Edgar Filing: HALLMARK FINANCIAL SERVICES INC

UNITED STATES

SECURITIES AND EXCHANGE COMMISSION

WASHINGTON, D.C. 20549

FORM 10-Q

Quarterly report pursuant to Section 13 or 15(d) of the

Securities Exchange Act of 1934

For the quarterly period ended September 30, 2012

Commission file number 001-11252

Hallmark Financial Services, Inc.

(Exact name of registrant as specified in its charter)

Nevada		87-0447375
(State or other jurisdiction of		(I.R.S. Employer
Incorporation or organization)		Identification No.)

777 Main Street, Suite 1000, Fort Worth, Texas		76102

(Address of principal executive offices)		(Zip Code)

Registrant's telephone number, including area code: (817) 348-1600

Indicate by check mark whether the registrant (1) has filed all reports required to be filed by Section 13 or 15(d) of the Securities Exchange Act of 1934 during the preceding 12 months (or for such shorter period that the registrant was required to file such reports), and (2) has been subject to such filing requirements for the past 90 days. Yes x No ¨

Indicate by check mark whether the registrant has submitted electronically and posted on its corporate Web site, if any, every Interactive Data File required to be submitted and posted pursuant to Rule 405 of Regulation S-T (§232.405 of this chapter) during the preceding 12 months (or for such shorter period that the registrant was required to submit and post such files). Yes x No ¨

Indicate by check mark whether the registrant is a large accelerated filer, an accelerated filer, a non-accelerated filer, or a smaller reporting company. See the definitions of “large accelerated filer,” “accelerated filer” and “smaller reporting company” in Rule 12b-2 of the Exchange Act.

Large accelerated filer ¨		Accelerated filer x
Non-accelerated filer ¨		Smaller reporting company ¨

Indicate by check mark whether the registrant is a shell company (as defined in Rule 12b-2 of the Exchange Act). Yes ¨ No x

Indicate the number of shares outstanding of each of the issuer's classes of common stock, as of the latest practicable date: Common Stock, par value $.18 per share – 19,263,457 shares outstanding as of November 7, 2012.

PART I

FINANCIAL INFORMATION

Item 1. Financial Statements

INDEX TO FINANCIAL STATEMENTS

	Page Number

Consolidated Balance Sheets at September 30, 2012 (unaudited) and December 31, 2011	3

Consolidated Statements of Operations (unaudited) for the three months and nine months ended September 30, 2012 and September 30, 2011	4

Consolidated Statements of Comprehensive Income (Loss) (unaudited) for the three months and nine months ended September 30, 2012 and September 30, 2011	5

Consolidated Statements of Stockholders’ Equity (unaudited) for the three months and nine months ended September 30, 2012 and September 30, 2011	6

Consolidated Statements of Cash Flows (unaudited) for the nine months ended September 30, 2012 and September 30, 2011	7

Notes to Consolidated Financial Statements (unaudited)	8

Hallmark Financial Services, Inc. and Subsidiaries

Consolidated Balance Sheets

($ in thousands, except share amounts)

	September 30			December 31
	2012			2011
	(unaudited)			(as adjusted)
ASSETS

Investments:
Debt securities, available-for-sale, at fair value (cost: $380,495 in 2012 and $380,578 in 2011)	$	384,288		$	380,469
Equity securities, available-for-sale, at fair value (cost: $29,118 in 2012 and $30,465 in 2011)		41,694			44,159

Total investments		425,982			424,628

Cash and cash equivalents		107,682			74,471
Restricted cash		8,246			9,372
Ceded unearned premiums		21,994			19,470
Premiums receivable		69,182			53,513
Accounts receivable		3,360			3,946
Receivable for securities		1,051			2,617
Reinsurance recoverable		50,109			42,734
Deferred policy acquisition costs		26,408			22,554
Goodwill		44,695			44,695
Intangible assets, net		23,965			26,654
Deferred federal income taxes, net		532			-
Federal income tax recoverable		-			6,738
Prepaid expenses		1,620			1,458
Other assets		11,008			13,209

Total assets	$	795,834		$	746,059

LIABILITIES AND STOCKHOLDERS' EQUITY
Liabilities:
Revolving credit facility payable	$	1,473		$	4,050
Subordinated debt securities		56,702			56,702
Reserves for unpaid losses and loss adjustment expenses		315,607			296,945
Unearned premiums		168,197			146,104
Reinsurance balances payable		5,976			3,139
Pension liability		3,245			3,971
Payable for securities		6,749			203
Deferred federal income taxes, net		-			135
Federal income tax payable		177			-
Accounts payable and other accrued expenses		18,600			17,954

Total liabilities		576,726			529,203

Commitments and Contingencies (Note 17)

Redeemable non-controlling interest		-			1,284

Stockholders' equity:
Common stock, $.18 par value, authorized 33,333,333 shares in 2012 and 2011; issued 20,872,831 in 2012 and 2011		3,757			3,757
Additional paid-in capital		122,412			122,487
Retained earnings		96,181			94,440
Accumulated other comprehensive income		8,316			6,446
Treasury stock (1,609,374 shares in 2012 and 2011), at cost		(11,558	)		(11,558	)

Total stockholders' equity		219,108			215,572

	$	795,834		$	746,059

The accompanying notes are an integral part

of the consolidated financial statements

Hallmark Financial Services, Inc. and Subsidiaries

Consolidated Statements of Operations

(Unaudited)

($ in thousands, except per share amounts)

	Three Months Ended						Nine Months Ended
	September 30						September 30
	2012			2011			2012			2011
				(as adjusted)						(as adjusted)

Gross premiums written	$	99,448		$	89,751		$	297,658		$	270,834
Ceded premiums written		(14,443	)		(11,869	)		(42,554	)		(37,762	)
Net premiums written		85,005			77,882			255,104			233,072
Change in unearned premiums		(4,524	)		(2,814	)		(19,166	)		(16,313	)
Net premiums earned		80,481			75,068			235,938			216,759

Investment income, net of expenses		3,795			3,980			11,573			11,765
Net realized gains		982			394			1,854			3,177
Finance charges		1,374			1,683			4,538			5,148
Commission and fees		(1,029	)		2,445			(1,033	)		2,617
Other income		17			178			307			203

Total revenues		85,620			83,748			253,177			239,669

Losses and loss adjustment expenses		52,839			56,136			168,859			181,841
Other operating expenses		25,726			24,850			77,077			71,890
Interest expense		1,137			1,159			3,464			3,470
Amortization of intangible assets		897			897			2,690			2,690

Total expenses		80,599			83,042			252,090			259,891

Income (loss) before tax		5,021			706			1,087			(20,222	)
Income tax expense (benefit)		1,350			602			(978	)		(9,048	)
Net income (loss)		3,671			104			2,065			(11,174	)
Less: Net income attributable to non-controlling interest		258			6			324			28

Net income (loss) attributable to Hallmark Financial Services, Inc.	$	3,413		$	98		$	1,741		$	(11,202	)

Net income (loss) per share attributable to Hallmark Financial
Services, Inc. common stockholders:
Basic	$	0.18		$	0.01		$	0.09		$	(0.57	)
Diluted	$	0.18		$	0.01		$	0.09		$	(0.57	)

The accompanying notes are an integral part

of the consolidated financial statements

HALLMARK FINANCIAL SERVICES, INC. AND SUBSIDIARIES

CONSOLIDATED STATEMENTS OF COMPREHENSIVE INCOME (LOSS)

(Unaudited)

($ in thousands)

	Three Months Ended						Nine Months Ended
	September						September
	2012			2011			2012			2011
				(as adjusted)						(as adjusted)

Net income (loss)	$	3,671		$	104		$	2,065		$	(11,174	)
Other comprehensive loss:

Change in net actuarial loss		120			72			362			215

Tax effect on change in net actuarial loss		(42	)		(25	)		(127	)		(75	)

Unrealized holding gains (losses) arising during the period		4,541			(8,134	)		4,560			(8,254	)

Tax effect on unrealized holding gains (losses) arising during the period		(1,589	)		2,847			(1,596	)		2,889

Reclassification adjustment for losses included in net income (loss)		(926	)		(393	)		(2,044	)		(3,177	)
		-						-
Tax effect on reclassification adjustment for losses included in net income		324			137			715			1,112

Other comprehensive gain (loss), net of tax		2,428			(5,496	)		1,870			(7,290	)

Comprehensive gain (loss)	$	6,099		$	(5,392	)	$	3,935		$	(18,464	)

Less: comprehensive income attributable to non-controlling interest		258			6			324			28

Comprehensive gain (loss) attributable to Hallmark Financial Services, Inc.	$	5,841		$	(5,398	)	$	3,611		$	(18,492	)

The accompanying notes are an integral

part of the consolidated financial statements

Hallmark Financial Services, Inc. and Subsidiaries

Consolidated Statements of Stockholders' Equity

(Unaudited)

($ in thousands)

	Three Months Ended						Nine Months Ended
	September 30,						September 30,
	2012			2011			2012			2011
				(as adjusted)						(as adjusted)
Common Stock
Balance, beginning of period	$	3,757		$	3,757		$	3,757		$	3,757

Balance, end of period		3,757			3,757			3,757			3,757

Additional Paid-In Capital
Balance, beginning of period		122,669			122,292			122,487			121,815
Accretion of redeemable noncontrolling interest		(321	)		(31	)		(392	)		(37	)
Equity based compensation		64			94			317			583
Exercise of stock options		-			-			-			(6	)

Balance, end of period		122,412			122,355			122,412			122,355

Retained Earnings
Balance, beginning of period, as previously reported		92,768			94,567			94,995			105,816
Cumulative effect of adjustments resulting from adoption
of change in accounting principle, net of tax		-			(536	)		(555	)		(485	)
Balance, beginning of period, as adjusted		92,768			94,031			94,440			105,331
Net income (loss) attributable to Hallmark Financial Services, Inc.		3,413			98			1,741			(11,202	)

Balance, end of period		96,181			94,129			96,181			94,129

Accumulated Other Comprehensive Income
Balance, beginning of period		5,888			7,843			6,446			9,637
Additional minimum pension liability, net of tax		78			47			235			140
Net unrealized holding (losses) gains arising during period, net of tax		2,952			(5,287	)		2,964			(5,365	)
Reclassification adjustment for gains included in net income, net of tax		(602	)		(256	)		(1,329	)		(2,065	)

Balance, end of period		8,316			2,347			8,316			2,347

Treasury Stock
Balance, beginning of period		(11,558	)		(10,068	)		(11,558	)		(5,262	)
Acquistion of treasury shares		-			(1,490	)		-			(6,401	)
Issuance of treasury stock upon option exercises		-			-			-			105
Balance, end of period		(11,558	)		(11,558	)		(11,558	)		(11,558	)

Total Stockholders' Equity	$	219,108		$	211,030		$	219,108		$	211,030

The accompanying notes are an integral part

of the consolidated financial statements

Hallmark Financial Services, Inc. and Subsidiaries

Consolidated Statements of Cash Flows

(Unaudited)

($ in thousands)

	Nine Months Ended
	September 30

	2012			2011
				(as adjusted)
Cash flows from operating activities:
Net income (loss)	$	2,065		$	(11,174	)

Adjustments to reconcile net income (loss) to cash provided by operating activities:
Depreciation and amortization expense		3,603			4,103
Deferred federal income taxes		(2,241	)		(2,737	)
Net realized gains		(1,854	)		(3,177	)
Shared-based payments expense		317			584
Change in ceded unearned premiums		(2,524	)		6,819
Change in premiums receivable		(15,669	)		(10,283	)
Change in accounts receivable		586			2,515
Change in deferred policy acquisition costs		(3,854	)		(2,642	)
Change in unpaid losses and loss adjustment expenses		18,662			29,344
Change in unearned premiums		21,690			9,493
Change in reinsurance recoverable		(7,375	)		(1,117	)
Change in reinsurance payable		2,837			(940	)
Change in current federal income tax recoverable		6,915			(2,930	)
Change in all other liabilities		(1,180	)		(7,297	)
Change in all other assets		6,209			4,447

Net cash provided by operating activities		28,187			15,008

Cash flows from investing activities:
Purchases of property and equipment		(366	)		(1,799	)
Net transfers from restricted cash		1,126			1,097
Payment for acquisition of subsidiaries		-			(13,334	)
Purchases of investment securities		(103,434	)		(234,994	)
Maturities, sales and redemptions of investment securities		110,772			229,796

Net cash provided by (used in) investing activities		8,098			(19,234	)

Cash flows from financing activities:
Proceeds from exercise of employee stock options		-			99
Purchase of treasury shares		-			(6,401	)
Activity under revolving credit facility		(2,577	)		(410	)
Payment of contingent consideration		(350	)		-
Distribution to non-controlling interest		(147	)		(165	)

Net cash used in financing activities		(3,074	)		(6,877	)

Increase (decrease) in cash and cash equivalents		33,211			(11,103	)
Cash and cash equivalents at beginning of period		74,471			60,519
Cash and cash equivalents at end of period	$	107,682		$	49,416

Supplemental cash flow information:

Interest paid	$	3,464		$	3,468

Income taxes paid (recovered )	$	(5,951	)	$	(3,381	)

Supplemental schedule of non-cash investing activities:

Change in receivable for securities related to investment disposals that settled after the balance sheet date	$	(1,566	)	$	2,204

Change in payable for securities related to investment purchases that settled after the balance sheet date	$	6,546		$	3,284

The accompanying notes are an integral part

of the consolidated financial statements

Hallmark Financial Services, Inc. and Subsidiaries

Notes to Consolidated Financial Statements (Unaudited)

1. General

Hallmark Financial Services, Inc. (“Hallmark” and, together with subsidiaries, “we,” “us” or “our”) is an insurance holding company engaged in the sale of property/casualty insurance products to businesses and individuals. Our business involves marketing, distributing, underwriting and servicing our insurance products, as well as providing other insurance related services.

We pursue our business activities through subsidiaries whose operations are organized into six business units that are supported by our insurance company subsidiaries. Our Standard Commercial P&C business unit (formerly known as the Standard Commercial business unit) handles commercial insurance products and services in the standard market, as well as occupational accident and employer’s liability insurance products. Our Workers Compensation business unit specializes in small and middle market workers compensation business. Our E&S Commercial business unit handles primarily commercial and medical professional liability insurance products and services in the excess and surplus lines market. Our General Aviation business unit handles general aviation insurance products and services. Our Excess & Umbrella business unit offers low and middle market commercial umbrella and excess liability insurance on both an admitted and non-admitted basis focusing primarily on trucking, specialty automobile and non-fleet automobile coverage. Our Personal Lines business unit handles personal insurance products and services. Our insurance company subsidiaries supporting these operating units are American Hallmark Insurance Company of Texas (“AHIC”), Hallmark Insurance Company (“HIC”), Hallmark Specialty Insurance Company (“HSIC”), Hallmark County Mutual Insurance Company (“HCM”), Hallmark National Insurance Company (“HNIC”) and Texas Builders Insurance Company (“TBIC”).

These six business units are segregated into three reportable industry segments for financial accounting purposes. The Standard Commercial Segment includes the Standard Commercial P&C business unit and the Workers Compensation business unit. The Personal Segment presently consists solely of the Personal Lines business unit. The Specialty Commercial Segment includes the E&S Commercial, General Aviation and Excess & Umbrella business units.

2. Basis of Presentation

Our unaudited consolidated financial statements included herein have been prepared in accordance with U.S. generally accepted accounting principles (“GAAP”) and include our accounts and the accounts of our subsidiaries. All significant intercompany accounts and transactions have been eliminated in consolidation. Certain information and footnote disclosures normally included in financial statements prepared in accordance with GAAP have been condensed or omitted pursuant to rules and regulations of the Securities and Exchange Commission (“SEC”) for interim financial reporting. These unaudited consolidated financial statements should be read in conjunction with our audited consolidated financial statements for the year ended December 31, 2011 included in our Annual Report on Form 10-K filed with the SEC.

The interim financial data as of September 30, 2012 and 2011 is unaudited. However, in the opinion of management, the interim data includes all adjustments, consisting of normal recurring adjustments, necessary for a fair statement of the results for the interim periods. The results of operations for the period ended September 30, 2012 are not necessarily indicative of the operating results to be expected for the full year.

Redeemable non-controlling interest

We have accreted the redeemable non-controlling interest to its redemption value from the date of issuance to the redemption date using the interest method. Changes in redemption value are considered a change in accounting estimate. We followed the two class method of computing earnings per share. We treated only the portion of the periodic adjustment to the redeemable non-controlling interest carrying amount that reflects a redemption in excess of fair value as being akin to an actual dividend. (See Note 3, “Business Combinations.”)

Income taxes

We file a consolidated federal income tax return. Deferred federal income taxes reflect the future tax consequences of differences between the tax bases of assets and liabilities and their financial reporting amounts at each year end. Deferred taxes are recognized using the liability method, whereby tax rates are applied to cumulative temporary differences based on when and how they are expected to affect the tax return. Deferred tax assets and liabilities are adjusted for tax rate changes in effect for the year in which these temporary differences are expected to be recovered or settled.

Use of Estimates in the Preparation of the Financial Statements

Our preparation of financial statements in conformity with GAAP requires us to make estimates and assumptions that affect our reported amounts of assets and liabilities and our disclosure of contingent assets and liabilities at the date of our consolidated financial statements, as well as our reported amounts of revenues and expenses during the reporting period. Refer to “Critical Accounting Estimates and Judgments” under Item 7 of our Annual Report on Form 10-K for the year ended December 31, 2011 for information on accounting policies that we consider critical in preparing our consolidated financial statements. Actual results could differ materially from those estimates.

Fair Value of Financial Instruments

Fair value estimates are made at a point in time, based on relevant market data as well as the best information available about the financial instruments. Fair value estimates for financial instruments for which no or limited observable market data is available are based on judgments regarding current economic conditions, credit and interest rate risk. These estimates involve significant uncertainties and judgments and cannot be determined with precision. As a result, such calculated fair value estimates may not be realizable in a current sale or immediate settlement of the instrument. In addition, changes in the underlying assumptions used in the fair value measurement technique, including discount rate and estimates of future cash flows, could significantly affect these fair value estimates.

Cash and Cash Equivalents: The carrying amounts reported in the balance sheet for these instruments approximate their fair values.

Restricted Cash: The carrying amount for restricted cash reported in the balance sheet approximates the fair value.

Revolving Credit Facility Payable: The carrying value of our bank revolving credit facility of $1.5 million approximates the fair value based on the current interest rate.

Subordinated Debt Securities: Our trust preferred securities have a carried value of $56.7 million and a fair value of $47.7 million as of September 30, 2012. The fair value of our trust preferred securities is based on discounted cash flows using a current yield to maturity of 8.0% based on similar issues to discount future cash flows and would be classified as Level 3 in the fair value hierarchy.

For reinsurance recoverable, federal income tax payable and receivable, other assets and other liabilities, the carrying amounts approximate fair value because of the short maturity of such financial instruments.

Variable Interest Entities

On June 21, 2005, we formed Hallmark Statutory Trust I (“Trust I”), an unconsolidated trust subsidiary, for the sole purpose of issuing $30.0 million in trust preferred securities. Trust I used the proceeds from the sale of these securities and our initial capital contribution to purchase $30.9 million of subordinated debt securities from Hallmark. The debt securities are the sole assets of Trust I, and the payments under the debt securities are the sole revenues of Trust I.

On August 23, 2007, we formed Hallmark Statutory Trust II (“Trust II”), an unconsolidated trust subsidiary, for the sole purpose of issuing $25.0 million in trust preferred securities. Trust II used the proceeds from the sale of these securities and our initial capital contribution to purchase $25.8 million of subordinated debt securities from Hallmark. The debt securities are the sole assets of Trust II, and the payments under the debt securities are the sole revenues of Trust II.

We evaluate on an ongoing basis our investments in Trust I and II (collectively the “Trusts”) and we do not have a variable interest in the Trusts. Therefore, the Trusts are not included in our consolidated financial statements.

We are also involved in the normal course of business with variable interest entities (“VIE’s”) primarily as a passive investor in mortgage-backed securities and certain collateralized corporate bank loans issued by third party VIE’s. The maximum exposure to loss with respect to these investments is the investment carrying values included in the consolidated balance sheets.

Adoption of New Accounting Pronouncements

Effective January 1, 2012, the Company adopted new guidance issued by the Financial Accounting Standards Board (“FASB”) related to the accounting for costs associated with acquiring or renewing insurance contracts. The guidance identifies those costs relating to the successful acquisition of new or renewal insurance contracts that should be capitalized. This guidance may be applied prospectively or retrospectively. The Company elected retrospective application of this guidance. The adoption of this guidance decreased deferred policy acquisition costs by $0.9 million, decreased deferred federal income taxes, net by $0.3 million and decreased stockholders’ equity by $0.6 million as of December 31, 2011. Amortization of deferred policy acquisition costs included in other operating expenses and income tax benefit for the three months and nine months ended September 30, 2011 were retrospectively restated to conform to the change in accounting guidance, the effect of which on previously reported net loss for the three months and nine months ended September 30, 2011 was immaterial. In this Form 10-Q, interim financial information for the three and nine-months ended September 30, 2011 and balances at December 31, 2011 have been adjusted in accordance with the adoption of this guidance.

In May 2011, the FASB issued amendments to achieve common fair value measurement and disclosure requirements in GAAP and International Financial Reporting Standards. New disclosures, with a particular focus on Level 3 measurement were required. All transfers between Level 1 and Level 2 were required to be disclosed. Information about when the current use of a non-financial asset measured at fair value differs from its highest and best use is to be disclosed. The amendments in this update are to be applied prospectively. The amendments are effective during interim and annual periods beginning after December 15, 2011. The adoption of this amendment did not have a material impact on our financial position or results of operations.

In June 2011, the FASB issued amendments to the presentation of comprehensive income. The amendments provide the option to present other comprehensive income either in a single continuous statement of comprehensive income or in two separate but consecutive statements. The components of other comprehensive income have not changed, nor has the guidance on when other comprehensive income items are reclassified to net income. All reclassification adjustments from other comprehensive income to net income are required to be presented on the face of the statement of comprehensive income. The adoption of this new guidance did not have a material impact on our financial position or results of operations but did require additional disclosures and impacted financial statement presentation.

In September 2011, the FASB issued an accounting update to simplify how entities test goodwill for impairment. Under the update, an entity is not required to calculate the fair value of a reporting unit unless the entity determines that it is more likely than not that its fair value is less than its carrying amount. The update permits an entity to first assess qualitative factors to determine whether it is more likely than not that the fair value of a reporting unit is less than its carrying amount as a basis for determining whether it is necessary to perform the current two-step goodwill impairment test. The update is effective for annual and interim goodwill impairment tests performed for fiscal years beginning after December 15, 2011. The adoption of this update did not have a material impact on our financial position or results of operations.

3. Business Combinations

We account for business combinations using the purchase method of accounting pursuant to ASC Topic 805, “Business Combinations.” The cost of an acquired entity is allocated to the assets acquired (including identified intangible assets) and liabilities assumed based on their estimated fair values. The excess of the cost of an acquired entity over the net of the amounts assigned to assets acquired and liabilities assumed is an asset referred to as “Goodwill.” Indirect and general expenses related to business combinations are expensed as incurred.

Effective August 29, 2008, we acquired 80% of the issued and outstanding membership interests in the subsidiaries now comprising our Excess & Umbrella business unit for consideration of $15.0 million. In connection with the acquisition, we executed an operating agreement for each subsidiary. The operating agreements granted us the right to purchase the remaining 20% membership interests in the subsidiaries and granted to an affiliate of the seller the right to require us to purchase such remaining membership interests. We exercised our call option effective September 30, 2012 and acquired the remaining 20% membership interests in the subsidiaries for $1.7 million. We reclassed the call option payable to accounts payable and other accrued expenses on our Consolidated Balance Sheet at fair value of $1.7 million as of September 30, 2012.

Effective December 31, 2010, we acquired all of the issued and outstanding capital stock of HNIC for initial consideration of $14.0 million paid in cash on January 3, 2011 to State Auto Financial Corporation, Inc. (“SAFCI”). In addition, an earnout of up to $2.0 million is payable to SAFCI quarterly in an amount equal to 2% of gross collected premiums on new or renewal personal lines insurance policies written by HNIC agents during the three years following closing. HNIC is an Ohio domiciled insurance company that writes non-standard personal automobile policies through independent agents in 21 states.

Effective July 1, 2011, we acquired all of the issued and outstanding capital stock of TBIC Holding Corporation (“TBIC Holding”) for initial consideration of $1.6 million paid in cash on July 1, 2011. In addition, a holdback purchase price of $350 thousand was paid during the third quarter of 2012. A contingent purchase price of up to $3.0 million may become payable following 16 full calendar quarters after closing based upon a formula contained in the acquisition agreement. We recorded a bargain purchase gain of $165 thousand on the acquisition which was reported in other income. The gain resulted from the difference in the estimated purchase price and the fair value of the net assets acquired and liabilities assumed as of July 1, 2011.

4. Fair Value

ASC 820 defines fair value, establishes a consistent framework for measuring fair value and expands disclosure requirements about fair value measurements. ASC 820, among other things, requires us to maximize the use of observable inputs and minimize the use of unobservable inputs when measuring fair value. In addition, ASC 820 precludes the use of block discounts when measuring the fair value of instruments traded in an active market, which were previously applied to large holdings of publicly traded equity securities.

We determine the fair value of our financial instruments based on the fair value hierarchy established in ASC 820. In accordance with ASC 820, we utilize the following fair value hierarchy:

Level 1: quoted prices in active markets for identical assets;

Level 2: inputs to the valuation methodology include quoted prices for similar assets and liabilities in active markets, inputs of identical assets for less active markets, and inputs that are observable for the asset or liability, either directly or indirectly, for substantially the full term of the instrument; and

Level 3: inputs to the valuation methodology that are unobservable for the asset or liability.

This hierarchy requires the use of observable market data when available.

Under ASC 820, we determine fair value based on the price that would be received for an asset or paid to transfer a liability in an orderly transaction between market participants on the measurement date. It is our policy to maximize the use of observable inputs and minimize the use of unobservable inputs when developing fair value measurements, in accordance with the fair value hierarchy described above. Fair value measurements for assets and liabilities where there exists limited or no observable market data are calculated based upon our pricing policy, the economic and competitive environment, the characteristics of the asset or liability and other factors as appropriate. These estimated fair values may not be realized upon actual sale or immediate settlement of the asset or liability.

Where quoted prices are available on active exchanges for identical instruments, investment securities are classified within Level 1 of the valuation hierarchy. Level 1 investment securities include common and preferred stock.

Level 2 investment securities include corporate bonds, collateralized corporate bank loans, municipal bonds, and U.S. Treasury securities for which quoted prices are not available on active exchanges for identical instruments. We use third party pricing services to determine fair values for each Level 2 investment security in all asset classes. Since quoted prices in active markets for identical assets are not available, these prices are determined using observable market information such as quotes from less active markets and/or quoted prices of securities with similar characteristics, among other things. We have reviewed the processes used by the pricing services and have determined that they result in fair values consistent with the requirements of ASC 820 for Level 2 investment securities. In addition, using the prices received for the securities from the third party pricing services, we compare a sample of the prices against additional sources. We have not adjusted any prices received from the third party pricing services.

In cases where there is limited activity or less transparency around inputs to the valuation, investment securities are classified within Level 3 of the valuation hierarchy. Level 3 investments are valued based on the best available data in order to approximate fair value. This data may be internally developed and consider risk premiums that a market participant would require. Investment securities classified within Level 3 include other less liquid investment securities.

The following table presents for each of the fair value hierarchy levels, our assets that are measured at fair value on a recurring basis at September 30, 2012 and December 31, 2011 (in thousands):

	As of September 30, 2012
	Quoted Prices in		Other
	Active Markets for		Observable		Unobservable
	Identical Assets		Inputs		Inputs
	(Level 1)		(Level 2)		(Level 3)		Total

U.S. Treasury securities and obligations of U.S. Government	$	-	$	16,101	$	-	$	16,101
Corporate bonds		-		90,324		-		90,324
Collateralized corporate bank loans		-		108,350		983		109,333
Municipal bonds		-		146,497		18,788		165,285
Mortgage-backed		-		3,245		-		3,245
Total debt securities		-		364,517		19,771		384,288

Financial services		14,651		-		-		14,651
All other		27,043		-		-		27,043
Total equity securities		41,694		-		-		41,694

Total debt and equity securities	$	41,694	$	364,517	$	19,771	$	425,982

	As of December 31, 2011
	Quoted Prices in		Other
	Active Markets for		Observable		Unobservable
	Identical Assets		Inputs		Inputs
	(Level 1)		(Level 2)		(Level 3)		Total

U.S. Treasury securities and obligations of U.S. Government	$	-	$	11,176	$	-	$	11,176
Corporate bonds		-		93,922		-		93,922
Collateralized corporate bank loans		-		91,707		1,186		92,893
Municipal bonds		-		158,919		19,422		178,341
Mortgage-backed		-		4,137		-		4,137
Total debt securities		-		359,861		20,608		380,469

Financial services		15,821		-		-		15,821
All other		28,338		-		-		28,338
Total equity securities		44,159		-		-		44,159

Total debt and equity securities	$	44,159	$	359,861	$	20,608	$	424,628

Due to significant unobservable inputs into the valuation model for certain municipal bonds and a collateralized corporate bank loan in illiquid markets, we classified these investments as level 3 in the fair value hierarchy. We used an income approach in order to derive an estimated fair value of the municipal bonds classified as Level 3, which included inputs such as expected holding period, benchmark swap rate, benchmark discount rate and a discount rate premium for illiquidity. The fair value of the collateralized corporate bank loan classified as level 3 is based on discounted cash flows using current yield to maturity of 9.2%, which is based on the relevant spread over LIBOR for this particular loan to discount future cash flows.

The following table summarizes the changes in fair value for all financial assets measured at fair value on a recurring basis using significant unobservable inputs (Level 3) at September 30, 2012 and December 31, 2011 (in thousands):

Beginning balance as of January 1, 2012	$	20,608
Settlements		(307	)
Total realized/unrealized gains included in net income		-
Net losses included in other comprehensive income		(530	)
Transfers into Level 3		-
Transfers out of Level 3		-
Ending balance as of September 30, 2012	$	19,771

Beginning balance as of January 1, 2011	$	21,981
Settlements		(554	)
Total realized/unrealized gains included in net income		-
Net losses included in other comprehensive income		(819	)
Transfers into Level 3		-
Transfers out of Level 3		-
Ending balance as of December 31, 2011	$	20,608

5. Investments

The amortized cost and estimated fair value of investments in debt and equity securities by category are as follows (in thousands):

			Gross		Gross
	Amortized		Unrealized		Unrealized			Fair
As of September 30, 2012	Cost		Gains		Losses			Value

U.S. Treasury securities and obligations of U.S. Government	$	16,082	$	19	$	-		$	16,101
Corporate bonds		88,459		2,829		(964	)		90,324
Collateralized corporate bank loans		109,010		976		(653	)		109,333
Municipal bonds		163,796		4,330		(2,841	)		165,285
Mortgage-backed		3,148		106		(9	)		3,245

Total debt securities		380,495		8,260		(4,467	)		384,288

Financial services		11,004		3,648		(1	)		14,651
All other		18,114		8,968		(39	)		27,043

Total equity securities		29,118		12,616		(40	)		41,694

Total debt and equity securities	$	409,613	$	20,876	$	(4,507	)	$	425,982

As of December 31, 2011

U.S. Treasury securities and obligations of U.S. Government	$	11,152	$	24	$	-		$	11,176
Corporate bonds		93,272		2,305		(1,655	)		93,922
Collateralized corporate bank loans		94,638		175		(1,920	)		92,893
Municipal bonds		177,432		3,458		(2,549	)		178,341
Mortgage-backed		4,084		80		(27	)		4,137

Total debt securities		380,578		6,042		(6,151	)		380,469

Financial services		11,618		4,463		(260	)		15,821
All other		18,847		9,554		(63	)		28,338

Total equity securities		30,465		14,017		(323	)		44,159

Total debt and equity securities	$	411,043	$	20,059	$	(6,474	)	$	424,628

Major categories of net realized gains (losses) on investments are summarized as follows (in thousands):

	Three Months Ended						Nine Months Ended
	September 30						September 30
	2012			2011			2012			2011

U.S. Treasury securities and obligations of U.S. Government	$	-		$	21		$	-		$	35
Corporate bonds		159			(21	)		9			250
Collateralized corporate bank loans		93			(23	)		229			617
Municipal bonds		(50	)		(318	)		(294	)		(319	)
Mortgage-backed		-			-			-			-
Equity securities-financial services		8			735			78			1,524
Equity securities-all other		772			-			2,078			1,070
Gain on investments		982			394			2,100			3,177
Other-than-temporary impairments		-			-			(246	)		-
Net realized gains	$	982		$	394		$	1,854		$	3,177

We realized gross gains on investments of $1.1 million and $0.8 million during the three months ended September 30, 2012 and 2011, respectively and $2.6 million and $3.8 million for the nine months ended September 30, 2012 and 2011, respectively. We realized gross losses on investments of $0.1 million and $0.4 million for the three months ended September 30, 2012 and 2011. We realized gross losses on investments of $0.5 million and $0.6 million for the nine months ended September 30, 2012 and 2011. We recorded proceeds from the sale of investment securities of $3.5 million and $18.6 million during the three months ended September 30, 2012 and 2011, respectively, and $9.7 million and $61.5 million for the nine months ended September 30, 2012 and 2011, respectively. Realized investment gains and losses are recognized in operations on the specific identification method.

The following schedules summarize the gross unrealized losses showing the length of time that investments have been continuously in an unrealized loss position as of September 30, 2012 and December 31, 2011 (in thousands):

	As of September 30, 2012
	12 months or less					Longer than 12 months					Total
			Unrealized					Unrealized					Unrealized
	Fair Value		Losses			Fair Value		Losses			Fair Value		Losses

U.S. Treasury securities and obligations of U.S. Government	$	-	$	-		$	-	$	-		$	-	$	-
Corporate bonds		16,700		(62	)		6,767		(902	)		23,467		(964	)
Collateralized corporate bank loans		3,386		(34	)		16,109		(619	)		19,495		(653	)
Municipal bonds		26,349		(346	)		32,692		(2,495	)		59,041		(2,841	)
Mortgage-backed		408		(9	)		21		-			429		(9	)
Total debt securities		46,843		(451	)		55,589		(4,016	)		102,432		(4,467	)

Financial services		88		(1	)		-		-			88		(1	)
All other		997		(39	)		-		-			997		(39	)
Total equity securities		1,085		(40	)		-		-			1,085		(40	)

Total debt and equity securities	$	47,928	$	(491	)	$	55,589	$	(4,016	)	$	103,517	$	(4,507	)

	As of December 31, 2011
	12 months or less					Longer than 12 months					Total
			Unrealized					Unrealized					Unrealized
	Fair Value		Losses			Fair Value		Losses			Fair Value		Losses

U.S. Treasury securities and obligations of U.S. Government	$	-	$	-		$	-	$	-		$	-	$	-
Corporate bonds		21,752		(869	)		2,366		(786	)		24,118		(1,655	)
Collateralized corporate bank loans		69,717		(1,917	)		19		(3	)		69,736		(1,920	)
Municipal bonds		26,780		(196	)		39,741		(2,353	)		66,521		(2,549	)
Mortgage-backed		740		(27	)		-		-			740		(27	)
Total debt securities		118,989		(3,009	)		42,126		(3,142	)		161,115		(6,151	)

Financial services		1,789		(260	)		-		-			1,789		(260	)
All other		2,959		(63	)		-		-			2,959		(63	)
Total equity securities		4,748		(323	)		-		-			4,748		(323	)

Total debt and equity securities	$	123,737	$	(3,332	)	$	42,126	$	(3,142	)	$	165,863	$	(6,474	)

At September 30, 2012, the gross unrealized losses more than twelve months old were attributable to 58 debt security positions. At December 31, 2011, the gross unrealized losses more than twelve months old were attributable to 25 debt security positions. We consider these losses as a temporary decline in value as they are predominately on bonds that we do not intend to sell and do not believe we will be required to sell prior to recovery of our amortized cost basis. We see no other indications that the decline in values of these securities is other-than-temporary.

Based on evidence gathered through our normal credit evaluation process, we presently expect that all debt securities held in our investment portfolio will be paid in accordance with their contractual terms. Nonetheless, it is at least reasonably possible that the performance of certain issuers of these debt securities will be worse than currently expected resulting in additional future write-downs within our portfolio of debt securities.

Also, as a result of the challenging market conditions, we expect the volatility in the valuation of our equity securities to continue in the foreseeable future. This volatility may lead to additional impairments on our equity securities portfolio or changes regarding retention strategies for certain equity securities.

We complete a detailed analysis each quarter to assess whether any decline in the fair value of any investment below cost is deemed other-than-temporary. All securities with an unrealized loss are reviewed. We recognize an impairment loss when an investment's value declines below cost, adjusted for accretion, amortization and previous other-than-temporary impairments and it is determined that the decline is other-than-temporary.

Debt Investments: We assess whether we intend to sell, or it is more likely than not that we will be required to sell, a fixed maturity investment before recovery of its amortized cost basis less any current period credit losses. For fixed maturity investments that are considered other-than-temporarily impaired and that we do not intend to sell and will not be required to sell, we separate the amount of the impairment into the amount that is credit related (credit loss component) and the amount due to all other factors. The credit loss component is recognized in earnings and is the difference between the investment’s amortized cost basis and the present value of its expected future cash flows. The remaining difference between the investment’s fair value and the present value of future expected cash flows is recognized in other comprehensive income.

Equity Investments: Some of the factors considered in evaluating whether a decline in fair value for an equity investment is other-than-temporary include: (1) our ability and intent to retain the investment for a period of time sufficient to allow for an anticipated recovery in value; (2) the recoverability of cost; (3) the length of time and extent to which the fair value has been less than cost; and (4) the financial condition and near-term and long-term prospects for the issuer, including the relevant industry conditions and trends, and implications of rating agency actions and offering prices. When it is determined that an equity investment is other-than-temporarily impaired, the security is written down to fair value, and the amount of the impairment is included in earnings as a realized investment loss. The fair value then becomes the new cost basis of the investment, and any subsequent recoveries in fair value are recognized at disposition. We recognize a realized loss when impairment is deemed to be other-than-temporary even if a decision to sell an equity investment has not been made. When we decide to sell a temporarily impaired available-for-sale equity investment and we do not expect the fair value of the equity investment to fully recover prior to the expected time of sale, the investment is deemed to be other-than-temporarily impaired in the period in which the decision to sell is made.

The amortized cost and estimated fair value of debt securities at September 30, 2012 by contractual maturity are as follows. Expected maturities may differ from contractual maturities because certain borrowers may have the right to call or prepay obligations with or without penalties.

	Amortized		Fair
	Cost		Value
	(in thousands)

Due in one year or less	$	50,324	$	50,937
Due after one year through five years		163,456		166,452
Due after five years through ten years		112,290		113,254
Due after ten years		51,277		50,400
Mortgage-backed		3,148		3,245
	$	380,495	$	384,288

6. Pledged Investments

We have pledged certain of our securities for the benefit of various state insurance departments and reinsurers. These securities are included with our available-for-sale debt securities because we have the ability to trade these securities. We retain the interest earned on these securities. These securities had a carrying value of $25.9 million and $27.5 million at September 30, 2012 and December 31, 2011, respectively.

7. Reserves for Unpaid Losses and Loss Adjustment Expenses

Unpaid losses and loss adjustment expenses (“LAE”) represent the estimated ultimate net cost of all reported and unreported losses incurred through each balance sheet date. The reserves for unpaid losses and LAE are estimated using individual case-basis valuations and statistical analyses. These reserves are revised periodically and are subject to the effects of trends in loss severity and frequency. Due to the inherent uncertainty in estimating unpaid losses and LAE, the actual ultimate amounts may differ from the recorded amounts. The estimates are periodically reviewed and adjusted as experience develops or new information becomes known. Such adjustments are included in current operations.

We recorded $2.2 million and $3.6 million of favorable prior years’ loss development during the three months and nine months ended September 30, 2012, respectively. For the year to date, our General Aviation business unit experienced $2.6 million of favorable prior years’ loss development related to our liability and aircraft lines of business. Our Standard Commercial P&C business unit experienced $2.0 million of favorable prior years’ loss development primarily related to commercial property and auto liability partially offset by the late development of a general liability claim. Our Workers Compensation business unit experienced $0.8 million of favorable prior year loss reserve development. Our E&S Commercial business unit experienced $1.1 million of favorable prior year loss reserve development primarily related to general liability and commercial auto physical damage. These favorable developments were partially offset by unfavorable prior year loss development of $2.9 million in our Personal Lines business unit for the nine months ended September 30, 2012 of which $2.2 million is the result of unfavorable development in auto liability claims spread throughout various states. The remaining unfavorable prior years’ loss development for our Personal Lines business unit was the result of $0.7 million of unfavorable prior years’ loss development in our low value dwelling/homeowners line of business.

We recorded $2.3 million and $18.1 million of unfavorable prior years’ loss development during the three and nine months ended September 30, 2011, respectively. The unfavorable prior year’s loss development for the nine months ended September 30, 2011 included $17.2 million of unfavorable prior years’ loss development in our Personal Lines business unit of which $10.1 million was attributable to Florida developing much worse than expected due primarily to rapid growth in the claim volume from Florida and the complexity related to Florida personal injury protection coverage claims. The remaining unfavorable prior years’ loss development for our Personal Lines business unit was primarily due to development of auto liability claims spread throughout our other states. For the first nine months of fiscal 2011, our E&S Commercial business unit had $3.4 million of unfavorable prior years’ loss development related primarily to commercial auto liability and physical damage. These unfavorable developments were partially offset by favorable prior years’ loss development of $2.3 million in our General Aviation business unit related to our liability lines of business and $0.2 million in our Standard Commercial P&C business unit primarily related to our commercial property lines of business, partially offset by unfavorable prior years’ loss development driven by a late developing umbrella claim.

8. Share-Based Payment Arrangements

Our 2005 Long Term Incentive Plan (“2005 LTIP”) is a stock compensation plan for key employees and non-employee directors that was approved by the shareholders on May 26, 2005. There are 2,000,000 shares authorized for issuance under the 2005 LTIP. As of September 30, 2012, there were incentive stock options to purchase 1,100,832 shares of our common stock outstanding and non-qualified stock options to purchase 319,157 shares of our common stock outstanding and there were 564,178 shares reserved for future issuance under the 2005 LTIP. The exercise price of all such outstanding stock options is equal to the fair market value of our common stock on the date of grant.

Incentive stock options granted under the 2005 LTIP prior to 2009 vest 10%, 20%, 30% and 40% on the first, second, third and fourth anniversary dates of the grant, respectively, and terminate five to ten years from the date of grant. Incentive stock options granted in 2009 and one grant of 5,000 incentive stock options in 2011 vest in equal annual increments on each of the first seven anniversary dates and terminate ten years from the date of grant. One grant of 25,000 incentive stock options in 2010 and one grant of 10,000 incentive stock options in 2011 vest in equal annual increments on each of the first three anniversary dates and terminate ten years from the date of grant. Non-qualified stock options granted under the 2005 LTIP generally vest 100% six months after the date of grant and terminate ten years from the date of grant. One grant of 200,000 non-qualified stock options in 2009 vests in equal annual increments on each of the first seven anniversary dates and terminates ten years from the date of grant.

A summary of the status of our stock options as of and changes during the nine months ended September 30, 2012 is presented below:

					Average
			Weighted		Remaining		Aggregate
			Average		Contractual		Intrinsic
	Number of		Exercise		Term		Value
	Shares		Price		(Years)		($000)

Outstanding at January 1, 2012		1,419,989	$	9.66
Granted		-
Exercised		-
Forfeited or expired		-
Outstanding at September 30, 2012		1,419,989	$	9.66		5.5	$	887
Exercisable at September 30, 2012		1,126,418	$	10.42		5.2	$	467

The following table details the intrinsic value of options exercised, total cost of share-based payments charged against income before income tax benefit and the amount of related income tax benefit recognized in income for the periods indicated (in thousands):

	Three Months Ended				Nine Months Ended
	September 30,				September 30,
	2012		2011		2012		2011

Intrinsic value of options exercised	$	-	$	-	$	-	$	4

Cost of share-based payments (non-cash)	$	64	$	94	$	317	$	584

Income tax benefit of share-based payments recognized in income	$	7	$	8	$	30	$	23

As of September 30, 2012, there was $0.8 million of total unrecognized compensation cost related to non-vested share-based compensation arrangements granted under our plans, of which $0.1 million is expected to be recognized during the remainder of 2012, $0.2 million is expected to be recognized each year from 2013 through 2015 and $0.1 million is expected to be recognized in 2016.

The fair value of each stock option granted is estimated on the date of grant using the Black-Scholes option pricing model. Expected volatilities are based on the historical volatility of Hallmark’s and similar companies’ common stock for a period equal to the expected term. The risk-free interest rates for periods within the contractual term of the options are based on rates for U.S. Treasury Notes with maturity dates corresponding to the options’ expected lives on the dates of grant. Expected term is determined based on the simplified method as we do not have sufficient historical exercise data to provide a basis for estimating the expected term. There have been no options granted during 2012. There were no options granted during the first or third quarter of 2011. There were two options granted during the second quarter of 2011 with a weighted average grant date fair value per share of $3.50, a weighted average expected term of 6.3 years, a weighted average expected volatility of 38.0% and a weighted average risk free interest rate of 2.6%.

9. Segment Information

The following is business segment information for the three and nine months ended September 30, 2012 and 2011 (in thousands):

	Three Months Ended						Nine Months Ended
	September 30,						September 30,
	2012			2011			2012			2011
Revenues:
Standard Commercial Segment	$	17,761		$	20,258		$	53,791		$	53,926
Specialty Commercial Segment		46,373			36,814			129,812			104,433
Personal Segment		21,172			25,637			68,508			76,556
Corporate		314			1,039			1,066			4,754
Consolidated	$	85,620		$	83,748		$	253,177		$	239,669

Pre-tax income (loss), net of non-controlling interest:
Standard Commercial Segment	$	(529	)	$	4,260		$	(2,601	)	$	(890	)
Specialty Commercial Segment		8,287			2,691			17,193			6,955
Personal Segment		(345	)		(4,536	)		(5,747	)		(22,341	)
Corporate		(2,650	)		(1,715	)		(8,082	)		(3,974	)
Consolidated	$	4,763		$	700		$	763		$	(20,250	)

The following is additional business segment information as of the dates indicated (in thousands):

	September 30,		December 31,
	2012		2011
Assets

Standard Commercial Segment	$	148,302	$	144,673
Specialty Commercial Segment		439,233		348,699
Personal Segment		193,839		232,381
Corporate		14,460		20,306
	$	795,834	$	746,059

10. Reinsurance

We reinsure a portion of the risk we underwrite in order to control the exposure to losses and to protect capital resources. We cede to reinsurers a portion of these risks and pay premiums based upon the risk and exposure of the policies subject to such reinsurance. Ceded reinsurance involves credit risk and is generally subject to aggregate loss limits. Although the reinsurer is liable to us to the extent of the reinsurance ceded, we are ultimately liable as the direct insurer on all risks reinsured. Reinsurance recoverables are reported after allowances for uncollectible amounts. We monitor the financial condition of reinsurers on an ongoing basis and review our reinsurance arrangements periodically. Reinsurers are selected based on their financial condition, business practices and the price of their product offerings. In order to mitigate credit risk to reinsurance companies, most of our reinsurance recoverable balance as of September 30, 2012 was with reinsurers that had an A.M. Best rating of “A–” or better.

The following table shows earned premiums ceded and reinsurance loss recoveries by period (in thousands):

	Three Months Ended				Nine Months Ended
	September 30,				September 30,
	2012		2011		2012		2011

Ceded earned premiums	$	14,141	$	12,430	$	40,031	$	44,581
Reinsurance recoveries	$	8,582	$	6,885	$	22,633	$	26,368

We currently reinsure the following exposures on business generated by our business units:

Property catastrophe. Our property catastrophe reinsurance reduces the financial impact a catastrophe could have on our commercial and personal property insurance lines. Catastrophes might include multiple claims and policyholders. Catastrophes include hurricanes, windstorms, earthquakes, hailstorms, explosions, severe winter weather and fires. Our property catastrophe reinsurance is excess-of-loss reinsurance, which provides us reinsurance coverage for losses in excess of an agreed-upon amount. We utilize catastrophe models to assist in determining appropriate retention and limits to purchase. The terms of our property catastrophe reinsurance are:

We retain the first $6.0 million of property catastrophe losses;

Our reinsurers reimburse us 100% for any loss involving tropical depressions, tropical storms and/or hurricanes occurring to risks located in the state of Texas in excess of our $6.0 million retention up to $9.0 million for each occurrence and our reinsurers reimburse us 87.5% for any loss occurring to risk in the state of Texas involving events other than tropical depressions, tropical storms and/or hurricanes in excess of our $6.0 million retention up to $9.0 million for each catastrophic occurrence; and

Our reinsurers reimburse us 100% for any loss occurrence in all states in excess of our $9.0 million retention up to $25.0 million, subject to an aggregate limit of $50.0 million.

Commercial property. Our commercial property reinsurance is excess-of-loss coverage intended to reduce the financial impact a single-event or catastrophic loss may have on our results. The terms of our commercial property reinsurance are:

We retain the first $1.0 million of loss for each commercial property risk;

Our reinsurers reimburse us for the next $5.0 million for each commercial property risk, and $10.0 million for all commercial property risk involved in any one occurrence, in all cases subject to an aggregate limit of $30.0 million for all commercial property losses occurring during the treaty period; and

Individual risk facultative reinsurance is purchased on any commercial property with limits above $6.0 million.

Commercial casualty. Our commercial casualty reinsurance is excess-of-loss coverage intended to reduce the financial impact a single-event loss may have on our results. The terms of our commercial casualty reinsurance are:

We retain the first $1.0 million of any commercial liability risk; and

Our reinsurers reimburse us for the next $5.0 million for each commercial liability risk.

Aviation. We purchase reinsurance specific to the aviation risks underwritten by our General Aviation business unit. This reinsurance provides aircraft hull and liability coverage and airport liability coverage on a per occurrence basis on the following terms:

We retain the first $1.0 million of each aircraft hull or liability loss or airport liability loss; and

Our reinsurers reimburse us for the next $5.5 million of each combined aircraft hull and liability loss and for the next $4.0 million of each airport liability loss.

Workers Compensation. We purchase excess of loss reinsurance specific to the workers compensation risks underwritten by our Workers Compensation business unit. The terms of our workers compensation reinsurance are:

We retain the first $1.0 million of each workers compensation loss; and

Our reinsurers reimburse us 100% for the next $14.0 million for each workers compensation loss, subject to a maximum limit of $10.0 million for any one person and an aggregate limit of $28.0 million for all workers compensation losses.

Standard Commercial P&C. We purchase proportional reinsurance where we cede 100% of the risks to reinsurers on the equipment breakdown coverage on our commercial multi-peril property and business owners risks and on the employment practices liability coverage on certain commercial multi-peril, general liability and business owners risks.

Excess & Umbrella. We purchase proportional reinsurance where we retain 20% of each risk and cede the remaining 80% to reinsurers. In states where we are not yet licensed to offer a non-admitted product, we utilize a fronting arrangement pursuant to which we assume all of the risk and then retrocede a portion of that risk under the same proportional reinsurance treaty. Through June 30, 2009, our Excess & Umbrella business unit wrote policies pursuant to a general agency agreement with an unaffiliated carrier and we assumed 35% of the risk from that carrier.

E&S Commercial. Effective June 1, 2012 we purchase proportional reinsurance on our medical professional liability risks where we retain 50% of each risk and cede the remaining 50% to reinsurers. Prior to June 1, 2012 we retained 40% of each risk and ceded the remaining 60% to reinsurers. In states where we are not yet licensed to offer a non-admitted product, we utilize a fronting arrangement pursuant to which we assume all of the risk and then retrocede a portion of that risk under the same proportional reinsurance treaty. In addition, we purchase facultative reinsurance on our commercial umbrella and excess liability risks where we retain 10% of the first $1.0 million of risk and cede the remaining 90% to reinsurers. We cede 100% of our commercial umbrella and excess liability risks in excess of $1.0 million.

Hallmark County Mutual. HCM is used to front certain lines of business in our Specialty Commercial and Personal Segments in Texas where we previously produced policies for third party county mutual insurance companies and reinsured 100% for a fronting fee. In addition, HCM is used to front business produced by unaffiliated third parties. HCM does not retain any business.

Hallmark National Insurance Company. Simultaneous with the December 31, 2010 closing of our acquisition of HNIC, HNIC entered into reinsurance contracts with an affiliate of the seller pursuant to which such affiliate of the seller handles all claims and assumes all liabilities arising under policies issued by HNIC prior to closing or during a transition period of up to six months following the closing.

11. Revolving Credit Facility Payable

Our First Restated Credit Agreement with The Frost National Bank dated January 27, 2006, as amended to date, provides a revolving credit facility of $15.0 million. We pay interest on the outstanding balance at our election at a rate of the prime rate or LIBOR plus 2.5%. We pay an annual fee of 0.25% of the average daily unused balance of the credit facility. We pay letter of credit fees at the rate of 1.00% per annum. Our obligations under the revolving credit facility are secured by a security interest in the capital stock of all of our subsidiaries, guarantees of all of our subsidiaries and the pledge of all of our non-insurance company assets. The revolving credit facility contains covenants that, among other things, require us to maintain certain financial and operating ratios and restrict certain distributions, transactions and organizational changes. We are in compliance with all of our covenants. As of September 30, 2012, the balance on the revolving note was $1.5 million. The revolving note currently bears interest at 2.88% per annum.

12. Subordinated Debt Securities

On June 21, 2005, we entered into a trust preferred securities transaction pursuant to which we issued $30.9 million aggregate principal amount of subordinated debt securities due in 2035. To effect the transaction, we formed Trust I as a Delaware statutory trust. Trust I issued $30.0 million of preferred securities to investors and $0.9 million of common securities to us. Trust I used the proceeds from these issuances to purchase the subordinated debt securities. Our Trust I subordinated debt securities bear an initial interest rate of 7.725% until June 15, 2015, at which time interest will adjust quarterly to the three-month LIBOR rate plus 3.25 percentage points. Trust I pays dividends on its preferred securities at the same rate. Under the terms of our Trust I subordinated debt securities, we pay interest only each quarter and the principal of the note at maturity. The subordinated debt securities are uncollaterized and do not require maintenance of minimum financial covenants. As of September 30, 2012, the balance of our Trust I subordinated debt was $30.9 million.

On August 23, 2007, we entered into a trust preferred securities transaction pursuant to which we issued $25.8 million aggregate principal amount of subordinated debt securities due in 2037. To effect the transaction, we formed Trust II as a Delaware statutory trust. Trust II issued $25.0 million of preferred securities to investors and $0.8 million of common securities to us. Trust II used the proceeds from these issuances to purchase the subordinated debt securities. Our Trust II subordinated debt securities bear an initial interest rate of 8.28% until September 15, 2017, at which time interest will adjust quarterly to the three-month LIBOR rate plus 2.90 percentage points. Trust II pays dividends on its preferred securities at the same rate. Under the terms of our Trust II subordinated debt securities, we pay interest only each quarter and the principal of the note at maturity. The subordinated debt securities are uncollaterized and do not require maintenance of minimum financial covenants. As of September 30, 2012, the balance of our Trust II subordinated debt was $25.8 million.

13. Deferred Policy Acquisition Costs

The following table shows total deferred and amortized policy acquisition cost activity by period (in thousands):

	Three Months Ended						Nine Months Ended
	September 30,						September 30,
	2012			2011			2012			2011

Deferred	$	(12,011	)	$	(11,978	)	$	(45,281	)	$	(40,034	)
Amortized		11,084			11,625			41,427			37,392

Net	$	(927	)	$	(353	)	$	(3,854	)	$	(2,642	)

14. Earnings per Share

The following table sets forth basic and diluted weighted average shares outstanding for the periods indicated (in thousands):

	Three Months Ended				Nine Months Ended
	September 30,				September 30,
	2012		2011		2012		2011

Weighted average shares - basic		19,263		19,286		19,263		19,812
Effect of dilutive securities		14		1		4		-
Weighted average shares - assuming dilution		19,277		19,287		19,267		19,812

For the three months and nine months ended September 30, 2012, 809,999 shares of common stock potentially issuable upon the exercise of employee stock options were excluded from the weighted average number of shares outstanding on a diluted basis because the effect of such options would be anti-dilutive. For the three months and nine months ended September 30, 2011, 1,011,666 shares and 924,166 shares, respectively, of common stock potentially issuable upon the exercise of employee stock options were excluded from the weighted average number of shares outstanding on a diluted basis because the effect of such options would be anti-dilutive.

15. Net Periodic Pension Cost

The following table details the net periodic pension cost incurred by period (in thousands):

	Three Months Ended						Nine Months Ended
	September 30,						September 30,
	2012			2011			2012			2011
Interest cost	$	141		$	152		$	422		$	457
Amortization of net loss		120			72			362			215
Expected return on plan assets		(146	)		(148	)		(438	)		(443	)
Net periodic pension cost	$	115		$	76		$	346		$	229

We contributed $410 thousand and $711 thousand to our frozen defined benefit cash balance plan during the three months and nine months ended September 30, 2012, respectively. We contributed $289 thousand and $509 thousand to our frozen defined benefit cash balance plan during the three months and nine months ended September 30, 2011, respectively. Refer to Note 14 to the consolidated financial statements in our Annual Report on Form 10-K for the year ended December 31, 2011 for more discussion of our retirement plans.

16. Income Taxes

Our effective income tax rate for the nine months ended September 30, 2012 was -90.0%, which varied from the statutory income tax rate primarily as a result of a taxable loss compared to book income. Tax exempt income accounted for the difference between our taxable loss and book income. Our effective income tax rate for the nine months ended September 30, 2011 was 44.7%, which varied from the statutory income tax rate primarily as a result of our tax exempt income increasing the tax benefit from our pre-tax loss and the recognition of a tax benefit related to the disposal of certain securities.

17. Commitments and Contingencies

In December 2010, our E&S Commercial business unit was informed by the Texas Comptroller of Public Accounts that a surplus lines tax audit covering the period January 1, 2007 through December 31, 2009 was complete. A subsidiary within our E&S Commercial business unit (“TGA”) frequently acts as a managing general underwriter (“MGU”) authorized to underwrite policies on behalf of Republic Vanguard Insurance Company and HSIC, both Texas eligible surplus lines insurance carriers. In its role as the MGU, TGA underwrites policies on behalf of these carriers while other agencies located in Texas, generally referred to as “producing agents,” deliver the policies to the insureds and collect all premiums due from the insureds. During the period under audit, the producing agents also collected the surplus lines premium taxes due on the policies from the insureds, held them in trust, and timely remitted those taxes to the Comptroller. We believe this system for collecting and paying the required surplus lines premium taxes complies in all respects with the Texas Insurance Code and other regulations, which clearly require that the same party who delivers the policies and collects the premiums will also collect premium taxes, hold premium taxes in trust, and pay premium taxes to the Comptroller. It also complies with long standing industry practice. The Comptroller asserts that TGA is liable for the surplus lines premium taxes related to policy transactions and premiums collected from surplus lines insureds during the audit period and that TGA owes $4.5 million in premium taxes, as well as $0.9 million in penalties and interest for the audit period.

We disagree with the Comptroller and intend to vigorously fight their assertion that TGA is liable for the surplus lines premium taxes. During the past several months we have been engaged in conversations with the Comptroller’s counsel and are waiting on the Comptroller’s position paper. At this stage, we cannot predict the course of any proceedings, the timing of any rulings or other significant events relating to such surplus lines tax audit. Given these limitations and the inherent difficulty of projecting the outcome of regulatory disputes, we are presently unable to reasonably estimate the possible loss or legal costs that are likely to arise out of the surplus lines tax audit or any future proceedings relating to this matter. Also, based on current information, we believe that a favorable outcome of this dispute is at least reasonably possible. Therefore we have not accrued any amount as of September 30, 2012 related to this matter.

We are engaged in other legal proceedings in the ordinary course of business, none of which, either individually or in the aggregate, are believed likely to have a material adverse effect on our consolidated financial position or results of operations, in the opinion of management. The various legal proceedings to which we are a party are routine in nature and incidental to our business.

18. Changes in Accumulated Other Comprehensive Income Balances

The changes in accumulated other comprehensive income balances as of September 30, 2012 and 2011 were as follows (in thousands):

	Minimum						Accumulated Other
	Pension			Unrealized			Comprehensive
	Liability			Gains (Loss)			Income (Loss)

Balance at December 31, 2010	$	(2,024	)	$	11,661		$	9,637

Other comprehensive income (loss):

Change in net actuarial loss		215			-			215

Tax effect on change in net actuarial loss		(75	)		-			(75	)

Net unrealized holding losses arising during the period		-			(8,254	)		(8,254	)

Tax effect on unrealized losses arising during the period		-			2,889			2,889

Reclassification adjustment for gains (losses) included in net income		-			(3,177	)		(3,177	)

Tax effect on reclassification adjustment for gains (losses) included in net income		-			1,112			1,112

Other comprehensive income (loss), net of tax		140			(7,430	)		(7,290	)

Balance at September 30, 2011	$	(1,884	)	$	4,231		$	2,347

Balance at December 31, 2011	$	(2,978	)	$	9,424		$	6,446

Other comprehensive income (loss):

Change in net actuarial loss		362			-			362

Tax effect on change in net actuarial loss		(127	)		-			(127	)
								-
Net unrealized holding gains arising during the period		-			4,560			4,560
								-
Tax effect on unrealized gains arising during the period		-			(1,596	)		(1,596	)

Reclassification adjustment for gains (losses) included in net income		-			(2,044	)		(2,044	)

Tax effect on reclassification adjustment for gains (losses) included in net income		-			715			715

Other comprehensive income (loss), net of tax		235			1,635			1,870

Balance at September 30, 2012	$	(2,743	)	$	11,059		$	8,316

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

The following discussion should be read together with our consolidated financial statements and the notes thereto. This discussion contains forward-looking statements. Please see “Risks Associated with Forward-Looking Statements in this Form 10-Q” for a discussion of some of the uncertainties, risks and assumptions associated with these statements.

Introduction

Hallmark Financial Services, Inc. (“Hallmark” and, together with subsidiaries, “we,” “us” or “our”) is an insurance holding company that, through its subsidiaries, engages in the sale of property/casualty insurance products to businesses and individuals. Our business involves marketing, distributing, underwriting and servicing commercial insurance, personal insurance and general aviation insurance, as well as providing other insurance related services. Our business is geographically concentrated in the south central and northwest regions of the United States, except for our General Aviation and Excess & Umbrella business which is written on a national basis. We pursue our business activities through subsidiaries whose operations are organized into six business units, which are supported by our insurance company subsidiaries.

Our non-carrier insurance activities are segregated by business units into the following reportable segments:

Standard Commercial Segment. Our Standard Commercial Segment includes the standard lines commercial property/casualty products and services handled by our Standard Commercial P&C business unit (formerly known as our Standard Commercial business unit) and the workers compensation insurance products handled by our Workers Compensation business unit.

Specialty Commercial Segment. Our Specialty Commercial Segment includes the excess and surplus lines commercial property/casualty and medical professional liability insurance products and services handled by our E&S Commercial business unit, the general aviation insurance products and services handled by our General Aviation business unit, the commercial excess liability and umbrella insurance products handled by our Excess & Umbrella business unit and satellite launch insurance products included in Specialty Programs.

Personal Segment. Our Personal Segment includes the non-standard personal automobile insurance, low value dwelling/homeowners, renters, motorcycle and business auto insurance products and services handled by our Personal Lines business unit.

The retained premium produced by our business units is supported by the following insurance company subsidiaries:

American Hallmark Insurance Company of Texas (“AHIC”) presently retains a portion of the risks on the commercial property/casualty and workers compensation policies marketed within the Standard Commercial Segment, retains a portion of the risks on personal policies marketed within the Personal Segment and retains a portion of the risks on the commercial, medical professional liability, aviation and satellite launch property/casualty policies marketed within the Specialty Commercial Segment.

Hallmark Specialty Insurance Company (“HSIC”) presently retains a portion of the risks on the commercial property/casualty and medical professional liability policies marketed within the Specialty Commercial Segment.

Hallmark Insurance Company (“HIC”) presently retains a portion of the risks on both the personal policies marketed within the Personal Segment and the commercial and aviation property/casualty products marketed within the Specialty Commercial Segment.

Hallmark National Insurance Company (“HNIC”) was acquired on December 31, 2010. Simultaneous with the closing of the acquisition, HNIC entered into reinsurance contracts with an affiliate of the seller, pursuant to which such affiliate of the seller will handle all claims and assume all liabilities arising under policies issued by HNIC prior to the closing or during a transition period of up to nine months following the closing. Commencing January 1, 2011, HNIC retains a portion of the risks on the personal policies marketed within the Personal Segment.

Hallmark County Mutual Insurance Company (“HCM”) control and management is maintained through our wholly owned subsidiary CYR Insurance Management Company (“CYR”). CYR has as its primary asset a management agreement with HCM, which provides for CYR to have management and control of HCM. HCM is used to front certain lines of business in our Specialty Commercial and Personal Segments in Texas. HCM does not retain any business.

Texas Builders Insurance Company (“TBIC”) was acquired on July 1, 2011 and retains a portion of the risks on the workers compensation policies marketed within our Standard Commercial Segment.

AHIC, HIC, HSIC and HNIC have entered into a pooling arrangement pursuant to which AHIC retains 30% of the total net premiums written by any of them, HIC retains 28% of our total net premiums written by any of them, HSIC retains 30% of our total net premiums written by any of them and HNIC retains 12% of our total premiums written by any of them. Neither HCM nor TBIC is a party to the intercompany pooling arrangement. This pooling arrangement has no impact on our consolidated financial statements reported in accordance with U.S. generally accepted accounting principles (“GAAP”).

Results of Operations

Management Overview During the three and nine months ended September 30, 2012, our total revenues were $85.6 million and $253.2 million, representing a 2% and 6% increase, respectively, from the $83.7 million and $239.7 million in total revenues for the same period of 2011. The growth in revenue was primarily attributable to increased premium production and resulting earned premium driven largely from our E&S Commercial business unit and from the acquisition of our Workers Compensation business unit during the third quarter of 2011. The increase in revenue was partially offset by an adverse profit share commission revenue adjustment in our Standard Commercial P&C business unit, combined with lower finance charges and earned premium in our Personal Segment due mostly to the impact of a reduction of premium written in underperforming states and products exited over the past twelve months. Further offsetting the increase in revenue was lower net realized gains for the nine months ended September 30, 2012.

The increase in revenue for the three months and nine months ended September 30, 2012 was complemented by decreased loss and loss adjustment expenses (“LAE”) due primarily to improved current accident year loss trends in our Standard Commercial P&C business unit for the year-to-date and Personal Lines business unit for both the quarter and year-to-date as well as significant adverse reserve development recognized during the prior year. During the three months and nine months ended September 30, 2012, we recorded $2.2 million and $3.6 million, respectively, of favorable prior year loss reserve development. During the three and nine months ended September 30, 2011, we recorded $2.3 million and $18.1 million, respectively, of unfavorable prior year loss reserve development. Of the $18.1 million unfavorable development recognized for the nine months ended September 30, 2011, $10.1 million was a result of adverse prior year loss reserve development in our Personal Segment in Florida. In addition, the results for the nine months ended September 30, 2012 and 2011 included $11.6 million and $10.0 million, respectively, in net losses from weather related claims.

We reported $3.4 million net income attributable to Hallmark for the three months ended September 30, 2012, as compared to $98 thousand net income attributable to Hallmark for the same period during 2011. We reported a net income attributable to Hallmark of $1.7 million for the nine months ended September 30, 2012, which was $12.9 million higher than the $11.2 million net loss attributable to Hallmark reported for the nine months ended September 30, 2011. On a diluted basis per share, we reported net income of $0.18 per share for the three months ended September 30, 2012, as compared to net income of $0.01 per share for the same period in 2011. On a diluted basis per share, net income per share was $0.09 for the nine months ended September 30, 2012, as compared to net loss per share of $0.57 for the same period during 2011. We reported an income tax benefit of $1.0 million, or an effective income tax rate of -90.0%, for the nine months ended September 30, 2012, as compared to income tax benefit of $9.0 million, or an effective rate of 44.7%, for the same period during 2011.

Third Quarter 2012 as Compared to Third Quarter 2011

The following is additional business segment information for the three months ended September 30, 2012 and 2011 (in thousands):

Hallmark Financial Services, Inc

Consolidated Segment Data

	Three Months Ended September 30, 2012
	Standard			Specialty
	Commercial			Commercial			Personal
	Segment			Segment			Segment			Corporate			Consolidated

Gross premiums written	$	18,706		$	62,349		$	18,393			-		$	99,448
Ceded premiums written		(1,876	)		(12,385	)		(182	)		-			(14,443	)
Net premiums written		16,830			49,964			18,211			-			85,005
Change in unearned premiums		736			(6,396	)		1,136			-			(4,524	)
Net premiums earned		17,566			43,568			19,347			-			80,481

Total revenues		17,761			46,373			21,172			314			85,620

Losses and loss adjustment expenses		12,476			25,532			14,831			-			52,839

Pre-tax income (loss), net of non-controlling interest		(529	)		8,287			(345	)		(2,650	)		4,763

Net loss ratio (1)		71.0	%		58.6	%		76.7	%					65.7	%
Net expense ratio (1)		33.4	%		27.3	%		29.3	%					30.1	%
Net combined ratio (1)		104.4	%		85.9	%		106.0	%					95.8	%

	Three Months Ended September 30, 2011
	Standard			Specialty
	Commercial			Commercial			Personal
	Segment			Segment			Segment			Corporate			Consolidated

Gross premiums written	$	16,698		$	48,417		$	24,636			-		$	89,751
Ceded premiums written		(1,489	)		(10,444	)		64			-			(11,869	)
Net premiums written		15,209			37,973			24,700			-			77,882
Change in unearned premiums		1,320			(2,993	)		(1,141	)		-			(2,814	)
Net premiums earned		16,529			34,980			23,559			-			75,068

Total revenues		20,258			36,814			25,637			1,039			83,748

Losses and loss adjustment expenses		10,703			23,356			22,077			-			56,136

Pre-tax income (loss), net of non-controlling interest		4,260			2,691			(4,536	)		(1,715	)		700

Net loss ratio (1)		64.8	%		66.8	%		93.7	%					74.8	%
Net expense ratio (1)		32.0	%		29.8	%		28.9	%					31.6	%
Net combined ratio (1)		96.8	%		96.6	%		122.6	%					106.4	%

(1) The net loss ratio is calculated as incurred losses and LAE divided by net premiums earned, each determined in accordance with GAAP. The net expense ratio is calculated for our business units that retain 100% of produced premium as total operating expenses for the unit offset by agency fee income divided by net premiums earned, each determined in accordance with GAAP. For the business units that do not retain 100% of the produced premium, the net expense ratio is calculated as underwriting expenses of the insurance company subsidiaries for the unit offset by agency fee income, divided by net premiums earned, each determined in accordance with GAAP. Net combined ratio is calculated as the sum of the net loss ratio and the net expense ratio.

Standard Commercial Segment

Gross premiums written for the Standard Commercial Segment were $18.7 million for the three months ended September 30, 2012, which was $2.0 million, or 12%, more than the $16.7 million reported for the same period in 2011. Net premiums written were $16.8 million for the three months ended September 30, 2012 as compared to $15.2 million reported for the same period in 2011. The increase in premium volume was primarily due to increased premium production in both our Standard Commercial P&C business unit and our Workers Compensation business unit.

Total revenue for the Standard Commercial Segment of $17.8 million for the three months ended September 30, 2012 was $2.5 million less than the $20.3 million reported during the same period in 2011. This decrease in total revenue was mostly due to an adverse profit share commission revenue adjustment of $1.2 million during the third quarter of 2012 as compared to a favorable profit share commission revenue adjustment of $2.5 million during the same period of 2011. This decrease in revenue was partially offset by increased net premiums earned of $1.0 million due primarily to increased premium production in both our Standard Commercial P&C business unit and our Workers Compensation business unit and higher net investment income of $0.2 million.

Our Standard Commercial Segment reported a pre-tax loss of $0.5 million for the three months ended September 30, 2012 as compared to pre-tax income of $4.3 million for the same period of 2011. The reduced revenue discussed above, higher loss and LAE of $1.8 million and higher operating expenses of $0.5 million were the primary drivers of the pre-tax loss for the three months ended September 30, 2012.

The Standard Commercial Segment reported a net loss ratio of 71.0% for the three months ended September 30, 2012 as compared to 64.8% for the same period of 2011. The gross loss ratio before reinsurance for the three months ended September 30, 2012 was 68.1% as compared to the 59.9% reported for the same period of 2011. The increase in the net loss ratio was impacted by higher current accident year loss trends during the third quarter of 2012 as compared to the same period in 2011. During the three months ended September 30, 2012, the Standard Commercial Segment reported favorable loss reserve development of $0.1 million as compared to $0.7 million favorable loss reserve development during the same period of 2011. The Standard Commercial Segment reported a net expense ratio of 33.4% for the three months ended September 30, 2012 as compared to 32.0% for the same period of 2011. The increase in the expense ratio is primarily due to increased production related expenses.

Specialty Commercial Segment

Gross premiums written for the Specialty Commercial Segment were $62.3 million for the three months ended September 30, 2012, which was $13.9 million, or 29%, more than the $48.4 million reported for the same period in 2011. Net premiums written were $50.0 million for the three months ended September 30, 2012 as compared to $38.0 million reported for the same period in 2011. The increase in premium volume was primarily due to increased premium production in our E&S Commercial business unit, Excess & Umbrella business unit and our space risk program, partially offset by reduced premium volume in our General Aviation business unit.

The $46.4 million of total revenue for the three months ended September 30, 2012 was $9.6 million higher than the $36.8 million reported by the Specialty Commercial Segment for the same period in 2011. This increase in revenue was primarily due to higher net premiums earned of $8.6 million largely from increased premium production discussed above. Further contributing to this increased revenue was higher net investment income of $0.7 million and a favorable profit share commission revenue adjustment of $0.1 million for the three months ended September 30, 2012 as compared to an adverse profit share commission revenue adjustment of $0.2 million for the same period of 2011.

Pre-tax income for the Specialty Commercial Segment of $8.3 million for the third quarter of 2012 was $5.6 million higher than the $2.7 million reported for the same period in 2011. The increase in pre-tax income was primarily due to the increased revenue discussed above partially offset by higher loss and LAE expenses of $2.2 million, higher operating expenses of $1.6 million and $0.3 million in expense related to the acquisition of the non-controlling interest in our Excess & Umbrella business unit during the third quarter of 2012. Our General Aviation business unit reported a $1.6 million increase in loss and LAE due primarily to higher current accident year loss trends, our Excess & Umbrella business unit reported a $0.2 million increase in loss and LAE due to increased premium production and our space risk program reported a $1.0 million increase in loss and LAE attributable to a large claim during the third quarter of 2012. These increases in loss and LAE were partially offset by a $0.6 million decrease in loss and LAE in our E&S Commercial business unit due primarily to favorable prior year loss reserve development for the three months ended September 30, 2012 as compared to the same period during 2011 partially offset by increased premium production. The increase in operating expenses for the three months ended September 30, 2012 were primarily the result of increased production related expenses of $1.4 million and increased salary and related expenses of $0.4 million, partially offset by lower professional service fees of $0.2 million.

The Specialty Commercial Segment reported a net loss ratio of 58.6% for the three months ended September 30, 2012 as compared to 66.8% for the same period during 2011. The gross loss ratio before reinsurance was 60.3% for the three months ended September 30, 2012 as compared to 65.6% for the same period in 2011. The Specialty Commercial Segment reported $2.7 million of favorable prior year loss reserve development for the three months ended September 30, 2012 as compared to $0.1 million adverse prior year loss reserve development for the same period in 2011. The Specialty Commercial Segment reported a decline in the net expense ratio to 27.3% for the three months ended September 30, 2012 as compared to 29.8% for the same period in 2011 primarily due to increased premium production.

Personal Segment

Gross premiums written for the Personal Segment were $18.4 million for the three months ended September 30, 2012, which was $6.2 million, or 25%, less than the $24.6 million reported for the same period in 2011. The decrease in premium was due mostly to the impact of rate increases and exiting certain underperforming states and programs.

Total revenue for the Personal Segment decreased 17% to $21.2 million for the third quarter of 2012 from $25.6 million for the third quarter of 2011. Lower earned premium of $4.2 million and lower finance charges of $0.3 million were the primary reason for the decrease in revenue for the period.

Pre-tax loss for the Personal Segment was $0.3 million for the three months ended September 30, 2012 as compared to $4.5 million for the same period of 2011. The decrease in pre-tax loss for the three months ended September 30, 2012 as compared to the same period in 2011 was driven by decreased losses and LAE of $7.2 million and lower operating expenses of $1.4 million due to decreased production related expense, professional service fees and salary and related expenses, partially offset by the lower revenue discussed above.

The Personal Segment reported a net loss ratio of 76.7% for the three months ended September 30, 2012 as compared to 93.7% for the third quarter of 2011. The loss ratio for the three months ended September 30, 2012 includes improved current accident year loss trends. The loss and LAE during the three months ended September 30, 2012 included $0.6 million of adverse prior year loss reserve development as compared to $2.9 million of adverse prior year loss reserve development for the same period in 2011.

Corporate

Total revenue for Corporate decreased by $0.7 million for the three months ended September 30, 2012 as compared to the same period the prior year. This decrease in total revenue was primarily due to lower net investment income of $1.1 million and the bargain purchase gain recorded on the acquisition of TBIC Holding of $0.1 million reported in other income during the third quarter of 2011. This decrease in total revenue was partially offset by higher net realized gains of $0.5 million for the three months ended September 30, 2012 as compared to the same period of the prior year.

Corporate pre-tax loss was $2.7 million for the three months ended September 30, 2012 as compared to $1.7 million pre-tax loss for the same period the prior year. The increase in pre-tax loss was the result of the decreased revenue discussed above and higher operating expenses of $0.3 million due primarily to an adjustment recorded during the three months ended September 30, 2011 to reduce the expected earn-out payable in conjunction with the acquisition of HNIC.

Nine Months Ended September 30, 2012 as Compared to Nine Months Ended September 30, 2011

The following is additional business segment information for the nine months ended September 30, 2012 and 2011 (in thousands):

Hallmark Financial Services, Inc.

Consolidated Segment Data

	Nine Months Ended September 30, 2012
	Standard			Specialty
	Commercial			Commercial			Personal
	Segment			Segment			Segment			Corporate			Consolidated

Gross premiums written	$	58,292		$	178,690		$	60,676			-		$	297,658
Ceded premiums written		(5,063	)		(36,948	)		(543	)		-			(42,554	)
Net premiums written		53,229			141,742			60,133			-			255,104
Change in unearned premiums		(2,194	)		(19,449	)		2,477			-			(19,166	)
Net premiums earned		51,035			122,293			62,610			-			235,938

Total revenues		53,791			129,812			68,508			1,066			253,177

Losses and loss adjustment expenses		39,253			76,827			52,779			-			168,859

Pre-tax income (loss), net of non-controlling interest		(2,601	)		17,193			(5,747	)		(8,082	)		763

Net loss ratio (1)		76.9	%		62.8	%		84.3	%					71.6	%
Net expense ratio (1)		33.8	%		28.2	%		28.5	%					30.4	%
Net combined ratio (1)		110.7	%		91.0	%		112.8	%					102.0	%

	Nine Months Ended September 30, 2011
	Standard			Specialty
	Commercial			Commercial			Personal
	Segment			Segment			Segment			Corporate			Consolidated

Gross premiums written	$	52,702		$	137,032		$	81,100			-		$	270,834
Ceded premiums written		(4,053	)		(29,041	)		(4,668	)		-			(37,762	)
Net premiums written		48,649			107,991			76,432			-			233,072
Change in unearned premiums		(867	)		(9,312	)		(6,134	)		-			(16,313	)
Net premiums earned		47,782			98,679			70,298			-			216,759

Total revenues		53,926			104,433			76,556			4,754			239,669

Losses and loss adjustment expenses		39,117			66,706			76,018			-			181,841

Pre-tax income (loss), net of non-controlling interest		(890	)		6,955			(22,341	)		(3,974	)		(20,250	)

Net loss ratio (1)		81.9	%		67.6	%		108.1	%					83.9	%
Net expense ratio (1)		32.5	%		30.2	%		26.8	%					31.3	%
Net combined ratio (1)		114.4	%		97.8	%		134.9	%					115.2	%

Standard Commercial Segment

Gross premiums written for the Standard Commercial Segment were $58.3 million for the nine months ended September 30, 2012, which was $5.6 million, or 11%, more than the $52.7 million reported for the same period in 2011. Net premiums written were $53.2 million for the nine months ended September 30, 2012 as compared to $48.6 million reported for the same period in 2011. The increase in premium volume was primarily due to the acquisition of our Workers Compensation business unit during the third quarter of 2011.

Total revenue for the Standard Commercial Segment of $53.8 million for the nine months ended September 30, 2012 was $0.1 million less than the $53.9 million reported during the same period in 2011. This decrease in total revenue was mostly due to an adverse profit share commission revenue adjustment of $1.4 million during the nine months ended September 30, 2012 as compared to a favorable profit share commission revenue adjustment of $2.7 million during the same period of 2011. This decrease in total revenue was offset by increased net premiums earned of $3.3 million due primarily to the acquisition of our Workers Compensation business unit during the third quarter of 2011 and higher net investment income of $0.7 million.

Our Standard Commercial Segment reported a pre-tax loss of $2.6 million for the nine months ended September 30, 2012 as compared to pre-tax loss of $0.9 million for the same period of 2011. The decreased revenue discussed above and higher operating expenses of $1.5 million primarily due to the acquisition of our Workers Compensation business unit during the third quarter of 2011 contributed to this increase in pre-tax loss for the nine months ended September 30, 2012. Further contributing to this increase in pre-tax loss were higher loss and LAE expenses of $0.1 million.

The Standard Commercial Segment reported a net loss ratio of 76.9% for the nine months ended September 30, 2012 as compared to 81.9% for the same period in 2011. The gross loss ratio before reinsurance for the nine months ended September 30, 2012 was 75.4% as compared to the 81.0% reported for the same period of 2011. The lower gross and net loss ratios for the nine months ended September 30, 2012 were aided by lower current accident year loss trends excluding catastrophe losses. The net loss ratios for the nine months ended September 30, 2012 and 2011 include $9.4 million and $7.5 million, respectively, of weather related losses. During the nine months ended September 30, 2012 and 2011 the Standard Commercial Segment reported $2.9 million and $0.2 million, respectively, of favorable prior years’ loss reserve development.

Specialty Commercial Segment

Gross premiums written for the Specialty Commercial Segment were $178.7 million for the nine months ended September 30, 2012, which was $41.7 million, or 30%, more than the $137.0 million reported for the same period in 2011. Net premiums written were $141.7 million for the nine months ended September 30, 2012 as compared to $108.0 million reported for the same period in 2011. The increase in premium volume was primarily due to increased premium production in our E&S Commercial business unit, Excess & Umbrella business unit and our space risk program partially offset by reduced premium volume in our General Aviation business unit.

The $129.8 million of total revenue for the Specialty Commercial Segment during the nine months ended September 30, 2012 was $25.4 million higher than the $104.4 million reported for the same period in 2011. This increase in revenue was due to higher net premiums earned of $23.6 million due predominately to increased production discussed above. Further contributing to this increased revenue was higher net investment income of $1.4 million and a favorable profit share commission revenue adjustment of $0.1 million for the nine months ended September 30, 2012 as compared to an adverse profit share commission revenue adjustment of $0.4 million for the same period of 2011, partially offset by lower finance charges of $0.1 million.

Pre-tax income for the Specialty Commercial Segment of $17.2 million for the first nine months of 2012 was $10.2 million higher than the $7.0 million reported for the same period in 2011. The increase in pre-tax income was primarily due to the increased revenue discussed above partially offset by higher loss and LAE expenses of $10.1 million, higher operating expenses of $4.8 million and $0.3 million in expense related to the acquisition of the non-controlling interest in our Excess & Umbrella business unit during the third quarter of 2012. Our E&S Commercial business unit reported a $9.0 million increase in loss and LAE due primarily to increased premium volume partially offset by lower accident year loss trends, our Excess & Umbrella business unit reported a $0.6 million increase in loss and LAE due to increased premium production and our space risk program reported a $1.2 million increase in loss and LAE due primarily to a $1.0 million claim incurred during the third quarter of 2012. These increases in loss and LAE were partially offset by a $0.7 million decrease in loss and LAE in our General Aviation business unit due primarily to a decline in premium volume. The increased operating expenses for the first nine months of 2012 were primarily the result of increased production related expenses of $4.3 million and higher salary and related expense of $0.8 million, partially offset by lower professional service fees of $0.3 million.

The Specialty Commercial Segment reported a net loss ratio of 62.8% for the nine months ended September 30, 2012 as compared to 67.6% for the same period during 2011. The lower net loss ratio was due primarily to $3.6 million favorable prior year loss reserve development for the nine months ended September 30, 2012 as compared to $1.1 million adverse development of prior year loss reserves for the same period the prior year.

Personal Segment

Gross premiums written for the Personal Segment were $60.7 million for the nine months ended September 30, 2012, which was $20.4 million, or 25%, less than the $81.1 million reported for the same period in 2011. The decrease in premium was due mostly to the impact of rate increases, the reduction of premium written in Florida and exiting certain other underperforming states and programs.

Total revenue for the Personal Segment decreased 11% to $68.5 million for the first nine months of 2012 from $76.6 million for the first nine months of 2011. Lower earned premium of $7.7 million and lower finance charges of $0.5 million were the primary reason for the decrease in revenue for the period. The decrease in revenue was partially offset by increased net investment income of $0.1 million during the first nine months of 2012.

Pre-tax loss for the Personal Segment was $5.7 million for the nine months ended September 30, 2012 as compared to pre-tax loss of $22.3 million for the same period of 2011. The lower pre-tax loss was the result of lower losses and LAE of $23.2 million and lower operating expenses of $1.4 million, primarily production related expenses. The decline in pre-tax loss was partially offset by lower revenue discussed above.

The Personal Segment reported a net loss ratio of 84.3% for the nine months ended September 30, 2012 as compared to 108.1% for the same period of 2011. The decrease in the net loss ratio was primarily due to normalizing claims experience during the first nine months of 2012 as compared to extremely adverse claims development during the same period in 2011 due to rapid growth in the Florida claim volume and the complexity related to Florida personal injury protection claims. The loss ratio for the nine months ended September 30, 2012 included improving current accident year loss trends in our non-standard auto line of business partially offset by increased weather and fire related losses in our low value dwelling/homeowners line of business. The loss and LAE during the nine months ended September 30, 2012 included $2.9 million of adverse prior year development as compared to $17.2 million of adverse prior year development for the same period during 2011.

Corporate

Total revenue for Corporate decreased by $3.7 million for the nine months ended September 30, 2012 as compared to the same period the prior year. This decrease in total revenue was due primarily to gains of $1.8 million recognized on our investment portfolio for the nine months ended September 30, 2012 as compared to $3.2 million of gains recognized during the same period in 2011. Further contributing to this decrease in revenue was lower net investment income of $2.3 million for the nine months ended September 30, 2012 as compared to the same period of the prior year.

Corporate pre-tax loss was $8.1 million for the nine months ended September 30, 2012 as compared to a $4.0 million pre-tax loss for the same period the prior year. The increase in pre-tax loss was the result of the decreased revenue discussed above and higher operating expenses of $0.4 million due primarily to lower reductions recorded to the expected earn-out payable in conjunction with the acquisition of HNIC during the nine months ended September 30, 2012 as compared to the same period in 2011.

Financial Condition and Liquidity

Sources and Uses of Funds

Our sources of funds are from insurance-related operations, financing activities and investing activities. Major sources of funds from operations include premiums collected (net of policy cancellations and premiums ceded), commissions, and processing and service fees. As a holding company, Hallmark is dependent on dividend payments and management fees from its subsidiaries to meet operating expenses and debt obligations. As of September 30, 2012, Hallmark had $3.7 million in unrestricted cash and cash equivalents at the holding company. Unrestricted cash and cash equivalents of our non-insurance subsidiaries were $8.4 million as of September 30, 2012. As of that date, our insurance subsidiaries held $95.6 million of unrestricted cash and cash equivalents as well as $384.3 million in debt securities with an average modified duration of 2.6 years. Accordingly, we do not anticipate selling long-term debt instruments to meet any liquidity needs.

AHIC and TBIC, domiciled in Texas, are limited in the payment of dividends to their stockholders in any 12-month period, without the prior written consent of the Texas Department of Insurance, to the greater of statutory net income for the prior calendar year or 10% of statutory policyholders’ surplus as of the prior year end. Dividends may only be paid from unassigned surplus funds. HIC, domiciled in Arizona, is limited in the payment of dividends to the lesser of 10% of prior year policyholders’ surplus or prior year's net investment income, without prior written approval from the Arizona Department of Insurance. HSIC, domiciled in Oklahoma, is limited in the payment of dividends to the greater of 10% of prior year policyholders’ surplus or prior year’s statutory net income, not including realized capital gains, without prior written approval from the Oklahoma Insurance Department. HNIC, domiciled in Ohio, is limited in the payment of dividends to the greater of 10% of statutory policyholders’ surplus as of the prior December 31 or statutory net income as of the prior December 31 without prior written approval from the Ohio Insurance Department. During 2012, the aggregate ordinary dividend capacity of these subsidiaries is $20.3 million, of which $15.0 million is available to Hallmark. As a county mutual, dividends from HCM are payable to policyholders. None of our insurance company subsidiaries paid a dividend to Hallmark during the first nine months of 2012 or the 2011 fiscal year.

Comparison of September 30, 2012 to December 31, 2011

On a consolidated basis, our cash and investments (excluding restricted cash) at September 30, 2012 were $533.7 million compared to $499.1 million at December 31, 2011. The acquisition of debt securities for which $6.5 million settled subsequent to quarter end and a $6.5 million federal income tax refund during the second quarter of 2012 were the primary reasons for this increase, as well as other cash flow from operations.

Comparison of Nine Months Ended September 30, 2012 and September 30, 2011

Net cash provided by our consolidated operating activities was $28.2 million for the first nine months of 2012 compared to net cash provided by operating activities of $15.0 million for the first nine months of 2011. The increase in operating cash flow was primarily due to a $6.5 million federal income tax refund during the second quarter of 2012 and higher premiums collected during the first nine months of 2012 as compared to the same period in 2011.

Net cash provided by investing activities during the first nine months of 2012 was $8.1 million as compared to net cash used in investing activities of $19.2 million for the same period of 2011. The increase in cash provided by investing activities during the first nine months of 2012 was due to a decrease in purchases of debt and equity securities of $131.6 million, a $14.0 million payment for the acquisition of HNIC during the first quarter 2011 partially offset by $0.7 million in net cash received in connection with the acquisition of TBIC Holdings during the third quarter 2011, and a decrease in purchases of property and equipment of $1.4 million, partially offset by a decrease in maturities, sales and redemptions of investment securities of $119.0 million.

Cash used in financing activities during the first nine months of 2012 was $3.1 million as a result of a $2.6 million repayment on our revolving credit facility, a $0.4 million payment of contingent consideration for the acquisition of TBIC, and a $0.1 million distribution to non-controlling interest for our Excess & Umbrella business unit. Cash used in financing activities during the first nine months of 2011 was $6.9 million primarily related to the repurchase of the Company’s common stock during the second quarter of 2011.

Credit Facilities

Subordinated Debt Securities

On June 21, 2005, we entered into a trust preferred securities transaction pursuant to which we issued $30.9 million aggregate principal amount of subordinated debt securities due in 2035. To effect the transaction, we formed a Delaware statutory trust, Hallmark Statutory Trust I (“Trust I”). Trust I issued $30.0 million of preferred securities to investors and $0.9 million of common securities to us. Trust I used the proceeds from these issuances to purchase the subordinated debt securities. Our Trust I subordinated debt securities bear an initial interest rate of 7.725% until June 15, 2015, at which time interest will adjust quarterly to the three-month LIBOR rate plus 3.25 percentage points. Trust I pays dividends on its preferred securities at the same rate. Under the terms of our Trust I subordinated debt securities, we pay interest only each quarter and the principal of the note at maturity. The subordinated debt securities are uncollaterized and do not require maintenance of minimum financial covenants. As of September 30, 2012, the balance of our Trust I subordinated debt was $30.9 million.

On August 23, 2007, we entered into a trust preferred securities transaction pursuant to which we issued $25.8 million aggregate principal amount of subordinated debt securities due in 2037. To effect the transaction, we formed a Delaware statutory trust, Hallmark Statutory Trust II (“Trust II”). Trust II issued $25.0 million of preferred securities to investors and $0.8 million of common securities to us. Trust II used the proceeds from these issuances to purchase the subordinated debt securities. Our Trust II subordinated debt securities bear an initial interest rate of 8.28% until September 15, 2017, at which time interest will adjust quarterly to the three-month LIBOR rate plus 2.90 percentage points. Trust II pays dividends on its preferred securities at the same rate. Under the terms of our Trust II subordinated debt securities, we pay interest only each quarter and the principal of the note at maturity. The subordinated debt securities are uncollaterized and do not require maintenance of minimum financial covenants. As of September 30, 2012, the balance of our Trust II subordinated debt was $25.8 million.

Item 3. Quantitative and Qualitative Disclosures About Market Risk.

There have been no material changes to the market risks discussed in Item 7A to Part II of our Form 10-K for the fiscal year ended December 31, 2011.

Item 4. Controls and Procedures.

The principal executive officer and principal financial officer of Hallmark have evaluated our disclosure controls and procedures and have concluded that, as of the end of the period covered by this report, such disclosure controls and procedures were effective in ensuring that information required to be disclosed by us in the reports that we file or submit under the Securities Exchange Act of 1934 is timely recorded, processed, summarized and reported. The principal executive officer and principal financial officer also concluded that such disclosure controls and procedures were effective in ensuring that information required to be disclosed by us in the reports that we file or submit under such Act is accumulated and communicated to our management, including our principal executive officer and principal financial officer, as appropriate, to allow timely decisions regarding required disclosure. During the most recent fiscal quarter, there have been no changes in our internal controls over financial reporting that have materially affected, or are reasonably likely to materially affect, our internal control over financial reporting.

Risks Associated with Forward-Looking Statements Included in this Form 10-Q

This Form 10-Q contains certain forward-looking statements within the meaning of Section 27A of the Securities Act of 1933 and Section 21E of the Securities Exchange Act of 1934, which are intended to be covered by the safe harbors created thereby. These statements include the plans and objectives of management for future operations, including plans and objectives relating to future growth of our business activities and availability of funds. The forward-looking statements included herein are based on current expectations that involve numerous risks and uncertainties. Assumptions relating to the foregoing involve judgments with respect to, among other things, future economic, competitive and market conditions, regulatory framework, weather-related events and future business decisions, all of which are difficult or impossible to predict accurately and many of which are beyond our control. Although we believe that the assumptions underlying the forward-looking statements are reasonable, any of the assumptions could be inaccurate and, therefore, there can be no assurance that the forward-looking statements included in this Form 10-Q will prove to be accurate. In light of the significant uncertainties inherent in the forward-looking statements included herein, the inclusion of such information should not be regarded as a representation by us or any other person that our objectives and plans will be achieved.

PART II

OTHER INFORMATION

Item 1.

Legal Proceedings.

Item 1A.

Risk Factors.

There have been no material changes to the risk factors discussed in Item 1A to Part 1 of our Form 10-K for the fiscal year ended December 31, 2011.

Item 2.

Unregistered Sales of Equity Securities and Use of Proceeds.

None.

Item 3.

Defaults Upon Senior Securities.

None.

Item 4.

Mine Safety Disclosures.

None.

Item 5.

Other Information.

None.

Item 6.

Exhibits.

The following exhibits are filed herewith or incorporated herein by reference:

Exhibit
Number		Description

3(a)		Restated Articles of Incorporation of the registrant, as amended (incorporated by reference to Exhibit 3.1 to the registrant’s Registration Statement on Form S-1 [Registration No. 333-136414] filed September 8, 2006).
3(b)		Amended and Restated By-Laws of the registrant (incorporated by reference to Exhibit 3.1 to the registrant’s Current Report on Form 8-K filed October 1, 2007).
10.1		Ninth Amendment to First Restated Credit Agreement among Hallmark Financial Services, Inc. and its subsidiaries and Frost Bank dated July 10, 2012 (incorporated by reference to Exhibit 10.1 to the registrant’s Current Report on Form 8-K filed July 12, 2012).

10.2		Tenth Amendment to First Restated Credit Agreement among Hallmark Financial Services, Inc. and its subsidiaries and Frost Bank dated September 30, 2012 (incorporated by reference to Exhibit 10.1 to the registrant’s Current Report on Form 8-K filed October 1, 2012).

31(a)		Certification of principal executive officer required by Rule 13a-14(a) or Rule 15d-14(a).

31(b)		Certification of principal financial officer required by Rule 13a-14(a) or Rule 15d-14(a).
32(a)		Certification of principal executive officer Pursuant to 18 U.S.C. 1350.
32(b)		Certification of principal financial officer Pursuant to 18 U.S.C. 1350.

101
INS+		XBRL Instance Document.

101
SCH+		XBRL Taxonomy Extension Schema Document.

Exhibit
Number		Description

101
CAL+		XBRL Taxonomy Extension Calculation Linkbase Document.

101
LAB+		XBRL Taxonomy Extension Label Linkbase Document.

101
PRE+		XBRL Taxonomy Extension Presentation Linkbase Document.

101
DEF+		XBRL Taxonomy Extension Definition Linkbase Document.

+		Furnished with this Quarterly Report on Form 10-Q and included in Exhibit 101 to this report are the following documents formatted in XBRL (Extensible Business Reporting Language): (i) the Consolidated Balance Sheets as of September 30, 2012 and December 31, 2011, (ii) the Consolidated Statements of Operations for the three and nine months ended September 30, 2012 and 2011, (iii) Consolidated Statements of Comprehensive Income for the three and nine months ended September 30, 2012 and 2011, (iv) Consolidated Statements of Stockholder’s Equity for the three and nine months ended September 30, 2012 and 2011, (v) the Consolidated Statements of Cash Flows for the nine months ended September 30, 2012 and 2011, and (vi) related notes.

SIGNATURES

In accordance with the requirements of the Exchange Act, the registrant has caused this report to be signed on its behalf by the undersigned, thereunto duly authorized.

HALLMARK FINANCIAL SERVICES, INC.

(Registrant)

Date: November 7, 2012	/s/ Mark J. Morrison
	Mark J. Morrison, Chief Executive Officer and President

Date: November 7, 2012	/s/ Jeffrey R. Passmore
	Jeffrey R. Passmore, Chief Accounting Officer and Senior Vice President