Hallmark Financial Services, Inc. Announces Fourth Quarter and Year 2006 Earnings Results

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

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

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

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

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

Three Months EndedYear EndedDecember 31,December 31,2006200520062005($ in thousands)Gross premiums written$60,227$26,482$213,945$89,467Net premiums written56,75225,819202,92888,252Net premiums earned47,17420,457152,06159,184Commission and fee income3,1203,16935,34316,703Net investment income2,9561,56210,4613,836Net realized gain (loss) oninvestments356(1,466)58Total revenues54,66926,638202,74187,035Net Income4,7302,8949,1919,186EPS – Basic$0.23$0.20$0.53$0.76EPS – Diluted$0.23$0.20$0.53$0.76Return on Average Equity13.9%13.8%7.8%15.6%Adjusted Net Income (1)4,7302,89415,2579,186Adjusted EPS – Basic (1)$0.23$0.20$0.89$0.76Adjusted EPS – Diluted (1)$0.23$0.20$0.89$0.76Adjusted Return on AverageEquity (1)13.9%13.8%17.2%15.6%Book Value Per Share$7.26$5.89$7.26$5.89(1) Adjusted to exclude the effect of the non-cash interest expensecharge of $6.1 million (net of tax) resulting from the convertiblepromissory notes issued and converted during the year.

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

Income excludingInterestinterest expense expense fromfrom amortization amortizationof discount,ofTaxNetnet of taxdiscounteffectIncomeYear ended December 31, 2006$15,257$9,625$(3,559)$9,191Weighted average shares -basic17,18117,181Weighted average shares -diluted17,19417,194Average shareholders’ equity117,960117,960Net income per share – basic$0.89$0.53Net income per share -diluted$0.89$0.53Return on average equity17.2%7.8%

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

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

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

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

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

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

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

For further information, please contact:Mark J. Morrison, President and Chief Executive Officer at 817.348.1600http://www.hallmarkgrp.com/HALLMARK FINANCIAL SERVICES, INC. AND SUBSIDIARIESCONSOLIDATED BALANCE SHEETSDecember 31, 2006 and 2005(In thousands)ASSETS20062005Investments:Debt securities, available-for-sale,at fair value$125,784$79,360Equity securities, available-for-sale,at fair value4,5803,403Short-term investments, available-for-sale,at fair value25,27512,281Total investments155,63995,044Cash and cash equivalents81,47444,528Restricted cash and investments31,81513,802Prepaid reinsurance premiums1,629767Premiums receivable44,64426,530Accounts receivable13,2232,083Reinsurance recoverable5,930444Deferred policy acquisition costs17,1459,164Excess of cost over fair value of net assetsacquired31,4274,836Intangible assets26,074459Deferred federal income taxes—3,992Prepaid expenses1,769802Other assets5,1846,455$415,953$208,906LIABILITIES AND STOCKHOLDERS’ EQUITYLiabilities:Notes payable$35,763$30,928Structured settlements24,587—Reserves for unpaid losses and lossadjustment expenses77,56426,321Unearned premiums91,60636,027Unearned revenue5,7344,055Reinsurance balances payable1,060116Accrued agent profit sharing1,7842,173Accrued ceding commission payable3,95611,430Pension liability3,1262,932Deferred federal income taxes2,310—Current federal income tax payable2,132300Accounts payable and other accrued expenses15,6009,436265,222123,718Commitments and contingenciesStockholders’ equity:Common stock, $.18 par value, authorized33,333,333 shares in 2006 and 16,666,667shares in 2005; issued 20,776,066 sharesin 2006 and 14,476,102 shares in 20053,7402,606Capital in excess of par value117,93262,907Retained earnings31,48022,289Accumulated other comprehensive loss(2,344)(2,597)Treasury stock, 7,828 shares in 2006 and2,470 shares in 2005, at cost(77)(17)Total stockholders’ equity150,73185,188$415,953$208,906Hallmark Financial Services, Inc. and SubsidiariesConsolidated Statements of Operations($ in thousands, except per share amounts)Three Months EndedYear EndedDecember 31December 312006200520062005Gross premiums written$60,227 $26,482 $213,945 $89,467Ceded premiums written(3,475)(663) (11,017) (1,215)Net premiums written56,75225,819202,92888,252Change in unearned premiums(9,578) (5,362) (50,867) (29,068)Net premiums earned47,17420,457152,06159,184Investment income, net of expenses2,9561,56210,4613,836Realized gain (loss)356(1,466)58Finance charges1,0435083,9832,044Commission and fees3,1203,16935,34316,703Processing and service fees3369312,3305,183Other income552927Total revenues54,66926,638202,74187,035Losses and loss adjustment expenses26,63911,20087,11733,784Other operating costs and expenses19,48610,74083,58338,492Interest expense1,0246005,7981,264Interest expense from amortization ofdiscount on convertible notes——9,625—Amortization of intangible asset574(4)2,29327Total expenses47,72322,536188,41673,567Income before tax6,9464,10214,32513,468Income tax expense2,2161,2085,1344,282Net income$4,730$2,894$9,191$9,186Common stockholders net income pershare:Basic$0.23$0.20$0.53$0.76Diluted$0.23$0.20$0.53$0.76Hallmark Financial Services, Inc.Consolidated Segment DataThree Months Ended December 31, 2006Standard SpecialtyCommercial Commercial PersonalConsol-SegmentSegmentSegment CorporateidatedProduced premium22,32240,87211,019—74,213Gross premiums written22,18627,02211,019—60,227Ceded premiums written(2,728)(747)——(3,475)Net premiums written19,45826,27511,019—56,752Change in unearnedpremiums250(9,767)(61)—(9,578)Net premiums earned19,70816,50810,958—47,174Total revenues17,55724,68612,05437254,669Loss and loss adjustmentexpenses11,6347,9397,074(8)26,639Pre-tax income5126,3842,000(1,950)6,946Loss ratio (1)59.0%48.1%64.6%56.5%Expense ratio (2)29.3%30.5%22.6%28.1%Combined ratio (3)88.3%78.6%87.2%84.6%Three Months Ended December 31, 2005Standard SpecialtyCommercial Commercial PersonalConsol-SegmentSegmentSegment CorporateidatedProduced premium19,512—8,337—27,849Gross premiums written18,083—8,399—26,482Ceded premiums written(1,151)—488—(663)Net premiums written16,932—8,887—25,819Change in unearnedpremiums(5,248)—(114)—(5,362)Net premiums earned11,684—8,773—20,457Total revenues15,873—10,7382726,638Loss and loss adjustmentexpenses6,979—4,237(16)11,200Pre-tax income1,890—3,981(1,769)4,102Loss ratio (1)59.7%48.3%54.7%Expense ratio (2)34.2%30.0%32.4%Combined ratio (3)93.9%78.3%87.1%Hallmark Financial Services, Inc.Consolidated Segment DataYear Ended December 31, 2006Standard SpecialtyCommercial Commercial PersonalConsol-SegmentSegmentSegment CorporateidatedProduced premium91,679156,48245,135—293,296Gross premiums written91,07077,74045,135—213,945Ceded premiums written(8,850)(2,167)——(11,017)Net premiums written82,22075,57345,135—202,928Change in unearnedpremiums(12,146) (35,903)(2,818)—(50,867)Net premiums earned70,07439,67042,317—152,061Total revenues75,32580,68946,998(271)202,741Loss and loss adjustmentexpenses38,79921,90826,443(33)87,117Pre-tax income11,75714,3098,760(20,501)14,325Loss ratio (1)55.4%55.2%62.5%57.3%Expense ratio (2)29.4%30.5%24.9%28.4%Combined ratio (3)84.8%85.7%87.4%85.7%Year Ended December 31, 2005Standard SpecialtyCommercial Commercial PersonalConsol-SegmentSegmentSegment CorporateidatedProduced premium81,721—36,345—118,066Gross premiums written52,952—36,515—89,467Ceded premiums written(1,703)—488—(1,215)Net premiums written51,249—37,003—88,252Change in unearnedpremiums(29,498)—430—(29,068)Net premiums earned21,751—37,433—59,184Total revenues43,067—43,9076187,035Loss and loss adjustmentexpenses12,610—21,239(65)33,784Pre-tax income6,651—11,647(4,830)13,468Loss ratio (1)58.0%56.7%57.1%Expense ratio (2)34.4%28.8%30.8%Combined ratio (3)92.4%85.5%87.9%(1) Net loss ratio is calculated as total net losses and loss adjustmentexpenses divided by net premiums earned, each determined inaccordance with GAAP.(2) Net expense ratio is calculated as total underwriting expenses of ourinsurance company subsidiaries, including allocated overhead expensesand offset by agency fee income, divided by net premiums earned, eachdetermined in accordance with GAAP. During the fourth quarter offiscal 2006, we adopted the widely used industry calculation thatoffsets expenses with agency fee income. All prior periodcomparative expense ratios have been restated.(3) Net combined ratio is calculated as the sum of the net loss ratio andthe net expense ratio.

Hallmark Financial Services, Inc.

CONTACT: Mark J. Morrison, President and Chief Executive Officer ofHallmark Financial Services, Inc., +1-817-348-1600

Web site: http://www.hallmarkgrp.com/