 2006, the FASB issued FASB Interpretation No. 48, “Accountingfor Uncertainty in Income Taxes” (FIN 48). FIN 48 prescribes arecognition threshold and a measurement attribute for the financial statementrecognition and measurement of a tax position taken or expected to be taken ina tax return. Benefits from tax positions should be recognized in the financialstatements only when it is more likely than not that the tax position will besustained upon examination by the appropriate taxing authority that would havefull knowledge of all relevant information. A tax position that meets themore-likely-than-not recognition threshold is measured at the largest amount ofbenefit that is greater than fifty percent likely of being realized uponultimate settlement. Tax positions that previously failed to meet themore-likely-than-not recognition threshold should be recognized in the firstsubsequent financial reporting period in which that threshold is met.Previously recognized tax positions that no longer meet themore-likely-than-not recognition threshold should be derecognized in the firstsubsequent financial reporting period in which that threshold is no longer met.FIN 48 also provides guidance on the accounting for and disclosure ofunrecognized tax benefits, interest and penalties. The Company adopted FIN 48 on October 1, 2007. The adoption did nothave any impact on the financial statements.

 

8

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In September 2006,the SEC issued Staff Accounting Bulletin (“SAB”) No. 108, “Considering theEffects of Prior Year Misstatements when Quantifying Misstatements in CurrentYear Financial Statements.” SAB 108 addresses the views of the SEC staffregarding the process of quantifying financial statement misstatements. SECregistrants are expected to reflect the effects of initially applying theguidance in SAB 108 in their annual financial statements covering the firstfiscal year ending after November 15, 2006. The cumulative effect of theinitial application should be reported in the carrying amounts of assets andliabilities as of the beginning of that fiscal year and the offsettingadjustment should be made to the opening balance of retained earnings for thatyear. The Company adopted SAB 108 on October 1, 2007 and the adoption didnot have any impact on the financial statements.

 

InSeptember 2006, the FASB issued SFAS No. 157, “Fair ValueMeasurements”. This Statement defines fair value, establishes a framework formeasuring fair value and expands disclosures about fair value measurements. Itclarifies that fair value is the price that would be received to sell an assetor paid to transfer a liability in an orderly transaction between marketparticipants in the market in which the reporting entity transacts. ThisStatement does not require any new fair value measurements, but rather, it providesenhanced guidance to other pronouncements that require or permit assets orliabilities to be measured at fair value. This Statement is effective forfiscal years beginning after November 15, 2007, with earlier adoptionpermitted. The Company will adoptthis standard in the first quarter of fiscal 2009. The Company does not expect that the adoption ofthis Statement will have a material impact on its financial position, resultsof operation and cash flows.

 

In February 2007,the FASB issued SFAS No. 159, “The Fair Value Option for Financial Assetsand Financial Liabilities”. This Statement permits entities to choose tomeasure many financial assets and financial liabilities at fair value. Unrealizedgains and losses on items for which the fair value option has been elected willbe reported in earnings. SFAS No. 159 is effective for fiscal yearsbeginning after November 15, 2007.  The Company will adopt thisstandard in the first quarter of fiscal 2009. The Company is currentlyevaluating the impact of SFAS No. 159 on its consolidated financialposition, results of operations and cash flows.

 

**Note2. Merger with Organizing Shareholder**

 

On November 15,2006, the Company completed the acquisition of TOHI pursuant to the Agreementand Plan of Merger, dated October 3, 2006. TOHI was one of the fiveorganizing shareholders of the Company and operated as a bank holding companyand significant shareholder of the Company, but otherwise had no activeoperations. The primary purpose of the merger was to achieve certainoperational efficiencies for the Company and its affiliates. The merger wasapproved by the Company’s Board of Directors and also by the Company’sshareholders at a Special Meeting of Shareholders held on October 24,2006. Prior to the consummation of the merger, TOHI held approximately 38% ofthe issued and outstanding shares of the Company’s common stock. Pursuant tothe Merger Agreement, (1) each issued and outstanding share of TOHI’scommon stock, par value $0.01 per share was converted into the right to receive0.8121 shares of the Company’s common stock, par value $0.01 per share, and (2) eachissued and outstanding share of TOHI’s preferred stock, par value $10.00 pershare, was converted into the right to receive 1.2034 shares of the Company’s commonstock.

 

TOHI had issued optionsto acquire shares of common stock to various individuals, 40,000 of which wereoutstanding as of the date of the merger. These options were assumed by theCompany and, pursuant to the conversion ratio, now represent options to acquire32,484 shares of the Company’s common stock. The options were fully vested atthe merger date. Also, at the closing of the merger, certain TOHIwarrantholders were issued new warrants to acquire, in the aggregate, 450,000shares of the Company’s common stock. The warrants were fully vested whenissued. The Company granted the TOHI shareholders certain limited registrationrights pursuant to a Registration Rights Agreement executed at the closing ofthe merger. Pursuant to the Registration Rights Agreement these former TOHIshareholders can request that the Company register their shares of the Company’scommon stock on a Registration Statement on Form S-3 if such form isavailable for use by the Company, but only once during any 12-month period. Theformer TOHI warrantholders were also granted similar S-3 registration rights.

 

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

 

9

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

 

----

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

 

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

 

A majority of the directors of the Company also servedon TOHI’s board of directors and were shareholders of both entities. TOHI also owned1,000,000 shares of the Company’s common stock, representing approximately 38%of the Company shares then outstanding. Because of these relationships betweenthe Company and TOHI, purchase accounting was not applied to the merger. Insteadthe net assets contributed by TOHI were recorded at their predecessor basis. The1,000,000 shares of Company common stock owned by TOHI were cancelled by theCompany and recorded as a reduction of its common stock accounts (par value andpaid in capital) at their fair market value, as determined by an independentappraisal, of $8.31 per share, or $8,310,000 in the aggregate. The 1,094,163new shares of Company stock issued to the TOHI shareholders were also recordedat the fair market value price of $8.31 per share, or $9,093,000 in theaggregate. The warrants issued by the Company in exchange for the TOHI warrantsand the TOHI options assumed by the Company were valued and recorded at theirfair value using a Black-Scholes pricing model.****Thenet effect of the contribution of assets and the capital stock transactions wasa $1,715,000 increase to the Company’s equity and a 94,163 net increase in thenumber of Company shares issued.

 

**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 beenoutstanding if dilutive common shares had been issued.  For the threemonths ended December 31, 2007, there were 1,023,291 potentially dilutivesecurities outstanding, however, due to the net loss, all potentially dilutivesecurities were all anti-dilutive.

 

For the three monthsended December 31, 2006, all potentially dilutive securities wereanti-dilutive except for stock options to purchase 15,500 shares of the Company’scommon stock at an exercise price of $8.00, stock options to purchase 32,484shares of the Company’s common stock at an exercise price of $6.16 that wereassumed in conjunction with the merger with TOHI and warrants to purchase450,000 of the Company’s common stock at an exercise price of the greater of$6.67 per share or the book value of the Company as defined by the warrantagreements.

 

10

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**Note 4. Securities**

 

Securities consisted of the following (in thousands):

 
| ** **                           | ** ** | **As of  December 31, 2007** | ** ** | **As of  September 30, 2007** | ** ** |
|--------------------------------------|------------|---------------------------------------------|------------|----------------------------------------------|------------|
| ** **                           | ** ** | **Amortized  Cost**                         | ** ** | **Fair  Value**                              | ** ** | **Amortized  Cost** | ** ** | **Fair  Value** | ** ** |
|                                 |       |                                        |       |                                         |       |   |   |   |   |
| Securities  Available for Sale:      |       |                                        |       |                                         |       |   |   |   |   |
| U.S. Government  Agencies            |       | $                                           | 4          |                                         | $          | 4 |   | $ | 5 |   | $ | 5 |   |
| Other mortgage  backed securities    |       | 2                                           |       | 2                                            |       | 2 |   | 2 |   |
|                                 |       |                                        |       |                                         |       |   |   |   |   |
| Total Securities  Available for Sale |       | $                                           | 6          |                                         | $          | 6 |   | $ | 7 |   | $ | 7 |   |
|                                 |       |                                        |       |                                         |       |   |   |   |   |
| Securities Held  to Maturity:        |       |                                        |       |                                         |       |   |   |   |   |
| U.S. Treasury  securities            |       | $                                           | 1,205      |                                         | $          | 1,210 |   | $ | 349 |   | $ | 350 |   |
| Other mortgage  backed securities    |       | 4                                           |       | 4                                            |       | 5 |   | 4 |   |
|                                 |       |                                        |       |                                         |       |   |   |   |   |
| Total Securities  Held to Maturity   |       | $                                           | 1,209      |                                         | $          | 1,214 |   | $ | 354 |   | $ | 354 |   |

 

At December 31, 2007,$513,000 of the Company’s securities at fair value were pledged to TexlineIndependent School District, and $707,000 to the City of Texline.

 

**Note 5. Loans and Allowance forLoan Losses**

 

The Company grants real estate, commercial and agribusiness loans tocustomers primarily in the Austin and Northwest Texas markets. Loans at December 31,2007, and September 30, 2007 were as follows (in thousands):

 
| ** **                       | ** ** | **As of December  31, 2007** | ** ** | **As of September  30, 2007** | ** ** |
|----------------------------------|------------|---------------------------------------------|------------|----------------------------------------------|------------|
|                             |       |                                        |       |                                         |       |
| Agriculture                      |       | $                                           | 3,730      |                                         | $          | 3,932 |   |
| Commercial                       |       | 29,537                                      |       | 29,502                                       |       |
| Commercial real  estate          |       | 21,404                                      |       | 21,015                                       |       |
| Residential real  estate         |       | 9,681                                       |       | 9,061                                        |       |
| Construction  real estate        |       | 13,448                                      |       | 14,108                                       |       |
| Consumer and  other              |       | 8,114                                       |       | 6,504                                        |       |
| Gross Loans                      |       | 85,914                                      |       | 84,122                                       |       |
| Less: allowance  for loan losses |       | (843                                        | )          | (789                                         | )          |
|                             |       |                                        |       |                                         |       |
| Net Loans                        |       | $                                           | 85,071     |                                         | $          | 83,333 |   |

 

11

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Activity in the allowance for loan losses for the three months and sixmonths ended December 31, 2007, was as follows (in thousands):

 
| ** **                                  | ** ** | **Three Months Ended  December 31,** | ** ** |
|---------------------------------------------|------------|-----------------------------------------------------|------------|
| ** **                                  | ** ** | **2007**                                            | ** ** | **2006** | ** ** |
| Balance at  beginning of period             |       | $                                                   | 789        |   | $ | 550 |   |
| Provision for  loan losses                  |       | 86                                                  |       | 75 |   |
| Loans charged  off                          |       | (33                                                 | )          | (51 | ) |
| Recoveries on  loans previously charged off |       | 1                                                   |       | 1 |   |
|                                        |       |                                                |       |   |   |
| Balance at end  of period                   |       | $                                                   | 843        |   | $ | 575 |   |

 

At December 31, 2007and September 30, 2007, the Bank had approximately $629,000 and $204,000,respectively, in nonperforming loans and non accrual loans. At December 31,2007 and September 30, 2007 the Bank had no repossessed assets, and$50,000 in other real estate owned.

 

**Note 6. Premises and Equipment**

 

Premises and equipment at December 31, 2007, and September 30,2007, were as follows (in thousands):

 
| ** **                                      | ** ** | **As of December  31, 2007** | ** ** | **As of September  30, 2007** | ** ** |
|-------------------------------------------------|------------|---------------------------------------------|------------|----------------------------------------------|------------|
|                                            |       |                                        |       |                                         |       |
| Land                                            |       | $                                           | 959        |                                         | $          | 959 |   |
| Building and  leasehold improvements            |       | 5,086                                       |       | 4,929                                        |       |
| Furniture,  fixtures and equipment              |       | 1,371                                       |       | 1,233                                        |       |
|                                            |       | 7,416                                       |       | 7,121                                        |       |
| Less accumulated  depreciation and amortization |       | (1,187                                      | )          | (1,077                                       | )          |
| Total                                           |       | $                                           | 6,229      |                                         | $          | 6,044 |   |

 

Depreciation andamortization expense for the three months ending December 31, 2007 and2006 was $110,000 and $86,000, respectively.

 

**Note 7. Deposits**

 

Time deposits of $100,000 or more totaled $12,599,000 and $13,470,000at December 31, 2007 and September 30, 2007, respectively. At December 31,2007 and September 30, 2007, the scheduled maturities of time depositswere as follows (in thousands):

 
| **Years Ending September 30,** | ** ** | **As of December  31, 2007** | ** ** | **As of September  30, 2007** | ** ** |
|-----------------------------------------------|------------|---------------------------------------------|------------|----------------------------------------------|------------|
|                                          |       |                                        |       |                                         |       |
| 2008                                          |       | $                                           | 27,955     |                                         | $          | 29,889 |   |
| 2009                                          |       | 1,488                                       |       | 299                                          |       |
| 2010                                          |       | 170                                         |       | —                                       |       |
|                                          |       |                                        |       |                                         |       |
|                                          |       | $                                           | 29,613     |                                         | $          | 30,188 |   |

 

12

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**Note 8. Goodwill and OtherIntangibles**

 

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 adecline in value exists which requires a charge to earnings and a reduction tothe goodwill reflected on the statement of financial condition of the Company.

 

Core depositintangibles are amortized on a straight-line basis over seven years. Thefollowing table reflects the net carrying amount of core deposit intangibles atDecember 31, 2007 and September 30, 2007 (in thousands):

 
| ** **                      | ** ** | **As of December  31, 2007** | ** ** | **As of September  30, 2007** | ** ** |
|---------------------------------|------------|---------------------------------------------|------------|----------------------------------------------|------------|
| Gross core  deposit intangibles |       | $                                           | 70         |                                         | $          | 70 |   |
| Less:  accumulated amortization |       | (38                                         | )          | (36                                          | )          |
|                            |       |                                        |       |                                         |       |
| Net core deposit  intangibles   |       | $                                           | 32         |                                         | $          | 34 |   |

 

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

 

The Company adoptedFinancial Accounting Standards Board Statement No. 123R, “Share-BasedPayment”, (“Statement 123R”) on October 1, 2006. Under Statement 123R, thecost of employee services received in exchange for an award of equityinstruments is based on the grant-date fair value of the award (with limitedexceptions). That cost is recognized over the period during which an employeeis required to provide service in exchange for the award – the requisiteservice period (usually the vesting period). The Company adopted Statement 123Rusing the modified prospective application, which was required for publiccompanies. Under the modified prospective application, Statement 123R appliesto new awards and to awards modified, repurchased, or cancelled after October 1,2006. Additionally, compensation cost for the portion of awards for which therequisite service had not been rendered that are outstanding as of October 1,2006 will be recognized as the requisite service is rendered subsequent to October 1,2006.

 

Prior to October 1,2006, the Company accounted for stock-based compensation to employees using theintrinsic value method. Accordingly, compensation costs for employee 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 Companyaccounts for stock-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 employees, non-employee board members, andindependent consultants or advisors.  The Company has reserved 500,000shares of common stock under the Plan, and the share reserve increases on the 1stbusiness day in January each year (beginning in 2005) by an amount equalto 2% of the number of outstanding shares of the Company on the last businessday in December of the preceding year, subject to a maximum annualincrease of 100,000 shares.  No person may receive stock option grants,stock issuances, or stock appreciation rights for more than 100,000 shares inthe aggregate in any calendar year under the Plan. Option awards are generallygranted with an exercise price equal to the market price of the Company’s stockat the date of the grant; have 10-year contractual terms and vest based onthree years of continuous service. Share awards generally vest over four years.

 

13

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The following tableillustrates the stock compensation expense recognized during the three monthsended December 31, 2007 and 2006.

 
| ** **                                 | ** ** | **Three Months  Ended December  31, 2007** | ** ** | **Three Months  Ended December  31, 2006** | ** ** |
|--------------------------------------------|------------|-----------------------------------------------------------|------------|-----------------------------------------------------------|------------|
| Stock options  for directors and employees |       | $                                                         | 46         |                                                      | $          | 44 |   |
| Restricted stock  for employees            |       | 27                                                        |       | 6                                                         |       |
|                                       |       |                                                      |       |                                                      |       |
|                                       |       | $                                                         | 73         |                                                      | $          | 50 |   |

 

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 31,2007 and 2006, has been estimated using the Black-Scholes option pricing modelwith the following assumptions:

 
| ** **               | ** ** | **Three Months Ended  December 31, 2007** | ** ** | **Three Months Ended  December 31, 2006** | ** ** |
|--------------------------|------------|---------------------------------------------------------------|------------|---------------------------------------------------------------|------------|
| Dividend yield           |       | 0                                                             | %          | 0                                                             | %          |
| Risk-free  interest rate |       | 3.34 - 4.14                                                   | %          | 4.70 - 4.75                                                   | %          |
| Expected  volatility     |       | 5.24                                                          | %          | 3.35                                                          | %          |
| Expected life in  years  |       | 4.0 Years                                                     |       | 6.85 Years                                                    |       |

 

As of December 31,2007, there were outstanding options under the Company’s Stock Incentive Planto purchase an aggregate of 540,162 shares of the Company’s common stock. Each option has an exercise price of between $8.00 and $10.95 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 31,2007, the Company granted stock options to purchase an aggregate of 110,862shares of its common stock with an exercise prices ranging from $10.35 to$10.50 per share to ten (10) officers and directors and 1,000 shares withan exercise price of $10.00 per share to an employee.

 

On November 20,2007, the Company awarded 13,324 shares of common stock to six (6) officers.The stock vests in four equal installments upon completion of each year ofservice over the four-year period of service measured from the date of theaward. On November 20, 2007 and December 20, 2007, four (4) officerssurrendered 5,206 vested shares of common stock to satisfy federal income taxwithholding requirements.

 

During the three monthsended December 31, 2006, the Company granted stock options to purchase anaggregate of 71,750 shares of its common stock with an exercise prices rangingfrom $8.00 to $9.00 per share to fifteen (15)

 

14

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officers and directors. Theoptions may be exercised in three equal annual installments for each year ofservice measured from the grant date.  Included in the option grants forthe three months ended December 31, 2006 was an award to Jeffrey L. Nash,in connection with the execution of his employment agreement with the Company,of 15,000 options to purchase shares of stock at an exercise price of $8.00 pershare.

 

On November 20,2006, the Company awarded 38,006 shares of common stock to six (6) officers.The stock vests in four equal installments upon completion of each year ofservice over the four-year period of service measured from the date of theaward.

 

The table below presentsthe summary of stock option and restricted stock activity for the Plan duringthe three months ended December 31, 2007.

 
| ** **                            | ** ** | **Three Months Ended December 31, 2007** | ** ** |
|---------------------------------------|------------|-------------------------------------------------------------------|------------|
| ** **                            | ** ** | **Restricted Stock**                                         | ** ** | **Options** | ** ** |
| ** **                            | ** ** | **Shares**                                                        | ** ** | **Weighted  Average  Remaining  Contractual  Term in  Years** | ** ** | **Shares** | ** ** | **Weighted  Average  Exercise  Price** | ** ** | **Weighted  Average  Remaining  Contractual  Term in  Years** | ** ** | **Aggregate  Intrinsic  Value** | ** ** |
|                                  |       |                                                              |       |   |   |   |   |   |   |   |   |   |   |
| Outstanding,  beginning of the period |       | 49,507                                                            |       |   |   | 433,300 |   | $ | 8.74 |   |   |   |   |   |
| Granted                               |       | 13,324                                                            |       |   |   | 111,862 |   | 10.36 |   |   |   |   |   |
| Exercised                             |       | —                                                            |       |   |   | (5,000 | ) | (8.33 | )  |   |   |   |   |
| Forfeited/expired/surrendered         |       | (5,206                                                            | )          |   |   | — |   | — |   |   |   |   |   |
| Outstanding, end  of the period       |       | 57,625                                                            |       | 3.0 |   | 540,162 |   | $ | 9.08 |   | 8.2 |   | $ | 600,738 |   |
|                                  |       |                                                              |       |   |   |   |   |   |   |   |   |   |   |
| Exercisable at  the end of the period |       | 5,972                                                             |       | — |   | 247,350 |   | $ | 8.47 |   | 7.1 |   | $ | 402,959 |   |

 

A summary ofshares of our common stock subject to our nonvested shares and options as of December 31,2007 and changes during the three months ended December 31, 2007 ispresented below:

 
| ** **                          | ** ** | **Three Months Ended December 31, 2007** | ** ** |
|-------------------------------------|------------|-------------------------------------------------------------------|------------|
| ** **                          | ** ** | **Restricted Stock**                                         | ** ** | **Options** | ** ** |
| ** **                          | ** ** | **Shares**                                                        | ** ** | **Weighted  Average  Grant Date  Fair Value** | ** ** | **Shares** | ** ** | **Weighted  Average  Grant Date  Fair Value** | ** ** |
|                                |       |                                                              |       |   |   |   |   |   |   |
| Nonvested,  beginning of the period |       | 47,106                                                            |       | $ | 8.25 |   | 229,117 |   | $ | 1.70 |   |
| Granted                             |       | 13,324                                                            |       | 10.00 |   | 111,862 |   | 1.36 |   |
| Vested                              |       | (8,777                                                            | )          | (8.00 | ) | (48,167 | ) | (1.79 | ) |
| Forfeited/expired                   |       | —                                                            |       | — |   | — |   | — |   |
| Nonvested, end  of the period       |       | 51,653                                                            |       | $ | 8.75 |   | 292,812 |   | $ | 1.57 |   |

 

As of December 31, 2007, there was $812,432 of total unrecognizedcompensation costs related to nonvested share-based compensation arrangementsgranted under the Plan. That cost is expected to be recognized over a 

 

15

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weighted-average period of 2.77 years. Options totaling 5,000 with an exercise price of $8.33 per share wereexercised during the three months ended December 31, 2007.

 

**Note10. Stock Warrants**

 

Asof December 31, 2007, the Company has 450,000 warrants to purchase theCompany’s common stock outstanding. The warrants are fully vested, have anexercise price of the greater of the Company’s book value per share of commonstock at the exercise date or $6.67 per share and expire on August 11, 2011.

 

**Note11. Other Related Party Transactions**

 

TheCompany had no amounts due from affiliates at December 31, 2007 and September 30,2007.

 

On October 11, 2005, the Company made a $355,000 loan to TOHI withmonthly interest payments due on the first of each month beginning November 1,2005. The purpose of the loan was to enable TOHI to pay off certainobligations, and to provide sufficient liquidity to TOHI until the proposedmerger with the Company was completed. On April 26, 2006, the obligationwas renewed and increased to $373,000 at the then current prime rate. The loanwas renewed and increased to $400,000 on September 1, 2006. The principalbalance ($396,000 as of September 30, 2007), along with any accruedinterest, was due and payable in full on November 1, 2006. On November 15,2006, in connection with the merger of TOHI and the Company, the loan was paidin full.

 

On August 24,2006, the Company made a $2,425,000 loan to TOHI with monthly interest paymentsat the current prime rate (8.25% at September 30, 2006) due on the 24thday of each month. The purpose of the loan was to enable TOHI to redeem sharesof common and preferred stock from certain of its shareholders. The loan wasdue and payable on February 24, 2007 but was paid-off in full on November 15,2006 in connection with the Company’s acquisition of TOHI.

 

**Note 12. Financial Instruments with Off-Balance Sheet Risk**

 

In the normal course of business, the Company is a party to financialinstruments with off-balance sheet risk to meet the financing needs of itscustomers, through the use of commitments to extend credit. Those instrumentsinvolve, to varying degrees, elements of credit and interest-rate risk inexcess of the amount recognized in the consolidated balance sheet. The contractor notional amounts of those instruments reflect the extent of the Company’sinvolvement in particular classes of financial instruments.

 

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

 

16

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

 
| ** **                    | ** ** | **As of December  31, 2007** | ** ** | **As of September  30, 2007** | ** ** |
|-------------------------------|------------|---------------------------------------------|------------|----------------------------------------------|------------|
| Commitments to  extend credit |       | $                                           | 18,303     |                                         | $          | 20,786 |   |
| Standby letters  of credit    |       | 4,418                                       |       | 2,251                                        |       |
|                               |            |                                             |            |                                              |            |  |  |

 

Commitments toextend credit are agreements to lend to a customer as long as there is noviolation of any condition established in the contract. Commitments generallyhave fixed expiration dates or other termination clauses and may requirepayment of a fee. Since many of the commitments are expected to expire withoutbeing drawn upon, the total commitment amounts do not necessarily representfuture cash requirements. The Company evaluates each customer’screditworthiness on a case-by-case basis. The amount of collateral obtained ifdeemed necessary by the Company upon extension of credit is based on management’scredit evaluation of the counterparty. Collateral held varies but may includeaccounts receivable, inventory, property, plant and equipment andincome-producing commercial properties.

 

Standby letters ofcredit are written conditional commitments used by the Company to guarantee theperformance of a customer to a third party. The Company’s policies generallyrequire that letter of credit arrangements contain security and debt covenantssimilar to those contained in loan arrangements. In the event the customer doesnot perform in accordance with the terms of the agreement with the third party,the Company would be required to fund the commitment. The maximum potentialamount of future payments the Company could be required to make is representedby the contractual amount shown in the table above. If the commitment isfunded, the Company would be entitled to seek recovery from the customer. As ofDecember 31, 2007, no amounts have been recorded as liabilities for theCompany’s potential obligations under these guarantees.

 

**Note 13.  Commitments andContingencies**

 

Thefollowing table presents a summary of non-cancelable future operating leasecommitments as of December 31, 2007 (in thousands):

 
| **Years Ending September 30,** | ** ** | **As of December  31, 2007** | ** ** |
|-----------------------------------------------|------------|----------------------------------------|------------|
|                                          |       |                                   |       |
| 2008                                          |       | $                                      | 112        |   |
| 2009                                          |       | 165                                    |       |
| 2010                                          |       | 174                                    |       |
| 2011                                          |       | 175                                    |       |
| 2012                                          |       | 178                                    |       |
| Thereafter                                    |       | 1,669                                  |       |
|                                          |       | $                                      | 2,473      |   |

 

**Note 14. Dividend Restrictionsand Regulatory Matters**

 

Banks and bank holding companies are subject toregulatory capital requirements administered by state and federal bankingregulatory agencies. Capital adequacy guidelines and, additionally for banks,prompt corrective action regulations involve quantitative measures of assets,liabilities, and certain off-balance sheet items calculated under regulatoryaccounting practices. Capital amounts and classifications are also subject toqualitative judgments by regulators about components, risk weightings and otherfactors. Failure to meet capital requirements can initiate regulatory action. Asof December 31, 2007, management believes the Bank is in compliance withall regulatory capital requirements to which it is subject.

 

17

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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, 2007             |       |       |       |                                         |       |                                                                                         |       |   |   |   |   |   |   |
| Tier 1 capital  (to average assets)       |       | $          | 9,223      |                                         | 8.56       | %                                                                                            | $          | 4,308 |   | 4 | % | $ | 5,385 |   | 5 | % |
| Tier 1 capital  (to risk-weighted assets) |       | 9,223      |       | 9.51                                         | %          | 3,878                                                                                        |       | 4 | % | 5,816 |   | 6 | % |
| Total Capital  (to risk-weighted assets)  |       | 10,066     |       | 10.38                                        | %          | 7,755                                                                                        |       | 8 | % | 9,694 |   | 10 | % |
|                                           |            |            |            |                                              |            |                                                                                              |            |  |  |  |  |  |  |  |  |  |

 
| ** **                                | ** ** | **Actual** | ** ** | ** ** | ** ** | **For Capital  Adequacy Purposes** | ** ** | **To Be Well  Capitalized Under  Prompt Corrective  Action  Provisions** | ** ** |
|-------------------------------------------|------------|------------|------------|------------|------------|----------------------------------------------|------------|----------------------------------------------------------------------------------------------|------------|
| ** **                                | ** ** | **Amount** | ** ** | **Ratio**  | ** ** | **Amount**                                   | ** ** | **Ratio**                                                                                    | ** ** | **Amount** | ** ** | **Ratio** | ** ** |
| As of  September 30, 2007            |       |       |       |       |       |                                         |       |                                                                                         |       |   |   |   |   |
| Tier 1 capital  (to average assets)       |       | $          | 9,079      |       | 8.78       | %                                            | $          | 4,243                                                                                        |       | 4 | % | $ | 5,303 |   | 5 | % |
| Tier 1 capital  (to risk-weighted assets) |       | 9,079      |       | 9.76       | %          | 3,726                                        |       | 4                                                                                            | %          | 5,589 |   | 6 | % |
| Total Capital  (to risk-weighted assets)  |       | 9,868      |       | 10.61      | %          | 7,451                                        |       | 8                                                                                            | %          | 9,314 |   | 10 | % |
|                                           |            |            |            |            |            |                                              |            |                                                                                              |            |  |  |  |  |  |  |  |

 

As of December 31, 2007 andSeptember 30, 2007, the Bank met the level of capital required to becategorized as “well capitalized” under prompt corrective action regulations. Managementis not aware of any conditions subsequent to December 31, 2007 that wouldchange the Bank’s capital category.

 

The Bank is a state chartered banking association and is subject toregulation, supervision and examination by the Texas Department of Banking andthe Federal Deposit Insurance Corporation (FDIC). In addition, upon makingcertain determinations with respect to the condition of any insured bank, theFDIC may begin proceedings to terminate a bank’s federal deposit insurance.

 

Certain restrictions exist regarding the ability of the Bank to paycash dividends. Regulatory approval is required in order to pay dividends untilsuch time as the accumulated deficit is eliminated and certain other conditionsare met. Further, the Company has been notified by its banking regulators thatno approval will be received in the first three years of operations.

 

**Note 15. Subsequent Event**

 

On November 13, 2007the Company’s Board of Directors approved a plan to deregister its common stockunder the Securities Exchange Act of 1934, as amended, and, therefore,terminate its obligations to file reports with the Securities and ExchangeCommission.  This “going private” transaction would be accomplishedthrough an amendment (the “Amendment”) to the Company’s Articles ofIncorporation, which would (1) authorize 2,500,000 shares of a new Series APreferred Stock and (2) effect a reclassification of all shares of commonstock held by record shareholders owning less than 2,500 shares of our commonstock into shares of Series A Preferred Stock on a one-for-one basis (the “Reclassification”). Shares of common stock held by record shareholders owning 2,500 or more shareswill remain outstanding and will be unaffected by the Reclassification.

 

18

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

 

**Introduction**

 

We are a bankholding company headquartered in Austin, Texas. We operate a state charteredbank, Treaty Oak Bank (the “Bank”) in Austin, Texas with branches in Texline,Texas, Marble Falls, Texas and the Barton Creek neighborhood in southwestAustin, Texas. We began operations in Austin, Texas on September 10, 2004.Given its greater growth potential, we are focusing the majority of our effortson growing a community-oriented bank out of our headquarters in Austin, Texasour branches in Marble Falls, Texas and Barton Creek in southwest Austin,Texas. In the course of preparing our consolidated financial statements, we usecertain estimates with respect to loans, intangibles, the allowance for loanlosses and other estimates necessary for 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.

 

**RecentDevelopments**

 

On January 7, 2008,the Bank opened its newest branch at 2800 Barton Creek Boulevard, Austin,Texas, in the affluent Barton Creek Estates community in southwest Austin.

 

On November 13,2007our Board of Directors approved a plan to deregister our common stock underthe Securities Exchange Act of 1934, as amended, and, therefore, terminate ourobligations to file reports with the Securities and Exchange Commission. This “going private” transaction would be accomplished through an amendment(the “Amendment”) to the Company’s Articles of Incorporation, which would (1) authorize2,500,000 shares of a new Series A Preferred Stock and (2) effect areclassification of all shares of common stock held by record shareholdersowning less than 2,500 shares of our common stock into shares of Series APreferred Stock on a one-for-one basis (the “Reclassification”).  Sharesof common stock held by record shareholders owning 2,500 or more shares willremain outstanding and will be unaffected by the Reclassification.

 

The Amendment andReclassification are subject to approval by the holders of two-thirds (2/3) ofthe outstanding shares of our common stock.  Shareholders will be asked toapprove the Amendment and Reclassification at our 2008 annual shareholdersmeeting to be held on February 25, 2008.

 

If the Amendment isapproved by our shareholders and, after completion of the Reclassification, wehave fewer than 300 shareholders of record of common stock, we intend toterminate the registration of our common stock under the Securities ExchangeAct of 1934, as amended, and become a non-reporting company.  If thatoccurs, we will no longer file periodic reports with the Securities andExchange Commission, including annual reports on Form 10-KSB and quarterlyreports on Form 10-QSB.

 

Those shareholdersreceiving shares of Series A Preferred Stock in the Reclassification willhave the option to sell those shares to us at any time during the 30 day periodfollowing the Reclassification at a cash price equal to $11.00 per share (the “PutPrice”).

 

Our Board of Directorsreceived a fairness opinion from its financial advisor, Fowler Valuation Services,LC, that the Put Price to be paid following the Reclassification is fair, froma financial perspective, to all of our shareholders.

 

**Resultsof Operations**

 

***General***

 

The followingdiscussion analyzes the results of the Company for the three months ended December 31,2007, and December 31, 2006.

 

19

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***Net Income-General***

 

The Company’sfiscal year ends on September 30. Net loss for the three months ended December 31,2007, was $226,000, compared to net income of $136,000 for the quarter ended December 31,2006. The decrease was primarily due to reduced earnings generated at the Bankas a result of the start-up costs in the Marble Falls and Barton Creek branchesand the decreased net interest margin as a result of recent interest ratereductions by the Federal Reserve Bank. The decrease in earnings was also aresult of professional fees and expenses related to the Reclassification andcontinuing costs related to being a public company, including financial reportingand compliance.

 

Our profitabilitydepends primarily on net interest income, which is defined as the differencebetween total interest earned on interest earning assets (investments andloans) and total interest paid on interest bearing liabilities (deposits,borrowed funds) and non-interest income. The Company’s net income is affectedby its provision for loan losses, as well as other income and other expenses.The provision for loan losses reflects the amount considered to be adequate tocover probable credit losses in the loan portfolio. Non-interest income orother income consists of service charges on deposits, gain on sale of loans,and other operating income. Other expenses include salaries and employeebenefits, occupancy expenses, data processing expenses, marketing, supplies,and other operating expenses.

 

Net interestincome is affected by changes in the volume and mix of interest earning assets,the level of interest rates earned on those assets, the volume and mix ofinterest bearing liabilities, and the level of interest rates paid on thoseinterest bearing liabilities. The provision for loan losses is dependent uponchanges in the loan portfolio and management’s assessment of the collectibilityof the loan portfolio, as well as economic and market conditions. Other incomeand other expenses are impacted by growth of operations and growth in thenumber of accounts through both acquisitions and core banking business growth.Growth in operations affects other expenses as a result of additional employees,branch facilities, and promotional marketing expense. Growth in the number ofaccounts affects other income including service fees, as well as other expensessuch as computer services, supplies, postage, telecommunications, and othermiscellaneous expenses.

 

***Net Interest Income***

 

Forthe three months ended December 31, 2007, our net interest income was$1,300,000 compared to $1,153,000 for three months ended December 31,2006.  Net interest income for the quarters ended December 31,2007 and 2006 was reduced by the amortization of direct loan origination costsof approximately $16,200 and $13,400, respectively.

 

Forthe comparative three month periods of December 31, 2006 and December 31,2007, the average rate on interest-bearing liabilities decreased 16 basispoints, from 4.38% to 4.22%, while the average rate on interest bearing assetsdecreased 9 basis points from 8.24% to 8.15% during the same period. Theaverage yield on loans decreased 42 basis points during the period due to thedecline in the prime rate and the corresponding impact on the variable rateloans in the portfolio. The decrease in loans was offset, in part, by increasedyields on investments with longer maturities. The decrease in the average rateon interest-bearing liabilities was due to the overall decline in interestrates during the period and the maturity and repricing of higher-yielding timedeposits. This decrease was partially offset by higher rates on promotionalmoney market products offered by our new branches. Deposit rates do not alwaysdecline as quickly as asset rates in a falling rate environment due to thematurities of certain deposit products and the general competition in themarket for deposits.

 

20

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Thefollowing tables present, for the periods indicated, the total dollar amount ofinterest income from average interest earning assets, and the resultant yields,as well as the interest expense on average interest bearing liabilities, andthe resultant costs, expressed both in dollars and rates. Yields are reflectedon an annualized basis (in thousands except for yields).

 
| ** **                                       | ** ** | **Three Months Ended  December 31, 2007** | ** ** | **Three Months Ended  December 31, 2006** | ** ** |
|--------------------------------------------------|------------|---------------------------------------------------------------|------------|---------------------------------------------------------------|------------|
| ** **                                       | ** ** | **Average  Balance**                                          | ** ** | **Interest  (2)**                                             | ** ** | **Yield/  Rate** | ** ** | **Average  Balance** | ** ** | **Interest  (2)** | ** ** | **Yield/  Rate** | ** ** |
|                                             |       |                                                          |       |                                                          |       |   |   |   |   |   |   |   |   |
| Interest Earning  Assets:                        |       |                                                          |       |                                                          |       |   |   |   |   |   |   |   |   |
| Loans (1)                                        |       | $                                                             | 82,417     |                                                          | $          | 1,816 |   | 8.81 | % | $ | 66,980 |   | $ | 1,545 |   | 9.23 | % |
| Taxable  investment securities                   |       | 1,125                                                         |       | 15                                                            |       | 5.33 | % | 1,711 |   | 14 |   | 3.27 | % |
| Federal funds  sold                              |       | 15,154                                                        |       | 182                                                           |       | 4.80 | % | 17,581 |   | 226 |   | 5.14 | % |
| Interest bearing  deposits with other Banks      |       | 2,112                                                         |       | 30                                                            |       | 5.68 | % | — |   | — |   | 0.00 | % |
| Federal Home  Loan Bank Stock                    |       | 336                                                           |       | 18                                                            |       | 21.44 | % | 326 |   | — |   | 0.00 | % |
| Total interest  earning assets                   |       | 101,144                                                       |       | 2,061                                                         |       | 8.15 | % | 86,598 |   | 1,785 |   | 8.24 | % |
| Non-interest  earning assets                     |       | 12,449                                                        |       |                                                          |       |   |   | 10,301 |   |   |   |   |   |
| Total assets                                     |       | $                                                             | 113,593    |                                                          |       |   |   |   | $ | 96,899 |   |   |   |   |   |
|                                             |       |                                                          |       |                                                          |       |   |   |   |   |   |   |   |   |
| Interest Bearing  Liabilities:                   |       |                                                          |       |                                                          |       |   |   |   |   |   |   |   |   |
| Deposits:                                        |       |                                                          |       |                                                          |       |   |   |   |   |   |   |   |   |
| NOW and money  market deposits                   |       | $                                                             | 38,930     |                                                          | $          | 388 |   | 3.99 | % | $ | 33,417 |   | $ | 296 |   | 3.54 | % |
| Savings deposits                                 |       | 631                                                           |       | 2                                                             |       | 1.27 | % | 510 |   | 2 |   | 1.57 | % |
| Time deposits                                    |       | 29,909                                                        |       | 332                                                           |       | 4.44 | % | 19,884 |   | 267 |   | 5.37 | % |
| Short-term  borrowings                           |       | —                                                        |       | —                                                        |       | 0.00 | % | 1,213 |   | 26 |   | 8.58 | % |
| Property  mortgage and long term borrowings      |       | 2,593                                                         |       | 39                                                            |       | 6.02 | % | 2,685 |   | 41 |   | 6.11 | % |
| Total interest  bearing liabilities              |       | 72,063                                                        |       | 761                                                           |       | 4.22 | % | 57,709 |   | 632 |   | 4.38 | % |
| Demand deposits—non-interest  bearing       |       | 25,619                                                        |       |                                                          |       |   |   | 26,411 |   |   |   |   |   |
| Other  non-interest bearing liabilities          |       | 649                                                           |       |                                                          |       |   |   | 537 |   |   |   |   |   |
| Shareholders’  equity                       |       | 15,262                                                        |       |                                                          |       |   |   | 12,242 |   |   |   |   |   |
| Total  liabilities and shareholders’ equity |       | $                                                             | 113,593    |                                                          |       |   |   |   | $ | 96,899 |   |   |   |   |   |
|                                             |       |                                                          |       |                                                          |       |   |   |   |   |   |   |   |   |
| Net interest  income                             |       |                                                          |       | $                                                             | 1,300      |   |   |   |   |   | $ | 1,153 |   |   |   |
|                                             |       |                                                          |       |                                                          |       |   |   |   |   |   |   |   |   |
| Interest rate  spread (3)                        |       |                                                          |       |                                                          |       | 3.93 | % |   |   |   |   | 3.86 | % |
| Net interest  margin (4)                         |       |                                                          |       |                                                          |       | 5.14 | % |   |   |   |   | 5.33 | % |

 

 

----

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

 

(2)           Interest income includes loan fees of $83,000, forthe three months ended December 31, 2007 and $49,000 for the three monthsended December 31, 2006.

 

(3)           Interest rate spread represents the differencebetween the average yield on interest earning assets and the average cost ofinterest bearing liabilities.

 

(4)           Net interest margin represents annualized netinterest income as a percentage of average interest earning assets.

 

21

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

 

Thefollowing table presents the extent to which changes in volume, changes ininterest rates, and changes in the interest rates times the changes in volumeof interest earning assets and interest bearing liabilities affected the Bank’sinterest income and interest expense during the period indicated. Informationis provided on changes in each category due to (1) changes attributable tochanges in volume (change in volume times the prior period interest rate), (2) changesattributable to changes in interest rate (changes in rate times the priorperiod volume), and (3) changes attributable to changes in rate/volume(changes in interest rate times changes in volume). Changes attributable to thecombined impact of volume and rate have been allocated proportionally to thechanges due to volume and the changes due to rate (in thousands):

 
| ** **                                  | ** ** | **Three Months Ended December 31, 2007  Compared to  Three Months Ended December 31, 2006** | ** ** |
|---------------------------------------------|------------|----------------------------------------------------------------------------------------------------------------------------------------------------|------------|
| ** **                                  | ** ** | **Change Due to  Volume**                                                                                                                | ** ** | **Change Due to  Rate** | ** ** | **Total Change** | ** ** |
|                                        |       |                                                                                                                                               |       |   |   |   |   |
| Interest Earning  Assets:                   |       |                                                                                                                                               |       |   |   |   |   |
| Loans                                       |       | $                                                                                                                                                  | 1,361      |   | $ | (1,090 | ) | $ | 271 |   |
| Taxable  investment securities              |       | (31                                                                                                                                                | )          | 32 |   | 1 |   |
| Federal funds  sold                         |       | (117                                                                                                                                               | )          | 73 |   | (44 | ) |
| Interest bearing  deposits with other Banks |       | 30                                                                                                                                                 |       | — |   | 30 |   |
| FHLB/TIB stock                              |       | 2                                                                                                                                                  |       | 16 |   | 18 |   |
| Increase in  interest income                |       | $                                                                                                                                                  | 1,245      |   | $ | (969 | ) | $ | 276 |   |
|                                        |       |                                                                                                                                               |       |   |   |   |   |
| Interest Bearing  Liabilities:              |       |                                                                                                                                               |       |   |   |   |   |
| NOW and money  market deposit accounts      |       | $                                                                                                                                                  | 220        |   | $ | (128 | ) | $ | 92 |   |
| Savings deposits                            |       | 2                                                                                                                                                  |       | (2 | ) | — |   |
| Time deposits                               |       | 445                                                                                                                                                |       | (380 | ) | 65 |   |
| Short-term  borrowings                      |       | (26                                                                                                                                                | )          | — |   | (26 | ) |
| Long term  borrowings                       |       | (6                                                                                                                                                 | )          | 4 |   | (2 | ) |
| Increase  (decrease) in interest expense    |       | 635                                                                                                                                                |       | (506 | ) | 129 |   |
| Increase  (decrease) in net interest income |       | $                                                                                                                                                  | 610        |   | $ | (463 | ) | $ | 147 |   |

 

***Provision for Loan Losses***

 

The provision forloan losses is an expense determined by management as the amount necessary toincrease the allowance for loan losses after net charge-offs have been deductedto a level that, in management’s best estimate, is necessary to absorb probablelosses in the loan portfolio. The amount of the provision is based onmanagement’s review of the loan portfolio and consideration of such factors ashistorical loss experience, general prevailing economic conditions, changes inthe size and composition of the loan portfolio and specific borrowerconsiderations, including the ability of the borrower to repay the loan and theestimated value of the underlying collateral. The provision is calculatedmonthly and a charge or credit to expense is made, as required, to adjust theallowance to the calculated level.

 

For the threemonths ended December 31, 2007, the Bank made $86,000 in provisions forloan losses, compared to $75,000 for the three months ended December 31,2006. For the three months ended December 31, 2007, the Bank charged off$33,000 in commercial and consumer loans and had recoveries of loans previouslycharged-off of $1,000 for net recoveries of $32,000. For the three months endedDecember 31, 2006, the Bank charged off $51,000 in commercial and consumerloans and had zero recoveries of loans previously charged-off for netcharge-offs of $1,000, for net charge-offs of $50,000. The factors combinedincreased the Allowance for Loan Losses to $843,000 or 0.98% of the portfolioat December 31, 2007. This amount represents management’s estimate ofprobable losses inherent in the portfolio.

 

22

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***Other Income***

 

Forthe three months ended December 31, 2007, other income increased $2,000from $105,000 during the three months ended December 31, 2006, to$107,000. Service charges and other income increased by $35,000 but were offsetby a decrease of $33,000 in sublease income in PGI Equity Partners, LP, whichis the real estate investment company that owns and manages the property wherethe Company’s offices are located.

 

***Non-Interest Expenses***

 

Forthe three months ended December 31, 2007, salaries and employee benefitswere $762,000 compared to $526,000 for the three months ended December 31,2006. Stock based compensation recognized for the three months ended December 31,2007 totaled $73,000 as compared to $50,000 for the three months ended December 31,2006. Occupancy and equipment expenses for the three months ended December 31,2007 increased from $112,000 for the three months ended December 31, 2006to $151,000. 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 at the new branches in Marble Falls and Barton Creek.The increase in stock based compensation was due to the issuance of stockoptions and restricted stock under the Company’s Stock Incentive Plan. Professionalfees paid for accounting and legal services, including regulatory filings andaudit services, totaled $196,000 and $55,000, respectively, for the three monthsended December 31, 2007 and 2006. The increase was due to expenses relatedto the Reclassification and the increased costs of being a public company,including additional financial reporting and compliance. Other expensesincreased from $354,000 for the three months ended December 31, 2006, to$438,000 for the three months ended December 31, 2007. Other expensesprimarily consist of data processing and software maintenance costs, marketingand advertising, business development expenses, and other operating costs. Thisincrease in other expenses was also a result of the growth of the Bank and theincrease in employees at all locations.

 

***Income Taxes***

 

No federal tax expense has been recorded for the three months ended December 31,2007 based upon net operating losses incurred and carried forward from prioryears.  Although we were profitable for the fiscal years ended September 30,2007 and 2006, we have fully reserved against the deferred tax benefitaccumulated through September 30, 2007, based upon our projected financialresults for the fiscal year ending September 30, 2008 and other factorsincluding our limited operating history.

 

**FinancialCondition**

 

***Loan Portfolio***

 

Net loansincreased $1,738,000 (2.1%) to $85,071,000 from $83,333,000 between September 30,2007 and December 31, 2007. The concentration within the portfolio hasshifted over time from the previous concentration of agricultural loans to realestate and commercial loans.

 

***Loan Portfolio Mix***

 

The followingtables set forth the composition of the loan portfolio (in thousands):

 
| ** **                       | ** ** | **As of December 31,  2007** | ** ** | **As of September30,  2007** | ** ** |
|----------------------------------|------------|---------------------------------------------|------------|----------------------------------------|------------|
|                             |       |                                        |       |                                   |       |
| Agriculture                      |       | $                                           | 3,730      |                                   | $          | 3,932 |   |
| Commercial                       |       | 29,633                                      |       | 29,502                                 |       |
| Commercial real  estate          |       | 21,198                                      |       | 21,015                                 |       |
| Residential real  estate         |       | 9,972                                       |       | 9,061                                  |       |
| Construction  real estate        |       | 13,447                                      |       | 14,108                                 |       |
| Consumer and  other              |       | 7,934                                       |       | 6,504                                  |       |
| Gross Loans                      |       | 85,914                                      |       | 84,122                                 |       |
| Less: allowance  for loan losses |       | (843                                        | )          | (789                                   | )          |
|                             |       |                                        |       |                                   |       |
| Net Loans                        |       | $                                           | 85,071     |                                   | $          | 83,333 |   |

 

Loanconcentrations are considered to exist when there are amounts loaned to amultiple number of borrowers engaged in similar activities that would causethem to be similarly impacted by economic or other conditions.

 

23

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For the threemonth period ended December 31, 2007, the majority of new loan growth camefrom the Austin and Marble Falls markets reflecting a broader, more diverse mixof industries and borrowers.

 

Management mayrenew loans at maturity when requested by a customer whose financial strengthappears to support such a renewal or when such a renewal appears to be in thebest interest of the Bank. The Bank requires payment of accrued interest insuch instances and may adjust the rate of interest, require a principalreduction, or modify other terms of the loan at the time of renewal.

 

***Loan Maturities***

 

The followingtable presents the contractual maturity ranges for agricultural, commercial,real estate and consumer loans outstanding at December 31, 2007, and at September 30,2007, and also presents for each maturity range the portion of loans that havefixed interest rates or interest rates that fluctuate over the life of the loanin accordance with changes in the interest rate environment as represented bythe base rate (in thousands):

 
| ** **                      | ** ** | **Due in One Year  or Less** | ** ** | **Due after One Year  Through  Five Years** | ** ** | **Due after  Five Years** | ** ** | ** **         | ** ** |
|---------------------------------|------------|--------------------------------------------------|------------|-----------------------------------------------------------------|------------|-------------------------------------|------------|--------------------|------------|
| **December 31, 2007** | ** ** | **Fixed  Rate**                                  | ** ** | **Floating  Rate**                                              | ** ** | **Fixed  Rate**                     | ** ** | **Floating  Rate** | ** ** | **Fixed  Rate** | ** ** | **Floating  Rate** | ** ** | **Total** | ** ** |
|                            |       |                                             |       |                                                            |       |                                |       |               |       |   |   |   |   |   |   |
| Agricultural                    |       | $                                                | 23         |                                                            | $          | 2,645                               |       | $                  | —     |   | $ | 578 |   | $ | — |   | $ | 484 |   | $ | 3,730 |   |
| Commercial                      |       | 376                                              |       | 18,671                                                          |       | 1,318                               |       | 9,075              |       | — |   | 193 |   | 29,633 |   |
| Commercial real  estate         |       | 230                                              |       | 8,121                                                           |       | 707                                 |       | 12,140             |       | — |   | — |   | 21,198 |   |
| Residential real  estate        |       | 1,808                                            |       | 2,954                                                           |       | 2,562                               |       | 2,024              |       | 624 |   | — |   | 9,972 |   |
| Construction  real estate       |       | 788                                              |       | 4,717                                                           |       | 168                                 |       | 5,742              |       | 129 |   | 1,903 |   | 13,447 |   |
| Consumer and  other             |       | 472                                              |       | 5,779                                                           |       | 360                                 |       | 1,299              |       | 24 |   | — |   | 7,934 |   |
| **Total**                       |       | $                                                | 3,697      |                                                            | $          | 42,887                              |       | $                  | 5,115      |   | $ | 30,858 |   | $ | 777 |   | $ | 2,580 |   | $ | 85,914 |   |

 
| ** **                       | ** ** | **Due in One Year  or Less** | ** ** | **Due after One Year  Through  Five Years** | ** ** | **Due after  Five Years** | ** ** | ** **         | ** ** |
|----------------------------------|------------|--------------------------------------------------|------------|-----------------------------------------------------------------|------------|-------------------------------------|------------|--------------------|------------|
| **September 30, 2007** | ** ** | **Fixed  Rate**                                  | ** ** | **Floating  Rate**                                              | ** ** | **Fixed  Rate**                     | ** ** | **Floating  Rate** | ** ** | **Fixed  Rate** | ** ** | **Floating  Rate** | ** ** | **Total** | ** ** |
|                             |       |                                             |       |                                                            |       |                                |       |               |       |   |   |   |   |   |   |
| Agricultural                     |       | $                                                | 38         |                                                            | $          | 2,731                               |       | $                  | —     |   | $ | 676 |   | $ | — |   | $ | 487 |   | $ | 3,932 |   |
| Commercial                       |       | 2,106                                            |       | 18,477                                                          |       | 1,026                               |       | 7,772              |       | — |   | 121 |   | 29,502 |   |
| Commercial real  estate          |       | 230                                              |       | 9,771                                                           |       | 732                                 |       | 10,282             |       | — |   | — |   | 21,015 |   |
| Residential real  estate         |       | 1,542                                            |       | 2,354                                                           |       | 1,959                               |       | 2,542              |       | 664 |   | — |   | 9,061 |   |
| Consumer and  other              |       | 825                                              |       | 3,915                                                           |       | 174                                 |       | 7,418              |       | — |   | 1,776 |   | 14,108 |   |
| Consumer and  other              |       | 480                                              |       | 4,368                                                           |       | 566                                 |       | 1,900              |       | — |   | — |   | 6,504 |   |
| **Total**                        |       | $                                                | 5,221      |                                                            | $          | 41,616                              |       | $                  | 4,457      |   | $ | 29,780 |   | $ | 664 |   | $ | 2,384 |   | $ | 84,122 |   |

 

As of December 31,2007, 54.2% of the loan portfolio, or $46,584,000, matures or re-prices withinone year or less and $76,325,000 of the loan portfolio, or 88.8%, were variablerate loans.   At September 30, 2007, 55.7% of the loanportfolio or $46,837,000, matured or re-priced within one year or less and$73,780,000 of these loans, or 87.7%, were variable rate loans.

 

24

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***Investment Securities***

 

The primarypurposes of the investment portfolio are to provide a source of earnings forliquidity management purposes, to provide collateral to pledge against publicdeposits, and to control interest rate risk. In managing the portfolio, theBank seeks to attain the objectives of safety of principal, liquidity,diversification, and maximized return on investment.

 

The followingtables set forth the amortized cost and fair value of the Bank’s securitiesportfolio by accounting classification category and by type of security asindicated (in thousands) as of December 31, 2007 and September 30,2007:

 
| ** **                           | ** ** | **As of  December 31, 2007** | ** ** | **As of  September 30, 2007** | ** ** |
|--------------------------------------|------------|---------------------------------------------|------------|----------------------------------------------|------------|
| ** **                           | ** ** | **Amortized  Cost**                         | ** ** | **Fair  Value**                              | ** ** | **Amortized  Cost** | ** ** | **Fair  Value** | ** ** |
|                                 |       |                                        |       |                                         |       |   |   |   |   |
| Securities  Available for Sale:      |       |                                        |       |                                         |       |   |   |   |   |
| U.S. Government  Agencies            |       | $                                           | 4          |                                         | $          | 4 |   | $ | 5 |   | $ | 5 |   |
| Other mortgage  backed securities    |       | 2                                           |       | 2                                            |       | 2 |   | 2 |   |
|                                 |       |                                        |       |                                         |       |   |   |   |   |
| Total Securities  Available for Sale |       | $                                           | 6          |                                         | $          | 6 |   | $ | 7 |   | $ | 7 |   |
|                                 |       |                                        |       |                                         |       |   |   |   |   |
| Securities Held  to Maturity:        |       |                                        |       |                                         |       |   |   |   |   |
| U.S. Treasury  Securities            |       | $                                           | 1,205      |                                         | $          | 1,210 |   | $ | 349 |   | $ | 350 |   |
| Other mortgage  backed securities    |       | 4                                           |       | 4                                            |       | 5 |   | 4 |   |
|                                 |       |                                        |       |                                         |       |   |   |   |   |
| Total Securities  Held to Maturity   |       | $                                           | 1,209      |                                         | $          | 1,214 |   | $ | 354 |   | $ | 354 |   |

 

U.S. Treasurysecurities and securities of U.S. Government agencies generally consist offixed rate securities with maturities of three months to five years. Othermortgage backed securities consists of fixed rate mortgage pass-throughsecurities with a maturity of five to fifteen years.

 

***Asset Quality***

 

The followingtable sets forth the amount of non-performing loans and non-performing assetsas of December 31, 2007, and September 30, 2007 (in thousands exceptfor percentages):

 
| ** **                                               | ** ** | **As of  December 31,  2007** | ** ** | **As of  September 30,  2007** | ** ** |
|----------------------------------------------------------|------------|-----------------------------------------|------------|------------------------------------------|------------|
|                                                     |       |                                    |       |                                     |       |
| Non-accruing  loans                                      |       | $                                       | 629        |                                     | $          | 204 |   |
| Loans 90 days or  more past due, still accruing interest |       | —                                  |       | —                                   |       |
|                                                     |       |                                    |       |                                     |       |
| Total  non-performing loans                              |       | 629                                     |       | 204                                      |       |
| Other real  estate owned                                 |       | 50                                      |       | 50                                       |       |
| Other  repossessed assets                                |       | —                                  |       | —                                   |       |
|                                                     |       |                                    |       |                                     |       |
| Total  non-performing assets                             |       | $                                       | 679        |                                     | $          | 254 |   |
|                                                     |       |                                    |       |                                     |       |
| Total  non-performing loans to total loans               |       | 0.73                                    | %          | 0.30                                     | %          |
| Allowance for  loan losses to non-performing loans       |       | 134                                     | %          | 311                                      | %          |
| Total  non-performing assets to total assets             |       | 0.58                                    | %          | 0.22                                     | %          |

 

25

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***Non-performing Loans***

 

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

 

During the ordinary course of business, management becomes aware ofborrowers that may not be able to meet the contractual requirements of loanagreements. Such loans are placed under close supervision with considerationgiven to placing the loan on a non-accrual status, increasing the allowance forloan losses, and (if appropriate) partial or full charge-off. After a loan isplaced on non-accrual status, any current year interest previously accrued butnot yet collected is reversed against current income. When payments arereceived on non-accrual loans, such payments are applied to principal and nottaken into income. Loans are not placed back on accrual status unless all backinterest and principal payments are made. If interest on non-accrual loans hadbeen accrued, such income would have amounted to approximately $4,000 for thethree months ended December 31, 2007 and $2,200 for the three months endedDecember 31, 2006. This amount was not included in interest income duringthis period.

 

UnderFederal and Texas law, any loan 90 or more days past due is required to beplaced on non-accrual basis unless specifically identified mitigatingcircumstances exist. Our policy is to place loans 90 days past due on non-accrualstatus. An exception is made when management believes the loan is fully securedand in process of collection. Non-accrual loans are further classified asimpaired when underlying collateral is not sufficient to cover the loan balanceand it is probable that we will not fully collect all principal and interest.As of December 31, 2007 and September 30, 2007, we had $629,000 and$204,000 in non-accrual loans respectively. There were no loans contractuallypast due over 90 days which continued to accrue interest on December 31,2007 and September 30, 2007, based upon specific information available atthat time to management. In compliance with these statutes we have developedpro forma financial statements assuming that no loans will continue to accrue interestif they become 90 days past due, and instead transfer all such loans tonon-accruing status.

 

A “troubleddebt restructuring” is a restructured loan upon which interest accrues at abelow market rate or upon which certain principal has been forgiven so as toaid the borrower in the final repayment of the loan, with any interestpreviously accrued, but not yet collected, being reversed against currentincome. Interest is accrued based upon the new loan terms. There were notroubled debt restructurings outstanding as of December 31, 2007 and September 30,2007*.*

 

Non-performingassets also consist of other repossessed assets and other real estate owned (“OREO”).OREO represents properties acquired through foreclosure or other proceedingsand is recorded at the lower of cost or fair market value less the estimatedcost of disposal. OREO is evaluated regularly to ensure that the recordedamount is supported by its current fair market value. Valuation allowances toreduce the carrying amount to fair market value less estimated costs ofdisposal are recorded as necessary. Revenues and expenses from the operationsof OREO and changes in the valuation are included in other income and otherexpenses on the income statement. As of December 31, 2007, and September 30,2007, we had $50,000 in other real estate owned. The property consists of twosingle family dwellings located in Texline and Clayton, New Mexico. There wereno repossessed assets at December 31, 2007 and September 30, 2007.

 

***Sources of Funds***

 

*General*

 

Deposits,short-term and long-term borrowings, loan and investment security repaymentsand prepayments, proceeds from the sale of securities, and cash flows generatedfrom operations are the primary sources of our funds for lending, investing,and other general purposes. Loan repayments are a relatively predictable sourceof funds except during periods of significant interest rate declines, whiledeposit flows tend to fluctuate with prevailing interests rates, money marketsconditions, general economic conditions, and competition.

 

26

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*Deposits*

 

Weoffer a variety of deposit accounts with a range of interest rates and terms.Core deposits consist of checking accounts (non-interest bearing), “NOW”accounts, savings accounts, and non-public certificates of deposit. Thesedeposits, along with public fund deposits and short-term borrowings, are usedto support our asset base. Deposits are obtained predominantly from thegeographic trade areas surrounding our office locations. We rely primarily oncustomer service and long-standing relationships with customers to attract andretain deposits; however, market interest rates and rates offered by competingfinancial institutions significantly affect our ability to attract and retaindeposits. As the competition for deposits has increased, we have continued toexpand and diversify the Bank’s funding sources. For the three months ended December 31,2007, we have utilized institutional deposits to ensure adequate funding of ourloan growth.

 

The followingtable sets forth the maturities of time deposits $100,000 and over as of December 31,2007, and September 30, 2007 (in thousands):

 
| ** **                                | ** ** | **As of  December 31,  2007** | ** ** | **As of  September 30,  2007** | ** ** |
|-------------------------------------------|------------|-----------------------------------------|------------|------------------------------------------|------------|
|                                      |       |                                    |       |                                     |       |
| Time deposits  $100,000 and over:         |       |                                    |       |                                     |       |
| Maturing within  three months             |       | $                                       | 3,619      |                                     | $          | 2,898 |   |
| After three  months but within six months |       | 3,663                                   |       | 2,814                                    |       |
| After six months  but within 12 months    |       | 5,117                                   |       | 7,453                                    |       |
| After 12 months                           |       | 200                                     |       | 305                                      |       |
|                                      |       |                                    |       |                                     |       |
| Total time  deposits $100,000 and over    |       | $                                       | 12,599     |                                     | $          | 13,470 |   |

 

*Return on Equity and Assets*

 

The followingtable sets forth certain information regarding the Company’s return on equityand assets for the periods indicated:

 
| ** **              | ** ** | **For the Three Months Ended** | ** ** |
|-------------------------|------------|----------------------------------------------------|------------|
| ** **              | ** ** | **December 31,  2007**                        | ** ** | **December 31,  2006** | ** ** |
| Return on assets        |       | (0.19                                              | )%         | 0.03 | % |
| Return on equity        |       | (1.49                                              | )%         | 0.21 | % |
| Dividend payout  ratio  |       | 0                                                  | %          | 0 | % |
| Equity to assets  ratio |       | 13.03                                              | %          | 15.36 | % |

 

Thefollowing table presents a summary of non-cancelable future operating leasecommitments as of December 31, 2007 (in thousands):

 
| **Years Ending September 30,** | ** ** | **As of December  31, 2007** | ** ** |
|-----------------------------------------------|------------|---------------------------------------------|------------|
|                                          |       |                                        |       |
| 2008                                          |       | $                                           | 112        |   |
| 2009                                          |       | 165                                         |       |
| 2010                                          |       | 174                                         |       |
| 2011                                          |       | 175                                         |       |
| 2012                                          |       | 178                                         |       |
| Thereafter                                    |       | 1,669                                       |       |
|                                          |       | $                                           | 2,473      |   |

 

27

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**CapitalResources**

 

The risk-based capital regulations established and administered by thebanking regulatory agencies discussed previously are applicable to the Bank.Risk-based capital guidelines are designed to make regulatory capitalrequirements more sensitive to differences in risk profiles among banks, toaccount for off-balance sheet exposure, and to minimize disincentives forholding liquid assets. Under the regulations, assets and off-balance sheetitems are assigned to broad risk categories, each with appropriate weights. Theresulting capital ratios represent capital as a percentage of total riskweighted assets and off-balance sheet items. Under the prompt corrective actionregulations, to be adequately capitalized a bank must maintain minimum ratiosof total capital to risk-weighted assets of 8.00%, Tier 1 capital torisk-weighted assets of 4.00%, and Tier 1 capital to total assets of 4.00%.Failure to meet these capital requirements can initiate certain mandatory andpossibly additional discretionary actions by regulators that, if undertaken,could have a direct material effect on the Bank’s financial statements.

 

Asof December 31, 2007 and as of September 30, 2007, the most recentnotifications from the federal Banking regulators categorized the Bank aswell-capitalized. A well-capitalized institution must maintain a minimum ratioof total capital to risk-weighted assets of at least 10.00%, a minimum ratio ofTier 1 capital to risk weighted assets of at least 6.00%, and a minimum ratioof Tier 1 capital to total assets of at least 5.00% and must not be subject toany written order, agreement, or directive requiring it to meet or maintain aspecific capital level. There are no conditions or events since thatnotification that the Bank’s management believes have changed the capitalclassification.

 

TheBank was in full compliance with all applicable capital adequacy requirementsas of December 31, 2007 and September 30, 2007. The required andactual amounts and ratios for the Bank as of December 31, 2007 and September 30,2007, 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, 2007             |       |       |       |                                         |       |                                                                                         |       |   |   |   |   |   |   |
| Tier 1 capital  (to average assets)       |       | $          | 9,223      |                                         | 8.56       | %                                                                                            | $          | 4,308 |   | 4 | % | $ | 5,385 |   | 5 | % |
| Tier 1 capital  (to risk-weighted assets) |       | 9,223      |       | 9.51                                         | %          | 3,878                                                                                        |       | 4 | % | 5,816 |   | 6 | % |
| Total Capital  (to risk-weighted assets)  |       | 10,066     |       | 10.38                                        | %          | 7,755                                                                                        |       | 8 | % | 9,694 |   | 10 | % |
|                                           |            |            |            |                                              |            |                                                                                              |            |  |  |  |  |  |  |  |  |  |

 
| ** **                                | ** ** | **Actual** | ** ** | **For Capital  Adequacy Purposes** | ** ** | **To Be Well  Capitalized Under  Prompt Corrective  Action  Provisions** | ** ** |
|-------------------------------------------|------------|------------|------------|----------------------------------------------|------------|----------------------------------------------------------------------------------------------|------------|
| ** **                                | ** ** | **Amount** | ** ** | **Ratio**                                    | ** ** | **Amount**                                                                                   | ** ** | **Ratio** | ** ** | **Amount** | ** ** | **Ratio** | ** ** |
| As of  September 30, 2007            |       |       |       |                                         |       |                                                                                         |       |   |   |   |   |   |   |
| Tier 1 capital  (to average assets)       |       | $          | 9,079      |                                         | 8.78       | %                                                                                            | $          | 4,243 |   | 4 | % | $ | 5,303 |   | 5 | % |
| Tier 1 capital  (to risk-weighted assets) |       | 9,079      |       | 9.76                                         | %          | 3,726                                                                                        |       | 4 | % | 5,589 |   | 6 | % |
| Total Capital  (to risk-weighted assets)  |       | 9,868      |       | 10.61                                        | %          | 7,451                                                                                        |       | 8 | % | 9,314 |   | 10 | % |
|                                           |            |            |            |                                              |            |                                                                                              |            |  |  |  |  |  |  |  |  |  |

 

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

 

With the participation ofmanagement, the Company’s chief executive officer and chief financial officerreviewed and evaluated the Company’s disclosure controls and procedures asdefined in Rules 13a-14(c) and 15d-14(c) under the SecuritiesExchange Act of 1934, as amended (the “Exchange Act”), as of the end of the periodcovered by this report. Based on this evaluation, the chief executive officerand 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’s rules andforms.

 

There have been nosignificant changes in the Company’s internal controls for financial reportingor in other factors that could significantly affect these controls, includingany significant deficiencies or material weaknesses of internal controls thatwould require corrective action. 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 mayfrom time to time make changes aimed at enhancing their effectiveness andensuring that the Company’s systems evolve with its business.

 

28

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**PART II.****                Other Information**

 

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

 

None

 

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

 

On May 7, 2004, theSecurities and Exchange Commission declared our Registration Statement on Form SB-2(File No. 333-112325) related to our initial public offering effective. Inaddition, on October 22, 2004, we filed a Form SB-2MEF under Rule 462registering additional shares of common stock and warrants to purchase ourcommon stock under our public offering. We registered a total of 1,944,000shares of our common stock, of which 324,000 shares are issuable underregistered common stock warrants. We accepted subscriptions for 1,589,602shares of our common stock under the offering and have received net offeringproceeds (after deducting offering expenses) of approximately $11.9 million.

 

Fromthe offering proceeds, we paid our organizing shareholder and affiliate, TreatyOak Holdings, Inc. (“TOHI”) for reimbursement of expenses and advances onour behalf in connection with our offering and repayment of the amount dueunder a convertible promissory note. TOHI owned approximately 39% of our commonstock, but was acquired by us in a transaction that closed on November 15,2006. We contributed to the capital of the Bank and paid operating expensesincluding repayment of certain costs previously paid by TOHI. We also repaidprincipal and interest under unsecured promissory notes issued in connectionwith the purchase price of the Bank, and have paid ongoing operating expenses.These payments are summarized in the table below:

 
| ** **                                                                                                                                                                                | ** ** | **As of**                  | ** ** |
|-------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------|------------|---------------------------------|------------|
| ** **                                                                                                                                                                                | ** ** | **December 31, 2007** | ** ** |
| Gross proceeds  from sale of shares                                                                                                                                                       |       | $                               | 13,276,271 |   |
| Gross proceeds  from exercise of warrants                                                                                                                                                 |       | —                          |       |
| 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)                                                                                                                    |       | (212,968                        | )          |
| Payments to  officers (salary and benefits)                                                                                                                                               |       | (386,108                        | )          |
| 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                                                                                                                                                              |       | (105,005                        | )          |
| Expenses related  to proposed reclassification transaction                                                                                                                                |       | (120,000                        | )          |
| Payment of  additional operating expenses (estimated)                                                                                                                                     |       | (1,068,281                      | )          |
| Remaining net  proceeds                                                                                                                                                                   |       | $                               | 361,181    |   |

 

In connection with theCompany’s acquisition of TOHI, we issued 1,094,163 shares of the Company’scommon stock to the TOHI shareholders. We also issued warrants to acquire, inthe aggregate, 450,000 shares of the

 

29

----

 

Company’s common stockwith an exercise price of the lesser of the Company’s book value or $6.67 tovarious TOHI warrantholders. We issued the stock and warrants under anexemption from registration under Section 4(2) of the Securities Actof 1933. The Company granted the TOHI shareholders certain limited registrationrights pursuant to a Registration Rights Agreement executed at the closing ofthe merger. Pursuant to the Registration Rights Agreement these former TOHIshareholders can request that the Company register their shares of the Company’sstock on a Registration Statement on Form S-3 if such form is availablefor use by the Company, but only once during any 12-month period. The formerTOHI warrantholders were also granted similar S-3 registration rights.

 

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

## ** **

## **None.**

## ** **

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

## ** **

On November 13, 2007our Board of Directors approved a plan to deregister our common stock under theSecurities Exchange Act of 1934, as amended, and, therefore, terminate ourobligations to file reports with the Securities and Exchange Commission. This “going private” transaction would be accomplished through an amendment(the “Amendment”) to the Company’s Articles of Incorporation, which would (1) authorize2,500,000 shares of a new Series A Preferred Stock and (2) effect areclassification of all shares of common stock held by record shareholdersowning less than 2,500 shares of our common stock into shares of Series APreferred Stock on a one-for-one basis (the “Reclassification”).  Sharesof common stock held by record shareholders owning 2,500 or more shares willremain outstanding and will be unaffected by the Reclassification.

 

The Amendment andReclassification are subject to approval by the holders of two-thirds (2/3) ofthe outstanding shares of our common stock.  Shareholders will be asked toapprove the Amendment and Reclassification at our 2008 annual shareholdersmeeting to be held on February 25, 2008.

 

If the Amendment isapproved by our shareholders and, after completion of the Reclassification, wehave fewer than 300 shareholders of record of common stock, we intend toterminate the registration of our common stock under the Securities ExchangeAct of 1934, as amended, and become a non-reporting company.  If thatoccurs, we will no longer file periodic reports with the Securities andExchange Commission, including annual reports on Form 10-KSB and quarterlyreports on Form 10-QSB.

 

Those shareholdersreceiving shares of Series A Preferred Stock in the Reclassification willhave the option to sell those shares to us at any time during the 30 day periodfollowing the Reclassification at a cash price equal to $11.00 per share (the “PutPrice”).

 

Our Board of Directorsreceived a fairness opinion from its financial advisor, Fowler ValuationServices, LC, that the Put Price to be paid following the Reclassification isfair, from a financial perspective, to all of our shareholders.

 

**Item 5.****                    *Other Information***

 

None.

 

30

----

 

**Item 6.****                    *Exhibits***

 

The following exhibitsare filed herewith or are incorporated by reference to exhibits previouslyfiled with the SEC.

 
| **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)             |       | Form of  Promotional Shares Lock-In Agreement                                                                                                          |
|                |       |                                                                                                                                                        |
| 10.3(2)*            |       | Treaty  Oak Bancorp, Inc. 2004 Stock Incentive Plan (amended and restated as of  May 20, 2004)                                                    |
|                |       |                                                                                                                                                        |
| 10.4(3)*            |       | Form of  Indemnification Agreement between Treaty Oak Bancorp, Inc. and its  directors and officers, and those of the Bank                        |
|                |       |                                                                                                                                                        |
| 10.5(4)*            |       | Employment  Agreement, dated September 27, 2006, between Treaty Oak  Bancorp, Inc. and Jeffrey L. Nash                                            |
|                |       |                                                                                                                                                        |
| 10.6(5)             |       | Form of  Warrant                                                                                                                                       |
|                |       |                                                                                                                                                        |
| 10.7(5)             |       | Form of  Registration Rights Agreement with former shareholders of Treaty Oak  Holdings, Inc.                                                     |
|                |       |                                                                                                                                                        |
| 10.8(5)             |       | Form of  Registration Rights Agreement with former warrantholders of Treaty Oak  Holdings, Inc.                                                   |
|                |       |                                                                                                                                                        |
| 10.9(6)             |       | Promissory  Note of PGI Equity Partners, L.P. dated March 15, 2005 payable to  Prudential Mortgage Capital Company, LLC                                |
|                |       |                                                                                                                                                        |
| 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 or arrangement.                                                           |
|-----|--------|-------------------------------------------------------------------------------------------------------------------------------|
| (1) |   | Incorporated by  reference to the Company’s Current Report on Form 8-K filed  October 10, 2006.                |
| (2) |   | Incorporated by  reference to the Company’s Registration Statement on Form S-8 filed  October 22, 2004.        |
| (3) |   | Incorporated by reference to the same numbered  exhibit to the Company’s Registration Statement on Form SB-2.       |
| (4) |   | Incorporated by  reference to the Company’s Current Report on Form 8-K filed  November 1, 2006.                |
| (5) |   | Incorporated by  reference to the Company’s same numbered exhibit to the Form 10-KSB  filed December 29, 2006. |
| (6) |   | Incorporated by reference  to the Company’s same numbered exhibit to the Form 10-KSB filed  December 31, 2007. |
| **  |   | 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, 2008 | By:                           | /s/ Jeffrey L. Nash |   |
|                           |                          | Jeffrey L. Nash,  President and Chief Executive Officer |
|                           |                          |
|                           |                          |
|                           | By:                           | /s/ Coralie S. Pledger |   |
|                           |                          | Coralie S. Pledger,  Chief Financial Officer |
|                                |                               |  |  |  |

 

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