Hallmark Financial Services (HALL) 8-K Announces Fourth Quarter and Year 2006 Earnings Results

FOR IMMEDIATE RELEASE

HALLMARK FINANCIAL SERVICES, INC.

ANNOUNCES FOURTH QUARTER AND YEAR 2006 EARNINGS RESULTS

FORT WORTH, Texas, (March 20, 2006) - Hallmark Financial Services, Inc. (NASDAQ: HALL) today reported quarterly net income of $4.7 million for the fourth quarter ended December 31, 2006, representing a 63% increase from the $2.9 million in net income for the fourth quarter of 2005. Diluted earnings per share for the three months ended December 31, 2006, were $0.23, representing a 15% increase over the $0.20 in diluted earnings per share for the same period of the prior year. Affecting the diluted per share earnings was the issuance of 3 million common shares from the successful completion of the Company’s underwritten public offering during the fourth quarter of 2006.

Hallmark also reported net income of $9.2 million and diluted earnings per share of $0.53 for the year ended December 31, 2006, compared to net income of $9.2 million and diluted earnings per share of $0.76 in the prior year. During the year ended December 31, 2006, Hallmark recorded $9.6 million of interest expense from amortization attributable to the deemed discount on convertible promissory notes issued in January 2006, and converted to common stock during the second quarter of 2006. In the absence of this non-cash expense, the Company's net income for the year ended December 31, 2006, would have been $15.3 million, representing a 66% increase over fiscal 2005, and its diluted earnings per share would have been $0.89 for the year ended December 31, 2006. Diluted earnings per share for the year ended December 31, 2006 were also impacted by the public offering in the fourth quarter.

During the three months and year ended December 31, 2006, Hallmark reported total revenues of $54.7 million and $202.7 million, representing 105% and 133% increases, respectively, over the $26.6 million and $87.0 million in total revenues for the comparable periods of 2005.

Mark J. Morrison, President and Chief Executive Officer, said, "We are very pleased with the results the Company achieved for 2006. Each of our reporting segments performed well during the year and contributed significantly to the overall results. Our record revenues and operating profits for the year are primarily due to recent acquisitions and increased premium retention, as well as year-over-year improvements in underwriting results and operational efficiency. Looking forward, we expect growth in gross written premium to continue into 2007 and beyond as a result of both increased retention of existing business and organic growth.”

Mark E. Schwarz, Executive Chairman of Hallmark, stated, “I believe that 2006 was a landmark year for our company in which we made excellent progress in implementing our long-term strategic goals.  We began the year with the acquisitions of the enterprises now comprising our Aerospace Operating Unit and TGA Operating Unit, which added significant breadth to the organization. These operating units, which constitute our Specialty Commercial Segment, have performed to our expectations and have been successfully integrated into our operational structure.  Our continuing goal is to selectively acquire businesses like these as a means to expand our existing segments into new specialty and niche markets. In addition, the successful completion of our public offering in the fourth quarter of 2006 has broadened our shareholder base and provided the capital structure needed to support the increased premium retention we anticipate.” 

	Three Months Ended					��	Year Ended
	December 31,						December 31,
	2006			2005			2006			2005
	($ in thousands)
Gross premiums written	$	60,227		$	26,482		$	213,945		$	89,467
Net premiums written		56,752			25,819			202,928			88,252
Net premiums earned		47,174			20,457			152,061			59,184
Commission and fee income		3,120			3,169			35,343			16,703
Net investment income		2,956			1,562			10,461			3,836
Net realized gain (loss) on investments		35			6			(1,466	)		58
Total revenues		54,669			26,638			202,741			87,035
Net Income		4,730			2,894			9,191			9,186
EPS - Basic	$	0.23		$	0.20		$	0.53		$	0.76
EPS - Diluted	$	0.23		$	0.20		$	0.53		$	0.76
Return on Average Equity		13.9	%		13.8	%		7.8	%		15.6	%
Adjusted Net Income (1)		4,730			2,894			15,257			9,186
Adjusted EPS - Basic (1)	$	0.23		$	0.20		$	0.89		$	0.76
Adjusted EPS - Diluted (1)	$	0.23		$	0.20		$	0.89		$	0.76
Adjusted Return on Average Equity (1)		13.9	%		13.8	%		17.2	%		15.6	%
Book Value Per Share	$	7.26		$	5.89		$	7.26		$	5.89

(1)       Adjusted to exclude the effect of the non-cash interest expense charge of $6.1 million (net of tax) resulting from the convertible promissory notes issued and converted during the year.

The following reconciles Hallmark's year to date net income, diluted earnings per share and return on average equity computed without the interest expense from amortization attributable to the deemed discount on convertible promissory notes to its reported results (in thousands). Management believes this reconciliation provides useful supplemental information in evaluating the operating results of Hallmark’s business. This disclosure should not be viewed as a substitute for net income, diluted earnings per share and return on average equity determined in accordance with U.S. generally accepted accounting principles (“GAAP”):

	Income excluding interest expense from amortization of discount, net of tax			Interest expense from amortization of discount		Tax effect			Net Income
Year ended December 31, 2006	$	15,257		$	9,625	$	(3,559	)	$	9,191
Weighted average shares - basic		17,181								17,181
Weighted average shares - diluted		17,194								17,194
Average shareholders' equity		117,960								117,960
Net income per share - basic	$	0.89							$	0.53
Net income per share - diluted	$	0.89							$	0.53
Return on average equity		17.2	%							7.8	%

Excluding the effect of the non-cash interest expense charge, the increase in net income for the three months and year ended December 31, 2006 versus the same periods in 2005 was primarily attributable to the results of Hallmark's Specialty Commercial Segment, the subsidiaries of which were acquired January 1, 2006, the retention of business produced by its Standard Commercial Segment beginning in the third quarter of 2005 and additional investment income.

The acquisitions of the subsidiaries comprising the Specialty Commercial Segment in the first quarter of 2006 contributed $24.7 million and $80.7 million to the increase in total revenues for the three months and year ended December 31, 2006, respectively, as compared to the same periods in 2005. The retention of business produced by the Standard Commercial Segment that was previously retained by third parties also contributed $8.0 million and $48.3 million to the increase in revenue for the three months and year ended December 31, 2006, respectively, but was partially offset by lower ceding commissions and fee revenues of $6.3 million and $18.3 million for the three months and year ended December 31, 2006, respectively, primarily attributable to the shift from a third-party agency structure to an insurance underwriting structure.

Net investment income for the three months and year ended December 31, 2006 were $3.0 million and $10.5 million, respectively, compared to $1.6 million and $3.8 million for the similar periods in 2005. The quarter and fiscal year increases of 89% and 173%, respectively, reflected higher interest rates and greater average cash and invested assets in 2006 attributable to positive cash flow from operations and reinvestment of the strong earnings. The fiscal year increase was partially offset by net realized losses on our investment portfolio of $1.5 million for fiscal 2006 as compared to nominal net realized gains during fiscal 2005.

Hallmark's net losses and loss adjustment expenses and its net loss ratio for the three months ended December 31, 2006 were $26.6 million and 56.5%, respectively, compared to $11.2 million and 54.7%, respectively, for the same period in 2005. The net losses and loss adjustment expenses and net loss ratio for the year ended December 31, 2006 were $87.1 million and 57.3%, respectively, compared to $33.8 million and 57.1%, respectively, for the same period of 2005. For the three months ended December 31, 2006, the Company had a reduction in its projected favorable development of prior years’ loss reserve estimates of $0.3 million, as compared to $1.2 million of favorable development recognized for the same period in 2005. For the year ended December 31, 2006, the Company recognized $1.2 million in favorable development of prior years’ loss reserve estimates as compared to $2.4 million of favorable development during 2005.

Hallmark's other operating costs and expenses and its expense ratio for the three months ended December 31, 2006 were $19.5 million and 28.1%, respectively, compared to $10.7 million and 32.4%, respectively, for the same period in 2005. Other operating costs and expenses and the expense ratio for the year ended December 31, 2006 were $83.6 million and 28.4%, respectively, compared to $38.5 million and 30.8% for the same period of 2005.

Hallmark Financial Services, Inc. is an insurance holding company which, through its subsidiaries, engages in the sale of property and casualty insurance products to businesses and individuals. The Company's business involves marketing, distributing, underwriting and servicing commercial insurance in Texas, New Mexico, Idaho, Oregon, Montana, Louisiana, Oklahoma, Arkansas and Washington; marketing, distributing, underwriting and servicing non- standard personal automobile insurance in Texas, New Mexico, Arizona, Oklahoma, Arkansas, Idaho, Oregon and Washington; marketing, distributing, underwriting and servicing general aviation insurance in 47 states; and providing other insurance related services. The Company is headquartered in Fort Worth, Texas and its common stock is presently listed on NASDAQ under the symbol "HALL."

Forward-looking statements in this Release are made pursuant to the “safe harbor” provisions of the Private Securities Litigation Act of 1995. Investors are cautioned that actual results may differ substantially from such forward-looking statements. Forward-looking statements involve risks and uncertainties including, but not limited to, continued acceptance of the Company’s products and services in the marketplace, competitive factors, interest rate trends, the availability of financing, underwriting loss experience and other risks detailed from time to time in the Company’s periodic report filings with the Securities and Exchange Commission.

For further information, please contact:

Mark J. Morrison, President and Chief Executive Officer at 817.348.1600

www.hallmarkgrp.com

HALLMARK FINANCIAL SERVICES, INC. AND SUBSIDIARIES

CONSOLIDATED BALANCE SHEETS

December 31, 2006 and 2005

(In thousands)

ASSETS	2006			2005
Investments:
Debt securities, available-for-sale, at fair value	$	125,784		$	79,360
Equity securities, available-for-sale, at fair value		4,580			3,403
Short-term investments, available-for-sale, at fair value		25,275			12,281
Total investments		155,639			95,044
Cash and cash equivalents		81,474			44,528
Restricted cash and investments		31,815			13,802
Prepaid reinsurance premiums		1,629			767
Premiums receivable		44,644			26,530
Accounts receivable		13,223			2,083
Reinsurance recoverable		5,930			444
Deferred policy acquisition costs		17,145			9,164
Excess of cost over fair value of net assets acquired		31,427			4,836
Intangible assets		26,074			459
Deferred federal income taxes		-			3,992
Prepaid expenses		1,769			802
Other assets		5,184			6,455
	$	415,953		$	208,906
LIABILITIES AND STOCKHOLDERS’ EQUITY
Liabilities:
Notes payable	$	35,763		$	30,928
Structured settlements		24,587			-
Reserves for unpaid losses and loss adjustment expenses		77,564			26,321
Unearned premiums		91,606			36,027
Unearned revenue		5,734			4,055
Reinsurance balances payable		1,060			116
Accrued agent profit sharing		1,784			2,173
Accrued ceding commission payable		3,956			11,430
Pension liability		3,126			2,932
Deferred federal income taxes		2,310			-
Current federal income tax payable		2,132			300
Accounts payable and other accrued expenses		15,600			9,436
		265,222			123,718
Commitments and contingencies
Stockholders’ equity:
Common stock, $.18 par value, authorized 33,333,333 shares in 2006 and 16,666,667
shares in 2005; issued 20,776,066 shares in 2006 and 14,476,102 shares in 2005		3,740			2,606
Capital in excess of par value		117,932			62,907
Retained earnings		31,480			22,289
Accumulated other comprehensive loss		(2,344	)		(2,597	)
Treasury stock, 7,828 shares in 2006 and 2,470 shares in 2005, at cost		(77	)		(17	)
Total stockholders’ equity		150,731			85,188
	$	415,953		$	208,906

Hallmark Financial Services, Inc. and Subsidiaries

Consolidated Statements of Operations

($ in thousands, except per share amounts)

	Three Months Ended December 31,						Year Ended December 31,
	2006			2005			2006			2005
Gross premiums written	$	60,227		$	26,482		$	213,945		$	89,467
Ceded premiums written		(3,475	)		(663	)		(11,017	)		(1,215	)
Net premiums written		56,752			25,819			202,928			88,252
Change in unearned premiums		(9,578	)		(5,362	)		(50,867	)		(29,068	)
Net premiums earned		47,174			20,457			152,061			59,184
Investment income, net of expenses		2,956			1,562			10,461			3,836
Realized gain (loss)		35			6			(1,466	)		58
Finance charges		1,043			508			3,983			2,044
Commission and fees		3,120			3,169			35,343			16,703
Processing and service fees		336			931			2,330			5,183
Other income		5			5			29			27
Total revenues		54,669			26,638			202,741			87,035
Losses and loss adjustment expenses		26,639			11,200			87,117			33,784
Other operating costs and expenses		19,486			10,740			83,583			38,492
Interest expense		1,024			600			5,798			1,264
Interest expense from amortization of discount on convertible notes		-			-			9,625			-
Amortization of intangible asset		574			(4	)		2,293			27
Total expenses		47,723			22,536			188,416			73,567
Income before tax		6,946			4,102			14,325			13,468
Income tax expense		2,216			1,208			5,134			4,282
Net income		4,730			2,894			9,191			9,186
Common stockholders net income per share:
Basic	$	0.23		$	0.20		$	0.53		$	0.76
Diluted	$	0.23		$	0.20		$	0.53		$	0.76

Hallmark Financial Services, Inc.

Consolidated Segment Data

	Three Months Ended December 31, 2006
	Standard			Specialty
	Commercial			Commercial			Personal
	Segment			Segment			Segment			Corporate			Consolidated
Produced premium		22,322			40,872			11,019			-			74,213
Gross premiums written		22,186			27,022			11,019			-			60,227
Ceded premiums written		(2,728	)		(747	)		-			-			(3,475	)
Net premiums written		19,458			26,275			11,019			-			56,752
Change in unearned premiums		250			(9,767	)		(61	)		-			(9,578	)
Net premiums earned		19,708			16,508			10,958			-			47,174
Total revenues		17,557			24,686			12,054			372			54,669
Loss and loss adjustment expenses		11,634			7,939			7,074			(8	)		26,639
Pre-tax income		512			6,384			2,000			(1,950	)		6,946
Loss ratio (1)		59.0	%		48.1	%		64.6	%					56.5	%
Expense ratio (2)		29.3	%		30.5	%		22.6	%					28.1	%
Combined ratio (3)		88.3	%		78.6	%		87.2	%					84.6	%

	Three Months Ended December 31, 2005
	Standard		Specialty
	Commercial		Commercial	Personal
	Segment		Segment	Segment		Corporate		Consolidated
Produced premium	19,512		-	8,337		-		27,849
Gross premiums written	18,083		-	8,399		-		26,482
Ceded premiums written	(1,151	)	-	488		-		(663	)
Net premiums written	16,932		-	8,887		-		25,819
Change in unearned premiums	(5,248	)	-	(114	)	-		(5,362	)
Net premiums earned	11,684		-	8,773		-		20,457
Total revenues	15,873		-	10,738		27		26,638
Loss and loss adjustment expenses	6,979		-	4,237		(16	)	11,200
Pre-tax income	1,890		-	3,981		(1,769	)	4,102
Loss ratio (1)	59.7	%		48.3	%			54.7	%
Expense ratio (2)	34.2	%		30.0	%			32.4	%
Combined ratio (3)	93.9	%		78.3	%			87.1	%

Hallmark Financial Services, Inc.

Consolidated Segment Data

	Year Ended December 31, 2006
	Standard			Specialty
	Commercial			Commercial			Personal
	Segment			Segment			Segment			Corporate			Consolidated
Produced premium		91,679			156,482			45,135			-			293,296
Gross premiums written		91,070			77,740			45,135			-			213,945
Ceded premiums written		(8,850	)		(2,167	)		-			-			(11,017	)
Net premiums written		82,220			75,573			45,135			-			202,928
Change in unearned premiums		(12,146	)		(35,903	)		(2,818	)		-			(50,867	)
Net premiums earned		70,074			39,670			42,317			-			152,061
Total revenues		75,325			80,689			46,998			(271	)		202,741
Loss and loss adjustment expenses		38,799			21,908			26,443			(33	)		87,117
Pre-tax income		11,757			14,309			8,760			(20,501	)		14,325
Loss ratio (1)		55.4	%		55.2	%		62.5	%					57.3	%
Expense ratio (2)		29.4	%		30.5	%		24.9	%					28.4	%
Combined ratio (3)		84.8	%		85.7	%		87.4	%					85.7	%

	Year Ended December 31, 2005
	Standard			Specialty
	Commercial			Commercial		Personal
	Segment			Segment		Segment			Corporate			Consolidated
Produced premium		81,721			-		36,345			-			118,066
Gross premiums written		52,952			-		36,515			-			89,467
Ceded premiums written		(1,703	)		-		488			-			(1,215	)
Net premiums written		51,249			-		37,003			-			88,252
Change in unearned premiums		(29,498	)		-		430			-			(29,068	)
Net premiums earned		21,751			-		37,433			-			59,184
Total revenues		43,067			-		43,907			61			87,035
Loss and loss adjustment expenses		12,610			-		21,239			(65	)		33,784
Pre-tax income		6,651			-		11,647			(4,830	)		13,468
Loss ratio (1)		58.0	%				56.7	%					57.1	%
Expense ratio (2)		34.4	%				28.8	%					30.8	%
Combined ratio (3)		92.4	%				85.5	%					87.9	%

¹ Net loss ratio is calculated as total net losses and loss adjustment expenses divided by net premiums earned, each determined in accordance with GAAP.

² Net expense ratio is calculated as total underwriting expenses of our insurance company subsidiaries, including allocated overhead expenses and offset by agency fee income, divided by net premiums earned, each determined in accordance with GAAP. During the fourth quarter of fiscal 2006, we adopted the widely used industry calculation that offsets expenses with agency fee income. All prior period comparative expense ratios have been restated.

³ Net combined ratio is calculated as the sum of the net loss ratio and the net expense ratio.