UNITED STATES
SECURITIES AND EXCHANGE COMMISSION
WASHINGTON, D.C. 20549

FORM 10-KSB
Mark One

[X] ANNUAL REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES EXCHANGE ACT OF 1934

For the Fiscal Year Ended December 31, 2003

OR

[ ] TRANSITION REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES EXCHANGE ACT OF 1934
For the Transition Period From ___________ to ___________.

Commission File Number 001-12818

SURETY CAPITAL CORPORATION
(Exact name of Registrant as specified in its charter)
Delaware 75-2065607
--------------------------------------------------------------------------------
(State of Incorporation) (IRS Employer Identification No.)

1501 Summit Avenue, Fort Worth, Texas 76102
(Address of Principal Executive Offices)

817-335-5955
(Registrant's telephone number, including area code)

Securities registered pursuant to Section 12(b) of the Act: None

Securities registered pursuant to Section 12(g) of the Act: Common Stock, $0.01 par value

Check 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 [ ]

Check if there is no disclosure of delinquent filers pursuant to Item 405 of Regulation S-B is not contained herein, and no disclosure will be contained, to the best of Registrant's knowledge, in definitive proxy or information statements incorporated by reference in Part III of this Form 10-KSB or any amendment to this Form 10-KSB.

Issuer's revenues for its most recent fiscal year: $5,811,165

The aggregate market value of Common Stock held by nonaffiliates of the Registrant on April 1, 2004, based on the average of the bid and ask price for the Common Stock, was $700,426. For purposes of this computation, all officers, directors and 5% beneficial owners of the Registrant are deemed to be affiliates. Such determination should not be deemed an admission that such officers, directors or 5% beneficial owners are, in fact, affiliates of the
Registrant.

As of April 1, 2004, 10,006,080 shares of Common Stock were outstanding.

Transitional Small Business Disclosure Format (check one). Yes [ ] No [X]

Documents Incorporated by Reference: None.

SPECIAL NOTE CONCERNING FORWARD-LOOKING STATEMENTS

This document (including information incorporated by reference) contains, and future oral and written statements of the Company and its management may contain, forward-looking statements, within the meaning of such term in the Private Securities Litigation Reform Act of 1995, with respect to the financial condition, results of operations, plans, objectives, future performance and business of the Company. Forward-looking statements, which may be based upon beliefs, expectations and assumptions of the Company's management and on information currently available to management, are generally identifiable by the use of words such as "believe," "expect," "anticipate," "plan," "intend," "estimate," "may," "will," "would," "could," "should" or other similar expressions. Additionally, all statements in this document, including forward-looking statements, speak only as of the date they are made, and the Company undertakes no obligation to update any statement in light of new information or future events.

The Company's ability to predict results or the actual effect of future plans or strategies is inherently uncertain. Factors that could have material adverse effects on the operations and future prospects of the Company and its subsidiaries include, but are not limited to, the following:

- The strength of the United States economy in general and the strength of the local economies in which the Company conducts its operations which may be less favorable than expected and may result in, among other things, a deterioration in the credit quality and value of the Company's assets.

- The economic impact of past and any future terrorist attacks, acts of war or threats thereof and the response of the United States (which may include military action) to any such threats and attacks.

- The effects of, and changes in, federal, state and local laws, regulations and policies affecting banking, securities, insurance and monetary and financial matters.

- The effects of changes in interest rates (including the effects of changes in the rate of prepayments of the Company's assets) and the policies of the Board of Governors of the Federal Reserve System.

- The ability of the Company to compete with other financial institutions as effectively as the Company currently intends due to increases in competitive pressures in the financial services sector.

- The inability of the Company to obtain new customers and to retain existing customers.

- The timely development and acceptance of products and services, including products and services offered through alternative delivery channels such as the Internet.

- Technological changes implemented by the Company and by other parties, including third party vendors, which may be more difficult or more expensive than anticipated or which may have unforeseen consequences to the Company and its customers.

- The ability of the Company to develop and maintain secure and reliable electronic systems.

- The ability of the Company to retain key executives and employees and the difficulty that the Company may experience in replacing key executives and employees in an effective manner.

- Consumer spending and saving habits which may change in a manner that affects the Company's business adversely.

- Business combinations and the integration of acquired businesses that may be more difficult or expensive than expected.

- The costs, effects and outcomes of existing or future litigation.

- Changes in accounting policies and practices, as may be adopted by state and federal regulatory agencies and the Financial Accounting Standards Board.

- The ability of the Company to manage the risks associated with the foregoing as well as its inability to meet its obligations under the subordinated convertible notes including interest payments that became due March 31, 2002 which the Company has not made.

- The ability of the Company to comply with the terms of the Formal Agreement with the OCC entered into on February 18, 2003 as more fully discussed in Note 18 to the Surety Capital Corporation Notes to Consolidated Financial Statements included later herein. These risks and uncertainties should be considered in evaluating forward-looking statements and undue reliance should not be placed on such statements. Additional information concerning the Company and its business, including other factors that could materially affect the Company's financial results, is included in the Company's filings with the Securities and Exchange Commission.

PART I

ITEM 1. BUSINESS.

GENERAL

Surety Capital Corporation (the "Company"), a corporation incorporated under the laws of the state of Delaware in 1985, is a bank holding company registered under the bank Holding Company Act of 1956, as amended (the "BHC Act"). The Company owns all of the issued and outstanding shares of capital stock of Surety Bank, National Association (the "Bank"), Fort Worth, Texas, formerly Texas Bank, National Association and formerly Texas National Bank. On December 31, 2003 the Bank had full service offices in Converse, Fort Worth, New Braunfels, San Antonio, Universal City, and Whitesboro, Texas. On January 15, 2004 the Bank sold its full service offices in Converse, New Braunfels, San Antonio and Universal City, Texas.

The Company's principal executive offices are located at 1501 Summit Avenue, Fort Worth, Texas 76102, and its telephone number is 817-335-5955.

THE COMPANY

Surety Finance Company, the predecessor to the Company, commenced business in 1985 as a sole proprietorship. In December 1989, the Company acquired approximately 98% of the common stock of the Bank and subsequently increased its ownership to 100%. Prior to its acquisition of the Bank, the Company operated as a casualty insurance premium financing ("IPF") company licensed by the State of Texas. Upon its acquisition by the Company, the Bank began making IPF loans, and the Company ceased writing new IPF business to allow the Bank to succeed to the existing business of the Company at that time. The Company conducts all its operations through the Bank.

THE BANK

The Bank was chartered as a national banking association in 1983. After January 15, 2004, the Bank operates full service offices in Fort Worth and Whitesboro, Texas. The Bank also operates one mobile branch to serve Dallas and Tarrant counties in Texas. The Bank provides retail and commercial banking services to its customers, including checking and savings accounts, time deposits, IRAs, money transfers, safe deposit facilities, commercial loans, real estate mortgage loans, consumer loans and night depository facilities. The Bank specializes in IPF lending. At December 31, 2003, commercial loans, real estate loans, consumer loans and IPF loans represented 16.19%, 66.64%, 9.02% and 7.95% of the Company's total loan portfolio, respectively. Management believes that no material industry or group concentrations exist in the loan portfolio.

REGULATORY RELATIONS

FORMAL AGREEMENT. On February 18, 2003, the Bank and OCC entered into a new formal written agreement (the "New Formal Agreement") that replaced prior agreements with the OCC. The New Formal Agreement requires the Bank to develop, within 90 days of the agreement, an action plan detailing the Board of Directors' assessment of how to improve the Bank including implementation and timetable. The New Formal Agreement also includes provisions for new appointments to the Board of Directors, management effectiveness, adoption of a three-year strategic plan and preparation of a three-year business plan. In addition, the New Formal Agreement requires that the Bank achieve ratios of Tier 1 capital to average assets of at least 8.0% and Total capital to adjusted total assets of 12.0% by June 30, 2003. The Board is also required to develop a three-year capital program, develop a written program to improve the Bank's loan portfolio and implement an internal audit program. The New Formal Agreement sets forth time limits to achieve each of the required actions. The OCC may extend the time requirements for good cause upon written application from the Board of Directors. If the Bank fails to achieve substantial compliance with the New Formal Agreement within 90 days of the expiration of the time limits (including any duly granted extensions of time), the Board of Directors must provide a written report setting out its plans to sell, merge, or liquidate the Bank. The Board of Directors and management intend to comply with the provisions of the New Formal Agreement. However, compliance with provisions of the Formal Agreement cannot be assured. At December 31, 2003 the Bank complied initially with all requirements of the Formal Agreement other than meeting the required ratios. However, with the sale of the 4 San Antonio branches, the Bank is now in substantial compliance with all ratios. On December 31, 2003 tier 1 capital to average assets was 6.36% and total capital to risk-weighted assets was 10.06% versus the ratios required under the Formal Agreement of 8.00% and 12.00%, respectively.

MEMORANDUM OF UNDERSTANDING. On October 28, 1999, the Board of Directors of the Company entered into a Memorandum of Understanding (the "MOU") with the Board of Governors of the Federal Reserve System (the "FRB"). Under the MOU, the Company is not permitted to declare or pay any corporate dividends or incur any additional debt without the prior approval of the FRB. Also, the Company was required to develop and submit to the FRB a written three-year capital plan, a plan to service the Company's existing debt without incurring any additional debt and written procedures designed to strengthen and maintain the Company's internal records and controls to ensure that future regulatory reports are filed in a timely and accurate manner. Finally, the Company is mandated under the MOU to comply fully with all formal and informal supervisory actions that have been or may be imposed on the Bank by the OCC. The Company has substantially complied with the requirements of the MOU. However, the Company has not yet met any of its interest payment obligations on the $4.350 million convertible subordinated debt since missing the payment that was due March 31, 2002. At December 31, 2003, the Company did not meet the capital ratios established for capital adequacy purposes. Tier 1 capital to average assets was 1.99%, Tier 1 capital to risk-weighted assets was 2.65% and total capital to risk-weighted assets was 5.24% versus ratios established by the FRB for capital adequacy purposes of 4.00%, 4.00% and 8.00%, respectively. The FRB may take formal action including requiring that capital be increased or that the Company divest the Bank.

SECURITIES AND EXCHANGE COMMISSION AGREEMENT. The Company is subject to the reporting requirements of the Securities Exchange Act of 1934, as amended, the “Exchange Act”. The Securities and Exchange Commission ("SEC") investigated the Company and others with respect to various accounting irregularities found by the Company in its IPF division during an internal audit of the division conducted in 1999 and the first quarter of 2000. Upon finding the irregularities, the Company reported them to the SEC, the OCC as well as certain other legal authorities. The Company fully cooperated with the SEC as well as bank regulatory agencies involved in investigating the irregularities. In February 2002, the SEC issued a finding that the Company violated certain sections of the Exchange Act. In March 2002, the Company entered into a settlement with the SEC. In connection with the settlement, the Company acknowledged certain reporting and internal control deficiencies and agreed to cease and desist from the stipulated violations in the future. The Company and the Bank no longer employ the persons directly responsible for managing the IPF division during the period when the diversions occurred and the Company no longer uses the services of the accounting firm auditing the Company at that time. None of the current members of the Company or Bank's Board of Directors served in those capacities during the period when the violations of the Exchange Act occurred.

DEPENDENCE ON BANK

The Company, as a holding company, is without significant assets other than its ownership of all the common stock of the Bank. The Company is dependent upon dividends received from the Bank in order to meet its cash obligations, including debt service on the $4,350,000 aggregate principal amount of 9% Convertible Subordinated Notes due 2008 (the "Notes"), issued under an indenture dated as of March 31, 1998 between the Company and Harris Trust and Savings Bank, Chicago, Illinois, as trustee (the "Indenture"). Under the New Formal Agreement, the Bank is currently precluded from declaring and paying any dividends without prior OCC approval and no approval has been obtained. There are no future commitments by any officer or director to loan the Company funds or purchase the Company's stock. Accordingly, the Company has no source of funds to pay interest on the Notes or provide other working capital needs. On March 28, 2000, the OCC approved a reduction in the Bank's surplus in the amount of $500,000 that enabled the Company to meet debt service obligations under the Notes and pay for other operating expenses through March 31, 2000. During 2001, certain Board members lent the Company $195,000 under noninterest bearing notes convertible into shares of unregistered restricted stock and purchased shares of newly issued restricted stock for $351,900 to enable the Company to meet its cash obligations, including interest payments on the Notes. During 2002, the Company issued 655,000 shares of unregistered restricted common stock for $68,100 and converted $95,000 of non-interest bearing notes into 438,392 shares of unregistered restricted common stock. During 2003, the Company received $15,000 to pay corporate expenses for the issuance of 833,333 shares of unregistered restricted common stock. The amount has been recorded as a liability pending the issuance of the common shares. There have been no approvals by the OCC for future reductions in the Bank's surplus, payment of dividends or other upstream of capital by the Bank to the Company which been requested. There are no future commitments by any officer or director to loan the Company funds or purchase the Company's stock. Accordingly, the Company has no source of funds to pay interest on the Notes or provide other working capital needs.

In recent conversations between the Company and certain holders of the notes, one holder has threatened to file an involuntary petition in bankruptcy against the Company. The Company understands that the threatening holder is seeking two other holders to join in the filing of an involuntary petition in bankruptcy against the Company. In the event the holder makes the threatened bankruptcy filing, the Company would evaluate whether legal recourse was available against the holder and, if appropriate, may initiate action against the holder.

COMMERCIAL AND CONSUMER LENDING

The Company provides general commercial lending services for corporate and other business clients as a part of the Company's efforts to serve the local communities in which it operates. Certain risks are involved in granting loans, primarily related to the borrowers' ability and willingness to repay the debt. Before the Company extends a new loan to a customer, these risks are assessed through a review of the borrower's past and current credit history, the collateral being used to secure the transaction, the borrower's general character and various other factors. Once the decision has been made to extend credit, a responsible credit officer monitors these factors throughout the life of the loan. The Company commissioned an independent loan review during the second quarter of 2002. Any loan identified as a problem credit by management or during the loan review is assigned to the Company's "watch loan list," and is subject to ongoing monitoring to ensure appropriate action is taken when deterioration has occurred. Commercial, industrial and agricultural loans are primarily variable-rate and include operating lines of credit and term loans made to small businesses primarily based on their ability to repay the loan from the business's cash flow. Business assets such as equipment and inventory typically secure these loans. When the borrower is not an individual, the Company generally obtains the personal guarantee of the business owner. As compared to consumer lending, which includes loans secured by a single-family residence, personal installment loans and automobile loans, commercial lending entails significant additional risks. These loans typically involve larger loan balances and are generally dependent on the business's cash flow and, thus, may be subject to adverse conditions in the general economy or in a specific industry. Management reviews the borrower's cash flows when deciding whether to grant the credit to evaluate whether estimated future cash flows will be adequate to service principal and interest of the new obligation in addition to existing obligations. Commercial real estate and farmland loans are primarily secured by borrower-occupied business real estate and are dependent on the ability of the related business to generate adequate cash flow to service the debt. Such loans primarily carry variable-interest rates. Commercial real estate loans are generally originated with a loan-to-value ratio of 80% or less. Management performs much the same analysis when deciding whether to grant a commercial real estate loan as a commercial loan.

Residential real estate loans and home equity lines of credit carry primarily variable rates, although fixed-rate loans are originated, and are secured by the borrower's residence. Such loans are made based on the borrower's ability to make repayment from employment and other income. Management assesses the borrower's ability to repay the debt through review of credit history and ratings, verification of employment and other income, review of debt-to-income
ratios and other measures of repayment ability. The Company generally makes these loans in amounts of 80% or less of the value of collateral. An appraisal is obtained from a qualified real estate appraiser for substantially all loans secured by real estate.

Construction loans are secured by residential and business real estate, generally occupied by the borrower on completion. The Company's construction lending program is established in a manner to minimize risk of this type of lending by not making a significant amount of loans on speculative projects. While not contractually required to do so, the Company usually makes the
permanent loan at the end of the construction phase. Construction loans also are generally made in amounts of 80% or less of the value of collateral. Consumer installment loans to individuals include loans secured by automobiles and other consumer assets. Consumer loans for the purchase of new automobiles generally do not exceed 80% of the sticker price of the car. Loans for used cars generally do not exceed average loan value as stipulated in a recent auto industry used car price guide. Overdraft protection loans are unsecured personal lines of credit to individuals of demonstrated good credit character with reasonably assured sources of income and satisfactory credit histories. Consumer loans generally involve more risk than residential mortgage loans because of the type and nature of collateral and, in certain types of consumer loans, the absence of collateral. Since these loans are generally repaid from ordinary income of an individual or family unit, repayment may be adversely affected by job loss, divorce, and ill health or by general declines in economic conditions. The Company assesses the borrower's ability to make repayment through a review of credit history, credit ratings, debt-to-income ratios and other measures of repayment ability.

INSURANCE PREMIUM FINANCING

The Company supplements its traditional community bank lending with its specialized niche-lending product of IPF. The Company funds this specialized lending activity by using relatively low cost core retail deposits from its network of community banking offices. This gives the Company a pricing advantage over non-bank competitors.

IPF lending involves the lending of funds to companies and individuals for the purpose of financing their purchase of property and casualty insurance. The Company markets this product through approximately 250 independent insurance agents and maintains a loan portfolio supported by insurance policies underwritten by approximately 300 insurance companies. The loans are relatively short term, generally with initial maturities of eight to ten months. The down payment and monthly installments on each loan are calculated so that in most cases the equity or value of the unearned premium in the policy exceeds the net balance due on the loan. If the borrower does not make the loan payments on time, the Company has the right, after notice to the borrower, to cancel the insurance policy and to receive the entire amount of the unearned premium from the insurance company writing the insurance. The unearned premium is then applied to the net loan balance. As a result of various accounting irregularities found by the Company during the course of an internal audit of the IPF division of the Bank conducted in 1999 and concluded in the first quarter of 2000, the Company recognized additional losses, including interest, of $2,611,000 (on a before tax basis) over prior years beginning in the first quarter of 1996 and extending through the fourth quarter of 1999. These losses were primarily the result of the diversion of refunds due certain insurance premium finance customers to the accounts of other customers. Errors resulting from the absence of appropriate accounting controls also contributed to a much lesser extent to such losses. Upon finding the irregular transactions, the Company's management reported the irregularities to the Board of Directors and the OCC. On September 21, 1999 the Board of Directors and the OCC entered into an Amendment to the original Formal Agreement pursuant to which the Bank was required to retain the services of a qualified and independent auditor of the Bank to review all IPF accounting transactions (from 1997 forward) relating to any overpayment of loan balances and/or refunds due to IPF customers and report to the Board of Directors and the OCC regarding the review. The Company engaged Thomas J. Kwentus C.P.A., an independent forensic accountant who later joined the Company's Board of Directors, to conduct an independent review of the IPF division covering the period from January 1, 1996 to December 31, 1999. Based on the findings of the review, the Company made refunds to affected borrowers totaling $2,523,000, of which $567,000 was interest. The Company and the Bank no longer employ the persons directly responsible for managing the IPF division during the period when the diversions occurred. There can be no assurance that additional regulatory actions involving the Company or the Bank will not be taken, or if taken, will not have a material adverse impact on the Company or the Bank. The Company is cooperating with regulatory and law enforcement agencies in their review of these matters. Additionally, the Company charged off $1.8 million in IPF loans, net of recoveries, in 1998 primarily related to IPF loans generated by the Bank's southeastern United States IPF operation headquartered in Atlanta, Georgia. The Atlanta office has been closed and, with the exception of a few relationships, loan production from that market has been terminated. Management will continue to actively and aggressively attempt to collect the charged-off IPF loans.

At December 31, 2003, IPF loans totaled $5.3 million or 7.95% of the Bank's gross loans, compared to $10.2 million, or 14.04% of gross loans, at December 31, 2002.

COMPETITION

There is significant competition among banks and bank holding companies in the market served by the Company, and the Company believes that such competition among such banks and bank holding companies, many of which have far greater assets and financial resources than the Company, will continue to increase in the future. The Company also encounters intense competition in its commercial and consumer banking business from savings and loan associations, credit unions, factors, insurance companies, commercial and captive finance companies, and certain other types of financial institutions, many of which are larger in terms of capital, resources and personnel. The casualty IPF business of the Company is also very competitive. Large insurance companies offer their own financing plans, and other independent premium finance companies and other financial institutions offer IPF loans.

The Company believes that such competition will continue and increase in the future. In addition, the manner in which and the means by which financial services are delivered to customers have changed significantly in the past and can be expected to continue to change in the future. It is not possible to predict the manner in which existing technology, and changes in existing technology, will affect the Company. Changes in technology are likely to require
additional capital investments to remain competitive. Although the Company has invested in new technology in the past, there can be no assurance that the Company will have sufficient financial resources or access to the proprietary technology, which might be necessary to remain competitive in the future. On November 12, 1999 the Gramm-Leach-Bliley Act (the "GLB Act") was enacted into law. The GLB Act makes sweeping changes in the financial services in which various types of financial institutions may engage. The Glass-Steagall Act, which had generally prevented banks from affiliating with securities and insurance firms, was repealed. A new "financial holding company," which owns only well capitalized and well managed depository institutions, will be permitted to engage in a variety of financial activities, including insurance and securities underwriting and agency activities. The GLB Act is not expected to have a material effect on the activities in which the Company and the Bank currently engage, except to the extent that competition with other types of financial institutions may increase as they engage in activities not permitted prior to enactment of the GLB Act. See "Gramm-Leach-Bliley Act of 1999" under "Item 1. Business - Supervision and Regulation: Regulation of the Company."

EMPLOYEES

As of December 31, 2003 the Bank had 77 full-time employees and 1 part-time employee. The Bank provides a number of benefits such as health, dental and life insurance for all employees, as well as education assistance for qualified, employees. None of the Bank's employees are subject to a collective bargaining agreement, and the Bank believes that its employee relations are good. The Company has no employees not also employed by the Bank.

SELECTED FINANCIAL DATA

The following summary of consolidated financial data of the Company is derived from the financial statements of the Company as of and for the five years ended December 31, 2003. At December 31,
-------------------------------------------------------------
(Dollars in thousands, except per share amounts)
2003 2002 2001 2000 1999(1)
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BALANCE SHEET DATA:

Total assets 91,438 104,049 $95,560 $93,180 $104,194
Cash and cash equivalents 14,426 18,411 14,403 11,023 9,751
Securities available for sale 1,580 4,522 10,598 13,071 12,480
Securities held to maturity -- -- -- -- --
Loans, net of unearned interest67,182 72,506 62,263 59,502 67,207
Allowance for credit losses on
loans (1,688) (1,461) (1,266) (1,264) (1,434)
Total deposits 81,437 94,026 83,155 79,661 84,878
Long term debt 4,350 4,350 4,350 4,350 4,350
Shareholders' equity 3,762 4,627 6,975 7,678 11,323

For the Year Ended December 31,
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2003 2002 2001 2000 1999(1)
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INCOME STATEMENT DATA:

Interest income 5,811 6,364 6,996 7,488 9,912
Interest expense 2,050 2,262 3,225 3,372 4,104
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Net interest income 3,761 4,102 3,771 4,116 5,808
Provision for credit losses 245 1,885 -- ( 35) 137
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Net interest income after
provision for credit losses 3,516 2,217 3,771 4,151 5,671
Noninterest income 959 1,007 858 1,900 4,552
Noninterest expense 5,249 5,973 6,183 9,326 10,809
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Income (loss) before income taxes ( 774) (2,751) (1,554) (3,275) (586)
Income tax expense (benefit) -- -- 839 (840) --
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Net income (loss) $ ( 774) $ (2,751) $ (1,554) $ (4,114) $ 254

COMMON SHARE DATA:

Net income (loss) – basic $ (0.08) $ (0.30) $ (0.23) $ (0.69) $ 0.04
Net income (loss) – diluted $ (0.08) $ (0.30) (0.23) (0.69) 0.04
Book value 0.38 0.47 0.87 1.30 1.92
Dividend pay-out ratio -- -- -- -- --

At or for the Year Ended December 31,
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2003 2002 2001 2000 1999(1)
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PERFORMANCE DATA

Return (loss) on average total
assets (0.85)% (2.72)% (1.64)% (4.20)% 0.19%
Return (loss) on average shareholders'
equity (20.6)% (47.35)% (20.72)% (38.02)% 2.28%
Net interest spread(2) 4.16% 3.96% 3.93% 4.30% 4.28%
Net interest margin(3) 4.48% 4.38% 4.60% 5.06% 4.98%
Average shareholders'
equity to average assets 4.30% 5.75% 7.92% 11.04% 8.11%
Total loans to total deposits at
year-end 80.42% 77.11% 74.88% 74.69% 79.18%

ASSET QUALITY RATIOS

Nonperforming assets to total
assets 5.82% 5.60% 1.54% 2.41% 1.48%
Nonperforming loans to total
loans 4.78% 5.55% 1.18% 2.15% 1.06%
Net loan charge-offs to average
loans 0.03% 2.42% 0.00% 0.22% 1.61%
Allowance for credit losses on loans to
total loans 2.51% 2.02% 2.03% 2.12% 2.12%
Allowance for credit losses on loans to
nonperforming 52.03% 36.32% 172.98% 98.53% 199.30%

(1) On June 30, 1999, the Company sold two branches located in Waxahachie and Midlothian, Texas.
(2) Calculated as the difference between the average yield on interest-earning assets and the average cost of interest-bearing liabilities.
(3) Calculated as net interest income divided by average interest-earning assets.

SUPERVISION AND REGULATION

GENERAL

The Company and the Bank are subject to the generally applicable state and federal laws governing businesses and employers. Special state and federal laws and regulations applicable only to financial institutions and their parent companies further regulate the Company and the Bank. Virtually all aspects of the Company's and the Bank's operations are subject to specific requirements or restrictions and general regulatory oversight, including laws regulating
consumer finance transactions, such as the Truth in Lending Act, the Home Mortgage Disclosure Act, the Equal Credit Opportunity Act and laws regulating collections and confidentiality, such as the Fair Debt Collection Practices Act, the Fair Credit Reporting Act and the Right to Financial Privacy Act. The supervision and regulation of bank holding companies and their subsidiaries is intended primarily for the protection of depositors, the deposit insurance funds of the Federal Deposit Insurance Corporation ("FDIC") and the banking system as a whole, and not for the protection of bank holding company stockholders or creditors.

To the extent that the following discussion describes statutory or regulatory provisions, it is qualified in its entirety by reference to the particular statute or regulation. Any change in applicable laws, regulations or policies of various regulatory authorities may have a material effect on the business, operations and prospects of the Company and the Bank. The Company is unable to predict the nature or the extent of the effects on its business or earnings that fiscal or monetary policies, economic control or new federal or state legislation may have in the future.

REGULATION OF THE COMPANY

The Company is a bank holding company registered under the BHC Act, and therefore is subject to regulation and supervision by the FRB. The Company is required to file reports with, and to furnish such other information as the FRB may require pursuant to the BHC Act, and to subject itself to examination by the FRB. The BHC Act and other federal laws subject bank holding companies (except those that have become "financial holding companies," as described below) to
particular restrictions on the types of activities in which they may engage, and to a range of supervisory requirements and activities, including regulatory enforcement actions for violations of laws and regulations. Certain violations may also result in criminal penalties.

MEMORANDUM OF UNDERSTANDING. On October 28, 1999, the Board of Directors of the Company entered into an MOU with the FRB. Under the MOU, the Company is not permitted to declare or pay any corporate dividends or incur any additional debt without the prior approval of the FRB. Also, the Company was required to develop and submit to the FRB a written three-year capital plan, a plan to service the Company's existing debt without incurring any additional debt, and written procedures designed to strengthen and maintain the Company's internal records and controls to ensure that future regulatory reports are filed in a timely and accurate manner. The Company has submitted each of the requested plans and procedures to the FRB. However, the Company did not pay its interest payment obligation on the $4.350 million subordinated convertible debt that was due March 31, 2002 or any interest payment due since then. Finally, the Company is mandated under the MOU to comply fully with all formal and informal supervisory actions that have been or may be imposed on the Company by the OCC. At December 31, 2003, the Company did not comply with the capital ratios established for capital adequacy purposes. Tier 1 capital to average assets was 1.10%, Tier 1 capital to risk-weighted assets was 1.31% and total capital to risk-weighted assets was 2.61% versus ratios established by the FRB for capital adequacy purposes of 4.00%, 4.00% and 8.00%, respectively.

Management does not know what action the FRB may take if the Company does not improve its capital ratios or if the Company continues to not pay the interest due under its subordinated debt obligations.

REGULATORY RESTRICTIONS ON DIVIDENDS AND SOURCE OF STRENGTH. It is the policy of the FRB that bank holding companies should pay cash dividends on common stock only out of income available over the past year and only if prospective earnings retention is consistent with the organization's expected future needs and financial condition. This supports the FRB's position that, in serving as a source of strength to its subsidiary banks, a bank holding company should stand ready to use available resources to provide adequate capital funds to its subsidiary banks during periods of financial stress or adversity and should maintain the financial flexibility and capital-raising capacity to obtain additional resources for assisting its subsidiary banks. A bank holding company's failure to meet its obligations to serve as a source of strength to its subsidiary banks will generally be considered by the FRB to be an unsafe and unsound banking practice or a violation of the FRB regulations or both. This doctrine has become known as the "source of strength" doctrine. As discussed below, a bank holding company in certain circumstances could be required to guarantee the capital plan of an undercapitalized banking subsidiary. Under the prompt corrective action provisions of the Federal Deposit Insurance Act, as amended ("FDIA"), any company which controls an undercapitalized bank can be required to guarantee compliance by the Bank with a capital restoration plan. The aggregate liability of the holding company of an undercapitalized bank is limited to the lesser of 5% of the institution's assets at the time it became undercapitalized or the amount necessary to cause the institution to become "adequately capitalized." The bank regulators have greater power in situations where an institution becomes "significantly" or "critically" undercapitalized or fails to submit a capital restoration plan. For example, a bank holding company controlling such an institution can be required to obtain prior FRB approval of proposed dividends, or might be required to consent to a consolidation or to divest the troubled institution or other affiliates.

In the event of a bank holding company's bankruptcy under Chapter 11 of the United States bankruptcy Code, the trustee will be deemed to have assumed and is required to cure immediately any deficit under any commitment by the debtor holding company to any of the federal banking agencies to maintain the capital of an insured depository institution, and any claim for breach of such obligation will generally have priority over most unsecured claims. As of the date of this report the Company has neither the cash flow nor the financial flexibility to act as a source of strength for the bank.

ACQUISITIONS OF CONTROL. The BHC Act and the Change in Bank Control Act, together with regulations promulgated by the FRB, require that, depending on the particular circumstances, either FRB approval must be obtained or notice must be furnished to the FRB and not disapproved
prior to any person or company acquiring "control" of a bank holding company, such as the Company, subject to certain exemptions for certain transactions. Control is conclusively presumed to exist if an individual or company acquires 25% or more of any class of voting securities of the bank holding company. Control is rebuttably presumed to exist if a person acquires 10% or more but less than 25% of any class of voting securities and either the company has registered securities under Section 12 of the Exchange Act, as amended, or no other person will own a greater percentage of that class of voting securities immediately after the transaction. The regulations provide a procedure for challenge of the rebuttable control presumption. Control is rebuttably presumed not to exist if a company acquires less than 5% of any class of voting securities of a bank or a bank holding company.

Bank holding companies (other than those that have become "financial holding companies," as described below) are required to obtain approval from the FRB prior to merging or consolidating with any other bank holding company, acquiring all or substantially all of the assets of any bank or acquiring ownership or control of shares of a bank or bank holding company if, after the acquisition, the bank holding company would directly or indirectly own or control 5% or more of the voting shares of such bank or bank holding company. In approving such bank acquisitions by bank holding companies, the FRB is required to consider the financial and managerial resources and future prospects of the bank holding company and the banks concerned, the convenience and needs of the communities to be served and various competitive factors.

ACTIVITIES CLOSELY RELATED TO BANKING. The BHC Act prohibits a bank holding company (other than those that have become "financial holding companies," as described below) with certain limited exceptions, from acquiring a direct or indirect interest in or control of more than 5% of the voting shares of any company which is not a bank or bank holding company and from engaging directly or indirectly in activities other than those of banking, managing or controlling banks or furnishing services to its subsidiary banks, except that it may engage in and may own shares of companies engaged in certain activities found by the FRB to be so closely related to banking or managing and controlling banks as to be a proper incident thereto. Some of the activities that have been determined by regulation to be closely related to banking include operating a mortgage, finance, credit card, or factoring company; performing certain data processing operations; providing investment and financial advice; acting as an insurance agent for certain types of credit-related insurance; leasing personal property on a full-payout, non-operating basis; and providing certain stock brokerage and investment advisory services. In approving acquisitions by bank holding companies of companies engaged in banking related activities or the addition of activities, the FRB considers whether the acquisition or the additional activities can reasonably be expected to produce benefits to the public, such as greater convenience, increased competition, or gains in efficiency, that outweigh such possible adverse effects as undue concentration of resources, decreased or unfair competition, conflicts of interest or unsound banking practices. The FRB is also empowered to differentiate between activities commenced de novo and activities commenced through acquisition of a going concern.

The BHC Act generally imposes certain limitations on transactions by and between banks that are members of the Federal Reserve System and other banks and non-bank companies in the same holding company structure, including limitations on extensions of credit (including guarantees of loans) by a bank to affiliates, investments in the stock or other securities of a bank holding company by its subsidiary bank, and the nature and amount of collateral that a bank may accept from any affiliate to secure loans extended to the affiliate. A bank holding company, as an affiliate of a bank, is also subject to these restrictions.

ANTI-TYING RESTRICTIONS. Under the BHC Act and FRB regulations, a bank holding company and its subsidiaries are prohibited from engaging in certain tie-in arrangements in connection with any extension of credit, lease or sale of property or furnishing of services.

GRAMM-LEACH-BLILEY ACT OF 1999. The Gramm-Leach-Bliley Act of 1999 (the "GLB Act") eliminates many legal barriers between banks and bank holding companies, on the one hand, and securities firms, insurance companies and other financial services providers, on the other. Among other things, the GLB Act repealed certain Glass-Steagall Act restrictions on affiliations between banks and securities firms, and amended the BHC Act to permit bank holding companies that
qualify as "financial holding companies" ("FHCs") to engage in activities, and acquire companies engaged in activities, that are: (a) financial in nature; (b) incidental to financial activities; or (c) complementary to financial activities if the FRB determines that they pose no substantial risk to the safety or soundness of depository institutions or the financial system in general. The GLB Act treats various lending, insurance underwriting, insurance company portfolio investment, financial advisory, securities underwriting, dealing and market making, and merchant banking activities as financial in nature for this purpose. The FRB, in consultation with the Secretary of the Treasury, may add to this list. The GLB Act not only permits bank holding companies to acquire securities and insurance firms, but also allows such firms to acquire banks and bank holding companies.

A bank holding company may become an FHC only if: (a) all of its depository institution subsidiaries are well capitalized; (b) all of its depository institution subsidiaries are well managed; and (c) the bank holding company has filed with the FRB a declaration that the company elects to be an FHC. In addition, a bank holding company generally may not commence any new activity or acquire any additional company as an FHC if any of its depository institution subsidiaries has received a rating of less than "satisfactory" in its most recent examination under the Community Reinvestment Act of 1977 ("CRA"). The GLB Act generally permits national banks to engage through special financial subsidiaries in the financial and other incidental activities authorized for FHCs by the GLB Act. However, such financial subsidiaries may not engage in insurance or annuity underwriting, insurance company portfolio investments, real estate investment and development or, at least for the first five years after the GLB Act's enactment, merchant banking. Also, the national bank in question and all its depository institution affiliates must be well capitalized, well managed and have satisfactory CRA ratings, and there are limits on such a bank's investments in such subsidiaries. With certain limited exceptions, a national bank's dealings with its financial subsidiaries are subject to Sections 23A and 23B of the Federal Reserve Act.

The GLB Act also imposes new restrictions on financial institutions' transfer and use of nonpublic personal information about their customers. Among other things, it directs the federal banking agencies to develop new regulations for this purpose; gives customers the right to "opt out" of having their nonpublic personal information shared with nonaffiliated third parties; bars financial institutions from disclosing customer account numbers or other such access codes to nonaffiliated third parties for direct marketing purposes; and requires
annual disclosure by financial institutions of their policies and procedures for protecting customers' nonpublic personal information.

SAFE AND SOUND BANKING PRACTICES. Bank holding companies are not permitted to engage in unsafe or unsound banking practices. The FRB's Regulation Y, for example, generally requires a bank holding company to give the FRB prior notice of any redemption or repurchase of its own securities, if the consideration to be paid, together with the consideration paid for any repurchases or redemptions in the preceding year, is equal to 10% or more of the company's consolidated net worth. The FRB may oppose the transaction if it believes that the transaction
would constitute an unsafe or unsound practice or would violate any law or regulation. Depending on the circumstances, the FRB could take the position that paying a dividend would constitute an unsafe or unsound banking practice. The FRB has broad authority to prohibit activities of bank holding companies and their nonbanking subsidiaries which represent unsafe and unsound banking practices or which constitute violations of laws or regulations, and can assess civil money penalties for certain activities conducted on a knowing and reckless
basis, if those activities caused a substantial loss to a depository institution. The penalties can be as high as $1,000,000 for each day the activity continues.

SECURITIES AND EXCHANGE COMMISSION AGREEMENT. The Company is subject to reporting and other requirements of the Exchange Act, as amended. The SEC investigated the Company and others with respect to various accounting irregularities found by the Company's in its IPF division during an internal audit of the division conducted in 1999 and the first quarter of 2000. Upon finding the irregularities, the Company reported them to the SEC, the OCC as well as certain other legal authorities. The Company fully cooperated with the SEC as well as bank regulatory agencies involved in investigating the irregularities. In February 2002, the SEC issued a finding that the Company violated certain sections of the Exchange Act.

In March 2002, the Company entered into a settlement with the SEC. In connection with the settlement, the Company acknowledged certain reporting and internal control deficiencies and agreed to cease and desist from the stipulated violations in the future. The SEC acknowledged the efforts and cooperation of the Company's current Board of Directors and management and recognized that none of the current members of the Board of Directors or senior management were associated with or employed by the Company during the periods investigated. The Company and the Bank no longer employs the persons directly responsible for managing the IPF division during the period when the diversions occurred and the Company no longer uses the accounting firm auditing the Company at that time. None of the current members of the Company or Bank's board of directors served in those capacities during the period when the violations of the Exchange Act occurred.

REGULATION OF THE BANK

The Bank is a national banking association and therefore is subject to regulation, supervision and examination by the OCC. The Bank is also a member of the FRB and the FDIC. Requirements and restrictions under the laws of the United States include a reserves requirement, restrictions on the nature and the amount of loans which can be made, restrictions on the business activities in which a bank may engage, restrictions on the payment of dividends to shareholders and minimum capital requirements. See "Item 6. Management's Discussion and Analysis of Financial Condition and Results of Operations - Capital Resources." Because the FRB regulates the bank holding company parent of the Bank, the FRB also has supervisory authority that directly affects the Bank. In addition, upon making certain determinations with respect to the condition of any insured national bank, such as the Bank, the FDIC may begin proceedings to terminate a bank's federal deposit insurance.

FORMAL AGREEMENT WITH THE OCC. On February 18, 2003, the Bank and OCC entered into the New Formal Agreement that replaced prior agreements with the OCC. The New Formal Agreement requires the Bank to develop, within 90 days of the agreement, an action plan detailing the Board of Directors' assessment of how to improve the Bank including implementation and timetable. The New Formal Agreement also includes provisions for new appointments to the Board of Directors, management effectiveness, adoption of a three-year strategic plan and preparation of a three-year business plan. In addition, the New Formal Agreement requires that the Bank achieve ratios of Tier 1 capital to average assets of at least 8.0% and Total capital to adjusted total assets of 12.0% by June 30, 2003. The Board is also to develop a three-year capital program, develop a written program to improve the Bank's loan portfolio and implement an internal audit program. The New Formal Agreement sets forth time limits to achieve each of the required actions. The OCC may extend the time requirements for good cause upon written application from the Board of Directors. If the Bank fails to achieve substantial compliance with the New Formal Agreement within 90 days of the expiration of the time limits (including any duly granted extension of time), the Board shall provide a written report setting out its plans to sell, merge, or liquidate the Bank. The Bank did not comply with all the provisions at the end of the 90 day period. Since the Bank had entered into a contract to sell the San Antonio, New Braunfels, Converse and Universal City banks, the OCC extended the period until the sale was closed. The sale was closed as of January 15, 2004 and the Bank is now in substantial compliance with the New Formal Agreement.

RESTRICTIONS ON DISTRIBUTION OF SUBSIDIARY BANK DIVIDENDS AND ASSETS. The Company owns all the outstanding common stock of the Bank. As a holding company without significant assets other than its ownership of all the common stock of the Bank, the Company's ability to meet its cash obligations, including debt service on the $4,350,000 aggregate principal amount of the Notes, is almost entirely dependent upon the payment of dividends by the Bank on its common stock. The declaration and payment of dividends by the Bank is subject to the discretion of the Board of Directors of the Bank and is restricted by the national banking laws and the regulations of the OCC, as well as by the New Formal Agreement.

Pursuant to 12 U.S.C. Section 56, a national bank may not pay dividends from its capital. All dividends must be paid out of undivided profits, subject to other applicable provisions of law. As of December 31, 2003 the Bank has negative undivided profits of $(8,925,803). Payment of dividends out of undivided profits is further limited by 12 U.S.C. Section 60(a), which prohibits a national bank from declaring a dividend on its shares of common stock until its surplus equals its common capital, unless there has been transferred to surplus not less than 1/10th of the national bank's net income of the preceding half year in the case of quarterly or semi-annual dividends or not less than 1/10th of the national bank's net income of the preceding two consecutive half year periods in the case of annual dividends. The payment of dividends by the Bank is also subject to the provisions of 12 U.S.C. Section 60(b), which provides that no dividend may be declared or paid without the prior approval of the OCC if the total of all dividends, including the proposed dividend, in any calendar year exceeds the total of the Bank's net income for that year combined with its retained net income (or loss) of the preceding two years. The Bank incurred aggregated losses for fiscal years 2003 and 2002 in the aggregate amount of $2,605,713. Furthermore, under federal law, a bank cannot pay a dividend if, after paying the dividend, the Bank will be "undercapitalized." Moreover, the OCC may find a dividend payment that meets all of the foregoing statutory requirements to be an unsafe and unsound practice and on those grounds prohibit the dividend.

Additionally, the New Formal Agreement prohibits the Board of Directors of the Bank from declaring or paying any dividends unless the Bank (a) is in compliance with 12 U.S.C. Sections 56 and 60, its approved capital program provided for in the New Formal Agreement, and the Tier 1 capital levels set forth in the New Formal Agreement, and (b) has obtained the prior written approval of the OCC. See "Formal Agreement with the OCC" under "Item 1. Business - Supervision and Regulation: Regulation of the Bank."

On November 9, 1999, the OCC approved a $262,000 reduction of the Bank's surplus, the proceeds of which were up streamed to the Company, which together with a $60,000 capital contribution by certain officers and directors of the Company and a $139,000 federal income tax payment by the Bank to the Company, was sufficient to enable the Company to meet its September 30, 1999 interest obligations under the Notes and to pay certain other operating expenses. On March 28, 2000 the OCC approved another reduction in the Bank's surplus in the amount of $500,000 that enabled the Bank to meet its debt service obligations under the Notes and to pay for other operating expenses through March 31, 2000. In October 2000, certain current and former members of the Company's Board of Directors and an employee loaned the Company $260,000 and another director agreed to accept a $38,000 promissory note for fees due. The notes did not bear interest and matured January 2, 2002, except for the note for fees due, which matured on December 31, 2001. The $38,000 promissory note for fees due was paid in January 2002 for $25,000. During 2001, certain Board members loaned the Company $195,000 under the notes and purchased Shares of newly issued restricted stock for $351,900 to enable the Company to meet its cash obligations, including interest payments on the Notes. During 2002, the Company sold 655,000 shares of restricted common stock to members of the Board of Directors for $68,100 and issued 438,392 shares in conversion of the remaining $95,000 of notes from directors mentioned above. During 2003, the Company received $15,000 for 833,333 shares of restricted common stock to from members of the Board of Directors. The amount has been recorded as a liability pending the issuance of the shares. There are no future commitments by any officer or director to loan the Company funds or purchase the Company's stock. Accordingly, the Company has no source of funds to pay interest on the Notes or provide other working capital needs. The Company is attempting to negotiate with Note Holders to accept non-interest bearing notes, warrants to purchase Company stock, and/or a modified conversion feature in exchange for interest to be due over the next three years. The Company does not know if it will be successful in these negotiations.

Until the restrictions under the New Formal Agreement are lifted and the Bank satisfies the other statutory and regulatory requirements with respect to the payment of dividends, the Bank is precluded from paying a dividend to the Company, without prior OCC approval. Under these circumstances it is highly unlikely that the Company would be able to rely on alternative sources of capital, such as borrowings from financial institutions or issuances of equity
securities and subordinated debt instruments. Therefore, the Company for the foreseeable future is dependent on the OCC's approval of future dividends by the Bank to the Company or continued loans from certain directors. The OCC may not approve dividends by the Bank to the Company, particularly if the Bank is unable to commence operating profitably in the near future.

The Company is unable to make the required interest payments, and continues to be in default under the Notes. The Indenture pursuant to which the Notes are issued does not provide for any right of acceleration of the payment of the Notes as a result of any failure of the Company to timely pay principal of and interest on the Notes, or to comply with the covenants contained in the Indenture; the holder of the Notes (or the Trustee on behalf of the holders of all the Notes affected) may, however, in lieu of accelerating the maturity of the Notes, seek to enforce payment of such interest, principal or premium, if any, and the performance of such covenants or agreements. Furthermore, the Notes may be accelerated in the event of the bankruptcy, insolvency or reorganization of the Company. The initiation of any such course of action by the holders of the Notes in the event of the failure of the Company to meet its debt servicing obligations under the Notes could have a significant adverse impact on the future operations of the Company. In February 2002, the Company notified the holders of its notes that it will not have funds to make future interest payments and offered the holders certain options as alternatives to interest payments. As of December 31, 2003, no agreement had been reached as to any restructuring of the convertible subordinated debt. Because the Company is a legal entity separate and distinct from its subsidiaries, its right to participate in the distribution of assets of any subsidiary upon the subsidiary's liquidation or reorganization will be subject to the prior claims of the subsidiary's creditors. In the event of a liquidation or other resolution of an insured depository institution, the claims of depositors and other general or subordinated creditors are entitled to a priority of payment over the claims of holders of any obligation of the institution to its stockholders, including any depository institution holding company (such as the Company) or any stockholder or creditor thereof.

LIMITATIONS ON INTEREST CHARGES. Federal and Texas state laws generally limit the amount of interest and fees that lenders, including the Bank, may charge regarding loans. The applicable law, and the applicable limits, may vary depending upon, among other things, the identity, nature and location of the lender, and the type of loan or collateral. In Texas, the maximum interest rate applicable to most loans changes with changes in the average auction rate for
United States Treasury Bills, but does not decline below 18% or rise above 24% (except for certain loans in excess of $250,000 for which the maximum annual rate may not rise above 28%). However, the interest that may be charged on an IPF loan is regulated by the Texas Department of Insurance and is governed by the Texas Consumer Loan Law. The Texas Consumer Loan Law provides that for regular transactions (loans payable in consecutive monthly installments of
substantially equal amounts with the first installment due within one month and 15 days after the date of the loan), the maximum interest rate may not exceed the amount of add-on rate equal to $18 per $100 per year on the first $1,380 and $8 per $100 on amounts of $1,380 up to $11,500. These amounts are subject to adjustments as of July 1 of each year under the Texas adjustment of dollar amounts provisions.

BRANCHING. National banks domiciled in Texas may establish a branch anywhere in Texas provided that the branch is approved in advance by the OCC, which considers a number of factors, including financial history, capital adequacy, earnings prospects, character of management, needs of the community and consistency with corporate powers. Under the Riegle-Neal Interstate banking and Branching Efficiency Act of 1994 ("Riegle-Neal"), subject to certain concentration limits and other requirements, (a) bank holding companies such as the Company are permitted to acquire banks and bank holding companies located in any state; (b) any bank that is a subsidiary of a bank holding company is permitted to receive deposits, renew time deposits, close loans, service loans and receive loan payments as an agent for any other bank subsidiary of the holding company, and (c) banks are permitted to acquire branch offices outside their home states by merging with out-of-state banks, purchasing branches in other states, and establishing de novo branch offices in other states - provided that, in the case of any such purchase or de novo branch establishment, the host state has adopted legislation "opting in" to those provisions of Riegle-Neal; and, provided that, in the case of a merger with a bank located in another state, neither of the two states involved has adopted legislation "opting out" of that provision of Riegle-Neal. On August 28, 1995 Texas enacted legislation opting out of interstate banking which was effective until September 1999. However, in the second quarter of 1998, the OCC approved a series of merger transactions requested by a non-Texas based institution that ultimately resulted in the merger of its Texas-based bank into the non-Texas based institution. Although challenged in the courts, the final legal ruling allowed the merger to proceed. In addition, on May 13, 1998, the Texas Banking Commission began accepting applications filed by state banks to engage in interstate mergers and branching.

CORRECTIVE MEASURES FOR CAPITAL DEFICIENCIES. FDIA requires the OCC to take "prompt corrective action" with respect to any national bank that does not meet specified minimum capital requirements. The applicable regulations establish five capital levels, ranging from "well-capitalized" to "critically undercapitalized," and require or permit the OCC to take supervisory action regarding any national bank that is not at least "adequately capitalized." Under these regulations, a national bank is considered "well capitalized" if it has a total risk-based capital ratio of 10% or greater, a Tier 1 risk-based capital ratio of 6% or greater, a leverage ratio of 5% or greater, and it is not subject to any order, written agreement or directive to meet and maintain a specific capital level for any capital measure. A national bank is considered "adequately capitalized" if it has a total risk-based capital ratio of 8% or greater, a Tier 1 risk-based capital ratio of 4% or greater, and a leverage capital ratio of 4% or greater, and the institution does not meet the definition of an undercapitalized institution. A national bank is considered "undercapitalized" if it has a total risk-based capital ratio that is less than 8%, a Tier 1 risk-based capital ratio that is less than 4%, or a leverage ratio that is less than 4%. A "significantly undercapitalized" institution is one which has a total risk-based capital ratio that is less than 6%, a Tier 1 risk-based capital ratio that is less than 3%, or a leverage ratio that is less than 3%. A "critically undercapitalized" institution is one that has a ratio of tangible equity to total assets that is equal to or less than 2%. With certain exceptions, national banks will be prohibited from making capital distributions or paying management fees if the payment of such distributions or fees will cause them to become undercapitalized. Furthermore, undercapitalized national banks will be required to file capital restoration plans with the OCC. Undercapitalized national banks also will be subject to restrictions on growth, acquisitions, branching and engaging in new lines of business unless they have an approved capital plan that permits otherwise. The OCC may also, among other things, require an undercapitalized national bank to issue shares or obligations, which could be voting stock, to recapitalize the institution or, under certain circumstances, to divest itself of any subsidiary.

The OCC is authorized to take various enforcement actions against any significantly undercapitalized national bank and any undercapitalized national bank that fails to submit an acceptable capital restoration plan or fails to implement a plan accepted by the OCC. The powers include, among other things, requiring the institution to be recapitalized, prohibiting asset growth, restricting interest rates paid, requiring prior approval of capital
distributions by any bank holding company which controls the institution, requiring divestiture by the institution of its subsidiaries or by the holding company of the institution itself, requiring a new election of directors and requiring the dismissal of directors and officers.

As an institution's capital decreases, the OCC's enforcement powers become more severe. A significantly undercapitalized institution is subject to mandated capital raising activities, restrictions on interest rates paid and transactions with affiliates, removal of management and other restrictions. The OCC has only very limited discretion in dealing with a critically undercapitalized institution and is virtually required to appoint a receiver or conservator.
Based on its capital ratios as of December 31, 2003, and exclusive of the New Formal Agreement, the Bank meets the requirements to be categorized as adequately capitalized under the applicable regulations. However, if the Bank was to become undercapitalized and these restrictions were to be imposed, the restrictions, either individually or in the aggregate, could have a significant adverse effect on the operations of the Bank.

CAPITAL ADEQUACY GUIDELINES. Capital management consists of providing equity to support both current and future operations. The Company is subject to capital adequacy requirements issued by the FRB and the Bank is subject to similar requirements imposed by the OCC.

The various federal bank regulatory agencies, including the FRB and the OCC, have adopted risk-based capital requirements for assessing bank holding company and Bank capital adequacy. These standards define capital and establish minimum capital requirements in relation to assets and off-balance sheet exposure, adjusted for credit risk. The risk-based capital standards are designed to make regulatory capital requirements more sensitive to differences in risk profile among bank holding companies and banks, to account for off-balance sheet exposure and to minimize disincentives for holding liquid assets. Assets and off-balance sheet items are assigned to broad risk categories, each with appropriate relative risk weights. The resulting capital ratios represent capital as a percentage of total risk-weighted assets and off-balance sheet items.

The minimum standard for the ratio of Tier 1 capital to total risk-weighted assets is 4% and the ratio of total capital to risk-weighted assets (including certain off-balance sheet obligations, such as standby letters of credit) is 8%. At least half of the risk-based capital must consist of common equity, retained earnings, and qualifying perpetual preferred stock, less deductions for goodwill and various other intangibles ("Tier 1 capital"). The remainder may consist of a limited amount of subordinated debt, certain hybrid capital instruments and
other debt securities, preferred stock, and a limited amount of the general valuation allowance for loan losses ("Tier 2 capital"). The sum of Tier 1 capital and Tier 2 capital is "total risk-based capital." See "Item 6. Management's Discussion and Analysis of Financial Condition and Results of Operations."

The FRB (for the Company) and the OCC (for the Bank) have also adopted guidelines which supplement the risk-based capital guidelines with a minimum leverage ratio of Tier 1 capital to average total consolidated assets ("leverage ratio") of 3% for institutions with well diversified risk (including no undue interest rate exposure, excellent asset quality, high liquidity, good earnings), that are generally considered to be strong banking organizations (rated a CAMEL 1 under applicable federal guidelines), and that are not experiencing or
anticipating significant growth. Other banking organizations are required to maintain a leverage ratio of at least 4% to 5%. These rules further provide that banking organizations experiencing internal growth or making acquisitions will be expected to maintain capital positions substantially above the minimum supervisory levels and comparable to peer group averages, without significant reliance on intangible assets. The FRB continues to consider a "tangible Tier 1 leverage ratio" in evaluating proposals for expanding activities by bank holding companies. The tangible Tier 1 leverage ratio is the ratio of a banking organization's Tier 1 capital (less deductions for intangibles otherwise includable in Tier 1 capital) to total tangible assets. See "Item 6.

Management's Discussion and Analysis of Financial Condition and Results of Operations - Capital Resources" for a discussion of the Company's and the Bank's Tier 1 and Tier 2 capital ratios.

RESTRICTIONS ON TRANSACTIONS WITH AFFILIATES AND INSIDERS. Transactions between the Bank and its nonbanking affiliates, including the Company, are subject to Section 23A of the Federal Reserve Act. In general, Section 23A imposes limits on the amount of such transactions and also requires certain levels of collateral for loans to such affiliated parties. It also limits the amount of advances to third parties that are collateralized by the securities or obligations of the Company or its subsidiaries.

Affiliate transactions are also subject to Section 23B of the Federal Reserve Act which generally requires that certain transactions between the Bank and its affiliates be on terms substantially the same, or at least as favorable to the Bank, as those prevailing at the time for comparable transactions with or involving nonaffiliated persons.

The restrictions on loans to directors, executive officers, principal stockholders and their related interests (collectively referred to herein as "insiders") contained in the Federal Reserve Act and Regulation O apply to all insured institutions and their subsidiaries and holding companies. These restrictions include limits on loans to one borrower and conditions that must be met before such a loan can be made. There is also an aggregate limitation on all
loans to insiders and their related interests. These loans cannot exceed the institution's total unimpaired capital and surplus, and the OCC may determine that a lesser amount is appropriate. Insiders are subject to enforcement actions for knowingly accepting loans in violation of applicable restrictions.

EXAMINATIONS. The OCC periodically examines and evaluates national banks. Based upon such an evaluation, the OCC may revalue the assets of the institution and require that it establish specific reserves to compensate for the difference between the OCC-determined value and the book value of such assets.

AUDIT REPORTS. Insured institutions with total assets of $500 million or more must submit annual audit reports prepared by independent auditors to federal and state regulators. In some instances, the audit report of the institution's holding company can be used to satisfy this requirement. Auditors must receive examination reports, supervisory agreements and reports of enforcement actions. In addition, financial statements prepared in accordance with generally accepted accounting principles, management's certifications concerning responsibility for the financial statements, internal controls and compliance with legal requirements designated by the FDIC, and an attestation by the auditor regarding the statements of management relating to the internal controls must be submitted. The Federal Deposit Insurance Corporation Improvement Act of 1991 ("FDICIA") requires that independent audit committees be formed, consisting of
outside directors only. The committees of such institutions must include members with experience in banking or financial management, must have access to outside counsel and must not include representatives of large customers. At present, these requirements do not apply to the Bank, since total assets are substantially below $500 million.

BROKERED DEPOSIT RESTRICTIONS. Adequately capitalized institutions cannot accept, renew or roll over brokered deposits except with a waiver from the OCC, and are subject to restrictions on the interest rates that can be paid on such deposits. Undercapitalized institutions may not accept, renew or roll over brokered deposits.

DEPOSITOR PREFERENCE STATUTE. Federal legislation has been enacted providing that deposits and certain claims for administrative expenses and employee compensation against an insured depository institution would be afforded a priority over other general unsecured claims against such institution, including federal funds and letters of credit, in the liquidation or other resolution of the institution by any receiver.

CROSS-GUARANTEE PROVISIONS. The Financial Institutions Reform, Recovery and Enforcement Act of 1989 ("FIRREA") contains a "cross-guarantee" provision which generally makes commonly controlled insured depository institutions liable to the FDIC for any losses incurred in connection with the failure of a commonly controlled depository institution.

DEPOSIT INSURANCE ASSESSMENTS. Deposits held by the Bank are insured by the Bank Insurance Fund ("BIF") of the FDIC. The FDIC assessment is calculated on the level of deposits held by the Bank. The BIF assessment rate is determined by the FDIC for categories of banks based upon the risk to the insurance fund. An institution's risk classification is assigned based on its capital levels and the level of supervisory concern the institution poses to the regulators. In addition, the FDIC can impose special assessments in certain instances. The current range of BIF assessments are between zero and 27 cents per $100 in assessable deposits. The FDIC has also established a process for raising or lowering all rates for insured institutions semi-annually if conditions warrant a change. Under this system, the FDIC has the flexibility to adjust the assessment rate schedule twice a year without seeking prior public comment, but
only within a range of five cents per $100 above or below the premium schedule adopted. The FDIC can make changes in the rate schedule outside the five-cent range above or below the current schedule only after a full rulemaking with opportunity for public comment.

The FDIC also applies an assessment against BIF-assessable deposits to be paid to the Financing Corporation ("FICO") to assist in paying interest on FICO bonds, which financed the resolution of the thrift industry crisis. The FICO assessment is approximately 1.22 basis points, on an annual basis, on BIF-insured deposits.

COMMUNITY REINVESTMENT ACT OF 1977 ("CRA"). Under the CRA, a bank's applicable regulatory authority (which is the OCC for the Bank) is required to assess the record of each financial institution which it regulates to determine if the institution meets the credit needs of its entire community, including low- and moderate-income neighborhoods served by the institution, and to take that record into account in its evaluation of any application made by such institution for, among other things, approval of the acquisition or establishment of a branch or other deposit facility, an office relocation, a merger, or the acquisition of shares of capital stock of another financial institution. The regulatory authority prepares a written evaluation of an institution's record of meeting the credit needs of its entire community and assigns a rating. The Bank has undertaken significant actions to comply with the CRA, and received a "satisfactory" rating in its most recent review by federal regulators with
respect to its compliance with the CRA. Both the United States Congress and the banking regulatory authorities have proposed substantial changes to the CRA and fair lending laws, rules and regulations, and there can be no certainty as to the effect, if any, that any such changes would have on the Bank.

INSTABILITY OF REGULATORY STRUCTURE. Various legislation, including proposals to overhaul the Bank regulatory system, expand the powers of banking institutions and bank holding companies and limit investments that a depository institution may make with insured funds, is from time to time introduced in Congress. Such legislation may change banking statutes and the operating environment of the Company and the Bank in substantial and unpredictable ways. The Company cannot determine the ultimate effect that potential legislation, if enacted, or implementing regulations with respect thereto, would have upon the financial condition or results of operations of the Company or the Bank.

EXPANDING ENFORCEMENT AUTHORITY. One of the major additional burdens imposed on the banking industry by FDICIA is the increased ability of banking regulators to monitor the activities of banks and their holding companies. In addition, the FRB, OCC and FDIC possess extensive authority to police unsafe or unsound practices and violations of applicable laws and regulations by depository institutions and their holding companies. For example, the FDIC may terminate the deposit insurance of any institution that it determines has engaged in an unsafe or unsound practice. The agencies can also assess civil money penalties, issue cease and desist or removal orders, seek injunctions, and publicly disclose such actions. FDICIA, FIRREA and other laws have expanded the agencies' authority in recent years, and the agencies have not yet fully tested the limits of their powers.

EFFECT ON ECONOMIC ENVIRONMENT. The policies of regulatory authorities, including the monetary policy of the FRB, have a significant effect on the operating results of bank holding companies and their subsidiaries. Among the means available to the FRB to affect the money supply are open market operations in United States government securities, changes in the discount rate on member bank borrowings and changes in reserve requirements against member bank deposits. These means are used in varying combinations to influence overall growth and distribution of bank loans, investments and deposits and their use may affect interest rates charged on loan or paid for deposits. FRB monetary policies have materially affected the operating results of commercial banks in the past and are expected to continue to do so in the future. The nature of future monetary policies and the effect of such policies on the business and earnings of the Company and the Bank cannot be predicted.

STATISTICAL DISCLOSURES

The following schedules present, for the periods indicated, certain financial and statistical information of the Company as required under the SEC's Industry Guide 3, "Statistical Disclosures By Bank Holding Companies" for a specific reference as to the location of required disclosures included as a part of this Form 10-KSB as of and for the year ended December 31, 2003.

I. DISTRIBUTION OF ASSETS, LIABILITIES AND STOCKHOLDERS' EQUITY; INTEREST RATES AND INTEREST DIFFERENTIAL A & B.

A. Average Balance Sheet and Related Analysis of Net Interest Earnings - This information is included under the heading "Yields Earned and Rates Paid" included in "Item 6. Management's Discussion and Analysis of Financial Condition and Results of Operations."

B. Interest Differential - This information is included under the heading "Yields Earned and Rates Paid" included in "Item 6. Management's Discussion and Analysis of Financial Condition and Results of Operations."

II. SECURITIES PORTFOLIO

A. The following is a schedule of the carrying values of securities available for sale and other securities at December 31:

2003 2002 2001
---- ---- ----
U.S. Treasury notes $ -- $ -- $ --
U.S. government agencies(1) 503,125 3,314,719 9,082,196
State and county municipals -- -- --
Mortgage-backed securities 249,845 437,475 748,737
Other securities 827,904 770,104 766,904
----------- ------------ ------------

Total securities $ 1,580,874 $ 4,522,298 $ 10,597,837
=========== ============ ============

(1) Declining interest rates during 2003 created a favorable environment for entities to issue new bonds at a lower rate and call or payoff existing bonds. The Bank elected not to repurchase bonds at a lower rate, but rather, elected to invest in Federal Funds (overnight investment) with the intent to fund IPF loans, the potential sale of our San Antonio branches and to fund new loans.

B. The following is a schedule of maturities for each category of securities available for sale and the related weighted-average yield of such securities as of December 31, 2003 (Other securities, which consists primarily of stock holdings in the Independent Bankers Corporation, the Federal Reserve Bank and the Federal Home Loan Bank are not considered in the calculation of total yield):

After 1 Year but After 5 Years but After 10 Years and
Within 1 year Within 5 Years Within 10 Years Other Securities
------------------- ------------------- -------------------- --------------------
Amount Yield Amount Yield Amount Yield Amount Yield
------ ----- ------ ----- ------ ----- ------ -----
U.S. government agencies
$503,125 3.30% $-- --% $-- --% $-- -%
Mortgage-backed securities
-- -- -- -- -- -- 249,845 2.31%
Other securities
-- -- -- -- -- -- 827,904 --%
-------- ---------- --------- ----------
Total
$503,125 3.30% $-- --% $-- --% $1,077,749 2.31%
======== ========== ========= ==========

The weighted-average yields are calculated using fair market value of securities and are based on coupon rates for securities purchased at par value and on effective interest rates considering amortization or accretion if the securities were purchased at a premium or discount. Other securities include stock holdings in the Independent Bankers Financial Corporation, the Federal Reserve Bank and the Federal Home Loan Bank that bear no stated maturity or yield.

C. Excluding holdings of obligations of U.S. government agencies with a cost of $3,228,569, there were no investments in securities of any one issuer exceeding 10% of the Company's consolidated shareholders' equity at December 31, 2003.

III. LOAN PORTFOLIO

A. Types of Loans - Total year-end loans are comprised of the following classifications:

2003 2002 2001 2000 1999
---------------------------------------------------------------------
Loans:
Insurance premium
financing $ 5,353,579 $ 10,221,479 $ 4,588,151 $5,951,300 $20,639,094
Commercial loans 10,900,978 13,219,136 13,311,170 10,919,098 8,841,027
Consumer loans 6,077,064 6,514,280 6,202,544 5,511,651 5,678,584
Real estate loans 44,865,978 42,521,100 38,296,528 37,280,209 32,558,724 Accounts Receivable
Factoring 126,612 309,044 -- -- --
---------------------------------------------------------------------
Total loans $67,324,211 $ 72,785,039 $62,398,393 $59,662,258 $67,717,429

Less: Unearned
interest (142,148) (278,213) (135,216) (160,237) (510,834)
Allowance for
credit losses (1,687,777) (1,461,487) (1,266,463) (1,263,961) (1,434,041)
------------ ----------- ----------- ----------- ----------
Total loans, net $65,494,286 $ 71,045,339 $60,996,714 $58,238,060 $65,772,554
============ ============= =========== =========== ===========

The following table details the percentage of loans in each category to total
loans as of December 31:
2003 2002 2001 2000 1999
------------------------------------------------
Loans:

Insurance premium financing 7.95% 14.04% 7.35% 9.97% 30.48%

Commercial loans 16.19% 18.59% 21.33% 18.30% 13.06%

Consumer loans 9.02% 8.95% 9.94% 9.24% 8.38%

Real estate loans 66.64% 58.42% 61.38% 62.49% 48.08%
------ ------ ------ ------ ------
Total loans 100.00% 100.00% 100.00% 100.00% 100.00%
====== ====== ====== ====== ======

B. Maturities and Sensitivities of Loans to Changes in Interest Rates - The following is a schedule of maturities of loans based on contractual terms and assuming no amortization or prepayments, excluding residential real estate and home equity loans, insurance premium finance loans and consumer installment loans, as of April 15, 2004:

Within One One Year to After Five
Year Five Years Years Total
------------- -------------- ----------- ---------
Fixed Rate:
Commercial and commercial real estate $ 349,513 $1,386,173 $2,697,625 $4,433,311

Real estate construction 908,470 -- 331,195 1,239,665
------------- -------------- ----------- ---------
Total $1,257,983 $1,386,173 $3,028,820 $5,672,976
============= ============== =========== =========

Variable Rate:

Commercial and commercial $3,391,669 $6,485,041 $7,953,584 $17,830,294
real estate

Real estate construction --- --- 43,618 43,618
------------- -------------- ----------- ---------
Total $3,391,669 $6,485,041 $7,997,202 $17,873,912
============= ============== =========== =========

C. Risk Elements

1. Nonaccrual, Past Due and Restructured Loans - The following schedule summarizes nonaccrual, past due and restructured loans as of December 31.

(a), (b) & (c) 2003 2002 2001 2000 1999
--------------------------------------------------------------------
Nonaccrual loans $1,845,931 $ 2,817,722 $ 732,131 $ 1,282,785 $ 705,969
Loans 90 days or more past
due and still accruing $1,370,139 1,206,742 -- -- 13,557
--------------------------------------------------------------------
Total nonperforming
loans $3,216,070 $ 4,024,464 $ 732,131 $ 1,282,785 $ 719,526
Other repossessed assets 2,109,188 1,798,022 737,000 960,155 825,245
--------------------------------------------------------------------

Total nonperforming
assets $5,325,258 $ 5,822,486 $ 1,469,131 $ 2,242,940 $1,544,771
====================================================================

There were no loans, which are "troubled debt restructurings" as defined in Statement of Financial Accounting Standards No. 15 (exclusive of loans included in total nonperforming loans in the above table). The policy for placing loans on nonaccrual status is to cease accruing interest on loans when management believes that collection of interest is doubtful, which is when loans are past due as to principal and interest 90 days or more (120 days for IPF), except that in certain circumstances interest accruals are continued on loans deemed by management to be fully collectible. In such cases, loans are individually evaluated in order to determine whether to continue income recognition after 90 days beyond the due dates. When loans are placed on nonaccrual status, any accrued interest is charged against interest income. The decrease in nonperforming loans of $780,813 is due primarily to the foreclosure of one large loan during 2003 that was previously recorded as nonperforming. The decrease in nonperforming assets (which includes the above described nonperforming loans) is the sale of other real estate in excess of those added through foreclosure in 2003. During 2003, $75,000 interest income was actually recorded on a cash basis on such loans.

(d) Impaired Loans - Information regarding impaired loans at December 31 is as follows:

2003 2002 2001 2000 1999
----------------------------------------------------------------
Year-end loans with allowance
allocated $6,383,173 $7,597,872 $ 1,495,244 $ 1,941,947 $3,958,654

Year-end loans with no
allowance allocated -- 60,183 1,217,478 1,256,490 414,419
----------------------------------------------------------------
Total impaired loans $6,383,173 $7,658,055 $ 2,712,722 $3,198,437 $4,373,073
================================================================

Amount of the allowance allocated $1,109,029 $ 955,740 $ 263,020 $ 504,346 $ 645,000
================================================================

Impaired loans are primarily comprised of commercial loans and installment loans, and are carried at present value of expected cash flows, discounted at the loan's effective interest rate or at fair value of collateral, if the loan is collateral dependent. A portion of the allowance for loan losses is allocated to impaired loans. Smaller-balance homogeneous loans are evaluated for impairment in total. Such loans include residential first mortgage and construction loans secured by one- to four-family residences, IPF, consumer and home equity loans. Commercial loans and mortgage loans secured by other properties are evaluated individually for impairment. When analysis of a borrower's operating results and financial condition indicates that the borrower's underlying cash flows are not adequate to meet its debt service requirements, the loan is evaluated for impairment. Impaired loans, or portions thereof, are charged off when deemed uncollectible. Year-end loans with allowance allocated and total impaired loans decreased by $1,274,882 due to the foreclosure of a large loan classified as impaired in 2002. During 2002, there was a change in management's analysis of the provision for loan and credit losses. Management has taken is more conservative position in analyzing loans with respect to a specific reserve. Loans which in prior years, would have been included in the calculation of a general reserve, are now specifically reserved. The change in management's philosophy is due to primarily to recommendations made by the OCC and changes in management.

1. Potential Problem Loans - At December 31, 2003, no loans were identified which management has serious doubts about the borrower's ability to comply with present loan repayment terms and which are not included in Item III.C.1., above.

2. Foreign Outstandings - There were no foreign outstandings during any period presented.

3. Loan Concentrations - At December 31, 2003, there were no concentrations of loans greater than 10% of total loans that are not otherwise disclosed as a category of loans in Item III.A. above.

D. Other Interest-Bearing Assets - At December 31, 2003, there were no other interest-bearing assets required to be disclosed under Item III.C.1. or 2. above, if such assets were loans.

IV. SUMMARY OF LOAN LOSS EXPERIENCE

A. The following schedule presents an analysis of the activity in the allowance for loan losses, average loan data and related ratios:

2003 2002 2001 2000 1999
---- ---- ---- ---- ----
Beginning balance $1,461,487 $ 1,266,463 $ 1,263,961 $ 1,434,041 $ 1,961,840

Charge-offs:
Commercial loans (9,472) (1,162,144) (121,455) (78,628) (602,922)

Consumer loans (56,786) (349,604) (58,838) (65,522) (254,334)

Real estate loans -- (310,757) -- (23,971) (249,848)

Insurance premium
finance (379,313) (378,660) (267,124) (592,213) (1,265,999)
--------- ---------- --------- --------- ----------
Total charge-offs (445,571) (2,201,165) ( 447,417) ( 760,334) (2,373,103)
--------- ---------- --------- --------- ----------

Recoveries:

Commercial loans 156,143 14,649 62,875 90,386 24,202

Consumer loans 28,237 62,761 33,256 42,103 57,343

Real estate loans 22,099 10,374 5,126 46,704 27,992

Insurance premium
finance 220,382 325,323 348,662 445,703 930,195
------- ------- ------- --------- -------
Total recoveries 426,861 511,189 449,919 624,896 1,039,732
------- ------- ------- --------- ---------

Net (charge-offs)
recoveries (18,710) (1,689,976) 2,502 (135,438) (1,333,371)

Provision for credit
losses on loans 245,000 1,885,000 -- (34,642) 136,936
------- ----------- ----------- ----------- ---------

Ending balance $1,687,777 $ 1,461,487 $ 1,266,463 $ 1,263,961 $ 1,434,041
========== ============ ============ =========== ===========

Average loans $67,735,535 $ 69,758,102 $ 61,465,810 $62,707,632 $82,725,870
=========== ============ ============ =========== ===========
Ratio of net charge-offs to
average loans 0.03% 2.42% --% 0.22% 1.61% =========== ============ ============ =========== ===========

B. The following schedule is a breakdown of the year-end allowance for credit losses allocated by type of credit. A breakdown of the percentage of loans in each category to total loans is included in Item III.A., above.

2003 2002 2001 2000 1999
-------------------------------------------------------------------------
Loans:

Insurance premium
financing $119,510 $ 278,030 $ 93,293 $ 115,464 $ 346,359

Commercial loans 814,035 837,699 480,346 386,314 352,833

Installment loans 21,046 45,042 22,020 132,017 187,370

Real estate loans 272,801 283,350 312,240 300,569 444,459

Unallocated 460,385 17,366 358,564 329,597 103,020
----------- ----------- ----------- ---------- ----------
Total for allowance loan
losses $1,687,777 $ 1,461,487 1,266,463 1,263,961 1,434,041

Management believes any allocation of the allowance for credit losses into categories lends an appearance of precision that does not exist. The allowance is utilized as a single unallocated allowance available for all loans. The above allocation table should not be interpreted as an indication of the specific amounts or the relative proportion of future charges to the allowance. Such a table is merely a convenient device for assessing the adequacy of the allowance as a whole. The allocation table has been derived by applying a general allowance to the portfolio as a whole, in addition to specific allowance amounts for internally classified loans. In retrospect, the specific allocation in any particular category may prove excessive or inadequate and consequently may be reallocated in the future to reflect the then current condition. Accordingly, the entire allowance is available for any charge-offs that occur.

V. DEPOSITS

A. The following is a schedule of average deposit amounts and average rates paid on each category for the periods indicated:

Average Amount Outstanding Average Rate Paid
During the Year During the Year
-------------------------------------------- -----------------------
2003 2002 2001 2003 2002 2001
------------ ------------ ------------ ---- ---- ----
Noninterest-bearing
demand deposits $17,477,024 $ 17,644,054 $ 16,168,798 --% --% --%

Interest-bearing demand
deposits 23,614,493 28,532,646 22,295,204 1.07% 1.56% 2.77%

Savings deposits 3,034,457 3,457,981 3,290,143 0.50% 0.92% 2.22%

Time deposits 43,654,854 39,650,260 39,956,954 3.19% 3.51% 5.36%
------------ ------------ ------------
Total average deposits $87,780,829 $ 89,284,941 $ 81,711,099 1.89% 2.61% 3.47%

B. Other categories - not applicable.

C. Foreign deposits - not applicable.

D. The following is a schedule of maturities of time deposits in amounts of $100,000 or more as of December 31, 2003:

Three months or less $ 1,544,169

Over three through six months 1,523,533

Six through twelve months 3,825,895

Over twelve months 7,408,347
-----------

Total $14,301,944
===========

E. Time deposits greater than $100,000 issued by foreign offices – not applicable.

VI. RETURN ON EQUITY AND ASSETS

This information is included in "Item 1. Business - Selected Financial Data."

VII. SHORT-TERM BORROWINGS

This item is not required for the Company because average outstanding balances of short-term borrowings during the years ended December 31, 20032 and 20021 were less than 30% of shareholders' equity at such dates.

ITEM 2. PROPERTIES.

The following chart provides information about the Company's existing facilities.

APPROX.
BRANCH/OFFICE SQ. FT. LOCATION/OWNERSHIP
---------------- -------- -------------------------
Converse 3,750 9154 FM 78
(Sold 1-15-04) Converse, Texas 78109
Owned

Fort Worth 18,208 1501 Summit Avenue
Fort Worth, Texas 76102
Owned

New Braunfels 1,250 1012 IH 35 South
(Sold 1-15-04) New Braunfels, Texas 78130
Land is Leased, Building and
premises are owned.

San Antonio 2,800 426 Wolfe
(Sold 1-15-04) San Antonio, Texas 78216
Owned

Universal City 12,000 600 Pat Booker Road
(Sold 1-15-04) Universal City, Texas 78148
Owned

Whitesboro 6,365 2500 Highway 82 East
Whitesboro, Texas 76263
Owned

The Company considers its physical properties to be in good operating condition and suitable for the purposes for which they are being used. All the properties owned by the Company are unencumbered by any mortgage or security interest and are, in management's opinion, adequately insured. The Company operates its community banking business segment out of each facility, while the IPF business segment is operated out of the Fort Worth facility.

ITEM 3. LEGAL PROCEEDINGS.

The Company is a defendant in various legal proceedings arising in connection with its ordinary course of business. In the opinion of management, the financial position of the Company will not be materially affected by the final outcome of these legal proceedings.

ITEM 4. SUBMISSION OF MATTERS TO A VOTE OF SECURITY HOLDERS.

None. The Company did not hold an annual shareholders meeting during the year 2003. The Board of Directors was restructured in 2003 due to resignations and an effort to make the Board of Directors more reflective of the local community. The Company plans to hold an annual shareholders meeting during the third quarter of 2004.

PART II

ITEM 5. MARKET FOR REGISTRANT'S COMMON EQUITY AND RELATED STOCKHOLDER MATTERS.

MARKET INFORMATION

During 2003, the Company received $15,000 for the purchase of 833,333 shares of unregistered common stock to directors for approximately $0.018 per share. The balance is recorded as a liability pending the issuance of the common shares. The Company did not use the services of any underwriter. The shares were sold at a discount to reflect lack of liquidity associated with nonregistered shares per a certified appraisal of the shares value. The Company relied on Regulation D of the Securities Act of 1933, as amended, for exemption to registration as the recipients were officers, directors and other accredited investors. Funds were used to pay general operating expenses.

The following table sets forth, for the periods indicated, the high and low bid price per share of the Company's Common Stock as reported on the National Quotation Bureau for 2003 and 2002. The quotations provided reflect inter-dealer prices, without retail markup, markdown or commission and may not represent actual transactions.

---------------------------------------------
High Low
---------------------------------------------
2003 Fiscal Year

First Quarter $0.16 $0.07
Second Quarter $0.16 $0.08
Third Quarter $0.10 $0.04
Fourth Quarter $0.10 $0.04

2002 Fiscal Year

First Quarter $0.50 $0.25
Second Quarter $0.56 $0.28
Third Quarter $0.43 $0.38
Fourth Quarter $0.38 $0.01

The Company's Common Stock is currently traded through the National Quotation Bureau (commonly known as "pink sheets") at any time that a broker agrees to make a market in the stock.

STOCKHOLDERS

As of December 31, 2003, there were approximately 409 record holders of the Company's Common Stock.

DIVIDEND POLICY

The Company has not previously paid any cash dividends. The Company currently intends to retain earnings to make the interest payment on the Notes and to pay its other operating expenses, rather than using earnings to pay dividends. The payment of any cash dividends by the Company in the future will depend to a large extent on the receipt of dividends from the Bank. The ability of the Bank to pay dividends is dependent upon the Bank's earnings and financial condition, the Bank's compliance with 12 U.S.C.Sections 56 and 60, and the Bank's fulfillment of certain requirements set forth in the New Formal Agreement. See "Formal Agreement with the OCC" and "Restrictions on Distribution of Subsidiary Bank Dividends and Assets" under "Item 1. Business - Supervision and Regulation: Regulation of the Bank" for a discussion of regulatory constraints on the payment of dividends by national banks and bank holding companies generally.

EQUITY COMPENSATION

There was no equity compensation given to any employee or Director during 2003.

TRANSFER AGENT

Securities Transfer Corporation
16910 Dallas Parkway, Suite 100
Dallas, Texas 75248
(972) 447-9890

ANNUAL AND OTHER REPORTS, STOCKHOLDER AND GENERAL INQUIRIES

Surety Capital Corporation is required to file an annual report on Form 10-KSB for its fiscal year ended December 31, 2003 with the Securities and Exchange Commission. Copies of the Form 10-KSB annual report and the Company's quarterly reports may be obtained without charge by contacting:

Surety Capital Corporation
1501 Summit Avenue
Fort Worth, Texas 76102
(817) 335-5955

ITEM 6. MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS OF OPERATIONS.

INTRODUCTION

In the following pages, management presents an analysis of the Company's financial condition and results of operations as of and for the year ended December 31, 2003, compared to 2002. This discussion is designed to provide stockholders with a more comprehensive review of the operating results and financial position than could be obtained from an examination of the financial statements alone. This analysis should be read in conjunction with the financial
statements and related footnotes included elsewhere in this report.

ANALYSIS OF FINANCIAL CONDITION

TOTAL ASSETS. The Company's total assets totaled $91.4 million at December 31, 2003 compared to $104 million at December 31, 2002, a decrease of $12.6 million, or 12.1%. The decrease in assets was primarily the result of the elimination of public funds in an attempt to meet the OCC’s required ratios under the New Formal Agreement. There was also a decrease the loans made by the insurance premium finance division due to the loss of two key accounts.

SECURITIES. Federal funds sold decreased $8.7 million, or 56.3%, from $15.4 million at December 31, 2002 to $6.7 million at December 31, 2003. The primary reason for this decrease in federal funds sold was to invest funds in short term interest bearing time deposits in other financial institutions which were at a higher interest rate. Securities available for sale decreased during the year due to liquidation of Public Funds. Total securities available for sale were $1.6 million at December 31, 2003, a 65.0% decrease from December 31, 2002. The Company invests primarily in U.S. Treasury notes, obligations of U.S. government agencies and corporations, and mortgage-backed securities. Mortgage-backed securities include Federal Home Loan Mortgage Corporation and Government National Mortgage Association participation certificates. Other securities include stock holdings in the Texas Independent Bankers Financial Corporation, the Federal Reserve Bank of Dallas and the Federal Home Loan Bank of Dallas. All of the Company's securities are classified as available for sale. Management classifies securities as available for sale to provide the Company with the flexibility to provide for liquidity needs or to move such funds into loans as demand warrants. The Company held no derivative securities or structured notes during any period presented. At December 31, 2003 the net unrealized loss on securities available for sale totaled $1,632 compared to a net unrealized gain of $89,853 at December 31, 2002.

LOANS. Net loans decreased $5.5 million, or 7.9%, from $71.0 million at December 31, 2002 to $65.5 million at December 31, 2003. IPF loans decreased $4.8 million or 47.06% from $10.2 million at December 31, 2002 to $5.4 million at December 31, 2003. The decrease in IPF loans was due primarily to the loss of two large accounts during the year. Commercial loans decreased $2.3 million or 17.4%. During the year, the Bank discontinued its accounts receivable factoring service. Real estate loans increased $2.4 million or 5.6%. Total loans, net of unearned interest, as a percentage of total deposits increased to 80.42% at December 31, 2003 compared to 77.11% at December 31, 2002.

NET PREMISES AND EQUIPMENT. Net premises and equipment declined to $4.7 million at December 31, 2003 compared to $5.1 million at December 31, 2002, due to $398,000 depreciation expense.

OTHER REAL ESTATE OWNED. Other real estate owned and repossessed assets totaled $2.1 million at December 31, 2003 compared to $1.8 million at December 31, 2002. The increase is due primarily to the $1.6 million acquisition of 29 acres of land in Fort Worth which was a steel mill and several small rental houses in the Fort Worth area. During 2003 the Company sold the $670,000 carrying value of real estate represented by 212 lots in Wilson County acquired in settlement of loans during 1999 for approximately $850,000, which gain has been deferred; sold several rental houses for approximately $100,000 net gain that is deferred; sold a building and approximately 1 acre of the steel mill property for approximately $630,000 for a net gain of approximately $550,000 that is deferred; sold land in Converse for a deferred gain of approximately $44,000; and entered into a contract to demolish all the buildings on the steel mill for $300,000. As of December 31, 2003, $100,000 had been received under the demolition contract which reduced the cost of the property. Subsequent to December 31, 2003, the Bank entered into a contract to sell 78 apartments in San Antonio for $1,250,000 that is carried on the books for $1,000,000 that closed the first half of April, 2004. The Bank has listed its other real estate with area brokers but does not know how quickly the properties can be sold.

DEPOSITS. Deposits are attracted principally from within the Company's primary market area through the offering of a broad selection of deposit instruments, including checking accounts, money market accounts, regular savings accounts, term certificate accounts and individual retirement accounts. Interest rates paid, maturity terms, service fees and withdrawal penalties for the various types of accounts are established periodically by management based on the Company's liquidity requirements, growth goals and interest rates paid by competitors. The Company does not use brokers to attract deposits. Total deposits decreased $12.6 million, or 13.4%, from $94.0 million at December 31, 2002 to $81.4 million at December 31, 2003. Non-interest-bearing deposits increased $1.2 million, or 7.0%, while savings, NOW and money market accounts decreased $7.5 million, or 24.1%. Time deposits $100,000 and over decreased $2.9 million or 16.9% and other time deposits decreased $3.4 million, or 11.9%. Money market deposits increase as a result of an interest rate premium paid on large deposits and certificates of deposit rose as a response to a rate premium offered on certificates of deposits with maturities of five years or more. The increase in non-interest bearing demand deposits is due to increased number and activity of commercial deposits. The Company's addition of marketing staff personnel during 2002 and customers switching money into liquid investments during a time of interest rate and stock market declines have also factored into the increase of deposits.

At December 31, 2003, the Bank's time deposits totaled $39.4 million, or 48.4% of total deposits compared to $45.8 million, or 48.7% of total deposits, at December 31, 2002. As of December 31, 2003, $21.2 million in time deposits were due to mature within one year. Based on past experience and the Company's prevailing pricing strategies, management believes a substantial percentage of such certificates will renew with the Company at maturity. The Bank discouraged Public Funds during 2003 and on December 31, 2003 had only $475,275.06 compared to $8,938,810.09 December 31, 2002. If there is a significant deviation from historical experience, the Company's Bank can utilize borrowings from the FHLB as an alternative to this source of funds, subject to regulatory approval under the New Formal Agreement.

BORROWINGS. Convertible subordinated debt totaled $4.4 million at December 31, 2003 and 2002. Convertible subordinated notes were issued on March 31, 1998 to provide funds to finance the acquisition of TexStar. The notes bear interest at a rate of 9% per annum until maturity. No principal payments are due until maturity on March 31, 2008, while interest on the notes is payable semi-annually. Details of these subordinated notes are discussed further in the notes to the consolidated financial statements. The Company did not make the interest payment due March 2002, or any subsequent interest payments due under the notes. In February 2002, the Company notified the holders of its convertible subordinated debt that it will not have funds to make future interest payments and offered the holders certain options as alternatives to interest payments. As of December 31, 2003, no agreement had been reached as to any restructuring of the convertible subordinated debt.

COMPARISON OF RESULTS OF OPERATIONS

NET LOSS. The Company's net income is primarily dependent upon its net interest income, which is the difference between interest income generated on interest-earning assets and interest expense incurred on interest-bearing liabilities. Provisions for credit losses, service charges, gains on the sale of assets and other income, noninterest expense and income taxes also affect net income. The Company realized a $0.8 million net loss for 2003 compared to $2.8 million net loss for 2002. The Company reported a $0.2 million provision for credit loss expense in 2003 while the 2002 provision for credit losses was $1.9. Net loss per share was $0.08 for 2003 and $0.30 for 2002. Net loss as a percentage of average assets was 0.85% and 2.72% for 2003 and 2002, respectively. Net loss as a percentage of average shareholders' equity was 20.6% and 47.4% over the same two years. General economic conditions, the monetary and fiscal policies of federal agencies and the regulatory policies of agencies that regulate financial institutions affect the operating results of the Company. Interest rates on competing investments and general market rates of interest influence the Company's cost of funds. Lending activities are influenced by the demand for various types of loans, which in turn is affected by the interest rates at which such loans are made, general economic conditions and the availability of funds for lending activities.

NET INTEREST INCOME. Net interest income is the largest component of the Company's income and is affected by the interest rate environment and the volume and composition of interest-earning assets and interest-bearing liabilities. Declining interest rates had a negative effect on the Company's net interest income. The FRB influences the general market rates of interest, including the deposit and loan rates offered by many financial institutions through adjustments to the discount rate. The discount rate is the interest rate at which member institutions can borrow funds from the Federal Reserve, if necessary. Through a series of rate reductions beginning in 2000, the FRB steadily lowered the discount rate. Over the same period, the Company's prime interest rate, the rate offered on loans to borrowers with strong credit, adjusted in a similar pattern. At December 31, 2003, 2002 and 2001, the prime rate was 4.00%, 5.00% and 9.50% respectively. The average yield on federal funds sold fell from 6.40% during the fourth quarter of 2000 to 1.82% during the fourth quarter of 2001 to 1.58% during the fourth quarter of 2002. For 2003, the average yield was just under 1.00%. The yield fell in direct correlation with the FRB discount rate. As of December 31, 2003 and 2002 the Company was in a positive gap position, or asset sensitive. The "gap" is the difference between the repricing of interest-earning assets and interest-bearing liabilities within certain time periods. The Company's positive gap is due primarily to the Bank's positions in Federal Funds Sold, IPF loans, which generally mature within nine months, and commercial loans that re-price with changes in the prime interest rate and a general reduction in the level of investment securities. Accordingly, the Company's interest-bearing assets will generally reprice more quickly than its interest-earning liabilities. Therefore, the Company's net interest margin is likely to increase in periods of rising interest rates in the market and decrease in periods of declining interest rates. The Company's net interest margin decreased to % in 2003 from 4.38% in 2002 from 4.60% in 2001 and 5.06% in 2000. The average yield earned on interest-earning assets decreased 161 basis points from 2001 while the average rate paid on interest bearing liabilities declined 163 basis points. The yields on all categories of earning assets declined during 2003. Yields on federal funds sold, investment securities, and loans fell 218 basis points, 218 basis points and 243 basis points, respectively. The beneficial impact in IPF loans, which bear higher interest rates, was partly offset by an increase in loans on non-accrual. The average rate paid on interest-bearing liabilities was 2.98% in 2003 compared to 2.98% in 2002. The average interest rate spread stayed fairly constant at 3.96% in 2003 compared to 3.96% in 2002. The ratio of average interest-earning assets to average interest-bearing liabilities was 117.2% in both 2003 and 2002. Net interest income decreased $341 thousand from $4.1 million in 2002 to $3.8 million in 2003. The decrease was due to the slightly higher decrease in rates earned versus yields paid as discussed above.

ALLOWANCE AND PROVISION FOR CREDIT LOSSES. The Company maintains an allowance for credit losses in an amount that, in management's judgment, is adequate to absorb reasonably foreseeable losses inherent in the loan portfolio. While management utilizes its best judgment and information available, the ultimate adequacy of the allowance is dependent upon a variety of factors, including the performance of the Company's loan portfolio, the economy, changes in real estate values and interest rates and the view of the regulatory authorities toward loan classifications. The provision for loan losses is determined by management as the amount to be added to the allowance for loan losses after net charge-offs have been deducted to bring the allowance to a level that is considered adequate to absorb losses inherent in the loan portfolio. The amount of the provision is based on management's review of the loan portfolio and consideration of such factors as historical loss experience, general prevailing economic conditions, changes in the size and composition of the loan portfolio and specific borrower considerations, including the ability of the borrower to repay the loan and the estimated value of the underlying collateral. All lending activity contains risks of loan losses and the Company recognizes these credit risks as a necessary element of its business activity. To assist in identifying and managing potential loan losses, the Company contracts with an independent loan review service provider to evaluate individual credit relationships as well as overall loan portfolio conditions. One of the primary objectives of the loan review function is to make =recommendations to management as to both specific loss reserves and overall portfolio loss reserves. The $0.245 million increase in provision for loan loss expense during 2003 is due primarily to the $0.8 million of loans identified during 2003 that may need to be charged off, net of recoveries. Net loans charged off during 2003 represented 0.22% of average loans. During 2002, the provision for loan loss expense increased $1.9 million primarily due to the $1.7 million of loans charged off during 2002. The year-end balance in the allowance for loan losses totaled $1.7 million at December 31, 2003 and $1.5 million at December 31, 2002 and represented 2.51% of total loans outstanding at December 31, 2003 and 2.03% at December 31, 2002. While management's analysis of the adequacy of the allowance for loan losses has concluded that it remains adequate, the Company might have to record additional provision for loan loss expense during 2004 if loan growth warrants an increase or if general economic conditions deteriorate. Nonperforming loans, defined as loans past due 90 days or more and loans for which the accrual of interest has been discontinued, totaled $3.2 million at December 31, 2003 compared to $4.0 at December 31, 2002. Non-performing loans as a percentage of total loans totaled 4.82% and 5.55%, respectively. Management will continue its emphasis to increase IPF loans but does not anticipate significant changes in loan portfolio risk in the near future, and will continue to monitor the appropriate factors when considering future levels of provisions and the allowance for loan losses. While management believes that it uses the best information available to determine the allowance for estimated loan losses, unforeseen market conditions could result in adjustments to the allowance for estimated loan losses and net earnings could be significantly affected if circumstances differ substantially from the assumptions used in determining the allowance.

NONINTEREST INCOME. Noninterest income totaled $.959 million in 2003 compared to $1.0 million in 2002, a $50,000 decrease. The decrease is due to a $111,000 decrease in service charges on deposit accounts, $61,000 increase in loan collection fees, and other income.

NONINTEREST EXPENSE. Noninterest expense was $5.2 million for 2003 compared to $6.0 million for 2002. Salaries and employee benefit expenses decreased $348,000 due to reduction in personnel during 2002. Occupancy expenses declined $146,000 due primarily to a $92,000 decrease in depreciation expense. The Company's efficiency ratio was 77.5% and 81.0% in 2003 and 2002, respectively. The efficiency ratio measures the percentage of total revenues, on a taxable equivalent basis excluding securities gains, fidelity bond recoveries, loss on impairment of long-lived assets and other nonrecurring gains, absorbed by non-interest expense. Expressed differently, for example, for every dollar of revenue the Company generated in 2003, the Company incurred $0.775 in overhead expenses. The Company's efficiency ratios for the comparable periods compare unfavorably to other financial institutions in the Company's peer group. However, management believes that this is due in large part because the Bank operates more facilities and has a larger market area than other banks its size. Management believes that it has established an infrastructure which will allow it to grow with only modest increases in overhead expenses, and that its efficiency ratio would compare more favorably with larger institutions. The efficiency ratio should improve if the additional staffing is successful in its growth initiatives. In January, 2004 the Bank sold its unprofitable branches in Universal City, San Antonio, Converse and New Braunfels, Texas for a net profit of approximately $350,000.

INCOME TAXES. The Company has incurred losses for income tax purposes in excess of recovery available by carry back to prior periods resulting in net operating losses that carry forward to future tax years. As of December 31, 2003 and 2002, management concluded a valuation allowance for the net deferred tax asset was necessary, as management could not predict with any degree of certainty that the Company will realize the net deferred tax assets during the carry-forward period. Accordingly, a valuation reserve was recorded which had the effect of eliminating the tax benefit associated with losses recorded in 2003 and 2002. Accordingly, no provisions for income taxes or income tax benefits were recorded in 2003 or 2002.

YIELDS EARNED AND RATES PAID. The following table sets forth information relating to the Company's average balance sheet and reflects the average yield on interest-earning assets and the average cost of interest-bearing liabilities for the periods indicated. Such yields and costs are derived by dividing income or expense by the average monthly balance of interest-earning assets or interest-bearing liabilities, for the periods presented. Average balances are derived from daily balances, which include nonaccruing loans in the loan portfolio.

Year ended December 31, 2003 Year ended December 31, 2002
--------------------------------------- -----------------------------------------
Interest Interest
Average Income/ Average Average Income/ Average
Balance Expense Rate Balance Expense Rate
------- ------- ---- ------- ------- -------
ASSETS
Interest-earning assets:
Interest-bearing deposits and federal
funds sold $10,790,497 124,815 1.16% $ 8,823,579 $ 139,445 1.58%
Secur ities 3,881,448 125,871 3.24% 9,975,518 355,048 3.60%
Loans(1) 69,318,851 5,560,479 8.02% 69,758,102 6,094,972 8.74%
---------- --------- ---------- ---------
Total interest-
earning assets 83,990,796 5,811,165 6.92% 88,557,199 6,363,916 7.19%

Noninterest-earning assets:
Cash and due from Banks 4,606,761 4,055,124
Premises and equipment 4,852,026 5,203,326
Accrued interest receivable 327,023 480,736
Other real estate owned 2,583,218 810,753
Other assets 2,673,450 3,159,449
Allowance for credit losses (1,583,316) (1,299,331)
----------- -----------

Total assets $97,449,958 $100,967,256
============= ============

LIABILITIES
Interest-bearing liabilities:
Interest-bearing
demand deposits $23,614,493 292,157 1.07% $ 28,532,646 445,782 1.56%
Savings deposits 3,034,457 15,244 0.50 3,457,981 31,892 0.92
Time deposits 43,654,854 1,390,903 3.19 39,650,260 1,392,776 3.51
----------- --------- ----------- ---------
Total interest-
bearing deposits 70,303,804 1,658,304 1.89 71,640,887 1,870,450 2.61
Other borrowed fund4,350,000 391,500 9.00 4,350,000 391,500 9.00
--------- ------- --------- -------
Total interest-
bearing liabilitie74,226,943 2,049,804 2.76 75,990,887 2,261,950 2.98
--------- ----------

Noninterest-bearing liabilities
Noninterest-bearing
deposits 17,477,024 17,644,054
Other liabilities 1,328,435 1,523,346
---------- ---------- \

Total liabilities 93,032,402 95,058,287
Shareholders' equity 4,417,556 5,808,969
---------- ----------
Total liabilities
and equity $97,449,958 $ 100,967,256
=========== ===========
Net interest
income $3,761,361 $3,876,417
========== ==========
Net interest spread 4.16% 4.21%
Net interest margin 4.48% 4.38%

(1) Calculated net of deferred loan fees and costs and unearned interest.

The table below describes the extent to which changes in interest rates and changes in volume of interest-earning assets and interest-bearing liabilities have affected the Company's interest income and expense during the years indicated. For each category of interest-earning assets and interest-bearing liabilities, information is provided on changes attributable to (1) changes in volume (multiplied by prior year rate); (2) changes in rate (multiplied by prior year volume); and (3) total changes in rate and volume. The combined effects of changes in both volume and rate, that are not separately identified, have been allocated proportionately to the change due to volume and change due to rate:

2003 Compared to 2002
Increase/(Decrease)
---------------------------------------------
Change Change
Due to Due to Total
Volume Rate Change
------ ---- ------
Interest Income:
Interest-bearing deposits and
federal funds sold $ 31,077 $ ( 45,707) $ (14,630)
Securities (219,387) ( 9,790) (229,177)
Loans ( 36,941) (272,003) (308,944)
------------ ----------- ----------

Total interest income (225,251) (327,500) (552,751)

Interest Expense:
Interest-bearing demand
deposits (76,723) (116,902) (193,625)
Savings deposits ( 3,896) (12,752) ( 16,648)
Time deposits 140,561 (142,434) ( 1,873)
------------ ----------- ----------
Total deposits 59,942 (272,088) (212,146)
Other borrowed funds -- -- --
------------ ----------- ----------
Total interest expense 59,942 (272,088) (212,146)
------------ ----------- ----------

Net interest margin ($ 285,193) $ (55,412) $ (340,605)
============ =========== ==========

ASSET AND LIABILITY MANAGEMENT AND MARKET RISK

The Company's primary market risk exposure is interest rate risk and liquidity risk. Interest rate risk is the risk that the Company's financial condition will be adversely affected due to movements in interest rates. The income of financial institutions is primarily derived from the excess of interest earned on interest-earning assets over the interest paid on interest-bearing liabilities. Accordingly, the Company places great importance on monitoring and controlling interest rate risk. There are several methods employed by the Company to monitor and control interest rate risk. One such method is using a gap analysis. As discussed above in management's analysis of net interest income, the gap is defined as the repricing variance between rate sensitive assets and rate sensitive liabilities within certain periods. The repricing can occur due to changes in rates on variable rate products as well as maturities of interest-earning assets and interest-bearing liabilities. A high ratio of interest sensitive liabilities, generally referred to as a negative gap, tends to benefit net interest income during periods of falling interest rates as the average rate paid on interest-bearing liabilities declines faster than the average rate earned on interest-earning assets. The opposite holds true during periods of rising interest rates. The Company attempts to minimize the interest rate risk through management of the gap in order to achieve consistent return. The Company's asset and liability management policy is to maintain a gap position whereby the ratio of rate sensitive assets to rate sensitive liabilities is between 60.0% and 140.0% on a one-year time horizon. As of December 31, 2003 the Company was in a positive gap position so its assets will reprice more quickly than its liabilities. The continuing decline in interest rates during 2003 resulted in issuing agencies calling high yielding bonds carried in the Company's securities portfolio. The Company was not willing to reinvest in longer-term instruments during a period of low interest rates and instead invested in federal funds sold. This had the effect of making the Company more interest rate sensitive. One strategy used by the Company is to originate variable rate loans tied to market indices. Such loans reprice on an annual, quarterly, monthly or daily basis as the underlying market indices change. Currently, $37.5 million, or 51.74%, of the Company's loan portfolio reprices on a regular basis or matures within one year.

The Company also invests excess funds in liquid federal funds that mature and reprice on a daily basis. Federal funds sold were $6.7 million at December 31, 2003 and represented 8.7% of total interest earning assets. The Company also maintains all of its securities in the available for sale portfolio to take advantage of interest rate swings and to maintain liquidity for loan funding and deposit withdrawals. In addition to the gap analysis, management measures the Company's interest rate risk by computing estimated changes in net interest income. The Company's senior management and the Board of Directors Asset/Liability review committee review the exposure to interest rates at least quarterly. Exposure to interest rate risk is measured with the use of an interest rate sensitivity analysis software to determine the impact of hypothetical changes in interest rates, while the gap analysis is used to determine the repricing characteristics of assets and liabilities. Computations of prospective effects of hypothetical interest rate changes are based on numerous assumptions, including relative levels of market interest rates, loan prepayments and deposit decay rates, and should not be relied upon as indicative of actual results. Further, the computations do not contemplate any actions the Company may undertake in response to changes in interest rates. As with any method of measuring interest rate risk, certain shortcomings are inherent. For example, although certain assets and liabilities may have similar maturities or periods of repricing, they may react in different degrees to changes in market interest rates. Also, the interest rates on certain types of assets and liabilities may fluctuate in advance of changes in market interest rates, while interest rates on other types may lag behind changes in market rates. Further, in the event of a change in interest rates, expected rates of prepayment on loans and mortgage-backed securities and early withdrawal levels from certificates of deposit would likely deviate significantly from those assumed in making risk calculations.

LIQUIDITY

Liquidity is the ability of the Company to fund customers' needs for borrowing and deposit withdrawals. The purpose of liquidity management is to assure sufficient cash flow to meet all of the financial commitments and to capitalize on opportunities for business expansion. This ability depends on the institution's financial strength, asset quality and types of deposit and investment instruments offered by the Company to its customers. The Company's principal sources of funds are deposits, loan and securities repayments, maturities of securities, sales of securities available for sale and other funds provided by operations. The Company also has the ability to borrow from the FHLB, subject to regulatory approval under the New Formal Agreement. The Bank has available approximately $5 million with the FHLB secured by residential real estate. While scheduled loan repayments and maturing investments are relatively predictable, deposit flows and early loan and mortgage-backed security prepayments are more influenced by interest rates, general economic conditions and competition. The Company maintains investments in liquid assets based upon management's assessment of (1) need for funds, (2) expected deposit flows, (3) yields available on short-term liquid assets and (4) objectives of the asset/liability management program. Cash and cash equivalents decreased $4.0 million, or 21.6%, from $18.4 million at December 31, 2002 to $14.4 million at December 31, 2003 due primarily to an elimination of public funds solicited. Cash and cash equivalents includes federal funds sold, which decreased $8.7 million. The continuous decline in interest rates during 2003 resulted in issuing agencies calling high yielding bonds carried in the Company's securities portfolio. Management was not willing to reinvest in longer-term securities during a period of low interest rates and instead invested in federal funds sold. Cash and cash equivalents represented 15.8% of total assets at December 31, 2003 compared to 17.7% of total assets at December 31, 2002. Subject to regulatory approval under the New Formal Agreement with the OCC, the Bank has the ability to borrow funds from FHLB, should the Bank need to supplement its future liquidity needs in order to meet deposit flows, loan demand or fund investment opportunities. Management believes the Bank's liquidity position was strong prior to the sale of the branches in Universal City, San Antonio, New Braunfels and Converse, Texas which occurred January 15, 2004 based on its high level of cash, cash equivalents, core deposits, the stability of its other funding sources and the support provided by its capital base. However, the Bank needed $17.9 million to close the sale of these branches which caused it to borrow $4.7 million from FHLB. This sale caused a temporary liquidity problem that was solved with the addition of a jumbo certificate of deposit promotion. As summarized in the Consolidated Statements of Cash Flows, the Company generated $307 thousand of cash for its operating activities during 2003 and $176 thousand during 2002. $8.3 million of cash was generated from investing activities, during 2003 compared to an decrease from investing activities of $7.1 million in 2002. The Company paid off $5.3 million in loans during 2003 compared to $13.0 million invested in loans by the Company during 2002. Deposits decreased $12.6 million in cash and equivalents during 2003 compared to an increase of $10.9 million during 2002. On a stand-alone basis, the Company had $5,000 in cash on hand as of December 31, 2003. The liquidity of the Company has been adversely affected by its inability to receive dividends from the Bank, which are limited by banking statutes and regulations and not currently allowed under the New Formal Agreement, discussed below. The subordinated convertible notes are obligations of the Company and not the Bank. The Company met its cash obligations for most of its corporate operating expense needs by borrowing funds from its directors and selling them stock. During 2003, the Company received $15,000 from directors for 833,333 shares of restricted, unregistered common stock. This balance has been recorded as a liability pending the issuance of the shares. During 2002, the Company sold 655,000 shares of restricted, unregistered common stock to directors, which raised $68,100 cash. During 2002, $95,000 of notes was converted into 438,392 shares of restricted, unregistered shares of common stock. In addition, director fees for 2003 and 2002 were paid in the form of restricted stock. There are no guarantees from any director, officer, or other party to lend funds or purchase Company stock in the future. The Company did not pay the interest due on its $4.3 million of convertible subordinated debt during 2003 and will not be able to make payments in the future unless holders of the notes agree to negotiations initiated by the Company. As of December 31, 2003, no agreement had been reached as to any restructuring of the convertible subordinated debt and the Company is continuing to negotiate a restructuring.

CAPITAL RESOURCES

Total shareholders' equity decreased $.865 million, due to the $.774 million net loss and a slight $91,000 decrease of the after-tax impact of unrealized losses on securities available for sale. The Company and the Bank are subject to regulatory capital requirements administered by federal banking agencies. Bank regulators monitor capital adequacy very closely and consider it an important factor in ensuring the safety of depositors' accounts. As a result, bank regulators have established standard risk based capital ratios that measure the amount of an institutions capital in relation to the degree of risk contained in the balance sheet, as well as off-balance sheet exposure. Federal law requires each federal banking regulatory agency to take prompt corrective action to resolve problems of insured depository institutions including, but not limited to, those that fall below one or more prescribed capital ratios. According to the regulations, institutions whose Tier 1 and total capital ratios meet or exceed 6.0% and 10.0% of risk-weighted assets, respectively, are considered "well capitalized." Institutions, whose Tier 1 and total capital ratios meet or exceed 4.0% and 8.0% of risk-weighted assets, respectively, are considered "adequately capitalized." Tier 1 capital is shareholders' equity excluding the unrealized gain or loss securities classified as available for sale and intangible assets. Tier 2 capital, or total capital, includes Tier 1 capital plus the allowance for loan losses not to exceed 1.25% of risk weighted assets. Risk weighted assets are the Company's total assets after such assets are assessed for risk and assigned a weighting factor based on their inherent risk. In addition to the risk-weighted ratios, all institutions are required to maintain Tier 1 leverage ratios of at least 5.0% to be considered "well capitalized" and 4.0% to be considered "adequately capitalized." The leverage ratio is defined as Tier 1 capital divided by adjusted total assets for the most recent quarter. As discussed above, the Bank is subject to more stringent capital requirements under the New Formal Agreement. The Bank did not meet the capital ratio requirements at December 31, 2003. However, with the sale of the 4 branches in the San Antonio area on January 15, 2004, the Bank is in full compliance with all the ratios.

The table below sets forth consolidated and bank-only actual capital levels in addition to the capital requirements under the Formal Agreement and prompt corrective action regulations:
Formal
Agreement at Year-End Capital Ratios December 31,
2003 2002 2003
------------------------- -------------
Leverage Ratio:

Tier 1 capital to average assets
Consolidated 1.10% 1.99%
Bank 6.80% 6.36% 8.00%

Risk-Based Capital Ratios:

Tier 1 capital to risk-weighted
assets
Consolidated 1.31% 2.65%
Bank 7.81% 8.80% 6.00%
Total capital to risk-weighted
assets
Consolidated 2.61% 5.24%
Bank 8.97% 10.06% 12.00%

At December 31, 2003 the Bank was not in compliance with two of the capital ratio requirements. Tier 1 capital to average assets was 6.80% and total risk based capital to adjusted total assets was 8.97% versus the ratios required under the Formal Agreement of 8.00% and 12.00%, respectively. On February 18, 2003, the Bank and OCC entered into a New Formal Agreement that replaced the prior agreements. The New Formal Agreement requires the Bank to develop, within ninety days of the agreement, an action plan detailing the Board of Directors' assessment of how to improve the Bank including implementation and timetable. The New Formal Agreement also includes provisions for new appointments to the Board of Directors, management effectiveness, adoption of a three-year strategic plan and preparation of a three-year business plan. In addition, the New Formal Agreement requires that the Bank achieve ratios of Tier 1 capital to risk-weighted assets of at least 8.0% and Total risk-based capital to adjusted total assets of 12.0% by June 30, 2003. The Board is also to develop a three-year capital program, develop a written program to improve the Bank's loan portfolio and implement an internal audit program. The New Formal Agreement sets forth time limits to achieve each of the required actions. The OCC may extend the time requirements for good cause upon written application from the Board of Directors. If the Bank fails to achieve substantial compliance with the New Formal Agreement within 90 days of the expiration of the time limits (including any duly granted extensions of time) the Board shall provide a written report setting out its plans to sell, merge, or liquidate the Bank. The Board and management intend to comply with the provisions of the New Formal Agreement. The Company is without significant assets other than its ownership of all the common stock of the Bank and is entirely dependent upon dividends received from the Bank or loans from its Directors or employees in order to meet its cash obligations, including debt service on the Notes. Under the New Formal Agreement the Bank is currently precluded from declaring and paying any dividends without prior OCC approval. The OCC will not approve future reductions in the Bank's surplus until the Bank is able to commence operating profitably in the near future. The Bank remains subject to the Formal Agreement and management does not know when or if the OCC will agree to terminate the Formal Agreement. The OCC informally extended the time limit to meet the ratios due to the pending sale of the four San Antonio, Texas branches. During 2002, directors purchased 655,000 shares of restricted unregistered stock for $68,100 and converted $95,000 of convertible notes purchased by them in 2001 into 438,000 shares of unregistered restricted shares of common stock. There are no commitments from the directors to provide operating capital or from regulatory authorities allowing the Bank to declare dividends in the near future. The Company has no other sources of liquidity.

OFF-BALANCE SHEET ARRANGEMENTS

The Company is not a party to any off-balance sheet arrangements as that term is used by the SEC in Item 303©(2) of Regulation S-B.

RECENT ACCOUNTING PRONOUNCEMENTS

The Financial Accounting Standards Board issued the following standards to be effective during various times during 2003, FIN 46 - Consolidation of Variable Interest Entities

A discussion of these standards is presented in Note 1 to the Surety Capital Corporation Notes to Consolidated Financial Statements contained elsewhere herein.

IMPACT OF INFLATION AND CHANGING PRICES

The consolidated financial statements and notes included herein have been prepared in accordance with generally accepted accounting principles ("GAAP"). Presently GAAP requires the Company to measure financial position and operating results primarily in terms of historic dollars. Changes in the relative value of money due to inflation or recession are generally not considered. The primary effect of inflation on the operations of the Company is reflected in increased operating costs. Unlike most industrial companies, virtually all of the assets and liabilities of a financial institution are monetary in nature. As a result, changes in interest rates have a more significant effect on the performance of a financial institution than do the effects of changes in the general rate of inflation and changes in prices. Interest rates do not necessarily move in the same direction or in the same magnitude as the prices of goods and services. Interest rates are highly sensitive to many factors that are beyond the control of the Company, including the influence of domestic and foreign economic conditions and the monetary and fiscal policies of the United States government and federal agencies, particularly the FRB. The FRB implements national monetary policy such as seeking to curb inflation and combat recession by its open market operations in United States government securities, control of the discount rate applicable to borrowing by banks, and establishment of reserve requirements against bank deposits. The actions of the FRB in these areas influence the growth of bank loans, investments and deposits, and affect the interest rates charged on loans and paid on deposits. The nature, timing and impact of any future changes in federal monetary and fiscal policies on the Company and its results of operations are not predictable.

Item 7. FINANCIAL STATEMENTS.

The financial statements and supplementary data required to be included pursuant to Item 7 are set forth on the "F" pages immediately following the exhibit index and are incorporated herein by reference.

ITEM 8. CHANGES IN AND DISAGREEMENTS WITH ACCOUNTANTS ON ACCOUNTING AND FINANCIAL DISCLOSURE OF THE REGISTRANT.

None.

Item 8A. CONTROLS AND PROCEDURES

An evaluation was performed under supervision and with participation of the Company’s management, including the Chairman and the Principal Financial Officer, of the effectiveness and operation of the Company’s disclosure controls and procedures (as defined in Rule 13a-15e promulgated under the Exchange Act) as of December 31, 2003. Based upon that evaluation, the Company’s Chairman and Principal Financial Officer concluded that the Company‘s disclosure controls and procedures are effective. There have been no significant changes in the Company’s internal controls or in other factors that could significantly affect the Company’s internal controls subsequent to the date of the evaluation, including any corrective actions with regard to significant deficiencies and material weaknesses.

PART III

ITEM 9. DIRECTORS AND EXECUTIVE OFFICERS.

The bylaws of the Company provide that the Board of Directors shall consist of such number of directors as shall be determined by resolution of the Board. By a resolution adopted by the Board on May 1, 2000, the number of directors comprising the Board of Directors was set at eight (8) and currently consists of six (6) members. Each member of the Board of Directors is elected for a one-year term to serve until his or her successor is elected and qualified. Each executive officer is appointed by the Board of Directors to serve until the first meeting of directors after the next annual meeting of stockholders.

The following table sets forth certain information relating to the directors and executive officers of the Company as of March 31, 2004:

NAME AGE POSITION

Richard N. Abrams 62 Chairman of the Board and Director

Tim Raso 46 Chief Operating Officer and Director

John Hernandez 72 Director

Vicki Dickerson 50 Director

Stephen Oeffner 55 Director

Glenn Forbes 44 Director

The business experience of each of these directors and executive officers during the past five years is set forth below:

RICHARD N. ABRAMS has served as a director of the Company since May, 2000 and was named Chairman of the Board of Directors in March, 2001 and Chief Executive Officer in March 2001 until 2002. He has served as Chairman of the Board and Chief Executive Officer of Funeral Financial Systems, Ltd. (a factor to the funeral industry) since August, 1985 until 2002, and of Executive Offices, Ltd. (a shared office building) since October, 1986 until 2002. Mr. Abrams has also served as Chairman of the Board of Funeraleasing, Ltd. (a leasing company for the funeral industry) since December, 1998 until 2002. Mr. Abrams is a certified public accountant. Mr. Abrams has served as a director of the Bank since March 2000.

TIM RASO has served as Chief Operating Officer since January, 2003 and a director of the Bank since February, 2003 and of the Company since January, 2003. He has been in banking or bank related activities for 28 years. Before joining Surety Bank, Mr. Raso was a senior bank consultant with the firm John M. Floyd and Associates, Baytown, Texas, and during the early 1990's he was a RTC auditor responsible for auditing and controlling the assets of failed savings and loans in South Texas. Mr. Raso's banking career includes seven years with Bank of America (or its predecessors), two years with Compass Bank and fifteen years with North Fort Worth Bank. In total, Mr. Raso has spent 24 years working for banks. During this time Mr. Raso became familiar with all aspects of banking. Mr. Raso attended the Texas Tech School of Banking in 1985, the SMU School of Banking in 1986 and the Graduate School of the South (LSU/Baton Rouge) in 1989.

JOHN HERNANDEZ has served as a director of the Bank since March, 2003 and of the Company since June, 2003. He has been a principal in the printing business for the past 20 years and for the past 13 years with JohnSons Press. He is the past Chairman of the Board of the Fort Worth Hispanic Chamber of Commerce.

STEPHEN OEFFNER has served as a director of the Bank since October, 2003 and Company since September, 2003. He is a certified public account and is Associate Vice President of University of North Texas Health Service Center since January, 1996. He was Regional Budget Officer of the Resolution Trust Corporation from 1992 through 1995.

VICKI DICKERSON has served as a director of the Bank and Company since May, 2003. She has been President, CEO and Principle in The Projects Group since January, 2003 and President and CEO of Sundance Projects Group from 1988 through 2002. Both companies are involved with management of construction projects. The Projects Group is nationwide and Sundance Project Group was involved with the Bass family in the redevelopment of downtown Fort Worth, Texas.

GLENN FORBES has served as a director of the Bank and Company since June, 2003. He is President and CEO of Southeast Fort Worth, Inc, an economic development corporation, since 2000. He was previously business development manager of Intel Corporation from June, 1997 to May 2000 when Intel closed its office in Fort Worth, Texas. From 1992 to 1997 he was Senior Lending Officer for Bank One.

No family relationships exist among the executive officers and directors of the Company. In the last five years the Company has not been involved with any legal proceedings that are reportable under Item 401(d) of Regulation S-B.

COMPLIANCE WITH SECTION 16(a) OF THE EXCHANGE ACT Section 16(a) of the Exchange Act requires the Company's directors, executive officers and holders of more than ten percent (10%) of the Company's common stock to file with the SEC initial reports of ownership and reports of changes in ownership of the Company's common stock. Such persons are required by SEC regulations to furnish the Company with copies of all Section 16(a) reports they file with the SEC. To the best knowledge of management of the Company, no director, officer or ten percent (10%) beneficial owner of common stock of the Company filed any required reports on Form 3, 4 or 5 regarding transactions in securities of the Company.

Code of Ethics - Because of the small size and limited resources of the Company, the Company has not adopted a code of ethics with standards as set out by the Securities and Exchange Commission's regulations applying to the principal executive officer, principle financial officer, principal accounting officer or controller, or persons performing similar functions. The Company's management will continue to consider whether the time and expense involved with developing such a code of ethics would be beneficial to the Company and its shareholders.

Although the Company’s Board of Directors has not determined whether the Company’s audit committee includes an “audit committee financial expert” as defined by regulations of the SEC, the Board believes that certain members of the audit committee possess knowledge and experience sufficient to understand the complexities of the financial statements of the Company.

ITEM 10. EXECUTIVE COMPENSATION.

SUMMARY OF CASH AND CERTAIN OTHER COMPENSATION

The following table provides certain summary information concerning compensation paid or accrued by the Company and the Bank to or on behalf of the Company's Chairman of the Board and Chief Executive Officer. There were no other executive officers that earned over $100,000 in 2003.

SUMMARY COMPENSATION TABLE
ANNUAL COMPENSATION
---------------------------------------------------------------------------------------------
NAME AND ALL OTHER
COMPENSATION
PRINCIPAL POSITION YEAR SALARY($)(1) BONUS($) ($)
----------------------------------------------------------------------------------------------
Richard N. Abrams, Chairman of the Board(4) 2003
2002 --- $ --- $20,417(2)
2001 --- $61,872(2) $ 4,760(3)

Tim Raso, Chief Operating Officer, Director 2003 $102,132 $ 2,500 $ ---
2002 $72,658 $ $ ---
2001 --- $ --- $ ---

John Quiroz, President (5) 2003 $94,451 $ --- $ ---
2002 --- --- ---
2001 --- --- ---

(1) Includes salary and directors' fees paid by the Bank, before any salary reduction for contributions to the Bank's Savings Plan under Section 401(k) of the Internal Revenue Code of 1986, as amended (the "Code") and the value of car allowance.

(2) Represents the discounted value of 400,000 shares of restricted Company common stock awarded to Mr. Abrams for services provided to the Company. The stock is not registered.

(3) Represents the discounted value of 70% and 20,000 shares of restricted, unregistered Company common stock issued as director fees for Board of Director and Committee meeting attendance during 2002 and 2001, respectively. No value is included for the value of lodging provided to Mr. Abrams while in Texas.

(4) Mr. Abrams became Chief Executive Officer in March, 2001 through 2002. The Company was not required to report Mr. Abrams' compensation in prior years and, therefore, the Company is only reporting his compensation for 2001, 2002 and 2003.

(5) Mr. Quiroz became President and Chief Lending Officer in January, 2003 and resigned February, 2004.

STOCK OPTION PLANS

OPTION GRANTS. No stock options were granted in fiscal year 2003.

OPTION EXERCISES AND HOLDINGS. The following table provides information with respect to the named executive officers concerning the exercise of incentive stock options during the last fiscal year and unexercised incentive stock options held as of the end of the last fiscal year under the Stock Option Plans:

AGGREGATED OPTION EXERCISES
IN LAST FISCAL YEAR
AND FY-END OPTION VALUES

Number of Value of Unexercised Unexercised Options at in the money
FY-End (#) FY-End ($)
----------------------------------------------------------------------------------------------
Shares Value
Acquired Realized Exercisable/ Exercisable/
Name on Exercise (#) ($)(1) Unexercisable Unexercisable(2)
----------------------------------------------------------------------------------------------
Richard N. Abrams --- $--- 0/0 $0/$0

Tim Raso --- $--- 0/0 $0/$0

(1) No incentive stock options were exercised in 2003 by the named executive officers.

COMPENSATION OF DIRECTORS

The Company's and the Bank's Board of Directors consist of the same members and both organizations hold meetings on the same dates. In 2001, the Bank discontinued payment of cash director fees and does not plan to pay director cash fees in the near future. The Company awarded each non-employee director 2,000 shares of restricted stock for each board of director meeting attended and 1,000 shares for each committee meeting attended plus additional shares as approved by the compensation committee. The Company will continue the same practice of awarding shares for board of director and committee meetings.

The Company has adopted the 1996 Stock Option Plan for Directors (the "1996 Directors Plan") and the 1997 Non-Qualified Stock Option Plan for Non-Employee Directors (the "1997 Directors Plan"). Under the 1996 Directors Plan and 1997 Directors Plan, an aggregate of 250,000 shares of Common Stock of the Company were set aside for issuance pursuant to the exercise of options granted thereunder, of which 178,000 shares are subject to outstanding options and 56,000 shares remain available for grant. The 1996 Directors Plan is a formula plan pursuant to which annual options are automatically granted to directors of the Company who are not employees of the Company or the Bank at fair market value. All options under the 1996 Directors Plan are non-qualified stock options, and vest one year following the date of grant. Pursuant to the plan, on the first business day of each calendar year, each non-employee director is automatically granted an option to purchase 2,000 shares of Common Stock of the Company at 100% of fair market value on the grant date. In 2002, none of the non-employee directors of the Company received an option to purchase 2,000 shares of Common Stock of the Company. The 1997 Directors Plan provided for the one time grant of 25,000 non-qualified stock options to directors of the Company who were not employees of the Company or the Bank at fair market value. In 1997, each non-employee director of the Company received an option to purchase 25,000 shares of Common Stock of the Company at exercise prices ranging from $4.18 to $5.375 per share. These options vest over five years. Currently, 140,000 options remain outstanding pursuant to the 1997 Director's Plan.

The Company adopted the 2000 Non-Qualified Stock Option Plan for Advisory Directors. Under the provisions of the plan, 100,000 shares were allocated for non-qualified stock options to advisory directors. Grantees are awarded 10-year options to acquire shares at the market price on the date the option is granted. The options vest and become fully exercisable based on a vesting schedule as determined by the Compensation Committee of the Board of Directors on the date of grant. On November 6, 2000, grantees were awarded options to acquire 28,000 shares of common stock of the Company at $0.55 per share, which vest and become fully exercisable one year from the date of grant.

STOCK OPTION PLANS. The Board has adopted the 1988, 1995 and 1998 Incentive Stock Option Plans of Surety Capital Corporation and the 1997 Non-Qualified Stock Option Plan for Officers and Key Employees of Surety Capital Corporation (the "Stock Option Plans") for officers and/or key employees of the Company. The 1988, 1995 and 1998 Stock Option Plans have been approved by the stockholders of the Company. The purpose of the Stock Option Plans is to attract and retain
capable employees and provide an incentive to such employees to remain in the employ of the Company. Options for the purchase of Common Stock under the Stock Option Plans may be granted to officers or key employees selected from time to time by the Stock Option Committee of the Board. The exercise price for any options granted pursuant to the Stock Option Plans must be at least equal to the fair market value of the Common Stock on the date the options are granted. Under the Stock Option Plans an aggregate of 1,200,000 shares of Common Stock of the Company were set aside for issuance pursuant to the exercise of options granted thereunder, of which 733,333 shares are subject to outstanding options and 308,825 shares remain available for grant. To exercise the options, grantees must pay the exercise price in cash or Common Stock, or any combination of cash and Common Stock. Options granted under the 1988, 1995 and 1998 Stock Option Plans are incentive stock options and options granted under the 1998 Stock
Option Plan are non-qualified stock options. The Stock Option Plans contain certain "change in control" provisions designed to attract and retain valued employees of the Company and to ensure that such employees' performance is not undermined by the possibility, threat or occurrence of a change in control. The 1988 and 1995 Plans provide that in the event of a change in control of the Company (in the form of a dissolution or liquidation of the Company or a merger or consolidation in which the Company is not the surviving corporation) any options granted under the plans become fully exercisable, notwithstanding any vesting schedule relating to such options to the contrary. The 1998 Plan provides for the acceleration of any applicable vesting schedule upon a "change in control," which definition not only includes the dissolution or liquidation of the Company or a merger or consolidation in which the Company is not the surviving corporation, but also the acquisition by a person or group of 20% or more of the combined voting power of the Company's capital stock or under certain circumstances a change in the constitution of the Board. The 1998 plan was amended in 2001 to allow for the award of options to all employees.

POST RETIREMENT SERVICES AGREEMENT. The Company and the Bank were parties to a post retirement services agreement with C. Jack Bean which was terminated in 2002 in connection with a settlement agreement. Under the agreement, the Company provided Mr. Bean payments totaling $53,825 per year, payable in annual, monthly or bi-monthly installments. Additionally, the Company provided or reimbursed Mr. Bean for the cost of health, accident and medical insurance
coverage that was equivalent to the coverage provided to those persons serving from time to time as the senior executive officers of the Company.

ITEM 11. SECURITY OWNERSHIP OF CERTAIN BENEFICIAL OWNERS AND MANAGEMENT.

BY MANAGEMENT

The following table shows beneficial ownership of shares of common stock of the Company by all current directors and executive officers of the Company named in "Item 10. Executive Compensation" individually, and together with all current executive officers of the Company as a group, as of March 31, 2004:
--------------------------------------------------------------------------------
Amount and
Name of Individual Nature of
or Number of Beneficial Percent
Persons In Group Ownership (1) of Class (2)
--------------------------------------------------------------------------------
Richard N. Abrams
1501 Summit Ave.
Fort Worth, TX 76102 400,281 (3) 4.0%

Tim Raso 138,888 (4) 1.4%

John Hernandez 138,888 (4) 1.4%

Vicki Dickerson 138,888 (4) 1.4%

Glenn Forbes 138,888 (4) 1.4%

Stephen Oeffner 0 0.0%

All Direcotrs and Executive Officers
as a group (6 persons) 955,833 9.6%

(1) Based on information furnished by persons named and, except as otherwise indicated below, each person has sole voting and dispositive power with respect to all shares of common stock owned by such person.

(2) Based on 10,006,805 shares of common stock, which includes 9,926,244 shares of common stock issued and outstanding at March 31, 2004.

(3) Includes 17,000 shares awarded as compensation and director fees during 2002 but not yet issued.

(4) Includes restricted common stock that has yet to be issued acquired during 2003.

5% STOCKHOLDERS

The following table sets forth certain information with respect to stockholders of the Company who were known to be beneficial owners of more than five percent (5%) of the issued and outstanding shares of the common stock of the Company as of March 31, 2004, except for Richard N. Abrams, whose ownership interest is disclosed in the preceding table.
-------------------------------------------------------------------------------------
Amount and Nature
Name and Address of Beneficial Percent
of Beneficial Owner Ownership(1) of Class(2)
-------------------------------------------------------------------------------------

Carlson Capital, L.P.
301 Commerce Street, Suite 3300
Fort Worth, Texas 76102 519,300 5.19%

David Chappell
201 Main St. #400
Fort Worth, Texas 76102 646,275 6.46%

Rodney Abrams(3)(4)
141 West Jackson Suite 1310 A
Chicago, Illinois, 60604 1,314,514 13.02%

STEPHANIE DENBY, TRUSTEE OF ABRAMS
2003 FAMILY TRUST (4)
330 N. Wabash Avenue
22nd Floor
Chicago, IL 60611-3607 1,267,600 12.77%

(1) Based on information furnished by the entities named and, except as otherwise indicated below, each entity has sole voting and dispositive power with respect to all shares of Common Stock owned by such entity.

(2) Based on 10,006,080 shares of common stock, which includes 9,926,244 shares of common stock issued and outstanding at March 31,2004, and shares convertible or exercisable within sixty (60) days, which are deemed outstanding for a specific stockholder pursuant to Rule 13d-3(d)(1) under the Exchange Act.

(3) As reported on a Schedule 13D/A filed on March 31, 2003, and includes 74,999 shares he can acquire upon the conversion of outstanding debentures and 11,250 shares owned directly by Funeral Financial Services, Inc., a company in which Mr. Abrams is a controlling stockholder.

(4) Rodney Abrams is one of the beneficiaries under the Abrams 2003 Family Trust.

ITEM 12. CERTAIN RELATIONSHIPS AND RELATED TRANSACTIONS.

>From time to time, the Bank makes loans to officers, directors and principal stockholders (and their affiliates) of the Company or the Bank. All loans to such persons are made in the ordinary course of business, are made on substantially the same terms, including interest rates and collateral, as those prevailing at the time for comparable transactions with other persons, and do not involve more than the normal risk of collectibility or present other unfavorable features.

During 2002, the Company sold 655,000 shares to members of the Board of Directors for $68,100 and issued 438,392 shares in conversion of the $95,000 of notes from directors funded in 2001.

During 2003, the Company received $15,000 from directors for 833,333 shares of restricted common stock. This amount has been recorded as a liability pending issuance of the shares.

ITEM 13. EXHIBITS AND REPORTS OF FORM 8-K

(a) EXHIBITS. The Exhibit Index, located directly after the signature pages, is incorporated herein by reference.

(b) REPORTS ON FORM 8-K. None filed

ITEM 14. PRINCIPAL ACCOUNTANTS AND FEES AND SERVICES

Audit Fees - The aggregate fees billed in 2003 and 2002 for professional services rendered by the principal accountant for the audit of the registrant's annual financial statements and review of the financial statements included in this 10-KSB or services that are normally provided by the accountant in connection with statutory and regulatory filings were $51,750 and $47,000, respectively.

Audit Related Fees - There were no fees billed in each of the last two years for assurance and related services by the principal accountant that are reasonably related the performance of the audit or review of the registrant's financial statements.

Tax Fees - There were no fees billed in each of the last two fiscal years for professional services rendered by the principal accountant for tax compliance, tax advice, or tax planning.

All Other Fees - There were no other fees billed in each of the last two fiscal years for products and services provided by the principal accountant.

SIGNATURES
In accordance with Section 13 or 15(d) of the Exchange Act, the Registrant has duly caused this report to be signed on its behalf by the undersigned, thereunto duly authorized.
SURETY CAPITAL CORPORATION

Date: April 15, 2004 By: /s/ Richard N. Abrams
--------------------
Richard N. Abrams,
Chairman of the Board

By: /s/ Tim Raso
-----------------
Tim Raso,
Chief Operating Officer (Principal Financial Officer and Chief Accounting Officer)

In accordance with Section 13 or 15(d) of the Exchange Act, this report has been signed below by the following persons on behalf of the Registrant and in the capacities indicated on this 15th day of April, 2004.

Signature Capacity

/s/ Richard N. Abrams
-------------------------
Richard N. Abrams Chairman of the Board and Director

s/ Tim Raso
--------------------------
Tim Raso Chief Operating Officer and Director

/s/ John Hernandez
--------------------------
John Hernandez Director


/s/ Vicki Dickerson
--------------------------
Vicki Dickerson Director



/s/ Stephen Oeffner
--------------------------
Stephen Oeffner Director



/s/ Glenn Forbes
--------------------------
Glenn Forbes Director

INDEX TO EXHIBITS

-----------------------------------------------------------------------------------------------
Incorporated Exhibit Herein by Filed
No. Description Reference To Herewith
-----------------------------------------------------------------------------------------------
3.01 Certificate of Incorporation, as Filed with the Company's Form 10-K dated December amended 31, 1993 and incorporated by reference herein.
-----------------------------------------------------------------------------------------------

3.03 Restated Bylaws of the Company Filed with the Company's Form 10-K dated December 31, 1994 and incorporated by reference herein.
-----------------------------------------------------------------------------------------------

4.01 Form of Common Stock certificate Filed with the Company's Form 10-K dated December 31, 1993 and incorporated by reference herein.
-----------------------------------------------------------------------------------------------

4.02 Indenture dated as of March 31, 1998 Filed with the Company's Form 10-Q for
between the Company and Harris Trust quarter ended March 31, 1998 and
and Savings Bank, Chicago, Illinois, incorporated by reference herein.
as trustee

----------------------------------------------------------------------------------------------

4.03 Form of Notes (included in the Filed with the Company’s Form 10-Q for
Exhibit 4.02) the quarter ended March 31, 1998 and
Incorporated by reference herein.
----------------------------------------------------------------------------------------------

4.04 Form of Note Purchase Agreements Filed with the Company's Registration dated March 31, 1998 Statement No. 333-57601 on Form S-3 and
incorporated by reference herein.
-----------------------------------------------------------------------------------------------

10.01 Surety Capital Corporation 1988 Filed with the Company's Form 10-K dated
Incentive Stock Option Plan December 31, 1991 and incorporated by
reference herein.
-----------------------------------------------------------------------------------------------

10.02 Surety Capital Corporation 1995 Filed with the Company's Form
Incentive Stock Option Plan 10-K dated December 31, 1994 and
incorporated by reference herein.
-----------------------------------------------------------------------------------------------

10.03 Surety Capital Corporation Amended Filed with the Company's Form 10-K dated
and Restated Stock Option Plan for December 31, 1996 and incorporated by
Directors, and Form of Stock Option reference herein.
Agreement

10.04 Surety Capital Corporation 1997 Filed with the Company's Form 10-K dated Non-Qualified Stock Option Plan for December 31, 1997 and incorporated
Officers and Key Employees, and Form by reference herein.
of Stock Option Agreement

-----------------------------------------------------------------------------------------------
10.05 Surety Capital Corporation 1997 Filed with the Company's Form 10-K dated Non-Qualified Stock Option Plan December 31, 1997 and incorporated by for Non-Employee Directors, and reference herein Form of Stock Option Agreement

-----------------------------------------------------------------------------------------------

10.06 Surety Capital Corporation 2001
Amended and Restated 1998 Incentive
Stock Option Plan
-----------------------------------------------------------------------------------------------

10.07 Form of Redeemable Convertible Filed with the Company's Form 10-K dated Promissory Note between Surety December 31, 1999 and incorporated by r Capital Corporation and C. Jack Bean, reference herein.
Charles M. Ireland, Margaret E.
Holland, Aaron M. Siegel, Garrett
Morris, Cullen W. Turner, William B.
Byrd, Michael L. Milam and Lloyd W.
Butts, and related Warrant, dated
October 29, 1999
-----------------------------------------------------------------------------------------------

10.8 Form of Indemnification Agreement Filed with the Company's Form 10-K dated between Surety Capital Corporation December 31, 1999 and incorporated by and William B. Byrd, Lloyd W. Butts, reference herein.
Charles M. Ireland, Margaret E.
Holland, Michael L. Milam, Garrett
Morris, Cullen W. Turner and John D.
Blackmon, dated January 18, 2000
-----------------------------------------------------------------------------------------------

10.9 Form of Indemnification Agreement Filed with the Company's Form 10-K dated between Surety Bank, National December 31, 1999 and incorporated by Association and William B. Byrd, reference herein.
Lloyd W. Butts, Charles M. Ireland,
Margaret E. Holland, Michael L.
Milam, Garrett Morris, Cullen W.
Turner and John D. Blackmon, dated
January 18, 2000

31.01 Certification of Richard N. Abrams, Chairman of the Board. Pursuant to Rule 13a- 14(a) and Rule 15d – 14(a)

31.02 Certification of Tim Raso, Chief Operating Officer. Pursuant to Rule 13a- 14(a) and Rule 15d – 14(a)

10.10 2001 Non-Qualified Stock Option Plan
for Advisory Directors
-----------------------------------------------------------------------------------------------
21.01 Subsidiaries of the Registrant
-----------------------------------------------------------------------------------------------
23.01 Consent of Weaver and Tidwell, L.L.P.
-----------------------------------------------------------------------------------------------
31.01 Certification of Richard N. Abrams, Chairman of the Board, pursuant to Rule 13a-14(a) and Rule 15(d)-14(c).
-----------------------------------------------------------------------------------------------
31.02 Certification of Tim Raso, Chief Operating Officer, pursuant to Rule 13a-14(a) and Rule 15 (d)-14(c).

32.01 Certification of Richard N. Abrams, Chairman of the Board, pursuant to 18 U.S.C., Section 1350, as adopted pursuant to Section 906 of the Sabranes – Oxley Act of 2002
-----------------------------------------------------------------------------------------------

32.02 Certification of Tim Raso, Chief Operating Officer, pursuant to 18 U.S.C., Section 1350, as adopted pursuant to Section 906 of the Sabranes – Oxley Act of 2002
-----------------------------------------------------------------------------------------------

SURETY CAPITAL CORPORATION

FINANCIAL REPORT
DECEMBER 31, 2003

C O N T E N T S

Page

INDEPENDENT AUDITOR’S REPORT F-1

FINANCIAL STATEMENTS

Consolidated Balance Sheets F-2

Consolidated Statements of Operations F-4

Consolidated Statements of Comprehensive Loss F-5

Consolidated Statements of Shareholders’ Equity F-6

Consolidated Statements of Cash Flows F-7

Notes to Consolidated Financial Statements F-9

INDEPENDENT AUDITOR’S REPORT

To the Board of Directors and shareholders of
Surety Capital Corporation
Fort Worth, Texas

We have audited the accompanying consolidated balance sheets of Surety Capital Corporation as of December 31, 2003 and 2002, and the related consolidated statements of operations, comprehensive loss, shareholders’ equity and cash flows for the years then ended. These financial statements are the responsibility of the Company’s management. Our responsibility is to express an opinion on these financial statements based on our audits.

We conducted our audits in accordance with U. S. generally accepted auditing standards. Those standards require that we plan and perform the audits to obtain reasonable assurance about whether the financial statements are free of material misstatement. An audit includes examining, on a test basis, evidence supporting the amounts and disclosures in the financial statements. An audit also includes assessing the accounting principles used and significant estimates made by management, as well as evaluating the overall financial statement presentation. We believe that our audits provide a reasonable basis for our opinion.

In our opinion, the consolidated financial statements referred to above present fairly, in all material respects, the consolidated financial position of Surety Capital Corporation as of December 31, 2003 and 2002, and the consolidated results of their operations and their cash flows for the years then ended in conformity with U. S. generally accepted accounting principles.

The accompanying financial statements have been prepared assuming that the Company will continue as a going concern. As discussed in Note 1 to the financial statements, the Company has incurred significant losses in all periods presented, is operating under a Formal Agreement with the Office of the Comptroller of the Currency and a Memorandum of Understanding with the Federal Reserve Board, all of which raise substantial doubt about its ability to continue as a going concern. Management’s plans in regard to these matters are also discussed in Note 1. The financial statements do not include any adjustments that might result from the outcome of this uncertainty.

WEAVER AND TIDWELL, L.L.P.

Fort Worth, Texas
April 12, 2004

4151

NOTE 1. SUMMARY OF SIGNIFICANT ACCOUNTING POLICIES

General Information and Basis of Presentation

The accompanying consolidated financial statements include the accounts of Surety Capital Corporation (the Holding Company) and its wholly-owned subsidiary, Surety Bank, NA (the Bank), together referred to as the Company. All significant intercompany accounts and transactions have been eliminated in consolidation.

The Company is principally engaged in traditional community banking activities provided through its six branches located in north Texas and south central Texas. Community banking activities include the Company’s commercial and retail lending, deposit gathering and investment, and liquidity management activities. In addition to its community banking services, the Company offers insurance premium financing. Insurance premium finance (IPF) lending involves the lending of funds to companies and individuals for the purpose of financing its purchase of property and casualty insurance.

The 2003 consolidated financial statements were prepared assuming the Company will continue as a going concern. Although the Company has suffered significant losses in its core business operations in all periods presented and is now operating under a written formal agreement with the Office of the Comptroller of the Currency (OCC) and a memorandum of understanding with the Federal Reserve Board (see Note 13), management believes the Company will be able to return to profitability. Management’s plans to improve the Company’s profitability include increasing marketing efforts, introducing new deposit products, emphasizing loan growth, reducing non-interest expense and selling certain branch operations. Subsequent to December 31, 2003, the Company sold its branches in San Antonio (See Note 17). Due to the sale of the San Antonio branches, the liquidity of the Bank was limited. The Holding Company is primarily dependent upon dividends received from the Bank to meet its cash obligations, including interest payments on its convertible subordinated debt. Since the Bank is currently precluded from paying dividends without prior OCC approval, certain Holding Company Directors and shareholders previously made loans to the Holding Company to fund interest payments on its convertible subordinated debt and other expenses incurred by the Holding Company. In February 2002, the Holding Company notified the holders of its convertible subordinated debt that these certain Directors and shareholders will no longer make loans to the Holding Company to fund future interest payments and that the Holding Company will not have funds to make future interest payments until the Bank obtains relief from restrictions prohibiting the Bank from paying dividends to the Holding Company. The interest payments due in 2003 and 2002 were not made. Management has offered the convertible debt holders certain options as alternatives to interest payments, however, an agreement had not been reached prior to December 31, 2003.

Use of Estimates

The preparation of financial statements in conformity with U. S. generally accepted accounting principles requires management to make estimates and assumptions that affect the reported amounts of assets and liabilities and disclosure of contingent assets

NOTE 1. SUMMARY OF SIGNIFICANT ACCOUNTING POLICIES – continued

Use of Estimates – continued

and liabilities at the date of the financial statements and the reported amounts of revenues and expenses during the reporting period. Actual results could differ from those estimates.

Cash Flow Reporting

Cash and cash equivalents include cash, deposits with other financial institutions that have an original maturity under 90 days, and federal funds sold. Net cash flows are reported for loan and deposit transactions, and short-term borrowings.

Securities

Securities are classified as held to maturity and carried at amortized cost when management has the positive intent and ability to hold them to maturity. Securities are classified as available for sale when they might be sold before maturity. Securities available for sale are carried at fair value, with unrealized holding gains and losses reported in other comprehensive income (loss). Trading securities are carried at fair value, with changes in unrealized holding gains and losses included in income. Management determines the appropriate classification of securities at the time of purchase. Other securities, such as stock in the Federal Reserve Bank and the Federal Home Loan Bank, are carried at cost. The Company had no securities classified as held to maturity or trading at December 31, 2003 and 2002. Securities classified as held to maturity were purchased during the year ended December 31, 2002, however, all matured or were called during 2002.

Interest income includes amortization of purchase premiums and discounts. Gains and losses on sales are based on the amortized cost of the security sold using specific identification. Securities are written down to fair value with a charge to income when a decline in fair value is not temporary.

Loans

Loans are reported at the principal balance outstanding net of unearned interest, deferred loan fees and costs, and the allowance for credit losses. Interest income is reported on the level-yield interest method and includes amortization of net deferred loans fees and costs over the loan term.

Interest income is not reported when full loan repayment is in doubt, typically, when the loan is impaired or payments are past due over 90 days based on contractual terms (120 days for insurance premium financing). Payments received on such loans are reported as principal reductions.

NOTE 1. SUMMARY OF SIGNIFICANT ACCOUNTING POLICIES – continued

Allowance for Credit Losses

The allowance for credit losses is a valuation allowance for probable credit losses, increased by the provision for credit losses and decreased by charge-offs less recoveries. Management estimates the allowance balance required on a monthly basis using past credit loss experience, the nature and volume of the portfolio, information about specific borrower situations and estimated collateral values, economic conditions, and other factors. Individual credits are reviewed based on size, past due status or other factors and all other credits are evaluated as a group. Allocations of the allowance may be made for specific credits, but the entire allowance is available for any credit that, in management’s judgment, should be charged-off. Credits deemed uncollectible by management are charged to the allowance. Because of uncertainties associated with regional economic conditions, collateral values, and future cash flows on impaired loans, it is reasonably possible that management’s estimate of credit losses inherent in the loan portfolio and the related allowance may change materially in the near term.

A loan is considered impaired when full payment of principal and interest under the loan terms is not expected. Impairment is evaluated in total for smaller balance loans of similar nature such as residential mortgage, consumer and insurance premium financing loans, and on an individual loan basis for other loans. If a loan is impaired, a portion of the allowance is allocated so that the loan is reported net, at the present value of estimated future cash flows using the loan’s existing rate or at the fair value of collateral if repayment is expected solely from the collateral.

Premises and Equipment

Land is carried at cost. Premises and equipment are stated at cost less accumulated depreciation. Depreciation is calculated using the straight-line method based on the estimated useful lives of the assets. Repairs and maintenance that do not extend the useful life of an asset are expensed as incurred.

Other Real Estate and Repossessed Assets

Assets acquired through or instead of loan foreclosure are initially recorded at fair value when acquired, establishing a new cost basis. If fair value declines, a valuation allowance is recorded through expense. Costs after acquisition are expensed.

Goodwill

Effective January 1, 2002, the Company adopted the provisions of Statement of Financial Accounting Standards (SFAS) No. 142, Goodwill and other Intangible Assets.” Goodwill, which represents the excess of cost over the fair value of the net assets of an acquired business, was amortized on a straight-line method up to fifteen years prior to the adoption of SFAS No. 142. Effective January 1, 2002, goodwill is no longer amortized but tested for impairment annually or whenever events or changes in circumstances indicate that the carrying amount should be assessed. Impairment, if any, for goodwill is recognized as a permanent charge to noninterest expense.

NOTE 1. SUMMARY OF SIGNIFICANT ACCOUNTING POLICIES – continued

Goodwill – continued

Management has determined that there is no goodwill impairment as of December 31, 2003 or 2002. All goodwill is associated with the community banking activities of the Company.

Long-term Assets

Premises and equipment and other long-term assets are reviewed for impairment when events indicate their carrying amount may not be recoverable from future undiscounted cash flows. If impaired, the assets are recorded at discounted amounts. There was no impairment in 2003 or 2002.

Income Taxes

Income tax expense is the total of the current year income tax due or refundable and the change in deferred tax assets and liabilities. Deferred tax assets and liabilities are the expected future tax amounts for the temporary differences between carrying amounts and tax bases of assets and liabilities, computed using enacted tax rates. A valuation allowance, if needed, reduces deferred tax assets to the expected amount to be realized.

Stock Based Compensation

The Company applies the provisions of Accounting Principles Board Opinion No. 25, “Accounting for Stock Issued to Employees” and related interpretations, in accounting for its stock-based compensation plans. Under Opinion 25, compensation cost is measured as the excess, if any, of the market price of the Company’s stock at the date of the grant above the amount an employee must pay to acquire the stock. No compensation expense is recognized when the exercise price is equal to the market value of the stock on the day of grant. The Financial Accounting Standards Board (“FASB”) published SFAS No. 123, “Accounting for Stock-Based Compensation” (SFAS No. 123) on January 1, 1996 which encourages, but does not require, companies to recognize compensation expense for grants of stock, stock options and other equity instruments to employees based on new fair value accounting rules. Companies that choose not to adopt the new rules will continue to apply the existing rules, but will be required to disclose pro forma net income under the new method.

The following table reflects charges calculated under SFAS No. 123 of $0 and $88,286 for the years ending December 31, 2003 and 2002, respectively.

2002 2002
Net income (loss)
As reported ($ 773,865) ($2,750,345)
Pro forma ( 773,865) ( 2,838,631)

NOTE 1. SUMMARY OF SIGNIFICANT ACCOUNTING POLICIES – continued

Stock Based Compensation - continued

Net income (loss) per share
As reported
Basic (0.08) (0.30)
Diluted (0.08) (0.30)
Pro forma
Basic (0.08) (0.31)
Diluted (0.08) (0.31)

Advertising

Advertising costs are expensed as incurred.

Fair Values of Financial Instruments

Fair values of financial instruments are estimated using relevant market information and other assumptions. Fair value estimates involve uncertainties and matters of significant judgment regarding interest rates, credit risk, prepayments and other factors, especially in the absence of broad markets for particular items. Changes in assumptions or in market conditions could significantly affect the estimates. The fair value estimates of existing on- and off-balance sheet financial instruments do not include the value of anticipated future business or the value of assets and liabilities not considered financial instruments.

Loss Contingencies

Loss contingencies, including claims and legal actions arising in the ordinary course of business, are recorded as liabilities when the likelihood of loss is probable and an amount or range of loss can be reasonably estimated. Management does not believe there now are such matters that will have a material effect on the financial statements.

Dividend Restriction

banking regulations require the maintenance of certain capital and net income levels that may limit the amount of dividends that may be paid. Regulatory capital require-ments and restrictions placed on the Company are more fully disclosed in a separate note.

Restrictions on Cash

The Company is required to have certain levels of cash on hand or on deposit with the Federal Reserve Bank to meet regulatory reserve and clearing requirements. Deposits with the Federal Reserve Bank do not earn interest. Additionally, the Company had time deposits with other financial institutions totaling $28,449 and $28,330 at year end 2003 and 2002, respectively, pledged as security to its merchant card clearing agent.

NOTE 1. SUMMARY OF SIGNIFICANT ACCOUNTING POLICIES – continued

Earnings Per Share

Earnings per share is computed in accordance with SFAS No. 128, which requires dual presentation of basic and diluted earnings per share (EPS) for entities with complex capital structures. Basic EPS is based on net income divided by the weighted-average number of shares outstanding during the period. Diluted EPS includes the dilutive effect of convertible debt and stock options granted using the treasury stock method only if the effect on earnings per share is dilutive.

Earnings per common share is computed by dividing net income by the weighted-average number of shares outstanding for the year. The weighted-average number of common shares outstanding for basic and diluted earnings per share computations were as follows:
2003 2002

Weighted-average shares outstanding – basic 10,006,080 9,172,797

Weighted-average share outstanding – diluted 10,006,080 9,172,797

The Company reported a net loss in 2003 and 2002. Accordingly, the dilutive effect of stock options and convertible debt is not considered in the net loss per share calculations for these years.

Comprehensive Income (Loss)

Comprehensive income (loss) is reported for all periods. Comprehensive income (loss) includes both net income (loss) and other comprehensive income (loss), which includes the change in unrealized gains and losses on securities available for sale.

Industry Segments

Internal financial information is primarily reported and aggregated in two lines of business consisting of community banking and insurance premium financing.

New Accounting Pronouncements

FASB Interpretation 46 – Consolidation of Variable Interest Entities

This interpretation was issued in an effort to expand upon and strengthen existing accounting guidance that addresses when a company should include in its financial statements the assets, liabilities and activities of another entity. Many variable interest entities have commonly been referred to as special-purpose entities or off-balance sheet structures, but the guidance applies to a larger population of entities. This interpretation will be effective for the year ending December 31, 2004, however, it is not expected to have a material affect on the financial statements of the Bank.

NOTE 1. SUMMARY OF SIGNIFICANT ACCOUNTING POLICIES – continued

Reclassifications

Some items in prior financial statements have been reclassified to conform to the current presentation. These reclassifications had no effect on net loss.

NOTE 2. SECURITIES

At December 31, securities available for sale consisted of the following:

Gross Gross Estimated
Amortized Unrealized Unrealized Fair
2003 Cost Gains (Losses) Value

U. S. government agencies
and corporations $ 501,150 $ 1,975 $ - $ 503,125
Mortgage-backed
Securities 253,452 - ( 3,607) 249,845
Other securities 827,904 - - 827,904

$ 1,582,506 $ 1,975 ($ 3,607) $ 1,580,874


Gross Gross Estimated
Amortized Unrealized Unrealized Fair
2002 Cost Gains (Losses) Value

U. S. government agencies
and corporations $ 3,228,569 $ 86,150 $ - $ 3,314,719
Mortgage-backed
securities 433,772 3,703 - 437,475
Other securities 770,104 - - 770,104

$ 4,432,445 $ 89,853 $ - $ 4,522,298

Mortgage-backed securities are backed by pools of mortgages that are insured or guaranteed by the Federal Home Loan Mortgage Corporation (FHLMC) and the Government National Mortgage Corporation (GNMA). Other securities include stock holdings in Independent Bankers Financial Corporation, the Federal Reserve Bank and the Federal Home Loan Bank.

The amortized cost and estimated fair value of securities at year end 2003 and 2002, by contractual maturity, are shown below. Expected maturities may differ from contractual

NOTE 2. SECURITIES - continued

maturities because issuers may have the right to call or prepay obligations. Mortgage-
backed securities and other securities are shown separately since they are not due at a single maturity date.
2003 2002
Estimated Estimated
Amortized Fair Amortized Fair
Cost Value Cost Value

Due within one year $ 501,150 $ 503,125 $ 715,290 $ 724,563
Due after one year
through five years - - 2,010,660 2,036,406
Due after five years
through ten years - - 502,619 553,750
Mortgage-backed securities 253,452 249,845 433,772 437,475
Other securities 827,904 827,904 770,104 770,104

Total Securities $ 1,582,506 $1,580,874 $ 4,432,445 $ 4,522,298

At year end 2003 and 2002, there were no holdings of securities of any one issuer, other than the U. S. government and its agencies or the Federal Reserve Bank, in an amount greater than 10% of shareholders’ equity.

At year end 2003 and 2002, securities with a carrying amount of $602,376 and $3,630,647, respectively, were pledged as collateral for public deposits, as required or permitted by law.

NOTE 3. LOANS

At December 31, loans were as follows:
2003 2002

Real estate loans $44,865,978 $42,521,100
Insurance premium financing 5,353,579 10,221,479
Commercial loans 10,900,978 13,219,136
Consumer loans 6,077,064 6,514,280
Accounts receivable factoring 126,612 309,044

Total gross loans 67,324,211 72,785,039

Unearned interest ( 142,148) ( 278,213)
Allowance for credit losses on loans ( 1,687,777) ( 1,461,487)

Loans, net $65,494,286 $71,045,339

NOTE 3. LOANS - continued

At December 31, 2003 and 2002, there were loans totaling $684,000 and $204,000, respectively, outstanding to directors, executive officers or principal shareholders of the Company, including their immediate families or companies in which they are principal owners.

Loans with fixed rates were approximately $29,803,000 and $26,605,000 at December 31, 2003 and 2002, respectively.

Activity in the allowance for credit losses on loans for 2003 and 2002 was as follows:

2003 2002

Balance at beginning of year $ 1,461,487 $ 1,266,463
Provision for credit losses on loans 245,000 1,885,000
Loans charged off ( 445,571) ( 2,201,165)
Recoveries 426,861 511,189

Balance at end of year $ 1,687,777 $ 1,461,487

Impaired loans were as follows:

Year end loans with allowance allocated $ 6,383,173 $ 7,597,872
Year end loans with no allowance allocated - 60,183

Impaired loans $ 6,383,173 $ 7,658,055

Amount of the allowance allocated $ 1,109,029 $ 955,740

Average impaired loans during the year $ 7,020,614 $ 6,328,609

Interest income recognized
during impairment – all cash basis $ 75,144 $ 93,128

Loans past due over 90 days still on accrual $ 1,370,139 $ 1,206,742
Non-accrual loans 1,845,931 2,817,722

Total non-performing loans $ 3,216,070 $ 4,024,464

NOTE 4. PREMISES AND EQUIPMENT

Premises and equipment at December 31, are summarized as follows:

Estimated
Useful Lives 2003 2002

Buildings 5 – 40 years $3,732,550 $3,732,550
Furniture, fixtures
and computers 3 – 10 years 3,825,592 3,836,399
Automobiles 3 – 5 years 117,804 121,314
Leasehold improvements 3 – 5 years 32,469 32,469

Total cost $7,708,415 $7,722,732

Less accumulated depreciation ( 4,195,465) ( 3,811,072)
Land 1,146,039 1,146,039

Premises and equipment, net $4,658,989 $5,057,699

Rent expense totaled $36,000 and $72,000 for 2003 and 2002, respectively. Rent commitments under noncancelable operating leases were as follows at December 31, 2003, before considering renewal options that generally are present.

Year Amount

2004 28,560
2005 28,560
2006 9,520

$ 66,640

NOTE 5. DEPOSITS

At December 31, 2003, the scheduled maturities of time deposits were as follows:

Year Amount

2004 $21,246,911
2005 6,155,588
2006 1,795,711
2007 8,539,246
2008 1,688,877
Thereafter 11,084

NOTE 6. CONVERTIBLE SUBORDINATED DEBT AND NOTES PAYABLE

On March 31, 1998, the Company issued $4,350,000 in 9% Convertible Subordinated Notes Due 2008 (Notes), pursuant to an indenture between the Company and Harris Trust and Savings Bank, Chicago, Illinois, as trustee (Trustee). The Notes are general unsecured obligations of the Company. The terms of the Notes are such that they qualify as Tier II capital under the Federal Reserve Board’s regulatory capital guidelines applicable to bank holding companies. The Notes bear interest at a rate of 9% per annum until maturity. Interest on the Notes is payable semi-annually on March 31 and September 30 of each year. No principal payments are due until maturity on March 31, 2008.

The amount of the principal and any accrued and unpaid interest on the Notes are subordinated in right of payment to the prior payment in full of all senior indebtedness of the Company, including the Bank’s deposits. Upon the occurrence of certain events involving the bankruptcy, insolvency, reorganization, receivership or similar proceedings of the Company, either the Trustee or the holders of not less than 25% in aggregate principal amount of the outstanding Notes may declare the principal of the Notes, together with any accrued and unpaid interest, to be immediately due and payable. The Notes do not otherwise provide for any right of acceleration of the payment of principal thereof.

Each holder of Notes has the right at any time prior to maturity of the Notes, unless previously redeemed, at the holder’s option, to convert such Notes, or any portion thereof which is an integral multiple of $10,000, into shares of Common Stock of the Company, at the conversion price of $6 per share, subject to certain antidilutive adjustments (Conversion Price).

The Notes are not subject to mandatory redemption or sinking fund provision. At any time after March 31, 2002 and prior to maturity, the Notes are redeemable for cash at the option of the Company, on at least 30 but not more than 60 days notice, in whole or in part, at the redemption prices set forth in the table below, plus accrued interest to the date of redemption.

If Redeemed During Percentage of If Redeemed During Percentage of
12 Months Ended Principal 12 Months Ended Principal
March 31, Amount March 31, Amount

2004 104% 2007 101%
2005 103% 2008 100%
2006 102%

Certain current and former members of the Company’s Board of Directors and one employee previously loaned the Company funds to enable the Company to meet its cash obligations. $37,746 of the promissory notes evidencing the loans advanced in 2001 matured December 31, 2001 and was due to a Company in which a former director held an interest. This note was settled in January 2002 with payment of $25,000. During 2002, an additional $195,000 was loaned to the Company. $95,000 of the promissory notes were converted into common stock during the year ended December 31, 2002. A total of 438,392 shares of common stock were issued upon conversion off the above notes payable in 2002.

NOTE 6. CONVERTIBLE SUBORDINATED DEBT AND NOTES PAYABLE

In February 2002, the Company notified the holders of its convertible subordinated debt that it will not have funds to make future interest payments and offered the holders certain options as alternatives to interest payments. As of December 31, 2003 an agreement had not been reached as to any restructuring of the convertible subordinated debt.

NOTE 7. STOCK OPTIONS

A summary of the Company’s stock option plans is as follows:

1995 Incentive Stock Option Plan: Under the provisions of the plan 100,000 shares were allocated for incentive stock options to be granted to officers and/or key employees. Grantees are awarded 10-year options to acquire shares at the market price on the date the option is granted. The options vest and become exercisable based on a vesting schedule determined by the Compensation Committee of the Board of Directors on the date of grant. As of December 31, 2003, there were no options outstanding and 77,158 options available for grant under the plan. All options must be granted within 10 years of the plan adoption date.

1996 Stock Option Plan for Directors: Under the provisions of the plan 100,000 shares were allocated for non-qualified stock options to be granted to directors. The plan is a formula plan pursuant to which annual options are automatically granted to directors of the Company, who are not employees of the Company or the Bank, at fair market value. On the first calendar business day of each year, each non-employee director is automatically granted 10-year options to purchase 2,000 shares of Common Stock of the Company at the market price on the grant date. The options fully vest and become exercisable after the first anniversary of the grant date. As of December 31, 2003, there were no options outstanding, and 94,000 options available for grant under the plan.

1997 Non-Qualified Stock Option Plan for Officers and Key Employees: Under the provisions of the plan 500,000 shares were allocated for non-qualified stock options to be granted to officers and/or key employees. On January 2, 1997, grantees were awarded 10-year options to acquire 500,000 shares at the market price on that date. No additional options may be granted under the plan. The options fully vest and become exercisable in five equal installments commencing on December 31, 1997, and annually thereafter. As of December 31, 2002, there were 475,000 options outstanding of which all were exercisable.

1997 Non-Qualified Stock Option Plan for Non-Employee Directors: Under the provisions of the plan 150,000 shares were allocated for non-qualified stock options to be granted to directors. In 1997, grantees were awarded 10-year options to acquire 150,000 shares at the market price on the date the options were granted. The options vest and become exercisable based on a vesting schedule as determined by the Stock Option Committee of the Board of Directors on the date of grant. As of December 31, 2003, there were 140,000 options outstanding, all of which were exercisable, and no options were available for grant under the plan.
NOTE 7. STOCK OPTIONS - continued

2001 Non-Qualified Stock Option Plan for Advisory Directors: Under the provisions of the Plan 100,000 shares were allocated for non-qualified stock options to be granted to advisory directors. Grantees are awarded 10-year options to acquire shares at the market price on the date the option is granted. The options vest and become fully exercisable based on a vesting schedule as determined by the Stock Option Committee of the Board of Directors on the date of grant. As of December 31, 2003, there were 131,000 options outstanding, all of which were exercisable, and there were no options available for grant under the plan.

2002 Amended and Restated 1998 Incentive Stock Option Plan: Under the provisions of the plan, 500,000 shares were allocated for incentive stock options to be granted to officers and/or key employees. Grantees are awarded 10-year options to acquire shares at the market price on the date the option is granted. The options vest and become exercisable based on a vesting schedule as determined by the Stock Option Committee of the Board of Directors on the date of grant. As of December 31, 2003, there were 114,915 options outstanding, all of which were exercisable, and 375,085 were options available for grant under the plan. All options must be granted within 10 years of the plan adoption date.

The following is a summary of activity in the Company’s stock option plans:

2003 2002

Number of Weighted Number of Weighted
Shares Average Shares Average
Underlying Exercise Underlying Exercise
Options Prices Options Prices
Outstanding at
beginning of the year 920,834 $3.03 1,100,369 $ 2.78
Granted - - 28,000 0.50
Exercised - - - -
Expired or forfeited ( 59,919) 0.94 ( 207,535) 1.36

Outstanding at end of year 860,915 3.17 920,834 3.03

Exercisable at end of year 860,915 3.17 920,834 3.03

Available for grant
at end of year 546,243 486,324

The weighted average remaining contractual life of options outstanding at December 31, 2003 and 2002 was 3.79 and 5.05 years, respectively.

NOTE 7. STOCK OPTIONS - continued

The following table summarizes information about stock options outstanding at
December 31, 2003:

Options Outstanding Options Exercisable
Weighted
Average Weighted Weighted
Remaining Average Average
Range of Number Contractual Exercise Number Exercise
Exercise Prices Outstanding Life Price Exercisable Price

$0.00 to $1.99 245,915 5.68 $0.54 245,915 $ 0.54
4.00 to 5.99 615,000 3.04 4.23 615,000 4.23

$0.50 to $6.94 860,915 3.79 3.17 860,915 3.17

The weighted-average value per share of options granted during 2002 was $0.28. The fair value of options granted was estimated on the date of grant using the Black-Scholes option pricing model with the following weighted-average assumptions: dividend yield of 0%; expected volatility of 207.61% for 2002; risk-free interest rate of 4.46% for 2002; and an expected life of 5 years for 2002. There were no options granted in 2003.

NOTE 8. EMPLOYEE BENEFIT PLANS

The Company offers a 401(k) profit sharing plan for the benefit of all full-time employees, age 21 or older. Participants may contribute up to 22.5% of their gross compensation, subject to statutory limits. Prior to 2003, the Company matched those contributions at a percentage to be determined by management. In April 2003, the Company discontinued the match of employee contributions to the plan. The Company may also provide an additional discretionary percentage. Employee contributions are vested at all times and the Company’s contributions vest at the end of three years of service. The contribution expense included in salaries and employee benefits was $9,000 and $14,000 for 2003 and 2002, respectively.

The Company provided certain post-retirement benefits to a former Chairman and officer. Under the agreement, the Company was required to provide the former Chairman payments, payable in annual, monthly or bi-monthly installments, totaling $53,825 per year. Additionally, the Company was to provide or reimburse the former Chairman for the cost of health, accident and medical insurance coverage that is equivalent to the coverage provided to those persons serving from time to time as the senior executive officers of the Company. The Company’s obligation under the agreement was originally to terminate at the earlier of death or when the former Chairman reaches 85 years of age. All amounts payable under the agreement were accelerated and became due immediately upon a change in control (as defined in the agreement). Under the agreement, the Company could terminate the agreement for cause (as defined in the agreement) or upon disability of the former Chairman. During 2002, the Company and the former Chairman agreed to terminate the contract. A payment of $187,500 was made to the former Chairman and the difference of

NOTE 8. EMPLOYEE BENEFIT PLANS - continued

approximately $133,000 between the payment and the accrual recorded is included in other income in the accompanying financial statements for 2002.

NOTE 9. FINANCIAL INSTRUMENTS WITH OFF-BALANCE SHEET RISK
AND CONCENTRATION OF CREDIT RISK

Some financial instruments, such as loan commitments, credit lines, letters of credit, and overdraft protection are issued in the normal course of business to meet the financing needs of customers. These are agreements to provide credit or to support the credit of others, as long as conditions established in the contract are met. These agreements usually 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 used, the total commitments do not necessarily represent future cash requirements. Off-balance-sheet risk of credit loss exists up to the face amount of these instruments, although material losses are not anticipated. The same credit policies are used to make such commitments as are used for loans, including obtaining collateral at exercise of the commitment.

The total amounts of financial instruments with off-balance-sheet risk at December 31, 2003 and 2002 were unfunded loan commitments of $3,741,000 and $4,341,000 and letters of credit of $75,000 and $234,000, respectively.

Federal funds sold total $6,721,842 and $15,375,333 at December 31, 2003 and 2002, respectively. These funds represent uncollateralized loans, in varying amounts, to other commercial banks with which the Company has correspondent relationships. The Company maintains deposits with other financial institutions in amounts that exceed FDIC insurance coverage. The Company has not experienced any losses in such accounts and believes it is not exposed to any significant credit risks on cash and cash equivalents.

The Company has geographic concentrations of credit in its principal trade areas of Bexar, Comal, Grayson and Tarrant Counties, Texas. Additionally, the Company has a significant concentration of credit, based upon like collateral. Insurance premium finance loans, secured by the residual value of unearned insurance premiums, comprise $5,353,579 or 8% and $10,221,479 or 14% of gross loans at December 31, 2003 and 2002.

NOTE 10. OTHER NON-INTEREST EXPENSE AND
IMPAIRMENT OF LONG-LIVED ASSETS

Other non-interest expense consisted of the following:
2003 2002

Advertising $ 38,276 $ 67,301
Amortization of intangibles
and debt issuance costs 41,591 41,591
Directors fees - 19,851

NOTE 10. OTHER NON-INTEREST EXPENSE AND
IMPAIRMENT OF LONG-LIVED ASSETS - continued

2003 2002

Assessments 176,998 102,386
Impairment of other real estate - 37,000
Insurance 131,062 153,023
Office supplies 73,338 91,257
Operational losses 76,126 65,271
Other 386,546 504,952
Postage 156,580 130,705
Professional services 454,955 501,500
Telephone 87,609 138,852

Total other non-interest expense $1,623,081 $1,853,689

During 2002, legal fees of approximately $182,000 were paid to a firm in which a director of the Company holds an interest. During 2003 this director resigned from the Board.

Fees of approximately $23,000 were paid to a director who resigned from the board during 2002 for professional services related to the Company’s regulatory filings.

NOTE 11. FEDERAL INCOME TAXES

Year end deferred tax assets and liabilities consist of the following:

2003 2002
Deferred tax liabilities
Depreciation and amortization ($1,095,620) ($1,055,021)
Deferred loan costs ( 7,422) ( 13,113)
Allowance for credit losses ( 65,510) ( 206,685)
Net unrealized gain on securities
available for sale - ( 30,550)
Other ( 8,765) ( 7,813)

Gross deferred tax liability ( 1,177,317) ( 1,313,182)

Deferred tax assets
Alternative minimum tax loss carryforward 239,997 239,997
Net operating loss carryforwards 4,602,003 4,362,730
Other real estate losses 56,651 118,977
Other 31,072 27,639

Gross deferred tax asset 4,929,723 4,749,343

NOTE 11. FEDERAL INCOME TAXES - continued

2003 2002

Net deferred tax asset 3,752,406 3,436,161

Less valuation allowance
for net deferred tax asset ( 3,752,406) ( 3,436,161)

Total net deferred tax asset $ - $ -

The realization of the net deferred tax asset is contingent upon the Company generating sufficient future taxable income during the carryforward period. Management has provided a 100% valuation allowance for its net deferred tax asset due to the uncertainty of realization during the carryforward period. The change in the valuation allowance was
$316,245 and $1,539,162 for the years ended December 31, 2003 and 2002, respectively.

The provision for federal income taxes consists of the following:

2003 2002

Current $ - $ -
Deferred
Federal ( 316,245) ( 1,539,162)
Valuation allowance 316,245 1,539,162
Provision (benefit) for federal income tax
expense charged to results of operations - -
Tax effect of change in unrealized
gain on securities available for sale - 6,022

Comprehensive provision
for federal income taxes $ - $ 6,022


The effective tax rate on net loss before income taxes differs from the U. S. statutory tax rate as follows:

2002 2001

U. S. statutory rate 34.0% 34.0%
Valuation allowance ( 34.0%) ( 34.0%)

Effective tax rate 0.0% 0.0%

NOTE 11. FEDERAL INCOME TAXES - continued

As of year end 2003 for income tax reporting purposes, the Company has a current net pretax operating loss carryforward of approximately $13,500,000 which ultimately expires in 2023.

The Tax Reform Act of 1986 imposed substantial restrictions on the utilization of net operating losses and tax credits in the event of an “ownership change” of a corporation. Accordingly, the Company’s ability to utilize net operating loss carryforwards may be limited as a result of such an “ownership change” as defined in the Internal Revenue Code.

The Company also has an alternative minimum tax credit carryover of approximately $706,000 which can be used to offset regular tax in future periods.

NOTE 12. COMMITMENTS AND CONTINGENCIES

Federal Home Loan Bank Advances: As a member of the Federal Home Loan Bank (FHLB) system, the Bank has the ability to obtain borrowings up to a maximum total of 75% of its total assets subject to the level of qualified, pledgable 1-4 family residential real estate loans and FHLB stock owned. As discussed in a separate note, under a formal agreement with the OCC, the Bank is prohibited from incurring additional debt without prior approval. The advances are collateralized by a blanket pledge of the Bank’s residential mortgage loan portfolio and FHLB stock. No FHLB advances were outstanding as of December 31, 2003 or 2002, however, advances of approximately $4,700,000 were made to the Bank subsequent to December 31, 2003 as a result of the sale of the San Antonio branches. (See Note 17.) The advances have been subsequently reduced to $3,700,000.

Litigation: The Company is a party to various claims and legal actions arising in the ordinary course of business. In the opinion of management, after consultation with legal counsel, the ultimate disposition of these matters is not expected to have a material effect on the Company’s financial condition or results of operations.

NOTE 13. REGULATORY MATTERS

Banks and Bank holding companies are subject to regulatory capital requirements administered by federal banking 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. Failure to meet capital requirements can initiate regulatory action.

The Bank is a national banking association and, therefore, is subject to regulation, supervision and examination by the OCC. The Bank is also a member of the Federal Reserve Banking System (FRB) and the Federal Deposit Insurance Corporation (FDIC). Because the FRB regulates the bank holding company parent of the Bank, the FRB also has

NOTE 13. REGULATORY MATTERS - continued

supervisory authority that directly affects the Bank. In addition, upon making certain determinations with respect to the condition of any insured national bank, such as the Bank, the FDIC may begin proceedings to terminate a bank’s federal deposit insurance.

On November 19, 1998, the Board of Directors of the Bank entered into a Formal Agreement with the OCC pursuant to which the Bank was required to achieve certain capital levels and adopt and implement certain plans, policies and strategies by March 31, 1999. This Formal Agreement was superseded by a New Formal Agreement entered into with the OCC on February 18, 2003. The New Formal Agreement required that the Bank achieve ratios of Tier 1 capital to average assets of at least 8.0% and total capital to adjusted total assets of 12.0% by June 30, 2003. The required capital ratios were not achieved by the Bank prior to the date as set forth in the Formal Agreement, however, the Bank was given additional time by the OCC pending the sale of the bank’s branches in San Antonio.

The Formal Agreement establishes higher capital requirements than those applicable under prompt corrective action regulations for an “adequately” and “well capitalized” bank. The following table sets forth Consolidated and bank Only actual capital levels in addition to the capital requirements under the Formal Agreement and prompt corrective action regulations.

Minimum Requirements
To Be Well
Requirements Capitalized
Actual Under Formal For Under Prompt
Year-end Agreement at Capital Corrective
Capital Ratios December 31, Adequacy Action
2003 2002 2003 Purposes Regulations
Leverage Ratio
Tier I capital to
average assets
Consolidated 1.10% 1.99% 4.00% 5.00%
Bank 6.80% 6.36% 8.00% 4.00% 5.00%
Risk-Based Capital Ratios
Tier I capital to risk-
weighted assets
Consolidated 1.31% 2.65% 4.00% 6.00%
Bank 7.81% 8.80% 6.00% 4.00% 6.00%
Total capital to risk-
weighted assets
Consolidated 2.61% 5.24% 8.00% 10.00%
Bank 8.97% 10.06% 12.00% 8.00% 10.00%

NOTE 13. REGULATORY MATTERS - continued

Year end Consolidated and Bank Only actual capital amounts were as follows:

Consolidated Bank Only
2003 2002 2003 2002

Tier I capital $ 991,000 $ 2,010,000 $ 6,106,000 $ 6,650,000
Tier II capital 991,000 1,959,000 907,000 951,000

Total capital $ 1,982,000 $ 3,969,000 $ 7,013,000 $ 7,601,000

Risk-weighted assets $75,914,000 $ 75,799,000 $78,195,000 $ 75,579,000

Adjusted average assets $90,050,000 $100,752,000 $89,833,000 $104,549,000

As of year end 2003 and 2002, the Bank met the level of capital required to be categorized as well capitalized under prompt corrective action regulations. The Holding Company did not meet the level of capital required for capital adequacy purposes at December 31, 2003 or 2002.

Additionally, pursuant to the Formal Agreement, the Board of Directors was required to develop an action plan detailing the Board’s assessment of how to improve the Bank including implementation and timetable. The plan was to be developed within ninety days and submitted to the OCC. It also included provisions for new appointments to the Board of Directors, management effectiveness, adoption of a three year strategic plan and preparation of a three year business plan. The Board is also required to develop a three year capital program, develop a written program to improve the Bank’s loan portfolio and implement an internal audit program. All of these recommended enhancements have been implemented.

The Formal Agreement also prohibits the Board of Directors from declaring or paying any dividends unless the Bank (i) is in compliance with 12 U.S.C. Section 56 and 60, its approved capital program provided for in the Formal Agreement, and the capital levels set forth in the Formal Agreement, as more fully described above, and (ii) has obtained the prior written approval of the OCC.

The Holding Company does not have material working capital needs separate from those of the Bank, other than the payment of interest on its convertible subordinated debt (Note 6). The Bank is currently precluded from declaring and paying any dividends to the Holding Company under the Formal Agreement. The provisions of the subordinated debt do not allow holders to force an interest payment. On November 9, 1999, the OCC approved a $262,000 reduction of the Bank’s surplus, the proceeds of which were upstreamed to the Holding Company which, together with a $60,000 capital contribution by certain officers and directors of the Holding Company and a $139,000 federal income tax payment by the Bank to the Holding Company, was sufficient to enable the Holding Company to meet its September 30, 1999 interest obligations under the Notes and to pay certain other operating

NOTE 13. REGULATORY MATTERS - continued

expenses. Additionally, on March 28, 2000, the OCC approved another reduction in the Bank’s surplus in the amount of $500,000 that enabled the Holding Company to meet debt service obligations under the Notes and pay for other operating expenses through March 31, 2000. Certain current and former members of the Company’s Board of Directors and one employee made loans to the Company to enable it to meet its cash needs (Note 6).

On October 28, 1999, the Holding Company entered into a Memorandum of Understanding (MOU) with the FRB. Under the MOU, the Company is not permitted to declare or pay any corporate dividends or incur any additional debt without the prior approval of the FRB. Also, the Holding Company was required to develop and submit to the FRB a written three year capital plan, a plan to service the Holding Company’s existing debt without incurring any additional debt, and written procedures designed to strengthen and maintain the Holding Company’s internal records and controls to ensure that future regulatory reports are filed in a timely and accurate manner. The Holding Company has submitted each of the requested plans and procedures to the FRB. Finally, the Holding Company is mandated under the MOU to comply fully with all formal and informal supervisory actions that have been or may be imposed on the Bank by the OCC.

NOTE 14. FAIR VALUE OF FINANCIAL INSTRUMENTS

The estimated fair value approximates carrying value for financial instruments except those described below:

Securities: Fair values for securities are based on quoted market prices or dealer quotes. If a quoted market price is not available, fair value is estimated using quoted market prices for similar instruments.

Loans: The fair value of fixed-rate loans and variable-rate loans which reprice on an infrequent basis is estimated by discounting future cash flows using the current interest rates at which similar loans with similar terms would be made to borrowers of similar credit quality.

Deposits: The fair value of deposit liabilities with defined maturities is estimated by discounting future cash flows using the interest rates currently offered for deposits of similar remaining maturities.

Long-term Debt: The fair value of the Company’s notes payable and subordinated debt is not readily determinable. The Company has estimated the value of the notes payable at face value of the subordinated debt at par plus the premium the Company would be required to pay if the notes were retired at year end.

NOTE 14. FAIR VALUE OF FINANCIAL INSTRUMENTS - continued

Off-Balance Sheet Instruments: The fair values of these items are not material and are, therefore, not included on the following schedule.

The estimated year end fair values of financial instruments were as follows:

2003 2002
Carrying Estimated Carrying Estimated
Value Fair Value Value Fair Value

Financial assets
Cash and cash
equivalents 14,425,589 14,426,000 $18,411,402 $18,411,000
Interest-bearing
time deposits 28,449 28,000 28,330 28,000
Securities available
for sale 1,580,874 1,581,000 4,522,298 4,522,000
Loans, net 65,494,286 65,495,000 71,045,339 73,425,000
Accrued interest
receivable 305,741 306,000 334,990 335,000

Financial liabilities
Noninterest-bearing
deposits (18,382,623) (18,383,000) ( 17,162,910) ( 17,163,000)
Interest-bearing
deposit (63,054,909) ( 3,055,000) ( 76,862,786) ( 77,291,000)
Long-term debt ( 4,350,000) ( 4,524,000) ( 4,350,000) ( 4,568,000)
Accrued interest
payable ( 997,199) ( 997,000) ( 643,296) ( 643,000)

NOTE 15. BUSINESS SEGMENTS

The accounting policies of the segments are the same as those described above in Note 1. The Company evaluates segment performance based on net interest income and profit or loss from operations.
Insurance
Community Premium
2003 Banking Financing Total

Net interest income $ 2,592,445 $ 1,168,916 $ 3,761,361
Provision for credit losses ( 245,000) - ( 245,000)
Noninterest income 904,002 54,683 958,685
Noninterest expense 4,619,765 629,146 5,248,911
Net income (loss) ( 1,374,318) 594,453 ( 773,865)
Loans, gross 61,790,632 5,353,579 67,324,211
Total assets 86,019,251 5,419,354 91,438,605

2002
Net interest income $ 3,059,950 $ 1,042,016 $ 4,101,966
Provision for credit losses (1,922,538) 37,538 (1,885,000)
Noninterest income 785,668 220,203 1,005,871
Noninterest expense 5,334,782 638,400 5,973,182
Net income (loss) (3,411,702) 661,357 (2,750,345)
Loans, gross 62,563,560 10,221,479 72,785,039
Total assets 94,697,845 9,351,218 104,049,063

NOTE 16. PARENT COMPANY CONDENSED FINANCIAL STATEMENTS

The following are condensed parent company financial statements:

Condensed Balance Sheets
December 31, 2003 and 2002

2003 2002
Assets
Cash and cash equivalents $ 5,496 $ 6,647
Investment in subsidiary 8,894,133 9,276,573
Other assets 200,150 241,740

Total assets $ 9,099,779 $ 9,524,960

Liabilities
Convertible subordinated debt $ 4,350,000 $ 4,350,000
Accrued interest payable 880,875 489,375
Other liabilities 107,008 58,339

5,337,883 4,897,714
Shareholder’s equity
Common stock 100,061 100,061
Additional paid-in capital 18,085,534 18,085,534
Accumulated deficit ( 14,046,624) ( 13,272,759)
Treasury stock ( 375,443) ( 375,443)
Accumulated other comprehensive loss ( 1,632) 89,853

Total shareholders’ equity 3,761,896 4,627,246

Total liabilities and shareholders’ equity $ 9,099,779 $ 9,524,960

Condensed Statements of Operations and Comprehensive Loss
Years Ended December 31, 2003 and 2002

2003 2002

Operating income $ - $ 97,939

Operating expenses
Interest expense 391,500 391,500
Other expenses 91,410 142,025

Total operating expenses 482,910 533,525

NOTE 16. PARENT COMPANY CONDENSED FINANCIAL STATEMENTS – continued

Condensed Statements of Operations and Comprehensive Loss
Years Ended December 31, 2003 and 2002
(continued)

2003 2002

Loss before income taxes and equity in
net loss of subsidiary ( 482,910) ( 435,586)

Income tax expense (benefit) - -

Loss before equity in net loss and
distributions in excess of net
loss of subsidiary ( 482,910) ( 435,586)

Equity in net loss of subsidiary ( 290,955) ( 2,314,759)

Net loss ( 773,865) ( 2,750,345)

Other comprehensive income (loss) – net change
in unrealized holding gain on securities
available for sale, net of tax ( 91,485) 101,542

Comprehensive loss ($ 865,350) ($ 2,648,803)

Condensed Statements of Cash Flows
Years Ended December 31, 2003 and 2002

2003 2002
Cash flows from operating activities
Net loss ($ 773,865) ($2,750,345)

Adjustments to reconcile net loss
to net cash used in from operating activities

Amortization of debt issuance costs 41,590 41,590
Equity in net loss of subsidiary 290,955 2,314,759
Net change in other assets
and other liabilities 440,169 336,394

Net cash used in operating activities ( 1,151) ( 57,602)

Cash flows from investing activities - -

Net cash used in investing activities - -

NOTE 16. PARENT COMPANY CONDENSED FINANCIAL STATEMENTS – continued

Condensed Statements of Cash Flows
Years Ended December 31, 2003 and 2002
(continued)

2003 2002

Cash flows from financing activities
Sale of common stock - 60,000
Payment on debt - ( 25,000)

Net cash provided by financing activities - 35,000

Net change in cash and cash equivalents ( 1,151) ( 22,602)

Beginning cash and cash equivalents 6,647 29,249

Ending cash and cash equivalents $ 5,496 $ 6,647

NOTE 17. SUBSEQUENT EVENTS

In January 2004, the Company sold four of its branches located in San Antonio. All deposits of the branches were assumed by the buyer and all real estate, furniture and equipment were purchased. The Company received a premium on the deposits and recognized a gain of approximately $350,000 on the sale. The San Antonio deposits represented 40% of the total deposits of the Company at December 31, 2003. In addition, loans representing 18% of the gross loans at December 31, 2003 were transferred to the buyer in the transaction. Included in the cost of the assets sold was $1,491,439 of goodwill associated with the San Antonio branches.

SURETY CAPITAL CORPORATION
CONSOLIDATED BALANCE SHEETS
DECEMBER 31, 2002 AND 2001
2002 2001
------------- -------------
ASSETS

Cash and due from Banks $ 3,036,069 $ 4,387,913
Federal funds sold 15,375,333 10,015,000
------------- -------------

Total cash and cash equivalents 18,411,402 14,402,913

Interest bearing time deposits in other financial
institutions 28,330 27,771
Securities available for sale, at fair value 4,522,298 10,597,837
Loans, net 71,045,339 60,996,714
Premises and equipment, net 5,057,699 5,310,166
Accrued interest receivable 334,990 439,190
Deferred tax assets, net of valuation allowance - 6,022
Other real estate and repossessed assets 1,798,022 737,000
Goodwill, net 2,536,679 2,536,679
Other assets 314,304 506,139
------------- -------------

TOTAL ASSETS 104,049,063 $ 95,560,431
============= =============

The Notes to Consolidated Financial Statements are an integral part of these
statements.
F-2

SURETY CAPITAL CORPORATION
CONSOLIDATED BALANCE SHEETS
DECEMBER 31, 2002 AND 2001
(CONTINUED)
2002 2001
------------ ------------
LIABILITIES AND SHAREHOLDERS' EQUITY

LIABILITIES

Noninterest bearing demand deposits $ 17,162,910 $ 15,936,327
Savings, NOW and money market accounts 31,086,993 28,196,609
Time deposits, $100,000 and over 17,233,090 14,392,822
Other time deposits 28,542,703 24,628,757
------------ ------------

Total deposits 94,025,696 83,154,515

Convertible subordinated debt 4,350,000 4,350,000
Notes payable - 132,746
Accrued interest payable and other liabilities 1,046,121 948,478
------------ ------------

Total liabilities 99,421,817 88,585,739

COMMITMENTS AND CONTINGENCIES - -

SHAREHOLDERS' EQUITY
Preferred stock, $.01 par value;
1,000,000 shares authorized;
none issued at December 31, 2002 and 2001 - -
Common stock, $0.01 par value;
20,000,000 shares authorized; 10,006,080 and
8,074,688 shares issued at December 31, 2002
and 2001, respectively 100,061 80,747
Additional paid-in capital =
18,085,534 17,803,491
Accumulated deficit (13,272,759) (10,522,414)
Treasury stock, 79,836 shares at cost (375,443) (375,443)
Accumulated other comprehensive income (loss) 89,853 (11,689)
------------ ------------

Total shareholders' equity 4,627,246 6,974,692
------------ ------------

TOTAL LIABILITIES AND SHAREHOLDERS' EQUITY $104,049,063 $ 95,560,431
============ ============

The Notes to Consolidated Financial Statements are an integral part of these
statements.
F-3

SURETY CAPITAL CORPORATION
CONSOLIDATED STATEMENTS OF OPERATIONS
YEARS ENDED DECEMBER 31, 2002 AND 2001
2002 2001
----------- -----------
INTEREST INCOME
Loans, including fees $ 5,643,874 $ 5,944,964
Securities, taxable 355,048 748,163
Federal funds sold and interest bearing deposits 139,445 302,749
----------- -----------

Total interest income 6,138,367 6,995,876

INTEREST EXPENSE

Deposits 1,870,450 2,833,621
Notes payable 391,500 391,500
----------- -----------

Total interest expense 2,261,950 3,225,121
----------- -----------

Net interest income 3,876,417 3,770,755

Provision for credit losses on loans 1,885,000 -
----------- -----------

Net interest income after provision for credit losses 1,991,417 3,770,755

NON-INTEREST INCOME
Service charges on deposit accounts 781,604 642,728
Loan collection fees and late charges 225,549 149,545
Other income 224,267 65,957
----------- -----------
Total non-interest income 1,231,420 858,230

NON-INTEREST EXPENSE
Salaries and employee benefits 3,069,487 2,694,132
Occupancy and equipment 1,050,006 1,225,706
Other expenses 1,853,689 2,263,484
----------- -----------

Total non-interest expense 5,973,182 6,183,322
----------- -----------

Loss before income taxes (2,750,345) (1,554,337)
Income tax expense - -
----------- -----------

Net loss ($2,750,345) ($1,554,337)
=========== ===========

Net loss per share - basic and diluted ($0.30) ($0.23)
=========== ===========

The Notes to Consolidated Financial Statements are an integral part of these
statements.
F-4

SURETY CAPITAL CORPORATION
CONSOLIDATED STATEMENTS OF COMPREHENSIVE LOSS
YEARS ENDED DECEMBER 31, 2002 AND 2001
2002 2001
----------- -----------
NET LOSS ($2,750,345) ($1,554,337)

OTHER COMPREHENSIVE INCOME
Unrealized gain on securities available for sale 107,564 271,909

Tax effect (6,022) (92,449)
----------- -----------

Total other comprehensive income 101,542 179,460
----------- -----------

COMPREHENSIVE LOSS ($2,648,803) ($1,374,877)
=========== ===========

The Notes to Consolidated Financial Statements are an integral part of these
statements.
F-5

SURETY CAPITAL CORPORATION
CONSOLIDATED STATEMENTS OF SHAREHOLDERS' EQUITY
YEARS ENDED DECEMBER 31, 2002 AND 2001
Accumulated Common Stock Other
------------------------- Additional Comprehensive
Par Paid-in Accumulated Treasury Income
Shares Value Capital Deficit Stock (Loss) Total
---------- ------------ ------------ ------------ ------------ ------------- ------------
BALANCE,

December 31, 2000 5,975,071 $ 59,751 $ 17,152,587 ($8,968,077) ($375,443) ($191,149) $ 7,677,669

Sale of common stock 1,210,738 12,107 339,793 - - - 351,900

Conversion of notes
payable to common
stock 888,879 8,889 311,111 - - - 320,000

Change in fair value of
securities available
for sale, net of tax
of $92,449 - - - - - 179,460 179,460

Net loss - - - (1,554,337) - - (1,554,337)
---------- ------------ ------------ ------------ ------------ ------------- ------------

BALANCE,

December 31, 2001 8,074,688 80,747 17,803,491 (10,522,414) (375,443) (11,689) 6,974,692

Sale of common stock 655,000 6,550 61,550 - - - 68,100

Conversion of notes
payable to common
stock 438,392 4,384 90,616 - - - 95,000

Issuance of common
stock for services 838,000 8,380 129,877 - - - 138,257

Change in fair value of
securities available
for sale, net of tax
of $6,022 - - - - - 101,542 101,542

Net loss - - - (2,750,345) - - (2,750,345)
---------- ------------ ------------ ------------ ------------ ------------- ------------

BALANCE,

December 31, 2002 10,006,080 $ 100,061 $ 18,085,534 ($13,272,759) ($375,443) $ 89,853 $ 4,627,246
========== ============ =
============ ============ ============ ============= ============

The Notes to Consolidated Financial Statements are an integral part of these
statements.
F-6

SURETY CAPITAL CORPORATION
CONSOLIDATED STATEMENTS OF CASH FLOWS
YEARS ENDED DECEMBER 31, 2002 AND 2001
2002 2001
----------- ------------
CASH FLOWS FROM OPERATING ACTIVITIES
Net loss ($2,750,345) ($1,554,337)
Adjustments to reconcile net loss to net cash
provided by (used in) operating activities

Provision for credit losses 1,885,000 -
Provision for other real estate owned 37,000 204,000
Directors fees, paid with common stock 19,851 -
Depreciation 490,083 590,103
Amortization, net of accretion 28,131 (47,694)
Amortization of intangable assets
and debt acquisition costs 41,591 303,931
FHLB stock dividends (3,200) (5,800)
Net gain on sale or disposal of assets - (4,669)
Other (12,745) -
Changes in assets and liabilities
Accrued interest receivable 104,200 181,988
Other assets 112,221 114,151
Accrued interest payable and other liabilities 224,149 (245,646)
----------- ------------

Net cash provided by (used in)
operating activities 175,936 (463,973)

CASH FLOWS FROM INVESTING ACTIVITIES
Net change in loans (12,993,625) (2,758,654)
Securities available for sale
Purchases (3,704,272) (9,809,848)
Maturities and repayments 9,862,444 12,608,652
Securities held to maturity
Purchases (2,250,000) -
Maturities and repayments 2,250,000 -
Purchase of interest-bearing time deposits (559) (1,223) Premises and equipment expenditures (237,616) (196,897)
Proceeds from sales of other real estate - 1,000
----------- ------------

Net cash used in investing activities (7,073,628) (156,970)

The Notes to Consolidated Financial Statements are an integral part of these
statements.
F-7

SURETY CAPITAL CORPORATION
CONSOLIDATED STATEMENTS OF CASH FLOWS
YEARS ENDED DECEMBER 31, 2002 AND 2001
(CONTINUED)
2002 2001
------------ ------------
CASH FLOWS FROM FINANCING ACTIVITIES
Net change in deposits 10,871,181 3,493,747
Sale of common stock 60,000 351,900
Payments on debt (25,000) (40,000)
Proceeds from issuance of debt,
net of issuance costs - 195,000
------------ ------------

Net cash provided by financing activities 10,906,181 4,000,647
------------ ------------

Net change in cash and cash equivalents 4,008,489 3,379,704

CASH AND CASH EQUIVALENTS, beginning of year 14,402,913 11,023,209
------------ ------------

CASH AND CASH EQUIVALENTS, end of year $ 18,411,402 $ 14,402,913
============ ============

SUPPLEMENTAL DISCLOSURES
Cash paid for interest $ 1,939,434 $ 3,306,485
============ ============

Issuance of common stock for directors fees $ 138,257 $ -
============ ============

Significant non-cash transactions
Transfers of repossessed collateral
to other real estate $ 1,060,000 $ -
============ ============

Conversion of debt to common stock $ 95,000 $ 320,000
============ ============
INDEX TO EXHIBITS

-----------------------------------------------------------------------------------------------
Incorporated Exhibit Herein by Filed
No. Description Reference To Herewith
-----------------------------------------------------------------------------------------------
3.01 Certificate of Incorporation, as Filed with the Company's Form 10-K dated December amended 31, 1993 and incorporated by reference herein.
-----------------------------------------------------------------------------------------------

3.03 Restated Bylaws of the Company Filed with the Company's Form 10-K dated December 31, 1994 and incorporated by reference herein.
-----------------------------------------------------------------------------------------------

4.01 Form of Common Stock certificate Filed with the Company's Form 10-K dated December 31, 1993 and incorporated by reference herein.
-----------------------------------------------------------------------------------------------

4.02 Indenture dated as of March 31, 1998 Filed with the Company's Form 10-Q for
between the Company and Harris Trust quarter ended March 31, 1998 and
and Savings Bank, Chicago, Illinois, incorporated by reference herein.
as trustee

----------------------------------------------------------------------------------------------

4.04 Form of Notes (included in the Filed with the Company’s Form 10-Q for
Exhibit 4.02) the quarter ended March 31, 1998 and
Incorporated by reference herein.
----------------------------------------------------------------------------------------------

4.04 Form of Note Purchase Agreements Filed with the Company's Registration dated March 31, 1998 Statement No. 333-57601 on Form S-3 and
incorporated by reference herein.
-----------------------------------------------------------------------------------------------

10.01 Surety Capital Corporation 1988 Filed with the Company's Form 10-K dated
Incentive Stock Option Plan December 31, 1991 and incorporated by
reference herein.
-----------------------------------------------------------------------------------------------

10.02 Surety Capital Corporation 1995 Filed with the Company's Form
Incentive Stock Option Plan 10-K dated December 31, 1994 and
incorporated by reference herein.
-----------------------------------------------------------------------------------------------

10.03 Surety Capital Corporation Amended Filed with the Company's Form 10-K dated
and Restated Stock Option Plan for December 31, 1996 and incorporated by
Directors, and Form of Stock Option reference herein.
Agreement

10.04 Surety Capital Corporation 1997 Filed with the Company's Form 10-K dated Non-Qualified Stock Option Plan for December 31, 1997 and incorporated
Officers and Key Employees, and Form by reference herein.
of Stock Option Agreement

-----------------------------------------------------------------------------------------------
10.05 Surety Capital Corporation 1997 Filed with the Company's Form 10-K dated Non-Qualified Stock Option Plan December 31, 1997 and incorporated by for Non-Employee Directors, and reference herein Form of Stock Option Agreement

-----------------------------------------------------------------------------------------------

10.06 Surety Capital Corporation 2001
Amended and Restated 1998 Incentive
Stock Option Plan
-----------------------------------------------------------------------------------------------

10.07 Form of Redeemable Convertible Filed with the Company's Form 10-K dated Promissory Note between Surety December 31, 1999 and incorporated by r Capital Corporation and C. Jack Bean, reference herein.
Charles M. Ireland, Margaret E.
Holland, Aaron M. Siegel, Garrett
Morris, Cullen W. Turner, William B.
Byrd, Michael L. Milam and Lloyd W.
Butts, and related Warrant, dated
October 29, 1999
-----------------------------------------------------------------------------------------------

10.8 Form of Indemnification Agreement Filed with the Company's Form 10-K dated between Surety Capital Corporation December 31, 1999 and incorporated by and William B. Byrd, Lloyd W. Butts, reference herein.
Charles M. Ireland, Margaret E.
Holland, Michael L. Milam, Garrett
Morris, Cullen W. Turner and John D.
Blackmon, dated January 18, 2000
-----------------------------------------------------------------------------------------------

10.9 Form of Indemnification Agreement Filed with the Company's Form 10-K dated between Surety Bank, National December 31, 1999 and incorporated by Association and William B. Byrd, reference herein.
Lloyd W. Butts, Charles M. Ireland,
Margaret E. Holland, Michael L.
Milam, Garrett Morris, Cullen W.
Turner and John D. Blackmon, dated
January 18, 2000

31.01 Certification of Richard N. Abrams, Chairman of the Board. Pursuant to Rule 13a- 14(a) and Rule 15d – 14(a)

31.02 Certification of Tim Raso, Chief Operating Officer. Pursuant to Rule 13a- 14(a) and Rule 15d – 14(a)

10.10 2001 Non-Qualified Stock Option Plan
for Advisory Directors
-----------------------------------------------------------------------------------------------
21.01 Subsidiaries of the Registrant
-----------------------------------------------------------------------------------------------
23.01 Consent of Weaver and Tidwell, L.L.P.
-----------------------------------------------------------------------------------------------
31.01 Certification of Richard N. Abrams, Chairman of the Board, pursuant to Rule 13a-14(a) and Rule 15(d)-14(c).
-----------------------------------------------------------------------------------------------
31.02 Certification of Tim Raso, Chief Operating Officer, pursuant to Rule 13a-14(a) and Rule 15 (d)-14(c).

32.01 Certification of Richard N. Abrams, Chairman of the Board, pursuant to 18 U.S.C., Section 1350, as adopted pursuant to Section 906 of the Sabranes – Oxley Act of 2002
-----------------------------------------------------------------------------------------------

32.02 Certification of Tim Raso, Chief Operating Officer, pursuant to 18 U.S.C., Section 1350, as adopted pursuant to Section 906 of the Sabranes – Oxley Act of 2002
-----------------------------------------------------------------------------------------------

EXHIBIT 10.06
2001 AMENDED AND RESTATED
1998 INCENTIVE STOCK OPTION PLAN
OF SURETY CAPITAL CORPORATION

This is the 2001 Amended and Restated 1998 incentive Stock Option Plan (the "Plan") of SURETY CAPITAL CORPORATION, a Delaware corporation (the "Company"), under which incentive stock ptions (the "Options") may be granted to employees of the Company and/or its subsidiaries to purchase shares of the Company's $0.01 par value common stock (the "Common Stock"). Options granted pursuant to the Plan are intended to be "incentive stock options" within the meaning of Section
422 of the Code (as defined below).

SECTION 1. PURPOSE. The purpose of the Plan is to permit selected employees of the company and/or its subsidiaries (now existing or hereafter acquired) to acquire a proprietary interest in the Company, thereby providing them with an additional incentive for further promoting the success of the Company's business operations and to encourage them to remain as employees of the Company and/or its subsidiaries.

SECTION 2. ADMINISTRATION OF PLAN. The Plan will be administered by the Stock Option Committee (the "Committee") of the Board of Directors of the Company (the "Board of Directors"). The Committee shall consist of two (2) or more members of the Board of Directors. Each member of the Committee must be a director of the Company who is ineligible to receive a grant of Options under the Plan. Subject to the provisions of the Plan, the Committee will have authority in its
discretion:
(a) to select the individuals to whom and the time or times at which Options will be granted under the Plan, to determine the number of shares subject to each Option granted under the Plan and the exercise price thereof, to determine the terms, conditions, restrictions and other provisions of such Options, and, subject to the restrictions imposed by SECTION 16, to cancel Options granted under the Plan;
(b) to construe and interpret the Plan and all Options granted under the Plan;
(c) to prescribe, amend and rescind rules and regulations relating to the Plan; and
(d) to make all other determinations necessary or advisable for the administration of the Plan. All determinations and interpretations made by the Committee will be binding and conclusive on all persons to whom Options are granted under the Plan and on their legal
representatives and beneficiaries. In administering the Plan, the Committee shall act by majority vote of its then members, by meeting or by writing filed without a meeting. The Committee shall maintain and keep adequate records concerning the Plan and concerning its proceedings and acts in such form and detail as the Committee may decide.

SECTION 3. SHARES SUBJECT TO PLAN. Subject to adjustment as provided in SECTION 10, the number and kind of shares which may be offered and sold under the Plan is 500,000 shares of common Stock. If any Option granted under the Plan is forfeited, expires or is cancelled for any reason without having been exercised in full, the unpurchased shares of Common Stock subject thereto will (unless the Plan has been terminated) again be available for other Options to be
granted under the Plan. Shares which are the subject of Options under the Plan may be made available from authorized and unissued stock or treasury stock of the Company.

SECTION 4. SELECTION OF OPTIONEES. Options may be granted under the Plan to present and future employees of the Company and/or its subsidiaries (whether now existing or hereafter acquired), all such persons being hereafter referred to as "Optionees." In determining the persons to whom Options will be granted and the number of shares of Common Stock to be covered by each Option, the Committee may take into account the nature of the services rendered by such persons, their
present and potential contributions to the success of the Company and such other factors as the Committee in its discretion may deem relevant. An Optionee who has been granted an Option under the Plan may be granted an additional Option or Options under the Plan if the Committee so determines.

SECTION 5. OPTION PRICE. Options granted under the Plan will be subject to such exercise price as may be determined by the Committee, except that in no event may such exercise price be less than the fair market value of the Common Stock on the date of the grant (the "Option Price"). In determining such fair market value, the Committee shall use the average of the closing bid and asked prices if such Common Stock is traded on the over-the-counter market, or the closing
price on a securities exchange (except that if there was no trading in such Common Stock on the date of the grant, the closing price on the earliest preceding day during which there was trading in such Common Stock shall be used). If the Common Stock is not publicly traded, the Board of Directors shall make a good faith effort and attempt to determine the fair market value based on such factors as recent sales prices, book value, etc. Notwithstanding what is
stated above, in the event an Option is granted to a person who, at the time the Option is granted, owns stock of the Company possessing more than ten percent (10%) of the total combined voting power of all classes of stock of the Company, then the Option Price must be at least one hundred ten percent (110%) of the fair market value of the Common Stock at the time such Option is granted.

SECTION 6. TERM OF OPTIONS. All Options which may be granted pursuant to the Plan must be granted within ten (10) years from the Effective Date. Subject to earlier termination as provided in SECTION 7, each Option granted pursuant to the Plan must be exercised within ten (10) years after the date of granting of such Option or such shorter period of time as determined by the Committee; provided however, in the event an Option is granted to a person who, at the time the Option is granted, owns stock of the Company possessing more than ten
percent (10%) of the total combined voting power of all classes of stock of the Company, such Option shall not be exercisable in full or in part after the expiration of five (5) years from the date such Option is granted.

SECTION 7. TERMS AND CONDITIONS RELATING TO EMPLOYMENT.

(a) A primary reason for the Company's granting of the Options under the Plan is to encourage each Optionee to remain an employee of the Company and/or its subsidiaries. Accordingly, if an Optionee voluntarily or involuntarily terminates his employment with the Company and/or its subsidiaries for any reason whatsoever, whether with or without cause, other than as a result of death or permanent and total disability within the meaning of Section 22 (e) (3) of the Code, such Optionee may exercise his Options, to the extent vested on the date of termination of employment, at any time within three (3) months following the date of such termination of employment (but in no event later than the termination date of the Options), after which period the Options shall expire. Under no circumstances may any Options of an Optionee be in any way affected by any change of the Optionee's activities, title or position within the group consisting of the Company and/or its subsidiaries.

(b) If an Optionee dies while in the employ of the Company and/or its subsidiaries, or within three (3) months following the date of termination of his employment with the Company and/or its subsidiaries, any Options of the Optionee, to the extent vested on the date of death of the Optionee, may be exercised by an heir or devisee who acquired the Options directly from the Optionee through the latter's will or pursuant to the applicable laws of descent and distribution or by the personal representative of the deceased Optionee's estate at any time within one (1) year after the date of such Optionee's death (but in no event later than the termination date of the Options), after which period the Options shall expire.

(c) In the case of an Optionee who becomes permanently and totally disabled within the meaning of Section 22 (e) (3) of the Code while in the employ of the Company and/or its subsidiaries, any Options of such Optionee, to the extent vested on the date when such Optionee becomes disabled, may be exercised by the Optionee or the Optionee's personal representative at any time within one (1) year after such Optionee ceases employment (but in no event later than the termination date of the Options), after which period the Options shall expire.

SECTION 8. ACCELERATION OR VESTING AND OTHER TERMS.

(a) Anything herein to the contrary notwithstanding, each Option shall become fully vested upon the occurrence of a Change in Control of the Company. A "Change in Control of the Company" shall be deemed to have occurred if
(1) any "person" (as such term is used in SECTIONS 13(d) and 14(d) of the securities Exchange Act of 1934, as amended (the "Exchange Act")), other than a trustee or
other fiduciary holding securities under an employee benefit plan of the Company, is or becomes the "beneficial owner" (as defined in Rule 13d-3 under the Exchange Act), directly or indirectly, of securities of the Company representing twenty percent (20%) or more of the combined voting power of the Company's then outstanding securities;
(2) during any period of two (2) consecutive years, individuals who at the beginning of such period constitute the Board of Directors cease for any reason to constitute at least a majority thereof, unless the election of each director who was not a director at the beginning of such period has been approved in advance by directors representing at least two-thirds (2/3rds) of the directors then in office who were directors at the beginning of the period;
(3) the stockholders of the Company approve a merger or consolidation of the Company with any other corporation, other than a merger or consolidation which would result in the voting securities of the Company outstanding immediately prior thereto continuing to represent (either by remaining outstanding or by being converted into voting securities of the
surviving entity) at least seventy-five (75%) of the combined voting power of the voting securities of the Company or such surviving entity outstanding immediately after such merger or consolidation; or
(4) the stockholders of the Company approve a plan of complete liquidation of the Company or an agreement for the sale or disposition of all or substantially all of its assets.

(b) Subject to the provisions of this Plan and applicable securities, tax and other laws and regulations, Options may be granted at such time or times and pursuant to such terms and conditions as may be determined by the Committee during the period this Plan is in effect. Each Option granted under the Plan shall be evidenced by a Stock Option Agreement between the Company and the Optionee which shall set forth such terms and conditions. Stock Option Agreements shall contain such provisions, restrictions, and conditions as are not inconsistent with this Plan, but need not be identical. The provisions of this Plan shall be set forth in full or incorporated by reference in each Stock Option Agreement.

(c) The Committee may, in its discretion, include in any Option granted under the Plan a condition that the Optionee shall agree to remain in the employ of, and to render services to, the Company or any of its subsidiaries for a period of time (specified in the Stock Option Agreement) following the date the Option is granted. No such agreement shall impose upon the Company or any of its subsidiaries, however, any obligation to employ the Optionee for any period of time.

SECTION 9. METHOD OF EXERCISING OPTIONS.

(a) Provided all of the provisions of the Plan have been fully complied with, each Option may be exercised by forwarding to the Company's business office in Hurst, Texas, by certified letter, a written instrument stating that the Option is being exercised and giving the number of shares of Common Stock with respect to which the Option is being exercised. Such written instrument shall be signed by the person exercising the Option and shall be accompanied by a certified check or cashier's check for the full amount of the Option Price. In lieu of paying the Option Price in cash, and subject to the ability of the Company to repurchase its Common Stock, the Optionee may tender and deliver to the Company with proper stock powers and required endorsement so many shares of Common Stock previously acquired, owned and held by the Optionee for at least seven (7) months, which have a fair market value as of the date of exercise of the Option equal to the Option Price. In the event a person or persons other than an Optionee attempts to exercise the Option, such written statement mailed to the Company shall demonstrate compliance with SECTION 11 hereof and be accompanied by such proof of right to ownership as is required by applicable law to be given to transfer agents in connection with the transfer of securities. The Company shall issue a certificate representing the shares being received upon exercise of the Option. All shares represented by any such certificate shall be fully paid and non-assessable. Subject to the limitations set forth in the Plan, each Option may be exercised at one time or in parts on several successive occasions; however, each Option may not be exercised in an amount less than one hundred shares at any one time (unless such exercise is being made as to the entire number of shares of Common Stock which may be purchased pursuant to the Option).

(b) The aggregate fair market value (determined at the time the Option is granted) of the Common Stock with respect to which such Options are exercisable for the first time during any calendar year under the Plan, or under any other plan of the Company or a corporation which is a parent or subsidiary of the Company, as those terms are defined in Sections 424 (e) and (f), respectively, of the Code, shall not exceed $100,000, with respect to any Optionee. The Committee may grant in any one calendar year Options to any Optionee respecting Common Stock having a fair market value in excess of $100,000; provided, however, that the Options granted therein shall be subject to successive annual rights of exercise such that Common Stock having a fair market value not in excess of $100,000 is first subject to exercise under the Stock Option Agreement during any one calendar year and to the extent such limitation is exceeded, such Option shall be treated as an option which is not an incentive stock option.

(c) If an Optionee sells or otherwise disposes of Common Stock received upon exercise of an incentive stock option on or before the later of (A) the date two (2) years after the date of grant, and (B) the date one year after the exercise of the incentive stock option (in either case a "Disqualifying Disposition"), the Optionee must immediately notify the Company in writing of such disposition. The Optionee may be subject to income tax withholding by the Company in the income recognized by the Optionee from the Disqualifying Disposition.

SECTION 10. CHANGES IN CAPITAL STRUCTURE.

(a) In the event any change occurs in the number of shares of Common Stock outstanding as a result of any stock split, stock dividend, recapitalization, merger, consolidation, reorganization, combination or exchange of shares, split-up, split-off, spin-off, liquidation or other similar change in capitalization, or any distribution to holders of Common Stock other than cash dividends, the number or kind of shares of Common Stock that may be issued under the Plan pursuant to SECTION 3, including shares of Common Stock covered by existing Options, shall be automatically adjusted to preserve the proportionate interests of the Optionees in the Company as represented by their outstanding Options, and the proportionality of the share pool under the Plan in relation to the total number of shares of Common Stock outstanding.

(b) If the outstanding shares of the Common Stock shall be changed into or become exchangeable for a different number or kind of shares of stock or other securities of the Company or another corporation, whether through reorganization, reclassification, recapitalization, stock split-up, combination of shares, merger or consolidation, then there shall be substituted for each share of Common Stock that may be issued under the Plan pursuant to SECTION 3, including shares of Common Stock covered by existing Options, the number and
kind of shares of stock or other securities into which each outstanding share of Common Stock shall be so changed or for which each such share of Common Stock shall become exchangeable.

(c) In case of any adjustment or substitution as provided for in SECTIONS 10(a) or 10(b), the aggregate Option Price for all shares of Common Stock subject to each then outstanding Option prior to such adjustment or substitution shall be the aggregate Option Price for all shares of stock or other securities (including any fraction) into which such shares of Common Stock shall have been converted or which shall have been substituted for such shares of Common Stock. Any new per share Option Price shall be carried to at least three decimal places with the last decimal place rounded upwards to the nearest whole number.

(d) If the outstanding shares of Common Stock shall be changed in value by reason of any spin-off, split-off or split-up, or dividend in partial liquidation, dividend in property other than cash or extraordinary distribution to holders of Common Stock, the Committee shall make any adjustments to any then outstanding Options which it determines are equitably required to prevent dilution or enlargement of the rights of the Optionees which would otherwise result from any such transaction.

(e) No adjustment or substitution provided for in this SECTION 10 shall require the Company to issue or sell a fraction of a share or other security. Accordingly, all fractional shares or other securities which result from any such adjustment or substitution shall be eliminated and not carried forward to any subsequent adjustment or substitution.

(f) Except as provided in this SECTION 10, an Optionee shall have no rights by reason of issuance by the Company of stock of any class or securities convertible into stock of any class, any subdivision or consolidation of shares of stock of any class, the payment of any stock dividend or any other increase or decrease in the number of shares of stock of any class.

SECTION 11. NONTRANSFERABILITY. No Option may be sold, pledged, assigned, hypothecated, transferred or disposed of in any manner other than by will or by the laws of descent and distribution. Each Option is exercisable, during the lifetime of an Optionee, only by the Optionee. Any attempted assignment, transfer, pledge, hypothecation or other encumbrance of any Option contrary to the provisions hereof, and any execution, attachment or similar process upon any Option, will be null, void and of no effect.

SECTION 12. RIGHTS AS STOCKHOLDER No Optionee may have any rights as a stockholder with respect to any shares of Common Stock covered by these Options until the date of issuance of a stock certificate to such Optionee for such shares after exercise. Except as is otherwise provided in SECTION 10, no adjustment will be made for dividends (ordinary or extraordinary and whether in
cash, securities or other property) or distributions or other rights for which the record date is prior to the date such stock certificate is issued.

SECTION 13. COMPANY'S OBLIGATIONS. The Company agrees to maintain at all times sufficient authorized Common Stock to meet the requirements of the Plan. The proceeds received by the Company from the sale of the Common Stock pursuant to these Options shall be used for general corporate purposes. The Company further agrees to pay all fees and expenses necessarily incurred by the Company in connection with these Options. Although the Company shall in no event be obligated to register any securities covered hereby pursuant to the Securities Act of 1933, as amended (the "Act"), it will use its best efforts to comply with all laws and regulations which, in the opinion of the Company's counsel, are applicable thereto. The inability of the Company to obtain from any regulatory body having jurisdiction the authority deemed necessary by counsel for the Company for the lawful issuance and sale of Common Stock hereunder shall relieve the Company of any liability in respect of the failure to issue or sell Common Stock as to which the requisite authority has not been obtained.

SECTION 14. REQUIREMENTS OF LAW.

(a) The Company shall not be required to sell or issue any shares of Common Stock subject to the Options if the issuance of such shares shall constitute a violation of any provision of any law or regulation of any governmental authority. Specifically, in connection with the Act, upon exercise of an Option, unless a registration statement under the Act is in effect with respect to the shares of Common Stock covered by the Option, the Company shall not be required
to issue such shares of Common Stock unless the Company has received an opinion of counsel that registration of such shares is not required. Any reasonable determination in this connection by the Company shall be final, binding and conclusive. If required by the Act or applicable state law in the opinion of counsel for the Company, an appropriate legend shall be placed on certificates representing shares of Common Stock issued pursuant to the exercise of an
Option.

(b) As a condition to the exercise of any portion of an Option, the Company may require the Optionee exercising such Option to represent and warrant at the time of such exercise that any shares of Common Stock acquired at exercise are being acquired only for investment and without any present intention to sell or distribute such shares, if, in the opinion of counsel for the Company, such a representation is required under the Act or any other applicable law, regulation or rule of any governmental agency.

SECTION 15. RELIANCE ON REPORTS. Each member of the Committee and each member of the Board of Directors shall be fully justified in relying or acting in good faith upon any report made by the independent public accountants of the Company and its subsidiaries and upon any other information furnished in connection with the Plan by any person or persons other than himself. In no event shall any person who is or shall have been a member of the Committee or of the Board of Directors be liable for any determination made or other action taken or any omission to act in reliance upon any such report or information or for any action, including the furnishing of information, taken or failure to act, if in good faith.

SECTION 16. AMENDMENT OR TERMINATION OF PLAN. The Board of Directors may at any time amend, alter or terminate the Plan, except that no amendment, alteration or termination may be made which would impair the rights of any Optionee under any option previously granted without such Optionee's consent, and except that no amendment, alteration or termination may be made which, without the further approval of the stockholders, would:

(a) increase the aggregate number of shares of Common Stock as to which Options may be granted under the Plan, except as provided in SECTION 10;

(b) change the class of employees eligible to receive options;

(c) change the manner of determining the minimum Option Price; or

(d) extend the term of the Plan or the period during which Options may be granted or
exercised under the Plan.

SECTION 17. MODIFICATION, EXTENSION AND RENEWAL OF OPTIONS. Subject to the terms and conditions and within the limitations of the Plan, the Committee may modify, extend or renew outstanding Options granted under the Plan, or accept the surrender of outstanding Options (to the extent not theretofore exercised) and authorize the granting of new Options in substitution therefor (to the extent not theretofore exercised), including canceling outstanding Options and reissuing new Options at a lower Option Price in the event that the fair market value per share of Common Stock at any time prior to the date of exercise falls below the Option Price of Options granted pursuant to the Plan. Notwithstanding the foregoing, however, no modification of an Option shall, without the consent of the Optionee, alter or impair any rights or obligations under any Option theretofore granted under the Plan.

EXHIBIT 23.01

INDEPENDENT AUDITOR'S CONSENT

We hereby consent to the incorporation by reference in the following registration statements and related prospectuses of our report dated April 7, 2003 on the consolidated balance sheet of Surety Capital Corporation as December 31, 2002, and the related consolidated statements of operations, comprehensive loss, changes in shareholders' equity, and cash flows for the year then ended, which report is included in this Annual Report on Form 10-KSB.
Form S-8 - File No. 33-63695
Form S-8 - File No. 333-20615
Form S-8 - File No. 333-57253

/s/ Weaver And Tidwell, L.L.P.

WEAVER AND TIDWELL, L.L.P.

Fort Worth, Texas
April 15, 2003

CERTIFICATION Exhibit 31.01

I, Richard N. Abrams, Chairman of the Board of Surety Capital Corporation, certify that:

1. I have reviewed this annual report on Form 10-KSB of Surety Capital Corporation;
2. Based on my knowledge, this annual report does not contain any untrue statement of a material fact or omit to state a material fact necessary to make the statements made, in light of the circumstances under which such statements were made, not misleading with respect to the period covered by this annual report;
3. Based on my knowledge, the financial statements, and other financial information included in this annual report, fairly present in all material respects the financial condition, results of operations and cash flows of the registrant as of, and for, the periods presented in this annual report;
4. The small business issuer’s other certifying officers and I are responsible for establishing and maintaining disclosure controls and procedures (as defined in Exchange Act Rules 13a-14 and 15d-14) for the registrant and have:
(a)designed such disclosure controls and procedures, or caused such disclosure controls and procedures to be designed under our supervision, to ensure that material information relating to the small business issuer, including its consolidated subsidiaries, is made known to us by others within those entities, particularly during the period in which this annual report is being prepared;
(b)(intentionally omitted)
(c)evaluated the effectiveness of the small business issuer’s disclosure controls and procedures and presented in this report our conclusions about the effectiveness of the disclosure controls and procedures, as of the end of the period covered by this report based on such evaluation; and
(d)disclosed in this report any change in the small business issuer’s internal control over financial reporting that occurred during the small business issuer’s most recent fiscal quarter that has materially affected, or is reasonably likely to materially affect, the small business issuer’s internal control over financial reporting; and
5. The small business issuer’s other certifying officer(s) and I have disclosed, based on our most recent evaluation of internal control over financial reporting, to the small business issuer's auditors and the audit committee of the small business issuer's board of directors (or persons performing the equivalent function):
(a)all significant deficiencies and material weaknesses in the design or operation of internal controls over financial reporting which are reasonably likely to adversely affect the small business issuer's ability to record, process, summarize and report financial information; and
(b)any fraud, whether or not material, that involves management or other employees who have a significant role in the small business issuer's internal controls over financial reporting

Date: April 15, 2004

/s/ Richard N. Abrams
Richard N. Abrams
Chairman of the Board

CERTIFICATION Exhibit 31.02

I, Tim Raso, Chief Operating Officer of Surety Capital Corporation, certify that:

1. I have reviewed this annual report on Form 10-KSB of Surety Capital Corporation;
2. Based on my knowledge, this annual report does not contain any untrue statement of a material fact or omit to state a material fact necessary to make the statements made, in light of the circumstances under which such statements were made, not misleading with respect to the period covered by this annual report;
3. Based on my knowledge, the financial statements, and other financial information included in this annual report, fairly present in all material respects the financial condition, results of operations and cash flows of the registrant as of, and for, the periods presented in this annual report;
4. The small business issuer’s other certifying officers and I are responsible for establishing and maintaining disclosure controls and procedures (as defined in Exchange Act Rules 13a-14 and 15d-14) for the registrant and have:
(a)designed such disclosure controls and procedures, or caused such disclosure controls and procedures to be designed under our supervision, to ensure that material information relating to the small business issuer, including its consolidated subsidiaries, is made known to us by others within those entities, particularly during the period in which this annual report is being prepared;
(b)(intentionally omitted)
(c)evaluated the effectiveness of the small business issuer’s disclosure controls and procedures and presented in this report our conclusions about the effectiveness of the disclosure controls and procedures, as of the end of the period covered by this report based on such evaluation; and
(d)disclosed in this report any change in the small business issuer’s internal control over financial reporting that occurred during the small business issuer’s most recent fiscal quarter that has materially affected, or is reasonably likely to materially affect, the small business issuer’s internal control over financial reporting; and
5. The small business issuer’s other certifying officer(s) and I have disclosed, based on our most recent evaluation of internal control over financial reporting, to the small business issuer's auditors and the audit committee of the small business issuer's board of directors (or persons performing the equivalent function):
(a)all significant deficiencies and material weaknesses in the design or operation of internal controls over financial reporting which are reasonably likely to adversely affect the small business issuer's ability to record, process, summarize and report financial information; and
(b)any fraud, whether or not material, that involves management or other employees who have a significant role in the small business issuer's internal controls over financial reporting

Date: April 15, 2004

/s/ Tim Raso
Tim Raso
Chief Operating Officer

EXHIBIT 32.01
CERTIFICATION PURSUANT TO
18 U.S.C. SECTION 1350,
AS ADOPTED PURSANT TO
SECTION 906 OF THE SABRANES - OXLEY ACT OF 2002

In connection with the Annual Report of Surety Capital Corporation (the "Company") on Form 10-KSB for the period ending December 31, 2003 as filed with the Securities and Exchange Commission on the date hereof (the "Report"), I, Richard N. Abrams, Chairman of the Board of Directors of the Company, certify, pursuant to U.S.C. Section 1350, as adopted pursuant to 906 of the Sabranes - Oxley of 2002, that:

(1) The Report fully complies with the requirements of section 13(a) or 15(d) of the Securities and Exchange Act of 1934; and

(2) The information contained in the Report fairly presents, in all material respects, the financial condition and result of operations of the Company.

/s/ Richard N. Abrams
----------------------
Richard N. Abrams
Chairman of the Board of Directors

A signed original of this written statement required by Section 906 has been provided to Surety Capital Corporation and will retained by Surety Capital Corporation and furnished to the Securities and Exchange Commission or its staff upon request.

EXHIBIT 32.02
CERTIFICATION PURSUANT TO
18 U.S.C. SECTION 1350,
AS ADOPTED PURSUANT TO
SECTION 906 OF THE SABRANES - OXLEY ACT OF 2002

In connection with the Annual Report of Surety Capital Corporation (the "Company") on Form 10-KSB for the period ending December 31, 2003 as filed with the Securities and Exchange Commission on the date hereof (the "Report"), I, Tim Raso, Chief Operating Officer, pursuant to U.S.C. Section 1350, as adopted pursuant to 906 of the Sabranes - Oxley of 2002, that:

(3) The Report fully complies with the requirements of section 13(a) or 15(d) of the Securities and Exchange Act of 1934; and

(4) The information contained in the Report fairly presents, in all material respects, the financial condition and result of operations of the Company.

/s/ Tim Raso
----------------
Tim Raso
Chief Operating Officer

A signed original of this written statement required by Section 906 has been provided to Surety Capital Corporation and will retained by Surety Capital Corporation and furnished to the Securities and Exchange Commission or its staff upon request.

End of Filing
F-6

SURETY CAPITAL CORPORATION
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS

F-50