PART I - FINANCIAL INFORMATION

Item 1. Financial Statements.

Texas Regional Bancshares, Inc. and Subsidiaries

Condensed Consolidated Balance Sheets

(Dollars in Thousands, Except Share Data)	September 30, 2004			December 31, 2003
	(Unaudited)
Assets
Cash and Due From Banks	$	138,860		$	100,167
Interest-Bearing Deposits at Other Banks	237			556
Total Cash and Cash Equivalents	139,097			100,723
Time Deposits	11			199
Securities Available for Sale, at Fair Value	1,513,326			1,385,814
Securities Held to Maturity, at Amortized Cost (Fair Value of $218 in 2004 and $431 in 2003)	210			410
Loans Held for Sale	20,223			24,078
Loans Held for Investment, Net of Unearned Discount of $518 in 2004 and $261 in 2003	3,538,428			2,519,694
Less: Allowance for Loan Losses	(43,153		)	(31,234		)
Net Loans Held for Investment	3,495,275			2,488,460
Premises and Equipment, Net	131,443			107,875
Accrued Interest Receivable	33,833			27,740
Other Real Estate	10,133			8,785
Goodwill, Net	163,928			29,856
Identifiable Intangibles, Net	30,803			15,263
Other Assets	81,000			28,733
Total Assets	$	5,619,282		$	4,217,936
Liabilities
Deposits
Demand	$	850,432		$	536,211
Savings	210,558			147,236
Money Market Checking and Savings	1,358,368			964,436
Time Deposits	2,152,755			1,868,552
Total Deposits	4,572,113			3,516,435
Other Borrowed Money	437,970			259,565
Accounts Payable and Accrued Liabilities	37,808			20,205
Total Liabilities	5,047,891			3,796,205
Commitments and Contingencies
Shareholders’ Equity
Preferred Stock; $1.00 Par Value, 10,000,000 Shares Authorized;				—
None Issued and Outstanding	—
Common Stock – Class A; $1.00 Par Value, 50,000,000 Shares Authorized; Issued and Outstanding 48,960,450 Shares in 2004 and 29,470,659 Shares in 2003	48,960			29,471
Paid-In Capital	387,788			278,131
Retained Earnings	130,130			103,773
Accumulated Other Comprehensive Income, Net of Tax	4,513			10,356
Total Shareholders’ Equity	571,391			421,731
Total Liabilities and Shareholders’ Equity	$	5,619,282		$	4,217,936

The accompanying notes are an integral part of the condensed consolidated financial statements.

Texas Regional Bancshares, Inc. and Subsidiaries

Condensed Consolidated Statements of Income and

Comprehensive Income

	Three Months Ended September 30,						Nine Months Ended September 30,
(Dollars in Thousands, Except Per Share Data)	2004			2003			2004			2003
	(Unaudited)
Interest Income
Loans Held for Sale	$	245		$	703		$	856		$	1,996
Loans Held for Investment, Including Fees	57,904			40,354			157,088			120,502
Securities
Taxable	12,252			9,268			34,887			29,898
Tax-Exempt	1,147			869			3,215			2,539
Interest-Bearing and Time Deposits	2			18			45			156
Federal Funds Sold	7			24			35			149
Total Interest Income	71,557			51,236			196,126			155,240
Interest Expense
Deposits	15,638			12,393			42,261			41,408
Federal Funds Purchased and Securities Sold Under Repurchase Agreements	549			798			1,597			2,719
Federal Home Loan Bank Advances	626			583			1,308			1,601
Other Borrowed Money	923			319			2,301			1,068
Total Interest Expense	17,736			14,093			47,467			46,796
Net Interest Income Before Provision for Loan Losses	53,821			37,143			148,659			108,444
Provision for Loan Losses	6,197			3,851			14,814			9,971
Net Interest Income After Provision for Loan Losses	47,624			33,292			133,845			98,473
Noninterest Income
Service Charges on Deposit Accounts	10,530			6,756			28,092			17,985
Other Service Charges	3,773			1,500			9,570			4,817
Trust Service Fees	1,674			710			3,845			2,129
Net Realized Gains on Sales of Securities Available for Sale	2,963			3,041			4,845			9,653
Data Processing Service Fees	2,080			1,950			6,330			5,412
Loan Servicing Loss, Net	(677		)	(1,276		)	(1,138		)	(3,202		)
Other Noninterest Income	659			560			2,011			2,498
Total Noninterest Income	21,002			13,241			53,555			39,292
Noninterest Expense
Salaries and Employee Benefits	20,514			11,954			53,724			35,174
Net Occupancy Expense	3,157			1,967			8,623			5,221
Equipment Expense	4,020			2,790			11,148			7,842
Other Real Estate (Income) Expense, Net	(57		)	124			636			435
Amortization of Identifiable Intangibles	1,995			849			4,384			2,532
Other Noninterest Expense	9,069			5,583			25,557			16,899
Total Noninterest Expense	38,698			23,267			104,072			68,103
Income Before Income Tax Expense	29,928			23,266			83,328			69,662
Income Tax Expense	10,107			7,697			27,518			23,297
Net Income	19,821			15,569			55,810			46,365
Other Comprehensive Income (Loss), Net of Tax
Net Unrealized Gains (Losses) on Securities Available for Sale
Net Unrealized Holding Gains (Losses) Arising During Period	17,310			(12,326		)	(2,694		)	(4,497		)
Less: Reclassification Adjustment for Net Realized Gains Included in Net Income	1,926			1,977			3,149			6,274
Total Other Comprehensive Income (Loss)	15,384			(14,303		)	(5,843		)	(10,771		)
Comprehensive Income	$	35,205		$	1,266		$	49,967		$	35,594
Net Income Per Common Share
Basic	$	0.41		$	0.35		$	1.17		$	1.05
Diluted	0.40			0.35			1.16			1.04

The accompanying notes are an integral part of the condensed consolidated financial statements.

Texas Regional Bancshares, Inc. and Subsidiaries

Condensed Consolidated Statements of

Changes in Shareholders’ Equity

(Dollars in Thousands)	Common Stock - Class A		Paid-In Capital		Retained Earnings			Accumulated Other Comprehensive Income			Total Shareholders’ Equity
	(Unaudited)
Nine Months Ended September 30, 2004
Balance, Beginning of Period	$	29,471	$	278,131	$	103,773		$	10,356		$	421,731
Net Income	—		—		55,810			—			55,810
Net Change in Unrealized Gains and Losses on
Securities Available for Sale, Net of
Tax and Reclassification Adjustment	—		—		—			(5,843		)	(5,843		)
Total Comprehensive Income	—		—		55,810			(5,843		)	49,967
Exercise of Stock Options, 105,359 Shares of Class A Common Stock	105		2,146		—			—			2,251
Tax Effect of Nonqualified Stock Options Exercised and Disqualifying Dispositions On Qualified Stock Options	—		510		—			—			510
Three-For-Two Stock Split	16,311		—		(16,348		)	—			(37		)
Purchase of Southeast Texas Bancshares, Inc.	3,073		107,001		—			—			110,074
Class A Common Stock Cash Dividends	—		—		(13,105		)	—			(13,105		)
Balance, End of Period	$	48,960	$	387,788	$	130,130		$	4,513		$	571,391

Nine Months Ended September 30, 2003
Balance, Beginning of Period	$	26,488	$	186,169	$	142,670		$	22,128		$	377,455
Net Income	—		—		46,365			—			46,365
Net Change in Unrealized Gains and Losses on
Securities Available for Sale, Net of
Tax and Reclassification Adjustment	—		—		—			(10,771		)	(10,771		)
Total Comprehensive Income	—		—		46,365			(10,771		)	35,594
Exercise of Stock Options, 256,343 Shares of Class A Common Stock	256		5,052		—			—			5,308
Tax Effect of Nonqualified Stock Options Exercised and Disqualifying Dispositions On Qualified Stock Options	—		921		—			—			921
Ten Percent Stock Dividend	2,668		84,292		(87,004		)	—			(44		)
Purchase of Corpus Christi Bancshares, Inc.	37		1,115		—			—			1,152
Class A Common Stock Cash Dividends	—		—		(10,645		)	—			(10,645		)
Balance, End of Period	$	29,449	$	277,549	$	91,386		$	11,357		$	409,741

The accompanying notes are an integral part of the condensed consolidated financial statements.

Texas Regional Bancshares, Inc. and Subsidiaries

Condensed Consolidated Statements of Cash Flows

	Nine Months Ended September 30,
(Dollars in Thousands)	2004			2003
	(Unaudited)
Cash Flows from Operating Activities
Net Income	$	55,810		$	46,365
Adjustments to Reconcile Net Income to Net Cash Provided by Operating Activities
Depreciation, Amortization and Accretion, Net	22,110			18,662
Provision for Loan Losses	14,814			9,971
Provision for Estimated Losses on Other Real Estate and Other Assets	966			9
Deferred Tax Benefit	(2,379		)	(3,190		)
Net Realized Gains on Sales of Securities Available for Sale	(4,845		)	(9,653		)
(Gain) Loss on Sale of Other Assets	(80		)	99
Gain on Sale of Other Real Estate	(195		)	(60		)
Gain on Disposal of Premises and Equipment	(4		)	(10		)
Gain on Sale of Loans Held for Sale	(98		)	(1,565		)
Net Decrease in Loans Held for Sale	6,644			32,414
(Increase) Decrease in Accrued Interest Receivable and Other Assets	(295		)	2,281
Increase in Accounts Payable and Accrued Liabilities	4,716			2,332
Net Cash Provided by Operating Activities	97,164			97,655
Cash Flows from Investing Activities
Net Decrease in Time Deposits	188			99
Proceeds from Sales of Securities Available for Sale	319,178			437,275
Proceeds from Maturing Securities Available for Sale	126,160			198,303
Purchases of Securities Available for Sale	(464,447		)	(739,916		)
Proceeds from Maturing Securities Held to Maturity	200			—
Loan Originations and Advances, Net	(346,823		)	(143,892		)
Recoveries of Charged-Off Loans	1,938			922
Proceeds from Sale of Premises and Equipment	321			24
Purchases of Premises and Equipment	(15,880		)	(23,001		)
Proceeds from Sale of Other Real Estate	3,943			1,127
Proceeds from Sale of Other Assets	1,122			880
Net Cash Provided by Merger	71,571			5,883
Net Cash Used in Investing Activities	(302,529		)	(262,296		)
Cash Flows from Financing Activities
Net Increase in Demand Deposits, Savings, Money Market Checking and Savings Accounts	72,190			151,879
Net Increase in Time Deposits	16,535			85,198
Net Increase in Other Borrowed Money	164,540			59,682
Cash Dividends Paid on Class A Common Stock	(11,740		)	(10,288		)
Cash Paid in Lieu of Fractional Shares	(37		)	(44		)
Proceeds from the Sale of Common Stock	2,251			5,308
Net Cash Provided by Financing Activities	243,739			291,735
Increase in Cash and Cash Equivalents	38,374			127,094
Cash and Cash Equivalents at Beginning of Period	100,723			138,539
Cash and Cash Equivalents at End of Period	$	139,097		$	265,633
Supplemental Disclosures of Cash Flow Information:
Interest Paid	$	46,170		$	48,117
Income Taxes Paid	30,403			25,558
Supplemental Schedule of Noncash Investing and Financing Activities:
Foreclosure and Repossession in Partial Satisfaction of Loans Receivable	4,684			6,588
Financing Provided for Sales of Other Real Estate	2,339			2,186
Net Increase (Decrease) in Security Purchases Not Settled	8,370			(479		)
Net Increase in Securities Sold But Not Settled	32,399			—
Net Increase in Dividends Payable	1,365			357
The Company Acquired Southeast Texas Bancshares, Inc. and its Subsidiary, Community Bank and Trust, SSB, on March 12, 2004. Assets Acquired and Liabilities Assumed are as Follows:
Fair Value of Assets Acquired, Including Goodwill, Net of Cash and Cash Equivalents Received	1,028,098			—
Net Cash and Cash Equivalents Received	71,571			—
Fair Value of Liabilities Assumed	989,595			—
Fair Value of Stock Issued	110,074			—
The Company Acquired Corpus Christi Bancshares, Inc. and its Subsidiary, First State Bank, on February 14, 2003. Assets Acquired and Liabilities Assumed are as Follows:
Fair Value of Assets Acquired Including Goodwill, Net of Cash and Cash Equivalents Received	—			25,205
Net Cash and Cash Equivalents Received	—			5,883
Fair Value of Liabilities Assumed	—			29,936
Fair Value of Stock Issued	—			1,152

The accompanying notes are an integral part of the condensed consolidated financial statements.

Texas Regional Bancshares, Inc. and Subsidiaries
Notes to CONDENSED Consolidated Financial Statements

Note 1: Significant Accounting Policies

Basis of Presentation

The accompanying unaudited condensed consolidated financial statements were prepared in accordance with instructions for Form 10-Q and, therefore, do not include all information and notes necessary for a complete presentation of financial position, results of operations, changes in shareholders’ equity, and cash flows in conformity with accounting principles generally accepted in the United States of America. However, the condensed consolidated financial statements include all adjustments that, in the opinion of management, are necessary for a fair presentation. All such adjustments were of a normal and recurring nature. The results of operations and cash flows for the nine months ended September 30, 2004 should not be considered indicative of the results to be expected for the full year. These condensed consolidated financial statements should be read in conjunction with the consolidated financial statements and notes thereto included in the Texas Regional Bancshares, Inc. and Subsidiaries (“Texas Regional” or the “Company”) Annual Report on Form 10-K for the year ended December 31, 2003.

The condensed consolidated financial statements include the accounts of Texas Regional Bancshares, Inc. (the “Parent”) and its wholly-owned subsidiaries, Texas Regional Delaware, Inc., Southeast Texas Insurance Services, L.P., operating under the name Community Insurance, Port Arthur Abstract and Title Company, Southeast Texas Title Company and Texas State Bank (the “Bank”). The Company eliminates all significant intercompany transactions and balances in consolidation. The Company accounts for its investments in subsidiaries on the equity method in the Parent’s financial statements.

Use of Estimates

The preparation of financial statements in conformity with accounting principles generally accepted in the United States of America requires management to make estimates and assumptions that affect the reported amounts of assets and liabilities and disclosures of contingent assets and liabilities at the date of the consolidated financial statements and the reported amounts of revenues and expenses during the reporting period. Actual results could differ from those estimates. Material estimates that are particularly susceptible to significant changes in the near-term relate to the determination of the allowance for loan losses, income taxes, and valuation of goodwill and other intangibles and their respective analysis of impairment.

New Accounting Pronouncements

In January 2003, the Financial Accounting Standards Board (“FASB”) issued FASB Interpretation No. 46 (“FIN 46”), “Consolidation of Variable Interest Entities, an interpretation of Accounting Research Bulletin No. 51”. This interpretation is intended to achieve more consistent application of consolidation policies to variable interest entities (“VIE”) and, thus, to improve comparability between enterprises engaged in similar activities even if some of those activities are conducted through VIEs. Including the assets, liabilities and results of activities of VIEs in the consolidated financial statements of their primary beneficiaries will provide more complete information about the resources, obligations, risk and opportunities of the consolidated enterprise. FIN 46 applied immediately to VIEs created after January 31, 2003, and to VIEs in which an enterprise obtained an interest after that date. It applied in the first fiscal or interim period beginning after June 15, 2003, to VIEs in which an enterprise held a variable interest that was acquired before February 1, 2003. However, in December 2003, the FASB revised FIN 46, delaying the effective dates for certain entities created before February 1, 2003, and making other amendments to clarify application of the guidance. For potential variable interest entities other than any Special Purpose Entities (“SPE”), the revised FIN 46 (“FIN 46R”) was required to be applied no later than the end of the first fiscal year or interim reporting period ending after March 15, 2004. The original guidance under FIN 46 is still applicable, however; for all SPEs created prior to February 1, 2003, application is required at the end of the first interim or annual reporting period ending after December 15, 2003. FIN 46R may be applied prospectively with a cumulative-effect adjustment as of the date it is first applied, or by restating previously issued financial statements with a cumulative-effect adjustment as of the beginning of the first year restated. FIN 46R also required certain disclosures of an entity’s relationship with variable interest entities.

On January 1, 2004, the Company adopted FIN 46R, resulting in the deconsolidation of Riverway Holdings Capital Trust I and Riverway Holdings Capital Trust II, both of which were created for the sole purpose of issuing trust preferred securities. Trust preferred securities had historically been presented in other borrowed money in the condensed consolidated balance sheets. As a result of the implementation of FIN 46R, the Company’s investment in the common equity of the two trusts is now included in the condensed consolidated balance sheets in other assets. In addition, trust preferred securities have been deconsolidated and junior subordinated debentures are now reflected in other borrowed money. The Company is now recording greater interest expense and dividend income received from the trusts with no effect on net income. The dividend income and interest expense

received from and paid to the trusts, respectively, is being included in the condensed consolidated statements of income and comprehensive income as other noninterest income and interest expense. As permitted, the provisions of FIN 46R were applied on a prospective basis.

In April 2003, the Financial Accounting Standards Board issued Statement No. 149 (“Statement 149”), “Amendment of Statement 133 on Derivative Instruments and Hedging Activities”. Statement 149 amends Financial Accounting Standards Board Statement No. 133 (“Statement 133”), “Accounting for Derivative Instruments and Hedging Activities” and clarifies financial accounting and reporting for derivative instruments, including certain derivative instruments embedded in other contracts and for hedging activities. Statement 149 improves financial reporting by requiring that contracts with comparable characteristics be accounted for similarly. In particular, this Statement clarifies under what circumstances a contract with an initial net investment meets the characteristic of a derivative, clarifies when a derivative contains a financing component, amends the definition of underlying to conform to the language in FASB Interpretation No. 45, and amends certain other existing pronouncements. Statement 149 is effective for contracts entered into or modified after September 30, 2003 and for hedging relationships designated after September 30, 2003. However, the provisions of Statement 149 that relate to Statement 133 Implementation Issues that have been effective for fiscal quarters that began prior to June 15, 2003, should continue to be applied in accordance with their respective effective dates. The adoption of Statement 149 did not have a material impact on the Company’s condensed consolidated financial statements.

In May 2003, the Financial Accounting Standards Board issued Statement No. 150 (“Statement 150”), “Accounting for Certain Financial Instruments with Characteristics of Both Liabilities and Equity”. Statement 150 requires certain financial instruments that have characteristics of both liabilities and equity to be classified as a liability on the balance sheet. Prior to the issuance of Statement 150, the Company classified trust preferred securities as other borrowed money on the condensed consolidated balance sheets and its related interest cost as interest expense on the condensed consolidated statements of income and comprehensive income, which is consistent with the requirements of Statement 150. Statement 150 is effective for financial instruments entered into or modified after May 31, 2003, and otherwise is effective at the beginning of the first interim period beginning after June 15, 2003. Statement 150 will be effected by reporting the cumulative effect of a change in accounting principle for contracts created before the issuance date and still existing at the beginning of that interim period. The adoption of Statement 150 did not have an impact on the Company’s condensed consolidated financial statements.

In December 2003, the Financial Accounting Standards Board issued Statement No. 132 (Revised 2003) (“Statement 132R”), “Employers’ Disclosures about Pensions and Other Postretirement Benefits, an amendment of FASB Statements No. 87, 88, and 106”. Statement 132R amends Statement No. 87, “Employers’ Accounting for Pensions”, Statement No. 88, “Employers’ Accounting for Settlements and Curtailments of Defined Benefit Pension Plans and for Termination Benefits” and Statement No. 106, “Employers’ Accounting for Postretirement Benefits Other Than Pensions”. However, the Statement does not change the recognition and measurement requirements of those Statements. Statement 132R retains the disclosure requirements contained in Financial Accounting Standards Board Statement 132, “Employers’ Disclosures about Pensions and Other Postretirement Benefits, an amendment of FASB Statements No. 87, 88, and 106”, which it replaces and requires additional disclosures about assets, obligations, cash flow and net periodic benefit cost. The adoption of Statement 132R did not have an impact on the Company’s condensed consolidated financial statements.

In December 2003, the American Institute of Certified Public Accountants issued Statement of Position 03-3 (“SOP 03-3”), “Accounting for Certain Loans or Debt Securities Acquired in a Transfer”. SOP 03-3 provides guidance on the accounting for differences between contractual and expected cash flows from the purchaser’s initial investment in loans or debt securities acquired in a transfer, if those differences are attributable, at least in part, to credit quality. Among other things, SOP 03-3: (1) prohibits the recognition of the excess of contractual cash flows over expected cash flows as an adjustment of yield, loss accrual, or valuation allowance at the time of purchase; (2) requires that subsequent increases in expected cash flows be recognized prospectively through an adjustment of yield; and (3) requires the subsequent decreases in expected cash flows be recognized as an impairment. In addition, SOP 03-3 prohibits the creation or carrying over of a valuation allowance in the initial accounting of all loans within its scope that are acquired in a transfer. SOP 03-3 becomes effective for loans or debt securities acquired in fiscal years beginning after December 15, 2004. The Company does not expect the requirements of SOP 03-3 to have a material impact on its condensed consolidated financial statements.

In March 2004, the Securities and Exchange Commission staff issued Staff Accounting Bulletin No. 105 (“SAB 105”), “Application of Accounting Principles to Loan Commitments”. SAB 105 summarizes the view of the staff regarding the application of generally accepted accounting principles to loan commitments accounted for as derivative instruments including recognition of the loan commitment and financial statement disclosures. The requirements of SAB 105 did not have a material impact on the Company’s condensed consolidated financial statements.

Stock-Based Employee Compensation

The Company accounts for its stock-based compensation plans in accordance with the intrinsic value provisions of Accounting Principles Board Opinion No. 25, “Accounting for Stock Issued to Employees”. As such, compensation expense would be recorded on the date of grant only if the current market price of the underlying stock exceeded the exercise price. All

outstanding options have been granted at fair market value on the date of grant; therefore, the Company did not record any compensation expense in the condensed consolidated financial statements for its stock-based compensation plans.

The following table illustrates the effect on net income and net income per share had compensation expense been recognized consistent with the fair value provisions of Statement of Financial Accounting Standards No. 123 (“Statement 123”), “Accounting for Stock-Based Compensation” based upon the treasury stock method (dollars in thousands, except per share data):

	Three Months Ended September 30,						Nine Months Ended September 30,
	2004			2003			2004			2003
	(Unaudited)
Net Income, As Reported	$	19,821		$	15,569		$	55,810		$	46,365
Deduct: Total Stock-Based Employee Compensation Expense Determined Under Fair Value Based Method For All Awards, Net of Related Tax Effect	(758		)	(368		)	(1,929		)	(1,355		)
Pro Forma Net Income	$	19,063		$	15,201		$	53,881		$	45,010

Net Income Per Share:
Basic – As Reported	$	0.41		$	0.35		$	1.17		$	1.05
Basic – Pro Forma	0.39			0.34			1.13			1.02

Diluted – As Reported	0.40			0.35			1.16			1.04
Diluted – Pro Forma	0.39			0.34			1.12			1.01

Reclassifications

Certain amounts in the prior year’s presentation have been reclassified to conform to the current presentation. These reclassifications have no effect on previously reported net income.

Note 2: Impaired Loans

Loans that the Company does not expect to collect the full principal and interest based on the terms of the original loan agreement are identified as impaired loans. These include loans that are on nonaccrual status or are considered troubled debt restructurings due to the granting of a below-market rate of interest or a partial forgiveness of indebtedness on an existing loan. The balance of impaired loans was $16,610,000 at September 30, 2004 for which there was a related allowance for loan losses of $3,889,000. At September 30, 2004, the Company had $460,000 in impaired loans for which there was no related allowance for loan losses. The average recorded investment in impaired loans during the nine months ended September 30, 2004 was $13,223,000. Interest income on impaired loans of $72,000 for cash payments received on nonaccrual loans was recognized during the nine months ended September 30, 2004.

Note 3: Junior Subordinated Debentures

On January 1, 2004, the Company adopted FIN 46R, with no restatement of prior periods, resulting in the deconsolidation of Riverway Holdings Capital Trust I and Riverway Holdings Capital Trust II, both of which were created for the sole purpose of issuing trust preferred securities. The implementation of FIN 46R resulted in the Company’s $465,000 investment in the common equity of the two trusts being included in the condensed consolidated balance sheets as other assets with a corresponding increase to other borrowed money. The Company is now recording greater interest expense and dividend income received from the trusts with no effect on net income. The dividend income and interest expense received from and paid to the trusts, respectively, is being included in the condensed consolidated statements of income and comprehensive income as other noninterest income and interest expense. The increases to other noninterest income and interest expense would have been $9,000 and $30,000 for the three and nine months ended September 30, 2003, respectively, had FIN 46R been implemented on January 1, 2003. On February 24, 2004, the Company issued an additional $51,547,000 in junior subordinated debentures to Texas Regional Statutory Trust I, a newly formed Connecticut statutory trust and wholly-owned subsidiary of Texas Regional Delaware, Inc., in order to partly fund the Southeast Texas Bancshares, Inc. acquisition.

As of September 30, 2004, the Riverway Holdings Capital Trust I, Riverway Holdings Capital Trust II and Texas Regional Statutory Trust I (“the Trusts”) had the following Trust Preferred Securities outstanding and the Company had the following issues of junior subordinated debentures, all held by the Trusts, outstanding (dollars in thousands):

Description

Issuance Date

Trust
Preferred
Securities
Outstanding

Interest Rate

Junior
Subordinated
Debt Owed
To Trust

Final Maturity
Date

Riverway Holdings Capital Trust I

March 28, 2001

10,000

10.18% Fixed

10,310

June 8, 2031

Riverway Holdings Capital Trust II

July 16, 2001

5,000

6-month
LIBOR plus
3.75%

5,155

July 25, 2031

Texas Regional Statutory Trust I

February 24, 2004

50,000

3-month
LIBOR plus
2.85%

51,547

March 17, 2034

The Company owns all of the common stock of the three business trusts, which have issued trust preferred securities in conjunction with the Company issuing junior subordinated debentures to the Trusts. The terms of the junior subordinated debentures are substantially the same as the terms of the trust preferred securities. The Company’s obligations under the debentures constitute a full and unconditional guarantee by the Company of the obligations of the Trusts.

Currently, regulatory capital rules allow trust preferred securities to be included as a component of regulatory capital. This treatment has continued despite the deconsolidation of these instruments for financial reporting purposes.

Note 4: Common Stock

On March 9, 2004, the Board of Directors approved a cash dividend of $0.083 per share for shareholders of record on April 1, 2004 and payable on April 15, 2004. In addition, on June 8, 2004, the Board of Directors approved a cash dividend of $0.083 per share for shareholders of record on July 1, 2004 and payable on July 15, 2004. On August 10, 2004, the Board of Directors approved a three-for-two stock split, effected as a 50 percent stock dividend, for shareholders of record on August 23, 2004 and payable on August 30, 2004. The dividends per share amounts for first and second quarter 2004 have been restated to retroactively give effect to the three-for-two stock split effected as a 50 percent stock dividend declared and distributed during third quarter 2004. On September 14, 2004, the Board of Directors approved a cash dividend of $0.10 per share for shareholders of record on October 1, 2004 and payable on October 15, 2004.

Note 5: Net Income Per Common Share Computations

The table below presents a reconciliation of basic and diluted net income per share computations (“EPS”) (dollars in thousands, except share data). The number of shares outstanding and related net income per share amounts for 2004 and 2003 have been restated to retroactively give effect to the three-for-two stock split effected as a 50 percent stock dividend declared and distributed during August 2004.

	Three Months Ended September 30,				Nine Months Ended September 30,
	2004		2003		2004		2003
	(Unaudited)
Net Income	$	19,821	$	15,569	$	55,810	$	46,365
Weighted Average Number of Common Shares Outstanding Used in Basic EPS Calculation	48,921,063		44,148,233		47,658,905		44,011,949
Add Assumed Exercise of Dilutive Securities Outstanding Stock Options	331,426		207,570		289,643		244,119
Riverway Holdback Shares	247,500		247,500		247,500		247,500
Weighted Average Number of Common Shares Outstanding Used in Diluted EPS Calculation	49,499,989		44,603,303		48,196,048		44,503,568
Basic EPS	$	0.41	$	0.35	$	1.17	$	1.05
Diluted EPS	0.40		0.35		1.16		1.04

Note 6: Material Business Combination

On March 12, 2004, the Company acquired 100 percent of the outstanding common shares of Southeast Texas Bancshares, Inc. (“Southeast Texas”), based in Beaumont, Texas. Southeast Texas Bancshares, Inc. was the privately held bank holding company for Community Bank and Trust, SSB and other subsidiaries, including Port Arthur Abstract and Title Company, Southeast Texas Title Company and Community Insurance. Community Bank and Trust, SSB operated through 29 banking locations in a seven county area. The results of operations from the Southeast Texas acquisition have been included in the condensed consolidated financial statements since the date of acquisition.

The shareholders of Southeast Texas Bancshares, Inc. received $113,197,000 in cash and 3,073,043 shares of newly issued Texas Regional common stock in exchange for all of the outstanding shares of Southeast Texas Bancshares, Inc. The aggregate purchase price was $225,828,000. The cash portion of the purchase price was partly funded through the proceeds of the trust preferred securities issued by Texas Regional Statutory Trust I. The value of the 3,073,043 shares issued is based on the average market price of Texas Regional common stock over the two-day period before and after the terms of the acquisition were agreed to and announced.

The following table summarizes the estimated fair value of the assets acquired and liabilities assumed on the date of acquisition (dollars in thousands). The purchase price allocation has not been finalized pending valuation of certain assets.

	As of March 12, 2004
	(Unaudited)
Assets
Cash and Cash Equivalents	$				187,325
Securities	143,569
Loans Held for Sale	2,691
Loans Held for Investment	687,884
Allowance for Loan Losses	(8,795					)
Property and Equipment	18,575
Intangible Assets	19,520
Goodwill	134,072
Other Assets	30,582
Total Assets Acquired	$			1,215,423
Liabilities
Deposits	$		966,953
Other Borrowed Money	13,400
Other Liabilities	9,242
Total Liabilities Assumed	989,595
Net Assets Acquired	$	225,828

The $19,520,000 acquired intangible assets are an estimate and consist principally of core deposit intangibles. The Company is continuing to evaluate the acquired intangibles.

The following table reflects the proforma results of operations for the three and nine months ended September 30, 2004 and 2003 as though the business combination had been completed as of January 1, 2003 (dollars in thousands, except per share data):

	Three Months Ended September 30,				Nine Months Ended September 30,
	2004		2003		2004		2003
	(Unaudited)
Net interest income	$	53,821	$	45,827	$	155,743	$	133,480
Net income	19,992		17,765		55,219		51,073
Net income per share:
Basic	0.41		0.36		1.13		1.05
Diluted	0.40		0.36		1.12		1.04

On July 26, 2004, the Company entered into a definitive agreement for the acquisition of Valley Mortgage Company, Inc. (“Valley Mortgage”). The acquisition is expected to close during fourth quarter 2004. The transaction is subject to customary closing conditions, including approval of the Valley Mortgage shareholders.

On October 8, 2004, the Company entered into a definitive agreement for the acquisition of Mercantile Bank & Trust, a Federal Savings Bank (“Mercantile”). The acquisition is expected to close during first quarter 2005. The transaction is subject to customary closing conditions, including receipt of all requisite regulatory approvals and the approval of the Mercantile shareholders.

Note 7: Related Party Transactions

On April 4, 2003, the Company purchased approximately 15.9 acres of land for $2.8 million from a partnership. The Chairman of the Board of the Company owns a 10% interest in the partnership. The property was purchased for development of an operations facility for the Company.

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

Forward-Looking Statements. This Management’s Discussion and Analysis includes forward-looking statements within the meaning of Section 27A of the Securities Act of 1933, as amended, and Section 21E of the Securities Exchange Act of 1934, as

amended, and are subject to the “safe harbor” created by these sections. These forward-looking statements involve certain risks and uncertainties that could cause actual results to differ materially from those in the forward-looking statements. Such risks and uncertainties include, but are not limited to, the following factors: significant increases in competitive pressure in the banking industry; changes in the interest rate environment reducing margins; general economic conditions, either nationally or regionally, becoming less favorable than expected, resulting in, among other things, a deterioration in credit quality and an increase in the provision for possible loan losses; changes in the regulatory environment; changes in business conditions; volatility of rate sensitive deposits; operational risks including data processing system failures or fraud; asset/liability matching risks and liquidity risks; and changes in the securities markets. Because of these uncertainties, actual future results may be materially different from the results indicated by these forward-looking statements. The Company assumes no obligation and does not intend to update these forward-looking statements. In addition, the Company’s past results do not necessarily indicate its future results.

Management’s discussion and analysis of the Company’s condensed consolidated financial condition and results of operations at the dates and for the periods indicated follows. This discussion should be read in conjunction with the Company’s condensed consolidated financial statements and the accompanying notes.

GENERAL

Texas Regional Bancshares, Inc. is a Texas business corporation incorporated in 1983 and headquartered in McAllen, Texas. The Company is a bank holding company within the meaning of the Bank Holding Company Act of 1956 and as such is registered with the Board of Governors of the Federal Reserve System (“Federal Reserve Board”). Texas Regional Delaware, Inc. (“Texas Regional Delaware”), incorporated under the laws of Delaware as a wholly-owned second tier bank holding company subsidiary, owns Texas State Bank (the “Bank”), the Company’s primary operating subsidiary. As a result of the acquisition of Southeast Texas Bancshares, Inc. during March 2004, Texas Regional Delaware is now the owner, directly or indirectly, of all of the ownership interests in (i) Southeast Texas Insurance Services, L.P., which operates under the name of Community Insurance and offers general lines of insurance, and (ii) Port Arthur Abstract and Title Company and its wholly-owned subsidiary, Southeast Texas Title Company, which offer title insurance agency services. The Bank has three active wholly-owned subsidiaries: (i) TSB Securities, Inc., incorporated in 1997 to provide full service broker-dealer services, (ii) TSB Properties, Inc., incorporated in 1998 primarily to receive and liquidate foreclosed assets and (iii) Hydrox Holdings, Inc., a subsidiary formed by an acquired institution to own and operate certain real estate properties.

By authority of the Board of Directors of the Company, Texas Regional in May 2000 filed a Declaration Electing to be a Financial Holding Company with the Federal Reserve Bank of Dallas. The Declaration became effective in June 2000.

Texas State Bank operates sixty-seven banking offices. Thirty banking locations are located in the Rio Grande Valley including four banking locations in McAllen (including its main office), four banking locations in Brownsville, four banking locations in Harlingen, three banking locations in Mission, two banking locations in Weslaco, two banking locations in Edinburg, two banking locations in San Juan, and one banking location each in Hidalgo, La Feria, Mercedes, Palm Valley, Peñitas, Progreso, Raymondville, Rio Grande City, and Roma. In addition, Texas State Bank operates one banking location each in Bishop, Corpus Christi, Eagle Pass and Sugar Land and two banking locations in Houston. Thirty-one banking locations are located in the East Texas area including seven banking locations in Beaumont, five banking locations in Port Arthur, two banking locations in Orange, two banking locations in Jasper, two banking locations in Lumberton, two banking locations in Silsbee, and one banking location each in Kountze, Port Neches, Sour Lake, Vidor, Tyler, Broaddus, Buna, Colmesneil, Kirbyville, San Augustine and Woodville. At September 30, 2004, Texas Regional had consolidated total assets of $5,619,282,000, loans held for investment (net of unearned discount) of $3,538,428,000, deposits of $4,572,113,000 and shareholders’ equity of $571,391,000.

The Company provides data processing services to correspondent banks. The Company’s data processing center serves banks both in North Texas and the Rio Grande Valley, in addition to providing data processing services for all of the Bank’s banking locations.

Financial Condition

Cash and Cash Equivalents

The Company offers a broad range of commercial banking services to individuals and businesses in its service area. It also acts as a correspondent to a number of banks in its service area, providing check clearing, wire transfer, federal funds transactions, loan participations and other correspondent services. The amount of cash and cash equivalents held on any day is significantly influenced by temporary changes in cash items in process of collection. The Company had cash and cash equivalents totaling $139,097,000 at September 30, 2004. By comparison, the Company had $100,723,000 in cash and cash equivalents at

December 31, 2003, an increase of $38,374,000 or 38.1%. The increase is primarily attributable to the addition of 29 banking locations with the Southeast Texas acquisition.

Securities

Securities consist of U.S. Treasury, U.S. Government Agency, mortgage-backed and state, county and municipal securities. The Bank classifies debt and equity securities into one of three categories: held to maturity, trading or available for sale. At each reporting date, management reassesses the appropriateness of the classification. Investments in debt securities are classified as held to maturity and measured at amortized cost in the condensed consolidated balance sheets only if management has the positive intent and ability to hold those securities to maturity. Securities that are bought and held principally for the purpose of selling them in the near term are classified as trading and measured at fair value in the condensed consolidated balance sheets with unrealized holding gains and losses included in earnings. Securities not classified as either held to maturity or trading are classified as available for sale and measured at fair value in the condensed consolidated balance sheets with unrealized holding gains and losses reported in accumulated other comprehensive income, net of applicable income taxes, until realized.

At September 30, 2004 and December 31, 2003, no securities were classified as trading. The Company does not currently engage in trading activities or use derivative instruments to control interest rate risk. Even though such activities may be permitted with the approval of the Board of Directors, the Company does not intend to engage in such activities in the immediate future. The following table presents the amortized cost and estimated fair value of securities at September 30, 2004 and December 31, 2003 (dollars in thousands):

	Amortized Cost		Gross Unrealized Gains		Gross Unrealized Losses			Estimated Fair Value
Securities Available for Sale September 30, 2004 (Unaudited)
U.S. Treasury	$	6,132	$	—	$	(9	)	$	6,123
U.S. Government Agency	827,040		6,647		(2,822		)	830,865
Mortgage-Backed	491,472		2,369		(2,652		)	491,189
States and Political Subdivisions	139,633		3,651		(250		)	143,034
Other	42,055		84		(24		)	42,115
Total	$	1,506,332	$	12,751	$	(5,757	)	$	1,513,326
December 31, 2003
U.S. Treasury	$	6,199	$	21	$	—		$	6,220
U.S. Government Agency	881,322		14,523		(3,340		)	892,505
Mortgage-Backed	345,358		1,983		(1,465		)	345,876
States and Political Subdivisions	105,853		4,262		(26		)	110,089
Other	31,013		111		—			31,124
Total	$	1,369,745	$	20,900	$	(4,831	)	$	1,385,814

Securities Held to Maturity September 30, 2004 (Unaudited)
States and Political Subdivisions	$	210	$	8	$	—		$	218
Total	$	210	$	8	$	—		$	218
December 31, 2003
States and Political Subdivisions	$	410	$	21	$	—		$	431
Total	$	410	$	21	$	—		$	431

Net unrealized holding gains on securities available for sale, net of related tax effect, of $4,513,000 and $10,356,000 at September 30, 2004 and December 31, 2003, respectively, were reported in a separate component of shareholders’ equity as accumulated other comprehensive income.

A summary of securities available for sale which were in an unrealized loss position at September 30, 2004 is provided below. The unrealized loss was primarily comprised of securities in a continuous loss position for less than twelve months and consisted primarily of U.S. Government Agencies and mortgage-backed securities. Although the securities are included in the available for sale portfolio, the Company has the ability and intent to hold the securities for a period of time sufficient for a recovery of cost. The Company believes the decrease in value is attributable to changes in market interest rates and not credit quality of the issuers.

	Less than 12 Months					12 Months or More					Total
(Dollars in Thousands)	Estimated Fair Value		Unrealized Losses			Estimated Fair Value		Unrealized Losses			Estimated Fair Value		Unrealized Losses
	(Unaudited)
U.S. Treasury	$	5,423	$	(9	)	$	—	$	—		$	5,423	$	(9	)
U.S. Government Agency	274,416		(1,430		)	64,656		(1,392		)	339,072		(2,822		)
Mortgage-Backed	204,951		(1,423		)	84,343		(1,229		)	289,294		(2,652		)
States and Political Subdivisions	50,233		(226		)	2,787		(24		)	53,020		(250		)
Other	8,290		(24		)	—		—			8,290		(24		)
Total Temporarily Impaired Securities	$	543,313	$	(3,112	)	$	151,786	$	(2,645	)	$	695,099	$	(5,757	)

Securities available for sale and securities held to maturity with carrying values of $1,282,620,000 and $210,000, respectively, at September 30, 2004 and $1,303,487,000 and $410,000, respectively, at December 31, 2003 were pledged to secure public funds, trust assets on deposit and for other purposes required or permitted by law.

Loans Held For Sale

Loans held for sale of $20,223,000 at September 30, 2004 decreased $3,855,000 or 16.0% compared to December 31, 2003 balance of $24,078,000, despite $2,691,000 added with the Southeast Texas acquisition. The decrease in loans held for sale for the nine months ended September 30, 2004 resulted primarily from a decrease in loan volume due to rising interest rates.

Loans Held For Investment

The Company manages its credit risk by establishing and implementing strategies and guidelines appropriate to the characteristics of borrowers, industries, geographic locations and risk products. Diversification of risk within each of these areas is a primary objective. Policies and procedures are developed to ensure that loan commitments conform to current strategies and guidelines. Management continually refines the Company’s credit policies and procedures to address the risks in the current and prospective environment and to reflect management’s current strategic focus. The credit process is controlled with continuous credit review and analysis, and review by internal auditors, external auditors and regulatory authorities. The Company’s loans are widely diversified by borrower and industry group. The Company does not maintain any single loan relationship that it considers material to the overall portfolio.

The Company has collateral management policies in place so that collateral lending of all types is approached on a basis consistent with safe and sound standards. Valuation analysis is utilized to take into consideration the potentially adverse economic conditions under which liquidation could occur. Collateral accepted against the commercial loan portfolio includes deeds of trust, accounts receivable, inventory, marketable securities, equipment and agricultural products. Autos, deeds of trust, life insurance and marketable securities are accepted as collateral for the consumer loan portfolio.

Management of the Company believes that the Company has benefited from increased loan demand due to passage of the North American Free Trade Agreement (“NAFTA”) and the strong population growth in the Rio Grande Valley. The effects of NAFTA have also increased cross-border trade and industrial development including activity at twin manufacturing plants located on each side of the border (referred to as maquiladoras), which benefit the Rio Grande Valley economy. Management believes that NAFTA will continue to have a positive impact on the Company’s growth and earnings prospects.

International loans are loans to borrowers that are domiciled in a country other than the United States of America. The Company’s total international loans at September 30, 2004 of $47,367,000 represented 1.3% of total loans held for investment.

Total loans held for investment of $3,538,428,000 at September 30, 2004 increased $1,018,734,000 or 40.4% compared to December 31, 2003 levels of $2,519,694,000. The Southeast Texas acquisition accounted for $687,884,000 of the increase. Internal loan growth amounted to $330,850,000, an increase of 13.1% since December 31, 2003. The increase in total loans held for investment for the nine months ended September 30, 2004 reflects growth in all loan categories except Commercial Tax Exempt and represents in part the vitality of the Rio Grande Valley economy and increased activity through the Company’s Houston area branches.

The following table presents the composition of the loans held for investment portfolio (dollars in thousands):

	September 30, 2004		December 31, 2003
	(Unaudited)
Commercial	$	1,037,481	$	751,267
Commercial Tax-Exempt	46,839		56,717
Total Commercial	1,084,320		807,984
Agricultural	67,415		62,319
Real Estate
Construction	723,959		308,331
Commercial Mortgage	1,126,293		991,976
Agricultural Mortgage	66,498		54,593
1-4 Family Mortgage	289,362		177,711
Total Real Estate	2,206,112		1,532,611
Consumer	180,581		116,780
Total Loans Held for Investment	$	3,538,428	$	2,519,694

In the ordinary course of business, the Company’s subsidiary bank makes loans to its officers and directors, including entities related to those individuals. These loans are made on substantially the same terms and conditions 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. As of September 30, 2004 and December 31, 2003, loans outstanding to directors, officers and their affiliates were approximately $58,638,000 and $9,823,000, respectively. The increase resulted primarily from two loan relationships added for directors elected in April 2004 as a result of the Southeast Texas acquisition.

The Company’s policy on maturity extensions and rollovers is based on management’s assessment of individual loans. Approvals for the extension or renewal of loans without reduction of principal for more than one twelve-month period are generally avoided, unless the loans are fully secured and properly margined by cash or marketable securities, or are revolving lines subject to annual analysis and renewal.

Nonperforming Assets

The Company has several procedures in place to assist in maintaining the overall quality of its loan portfolio. The Bank has established underwriting guidelines to be followed by its officers and monitors its delinquency levels for any negative or adverse trends.

Nonperforming assets consist of nonperforming (impaired) loans and other assets, primarily real estate, acquired in partial or full satisfaction of loan obligations. The Company’s policy generally is to place a loan on nonaccrual status when payment of principal or interest is contractually past due 90 days, or earlier when concern exists as to the ultimate collection of principal and interest. At the time a loan is placed on nonaccrual status, interest previously accrued but uncollected is reversed and charged against current income unless the collateral provides more than adequate margin to ensure collection of that interest. A restructured loan is generally a loan that is accruing interest, but on which concessions in terms have been made as a result of deterioration in the borrower’s financial condition. The Company’s classification of nonperforming loans includes those loans for which management believes collection is doubtful. Management is not aware of any specific borrower relationships that are not reported as nonperforming where management has serious doubts as to the ability of such borrowers to comply with the present loan repayment terms which would cause nonperforming assets to increase materially.

Nonperforming assets of $27,996,000 at September 30, 2004 increased $7,327,000 or 35.4% compared to December 31, 2003 levels of $20,669,000. Nonaccrual loans of $16,610,000 at September 30, 2004 increased $6,488,000 or 64.1% compared to $10,122,000 at December 31, 2003. The increase was primarily the result of the addition of five loan relationships totaling $9,124,000. The increase was partially offset by one loan relationship totaling $2,730,000 that was paid off as of September 30, 2004. Foreclosed and other assets of $11,386,000 at September 30, 2004 increased $839,000 or 8.0% compared to $10,547,000 at December 31, 2003. The increase in foreclosed and other assets during 2004 was primarily attributable to $4,208,000 in other real estate acquired with the Southeast Texas acquisition. The increase was partially offset by the sale of four properties totaling $3,394,000. Management actively seeks buyers for all Other Real Estate and other foreclosed assets. See “Noninterest Expense” below.

Loans which are contractually past due 90 days or more, which are both well secured or guaranteed by financially responsible third parties and in the process of collection, generally are not placed on nonaccrual status. The amount of such loans

past due 90 days or more and still accruing at September 30, 2004 and December 31, 2003 totaled $6,785,000 and $8,886,000, respectively. The decrease in accruing loans past due 90 days or more at September 30, 2004 as compared to December 31, 2003 resulted primarily from a $2,000,000 loan that is now current and $2,658,000 from two loan relationships that was transferred to either nonaccrual status or foreclosed assets as of September 30, 2004. The decrease was partially offset by the addition of two loan relationships totaling $2,832,000. The ratio of nonperforming assets plus accruing loans 90 days or more past due as a percent of total loans held for investment and foreclosed and other assets at September 30, 2004 decreased to 0.98% from 1.17% at December 31, 2003.

An analysis of the components of nonperforming assets follows (dollars in thousands):

	September 30, 2004			December 31, 2003
	(Unaudited)
Nonaccrual Loans	$	16,610		$	10,122
Nonperforming Loans	16,610			10,122
Foreclosed and Other Assets	11,386			10,547
Total Nonperforming Assets	27,996			20,669
Accruing Loans 90 Days or More Past Due	6,785			8,886
Total Nonperforming Assets and Accruing Loans 90 Days or More Past Due	$	34,781		$	29,555
Nonperforming Loans as a% of Total Loans Held for Investment	0.47		%	0.40		%
Nonperforming Assets as a% of Total Loans Held for Investment and Foreclosed and Other Assets	0.79			0.82
Nonperforming Assets as a% of Total Assets	0.50			0.49
Nonperforming Assets Plus Accruing Loans 90 Days or More Past
Due as a% of Total Loans Held for Investment and Foreclosed and Other Assets	0.98			1.17

Management regularly reviews and monitors the loan portfolio to identify borrowers experiencing financial difficulties. Management believes that, at September 30, 2004, all such loans had been identified and included in the nonaccrual, renegotiated or 90 days or more past due loan totals reflected in the table above. Management continues to emphasize maintaining a low level of nonperforming assets and returning nonperforming assets to an earning status.

Allowance for Loan Losses - Critical Accounting Policy

Management analyzes the loan portfolio to determine the adequacy of the allowance for loan losses and the appropriate provision required to maintain an adequate allowance. Estimating the allowance is a critical accounting policy. It is subjective in nature and requires material estimates that may be subject to revision as facts and circumstances warrant. In assessing the adequacy of the allowance, management reviews the size, quality and risks of loans in the portfolio and considers factors such as specific known risks, past experience, the status and amount of nonperforming assets and economic conditions. A specific percentage is allocated to total loans not specifically reserved while additional amounts are added for individual loans considered to have specific probable loss potential. Loans identified as losses are charged-off. In addition, the loan review committee of the Bank reviews the assessments of management in determining the adequacy of the Bank’s allowance for loan losses on a quarterly basis. Based on total allocations, the provision is recorded to maintain the allowance at a level deemed appropriate by management based on probable losses in the loan portfolio. There can be no assurance that future additions or reductions to the allowance will not be necessary.

The allowance for loan losses at September 30, 2004 totaled $43,153,000, representing a net increase of $11,919,000 or 38.2% compared to $31,234,000 at December 31, 2003. The acquisition of Southeast Texas during first quarter 2004 attributed to $8,795,000 of the increase. Management believes that the allowance for loan losses at September 30, 2004 adequately reflects the probable losses in the loan portfolio. Various regulatory agencies, as an integral part of their examination process, periodically review the Bank’s allowance for loan losses. Such agencies may require the Bank to recognize additions to the allowance based on their judgments of information available to them at the time of their examination.

The following table summarizes the activity in the allowance for loan losses (dollars in thousands):

	Three Months Ended September 30,						Nine Months Ended September 30,
	2004			2003			2004			2003
	(Unaudited)
Balance at Beginning of Period	$	41,956		$	29,366		$	31,234		$	28,116
Balance from Acquisition	—			—			8,795			228
Provision for Loan Losses	6,197			3,851			14,814			9,971
Charge-Offs
Commercial	4,834			1,875			11,177			5,506
Agricultural	—			296			189			1,296
Real Estate	89			681			243			793
Consumer	669			687			2,019			1,718
Total Charge-Offs	5,592			3,539			13,628			9,313
Recoveries
Commercial	312			50			1,023			304
Agricultural	32			56			36			56
Real Estate	24			7			167			50
Consumer	224			133			712			512
Total Recoveries	592			246			1,938			922
Net Charge-Offs	5,000			3,293			11,690			8,391
Balance at End of Period	$	43,153		$	29,924		$	43,153		$	29,924
Ratio of Allowance for Loan Losses to Loans Held for Investment Outstanding, Net of Unearned Discount	1.22		%	1.24		%	1.22		%	1.24		%
Ratio of Allowance for Loan Losses to Nonperforming Loans	259.80			283.34			259.80			283.34
Ratio of Net Charge-Offs to Average Total Loans Held for Investment Outstanding, Net of Unearned Discount	0.57			0.56			0.49			0.48

Premises and Equipment, Net

Premises and equipment, net of $131,443,000 at September 30, 2004 increased by $23,568,000 or 21.8% compared to December 31, 2003 levels of $107,875,000. The increase resulted primarily from $18,575,000 of premises and equipment acquired in the Southeast Texas acquisition during first quarter 2004, as well as $1,396,000 in real estate purchased during the second quarter 2004 in The Woodlands, Texas for a future banking location.

Goodwill and Identifiable Intangibles, Net

Goodwill of $163,928,000 at September 30, 2004 increased $134,072,000 compared to $29,856,000 at December 31, 2003. The increase is attributable to the goodwill added with the Southeast Texas acquisition. Identifiable intangibles, net of $30,803,000 at September 30, 2004 increased $15,540,000 or 101.8% compared to $15,263,000 at December 31, 2003. Identifiable intangibles, net increased primarily as a result of $19,520,000 in identifiable intangibles added with the Southeast Texas acquisition. The increase was offset by net amortization of $3,980,000 for the nine months ended September 30, 2004, including amortization of $392,000 on the unfavorable lease commitment obtained with the Southeast Texas acquisition included as a reduction of net occupancy expense.

Deposits

Total deposits of $4,572,113,000 at September 30, 2004 increased $1,055,678,000 or 30.0% compared to December 31, 2003 levels of $3,516,435,000. The increase in total deposits for the nine months ended September 30, 2004 is primarily attributable to $966,953,000 added with the Southeast Texas acquisition, as well as growth in the volume of business conducted by the Company.

The following table presents the composition of total deposits (dollars in thousands):

	September 30, 2004		December 31, 2003
	(Unaudited)
Demand Deposits
Commercial and Individual	$	835,980	$	530,754
Public Funds	14,452		5,457
Total Demand Deposits	850,432		536,211
Interest-Bearing Deposits
Savings
Commercial and Individual	210,142		146,836
Public Funds	416		400
Money Market Checking and Savings
Commercial and Individual	975,056		575,689
Public Funds	383,312		388,747
Time Deposits
Commercial and Individual	1,605,585		1,280,589
Public Funds	547,170		587,963
Total Interest-Bearing Deposits	3,721,681		2,980,224
Total Deposits	$	4,572,113	$	3,516,435

Other Borrowed Money

Other borrowed money of $437,970,000 at September 30, 2004 increased $178,405,000 or 68.7% compared to December 31, 2003 levels of $259,565,000. The increase in other borrowed money is primarily attributable to a $125,949,000 increase in borrowings from the Federal Home Loan Bank. In addition, the Company issued $51,547,000 in junior subordinated debentures to Texas Regional Statutory Trust I during February 2004. The Trust, in turn, issued $50,000,000 in trust preferred securities.

As a result of the deconsolidation of the Trusts upon adoption of FIN 46R on January 1, 2004, the trust preferred securities are no longer shown as other borrowed money in the condensed consolidated balance sheets. Instead, the junior subordinated debentures issued to the Trusts are included as other borrowed money. The components of other borrowed money are as follows (dollars in thousands):

	September 30, 2004		December 31, 2003
	(Unaudited)
Federal Funds Purchased and Securities Sold Under Repurchase Agreements	$	92,009	$	91,565
Federal Home Loan Bank Advances	278,949		153,000
Trust Preferred Securities	—		15,000
Junior Subordinated Debentures	67,012		—
Total Other Borrowed Money	$	437,970	$	259,565

At September 30, 2004, the Company had available lines of credit totaling $125,000,000 with correspondent banks for short-term liquidity needs. In addition, the Company had available credit of approximately $839,203,000 with the Federal Home Loan Bank, of which $278,949,000 was advanced at September 30, 2004.

Shareholders’ Equity

Shareholders’ equity increased by $149,660,000 or 35.5% during the nine months ended September 30, 2004 primarily due to $110,074,000 added with the Southeast Texas acquisition, as well as comprehensive income of $49,967,000 less cash dividends of $13,105,000. Comprehensive income for the period included net income of $55,810,000 and net change in unrealized gains and losses on securities available for sale, net of tax, of $(5,843,000).

Bank holding companies are required to maintain capital ratios in accordance with guidelines adopted by the Federal Reserve Board (“FRB”). The guidelines are commonly known as Risk-Based Capital Guidelines. The table below reflects various measures of regulatory capital (dollars in thousands):

	Actual				For Capital Adequacy Purposes				To Be Well Capitalized Under Prompt Corrective Action Provision
	Amount		Ratio		Amount		Ratio		Amount		Ratio
Texas Regional Bancshares, Inc.
As of September 30, 2004 (Unaudited)
Total Capital (to Risk-Weighted Assets)	$	479,272	11.85	%	$	323,615	8.00	%	$	404,518	10.00	%
Tier I Capital (to Risk-Weighted Assets)	436,119		10.78		161,807		4.00		242,711		6.00
Tier I Capital (to Average Assets)	436,119		8.17		213,558		4.00		266,947		5.00

As of December 31, 2003
Total Capital (to Risk-Weighted Assets)	$	411,360	13.94	%	$	236,074	8.00	%	$	295,092	10.00	%
Tier I Capital (to Risk-Weighted Assets)	380,126		12.88		118,037		4.00		177,055		6.00
Tier I Capital (to Average Assets)	380,126		9.26		164,120		4.00		205,149		5.00

Texas State Bank
As of September 30, 2004 (Unaudited)
Total Capital (to Risk-Weighted Assets)	$	448,632	11.11	%	$	323,042	8.00	%	$	403,802	10.00	%
Tier I Capital (to Risk-Weighted Assets)	405,479		10.04		161,521		4.00		242,281		6.00
Tier I Capital (to Average Assets)	405,479		7.61		213,149		4.00		266,436		5.00

As of December 31, 2003
Total Capital (to Risk-Weighted Assets)	$	387,344	13.14	%	$	235,890	8.00	%	$	294,863	10.00	%
Tier I Capital (to Risk-Weighted Assets)	356,110		12.08		117,945		4.00		176,918		6.00
Tier I Capital (to Average Assets)	356,110		8.68		164,021		4.00		205,026		5.00

At September 30, 2004, the Company and the Bank met the criteria for classification as a “well-capitalized” institution under the prompt corrective action rules promulgated under the Federal Deposit Insurance Act. Designation as a well-capitalized institution under these regulations does not constitute a recommendation or endorsement of the Company or the Bank by Federal bank regulators.

Results of Operations

Net Income

Net income was $19,821,000 and $15,569,000 and net income per diluted common share was $0.40 and $0.35 for the three months ended September 30, 2004 and 2003, respectively. Net income increased primarily due to sustained loan growth and service charge income. The increase was partially offset by increases in salary and employee benefits resulting primarily from higher staff levels. Return on assets averaged 1.43% and 1.51% while return on shareholders’ equity averaged 14.10% and 15.09% for the three months ended September 30, 2004 and 2003, respectively.

For the nine months ended September 30, 2004, net income was $55,810,000 compared to $46,365,000 for the same period in 2003, representing an increase of $9,445,000 or 20.4%. Net income per diluted common share was $1.16 and $1.04 for the nine months ended September 30, 2004 and 2003, respectively. Return on assets averaged 1.44% and return on shareholders’ equity averaged 14.30% for the nine months ended September 30, 2004 compared to 1.55% and 15.50%, respectively, for the same period in 2003.

Interest Income

Total interest income for the three months ended September 30, 2004 was $71,557,000, representing an increase of $20,321,000 or 39.7% from the three months ended September 30, 2003. For the nine months ended September 30, 2004, interest income was $196,126,000, reflecting a $40,886,000 or 26.3% increase from the same period in 2003. This increase in interest income is due to a $1,235,741,000 or 32.6% increase in average interest-earning assets to $5,024,885,000 for the three months ended September 30, 2004 compared to the same period in 2003. Average interest-earning assets increased by $1,005,306,000 or 27.2% to $4,705,768,000 for the nine months ended September 30, 2004 compared to the same period in 2003. The increase in average interest-earning assets resulted from continued emphasis on loan growth, as well as the Southeast Texas acquisition.

Interest income on loans held for investment increased $17,550,000 or 43.5% to $57,904,000 for the three months ended September 30, 2004 compared to the same period in 2003. A $1,104,090,000 or 46.4% increase in average loans held for investment over the same period in 2003 contributed significantly to the increase. The increase in average loans held for investment was primarily due to the Southeast Texas acquisition during first quarter 2004. Interest income on securities increased to $13,399,000, reflecting a $3,262,000 or 32.2% increase from the prior comparable period. This increase was attributable to a $173,593,000 or 12.9% increase in average securities compared to the three months ended September 30, 2003. In addition, the yield on average securities of 3.7% during third quarter 2004 increased 54 basis points compared the same period in 2003.

For the nine months ended September 30, 2004, interest income on loans held for investment increased $36,586,000 or 30.4% to $157,088,000, up from $120,502,000 for the same period in 2003. Although average loans held for investment increased by $850,460,000 or 36.3% to $3,194,656,000 for the nine months ended September 30, 2004 compared to the same period in 2003, the increase in interest income was hindered by a 31 basis point decrease in the yield on loans held for investment over the comparable prior year period. The yield on loans held for investment decreased to 6.61% for the nine months ended September 30, 2004 compared to 6.92% for the same period in 2003. Interest income on securities increased to $38,102,000, an increase of $5,665,000 or 17.5% from the comparable prior period. The increase was principally related to a 15.8% increase in average securities to $1,480,947,000 for the nine months ended September 30, 2004 from the same period last year.

Interest Expense

Interest expense increased to $17,736,000 for the three months ended September 30, 2004 compared to $14,093,000 for the same period in 2003, representing an increase of $3,643,000 or 25.8%. A $947,390,000 or 30.3% increase in average interest-bearing liabilities over the same period in 2003 contributed significantly to the increase. The cost of funds of 1.73% during the three months ended September 30, 2004 was comparable to the same period in 2003, decreasing by only six basis points. Interest expense on deposits increased by $3,245,000 or 26.2% to $15,638,000 for third quarter 2004 compared to the comparable period in 2003. The increase resulted primarily from a $904,475,000 or 31.7% increase in average interest-bearing deposits to $3,758,880,000 for third quarter 2004 compared to third quarter 2003. The increase in average interest-bearing deposits was primarily attributable to the Southeast Texas acquisition during first quarter 2004. Interest expense on other borrowed money increased $398,000 or 23.4% to $2,098,000 for the three months ended September 30, 2004 compared to the same period in 2003. The increase was primarily attributable to a $42,915,000 or 15.9% increase in average other borrowed money to $312,575,000 during the three months ended September 30, 2004 compared to $269,660,000 during the three months ended September 30, 2003. The increase in average other borrowed money reflects the $51,547,000 in junior subordinated debt issued by the Company during February 2004, the proceeds which were used to partially fund the Southeast Texas acquisition. The increase was further affected by a 17 basis point increase in the cost of other borrowed money during the three months ended September 30, 2004 compared to the same period in 2003.

For the nine months ended September 30, 2004, interest expense of $47,467,000 was comparable to $46,796,000 for the same period in 2003, increasing by only 1.4%. Although average interest-bearing liabilities for the nine months ended September 30, 2004 increased by $769,912,000 or 25.1% to $3,842,728,000 compared to the same period in 2003, the 39 basis point decrease in the cost of funds offset the majority of the increase. Interest expense on deposits totaled $42,261,000 for the nine months ended September 30, 2004 reflecting an increase of $853,000 or 2.1% compared to the same prior year period. The increase resulted primarily from a $728,401,000 or 25.7% in average interest-bearing deposits during the nine months ended September 30, 2004 compared to the comparable prior year period. The increase was partially offset by a 37 basis point decrease in the rate paid on deposits to an average rate of 1.58%. Interest expense on other borrowed money decreased to $5,206,000 for the nine months ended September 30, 2004 compared to $5,388,000 for the same prior year period. The decrease was primarily attributable to a 54 basis point decrease in the cost of other borrowed money. The decrease was partially offset by a $41,511,000 or 17.3% increase in average other borrowed money to $281,007,000 during the nine months ended September 30, 2004 compared to same period in 2003, reflecting the addition of $51,547,000 in junior subordinated debt during February 2004.

Net Interest Income

Net interest income, reported on a tax-equivalent basis, was $54,813,000 for the three months ended September 30, 2004, compared with $37,997,000 for the same period in 2003, representing an increase of $16,816,000 or 44.3%. For the nine months ended September 30, 2004, net interest income, reported on a tax-equivalent basis, increased $40,861,000 or 37.0% to $151,433,000 from $110,572,000 for the same period in 2003. See “Interest Income” and “Interest Expense” for a discussion on the increase in net interest income during the three and nine months ended September 30, 2004.

The net interest margin was 4.34% for the three months ended September 30, 2004, compared with 3.98% for the same period in 2003. For the nine months ended September 30, 2004 the net interest margin was 4.30%, up from 4.00% for the same period in 2003.

	Three Months Ended
	September 30, 2004							September 30, 2003
Tax-Equivalent Basis (1)	Average Balance			Interest		Yield/ Rate (2)		Average Balance			Interest		Yield/ Rate (2)
	(Unaudited)
Assets
Interest-Earning Assets
Loans Held for Sale	$	15,301		$	245	6.37	%	$	44,556		$	703	6.26	%
Loans Held for Investment
Commercial	1,138,838			17,386		6.07		807,015			12,320		6.06
Real Estate	2,162,582			37,342		6.87		1,444,189			25,683		7.06
Consumer	181,934			3,550		7.76		128,060			2,737		8.48
Total Loans Held for Investment	3,483,354			58,278		6.66		2,379,264			40,740		6.79
Securities
Taxable	1,384,945			12,252		3.52		1,258,063			9,268		2.92
Tax-Exempt	138,599			1,765		5.07		91,888			1,337		5.77
Total Securities	1,523,544			14,017		3.66		1,349,951			10,605		3.12
Interest-Bearing and Time Deposits	445			2		1.79		5,320			18		1.34
Federal Funds Sold	2,241			7		1.24		10,053			24		0.95
Total Interest-Earning Assets	5,024,885			$	72,549	5.74	%	3,789,144			$	52,090	5.45	%
Cash and Due from Banks	126,523							125,479
Premises and Equipment, Net	129,560							103,899
Other Assets, Net	292,067							114,337
Allowance for Loan Losses	(43,108		)					(30,435		)
Total Assets	$	5,529,927						$	4,102,424
Liabilities
Interest-Bearing Liabilities Savings	$	212,401		$	235	0.44	%	$	148,218		$	120	0.32	%
Money Market Checking and Savings	1,354,253			3,084		0.91		904,197			1,848		0.81
Time Deposits	2,192,226			12,319		2.24		1,801,990			10,425		2.30
Total Savings and Time Deposits	3,758,880			15,638		1.66		2,854,405			12,393		1.72
Other Borrowed Money	312,575			2,098		2.67		269,660			1,700		2.50
Total Interest-Bearing Liabilities	4,071,455			$	17,736	1.73	%	3,124,065			$	14,093	1.79	%
Demand Deposits	864,818							540,734
Other Liabilities	34,473							28,396
Total Liabilities	4,970,746							3,693,195
Shareholders’ Equity	559,181							409,229
Total Liabilities and Shareholders’ Equity	$	5,529,927						$	4,102,424
Net Interest Income				$	54,813						$	37,997
Net Yield on Total Interest- Earning Assets						4.34	%						3.98	%

(1) For analytical purposes, income from tax-exempt assets, primarily securities issued by state and local governments or authorities, is adjusted by an increment that equates tax-exempt income to income from taxable assets (assuming a 35% effective federal income tax rate). Income on a tax-equivalent basis is not considered to be in accordance with generally accepted accounting principles. The following is a reconciliation of tax-equivalent net interest income to net interest income, as reported (dollars in thousands):

	Three Months Ended September 30,
	2004			2003
	(Unaudited)
Tax-Equivalent Net Interest Income	$	54,813		$	37,997
Tax-Equivalent Adjusment	(992		)	(854		)
Net Interest Income, as Reported	$	53,821		$	37,143

(2) Annualized

Tax-Equivalent Basis (1)	Nine Months Ended
	September 30, 2004							September 30, 2003
	Average Balance			Interest		Yield/ Rate (2)		Average Balance			Interest		Yield/ Rate (2)
	(Unaudited)
Assets
Interest-Earning Assets
Loans Held for Sale	$	19,634		$	856	5.82	%	$	44,417		$	1,996	6.01	%
Loans Held for Investment
Commercial	1,095,563			47,585		5.80		787,474			36,361		6.17
Real Estate	1,936,845			100,529		6.93		1,424,251			76,281		7.16
Consumer	162,248			10,016		8.25		132,471			8,621		8.70
Total Loans Held for Investment	3,194,656			158,130		6.61		2,344,196			121,263		6.92
Securities
Taxable	1,356,718			34,887		3.43		1,190,891			29,898		3.36
Tax-Exempt	124,229			4,947		5.32		87,910			3,906		5.94
Total Securities	1,480,947			39,834		3.59		1,278,801			33,804		3.53
Interest-Bearing and Time Deposits	6,314			45		0.95		15,286			156		1.36
Federal Funds Sold	4,217			35		1.11		17,762			149		1.12
Total Interest-Earning Assets	4,705,768			$	198,900	5.65	%	3,700,462			$	157,368	5.69	%
Cash and Due from Banks	124,028							120,340
Premises and Equipment, Net	122,554							97,720
Other Assets, Net	248,025							116,411
Allowance for Loan Losses	(40,680		)					(30,265		)
Total Assets	$	5,159,695						$	4,004,668
Liabilities
Interest-Bearing Liabilities
Savings	$	196,555		$	530	0.36	%	$	146,869		$	551	0.50	%
Money Market Checking and Savings	1,244,149			7,394		0.79		887,985			6,622		1.00
Time Deposits	2,121,017			34,337		2.16		1,798,466			34,235		2.55
Total Savings and Time Deposits	3,561,721			42,261		1.58		2,833,320			41,408		1.95
Other Borrowed Money	281,007			5,206		2.47		239,496			5,388		3.01
Total Interest-Bearing Liabilities	3,842,728			$	47,467	1.65	%	3,072,816			$	46,796	2.04	%
Demand Deposits	766,781							500,088
Other Liabilities	28,732							31,746
Total Liabilities	4,638,241							3,604,650
Shareholders’ Equity	521,454							400,018
Total Liabilities and Shareholders’ Equity	$	5,159,695						$	4,004,668
Net Interest Income				$	151,433						$	110,572
Net Yield on Total Interest- Earning Assets						4.30	%						4.00	%

	Nine Months Ended September 30,
	2004			2003
	(Unaudited)
Tax-Equivalent Net Interest Income	$	151,433		$	110,572
Tax-Equivalent Adjusment	(2,774		)	(2,128		)
Net Interest Income, as Reported	$	148,659		$	108,444

(2) Annualized.

The following table presents the effects of changes in volume, rate and rate/volume on interest income and interest expense for major categories of interest-earning assets and interest-bearing liabilities. Nonaccrual loans are included in assets, thereby reducing yields (see “Nonperforming Assets”). The allocation of the rate/volume variance has been made pro-rata on the percentage that volume and rate variances produce in each category. An analysis of changes in net interest income follows (dollars in thousands):

	Three Months Ended September 30, 2004 Compared to 2003												Nine Months Ended September 30, 2004 Compared to 2003
	Net			Due to Change in						Rate/			Net			Due to Change in						Rate/
Tax-Equivalent Basis (1)	Change			Volume			Rate			Volume			Change			Volume			Rate			Volume
	(Unaudited)
Interest Income
Loans Held for Sale	$	(458	)	$	(462	)	$	12		$	(8	)	$	(1,140	)	$	(1,489	)	$	(82	)	$	431
Loans Held for Investment	17,538			18,742			(823		)	(381		)	36,867			58,819			(7,134		)	(14,818		)
Securities
Taxable	2,984			907			1,887			190			4,989			5,566			932			(1,509		)
Tax-Exempt	428			675			(163		)	(84		)	1,041			2,158			(546		)	(571		)
Interest-Bearing and Time Deposits	(16		)	(16		)	6			(6		)	(111		)	(122		)	(63		)	74
Federal Funds Sold	(17		)	(19		)	7			(5		)	(114		)	(152		)	(2		)	40
Total Interest Income	20,459			19,827			926			(294		)	41,532			64,780			(6,895		)	(16,353		)
Interest Expense
Deposits	3,245			3,882			(484		)	(153		)	853			14,233			(10,456		)	(2,924		)
Other Borrowed Money	398			265			115			18			(182		)	1,249			(1,277		)	(154		)
Total Interest Expense	3,643			4,147			(369		)	(135		)	671			15,482			(11,733		)	(3,078		)
Net Interest Income Before Allocation of Rate/Volume	16,816			15,680			1,295			(159		)	40,861			49,298			4,838			(13,275		)
Allocation of Rate/Volume	—			(157		)	(2		)	159			—			(13,029		)	(246		)	13,275
Changes in Net Interest Income	$	16,816		$	15,523		$	1,293		$	—		$	40,861		$	36,269		$	4,592		$	—

Provision for Loan Losses

The Company recorded a provision for loan losses of $6,197,000 for the three months ended September 30, 2004 compared to $3,851,000 for the three months ended September 30, 2003. For the nine months ended September 30, 2004, the Company recorded a provision for loan losses of $14,814,000 compared to $9,971,000 for the same period in 2003. The increases in the provision for loan losses for the three and nine months ended September 30, 2004 compared to the same periods in 2003 were a result of loan growth, management’s assessment of current regional economic conditions and probable losses in the portfolio. Internal growth of loans held for investment was $99,762,000 or 2.9 percent during third quarter 2004 compared to $56,659,000 or 2.4 percent during the same period in 2003. For the nine-month period ended September 30, 2004, internal growth of loans held for investment was $330,850,000 or 13.1% compared to $132,555,000 or 5.8% for the comparable prior year period. Net charge-offs totaled $5,000,000 and $11,690,000 for the three and nine months ended September 30, 2004, respectively, compared to $3,293,000 and $8,391,000 for the same comparable periods in 2003. Net charge-offs to average loans held for investment totaled 0.49% during the nine months ended September 30, 2004 compared to 0.48% for the same period in 2003.

Management charges provisions for loan losses to earnings to bring the total allowance for loan losses to a level deemed appropriate. Management bases its decision on many factors which include historical loan loss experience, the volume and type of lending conducted by the Company, the amount of nonperforming assets, specific provisions for individual nonperforming loans, regulatory policies, generally accepted accounting principles, and general economic conditions, particularly as they relate to the Company’s lending area. For additional information on charge-offs and recoveries and the aggregate provision for loan losses, see the “Allowance for Loan Losses – Critical Accounting Policy” section of this report.

Noninterest Income

The Company’s primary sources of noninterest income are service charges on deposit accounts, other banking service related fees and data processing service fees. Noninterest income totaled $21,002,000 for the three months ended September 30, 2004 compared to $13,241,000 for the same period in 2003. Excluding net realized gains on sales of securities available for sale,

noninterest income for third quarter 2004 increased $7,839,000 or 76.9% compared to third quarter 2003. The increase was primarily attributable to an increase in total service charges. For the nine months ended September 30, 2004, noninterest income totaled $53,555,000, up from $39,292,000 for the same period in 2003. Noninterest income for the nine months ended September 30, 2004, excluding net realized gains on sales of securities available for sale, increased $19,071,000 or 64.3% over the same period in 2003. The majority of the increase is attributable to an increase in total service charges.

Total service charges of $14,303,000 for third quarter 2004 increased $6,047,000 or 73.2% compared to $8,256,000 for the same period in 2003. Total service charges were $37,662,000 for the nine months ended September 30, 2004 compared to $22,802,000 for the same period in 2003, reflecting an increase of $14,860,000 or 65.2%. The increase in service charges is reflective of the increase in average demand deposits of 59.9% and 53.3% for the three and nine months ended September 30, 2004, respectively, compared to the comparable prior year periods, attributable primarily to the Southeast Texas acquisition. In addition, non-sufficient and return item charges increased by $2,901,000 or 53.7% and $7,836,000 or 55.8% for the three and nine months ended September 30, 2004, respectively, compared with the same periods in 2003. The increase in non-sufficient and return item income resulted from deposit growth, as well as an increase in non-sufficient fund item charges implemented by the Company during July 2003 from $25 per item to $30 per item. Furthermore, the Company recognized $1,460,000 and $2,860,000 in service fees for the three and nine months ended September 30, 2004, respectively, associated with the title insurance and general lines insurance agencies acquired with the Southeast Texas acquisition.

Trust service fees of $1,674,000 for the three months ended September 30, 2004 increased $964,000 or 135.8% compared to $710,000 for comparable prior year period. Trust service fees totaled $3,845,000 for the nine months ended September 30, 2004 compared to $2,129,000 for the same period in 2003, increasing by $1,716,000 or 80.6%. The increase in trust service fees is reflective of the increase in the average fair value of trust accounts by 132.0% during the nine months ended September 30, 2004 compared to the prior comparable period. The increase in the average fair value of trust accounts is primarily due to the addition of $623,267,000 in trust assets with the Southeast Texas acquisition and additional trust business developed in the former Southeast Texas market areas. The fair market value of trust accounts at September 30, 2004 was $1,420,664,000 compared to $495,593,000 at December 31, 2003 and $479,126,000 a year ago. Assets held by the trust department of the Bank in fiduciary or agency capacities are not assets of the Company and are not included in the condensed consolidated balance sheets.

Net realized gains on sales of securities available for sale for the three months ended September 30, 2004 totaled $2,963,000 compared to $3,041,000 for the same period in 2003. For the nine months ended September 30, 2004, net realized gains on sales of securities available for sale totaled $4,845,000 compared to $9,653,000 for the comparable period in 2003. Opportunities to recognize unrealized gains in the investment portfolio decreased as net unrealized gains in the available for sale portfolio decreased from $34,501,000 at December 31, 2002 to $16,069,000 at December 31, 2003. At September 30, 2004, the available for sale portfolio had a net unrealized gain of $6,994,000. Net unrealized holding gains on securities available for sale, net of tax, totaled $4,513,000 at September 30, 2004. See “Shareholders’ Equity”.

Data processing service fees of $2,080,000 for third quarter 2004 increased $130,000 or 6.7% compared to $1,950,000 for the same period last year. During the nine months ended September 30, 2004, data processing service fees increased $918,000 or 17.0% to $6,330,000 compared to $5,412,000 during the same period in 2003. The increase in data processing fees for the three and nine months ended September 30, 2004 compared to the comparable prior year periods was due to an increase in account volume for five data processing clients. The data processing contracts stipulate an increase in monthly fees based on account volume. There were 26 data processing clients at September 30, 2004 and 25 at September 30, 2003.

Loan servicing loss, net of amortization of the mortgage servicing rights (“MSR”) asset decreased $599,000 or 46.9% to a $677,000 loss for third quarter 2004 compared to a $1,276,000 loss for third quarter 2003. The decrease resulted from a $800,000 decrease in mortgage servicing right asset amortization during third quarter 2004 to $1,050,000 compared to third quarter 2003. During the nine months ended September 30, 2004, loan servicing loss, net decreased $2,064,000 or 64.5% to a $1,138,000 loss compared to the same period in 2003. MSR amortization decreased $2,650,000 to a $2,400,000 loss for the nine months ended September 30, 2004 compared to the comparable prior year period. The decrease in MSR amortization resulted from a reduction in mortgage prepayments experienced during 2004 compared to 2003 as a result of rising interest rates.

Other noninterest income of $659,000 for the three months ended September 30, 2004 increased $99,000 or 17.7% compared to $560,000 for the comparable 2003 period. The increase resulted predominately from a $191,000 increase in miscellaneous income during third quarter 2004 to $226,000 compared to third quarter 2003. Income from the Rabbi Trust increased by $103,000 from a $100,000 loss during third quarter 2003 to $3,000 in income during third quarter 2004, primarily from net losses on sale of securities in the Rabbi Trust realized in 2003. The Rabbi Trust was set up to provide funding for the Deferred Compensation Plan for the benefit of Glen E. Roney, Chief Executive Officer of the Company. In addition, there was an $82,000 or 60% increase in income from a check printing company resulting from deposit growth. The increases were partially offset by a decrease of $297,000 in net realized gains on sale of assets for third quarter 2004 compared to the same period in 2003 attributable to an increase of $332,000 in net gains realized on sale of loans. During the nine months ended September 30,

2004, other noninterest income decreased $487,000 or 19.5% to $2,011,000 compared to $2,498,000 during the same period in 2003. The decrease resulted primarily from a decrease of $1,269,000 in net gains on sale of assets, of which $1,467,000 related to decreased net gains on sale of loans. The decrease was partially offset by a $453,000 increase in miscellaneous income during the nine months ended September 30, 2004 to $613,000 compared to the same period in 2003, as well as a $197,000 increase in income from a check printing company. Furthermore, income from the Rabbi Trust increased by $106,000 from a $98,000 loss for the nine months ended September 30, 2003 to $8,000 in income for the same period in 2004, primarily resulting from net realized losses recognized during 2003.

Noninterest Expense

Noninterest expense of $38,698,000 for third quarter 2004 increased $15,431,000 or 66.3% compared to $23,267,000 for the same period in 2003. For the nine months ended September 30, 2004, noninterest expense totaled $104,072,000 compared to $68,103,000 for the same period in 2003, representing an increase of $35,969,000 or 52.8%. The increase in noninterest expense resulted from growth in business volumes as banking locations increased by 33 to 67 during the twelve months ended September 30, 2004, including 29 acquired with the Southeast Texas acquisition. The efficiency ratio was 51.72% for third quarter 2004 compared to 46.18% for third quarter 2003. For the nine months ended September 30, 2004, the efficiency ratio was 51.47%, up from 46.10% for the same period in 2003. The efficiency ratio is defined as noninterest expense divided by the total of net interest income and noninterest income.

Salaries and employee benefits, the largest category of noninterest expense, totaled $20,514,000 for third quarter 2004, increasing by $8,560,000 or 71.6% compared to the same period last year. Salaries and employee benefits for the nine months ended September 30, 2004 totaled $53,724,000, reflecting an increase of $18,550,000 or 52.7% from the comparable prior year period. The increase is primarily attributable to the Southeast Texas acquisition and also reflects higher base salaries, increases in other compensation and higher levels of staff in other locations. In addition, the Company expanded its medical benefits for eligible part-time employees in February 2004. The number of full-time equivalent employees of 1,914 at September 30, 2004 represents an increase of 50.8% from 1,269 at September 30, 2003. Salaries and employee benefits averaged 1.48% of average assets for third quarter 2004 compared to 1.16% for third quarter 2003. For the nine months ended September 30, 2004, salaries and employee benefits averaged 1.39% of average assets compared to 1.17% for the nine months ended September 30, 2003.

Net occupancy expense totaled $3,157,000 for the three months ended September 30, 2004 compared to $1,967,000 reported for third quarter 2003, increasing by $1,190,000 or 60.5%. For the nine months ended September 30, 2004, net occupancy expense increased $3,402,000 or 65.2% to $8,623,000 compared to the same period a year ago. The increase in net occupancy expenses is reflective of the increase in the number of banking locations, including the 29 acquired the Southeast Texas acquisition.

Equipment expense of $4,020,000 for the three months ended September 30, 2004 increased $1,230,000 or 44.1% from $2,790,000 reported for the same period in 2003. For the nine months ended September 30, 2004, equipment expense totaled $11,148,000, reflecting an increase of $3,306,000 or 42.2% compared to the same period in 2003. The increase is primarily the result of equipment expenses incurred from the acquired and new banking locations. The majority of the increase in equipment expense resulted from increases in depreciation expense on equipment and equipment service contracts. Depreciation expense on equipment increased $695,000 and $1,735,000 for the three and nine months ending September 30, 2004, respectively, compared to the same periods last year. Equipment service contracts expense increased $326,000 and $835,000 for the three and nine months ending September 30, 3004, respectively, compared to the same periods in 2003.

Other real estate (income) expense, net includes income from foreclosed properties, gain or loss on sale of other real estate properties and direct expenses of foreclosed real estate including property taxes, maintenance costs and write-downs. Write-downs of other real estate are required if the fair value less estimated selling costs of an asset acquired in a loan foreclosure subsequently declines below its carrying value. Other real estate income of $57,000 for third quarter 2004 decreased $181,000 from a $124,000 net expense for third quarter 2003. The decrease resulted primarily from a $109,000 decrease in direct expense combined with a $114,000 increase in the net gains on sale of other real estate during third quarter 2004 compared to the same period in 2003. During the nine months ended September 30, 2004, other real estate expense, net totaled $636,000, increasing by $201,000 or 46.2% compared to $435,000 for the same period in 2003. The increase resulted from a $202,000 increase in write-downs of other real estate during the nine months ended September 30, 2004 compared to the same period in 2003. Management is actively seeking buyers for all other real estate.

Amortization of identifiable intangibles of $1,995,000 for the three months ended September 30, 2004 increased $1,146,000 or 135.0% compared to $849,000 for the same period in 2003. For the nine months ended September 30, 2004, amortization of identifiable intangibles increased $1,852,000 or 73.1% to $4,384,000 compared to the same prior year period. The increase was primarily attributable to the amortization on $20,898,000 of core deposit intangibles added with the Southeast Texas acquisition.

A detailed summary of Noninterest Expense follows (dollars in thousands):

	Three Months Ended September 30,						Nine Months Ended September 30,
	2004			2003			2004			2003
	(Unaudited)
Salaries and Wages	$	15,748		$	8,703		$	41,061		$	25,553
Employee Benefits	4,766			3,251			12,663			9,621
Total Salaries and Employee Benefits	20,514			11,954			53,724			35,174
Net Occupancy Expense	3,157			1,967			8,623			5,221
Equipment Expense	4,020			2,790			11,148			7,842
Other Real Estate Expense, Net
Income	(125		)	(103		)	(637		)	(373		)
Gain on Sale	(196		)	(82		)	(195		)	(60		)
Expenses	200			309			1,261			863
Write-Downs	64			—			207			5
Total Other Real Estate (Income) Expense, Net	(57		)	124			636			435
Amortization of Identifiable Intangibles	1,995			849			4,384			2,532
Other Noninterest Expense
Advertising and Public Relations	1,345			892			3,917			2,640
Data Processing and Check Clearing	1,807			848			4,729			2,611
Director Fees	197			129			530			371
Franchise Tax	79			74			242			222
Insurance	205			157			463			409
FDIC Insurance	167			133			508			389
Legal	540			570			1,419			1,167
Professional Fees	778			813			2,132			2,512
Postage, Delivery and Freight	685			408			2,063			1,257
Printing, Stationery and Supplies	861			505			2,788			1,732
Telephone	506			244			1,280			694
Other Losses	496			51			1,413			478
Miscellaneous Expense	1,403			759			4,073			2,417
Total Other Noninterest Expense	9,069			5,583			25,557			16,899
Total Noninterest Expense	$	38,698		$	23,267		$	104,072		$	68,103

Income Tax Expense

The Company recorded income tax expense of $10,107,000 for third quarter 2004 compared to $7,697,000 for third quarter 2003. For the nine months ended September 30, 2004, income tax expense totaled $27,518,000, representing an increase of $4,221,000 or 18.1% compared to the same prior year period. The increase in income tax is primarily due to an increased level of pretax income for the three and nine months ended September 30, 2004 compared to the same periods in 2003. The Company’s effective tax rate was 33.0% for the nine months ended September 30, 2004 and 33.4% for the nine months ended September 30, 2003.

Capital and Liquidity

Bank holding companies are required to maintain capital ratios in accordance with guidelines adopted by the Federal Reserve Board (“FRB”). The guidelines are commonly known as Risk-Based Capital Guidelines. On September 30, 2004, the Company exceeded all applicable capital requirements, having a total risk-based capital ratio of 11.85%, a Tier I risk-based capital ratio of 10.78%, and a leverage ratio of 8.17%.

Shareholders’ equity increased by $149,660,000 or 35.5% during the nine months ended September 30, 2004. The increase was primarily due to the addition of $110,074,000 resulting from the issuance of 3,073,043 shares to former Southeast Texas shareholders and net income of $55,810,000, offset by net unrealized holding losses, net of tax, of $5,843,000 and dividends of $13,105,000.

Liquidity management assures that adequate funds are available to meet deposit withdrawals, loan demand and maturing liabilities. Insufficient liquidity can result in higher costs of obtaining funds, while excessive liquidity can lead to a decline in earnings due to the cost of foregoing alternative investments. The ability to renew and acquire additional deposit liabilities is a

Possible Negative Impact of Litigation

The Company’s subsidiary, Texas State Bank, is a party to two cases arising out of a series of lease pool purchase and sale transactions that Riverway Bank engaged in with Commercial Money Center, Inc. and its affiliates (“CMC”), prior to the acquisition of Riverway Bank by the Company. Riverway Bank sold the lease pools to General Electric Capital Corporation (“GECC”) in 2000, and CMC filed for bankruptcy in 2002. The Company acquired Riverway Holdings, Inc. (“Riverway”) and its subsidiary, Riverway Bank, on February 22, 2002. As provided in the agreement included in the proxy statement sent to the Riverway shareholders, 100,000 shares (247,500 shares following the stock splits and stock dividends effected since date of acquisition) of Texas Regional were issued and held in escrow pursuant to a holdback escrow agreement pending the outcome of certain contingencies, including these matters. As of September 30, 2004, no shares relating to that agreement have been released. Based on information presently available, the Company has concluded that it is not probable that a liability has been incurred as of September 30, 2004 relative to these lawsuits. In addition, the Company has further concluded that the amount of any possible loss cannot be reasonably estimated either as of the date of the financial statements or as of this time. Therefore, the Company has accrued no loss for these lawsuits.

The first case involves insurers who issued policies providing protection to investors against losses from defaults within the CMC lease pools, and who failed to pay claims of the investors, including GECC. The claim against Texas State Bank is one small part of a complex consolidated case involving multiple claimants against CMC and the insurers and involving substantial aggregate damage claims. The insurers have not sought damages against Texas State Bank; however, GECC has counterclaimed against Texas State Bank as successor to Riverway Bank, for damages relative to leases sold to GECC. Texas State Bank has and will continue to vigorously contest all allegations in this litigation. Based primarily on the estimate of the outside counsel handling this matter, in the event of an unfavorable outcome, the Company estimates that the maximum liability, if any, should not exceed $5,000,000 in this matter.

The second case involves allegations by lessees that, among other things, CMC’s lease transactions were disguised security agreements and that CMC failed to comply with certain California licensing requirements. The Company believes that this lawsuit is completely without merit and therefore estimates liability in this case to be none.

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

Item 3. Quantitative and Qualitative Disclosures about Market Risk.

Market risk is the exposure to loss resulting from changes in interest rates, foreign currency exchange rates, commodity prices and equity prices. The primary market risk to which the Company is exposed is interest rate risk. Interest rate risk occurs when assets and liabilities reprice at different times as interest rates change. For example, if fixed-rate loans are funded with floating-rate deposits, the spread between loan and deposit rates will decline or turn negative if rates increase. Other types of market risk, such as foreign currency exchange rate risk and commodity price risk, do not arise in the normal course of the Company’s business activities. The Company’s interest rate risk arises from transactions entered into for purposes other than trading. The Company does not currently engage in trading activities or use derivative instruments to control interest rate risk. Even though such activities may be permitted with the approval of the Board of Directors, the Company does not intend to engage in such activities in the immediate future.

Interest rate risk is managed within the funds management policy of the Company. The principal objectives of the funds management policy are to avoid fluctuating net interest margins and to maintain consistent growth of net interest income through periods of changing interest rates. The Board of Directors oversees implementation of strategies to control interest rate risk. The Company may take steps to alter its net sensitivity position by offering deposit and/or loan structures that tend to counter the natural rate risk profile of the Company. Funding positions are kept within predetermined limits designed to ensure that risk-taking is not excessive and that liquidity is properly managed. Because of the volatility of market rates and uncertainties, there can be no assurance of the effectiveness of management programs to achieve a targeted moderation of risk.

In order to measure earnings and fair value sensitivity to changing rates, the Company utilizes three different measurement tools including static gap analysis, simulation earnings, and market value sensitivity (fair value at risk). The primary analytical tool used by the Company to quantify interest rate risk is a simulation model to project changes in net interest income that result from forecast changes in interest rates. This analysis estimates a percentage of change in net interest income from the stable rate scenario under scenarios of rising and falling market interest rates over a twelve month time horizon. The prime rate serves as a “driver” and is made to rise (or fall) evenly in 100 basis point increments over the 12-month forecast interval. These simulations

incorporate assumptions regarding balance sheet growth and mix, pricing and the repricing and maturity characteristics of the existing and projected balance sheet.

The following table summarizes the simulated change in net interest income over a twelve month period as of September 30, 2004 and December 31, 2003 (dollars in thousands):

Changes in Interest Rates (Basis Points)	Estimated Net Interest Income		Increase (Decrease) in Net Interest Income
Changes in Interest Rates (Basis Points)	Estimated Net Interest Income		Amount			Percent
September 30, 2004
(Unaudited)
+100	$	240,945	$	10,822		4.7	%
—	230,123		—			—
-100	214,668		(15,455		)	(6.7	)
December 31, 2003
+100	173,992		9,637			5.9
—	164,355		—			—
-100	158,866		(5,489		)	(3.3	)

All the measurements of risk described above are made based upon the Company’s business mix and interest rate exposures at the particular point in time. An immediate 100 basis point change in interest rates is a hypothetical rate scenario, used to calibrate risk, and does not necessarily represent management’s current view of future market developments. Because of uncertainties as to the extent of customer behavior, refinance activity, absolute and relative loan and deposit pricing levels, competitor pricing and market behavior, product volumes and mix, and other unexpected changes in economic events impacting movements and volatility in market rates, there can be no assurance that simulation results are reliable indicators of net interest income under such conditions.

Item 4. Controls and Procedures.

As of the date of the end of the period covered by this Quarterly Report on Form 10-Q, the Company carried out an evaluation, under the supervision and with the participation of the Company’s management, including the Company’s Chief Executive Officer along with the Company’s Chief Financial Officer, of the effectiveness of the design and operation of the Company’s disclosure controls and procedures pursuant to Rule 13a-15(b), as adopted by the Securities and Exchange Commission (“SEC”) under the Securities Exchange Act of 1934 (“Exchange Act”). Based upon that evaluation, the Company’s Chief Executive Officer along with the Company’s Chief Financial Officer concluded that the Company’s disclosure controls and procedures are effective to timely alert them to material information relating to the Company (including its consolidated subsidiaries) required to be included in the Company’s periodic SEC filings.

Disclosure controls and procedures are the controls and other procedures that are designed to ensure that information required to be disclosed in the reports that the Company files or submits under the Exchange Act is recorded, processed, summarized and reported within the time periods specified in the SEC’s rules and forms. Disclosure controls and procedures include, without limitation, controls and procedures designed to ensure that information required to be disclosed in the reports that the Company files under the Exchange Act is accumulated and communicated to management, including the Chief Executive Officer and Chief Financial Officer, as appropriate, to allow timely decisions regarding required disclosure.

There have been no changes in the Company's internal controls or in other factors which could significantly affect these controls over financial reporting that have materially affected, or are or are reasonably likely to materially affect, the Company's internal controls over financial reporting.

PART II - OTHER INFORMATION

Item 1. Legal Proceedings.

ý	Quarterly Report Pursuant to Section 13 or 15(d) of the Securities Exchange Act of 1934

	For the quarterly period ended September 30, 2004

or

o	Transition Report Pursuant to Section 13 or 15(d) of the Securities Exchange Act of 1934

	For the transition period from to

Texas	74-2294235
(State or other jurisdiction of incorporation or organization)	(I.R.S. Employer Identification No.)

3900 North 10^th Street, 11^th Floor McAllen, Texas 78501
(Address of principal executive offices) (Zip Code)

(956) 631-5400
(Registrant’s telephone number, including area code)

Not Applicable
(Former name, former address and former fiscal year, if changed since last report)

10.1	Amendment Number 13 to Texas Regional Bancshares, Inc. Amended and Restated Employee Stock Ownership Plan (with 401(k) provisions) (filed herewith).

31.1	Certification required by Rule 13a-14(a) as adopted pursuant to section 302 of the Sarbanes-Oxley Act of 2002 (of Chief Executive Officer).

31.2	Certification required by Rule 13a-14(a) as adopted pursuant to section 302 of the Sarbanes-Oxley Act of 2002 (of Chief Financial Officer).

32.1	Certification required by Rule 13a-14(b) and 18 U.S.C. §1350 as adopted pursuant to section 906 of the Sarbanes-Oxley Act of 2002.

	TEXAS REGIONAL BANCSHARES, INC.
	(Registrant)

November 9, 2004		/s/ G. E. Roney
	Glen E. Roney
	Chairman of the Board, President & Chief Executive Officer

November 9, 2004		/s/ R. T. Pigott, Jr.
	R. T. Pigott, Jr.
	Executive Vice President & Chief Financial Officer

PART I - FINANCIAL INFORMATION

Item 1. Financial Statements.

Texas Regional Bancshares, Inc. and Subsidiaries Notes to CONDENSED Consolidated Financial Statements

Note 1: Significant Accounting Policies

Basis of Presentation

Use of Estimates

New Accounting Pronouncements

Stock-Based Employee Compensation

Reclassifications

Note 2: Impaired Loans

Note 3: Junior Subordinated Debentures

Note 4: Common Stock

Note 5: Net Income Per Common Share Computations

Note 6: Material Business Combination

Note 7: Related Party Transactions

Financial Condition

Cash and Cash Equivalents

Securities

Loans Held For Sale

Loans Held For Investment

Nonperforming Assets

Allowance for Loan Losses - Critical Accounting Policy

Premises and Equipment, Net

Goodwill and Identifiable Intangibles, Net

Deposits

Other Borrowed Money

Shareholders’ Equity

Results of Operations

Net Income

Interest Income

Interest Expense

Net Interest Income

Provision for Loan Losses

Noninterest Income

Noninterest Expense

Income Tax Expense

Capital and Liquidity

Effects of Inflation

Critical Accounting Policies

Possible Negative Impact of Litigation

PART II - OTHER INFORMATION

SIGNATURES

Texas Regional Bancshares, Inc. and Subsidiaries
Notes to CONDENSED Consolidated Financial Statements