Hallmark Financial Services 10Q 2022 Q1 Quarterly report

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UNITED STATES

SECURITIES AND EXCHANGE COMMISSION

WASHINGTON, D.C. 20549

FORM 10-Q

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

(Mark One) Securities Exchange Act of 1934

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

For the quarterly period ended March 31, 2022

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

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.)

5420 Lyndon B. Johnson Freeway, Suite 1100, Dallas, Texas	75240

(Address of principal executive offices)	(Zip Code)

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

Securities registered pursuant to Section 12(b) of the Act:



Title of each class	Trading Symbol(s)	Name of each exchange on which registered
Common Stock, $0.18 par value	HALL	Nasdaq Global Market

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 ☒ No ☐

Indicate by check mark whether the registrant has submitted electronically every Interactive Data File required to be submitted 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 such files). Yes ☒ No ☐

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


Large accelerated filer ☐	Accelerated filer ☐

Non-accelerated filer ☒	Smaller reporting company ☒	Emerging growth company ☐

If an emerging growth company, indicate by check mark if the registrant has elected not to use the extended transition period for complying with any new or revised financial accounting standards provided pursuant to Section 15(a) of the Exchange Act. ☐

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

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 $0.18 per share –18,190,418 shares outstanding as of May 12, 2022.

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PART I

FINANCIAL INFORMATION

Item 1. Financial Statements

INDEX TO FINANCIAL STATEMENTS

	Page Number

Consolidated Balance Sheets at March 31, 2022 (unaudited) and December 31, 2021	3
Consolidated Statements of Operations (unaudited) for the three months ended March 31, 2022 and March 31, 2021	4
Consolidated Statements of Comprehensive (Loss) Income (unaudited) for the three months ended March 31, 2022 and March 31, 2021	5
Consolidated Statements of Stockholders’ Equity (unaudited) for the three months ended March 31, 2022 and March 31, 2021	6
Consolidated Statements of Cash Flows (unaudited) for the three months ended March 31, 2022 and March 31, 2021	7
Notes to Consolidated Financial Statements (unaudited)	8

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Hallmark Financial Services, Inc. and Subsidiaries

Consolidated Balance Sheets

($ in thousands, except par value)


		March 31,		December 31,
	2022		2021
		(unaudited)
ASSETS
Investments:
Debt securities, available-for-sale, at fair value (amortized cost; $389,582 in 2022 and $288,175 in 2021)	$	388,254	$	290,073
Equity securities (cost; $46,125 in 2022 and $42,120 in 2021)		52,604		48,695
Total investments		440,858		338,768

Cash and cash equivalents		183,377		352,867
Restricted cash		4,239		3,810
Ceded unearned premiums		142,645		146,433
Premiums receivable		88,420		90,621
Accounts receivable		20,094		6,914
Receivable for securities		1,209		1,326
Reinsurance recoverable		545,266		549,964
Deferred policy acquisition costs		6,847		6,811
Intangible assets, net		693		819
Federal income tax recoverable		14,748		18,217
Deferred federal income taxes, net		9,412		8,906
Prepaid expenses		5,389		2,389
Other assets		26,666		25,753
Total assets	$	1,489,863	$	1,553,598
LIABILITIES AND STOCKHOLDERS’ EQUITY
Liabilities:
Senior unsecured notes due 2029 (less unamortized debt issuance cost of $721 in 2022 and $746 in 2021)	$	49,279	$	49,254
Subordinated debt securities (less unamortized debt issuance cost of $730 in 2022 and $744 in 2021)		55,972		55,959
Reserves for unpaid losses and loss adjustment expenses		798,338		816,681
Unearned premiums		276,485		284,427
Reinsurance payable		85,980		117,908
Pension liability		59		174
Payable for securities		2,374		3,280
Accounts payable and other liabilities		51,540		50,394
Total liabilities		1,320,027		1,378,077
Commitments and contingencies (Note 17)
Stockholders’ equity:
Common stock, $.18 par value, authorized 33,333,333 shares; issued 20,872,831 shares in 2022 and 2021		3,757		3,757
Additional paid-in capital		122,741		122,844
Retained earnings		71,484		74,703
Accumulated other comprehensive loss		(3,563)		(1,035)
Treasury stock (2,682,413 shares in 2022 and 2,700,364 in 2021), at cost		(24,583)		(24,748)
Total stockholders’ equity		169,836		175,521
Total liabilities and stockholders’ equity	$	1,489,863	$	1,553,598

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

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Hallmark Financial Services, Inc. and Subsidiaries

Consolidated Statements of Operations

(Unaudited)

($ in thousands, except per share amounts)



	Three Months Ended March 31,
	2022		2021
Gross premiums written	$	150,959	$	163,018
Ceded premiums written		(72,638)		(71,521)
Net premiums written		78,321		91,497
Change in unearned premiums		4,155		10,355
Net premiums earned		82,476		101,852

Investment income, net of expenses		1,859		3,010
Investment gains, net		51		5,779
Finance charges		983		1,133
Commission and fees		287		260
Other income		16		19

Total revenues		85,672		112,053

Losses and loss adjustment expenses		64,024		69,479
Operating expenses		24,377		29,972
Interest expense		1,264		1,249
Amortization of intangible assets		126		126

Total expenses		89,791		100,826

(Loss) income before tax		(4,119)		11,227
Income tax (benefit) expense		(900)		2,256
Net (loss) income	$	(3,219)	$	8,971

Net (loss) income per share:
Basic	$	(0.18)	$	0.49
Diluted	$	(0.18)	$	0.49

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

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Hallmark Financial Services, Inc. and Subsidiaries

Consolidated Statements of Comprehensive (Loss) Income

(Unaudited)

($ in thousands)



	Three Months Ended
	March 31,
	2022		2021
Net (loss) income	$	(3,219)	$	8,971
Other comprehensive (loss) income:
Change in net actuarial gain		27		43
Tax effect on change in net actuarial gain		(6)		(9)
Unrealized holding (losses) gains arising during the period		(3,081)		585
Tax effect on unrealized holding losses (gains) arising during the period		647		(123)
Reclassification adjustment for gains included in net (loss) income		(146)		(1,403)
Tax effect on reclassification adjustment for gains included in net (loss) income		31		295
Other comprehensive loss, net of tax		(2,528)		(612)
Comprehensive (loss) income	$	(5,747)	$	8,359

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

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Hallmark Financial Services, Inc. and Subsidiaries

Consolidated Statements of Stockholders’ Equity

(Unaudited)

($ in thousands)


	Three Months Ended
	March 31,
	2022		2021
Common Stock
Balance, beginning of period	$	3,757	$	3,757

Balance, end of period		3,757		3,757

Additional Paid-In Capital
Balance, beginning of period		122,844		122,893
Equity based compensation		62		97
Shares issued under employee benefit plans		(165)		(265)
Balance, end of period		122,741		122,725

Retained Earnings
Balance, beginning of period		74,703		65,697
Net income (loss)		(3,219)		8,971
Balance, end of period		71,484		74,668

Accumulated Other Comprehensive Income
Balance, beginning of period		(1,035)		383
Additional minimum pension liability, net of tax		21		34
Unrealized holding (losses) gains arising during period, net of tax		(2,434)		462
Reclassification adjustment for gains included in net (loss) income, net of tax		(115)		(1,108)
Balance, end of period		(3,563)		(229)

Treasury Stock
Balance, beginning of period		(24,748)		(25,026)
Shares issued under employee benefit plans		165		265
Balance, end of period		(24,583)		(24,761)

Total Stockholders' Equity	$	169,836	$	176,160

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

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Hallmark Financial Services, Inc. and Subsidiaries

Consolidated Statements of Cash Flows

(Unaudited)

($ in thousands)


	Three Months Ended March 31,
	2022		2021
Cash flows from operating activities:
Net (loss) income	$	(3,219)	$	8,971

Adjustments to reconcile net (loss) income to cash used in operating activities:
Depreciation and amortization expense		706		830
Deferred federal income taxes (benefit) expense		(339)		568
Investment (gains) losses , net		(51)		(5,779)
Share-based payments expense (benefit)		62		97
Change in ceded unearned premiums		3,788		5,436
Change in premiums receivable		2,201		10,533
Change in accounts receivable		(13,180)		1,342
Change in deferred policy acquisition costs		(36)		1,454
Change in reserves for losses and loss adjustment expenses		(18,343)		22,504
Change in unearned premiums		(7,942)		(15,791)
Change in reinsurance recoverable		4,698		(6,008)
Change in reinsurance balances		(31,928)		6,155
Change in federal income tax payable (recoverable)		3,469		1,687
Change in all other liabilities		1,069		515
Change in all other assets		(2,936)		(3,038)
Net cash (used in) provided by operating activities		(61,981)		29,476
Cash flows from investing activities:
Purchases of property and equipment		(631)		(64)
Purchases of investment securities		(166,832)		(27,829)
Maturities, sales and redemptions of investment securities		60,383		177,392
Net cash (used in) provided by investing activities		(107,080)		149,499
(Decrease) increase in cash and cash equivalents and restricted cash		(169,061)		178,975
Cash and cash equivalents and restricted cash at beginning of period		356,677		108,308
Cash and cash equivalents and restricted cash at end of period	$	187,616	$	287,283

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

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Hallmark Financial Services, Inc. and Subsidiaries

Notes to Consolidated Financial Statements (Unaudited)

1. General

Hallmark Financial Services, Inc. (“Hallmark” and, together with subsidiaries, the “Company”, “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 our insurance products, as well as providing other insurance related services.

We market, distribute, underwrite and service our property/casualty insurance products primarily through business units organized by products and distribution channels. Our business units are supported by our insurance company subsidiaries. Our Commercial Auto business unit offers primary and excess commercial vehicle insurance products and services; our E&S Casualty business unit offers primary and excess liability, excess public entity liability, E&S package and garage liability insurance products and services; our E&S Property business unit offers primary and excess commercial property insurance for both catastrophe and non-catastrophe exposures; our Professional Liability business unit offers healthcare and financial lines professional liability insurance products and services primarily for businesses, medical professionals, medical facilities and, through 2020, senior care facilities; and our Aerospace & Programs business unit offers general aviation and, until exited during 2020, satellite launch property/casualty insurance products and services, as well as certain specialty programs. Our Commercial Accounts business unit offers package and monoline property/casualty and, until exited in 2016, occupational accident insurance products. Our Specialty Personal Lines business unit offers non-standard personal automobile and renters insurance products and services. Our former Workers Compensation operating unit specialized in small and middle market workers compensation business until discontinued during 2015. Our insurance company subsidiaries supporting these business 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 business units are segregated into 3 reportable industry segments for financial accounting purposes. The Specialty Commercial Segment includes our Commercial Auto business unit, E&S Casualty business unit, E&S Property business unit, Professional Liability business unit and Aerospace & Programs business unit. The Standard Commercial Segment consists of the Commercial Accounts business unit and the runoff from our former Workers Compensation operating unit. The Personal Segment consists solely of our Specialty Personal Lines business unit.

2. Basis of Presentation

Our unaudited consolidated financial statements included herein have been prepared in accordance with accounting principles generally accepted in the United States of America (“GAAP”) and include our accounts and the accounts of our subsidiaries. All intercompany accounts and transactions have been eliminated in consolidation. Certain 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, 2021 included in our Annual Report on Form 10-K filed with the SEC.

The interim financial data as of March 31, 2022 and 2021 is unaudited. However, in the opinion of management, the interim financial 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 three month periods ended March 31, 2022 and 2021, are not necessarily indicative of the operating results to be expected for the full year.

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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, 2021 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 consolidated balance sheets for these instruments approximate their fair values.

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

Senior Unsecured Notes Due 2029: Our senior unsecured notes payable due in 2029 had a carrying value of $49.3 million and a fair value of $48.3 million as of March 31, 2022. Our senior unsecured notes payable would be included in Level 3 of the fair value hierarchy if they were reported at fair value

Subordinated Debt Securities: Our trust preferred securities had a carrying value of $56.0 million and a fair value of $30.6 million as of March 31, 2022. Our trust preferred securities would be included in Level 3 of the fair value hierarchy if they were reported at fair value.

For accounts receivable, reinsurance balances, premiums receivable, federal income tax recoverable and other assets, the carrying amounts are held at net realizable value which approximates fair value because of the short maturity of such financial instruments.

Variable Interest Entities

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 Trust II (collectively the “Trusts”) and have determined that we do not have a variable interest in the Trusts. Therefore, the Trusts are not included in our consolidated financial statements.

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Income Taxes

We file a consolidated federal income tax return. Deferred federal income taxes reflect the future tax consequences of differences between the tax basis 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. Net deferred tax assets are held at their net realizable value and an allowance is taken as needed. The Company recognizes interest and penalties related to uncertain tax positions in income tax expense. There were no uncertain tax positions at March 31, 2022.

Recently Issued Accounting Pronouncements

In March 2020, the FASB issued ASU 2020-04, Reference Rate Reform ("ASU 2020-04"). ASU 2020-04 provides optional guidance for a limited period of time to ease potential accounting impact associated with transitioning away from reference rates that are expected to be discontinued, such as the London Interbank Offered Rate ("LIBOR"). The amendments in this ASU apply only to contracts, hedging relationships, and other transactions that reference LIBOR or another reference rate expected to be discontinued. The amendments in ASU 2020-04 could be adopted as of March 12, 2020 and are effective through December 31, 2022. We do not currently have any contracts that have been changed to a new reference rate and do not expect the adoption of this guidance to have a material effect on the Company’s results of operations, financial position or liquidity.

In June 2016, the FASB issued ASU 2016-13, “Measurement of Credit Losses on Financial Instruments” (Topic 326). ASU 2016-13 requires organizations to estimate credit losses on certain types of financial instruments, including receivables and available-for-sale debt securities, by introducing an approach based on expected losses. The expected loss approach will require entities to incorporate considerations of historical information, current information and reasonable and supportable forecasts. As a smaller reporting company, ASU 2016-13 is effective for fiscal years of the Company beginning after December 15, 2022, including interim periods within those fiscal years. ASU 2016-13 requires a modified retrospective transition method and early adoption is permitted. We are currently evaluating the impact that the adoption of this standard will have on our financial results and disclosures, but do not anticipate that any potential impact would be material.

3. Fair Value

ASC 820 defines fair value, establishes a consistent framework for measuring fair value and requires disclosure 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.

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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 equity securities.

Level 2 investment securities include corporate bonds, collateralized corporate bank loans, municipal bonds, U.S. Treasury securities, other obligations of the U.S. Government and mortgage-backed 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. We have not adjusted any prices received from third-party pricing sources. There were no transfers between Level 1 and Level 2 securities.

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, assets that are measured at fair value on a recurring basis at March 31, 2022 and December 31, 2021 (in thousands):


	As of March 31, 2022
	Quoted Prices in
	Active Markets for
	Identical Assets		Other Observable		Unobservable
	(Level 1)		Inputs (Level 2)		Inputs (Level 3)		Total
U.S. Treasury securities and obligations of U.S. Government	$	0	$	42,483	$	0	$	42,483
Corporate bonds		0		222,120		0		222,120
Corporate bank loans		0		80,018		0		80,018
Municipal bonds		0		41,889		0		41,889
Mortgage-backed		0		1,744		0		1,744
Total debt securities		0		388,254		0		388,254
Total equity securities		52,604		0		0		52,604
Total investments	$	52,604	$	388,254	$	0	$	440,858

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	As of December 31, 2021
	Quoted Prices in
	Active Markets for
	Identical Assets		Other Observable		Unobservable
	(Level 1)		Inputs (Level 2)		Inputs (Level 3)		Total
U.S. Treasury securities and obligations of U.S. Government	$	0	$	62,984	$	0	$	62,984
Corporate bonds		0		105,234		347		105,581
Corporate bank loans		0		81,189		0		81,189
Municipal bonds		0		38,464		0		38,464
Mortgage-backed		0		1,855		0		1,855
Total debt securities		0		289,726		347		290,073
Total equity securities		48,695		0		0		48,695
Total investments	$	48,695	$	289,726	$	347	$	338,768

Due to significant unobservable inputs into the valuation model for 1 corporate bond as of December 31, 2021, we classified this investment as Level 3 in the fair value hierarchy. The corporate bond is a convertible senior note and its fair value was estimated by the sum of the bond value using an income approach discounting the scheduled interest and principal payments and the conversion feature utilizing a binomial lattice model.

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) during the three months ended March 31, 2022 and 2021 (in thousands):


Beginning balance as of January 1, 2022	$	347
Sales		0
Settlements		(347)
Purchases		0
Issuances		0
Total realized/unrealized losses included in net income		0
Net gain included in other comprehensive income		0
Transfers into Level 3		0
Transfers out of Level 3		0
Ending balance as of March 31, 2022	$	0


Beginning balance as of January 1, 2021	$	347
Sales		0
Settlements		0
Purchases		0
Issuances		0
Total realized/unrealized gains included in net loss		0
Net gains included in other comprehensive loss		7
Transfers into Level 3		0
Transfers out of Level 3		0
Ending balance as of March 31, 2021	$	354

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4. Investments

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


			Gross		Gross
		Amortized Cost/	Unrealized		Unrealized
	Carrying Value		Gains		Losses		Fair Value
As of March 31, 2022
U.S. Treasury securities and obligations of U.S. Government	$	43,175	$	0	$	(692)	$	42,483
Corporate bonds		221,775		1,454		(1,109)		222,120
Corporate bank loans		81,024		9		(1,015)		80,018
Municipal bonds		41,862		144		(117)		41,889
Mortgage-backed		1,746		11		(13)		1,744
Total debt securities		389,582		1,618		(2,946)		388,254
Total equity securities		46,125		9,833		(3,354)		52,604
Total investments	$	435,707	$	11,451	$	(6,300)	$	440,858


				Gross		Gross
		Amortized Cost/		Unrealized		Unrealized
As of December 31, 2021		Carrying Value		Gains		Losses		Fair Value
U.S. Treasury securities and obligations of U.S. Government	$	63,098	$	56	$	(170)	$	62,984
Corporate bonds		103,515		2,115		(49)		105,581
Corporate bank loans		81,570		84		(465)		81,189
Municipal bonds		38,162		372		(70)		38,464
Mortgage-backed		1,830		29		(4)		1,855
Total debt securities		288,175		2,656		(758)		290,073
Total equity securities		42,120		9,355		(2,780)		48,695
Total investments	$	330,295	$	12,011	$	(3,538)	$	338,768

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


	Three Months Ended March 31,
	2022		2021
Corporate bonds	$	12	$	197
Corporate bank loans		5		51
Municipal bonds		0		(9)
Equity securities		129		1,164
Gain on investments		146		1,403
Unrealized (losses) gain on equity investments		(95)		4,376
Investment gains, net	$	51	$	5,779

We realized gross gains on investments of $152 thousand and $1.5 million during the three months ended March 31, 2022 and 2021, respectively. We realized gross losses on investments of $6 thousand and $0.1 million for the three months ended March 31, 2022 and 2021, respectively. We recorded proceeds from the sale of investment securities of $0.5 million and $1.2 million during the three months ended March 31, 2022 and 2021, respectively. Realized investment gains and losses are recognized in operations on the first in-first out method.

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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 March 31, 2022 and December 31, 2021 (in thousands):


	As of March 31, 2022
	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	$	42,483	$	(692)	$	0	$	0	$	42,483	$	(692)
Corporate bonds		130,766		(1,089)		1,149		(20)		131,915		(1,109)
Corporate bank loans		45,991		(480)		28,458		(535)		74,449		(1,015)
Municipal bonds		9,149		(106)		838		(11)		9,987		(117)
Mortgage-backed		1,669		(8)		9		(5)		1,678		(13)
Total debt securities		230,058		(2,375)		30,454		(571)		260,512		(2,946)
Total equity securities		14,165		(1,484)		3,922		(1,870)		18,087		(3,354)
Total investments	$	244,223	$	(3,859)	$	34,376	$	(2,441)	$	278,599	$	(6,300)


	As of December 31, 2021
	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	$	43,273	$	(170)	$	0	$	0	$	43,273	$	(170)
Corporate bonds		0		0		2,245		(49)		2,245		(49)
Corporate bank loans		42,256		(177)		16,763		(288)		59,019		(465)
Municipal bonds		3,321		(58)		1,038		(12)		4,359		(70)
Mortgage-backed		0		0		10		(4)		10		(4)
Total debt securities		88,850		(405)		20,056		(353)		108,906		(758)
Total equity securities		6,221		(710)		5,055		(2,070)		11,276		(2,780)
Total investments	$	95,071	$	(1,115)	$	25,111	$	(2,423)	$	120,182	$	(3,538)

We had a total of 197 debt securities with an unrealized loss, of which 164 were in an unrealized loss position for less than one year and 33 were in an unrealized loss position for a period of one year or greater, as of March 31, 2022. We held a total of 100 debt securities with an unrealized loss, of which 74 were in an unrealized loss position for less than one year and 26 were in an unrealized loss position for a period of one year or greater, as of December 31, 2021. We consider these losses as a temporary decline in value as they are on securities 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. The gross unrealized losses on the debt security positions at March 31, 2022 and December 31, 2021 were due predominately to market and interest rate fluctuations and 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 future write-downs within our portfolio of debt securities.

We complete a detailed analysis each quarter to assess whether any decline in the fair value of any debt security below cost is deemed other-than-temporary. All debt securities with an unrealized loss are reviewed. We recognize an impairment loss when a debt security’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. We did 0t recognize any impairment loss on debt securities during the three months ended March 31, 2022 and 2021, respectively.

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)

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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. We did 0t dispose of any previously impaired securities during the three months ended March 31, 2022 or 2021, respectively.

Equity Investments: Equity investments that are not consolidated or accounted for under the equity method of accounting with readily determinable fair values are not required to be evaluated for other-than-temporary-impairment.

The amortized cost and estimated fair value of debt securities at March 31, 2022 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 Cost		Fair Value

	(in thousands)
Due in one year or less	$	98,318	$	98,804
Due after one year through five years		222,617		221,341
Due after five years through ten years		59,833		59,300
Due after ten years		7,068		7,065
Mortgage-backed		1,746		1,744
	$	389,582	$	388,254

5. 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 $30.0 million at March 31, 2022 and December 31, 2021, respectively.

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6. Reserves for Unpaid Losses and Loss Adjustment Expenses

Year to-date activity in the consolidated reserves for unpaid losses and LAE is summarized as follows (in thousands):


	March 31,		March 31,
	2022		2021
Balance at January 1	$	816,681	$	789,768
Less reinsurance recoverable		387,915		357,200
Net balance at January 1		428,766		432,568

Incurred related to:
Current year		56,333		71,565
Prior years		7,691		(2,086)
Total incurred		64,024		69,479

Paid related to:
Current year		12,757		7,067
Prior years		62,213		52,360
Total paid		74,970		59,427

Net balance at March 31		417,820		442,620
Plus reinsurance recoverable		380,518		369,652
Balance at March 31	$	798,338	$	812,272

The year to date impact from the unfavorable (favorable) net prior years’ loss development on each reporting segment is presented below:


	March 31,
	2022		2021
Specialty Commercial Segment	$	6,380	$	(1,899)
Standard Commercial Segment		(262)		(1,361)
Personal Segment		1,573		1,174
Total unfavorable (favorable) net prior year development	$	7,691	$	(2,086)

The following describes the primary factors behind each segment’s prior accident year reserve development for the three months ended March 31, 2022 and 2021:

Three months ended March 31, 2022:

●

Specialty Commercial Segment. Our Commercial Auto business unit experienced net unfavorable development in the 2020 and 2019 accident years primarily in the exited contract binding commercial automobile liability line of business, partially offset by net favorable development in both the primary and excess commercial automobile lines of business in the 2021 accident year. Our E&S Property business unit experienced net unfavorable development due to the development of catastrophe-related losses in the 2021 and 2020 accident years. We experienced net unfavorable development in our E&S Casualty and Professional Liability business units. We experienced net favorable development in our and Aerospace & Programs business unit..

●

Standard Commercial Segment. Our Commercial Accounts business unit experienced net favorable development in our commercial auto liability and property lines of business in accident years 2021 and 2020, partially offset by net unfavorable development in the general liability lines of business in accident

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years 2019 and 2016. The run-off from our former Workers Compensation operating unit experienced net favorable development in the 2015 and prior accident years.

●

Personal Segment. Net unfavorable development in our Specialty Personal Lines business unit was driven predominately by unfavorable development attributable to the 2021 and 2020 accident years due in part to rising inflationary trends, specifically loss costs, that the industry began experiencing in 2021.

Three months ended March 31, 2021:

●

Specialty Commercial Segment. Our Commercial Auto business unit experienced net favorable development in the 2020 and 2019 accident years both in the primary and excess commercial automobile liability lines of business, partially offset by net unfavorable development in the excess commercial automobile lines of business in the 2018, 2017 and 2016 accident years. Our E&S Casualty business unit experienced net unfavorable development primarily in our primary liability line of business in the 2018 and prior accident years, partially offset by net favorable development in the 2019 accident year. We experienced net favorable development in our E&S Property, Professional Liability and Aerospace & Programs business units.

●

Standard Commercial Segment. Our Commercial Accounts business unit experienced net favorable development in our commercial property lines of business in accident year 2020, partially offset by net unfavorable development in the general liability lines of business in accident years 2020 and 2017. The run-off from our former Workers Compensation operating unit experienced net favorable development in the 2014 and prior accident years.

●

Personal Segment. Net unfavorable development in our Specialty Personal Lines business unit was driven predominately by unfavorable development attributable to the 2020, 2019 and 2017 accident years.

7. Share-Based Payment Arrangements

Our 2015 Long Term Incentive Plan (“2015 LTIP”) was approved by shareholders on May 29, 2015. There are 2,000,000 shares authorized for issuance under the 2015 LTIP. As of March 31, 2022, restricted stock units representing the right to receive up to 768,177 shares of our common stock were outstanding under the 2015 LTIP. There were 0 stock option awards granted under the 2015 LTIP as of March 31, 2022.

Stock Options:

There were 0 stock options outstanding at any point during the three months ended March 31, 2022. There were no stock options granted, exercised or forfeited during the three months ended March 31, 2022 or 2021, respectively. As of March 31, 2022, there was 0 unrecognized compensation cost related to non-vested stock options.

Restricted Stock Units:

Restricted stock units awarded under the 2015 LTIP represent the right to receive shares of common stock upon the satisfaction of vesting requirements, performance criteria and other terms and conditions. For grants issued prior to 2021, restricted stock units vest and shares of common stock become issuable on March 31 of the third calendar year following the year of grant if performance criteria have been satisfied. Restricted stock units awarded under the 2015 LTIP during 2021 cumulatively vest up to 50%, 80% and 100%, and shares of common stock become issuable, on March 31 of the third, fourth and fifth calendar years, respectively, following the year of grant if performance criteria have been satisified.

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The performance criteria for restricted stock units vary based on grantee. The number of shares of common stock to be received ranges from 50% to 150% of the number of restricted stock units granted based on the level of achievement of the performance criteria. Grantees of restricted stock units do not have any rights of a stockholder, and do not participate in any distributions to our common stockholders, until the award fully vests upon satisfaction of the vesting schedule, performance criteria and other conditions set forth in their award agreement. Therefore, unvested restricted stock units are not considered participating securities under ASC 260, “Earnings Per Share” (Topic 260), and are not included in the calculation of basic or diluted earnings per share.

Compensation cost is measured as an amount equal to the fair value of the restricted stock units on the date of grant and is expensed over the vesting period if achievement of the performance criteria is deemed probable, with the amount of the expense recognized based on our best estimate of the ultimate achievement level. The grant date fair value of restricted stock units granted in 2018, 2019 and 2021 was $10.87, $18.10 and $4.21 per unit, respectively. We incurred compensation expense of $62 thousand and $97 thousand related to restricted stock units during the three months ended March 31, 2022 and 2021, respectively. We recorded income tax benefit of $13 thousand and $20 thousand related to restricted stock units during the three months ended March 31, 2022 and 2021, respectively.

The following table details the status of our restricted stock units as of and for the three months ended March 31, 2022 and 2021.



	Number of Restricted Stock Units
	2022	2021
Nonvested at January 1	581,689	228,827
Granted	8,313	0
Vested	(17,951)	(28,874)
Forfeited	(59,933)	(130,903)
Nonvested at March 31	512,118	69,050

As of March 31, 2022, there was $1.9 million of unrecognized grant date compensation cost related to unvested restricted stock units assuming compensation cost accrual at target achievement level. Based on the current performance estimate, we expect to recognize $1.7 million of compensation cost related to unvested restricted stock units, of which $0.5 million is expected to be recognized during the remainder of 2022, $0.7 million in 2023, $0.4 million in 2024, $0.1 million in 2025 and $22 thousand in 2026.

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8. Segment Information

The following is business segment information for the three months ended March 31, 2022 and 2021 (in thousands):


	Three Months Ended March 31,
	2022		2021
Revenues
Specialty Commercial Segment	$	51,911	$	69,599
Standard Commercial Segment		17,128		17,688
Personal Segment		16,819		18,959
Corporate		(186)		5,807
Consolidated	$	85,672	$	112,053

Pre-tax (loss) income
Specialty Commercial Segment	$	2,565	$	11,348
Standard Commercial Segment		(692)		366
Personal Segment		(1,026)		(1,623)
Corporate		(4,966)		1,136
Consolidated	$	(4,119)	$	11,227

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


	March 31,		December 31,
Assets:	2022		2021
Specialty Commercial Segment	$	1,105,918	$	1,163,947
Standard Commercial Segment		193,088		194,594
Personal Segment		125,340		128,165
Corporate		65,517		66,892
Consolidated	$	1,489,863	$	1,553,598

9. 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 March 31, 2022 was with reinsurers that had an A.M. Best rating of “A-” or better. We also mitigate our credit risk for the remaining reinsurance recoverable by obtaining letters of credit.

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


	Three Months Ended
	March 31,
	2022		2021

Ceded earned premiums	$	76,425	$	76,957
Reinsurance recoveries	$	66,581	$	61,899

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Loss Portfolio Transfer

On July 16, 2020, AHIC, HIC, HSIC, HCM and HNIC (collectively, the “Hallmark Insurers”), entered into a Loss Portfolio Transfer Reinsurance Contract to be effective as of January 1, 2020 (the “LPT Contract”) with DARAG Bermuda Ltd. (“DARAG Bermuda”) and DARAG Insurance (Guernsey) Limited (“DARAG Guernsey” and, collectively, the “Reinsurers”). The LPT Contract was consummated on July 31, 2020. The Company recorded a $21.7 million pre-tax loss during the third quarter of 2020 attributable to the closing of the LPT Contract.

Pursuant to the LPT Contract, (a) the Hallmark Insurers ceded to the Reinsurers all existing and future claims for losses occurring on or prior to December 31, 2019 on the binding primary commercial automobile liability insurance policies and the brokerage primary commercial automobile liability insurance policies issued by the Hallmark Insurers (the “Subject Business”) up to an aggregate limit of $240.0 million, with (i) the first layer of $151.2 million in reinsurance provided by DARAG Bermuda, (ii) the Hallmark Insurers retaining a loss corridor of the next $24.9 million in losses on the Subject Business, (iii) DARAG Bermuda reinsuring a second layer of $27.8 million above the first layer and the Hallmark Insurers’ loss corridor, and (iv) DARAG Guernsey reinsuring the top layer of $36.1 million in losses on the Subject Business, in each case net of third-party reinsurance and other recoveries; (b) the Hallmark Insurers will continue to manage and retain the benefit of other third-party reinsurance on the Subject Business; and (c) the Hallmark Insurers paid the Reinsurers a net reinsurance premium of $92.6 million. In connection with the closing, the parties also entered into a Services Agreement and a Trust Agreement. Pursuant to the Services Agreement, DARAG Bermuda assumed responsibility for certain administrative services, including claims handling, for the Subject Business. Pursuant to the Trust Agreement, the Reinsurers made initial cash deposits in the aggregate amount of $96.7 million into collateral trust accounts with The Bank of New York Mellon, as trustee, to be held as security for the Reinsurers’ obligations to the Hallmark Insurers under the LPT Contract. The Reinsurers and the Hallmark Insurers have agreed to submit to binding arbitration a dispute that has arisen regarding the rights and obligations of the parties under the LPT Contract. Pending resolution of the dispute, the Hallmark Insurers have agreed to fund the payment of claims under the LPT contract without prejudice to their right to seek reimbursement and other relief in the arbitration proceedings. (See Note 18.) As of March 31, 2022, our consolidated balance sheet included a $13.5 million account receivable from DARAG related to the Hallmark Insurers funding claim payments under the LPT contract pending resolution of the dispute.

As of March 31, 2022, the ultimate incurred losses from the subject business were $243.6 million or $3.6 million in excess of the aggregate limit of $240.0 million. Our reinsurance recoverables of $545.3 million include $52.4 million related to the LPT Contract as of March 31, 2022.

10. Subordinated Debt Securities

We issued trust preferred securities through Trust I and Trust II. These Delaware statutory trusts are sponsored and wholly-owned by Hallmark and each was created solely for the purpose of issuing the trust preferred securities. Each trust pays dividends on its preferred securities at the same rate each quarter as interest is paid on the junior subordinated debt securities. Under the terms of the junior subordinated debt securities, we pay interest only each quarter and the principal of each note at maturity. The subordinated debt securities of each trust are uncollateralized and do not require maintenance of minimum financial covenants.

The following table summarizes the nature and terms of the junior subordinated debt and trust preferred securities:


		Hallmark		Hallmark
		Statutory		Statutory
		Trust I		Trust II

Issue date		June 21, 2005		August 23, 2007
Principal amount of trust preferred securities	$	30,000	$	25,000
Principal amount of junior subordinated debt securities	$	30,928	$	25,774
Maturity date of junior subordinated debt securities		June 15, 2035		September 15, 2037

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Trust common stock	$	928	$	774
Interest rate, per annum		Three Month LIBOR + 3.25%		Three Month LIBOR + 2.90%
Current interest rate at March 31, 2022		4.08%		3.73%

11. Senior Unsecured Notes

On August 19, 2019, Hallmark issued $50.0 million of senior unsecured notes (“Notes”) due August 15, 2029. Interest on the Notes accrues at the rate of 6.25% per annum and is payable semi-annually in arrears commencing February 15, 2020. The Notes are not obligations of or guaranteed by any of Hallmark’s subsidiaries and are not subject to any sinking fund requirements. At Hallmark’s option, the Notes are redeemable, in whole or in part, prior to the stated maturity subject to certain provisions intended to make the holders of the Notes whole on scheduled interest and principal payments. The indenture governing the Notes contains covenants which, among other things, restrict Hallmark’s ability to incur additional indebtedness, make certain payments, create liens on the stock of certain subsidiaries, dispose of certain assets, or merge or consolidate with other entities. The terms of the indenture prohibit payments or other distributions on any security of the Company that ranks junior to the Notes when the Company’s debt to capital ratio (as defined in the indenture) is greater than 35%. The Company’s debt to capital ratio was 38.3% as of March 31, 2022.

12. Deferred Policy Acquisition Costs

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


	Three Months Ended
	March 31,
	2022		2021

Deferred	$	(24,325)	$	(15,103)
Amortized		24,289		16,557
Net	$	(36)	$	1,454

13. Earnings per Share

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


	Three Months Ended
	March 31,
	2022	2021

Weighted average shares - basic	18,172	18,142
Effect of dilutive securities	0	0
Weighted average shares - assuming dilution	18,172	18,142

We had 0 shares of common stock potentially issuable upon exercise of employee stock options for the three months ended March 31, 2022. For the three months ended March 31, 2021, we had 14,157 shares of common stock potentially issuable upon the exercise of employee stock options which were excluded from the weighted average number of shares outstanding on a diluted basis because the effect of such options would be anti-dilutive. These instruments, to the extent not previously cancelled or exercised, expired in 2021.

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14. Net Periodic Pension Cost

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


	Three Months Ended
	March 31,
	2022		2021
Interest cost	$	75	$	68
Amortization of net loss		27		43
Expected return on plan assets		(191)		(177)
Net periodic pension cost	$	(89)	$	(66)
Contributed amount	$	0	$	0

15. Income Taxes

Our effective income tax rate for the three months ended March 31, 2022 and 2021 was 21.8% and 20.1%, respectively. The effective tax rates for the three months ended March 31, 2022 and 2021 varied from the statutory tax rates primarily due to tax exempt interest. We concluded that 0 valuation allowance was necessary against our deferred tax assets as of March 31, 2022 and December 31, 2021.

16. Supplemental Cash Flow Information

The following table provides a reconciliation of cash, cash equivalents and restricted cash reported in the consolidated balance sheet to the total of the same such amounts shown in the statement of cash flows (in thousands):


	As of March 31,
	2022		2021

Cash and cash equivalents	$	183,377	$	281,849
Restricted cash		4,239		5,434
Total cash, cash equivalents and restricted cash shown in the statement of cash flows	$	187,616	$	287,283

Restricted cash represents amounts required to be set aside by a contractual agreement with a third-party insurer and amounts pledged for the benefit of various state insurance departments.

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The following table provides supplemental cash flow information for the three months ended March 31, 2022 and 2021:


	Three Months Ended March 31,
	2022		2021


Interest paid	$	1,577	$	1,576

Supplemental schedule of non-cash investing activities:

Receivable for securities related to investment disposals	$	1,209	$	1,382

Payable for securities related to investment purchases	$	2,374	$	10,979

17. Commitments and Contingencies

The Reinsurers and the Hallmark Insurers have agreed to submit to binding arbitration a dispute that has arisen regarding the rights and obligations of the parties under the LPT Contract. (See Note 10.) Pending resolution of the dispute, the Hallmark Insurers have agreed to fund the payment of claims under the LPT Contract without prejudice to their right to seek reimbursement and other relief in the arbitration proceedings. The arbitration panel has not yet been constituted and no pleadings have been submitted. However, based on prior negotiations, the Company expects the Reinsurers to seek rescission of the LPT Contract on the basis of alleged breach and fraudulent inducement by the Hallmark Insurers. The Company believes any such claims are without factual basis or legal merit and intends to vigorously contest the matter. The Company also intends to pursue an arbitration award enforcing the terms of the LPT Contract and reimbursing the Hallmark Insurers for all claim amounts funded by them during the pendency of the arbitration, as well as all other damages sustained by the Hallmark Insurers. The arbitration panel is currently being constituted, and no pleadings have yet been submitted. Because the dispute is at an initial stage, we are unable at this time to provide an evaluation of the likelihood of an adverse outcome.

As of March 31, 2022 we were engaged in various 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 were a party are routine in nature and incidental to our business.

From time to time, assessments are levied on us by the guaranty association of the states where we offer our insurance products. Such assessments are made primarily to cover the losses of policyholders of insolvent or rehabilitated insurers. Since these assessments can generally be recovered through a reduction in future premium taxes paid, we capitalize the assessments that can be recovered as they are paid and amortize the capitalized balance against our premium tax expense. We did 0t pay an assessment during the first three months of 2022 or 2021.

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18. Changes in Accumulated Other Comprehensive (Loss) Income Balances

The changes in accumulated other comprehensive (loss) income balances as of March 31, 2022 and 2021 were as follows (in thousands):


					Accumulated Other
	Pension		Unrealized		Comprehensive
	Liability		Gains (Loss)		Income (Loss)
Balance at January 1, 2021	$	(3,762)	$	4,145	$	383
Other comprehensive loss:
Change in net actuarial gain		43		0		43
Tax effect on change in net actuarial gain		(9)		0		(9)
Unrealized holding losses arising during the period		0		585		585
Tax effect on unrealized holdings losses arising during the period		0		(123)		(123)
Reclassification adjustment for gains included in net income		0		(1,403)		(1,403)
Tax effect on reclassification adjustment for gains included in net income		0		295		295
Other comprehensive loss, net of tax		34		(646)		(612)

Balance at March 31, 2021	$	(3,728)	$	3,499	$	(229)

Balance at January 1, 2022	$	(2,641)	$	1,606	$	(1,035)
Other comprehensive income:
Change in net actuarial gain		27		0		27
Tax effect on change in net actuarial gain		(6)		0		(6)
Unrealized holding gains arising during the period		0		(3,081)		(3,081)
Tax effect on unrealized holding gains arising during the period		0		647		647
Reclassification adjustment for gains included in net income		0		(146)		(146)
Tax effect on reclassification adjustment for gains included in net income		0		31		31
Other comprehensive loss, net of tax		21		(2,549)		(2,528)

Balance at March 31, 2022	$	(2,620)	$	(943)	$	(3,563)

19. Leases

Right-of-use assets are included in the other assets line item and lease liabilities are included in the other liabilities line item of the consolidated balance sheet. We determine if a contract contains a lease at inception and recognize operating lease right-of-use assets and operating lease liabilities based on the present value of the future minimum lease payments at the commencement date. Since our leases do not provide an implicit rate, we use our incremental borrowing rate based on the information available at the commencement date in determining the present value of future payments. Lease agreements have lease and non-lease components, which are accounted for as a single lease component. Lease expense is recognized on a straight-line basis over the lease term.

The Company’s operating lease obligations predominately pertain to office leases utilized in the operation of our business. Our leases have remaining terms of one to 12 years, some of which include options to extend the leases. The components of lease expense and other lease information as of and during the three month periods ended March 31, 2022 and 2021 were as follows (in thousands):

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	Three Months Ended		Three Months Ended
	March 31,		March 31,
	2022		2021

Operating lease cost	$	673	$	719

Cash paid for amounts included in the measurement of lease liabilities
Operating cash flows from operating leases	$	547	$	545

Right-of-use assets obtained in exchange for new operating lease liabilities	$	0	$	0

Other lease information as of March 31, 2022 and December 31, 2021 are as follows (in thousands):


	March 31,		December 31,
	2022		2021

Operating lease right-of-use assets	$	13,495	$	13,211

Operating lease liabilities	$	15,455	$	15,062

Weighted-average remaining lease term - operating leases		11.0		11.4

Weighted-average discount rate - operating leases		6.22%		6.22%

We incurred $0.1 million in short-term lease payments not included in our lease liability during the three months ended March 31, 2022.

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Future minimum lease payments under non-cancellable leases as of March 31, 2022 and December 31, 2021 were as follows (in thousands):


	March 31,			December 31,
	2022			2021

2022	$	1,772	$	2,171
2023		2,224		2,023
2024		2,421		2,216
2025		2,537		2,450
2026		2,497		2,497
Thereafter		15,767		15,767
Total future minimum lease payments	$	27,218	$	27,124

Less imputed interest	$	(11,763)	$	(12,062)
Total operating lease liability	$	15,455	$	15,062

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,” “our,” or the Company) 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 our insurance products, 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 Specialty Commercial business which is written on a national basis. We pursue our business activities through subsidiaries whose operations are organized into product-specific 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:

●

Specialty Commercial Segment. Our Specialty Commercial Segment includes our Commercial Auto business unit which offers primary and excess commercial vehicle insurance products and services; our E&S Casualty business unit which offers primary and excess liability, excess public entity liability and E&S package and garage liability insurance products and services; our E&S Property business unit which offers primary and excess commercial property insurance for both catastrophe and non-catastrophe exposures; our Professional Liability business unit which offers healthcare and financial lines professional liability insurance products and services primarily for businesses, medical professionals, medical facilities and, through 2020, senior care facilities; and our Aerospace & Programs business unit which offers general aviation and, until exited during 2020, satellite launch property/casualty insurance products and services, as well as certain specialty programs.

●

Standard Commercial Segment. Our Standard Commercial Segment includes the package and monoline property/casualty and, until exited during 2016, occupational accident insurance products and services

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handled by our Commercial Accounts business unit; and the runoff of workers compensation insurance products handled by our former Workers Compensation operating unit until discontinued during 2016.

●

Personal Segment. Our Personal Segment includes the non-standard personal automobile and renters insurance products and services handled by our Specialty Personal Lines business unit.

The retained premium produced by these reportable segments is supported by our American Hallmark Insurance Company of Texas (“AHIC”), Hallmark Specialty Insurance Company (“HSIC”), Hallmark Insurance Company (“HIC”), Hallmark National Insurance Company (“HNIC”) and Texas Builders Insurance Company (“TBIC”) insurance subsidiaries. In addition, control and management of Hallmark County Mutual Insurance Company (“HCM”) 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.

AHIC, HIC, HSIC and HNIC have entered into a pooling arrangement pursuant to which AHIC retains 32% of the total net premiums written by any of them, HIC retains 32% of our total net premiums written by any of them, HSIC retains 26% of our total net premiums written by any of them and HNIC retains 10% of our total net premiums written by any of them. Neither HCM nor TBIC is a party to the intercompany pooling arrangement.

Results of Operations

Management overview. During the three months ended March 31, 2022, our total revenue was $85.7 million, representing a decrease of 24% from the $112.1 million in total revenue for the same period of 2021. During the three months ended March 31, 2022, we reported a pre-tax loss of $4.1 million, as compared to a pre-tax income of $11.2 million reported during the same period the prior year.

The decrease in revenue for the three months ended March 31, 2022 compared to the same period of the prior year was primarily due to lower net premiums earned of $19.4 million, lower net investment income of $1.2 million, lower finance charges of $0.1 million, and lower net investment gains of $5.7 million.

The deterioration in pre-tax earnings for the first quarter of 2022 compared to the same period of the prior year was primarily due to the decreased revenue discussed above, partially offset by lower losses and loss adjustment expenses (“LAE”) of $5.5 million and lower operating expenses of $5.6 million. The decrease in losses and LAE was primarily due to decreased net premiums earned and lower net catastrophe losses, partially offset by unfavorable net prior year loss reserve development during the first quarter of 2022 compared to favorable net prior year loss development during the same period of 2021. Losses and LAE for the first quarter of 2022 included $1.1 million of net catastrophe losses as compared to $5.9 million during the same period of the prior year. During the first quarter of 2022, we experienced $7.7 million of unfavorable net prior year loss reserve development, driven primarily by our exited contract binding line of business, compared to $2.1 million of favorable net prior year loss development during the same period of 2021.

We reported a net loss of $3.2 million for the three months ended March 31, 2022 as compared to net income of $9.0 million for the same period in 2021. On a fully diluted basis, we reported a net loss of $0.18 per share for the three months ended March 31, 2022, compared to net income of $0.49 per share for the same period in 2021. Our effective tax rate was 21.8% for the first three months of 2022 compared to 20.1% for the same period in 2021. The effective tax rates for the three months ended March 31, 2022 and 2021 varied from the statutory tax rates primarily due to tax-exempt interest income.

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First Quarter 2022 as Compared to First Quarter 2021

The following is additional business segment information for the three months ended March 31, 2022 and 2021 (in thousands):


	Three Months Ended March 31,
	Specialty Commercial						Standard Commercial
	Segment						Segment						Personal Segment						Corporate				Consolidated
	2022			2021			2022			2021			2022			2021			2022		2021		2022			2021
Gross premiums written	$	103,850		$	113,990		$	30,277		$	29,735		$	16,832		$	19,293		$	—	$	—	$	150,959		$	163,018
Ceded premiums written		(61,069)			(61,204)			(11,493)			(10,250)			(76)			(67)			—		—		(72,638)			(71,521)
Net premiums written		42,781			52,786			18,784			19,485			16,756			19,226			—		—		78,321			91,497
Change in unearned premiums		7,429			14,425			(2,077)			(2,419)			(1,197)			(1,651)			—		—		4,155			10,355
Net premiums earned		50,210			67,211			16,707			17,066			15,559			17,575			—		—		82,476			101,852

Total revenues		51,911			69,599			17,128			17,688			16,819			18,959			(186)		5,807		85,672			112,053

Losses and loss adjustment expenses		39,312			42,983			12,133			12,091			12,579			14,405			—		—		64,024			69,479

Pre-tax income (loss)	$	2,565		$	11,348		$	(692)		$	366		$	(1,026)		$	(1,623)		$	(4,966)	$	1,136	$	(4,119)		$	11,227

Net loss ratio (1)		78.3	%		64.0	%		72.6	%		70.8	%		80.8	%		82.0	%						77.6	%		68.2	%
Net expense ratio (1)		22.1	%		24.1	%		34.7	%		31.6	%		29.0	%		30.4	%						28.4	%		27.2	%
Net combined ratio (1)		100.4	%		88.1	%		107.3	%		102.4	%		109.8	%		112.4	%						106.0	%		95.4	%

Net (unfavorable) favorable prior year development	$	(6,380)		$	1,899		$	262		$	1,361		$	(1,573)		$	(1,174)						$	(7,691)		$	2,086

(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 as total underwriting expenses 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.

Specialty Commercial Segment

Gross premiums written for the Specialty Commercial Segment were $103.9 million for the three months ended March 31, 2022, which was $10.1 million, or 9%, less than the $114.0 million reported for the same period of 2021. Net premiums written were $42.8 million for the three months ended March 31, 2022 as compared to $52.8 million for the same period of 2021. The decrease in gross and net premiums written was primarily the result of lower premium production in our Commercial Auto, Professional Liability and E&S Casualty business units, partially offset by increased premium production in our E&S Property and Aerospace & Programs business units.

The $51.9 million of total revenue for the three months ended March 31, 2022 was $17.7 million less than the $69.6 million reported by the Specialty Commercial Segment for the same period in 2021. This decrease in revenue was primarily due to lower net premiums earned of $17.0 million, driven primarily by decreased net premiums earned in our Commercial Auto and Professional Liability business units. Further contributing to the decrease in revenue was lower net investment income of $0.5 million for the three months ended March 31, 2022 as compared to the same period of 2021.

The Specialty Commercial Segment reported pre-tax income of $2.6 million for the first quarter of 2022 as compared to pre-tax income of $11.3 million reported for the same period in 2021. The decrease in pre-tax income was primarily the result of the lower total revenue discussed above, partially offset by lower losses and LAE of $3.6 million and lower operating expenses of $5.4 million during the three months ended March 31, 2022 as compared to the same period during 2021.

Our Specialty Commercial Segment reported lower losses and LAE for the quarter ended March 31, 2022 compared to the same period of the prior year as the combined result of (a) a $1.0 million decrease in losses and LAE in our Commercial Auto business unit, (b) a $4.5 million increase in losses and LAE in our E&S Property business unit, (c) a $1.3 million decrease in losses and LAE in our E&S Casualty business unit, (d) a $4.8 million decrease in losses and

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LAE in our Aerospace & Programs business unit, and (e) a $1.0 million decrease in losses and LAE attributable to our Professional Liability business unit. The Commercial Auto business unit’s decrease in losses and LAE was primarily due to lower net premiums earned partially offset by $2.5 million of unfavorable net prior year loss reserve development for the first quarter of 2022 as compared to $1.3 million of favorable net prior year loss reserve development during the first quarter of 2021. The unfavorable development during the first quarter of 2022 included $8.9 million of unfavorable net prior year loss reserve development attributable to the exited contract binding line of business. The E&S Property business unit’s increase in losses and LAE was primarily due to lower net premiums earned and $3.0 million unfavorable net prior year loss reserve development during the first quarter of 2022 as compared to $0.4 million favorable net prior year loss reserve development during the same period of 2021, partially offset by a $0.7 million improvement in net catastrophe losses and lower current accident year non-catastrophe losses. The E&S Casualty business unit’s decrease in losses and LAE was primarily due to lower current accident year loss trends and $1.0 million of unfavorable prior year net loss reserve development during the first quarter of 2022 as compared to $1.3 million of unfavorable prior year net loss reserve development during the same period of 2021. The Aerospace & Programs business unit’s decrease in losses and LAE was primarily due to lower current accident year net loss trends in its general aviation line of business and $0.7 million of favorable prior year net loss reserve development during the first quarter of 2022 as compared to $0.4 million of favorable prior year net loss reserve development during the same period of 2021. The Professional Liability business unit’s decrease in losses and LAE was primarily due to lower current accident year loss trends partially offset by $0.2 million of favorable prior year net loss reserve development during the first quarter of 2022 as compared to $1.3 million of favorable prior year net loss reserve development during the same period of 2021.

Operating expenses decreased $5.4 million primarily as the result of lower production related expenses of $4.8 million, lower salary and related expenses of $0.7 million and lower other operating expenses of $0.2 million, partially offset by higher professional services of $0.2 million and higher travel related expenses of $0.1 million.

The Specialty Commercial Segment reported a net loss ratio of 78.3% for the three months ended March 31, 2022 as compared to 64.0% for the same period in 2021. The gross loss ratio before reinsurance was 86.9% for the three months ended March 31, 2022 as compared to 74.9% for the same period in 2021. The increase in the gross and net loss ratios was driven primarily by increased unfavorable prior year loss development primarily in our exited contract binding line of business, partially offset by lower catastrophe losses. The Specialty Commercial Segment reported unfavorable net loss reserve development of $6.4 million during the three months ended March 31, 2022 as compared to favorable net loss reserve development of $1.9 million during the same period of 2021. The Specialty Commercial Segment reported $3.5 million of gross catastrophe losses during the first quarter of 2022 as compared to $7.6 million during the same period of 2021. Net catastrophe losses were $1.1 million for the three months ended March 31, 2022 as compared to $5.9 million during the first quarter of 2021. The Specialty Commercial Segment reported a net expense ratio of 22.1% for the first quarter of 2022 as compared to 24.1% for the same period of 2021 driven primarily by lower operating expenses.

Standard Commercial Segment

Gross premiums written for the Standard Commercial Segment were $30.3 million for the three months ended March 31, 2022, which was $0.6 million more than the $29.7 million reported for the same period in 2021. Net premiums written were $18.8 million for the three months ended March 31, 2022 as compared to $19.5 million for the same period in 2021. The increase in the gross premiums written was due to higher premium production in our Commercial Accounts business unit. The decrease in net premiums written was due to higher ceded catastrophe premiums during the first quarter of 2022.

Total revenue for the Standard Commercial Segment of $17.1 million for the three months ended March 31, 2022, was $0.6 million less than the $17.7 million reported for the same period in 2021. This decrease in total revenue was due to lower net premiums earned of $0.4 million and lower net investment income of $0.2 million for the three months ended March 31, 2022 as compared to the same period of 2021.

The Standard Commercial Segment reported a pre-tax loss of $0.7 million for the three months ended March 31, 2022 as compared to pre-tax income of $0.4 million for the same period of 2021. This deterioration in pre-tax earnings was primarily the result of lower revenue discussed above and higher operating expenses of $0.5 million. Increased

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operating expenses were primarily the result of higher salary and related expenses of $0.2 million, higher other operating expenses of $0.3 million and higher professional services of $0.1 million, partially offset by lower production related expenses of $0.1 million.

The Standard Commercial Segment reported a net loss ratio of 72.6% for the three months ended March 31, 2022 as compared to 70.8% for the same period of 2021. The gross loss ratio before reinsurance for the three months ended March 31, 2022 was 58.6% as compared to 57.7% reported for the same period of 2021. The increase in the gross and net loss ratio was due primarily to higher current accident year loss trends and lower favorable net loss reserve development, partially offset by lower net catastrophe losses of $0.2 million during the first quarter of 2022 compared to $2.0 million for the same period of the prior year. The Standard Commercial Segment reported favorable net loss reserve development of $0.3 million during the three months ended March 31, 2022 as compared to $1.4 million during the same period of 2021. The Standard Commercial Segment reported a net expense ratio of 34.7% for the first quarter of 2022 as compared to 31.6% for the same period of 2021.

Personal Segment

Gross premiums written for the Personal Segment were $16.8 million for the three months ended March 31, 2022 as compared to $19.3 million for the same period in the prior year. Net premiums written for the Personal Segment were $16.8 million in the first quarter of 2022, which was a decrease of $2.4 million from the $19.2 million reported for the first quarter of 2021. The decrease in gross and net written premiums was primarily due to lower premium production in our current geographical footprint.

Total revenue for the Personal Segment was $16.8 million for the first quarter of 2022 as compared to $19.0 million for the same period in 2021. The decrease in revenue was primarily due to lower net premiums earned of $2.0 million and lower finance charges of $0.2 million during the first quarter of 2022 as compared to the same period during 2021.

Pre-tax loss for the Personal Segment was $1.0 million for the three months ended March 31, 2022 as compared to a pre-tax loss of $1.6 million for the same period of 2021. The reduction in pre-tax loss was primarily the result of lower losses and LAE of $1.8 million and decreased operating expenses of $1.0 million for the three months ended March 31, 2022 as compared to the same period during 2021, partially offset by the decreased revenue as discussed above. However, rising inflationary trends, specifically loss costs, continue to impact the profitability of our Personal Segment.

The Personal Segment reported a net loss ratio of 80.8% for the three months ended March 31, 2022 as compared to 82.0% for the same period of 2021. The gross loss ratio before reinsurance was 81.1% for the three months ended March 31, 2022 as compared to 84.4% for the same period in 2021. The lower gross and net loss ratios were impacted by lower losses and LAE despite $0.4 million higher net unfavorable prior year loss reserve development during the first quarter of 2022 as compared to the same period of 2021. The Personal Segment reported a net expense ratio of 29.0% for the first quarter of 2022 as compared to 30.4% for the same period of 2021. The decrease in the expense ratio was due primarily to lower operating expenses.

Corporate

Total revenue for Corporate decreased by $6.0 million for the three months ended March 31, 2022 as compared to the same period the prior year. This decrease in total revenue was due predominately to lower net investment income of $0.4 million for the three months ended March 31, 2022 as compared to the same period during 2021, as well as a $5.6 million reduction in investment gains during the first quarter of 2022 as compared to the same period of 2021.

Corporate pre-tax loss was $5.0 million for the three months ended March 31, 2022 as compared to pre-tax income of $1.1 million for the same period of 2021. The pre-tax loss for the first quarter of 2022 was primarily due to the lower revenue discussed above and higher operating expenses of $0.1 million.

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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 March 31, 2022, Hallmark and its non-insurance company subsidiaries had $11.4 million in unrestricted cash and cash equivalents. As of that date, our insurance subsidiaries held $172.0 million of unrestricted cash and cash equivalents, as well as $388.3 million in debt securities with an average modified duration of 1.0 years. Accordingly, we do not anticipate selling long-term debt instruments to meet 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 and HNIC, both domiciled in Arizona, are limited in the payment of dividends to the lesser of 10% of prior year policyholders’ surplus or prior year’s statutory net 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. During 2022, the aggregate ordinary dividend capacity of these subsidiaries is $32.0 million, of which $22.7 million is available to Hallmark. As a county mutual, dividends from HCM are payable to policyholders. During the first three months of 2022 and 2021, our insurance subsidiaries did not pay any dividends to Hallmark. During the first three months of 2022 and 2021, our insurance subsidiaries paid $3.0 million and $4.5 million in management fees to Hallmark, respectively.

Comparison of March 31, 2022 to December 31, 2021

On a consolidated basis, our cash (excluding restricted cash) and investments at March 31, 2022 were $624.2 million compared to $691.6 million at December 31, 2021. The primary reasons for this decrease in unrestricted cash and investments were cash used by operations and purchases of investment securities.

Comparison of Three Months Ended March 31, 2022 and March 31, 2021

During the three months ended March 31, 2022, our cash flow used by operations was $62.0 million compared to cash flow provided by operations of $29.5 million during the same period the prior year. The cash flow used in operations was driven primarily by higher reinsurance balances paid during the first quarter of 2022 of $50.0 mllion due primarily to the correction of immaterial errors relating to certain reinsurance treaties reported during the third quarter of 2021, an increase in net paid claims and lower collected investment income, partially offset by decreased paid operating expenses during the three months ended March 31, 2022 as compared to the same period the prior year.

Net cash used in investing activities during the first three months of 2022 was $107.1 million as compared to net cash provided by investing activities of $149.5 million during the first three months of 2021. The net cash used in investing activities during the first three months of 2022 was primarily comprised of an increase of $139.0 million in purchases of debt and equity securities, a decrease of $117.0 million in maturities, sales and redemptions of investment securities and a $0.6 million increase in purchases of fixed assets.

The Company did not report any net cash from financing activities during the first three months of 2022 or 2021.

Senior Unsecured Notes

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to any sinking fund requirements. At Hallmark’s option, the Notes are redeemable, in whole or in part, prior to the stated maturity subject to certain provisions intended to make the holders of the Notes whole on scheduled interest and principal payments. The indenture governing the Notes contains certain covenants which, among other things, restrict Hallmark’s ability to incur additional indebtedness, make certain payments, create liens on the stock of certain subsidiaries, dispose of certain assets, or merge or consolidate with other entities. The terms of the indenture prohibits payments or other distributions on any security of the Company that ranks junior to the Notes when the Company’s debt to capital ratio (as defined in the indenture) is greater than 35%. The Company’s debt to capital ratio was 38.3% as of March 31, 2022.

Subordinated Debt Securities

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 junior 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.

Each trust pays dividends on its preferred securities at the same rate each quarter as interest is paid on the junior subordinated debt securities. Under the terms of the trust subordinated debt securities, we pay interest only each quarter and the principal of each note at maturity. We may elect to defer payments of interest on the trust subordinated debt securities by extending the interest payment period for up to 20 consecutive quarterly periods. During any such extension period, interest continues to accrue on the trust subordinated debt securities, as well as interest on such accrued interest. In order to maintain compliance with the terms of our senior unsecured Notes, we have elected to defer payment of interest on the trust subordinated securities until our debt to capital ratio (as defined in the indenture governing the Notes) is less than 35%. The subordinated debt securities of each trust are uncollateralized and do not require maintenance of minimum financial covenants.

The following table summarizes the nature and terms of the junior subordinated debt and trust preferred securities:


		Hallmark		Hallmark
		Statutory		Statutory
		Trust I		Trust II

Issue date		June 21, 2005		August 23, 2007
Principal amount of trust preferred securities	$	30,000	$	25,000
Principal amount of junior subordinated debt securities	$	30,928	$	25,774
Maturity date of junior subordinated debt securities		June 15, 2035		September 15, 2037
Trust common stock	$	928	$	774
Interest rate, per annum		Three Month LIBOR + 3.25%		Three Month LIBOR + 2.90%
Current interest rate at March 31, 2021		4.08%		3.73%

Item 3. Quantitative and Qualitative Disclosures About Market Risk.

Not required for smaller reporting company.

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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.

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PART II

OTHER INFORMATION

Item 1. Legal Proceedings.

AHIC, HIC, HSIC, HCM and HNIC (collectively, the “Hallmark Insurers”) are parties to a Loss Portfolio Transfer Reinsurance Contract (the “LPT Contract”) and related agreements with DARAG Bermuda Ltd. (“DARAG Bermuda”) and DARAG Insurance (Guernsey) Limited (“DARAG Guernsey” and, collectively, the “Reinsurers”). (See Note 9, “Reinsurance – Loss Portfolio Transfer” in the Notes to Consolidated Financial Statements.)

Item 1A. Risk Factors.

There have been no material changes to the risk factors discussed in Item 1A to Part I of our Form 10-K for the fiscal year ended December 31, 2021.

Item 2. Unregistered Sales of Equity Securities and Use of Proceeds.

Our stock buyback program initially announced on April 18, 2008, authorized the repurchase of up to 1,000,000 shares of our common stock in the open market or in privately negotiated transactions (the “Stock Repurchase Plan”). On January 24, 2011, we announced an increased authorization to repurchase up to an additional 3,000,000 shares. The Stock Repurchase Plan does not have an expiration date. We did not repurchase any shares of our common stock during the three months ended March 31, 2022.

Item 3. Defaults Upon Senior Securities.

None.

Item 4. Mine Safety Disclosures.

None.

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Item 5. Other Information.

None.

Item 6. Exhibits.

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

Exhibit Number		Description
3.1		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).

3.2		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 January 12, 2022).

4		Description of registrant’s securities (incorporated by reference to Exhibit 4.1 to the registrant’s Form 10-K for the year ended December 31, 2019).

4.2		Specimen certificate for common stock, $0.18 par value, of the registrant (incorporated by reference to Exhibit 4.1 to Amendment No. 1 to the registrant’s Registration Statement on Form S-1 [Registration No. 333-136414] filed September 8, 2006).

4.3		Indenture dated June 21, 2005, between Hallmark Financial Services, Inc. and JPMorgan Chase Bank, National Association (incorporated by reference to Exhibit 4.1 to the registrant’s Current Report on Form 8-K filed June 27, 2005).

4.4		Amended and Restated Declaration of Trust of Hallmark Statutory Trust I dated as of June 21, 2005, among Hallmark Financial Services, Inc., as sponsor, Chase Bank USA, National Association, as Delaware trustee, and JPMorgan Chase Bank, National Association, as institutional trustee, and Mark Schwarz and Mark Morrison, as administrators (incorporated by reference to Exhibit 4.2 to the registrant’s Current Report on Form 8-K filed June 27, 2005).

4.5		Form of Junior Subordinated Debt Security Due 2035 (included in Exhibit 4.3 above).

4.6		Form of Capital Security Certificate (included in Exhibit 4.4 above).

4.7		Indenture dated as of August 23, 2007, between Hallmark Financial Services, Inc. and The Bank of New York Trust Company, National Association (incorporated by reference to Exhibit 4.1 to the registrant’s Current Report on Form 8-K filed August 24, 2007).

4.8		Amended and Restated Declaration of Trust of Hallmark Statutory Trust II dated as of August 23, 2007, among Hallmark Financial Services, Inc., as sponsor, The Bank of New York (Delaware), as Delaware trustee, and The Bank of New York Trust Company, National Association, as institutional trustee, and Mark Schwarz and Mark Morrison, as administrators (incorporated by reference to Exhibit 4.2 to the registrant’s Current Report on Form 8-K filed August 24, 2007).

4.9		Form of Junior Subordinated Debt Security Due 2037 (included in Exhibit 4.7 above).

4.10		Form of Capital Security Certificate (included in Exhibit 4.8 above).

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4.11		Indenture between Hallmark Financial Services, Inc. and The Bank of New York Mellon Trust Company, N.A. dated August 19, 2019 (incorporated by reference to Exhibit 4.1 to the registrant’s Form 8-K filed August 21, 2019).

4.12		First Supplemental Indenture between Hallmark Financial Services, Inc. and The Bank of New York Mellon Trust Company, N.A. dated August 19, 2019 (incorporated by reference to Exhibit 4.2 to the registrant’s Form 8-K filed August 21, 2019).



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- the instance document does not appear in the Interactive Data File because its XBRL tags are embedded within the Inline XBRL document

101 SCH+		XBRL Taxonomy Extension Schema Document.

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.

Exhibit 104		Cover Page Interactive Data File - The cover page interactive data file does not appear in the Interactive Data File because its XBRL tags are embedded within the Inline XBRL document

+		Filed 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) Consolidated Balance Sheets as of March 31, 2022 and December 31, 2021, (ii) Consolidated Statements of Operations for the three months ended March 31, 2022 and 2021, (iii) Consolidated Statements of Comprehensive Income for the three months ended March 31, 2022 and 2021, (iv) Consolidated Statements of Stockholder’s Equity for the three months ended March 31, 2022 and 2021, (v) Consolidated Statements of Cash Flows for the three months ended March 31, 2022 and 2021 and (vi) related notes.

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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: May 12, 2022	/s/ Mark E. Schwarz
	Mark E. Schwarz, Executive Chairman and Chief Executive Officer (principal executive officer)


Date: May 12, 2022	/s/ Christopher J. Kenney
	Christopher J. Kenney, President and Chief Financial Officer (principal financial officer)

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Hallmark Financial Services (HALL) 10-Q2022 Q1 Quarterly report

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