UNITED STATES

SECURITIES AND EXCHANGE COMMISSION

WASHINGTON, DC 20549

FORM 10-QSB

For the quarterly period ended December 31, 2007

Commission File Number: 333-112325

Treaty Oak Bancorp, Inc.

(Exact name of registrant as specified in its charter)

Texas

(State or other jurisdiction of

corporation or organization)

20-0413144

(I.R.S. Employer Identification Number)

101 Westlake Drive, Austin, Texas

(Address of Principal Executive Offices)

78746

(Zip Code)

(512) 617-3600

(Registrant’s telephone number, including area code)

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

Yes x      No.o

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

Yes o      No.x

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

QUARTERLY REPORT ON FORM 10-QSB

FOR THE PERIOD ENDED DECEMBER 31, 2007

TABLE OF CONTENTS

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

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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 Share Amounts)

See Notes to Consolidated Financial Statements (unaudited)

(1)  Derived from Audited Consolidated Financial Statement

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Treaty Oak Bancorp, Inc.

Consolidated Statements of Operations (unaudited)

Three Months Ended December 31, 2007 and 2006

(Dollars In Thousands, Except Share and Per Share Amounts)

See Notes to Consolidated Financial Statements (unaudited)

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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)

See Notes to Consolidated Financial Statements (unaudited)

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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)

See Notes to Consolidated Financial Statements (unaudited)

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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)

See Notes to Consolidated Financial Statements (unaudited)

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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 common stock of Treaty Oak Bank (formerly Texline State Bank, the “Bank”). The Company, through Treaty Oak Bank, provides a full range of commercial and consumer banking services to individuals and businesses in the commercial sector in Austin, Texas, Marble Falls, Texas and in the agriculture, cattle and commercial sectors in the community of Texline, Texas.

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

The Company acquired a 47.5% interest in PGI Equity Partners, LP (the “Partnership”) on December 31, 2004. The Partnership owns and operates the building in which the Company offices. On February 23, 2006, the Company acquired additional 2.5% Class A and 1.25% Class B interests in the Partnership from the sole remaining minority shareholder, bringing the Company’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 the Company’s merger with TOHI on November 15, 2006, the Company now owns 100.0% of the limited partnership interests in the Partnership as well as the 5.0% general partnership interest held by PGI Capital, Inc., the Partnership’s general partner. The Partnership has been consolidated in the Company’s financial statements since December 31, 2004. TOHI and PGI Capital, Inc.’s interests have been accounted for as minority interests until the merger on November 15, 2006.

The consolidated financial statements include the accounts of Treaty Oak Bancorp, Inc., its wholly owned subsidiary Treaty Oak Bank, and PGI Equity Partners, LP. The consolidated 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 been prepared in accordance with the instructions to Form 10-QSB and, therefore, do not include all of the disclosures and notes required by accounting principles generally accepted in the United States of America. In the opinion of management, all material adjustments (which are of a normal recurring nature) considered necessary for a fair presentation have been made. The results for the interim period are not necessarily indicative of the results to be expected for the entire year or any other interim period.

New Accounting Pronouncements

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

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In September 2006, the SEC issued Staff Accounting Bulletin (“SAB”) No. 108, “Considering the Effects of Prior Year Misstatements when Quantifying Misstatements in Current Year Financial Statements.” SAB 108 addresses the views of the SEC staff regarding the process of quantifying financial statement misstatements. SEC registrants are expected to reflect the effects of initially applying the guidance in SAB 108 in their annual financial statements covering the first fiscal year ending after November 15, 2006. The cumulative effect of the initial application should be reported in the carrying amounts of assets and liabilities as of the beginning of that fiscal year and the offsetting adjustment should be made to the opening balance of retained earnings for that year. The Company adopted SAB 108 on October 1, 2007 and the adoption did not have any impact on the financial statements.

In September 2006, the FASB issued SFAS No. 157, “Fair Value Measurements”. This Statement defines fair value, establishes a framework for measuring fair value and expands disclosures about fair value measurements. It clarifies that fair value is the price that would be received to sell an asset or paid to transfer a liability in an orderly transaction between market participants in the market in which the reporting entity transacts. This Statement does not require any new fair value measurements, but rather, it provides enhanced guidance to other pronouncements that require or permit assets or liabilities to be measured at fair value. This Statement is effective for fiscal years beginning after November 15, 2007, with earlier adoption permitted. The Company will adopt this standard in the first quarter of fiscal 2009. The Company does not expect that the adoption of this Statement will have a material impact on its financial position, results of operation and cash flows.

In February 2007, the FASB issued SFAS No. 159, “The Fair Value Option for Financial Assets and Financial Liabilities”. This Statement permits entities to choose to measure many financial assets and financial liabilities at fair value. Unrealized gains and losses on items for which the fair value option has been elected will be reported in earnings. SFAS No. 159 is effective for fiscal years beginning after November 15, 2007.  The Company will adopt this standard in the first quarter of fiscal 2009. The Company is currently evaluating the impact of SFAS No. 159 on its consolidated financial position, results of operations and cash flows.

Note 2. Merger with Organizing Shareholder

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

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

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

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

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

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

Note 3. Earnings (Loss) Per Share

Basic earnings (loss) per share is computed by dividing net earnings (loss) by the weighted-average number of common shares outstanding for the period.  Diluted earnings per share is computed using the weighted-average number of common shares outstanding plus the number of additional common shares that would have been outstanding if dilutive common shares had been issued.  For the three months ended December 31, 2007, there were 1,023,291 potentially dilutive securities outstanding, however, due to the net loss, all potentially dilutive securities were all anti-dilutive.

For the three months ended December 31, 2006, all potentially dilutive securities were anti-dilutive except for stock options to purchase 15,500 shares of the Company’s common stock at an exercise price of $8.00, stock options to purchase 32,484 shares of the Company’s common stock at an exercise price of $6.16 that were assumed in conjunction with the merger with TOHI and warrants to purchase 450,000 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 warrant agreements.

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Note 4. Securities

Securities consisted of the following (in thousands):

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

Note 5. Loans and Allowance for Loan Losses

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

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

At December 31, 2007 and 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):

Depreciation and amortization expense for the three months ending December 31, 2007 and 2006 was $110,000 and $86,000, respectively.

Note 7. Deposits

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

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Note 8. Goodwill and Other Intangibles

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

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

Note 9. Stock Based Compensation and 2004 Stock Incentive Plan

The Company adopted Financial Accounting Standards Board Statement No. 123R, “Share-Based Payment”, (“Statement 123R”) on October 1, 2006. Under Statement 123R, the cost of employee services received in exchange for an award of equity instruments is based on the grant-date fair value of the award (with limited exceptions). That cost is recognized over the period during which an employee is required to provide service in exchange for the award – the requisite service period (usually the vesting period). The Company adopted Statement 123R using the modified prospective application, which was required for public companies. Under the modified prospective application, Statement 123R applies to new awards and to awards modified, repurchased, or cancelled after October 1, 2006. Additionally, compensation cost for the portion of awards for which the requisite 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 the intrinsic value method. Accordingly, compensation costs for employee stock options was measured as the excess, if any, of the fair value of the Company’s common stock at date of grant over the exercise price.

The Company accounts 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 Incentive Plan (the “Plan”).  The Plan authorizes incentive stock option grants, non-statutory stock option grants, direct stock issuances, stock appreciation rights, salary investment option grants, and director fee option grants.  Eligible participants are employees, non-employee board members, and independent consultants or advisors.  The Company has reserved 500,000 shares of common stock under the Plan, and the share reserve increases on the 1^st business day in January each year (beginning in 2005) by an amount equal to 2% of the number of outstanding shares of the Company on the last business day in December of the preceding year, subject to a maximum annual increase of 100,000 shares.  No person may receive stock option grants, stock issuances, or stock appreciation rights for more than 100,000 shares in the aggregate in any calendar year under the Plan. Option awards are generally granted with an exercise price equal to the market price of the Company’s stock at the date of the grant; have 10-year contractual terms and vest based on three years of continuous service. Share awards generally vest over four years.

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The following table illustrates the stock compensation expense recognized during the three months ended December 31, 2007 and 2006.

The fair value of each option award is estimated on the date of grant using the Black-Scholes option pricing model. The Black-Scholes option pricing model requires the input of highly subjective assumptions. The Company continues to assess the assumptions and methodologies used to calculate the estimated fair value of the stock-based compensation. Circumstances may change and additional data may become available over time, which could result in changes to these assumptions and methodologies. The risk-free rate for periods within the expected life of the options 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 and contractual life of the options. Volatility in the Black-Scholes model is based on historical volatility for comparable publicly-traded banks and the Company’s historical stock prices since inception.

The fair value of restricted common stock granted under the Plan is estimated using the most recently traded market price of the Company’s common stock at the time of the grant.

The weighted average fair value of the options granted during the three months ended December 31, 2007 and 2006, has been estimated using the Black-Scholes option pricing model with the following assumptions:

As of December 31, 2007, there were outstanding options under the Company’s Stock Incentive Plan to 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 may be exercised in three equal annual installments for each year of service measured from the grant date.  During the three months ended December 31, 2007, the Company granted stock options to purchase an aggregate of 110,862 shares 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 with an 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 of service over the four-year period of service measured from the date of the award. On November 20, 2007 and December 20, 2007, four (4) officers surrendered 5,206 vested shares of common stock to satisfy federal income tax withholding requirements.

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

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officers and directors. The options may be exercised in three equal annual installments for each year of service measured from the grant date.  Included in the option grants for the 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 per share.

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 of service over the four-year period of service measured from the date of the award.

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

A summary of shares 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 is presented below:

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

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

Note 10. Stock Warrants

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

Note 11. Other Related Party Transactions

The Company 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 with monthly 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 certain obligations, and to provide sufficient liquidity to TOHI until the proposed merger with the Company was completed. On April 26, 2006, the obligation was renewed and increased to $373,000 at the then current prime rate. The loan was renewed and increased to $400,000 on September 1, 2006. The principal balance ($396,000 as of September 30, 2007), along with any accrued interest, 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 paid in full.

On August 24, 2006, the Company made a $2,425,000 loan to TOHI with monthly interest payments at the current prime rate (8.25% at September 30, 2006) due on the 24^th day of each month. The purpose of the loan was to enable TOHI to redeem shares of common and preferred stock from certain of its shareholders. The loan was due 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 financial instruments with off-balance sheet risk to meet the financing needs of its customers, through the use of commitments to extend credit. Those instruments involve, to varying degrees, elements of credit and interest-rate risk in excess of the amount recognized in the consolidated balance sheet. The contract or notional amounts of those instruments reflect the extent of the Company’s involvement in particular classes of financial instruments.

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

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

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

Standby letters of credit are written conditional commitments used by the Company to guarantee the performance of a customer to a third party. The Company’s policies generally require that letter of credit arrangements contain security and debt covenants similar to those contained in loan arrangements. In the event the customer does not perform in accordance with the terms of the agreement with the third party, the Company would be required to fund the commitment. The maximum potential amount of future payments the Company could be required to make is represented by the contractual amount shown in the table above. If the commitment is funded, the Company would be entitled to seek recovery from the customer. As of December 31, 2007, no amounts have been recorded as liabilities for the Company’s potential obligations under these guarantees.

Note 13.  Commitments and Contingencies

The following table presents a summary of non-cancelable future operating lease commitments as of December 31, 2007 (in thousands):

Note 14. Dividend Restrictions and Regulatory Matters

Banks and bank holding companies are subject to regulatory capital requirements administered by state and federal banking regulatory 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 regulatory accounting practices. Capital amounts and classifications are also subject to qualitative judgments by regulators about components, risk weightings and other factors. Failure to meet capital requirements can initiate regulatory action. As of December 31, 2007, management believes the Bank is in compliance with all regulatory capital requirements to which it is subject.

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