- Quarterly Report (10-Q)

Large accelerated filer

Accelerated filer

Non-accelerated filer

¨ (Do not check if a smaller reporting company)

Smaller reporting company

UNITED STATES

SECURITIES AND EXCHANGE COMMISSION

WASHINGTON, D.C. 20549

Form 10-Q

x	QUARTERLY REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES EXCHANGE ACT OF 1934

For the quarterly period ended March 30, 2012

¨	TRANSITION REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES EXCHANGE ACT OF 1934

For the transition period from to

Commission file number 000-19483

SWS GROUP, INC.

(Exact name of registrant as specified in its charter)


Delaware		75-2040825
(State or other jurisdiction of incorporation or organization)		(I.R.S. Employer Identification No.)

1201 Elm Street, Suite 3500, Dallas, Texas		75270
(Address of principal executive offices)		(Zip Code)

Registrant’s telephone number, including area code (214) 859-1800

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

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

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

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

As of May 4, 2012, there were 32,882,992 shares of the registrant’s common stock, $0.10 par value, outstanding.

SWS GROUP, INC. AND SUBSIDIARIES

INDEX


PART I. FINANCIAL INFORMATION

Item 1. Financial Statements

Consolidated Statements of Financial Condition March 30, 2012 ( unaudited ) and June 24, 2011			3

Consolidated Statements of Income (Loss) and Comprehensive Income (Loss) For the three and nine-months ended March 30, 2012 and March 25, 2011 ( unaudited )			4

Consolidated Statements of Cash Flows For the nine-months ended March 30, 2012 and March 25, 2011 ( unaudited )			5

Notes to Consolidated Financial Statements ( unaudited )			7

Item 2. Management's Discussion and Analysis of Financial Condition and Results of Operations			48

Item 3. Quantitative and Qualitative Disclosures About Market Risk			85

Item 4. Controls and Procedures			85

PART II. OTHER INFORMATION

Item 1. Legal Proceedings			85

Item 1A. Risk Factors			86

Item 2. Unregistered Sales of Equity Securities and Use of Proceeds			86

Item 3. Defaults Upon Senior Securities			86

Item 4. Mine Safety Disclosures			86

Item 5. Other Information			86

Item 6. Exhibits			86

SIGNATURES			87

EXHIBIT INDEX			88

PART I. FINANCIAL INFORMATION

Item 1. Financial Statements

SWS Group, Inc. and Subsidiaries

CONSOLIDATED STATEMENTS OF FINANCIAL CONDITION

March 30, 2012 and June 24, 2011

(In thousands, except par values and share amounts)


	March			June
	(Unaudited)
Assets
Cash and cash equivalents	$	303,407		$	298,903
Restricted cash and cash equivalents		30,044			—
Assets segregated for regulatory purposes		209,139			238,325
Receivable from brokers, dealers and clearing organizations		1,313,839			1,620,523
Receivable from clients, net		265,769			240,491
Loans held for sale		—			5,241
Loans, net		824,538			946,768
Securities owned, at fair value		244,153			221,587
Securities held to maturity		28,408			34,176
Securities purchased under agreements to resell		12,033			42,649
Goodwill		7,552			7,552
Securities available for sale		125,191			2,020
Other assets		142,977			143,922

	$	3,507,050		$	3,802,157

Liabilities and Stockholders’ Equity
Short-term borrowings	$	126,000		$	110,000
Payable to brokers, dealers and clearing organizations		1,240,227			1,568,033
Payable to clients		354,165			397,590
Deposits		1,061,647			1,106,471
Securities sold under agreements to repurchase		4,270			10,313
Securities sold, not yet purchased, at fair value		61,379			68,661
Drafts payable		27,502			23,656
Advances from Federal Home Loan Bank (the “FHLB”)		78,746			94,712
Long-term debt, net		78,159			—
Warrants		31,067			—
Other liabilities		88,897			65,252

		3,152,059			3,444,688
Commitments and contingencies
Stockholders’ equity:
Preferred stock of $1.00 par value. Authorized 100,000 shares; none issued		—			—
Common stock of $0.10 par value. Authorized 60,000,000 shares; issued 33,312,140 and outstanding 32,607,401 shares at March 30, 2012; issued 33,312,140 and outstanding 32,285,076 shares at June 24, 2011		3,331			3,331
Additional paid-in capital		324,192			326,986
Retained earnings		30,388			34,813
Accumulated other comprehensive income – unrealized holding gain, net of tax of $984 at March 30, 2012 and $334 at June 24, 2011		1,983			765
Deferred compensation, net		3,364			3,308

Treasury stock (704,739 shares at March 30, 2012 and 1,027,064 shares at June 24, 2011, at cost)		(8,267	)		(11,734	)

Total stockholders’ equity		354,991			357,469

Total liabilities and stockholders’ equity	$	3,507,050		$	3,802,157

See accompanying Notes to Consolidated Financial Statements.

SWS Group, Inc. and Subsidiaries

CONSOLIDATED STATEMENTS OF INCOME (LOSS)

AND COMPREHENSIVE INCOME (LOSS)

For the three and nine-months ended March 30, 2012 and March 25, 2011

(In thousands, except per share and share amounts)

(Unaudited)


	For the Three-Months Ended						For the Nine-Months Ended
	March 30, 2012			March 25, 2011			March 30, 2012			March 25, 2011
Revenues:
Net revenues from clearing operations	$	2,371		$	2,805		$	7,311		$	8,065
Commissions		34,411			32,915			99,571			110,010
Interest		29,999			31,606			94,727			107,180
Investment banking, advisory and administrative fees		8,771			7,271			26,629			31,537
Net gains on principal transactions		8,529			10,544			22,444			30,386
Other		7,476			4,352			16,968			13,898

Total revenue		91,557			89,493			267,650			301,076
Interest expense		15,797			11,566			46,720			35,196

Net revenues		75,760			77,927			220,930			265,880

Non-interest expenses:
Commissions and other employee compensation		54,073			52,841			156,512			168,884
Occupancy, equipment and computer service costs		8,134			8,375			23,860			25,320
Communications		3,191			3,254			9,216			9,811
Floor brokerage and clearing organization charges		1,004			1,112			3,111			3,296
Advertising and promotional		1,049			702			2,276			2,057
Provision for loan loss		—			4,727			2,475			50,967
Unrealized (gain) loss on warrant valuation		(12,502	)		—			6,931			—
Other		8,063			10,317			23,127			39,937

Total non-interest expenses		63,012			81,328			227,508			300,272

Income (loss) before income tax expense (benefit)		12,748			(3,401	)		(6,578	)		(34,392	)
Income tax expense (benefit)		4,486			(1,254	)		(2,152	)		(11,167	)

Net income (loss)		8,262			(2,147	)		(4,426	)		(23,225	)
Net gain/(loss) recognized in other comprehensive income (loss), net of tax of $367 and $(57) for the three-months ended March 30, 2012 and March 25, 2011, respectively, and $650 and $174 for the nine-months ended March 30, 2012 and March 25, 2011, respectively, on available for sale securities		690			(110	)		1,218			333

Comprehensive income (loss)	$	8,952		$	(2,257	)	$	(3,208	)	$	(22,892	)

Earnings (loss) per share – basic
Net income (loss)	$	0.25		$	(0.07	)	$	(0.14	)	$	(0.71	)

Weighted average shares outstanding – basic		32,716,251			32,501,344			32,589,539			32,510,570

Earnings (loss) per share – diluted
Net income (loss)	$	0.04		$	(0.07	)	$	(0.14	)	$	(0.71	)

Weighted average shares outstanding – diluted		50,107,555			32,501,344			32,589,539			32,510,570

See accompanying Notes to Consolidated Financial Statements.

SWS Group, Inc. and Subsidiaries

CONSOLIDATED STATEMENTS OF CASH FLOWS

For the nine-months ended March 30, 2012 and March 25, 2011

(In thousands)

(Unaudited)


	For the Nine-Months Ended
	March 30, 2012			March 25, 2011
Cash flows from operating activities:
Net loss	$	(4,426	)	$	(23,225	)
Adjustments to reconcile net loss to net cash provided by (used in) operating activities:
Depreciation and amortization		4,355			5,477
Accretion of discount on long-term debt		2,295			—
Amortization of deferred debt issuance costs		328			—
Increase in fair value of warrants		6,931			—
Amortization of premiums/discounts on loans purchased		(62	)		(106	)
Amortization of premiums /discounts on investment securities		637			146
Provision for doubtful accounts on receivables from customers		240			405
Provision for loan loss and write downs on real estate owned		3,581			64,316
Deferred income tax expense (benefit)		8,177			(4,388	)
Allowance for deferred tax asset		(240	)		844
Deferred compensation for deferred compensation plan and restricted stock plan		(74	)		3,402
Loss on sale of loans		42			661
(Gain) loss on fixed assets transactions		(1	)		6
Gain on the sale of investment securities		—			(81	)
Loss on sale of real estate		48			3,027
Gain on issuer’s redemption of investment securities		—			(1,078	)
Equity in earnings of unconsolidated ventures		(1,240	)		(177	)
Dividend received on investments		(57	)		(19	)
Shortfall for taxes on vesting of restricted stock		62			314
Change in operating assets and liabilities:
Decrease in assets segregated for regulatory purposes		29,186			52,806
Net change in broker, dealer and clearing organization accounts		(21,122	)		(16,264	)
Net change in client accounts		(68,943	)		(57,762	)
Net change in loans held for sale		—			424,055
Increase in securities owned		(22,566	)		(21,005	)
Decrease (increase) in securities purchased under agreements to resell		30,616			(27,467	)
Increase in other assets		(5,195	)		(11,385	)
Increase (decrease) in drafts payable		3,846			(113	)
(Decrease) increase in securities sold, not yet purchased		(7,282	)		26,142
Increase (decrease) in other liabilities		24,383			(8,818	)

Net cash provided by (used in) operating activities		(16,481	)		409,713

Cash flows from investing activities:
Purchase of fixed assets and capitalized improvements on real estate owned		(2,104	)		(2,399	)
Proceeds from the sale of fixed assets and real estate		13,492			41,748
Proceeds from the sale of loans		1,751			42,214
Loan originations and purchases		(2,945,591	)		(4,202,458	)
Loan repayments		3,049,519			4,241,999
Purchase of investment securities		(130,305	)		(35,525	)
Proceeds from the sale of investment securities		—			75,555
Proceeds from the issuer’s redemption of investment securities		—			7,347
Cash received on investments		14,649			5,557
Proceeds from the sale of FHLB stock		402			2,886
Purchases of FHLB stock		—			(1,460	)
(continued)


	For the Nine-Months Ended
	March 30, 2012			March 25, 2011
(continued)
Investment of proceeds received from Hilltop Holdings, Inc., Oak Hill Capital Partners III, L.P. and Oak Hill Capital Management Partners III, L.P. in restricted fund	$	(30,000	)	$	—

Net cash provided by (used in) investing activities		(28,187	)		175,464

Cash flows from financing activities:
Payments on short-term borrowings		(2,091,150	)		(4,278,782	)
Cash proceeds from short-term borrowings		2,107,150			4,349,782
Cash proceeds from other financing activities		—			4,400
Decrease in deposits		(44,824	)		(368,714	)
Advances from the FHLB		—			418,644
Payments on advances from the FHLB		(15,966	)		(454,656	)
Payment of cash dividends on common stock		—			(3,578	)
Shortfall for taxes on vesting of restricted stock		(62	)		(314	)
Cash payments on securities sold under agreements to repurchase		(6,043	)		(5,172	)
Cash proceeds received from Hilltop Holdings, Inc., Oak Hill Capital Partners III, L.P. and Oak Hill Capital Management Partners III, L.P.		100,000			—
Proceeds related to the deferred compensation plan		245			385
Purchase of treasury stock related to the deferred compensation plan		(178	)		(340	)

Net cash provided by (used in) financing activities		49,172			(338,345	)

Net increase in cash and cash equivalents		4,504			246,832
Cash and cash equivalents at beginning of period		298,903			27,190

Cash and cash equivalents at end of period	$	303,407		$	274,022

Supplemental schedule of non-cash investing and financing activities:
Granting of restricted stock	$	3,628		$	670

Foreclosures on loans	$	19,337		$	40,089

Transfer of securities from held to maturity to available for sale	$	—		$	42,519

Transfer of loans from investment to held for sale	$	—		$	50,559

Transfer of loans from held for sale to investment	$	3,380		$	—

Supplemental disclosure of cash flow information:
Cash paid during the period for:
Interest	$	52,373		$	33,237

Income taxes	$	—		$	1,635

See accompanying Notes to Consolidated Financial Statements.

SWS Group, Inc. and Subsidiaries

Notes to Consolidated Financial Statements

Three and Nine-Months Ended March 30, 2012 and March 25, 2011

(Unaudited)

GENERAL AND BASIS OF PRESENTATION

The interim consolidated financial statements as of March 30, 2012, and for the three and nine-months ended March 30, 2012 and March 25, 2011, are unaudited; however, in the opinion of management, these interim statements include all adjustments, consisting only of normal recurring adjustments, necessary for a fair presentation of the financial position, results of operations and cash flows. These financial statements should be read in conjunction with the audited consolidated financial statements and related notes as of and for the fiscal year ended June 24, 2011 filed on Form 10-K. Amounts as of June 24, 2011 are derived from the audited consolidated financial statements as filed on Form 10-K. All significant inter-company balances and transactions have been eliminated.

The consolidated financial statements include the accounts of SWS Group, Inc. (“SWS Group”) and the consolidated active subsidiaries listed below (collectively with SWS Group, “SWS” or the “Company”):


Southwest Securities, Inc.		“Southwest Securities”
SWS Financial Services, Inc.		“SWS Financial”
Southwest Financial Insurance Agency, Inc.
Southwest Insurance Agency, Inc.
Southwest Insurance Agency of Alabama, Inc.		collectively, “SWS Insurance”
SWS Banc Holdings, Inc.		“SWS Banc”
Southwest Securities, FSB		“Bank”

Southwest Securities is a New York Stock Exchange NYSE member broker/dealer. Southwest Securities and SWS Financial are members of the Financial Industry Regulatory Authority FINRA. Southwest Securities and SWS Financial are also registered with the Securities and Exchange Commission (the “SEC”) as broker/dealers under the Securities Exchange Act of 1934 (“Exchange Act”) and as registered investment advisors under the Investment Advisors Act of 1940.

SWS Insurance holds insurance agency licenses in forty-two states for the purpose of facilitating the sale of insurance and annuities for Southwest Securities and its correspondents. The Company retains no underwriting risk related to the insurance and annuity products that SWS Insurance sells.

The Bank is a federally chartered savings bank regulated since July 21, 2011 by the Office of the Comptroller of the Currency (“OCC”). Prior to July 21, 2011, the Bank was regulated by the Office of Thrift Supervision (“OTS”). As of July 21, 2011, the Federal Reserve Board (“FRB”) began supervising and regulating SWS Group and SWS Banc. SWS Banc is a wholly owned subsidiary of SWS Group and became the sole shareholder of the Bank in 2004.

Consolidated Financial Statements. The quarterly consolidated financial statements of SWS are customarily closed on the last Friday of the month. The Bank’s third quarter financial statements are prepared as of March 31, 2012. Any individually material transactions are reviewed and recorded in the appropriate quarterly period. All significant intercompany balances and transactions have been eliminated.

Update of Significant Accounting Policies. A summary of the Company’s significant accounting policies is included in Note 1 of the Company’s Form 10-K for the fiscal year ended June 24, 2011 filed on September 2, 2011 (the “Fiscal 2011 Form 10-K”). Except as discussed in the individual notes to the Consolidated Financial Statements, there have been no significant accounting changes since June 24, 2011.

Real estate owned (“REO”) and other repossessed assets . REO and other repossessed assets are valued at the lower of cost or market, less a selling discount and are included in other assets on the Consolidated Statements of Financial Condition. For those investments where the REO is valued at market, the value is determined by third party appraisals or if the REO is being sold in an auction, by accepted bid amount. For those REO assets that are in an auction and a bid has not been accepted, a fair value estimate is derived by utilizing market data including appraised value adjusted for distressed sales. In certain circumstances, the Company adjusts appraised values to more accurately reflect the economic conditions of the area at the time of valuation. These adjustments are largely based on the historical loss on sales of REO properties. Included in other repossessed assets are land leases which are valued using a discounted cash flow analysis. The amount of subsequent write-downs required to reflect current fair value was $1,106,000 and $13,349,000 for the nine-months ended March 31, 2012 and March 25, 2011, respectively.

Accounting Pronouncements. The Financial Accounting Standards Board (“FASB”) and the SEC have recently issued the following statements, which are applicable to SWS. Any other new accounting pronouncements not specifically identified in our disclosures are not applicable to SWS:

Accounting Standards Update (“ASU”) 2011-11 “Disclosures about Offsetting Assets and Liabilities.” In December 2011, the FASB issued ASU 2011-11 which requires entities to disclose both gross and net information about instruments and transactions eligible for offset in the statement of financial position and instruments and transactions subject to an agreement similar to a master netting agreement. The purpose of ASU 2011-11 is to facilitate comparison between entities that prepare their financial statements on a basis of accounting principles generally accepted in the United States (“GAAP”) and entities that prepare their financial statements on the basis of International Financial Reporting Standards (“IFRS”). ASU 2011-11 applies to derivatives, sale and repurchase agreements and reverse sale and repurchase agreements and securities borrowing and lending arrangements. ASU 2011-11 is effective for annual reporting periods beginning on or after January 1, 2013, and interim periods within those annual periods, the Company’s first quarter of fiscal 2014. The Company is in the process of evaluating the impact of ASU 2011-11 on its financial statements and processes.

ASU 2011-08, “Testing Goodwill for Impairment.” In September 2011, the FASB issued ASU 2011-08 to simplify testing goodwill for impairment. An entity is no longer required to calculate the fair value of a reporting unit unless the entity determines, based on a qualitative assessment, that it is more likely than not that a reporting unit’s fair value is less than its carrying amount. ASU 2011-08 is effective for interim and annual goodwill impairment tests performed for fiscal years beginning after December 15, 2011, the Company’s first quarter of fiscal 2013 and early adoption is permitted. The Company does not expect ASU 2011-08 to have a material impact on its financial statements and processes.

ASU 2011-05, “Comprehensive Income” as amended by ASU 2011-12 “Deferral of the Effective Date for Amendments to the Presentation of Reclassification of Items Out of Accumulated Other Comprehensive Income.” In June 2011, the FASB issued ASU 2011-05 to increase the prominence of items reported in other comprehensive income. ASU 2011-05 requires that all non-owner changes in stockholders’ equity be presented in either a single continuous statement of comprehensive income or in two separate but consecutive statements. ASU 2011-05 is effective for annual periods beginning after December 15, 2011, the Company’s first quarter of fiscal 2013 and early adoption is permitted. In December 2011, the FASB issued ASU 2011-12, which indefinitely defers the presentation of reclassification adjustments out of other comprehensive income by component in both the statement in which net income is presented and the statement in which comprehensive income is presented. The Company does not expect ASU 2011-05 or ASU 2011-12 to have a material impact on its financial statements and processes.

Income Taxes. As of March 30, 2012, the Company’s deferred tax assets include $647,000 related to capital losses from investments in various partnership assets. To use these deferred tax assets, the Company must generate sufficient capital gain income within the carry-back and carry-forward period available under the tax law. As of March 30, 2012, the Company did not believe it was more likely than not that it would generate sufficient capital gain income to offset these capital losses. Accordingly, the Company has a $604,000 valuation allowance to reflect the amount of the deferred tax assets that it believes is more likely than not to not be recognized. The valuation allowance decreased $240,000 from June 24, 2011 as a result of receiving additional valuation information about these investments.

At March 30, 2012, the Company had approximately $1,096,000 of unrecognized tax benefits. The Company’s net liability for unrecognized tax benefits decreased $298,000 from June 24, 2011 to March 30, 2012 due to the expiration of the applicable statute of limitations. While the Company expects that the net liability for uncertain tax positions will change during the next twelve months, the Company does not believe that the change will have a significant impact on its consolidated financial position or results of operations.

The Company recognizes interest and penalties on income taxes in income tax expense. Included in the net liability is accrued interest and penalties of $260,000, net of federal benefit, as of March 30, 2012 and $322,000, net of federal benefit, as of June 24, 2011. The total amount of unrecognized income tax benefits that, if recognized, would reduce income tax expense was approximately $836,000 as of March 30, 2012, net of federal benefit, and $1,072,000 as of June 24, 2011, net of federal benefit.

With limited exceptions, the Company is no longer subject to U.S. federal, state or local tax audits by taxing authorities for years preceding 2008. Examinations of certain state returns for the years ended December 31, 2007 through 2010 are underway. The IRS began its examination of the Company’s federal tax returns for 2008-2010 in February 2012.

Income tax expense (benefit) for the three and nine-month periods ended March 30, 2012 and March 25, 2011 (effective rate of 35.2% and 36.9% in the three-month periods ended March 30, 2012 and March 25, 2011, respectively, and 32.7% and 32.5% in the nine-month periods ended March 30, 2012 and March 25, 2011, respectively) differs from the amount that would otherwise have been calculated by applying the federal corporate tax rate (35% in fiscal 2012 and 2011) to income (loss) before income tax expense (benefit) and is comprised of the following (in thousands):


	Three-Months Ended						Nine-Months Ended
	March 30,			March 25,			March 30,			March 25,
	2012			2011			2012			2011
Income tax expense (benefit) at the statutory rate	$	4,462		$	(1,190	)	$	(2,302	)	$	(12,037	)
Tax exempt interest		(196	)		(231	)		(629	)		(651	)
Tax exempt income from company-owned life insurance (“COLI”)		(392	)		(148	)		(94	)		(614	)
State income taxes, net of federal tax benefit		286			24			113			464
Non-deductible meals and entertainment		77			48			149			125
Non-deductible compensation		298			245			925			630
Valuation allowance		(56	)		—			(240	)		844
Other, net		7			(2	)		(74	)		72

	$	4,486		$	(1,254	)	$	(2,152	)	$	(11,167	)

The tax effects of temporary differences that give rise to the deferred tax assets and deferred tax liabilities as of March 30, 2012 and June 24, 2011 are presented below (in thousands):


	March 30, 2012			June 24, 2011
Deferred tax assets:
Employee compensation plans	$	11,236		$	12,711
Allowance for probable loan losses		8,505			16,735
Bad debt reserve		1,953			1,709
Deferred rent		1,642			1,659
Gain on sale of loans deferred		283			508
Investment in unconsolidated ventures		647			128
Long-term debt		2,413			—
State taxes		1,155			1,426
Other		877			690

Gross deferred tax assets		28,711			35,566
Valuation allowance		(604	)		(844	)

Net deferred tax asset	$	28,107		$	34,722

Deferred tax liabilities:
Securities available for sale	$	(1,048	)	$	(398	)
Extraordinary gain related to the M.L. Stern & Co., LLC acquisition		(239	)		(239	)
Fixed assets, net		(491	)		(440	)
Real estate owned (“REO”)		(284	)		—
Investment in unconsolidated ventures		(801	)		—
Other		(65	)		(66	)

Total gross deferred tax liabilities		(2,928	)		(1,143	)

Net deferred tax assets – included in other assets on the Consolidated Statements of Financial Condition	$	25,179		$	33,579

FAIR VALUE OF FINANCIAL INSTRUMENTS

The Company’s fair value policies are discussed in Note 1 (u), Fair Value of Financial Instruments of the Fiscal 2011 Form 10-K, except as noted below. Additional information from the implementation of ASU 2011-04, “Amendments to Achieve Common Fair Value Measurement and Disclosure Requirements in U.S. GAAP and IFRSs” is presented herein.

Recurring Fair Value Measurements .

Warrants. The warrants held by Hilltop Holdings, Inc. (“Hilltop”), Oak Hill Capital Partners III, L.P. (“OHCP”) and Oak Hill Capital Management Partners III, L.P. (collectively with OHCP, “Oak Hill”) are valued using a binomial model which forecasts the Company’s potential stock price at certain points in time between the valuation date and expiration. In addition to the Company’s stock price, variables in the model include the risk free rate of return, dividend yield, time to maturity and volatility of the Company’s stock price.

The following tables summarize by level within the fair value hierarchy “Assets segregated for regulatory purposes,” “Securities available for sale,” “Securities owned, at fair value”, “Securities sold, not yet purchased, at fair value” and “Warrants” which were measured at fair value on a recurring basis at March 30, 2012 and June 24, 2011 and for the Bank at March 31, 2012 and June 30, 2011 (in thousands):


March 2012
	Level 1		Level 2		Level 3			Total
ASSETS
Assets segregated for regulatory purposes
U.S. government guaranteed obligations	$	35,307	$	—	$	—		$	35,307

	$	35,307	$	—	$	—		$	35,307


Securities available for sale
U.S. Home Systems, Inc. (“USHS”) common stock	$	3,329	$	—	$	—		$	3,329
Westwood Holdings Group, Inc. (“Westwood”) common stock		163		—		—			163
U.S. government and government agency obligations ^(*)		—		121,699		—			121,699

	$	3,492	$	121,699	$	—		$	125,191


Securities owned, at fair value
Corporate equity securities	$	733	$	—	$	675		$	1,408
Municipal obligations		—		94,263		25,217			119,480
U.S. government and government agency obligations		4,348		22,712		—			27,060
Corporate obligations		—		72,286		—			72,286
Other		692		23,227		—			23,919

	$	5,773	$	212,488	$	25,892		$	244,153

LIABILITIES

Securities sold, not yet purchased, at fair value
U.S. government and government agency obligations	$	22,201	$	1,363	$	—		$	23,564
Corporate obligations		—		37,261		—			37,261
Other		—		554		—			554

	$	22,201	$	39,178	$	—		$	61,379


Warrants
Stock purchase warrants	$	—	$	—	$	31,067		$	31,067

	$	—	$	—	$	31,067		$	31,067

Grand total	$	22,371	$	295,009	$	(5,175	)	$	312,205

^(*)

The Company’s fair value policies regarding U.S. government and government agency obligations held as securities available for sale are the same as those discussed in Note 1 (u), Fair Value of Financial Instruments of the Fiscal 2011 Form 10-K for securities classified as Level 2 securities held as securities owned, at fair value.


June 2011
	Level 1		Level 2		Level 3		Total
ASSETS
Assets segregated for regulatory purposes
U.S. government guaranteed obligations	$	55,617	$	—	$	—	$	55,617

	$	55,617	$	—	$	—	$	55,617


Securities available for sale
USHS stock	$	1,868	$	—	$	—	$	1,868
Westwood stock		152		—		—		152

	$	2,020	$	—	$	—	$	2,020


Securities owned, at fair value
Corporate equity securities	$	915	$	__	$	1,225	$	2,140
Municipal obligations		__		76,589		21,676		98,265
U.S. government and government agency obligations		16,491		10,889		—		27,380
Corporate obligations		—		72,053		—		72,053
Other		692		21,057		—		21,749

	$	18,098	$	180,588	$	22,901	$	221,587

LIABILITIES

Securities sold, not yet purchased, at fair value
U.S. government and government agency obligations	$	50,350	$	623	$	—	$	50,973
Corporate obligations		—		17,289		—		17,289
Other		—		399		—		399

	$	50,350	$	18,311	$	—	$	68,661

Grand total	$	25,385	$	162,277	$	22,901	$	210,563

The following table provides a reconciliation of the beginning and ending balances for the major classes of assets and liabilities measured at fair value using significant unobservable inputs (Level 3) (in thousands):


	Corporate Equity Securities			Municipal Obligations		Warrants			Total
Beginning balance at June 24, 2011	$	1,225		$	21,676	$	—		$	22,901
Sales/redemption		(425	)		—		—			(425	)
Increase in warrant valuation (unrealized loss)		—			—		(171	)		(171	)
Issuance of warrants		—			—		(24,136	)		(24,136	)

Ending balance at September 30, 2011	$	800		$	21,676	$	(24,307	)	$	(1,831	)
Sales/redemption		(125	)		—		—			(125	)
Increase in warrant valuation (unrealized loss)		—			—		(19,262	)		(19,262	)
Transfers from Level 2 to Level 3		—			6		—			6

Ending balance at December 30, 2011	$	675		$	21,682	$	(43,569	)	$	(21,212	)
Decrease in warrant valuation (unrealized gain)		—			—		12,502			12,502
Purchases		—			3,535		—			3,535

Ending balance at March 30, 2012	$	675		$	25,217	$	(31,067	)	$	(5,175	)

At the end of each respective quarterly reporting period, the Company recognizes transfers of financial instruments between levels. There were no transfers between Level 1 and Level 2 for the nine-months ended March 30, 2012. During the three-months ended December 30, 2011, the transfer from Level 2 to Level 3 was due to a default on a municipal obligation.

Changes in unrealized gains (losses) and realized gains (losses) for corporate and municipal obligations and corporate equity securities are presented in “Net gains on principal transactions” on the Consolidated Statements of Income (Loss) and Comprehensive Income (Loss). Changes in unrealized gain (loss) for the stock purchase warrants are presented in unrealized (gain) loss on warrant valuation on the Consolidated Statements of Income (Loss) and Comprehensive Income (Loss). The total unrealized gain included in earnings related to assets and liabilities still held for the three-months ended March 30, 2012 was $12,502,000 and the total unrealized loss included in earnings related to assets and liabilities still held for the nine-months ended March 30, 2012 was $6,931,000.

The following table highlights, for each asset and liability measured at fair value on a recurring basis and categorized within Level 3 of the fair value hierarchy, the significant unobservable inputs used in the fair value measurement as of March 30, 2012 (dollars in thousands):


Asset/ Liability	Fair Value		Valuation Technique(s)	Unobservable Inputs	Range (Weighted) Average
Securities owned, at fair value

Corporate equity securities – auction rate preferred	$	675	Analysis of comparable securities	N/A	N/A
Municipal obligation – defaulted municipal obligation		6	Par	N/A	N/A
Municipal obligations – auction rate bonds		21,676	Discounted Cash Flow	Holding Period	one to five years (3 years)
Municipal obligation—loan		3,535	Par	N/A	N/A
Warrants
Stock purchase warrants		31,067	Binomial Model	Derived Volatility	50% -64% (51%)

The Company holds twenty-seven auction rate preferred securities valued at $675,000 at March 30, 2012, which are valued at par based on observed values of comparable securities. Since June 2010, the Company has held up to $1.8 million in Level 3 auction rate preferred securities, of which $1.2 million have been redeemed at par. The remaining $675,000 of auction rate preferred securities are similar to those that were previously redeemed. The Company anticipates that the remaining securities will also be called at par. While a liquidity discount has been considered for these securities, the Company does not believe a discount is warranted. To the extent these securities are redeemed at a price below par, the Company would consider revaluing any remaining securities at a discounted price.

The Company holds one municipal auction rate bond valued at $21,676,000 at March 30, 2012. The security matures in 2032 and pays interest on a weekly basis that is indexed to a variable short term interest rate. The Company performs a discounted cash flow analysis quarterly to value this bond. This analysis considers the coupon in light of market yields on similar municipal securities. A probability weighted matrix is used to determine what the theoretical value of this security would be if it were redeemed at par in one to five years. In addition, the Company reviews recent market activity in similar securities. The final valuation is derived by applying a weight to the discounted cash flow valuation and observed market values. In the future, there could be a reduction in the valuation of the bond if the spread widens between the coupon paid on the bond and the required market yield.

The Company holds a $3,535,000 short-term loan to a municipal issuer in its proprietary inventory bearing a fixed interest rate at March 30, 2012. The loan is currently valued at par. The Company loaned the municipality $3,535,000 in the third quarter of fiscal 2012. The loan is expected to be paid in full by the end of the fourth quarter of fiscal 2012, as such, due to its short-term nature, and the sound credit of the borrower, the loan is valued at par. The loan is determined to be Level 3 as there is no current market for this loan.

The stock purchase warrants are valued quarterly using a binomial model. The model considers the following variables: price and volatility of the Company’s stock, treasury yield, annual dividend, and the remaining life of the warrants. The derived volatility estimate considers both the historical and implied forward volatility of the Company’s common stock. All else being equal, the warrants will lose time value as they near maturity. Other than remaining life, the primary drivers of value are the price and volatility of the Company’s common stock. As the volatility and/or stock price increase the value of the warrants increase as well. The movement of these two variables will amplify or offset one another depending on the direction and velocity of their movements.

Non-Recurring Fair Value Measurements.

Certain assets and liabilities are not measured at fair value on an ongoing basis but are subject to fair value measurement only in certain circumstances; for example, when there is evidence of impairment or in other situations where the lower of cost or fair value method of accounting is applied.

The following tables summarize by level within the fair value hierarchy REO and other repossessed assets and loans held for sale which were measured at fair value on a non-recurring basis at March 31, 2012 and June 30, 2011 (in thousands):


	Level 1		Level 2		Level 3		Total
March 2012
ASSETS
REO and other repossessed assets	$	—	$	—	$	29,273	$	29,273
Loans held for sale ^(*)		—		—		—		—

	$	—	$	—	$	29,273	$	29,273

June 2011
ASSETS
REO	$	—	$	—	$	24,562	$	24,562
Loans held for sale		—		—		5,241		5,241

	$	—	$	—	$	29,803	$	29,803

^(*)	Loans were reclassified to held for investment as these loans no longer met the criteria to be classified as held for sale, see discussion in “ Loans Held for Sale ”.

Other Fair Value Disclosures.

The Company’s fair value policies for instruments measured at fair value in accordance with the disclosure requirements of Accounting Standards Codification (“ASC”) 820-Fair Value Measurements and Disclosures are discussed in Note 1 (u), Fair Value of Financial Instruments—Other Fair Value Disclosures of the Fiscal 2011 Form 10-K, except as noted below.

Long-Term Debt. The fair value of long-term debt was estimated using a discounted cash flow model with assumptions regarding the factors a market participant would consider in valuing the liability, including credit and liquidity risk.

The recorded amounts, fair value and level of the fair value hierarchy of the Company’s financial instruments at March 30, 2012 and June 24, 2011 and for the Bank at March 31, 2012 and June 30, 2011 were as follows (in thousands):


			March				June
	Level		Recorded Value		Fair Value		Recorded Value		Fair Value
Financial assets:
Cash and cash equivalents		1	$	303,407	$	303,407	$	298,903	$	298,903
Restricted cash and cash equivalents		1		30,044		30,044		—		—
Securities held to maturity:
Government National Mortgage Association (“GNMA”) securities ^(*)		2		28,408		29,138		34,176		34,496
Loans, net:
Purchased mortgage loans held for investment		2		217,214		217,613		100,239		100,483
Other loans held for investment		2		607,324		686,189		846,529		922,879
Financial liabilities:
Short-term borrowings		1		126,000		126,000		110,000		110,000
Deposits:
Deposits with no stated maturity		2		1,022,123		1,022,123		1,058,155		1,058,155
Time deposits		2		39,524		40,077		48,316		49,054
Advances from the FHLB		2		78,746		89,446		94,712		106,729
Long-term debt		3		78,159		82,052		—		—

^(*)

The Company’s fair value policies regarding U.S. government and government agency obligations held as securities held to maturity are the same as those discussed in Note 1 (u), Fair Value of Financial Instruments of the Fiscal 2011 Form 10-K for securities classified as Level 2 securities held as securities owned, at fair value.

EMPLOYEE BENEFITS

Restricted Stock Plan . During the first nine-months of fiscal 2012, the Board of Directors approved grants to various officers and employees totaling 348,810 shares with a weighted average market value of $7.02 per share. During the first nine-months of fiscal 2011, the Board of Directors approved grants to various officers and employees totaling 64,151 shares with a weighted average market value of $6.16 per share. For the three and nine-months ended March 30, 2012, SWS recognized compensation expense related to restricted stock grants of approximately $336,000 and $791,000, respectively. For the three and nine-months ended March 25, 2011, SWS recognized compensation expense related to restricted stock grants of approximately $354,000 and $901,000, respectively.

At March 30, 2012, there were 413,811 unvested shares outstanding under the Restricted Stock Plan and 23,804 shares available for future grants.

CASH AND CASH EQUIVALENTS

For the purpose of the Consolidated Statements of Cash Flows, SWS considers cash to include cash on hand and in bank accounts. In addition, SWS considers funds due from banks and interest bearing deposits in other banks to be cash. Highly liquid debt instruments purchased with maturities of three months or less, when acquired, are considered to be cash equivalents. The Federal Deposit Insurance Corporation (“FDIC”) insures interest-bearing cash accounts up to $250,000. Also, non-interest bearing transaction accounts have unlimited coverage under FDIC insurance until December 31, 2012 in accordance with the Dodd-Frank Wall Street Reform and Consumer Protection Act (the “Dodd-Frank Act”). At March 30, 2012 and June 24, 2011, cash balances included $753,000 and $752,000 that were not federally insured because they exceeded federal insurance limits, respectively. This at-risk amount is subject to fluctuation on a daily basis, but management does not believe there is significant risk of loss on these deposits.

The Bank is required to maintain balances on hand or with the Federal Reserve Bank. At March 31, 2012 and June 30, 2011, these reserve balances amounted to $1,609,000 and $4,158,000, respectively.

RESTRICTED CASH AND CASH EQUIVALENTS

Restricted cash and cash equivalents represents funds received from Hilltop and Oak Hill upon completion of the transactions contemplated by the Funding Agreement entered into on March 20, 2011. The Company is required to keep these funds in a restricted account until the Company’s Board of Directors, Hilltop and Oak Hill determine the amount(s) to be distributed to the Company’s subsidiaries. See additional discussion in “ Debt Issued with Stock Purchase Warrants .” Upon approval of the Board of Directors, the Company contributed $20,000,000 of this cash to the Bank in December 2011 and in the third quarter of fiscal 2012, SWS Group loaned Southwest Securities $50,000,000 to use in general operations by reducing Southwest Securities’ use of short-term borrowings for the financing of the Company’s day-to-day cash management needs. The remaining $30,000,000 remains at the parent company to be used for general corporate purposes. Restricted cash and cash equivalents are excluded from cash and cash equivalents in the Consolidated Statements of Financial Condition and Consolidated Statements of Cash Flows. The Company holds restricted cash and cash equivalents in money market funds.

ASSETS SEGREGATED FOR REGULATORY PURPOSES

At March 30, 2012, SWS held Temporary Liquidity Guarantee Program (“TLGP”) bonds with a fair value of $35,307,000 and cash of approximately $173,832,000 segregated in special reserve bank accounts for the exclusive benefit of customers under Rule 15c3-3 of the Securities Exchange Act of 1934, as amended (“Exchange Act Rule 15c3-3”). SWS had no reserve deposits in special reserve bank accounts for the Proprietary Accounts of Introducing Brokers (“PAIB”) at March 30, 2012.

At June 24, 2011, SWS held TLGP bonds with a fair value of $55,617,000 and cash of approximately $182,708,000 segregated in special reserve bank accounts for the exclusive benefit of customers under Exchange Act Rule 15c3-3. SWS had no reserve deposits in special reserve bank accounts for the PAIB at June 24, 2011.

RECEIVABLE FROM AND PAYABLE TO BROKERS, DEALERS AND CLEARING ORGANIZATIONS

At March 30, 2012 and June 24, 2011, SWS had receivable from and payable to brokers, dealers and clearing organizations related to the following (in thousands):


	March		June
Receivable
Securities failed to deliver	$	15,443	$	19,387
Securities borrowed		1,220,832		1,529,707
Correspondent broker/dealers		34,248		38,019
Clearing organizations		20,511		20,879
Other		22,805		12,531

	$	1,313,839	$	1,620,523

Payable
Securities failed to receive	$	25,940	$	18,214
Securities loaned		1,192,043		1,519,665
Correspondent broker/dealers		13,237		12,087
Other		9,007		18,067

	$	1,240,227	$	1,568,033

SWS participates in the securities borrowing and lending business by borrowing and lending securities other than those of its clients. SWS obtains or releases collateral as prices of the underlying securities fluctuate. At March 30, 2012, SWS had collateral of $1,220,825,000 under securities lending agreements, of which SWS had repledged $1,159,480,000. At June 24, 2011, SWS had collateral of $1,529,607,000 under securities lending agreements, of which SWS had repledged $1,484,485,000.

LOANS HELD FOR SALE

Loans held for sale consist of originated loans that were held for investment that management subsequently decided to sell.

The recorded values of loans held for sale were as follows (in thousands):


	March 31, 2012		June 30, 2011
Loans held for sale	$	—	$	5,241

In fiscal year 2011, loans were transferred to the held for sale category in anticipation of immediate disposition. These loans were classified loans that were being marketed through an international marketing campaign. The fair value of these loans was determined using a discounted cash flow model to reflect the return required for immediate disposition of a distressed loan.

In the third quarter of fiscal year 2012, the Bank determined that the remaining $3,380,000 of loans held for sale, no longer met the criteria of the held for sale classification because the loans were no longer being actively marketed for sale, the Bank was no longer committed to a plan to sell the loans or locate a buyer and there were no indications that the loans would be sold within the next twelve months. As a result, the loans were reclassified to loans held for investment at March 31, 2012.

LOANS AND ALLOWANCE FOR PROBABLE LOAN LOSSES

The Bank grants loans to customers primarily within Texas and New Mexico. Although the Bank has a diversified loan portfolio, a substantial portion of its debtors’ ability to honor their loans is dependent upon the general economic conditions of Texas and New Mexico.

Loans receivable at March 31, 2012 and June 30, 2011 were as follows (in thousands):


	March			June
Loans receivable:
Residential construction	$	8,826		$	33,296
Lot and land development		24,406			60,070
1-4 family (*)		312,823			217,175
Commercial real estate		361,825			444,064
Multi-family		17,036			60,831
Commercial loans		123,976			173,170
Consumer loans		2,209			3,055

		851,101			991,661
Unamortized premiums and discounts		(381	)		(460	)

		850,720			991,201
Allowance for probable loan losses		(26,182	)		(44,433	)

	$	824,538		$	946,768

^(*)

Includes $217,214 and $100,239 of purchased mortgage loans held for investment at March 31, 2012 and June 30, 2011, respectively. The loans included in the Bank’s purchased mortgage loans held for investment portfolio are purchases made by the Bank’s mortgage purchase division of participations in newly originated residential loans from various mortgage bankers nationwide at par.

There were $810,000 and $1,452,000 of unamortized deferred fees and costs in the loans receivable balances at March 31, 2012 and June 30, 2011, respectively.

In the first quarter of fiscal 2012, the Company adopted ASU 2011-02, “A Creditor’s Determination of Whether a Restructuring is a Troubled Debt Restructuring,” (ASU 2011-02). The information required by this ASU is presented in the tables below.

The allowance for probable loan loss is increased by charges to income and decreased by charge-offs (net of recoveries). Management periodically evaluates the adequacy of the allowance through a review of the Bank’s past loan loss experience, known and inherent risks in the portfolio, adverse situations that may affect the borrower’s ability to repay, the estimated value of any underlying collateral and current economic conditions. In determining the appropriate loan loss allowance at the balance sheet date, management evaluated the Bank’s historical loss percentage, concentrations of risk in the portfolio, estimated changes in the value of underlying collateral as well as changes in the volume and growth in the portfolio and the credit quality of the loan portfolio to capture additional risk of loss associated with concentrations of criticized and classified loans in the total loan portfolio.

The analysis of the allowance for loan losses for the three and nine-months ended March 31, 2012 and 2011 and the recorded investment in loans receivable at March 31, 2012 and 2011 were as follows (in thousands):


	Three-Months Ended March 31, 2012
	Residential Construction			Lot and Land Development			1-4 Family			Commercial Real Estate			Multi- family			Commercial			Consumer			Total
Allowance for loan losses:
Balance at beginning of period	$	834		$	3,370		$	4,551		$	17,203		$	3,700		$	3,420		$	33		$	33,111
Charge-offs		(457	)		(478	)		(1,779	)		(3,363	)		(801	)		(541	)		—			(7,419	)
Recoveries		8			85			131			139			—			120			7			490

Net charge-offs		(449	)		(393	)		(1,648	)		(3,224	)		(801	)		(421	)		7			(6,929	)
Additions charged to operations		290			(1,275	)		1,217			838			(577	)		(461	)		(32	)		—

Balance at end of period	$	675		$	1,702		$	4,120		$	14,817		$	2,322		$	2,538		$	8		$	26,182

Ending balance: individually evaluated for impairment	$	—		$	—		$	417		$	1,766		$	—		$	114		$	—		$	2,297

Ending balance: collectively evaluated for impairment	$	675		$	1,702		$	3,703		$	13,051		$	2,322		$	2,424		$	8		$	23,885

Financing receivables:
Balance at end of period	$	8,826		$	24,336		$	312,726		$	361,647		$	17,019		$	123,957		$	2,209		$	850,720

Ending balance: individually evaluated for impairment	$	3,895		$	4,804		$	17,435		$	30,913		$	1,199		$	6,083		$	3		$	64,332

Ending balance: collectively evaluated for impairment	$	4,931		$	19,532		$	295,291		$	330,734		$	15,820		$	117,874		$	2,206		$	786,388


	Three-Months Ended March 31, 2011
	Residential Construction			Lot and Land Development			1-4 Family			Commercial Real Estate			Multi- family			Commercial			Consumer			Total
Allowance for loan losses:
Balance at beginning of period	$	2,780		$	5,442		$	6,052		$	27,759		$	1,108		$	3,880		$	20		$	47,041
Charge-offs		—			(2,690	)		(588	)		(1,020	)		—			(297	)		(1	)		(4,596	)
Recoveries		59			57			13			1			—			12			—			142

Net charge-offs		59			(2,633	)		(575	)		(1,019	)		—			(285	)		(1	)		(4,454	)
Additions charged to operations		(1,752	)		4,270			(271	)		1,801			(55	)		715			19			4,727

Balance at end of period	$	1,087		$	7,079		$	5,206		$	28,541		$	1,053		$	4,310		$	38		$	47,314

Ending balance: individually evaluated for impairment	$	2		$	5		$	387		$	881		$	—		$	209		$	—		$	1,484

Ending balance: collectively evaluated for impairment	$	1,085		$	7,074		$	4,819		$	27,660		$	1,053		$	4,101		$	38		$	45,830


Financing receivables:
Balance at end of period	$	41,677		$	70,519		$	187,952		$	460,797		$	63,298		$	192,882		$	3,673		$	1,020,798

Ending balance: individually evaluated for impairment	$	7,577		$	21,490		$	5,553		$	31,025		$	16,633		$	4,726		$	80		$	87,084

Ending balance: collectively evaluated for impairment	$	34,100		$	49,029		$	182,399		$	429,772		$	46,665		$	188,156		$	3,593		$	933,714


	Nine-Months Ended March 31, 2012
	Residential Construction			Lot and Land Development			1-4 Family			Commercial Real Estate			Multi- family			Commercial			Consumer			Total
Allowance for loan losses:
Balance at beginning of period	$	531		$	3,168		$	6,107		$	28,306		$	871		$	5,417		$	33		$	44,433
Charge-offs		(1,477	)		(2,365	)		(1,963	)		(7,418	)		(6,854	)		(1,700	)		(10	)		(21,787	)
Recoveries		143			194			168			357			—			192			7			1,061

Net charge-offs		(1,334	)		(2,171	)		(1,795	)		(7,061	)		(6,854	)		(1,508	)		(3	)		(20,726	)
Additions charged to operations		1,478			705			(192	)		(6,428	)		8,305			(1,371	)		(22	)		2,475

Balance at end of period	$	675		$	1,702		$	4,120		$	14,817		$	2,322		$	2,538		$	8		$	26,182


	Nine-Months Ended March 31, 2011
	Residential Construction			Lot and Land Development			1-4 Family			Commercial Real Estate			Multi- family			Commercial			Consumer			Total
Allowance for loan losses:
Balance at beginning of period	$	3,362		$	4,808		$	3,542		$	19,733		$	812		$	2,853		$	31		$	35,141
Charge-offs		(1,999	)		(5,350	)		(4,225	)		(25,163	)		(562	)		(1,975	)		(1	)		(39,275	)
Recoveries		216			153			27			29			—			55			1			481

Net charge-offs		(1,783	)		(5,197	)		(4,198	)		(25,134	)		(562	)		(1,920	)		—			(38,794	)
Additions charged to operations		(492	)		7,468			5,862			33,942			803			3,377			7			50,967

Balance at end of period	$	1,087		$	7,079		$	5,206		$	28,541		$	1,053		$	4,310		$	38		$	47,314

As of March 31, 2012 and 2011, the ratio of loan loss allowance to ending loan balance, excluding purchased mortgage loans held for investment, was 4.13% and 4.93%, respectively. There is no loan loss allowance for purchased mortgage loans held for investment. Those purchased mortgage loans held for investment are held on average for 25 days or less, which substantially eliminates credit risk.

Loans receivable on non-accrual status as of March 31, 2012 and June 30, 2011 were as follows (in thousands):


	March 31, 2012		June 30, 2011
Residential construction	$	3,895	$	4,799
Lot and land development		3,983		17,888
1-4 family		16,186		3,377
Commercial real estate		13,806		20,626
Multi-family		1,199		14,493
Commercial loans		6,075		3,166
Consumer loans		3		21

	$	45,147	$	64,370

Loans are classified as non-performing when they are 90 days or more past due as to principal or interest or when reasonable doubt exists as to timely collectability. The Bank uses a standardized review process to determine which loans should be placed on non-accrual status. At the time a loan is placed on non-accrual status, previously accrued and uncollected interest is reversed against interest income. Interest income on non-accrual loans is subsequently recognized to the extent cash payments are received for loans where ultimate full collection is likely. For loans where full collection is not likely, interest payments are applied to the outstanding principal and income is only recognized if full payment is made. The average recorded investment in non-accrual loans was approximately $54,406,000 during the nine-months ended March 31, 2012 and $61,633,000 during the nine-months ended March 31, 2011. Interest income recorded on non-accrual loans prior to being placed on non-accrual status totaled approximately $45,000 and $903,000 for the three and nine-months ended March 31, 2012, respectively, and $7,000 and $591,000 for the three and nine-months ended March 31, 2011, respectively.

The following tables highlight the Bank’s recorded investment and unpaid principal balance for impaired loans by type as well as the related allowance, average recorded investment and interest income recognized as of March 31, 2012 and June 30, 2011 (in thousands):


	Recorded Investment		Unpaid Principal Balance		Related Allowance		Average Recorded Investment ^(*)		Interest Income Recognized ^(#)
March 31, 2012
With no related allowance recorded:
Residential construction	$	3,895	$	4,831	$	—	$	2,736	$	—
Lot and land development		4,804		5,770		—		7,299		55
1-4 family		16,186		17,578		—		5,580		—
Commercial real estate		18,363		22,920		—		13,729		106
Multi-family		1,199		2,216		—		8,612		—
Commercial loans		5,773		6,462		—		3,818		—
Consumer loans		3		10		—		28		—

		50,223		59,787		—		41,802		161

With an allowance recorded:
Residential construction		—		—		—		1,963		44
Lot and land development		—		—		—		1,368		—
1-4 family		1,249		1,249		417		2,009		—
Commercial real estate		12,550		12,550		1,766		27,930		509
Multi-family		—		—		—		6,441		—
Commercial loans		310		310		114		1,155		17

		14,109		14,109		2,297		40,866		570


	Recorded Investment		Unpaid Principal Balance		Related Allowance		Average Recorded Investment ^(*)		Interest Income Recognized ^(#)
March 31, 2012
Total
Residential construction	$	3,895	$	4,831	$	—	$	4,699	$	44
Lot and land development		4,804		5,770		—		8,667		55
1-4 family		17,435		18,827		417		7,589		—
Commercial real estate		30,913		35,470		1,766		41,659		615
Multi-family		1,199		2,216		—		15,053		—
Commercial loans		6,083		6,772		114		4,973		17
Consumer loans		3		10		—		28		—

	$	64,332	$	73,896	$	2,297	$	82,668	$	731

^(*)	Represents the average recorded investment for the nine-months ended March 31, 2012.

^(#)	Represents interest income recognized on impaired loans for the nine-months ended March 31, 2012.


	Recorded Investment		Unpaid Principal Balance		Related Allowance		Average Recorded Investment ^(*)		Interest Income Recognized ^(#)
June 30, 2011
With no related allowance recorded:
Residential construction	$	4,799	$	5,702	$	—	$	3,181	$	—
Lot and land development		19,418		20,329		—		13,630		70
1-4 family		3,214		3,604		—		6,032		2
Commercial real estate		11,446		13,658		—		14,705		35
Multi-family		14,493		15,303		—		10,318		—
Commercial loans		2,818		3,740		—		1,837		—
Consumer loans		21		27		—		98		—

		56,209		62,363		—		49,801		107


	Recorded Investment		Unpaid Principal Balance		Related Allowance		Average Recorded Investment ^(*)		Interest Income Recognized ^(#)
June 30, 2011
With an allowance recorded:
Residential construction	$	230	$	230	$	2	$	116	$	10
Lot and land development		112		112		23		1,167		24
1-4 family		2,560		2,560		381		3,136		136
Commercial real estate		17,147		17,784		2,322		13,995		291
Multi-family		—		—		—		3,626		—
Commercial loans		1,797		1,797		425		682		539
Consumer loans		—		—		—		—		—

		21,846		22,483		3,153		22,722		1,000


	Recorded Investment		Unpaid Principal Balance		Related Allowance		Average Recorded Investment ^(*)		Interest Income Recognized ^(#)
June 30, 2011
Total
Residential construction		5,029		5,932		2		3,297		10
Lot and land development		19,530		20,441		23		14,797		94
1-4 family		5,774		6,164		381		9,168		138
Commercial real estate		28,593		31,442		2,322		28,700		326
Multi-family		14,493		15,303		—		13,944		—
Commercial loans		4,615		5,537		425		2,519		539
Consumer loans		21		27		—		98		—

	$	78,055	$	84,846	$	3,153	$	72,523	$	1,107

^(*)	Represents the average recorded investment for the fiscal year ended June 30, 2011.

^(#)	Represents interest income recognized on impaired loans for the fiscal year ended June 30, 2011.

In compliance with the Order to Cease and Desist, Order No. WN-11-003, effective February 4, 2011 (the “Order”), the Bank implemented processes to continuously monitor the credit quality of its loan portfolio as well as compliance with both internal policies and regulatory guidance. These processes include an internal credit review department and the use of external credit review consultants. Reports provided by these groups to management and the Board assist in overall risk mitigation for the Bank’s loan portfolio and with compliance with the Order. See “ Cease and Desist Order with the Office of the Comptroller of the Currency .”

The Bank prepares a criticized and classified loan report that it uses to assist in calculating an adequate allowance for loan losses. The following tables summarize this report and highlight the overall quality of the Bank’s financing receivables, excluding loans held for sale, as of March 31, 2012 and June 30, 2011 (in thousands):


	Pass		Special Mention ^(*)		Substandard ^(#)		Total
March 31, 2012
Residential construction	$	4,430	$	—	$	4,396	$	8,826
Lot and land development		15,639		27		8,670		24,336
1-4 family		292,610		927		19,189		312,726
Commercial real estate		298,531		6,113		57,003		361,647
Multi-family		15,040		—		1,979		17,019
Commercial loans		112,095		2,546		9,316		123,957
Consumer loans		2,105		101		3		2,209

	$	740,450	$	9,714	$	100,556	$	850,720


	Pass		Special Mention ^(*)		Substandard ^(#)		Total
June 30, 2011
Residential construction	$	20,860	$	465	$	11,971	$	33,296
Lot and land development		24,873		3,230		31,887		59,990
1-4 family		198,719		61		18,258		217,038
Commercial real estate		337,254		7,193		99,367		443,814
Multi-family		34,378		6,225		20,210		60,813
Commercial loans		155,174		4,103		13,918		173,195
Consumer loans		3,021		13		21		3,055

	$	774,279	$	21,290	$	195,632	$	991,201

^(*)	These loans are currently protected by the current sound worth and paying capacity of the obligor, but have a potential weakness that would create a higher credit risk.

^(#)

These loans exhibit well defined weaknesses that could jeopardize the ultimate collection of all or part of the debt. Substandard loans are inadequately protected by the current sound worth and paying capacity of the obligor or of the collateral pledged. They are characterized by the distinct possibility that the Bank will sustain some loss if the deficiencies are not corrected. Loss potential, while existing in the aggregate for substandard assets, does not have to exist in individual assets classified as “Substandard”.

The following tables highlight the age analysis of the Bank’s financing receivables as of March 31, 2012 and June 30, 2011 (in thousands):


	30-59 Days Past Due		60-89 Days Past Due		90 Days and Greater Past Due		Total Past Due		Current		Total Financing Receivables		Recorded Investment > 90 Days and Accruing
March 31, 2012
Residential construction	$	397	$	—	$	3,895	$	4,292	$	4,534	$	8,826	$	—
Lot and land development		342		516		2,829		3,687		20,649		24,336		—
1-4 family		3,337		708		10,666		14,711		298,015		312,726		—
Commercial real estate		932		—		9,485		10,417		351,230		361,647		—
Multi-family		—		—		1,198		1,198		15,821		17,019		—
Commercial loans		1,133		24		5,595		6,752		117,205		123,957		—
Consumer loans		3		101		—		104		2,105		2,209		—

	$	6,144	$	1,349	$	33,668	$	41,161	$	809,559	$	850,720	$	—


	30-59 Days Past Due		60-89 Days Past Due		90 Days and Greater		Total Past Due		Current		Total Financing Receivables		Recorded Investment > 90 Days and Accruing
June 30, 2011
Residential construction	$	870	$	849	$	4,251	$	5,970	$	27,326	$	33,296	$	—
Lot and land development		714		—		2,373		3,087		56,903		59,990		—
1-4 family		837		221		2,053		3,111		213,927		217,038		—
Commercial real estate		1,452		2,799		9,870		14,121		429,693		443,814		—
Multi-family		—		—		2,010		2,010		58,803		60,813		—
Commercial loans		1,446		717		2,222		4,385		168,810		173,195		—
Consumer loans		63		13		14		90		2,965		3,055		—

	$	5,382	$	4,599	$	22,793	$	32,774	$	958,427	$	991,201	$	—

In certain circumstances, the Bank modifies the terms of its loans to a troubled borrower. Modifications may include extending the maturity date, reducing the stated interest rate or rescheduling future cash flows. The Bank accounts for the modification as a troubled debt restructuring (“TDR”).

Loans that have been modified in a TDR continue to be considered restructured until paid in full. These loans, including loans restructured in the prior 12 months that defaulted during the period, are individually evaluated for impairment taking into consideration payment status, collateral value, and the probability of collecting scheduled principal and interest payments when due. A specific allowance for an impaired loan that has been modified in a TDR is established when the loan’s fair value is lower than its recorded investment. In addition, the historical rate of charge-offs to the pre-modification recorded investment by portfolio segment is factored into the formula utilized to determine the general allowance for probable loan losses.

The table below presents the recorded investment in loans modified in TDRs as of March 31, 2012 and June 30, 2011 (in thousands):


	March 31, 2012 ⁽¹⁾		June 30, 2011 ⁽¹⁾
Lot and land development	$	1,855	$	4,295
1-4 family		2,436		50
Commercial real-estate		—		4,868
Multi-family		—		13,009
Commercial		5,062		693

	$	9,353	$	22,915

⁽¹⁾

The allowance for loan losses, excluded from the recorded investment, associated with loans modified in TDRs as of March 31, 2012 and June 30, 2011, was $50 and $0, respectively. The recorded investment includes $641 and $540 of loans on accrual status as of March 31, 2012 and June 30, 2011, respectively.

The following table summarizes the financial effects of loan modifications accounted for as TDRs that occurred during the three and nine-months ended March 31, 2012 (dollars in thousands):


	Three-Months Ended March 31, 2012						Nine-Months Ended March 31, 2012
	Number of Contracts		Pre- Modification Outstanding Recorded Investment		Post- Modification Outstanding Recorded Investment		Number of Contracts		Pre- Modification Outstanding Recorded Investment		Post- Modification Outstanding Recorded Investment
Lot and land development		1	$	430	$	430		1	$	430	$	430
1-4 family		5		2,072		2,072		6		2,442		2,442
Commercial		4		4,478		4,478		6		5,078		5,078

		10	$	6,980	$	6,980		13	$	7,950	$	7,950

The table below summarizes the type of loan modifications made for TDR’s during the three and nine-months ended March 31, 2012 (in thousands):


	Amount of Loan Modifications
Type of Modification	Three-Months Ended March 31, 2012		Nine-Months Ended March 31, 2012
Extended maturity date	$	—	$	970
Rescheduled future cash flows		2,072		2,072
Combination of maturity date extension and rescheduling of future cash flows		4,478		4,478
Combination of maturity date extension and reduction of the stated interest rate		430		430

	$	6,980	$	7,950

Loan modifications accounted for as TDRs within the previous 12 months that subsequently defaulted during the three and nine-months ended March 31, 2012 are summarized in the following table (dollars in thousands):


	Three-Months Ended March 31, 2012				Nine-Months Ended March 31, 2012
	Number of Contracts		Recorded Investment		Number of Contracts		Recorded Investment
1-4 family		2	$	281		2	$	281
Commercial		1		217		1		217

		3	$	498		3	$	498

SECURITIES OWNED AND SECURITIES SOLD, NOT YET PURCHASED

Securities owned and securities sold, not yet purchased at March 30, 2012 and June 24, 2011 consisted of the following (in thousands):


	March		June
Securities owned
Corporate equity securities	$	1,408	$	2,140
Municipal obligations		119,480		98,265
U.S. government and government agency obligations		27,060		27,380
Corporate obligations		72,286		72,053
Other		23,919		21,749

	$	244,153	$	221,587

Securities sold, not yet purchased
U.S. government and government agency obligations	$	23,564	$	50,973
Corporate obligations		37,261		17,289
Other		554		399

	$	61,379	$	68,661

Securities owned and securities sold, not yet purchased are carried at fair value. See additional discussion in “ Fair Value of Financial Instruments .”

Some of these securities were pledged to secure short-term borrowings and as security deposits at clearing organizations for SWS’s clearing business. See additional discussion in “ Short-Term

Borrowings .” At March 30, 2012 and June 24, 2011, securities pledged as security deposits at clearing organizations were $2,349,000 and $2,550,000, respectively.

SECURITIES HELD TO MATURITY

Securities held to maturity consisted of the following (in thousands):


	March 31, 2012		June 30, 2011
GNMA securities	$	28,408	$	34,176

In March 2011, the Bank purchased GNMA securities at a cost of $35,525,000 including a premium of $525,000. The premium is amortized over the period from the date of purchase to the stated maturity date (15 years) of the GNMA securities using the interest method. At March 31, 2012, the GNMA securities had a recorded value of $28,408,000. During the three and nine-months ended March 31, 2012, the Bank recorded $57,000 and $155,000, respectively, in amortization of the premium and received $2,283,000 and $6,311,000, respectively, of principal and interest payments, recording $220,000 and $698,000, respectively, in interest. These securities are accounted for at amortized cost. As of March 31, 2012, the yield on this investment was expected to be 2.6% and the weighted average maturity was expected to be 3.2 years based on the anticipated timing of future cash payments.

In the third quarter of fiscal 2010, the Bank purchased GNMA securities at a cost of $83,047,000, including a premium of $837,000. The premium was being amortized over an average life of four years using the interest method. In December 2010, the Bank sold $32,955,000 of the GNMA securities for $32,976,000, generating a realized gain of $21,000. The Bank sold these securities in order to increase the Bank’s capital ratios by reducing the Bank’s asset base. As a result of this sale, it was determined that the remaining balance of the GNMA securities was no longer held to maturity and was reclassed to securities available for sale. These securities were marked to market with any unrealized gain/loss being recorded to other comprehensive income. The remaining balance of the GNMA securities was sold in January 2011, yielding a gain of $60,000. The Bank recorded $0 and $151,000 in amortization of the premium on these GNMA securities during the three and nine-month periods ended March 31, 2011, respectively. During the three and nine-month periods ended March 31, 2011, the Bank received $26,000 and $6,234,000 of principal and interest payments, respectively, recording $26,000 and $983,000 in interest, respectively, on these GNMA securities.

SECURITIES PURCHASED/SOLD UNDER AGREEMENTS TO RESELL/REPURCHASE

Transactions involving purchases of securities under agreement to resell (“reverse repurchase agreements”) are accounted for as collateralized financings except where SWS does not have an agreement to sell the same or substantially the same securities before maturity at a fixed or determinable price. At March 30, 2012, SWS held reverse repurchase agreements totaling $12,033,000, collateralized by U.S. government and government agency obligations with a fair value of approximately $11,973,000. At June 24, 2011, SWS held reverse repurchase agreements totaling $42,649,000, collateralized by U.S. government and government agency obligations with a market value of approximately $42,834,000.

Securities sold under repurchase agreements, which are secured borrowings, generally mature within one to four days from the transaction date. Securities sold under repurchase agreements are reflected at the amount of cash received in connection with the transactions. The Company may be required to provide additional collateral based on the fair value of the underlying securities. The Company monitors the fair value of the underlying securities on a daily basis. Securities sold under repurchase agreements at March 30, 2012 and June 24, 2011 were $4,270,000 and $10,313,000, respectively.

SECURITIES AVAILABLE FOR SALE

SWS Group owns shares of common stock of USHS and Westwood, which it classifies as securities available for sale. In addition to the shares of common stock owned by SWS Group, the Bank owns U.S. government and government agency obligations that are available for sale. The unrealized holding gains (losses), net of tax, related to these securities are recorded as a separate component of stockholders’ equity on the Consolidated Statements of Financial Condition.

The following table summarizes the cost and market value of these investments at March 30, 2012 and June 24, 2011 and for the Bank at March 31, 2012 and June 30, 2011 (dollars in thousands):


	Shares Held		Original Cost		Gross Unrealized Gains		Gross Unrealized Losses		Market Value
March
USHS		357,154	$	914	$	2,415	$	—	$	3,329
Westwood		4,216		7		156		—		163
U.S. government and government agency obligations(*)		N/A		121,303		396		—		121,699

Securities available for sale			$	122,224	$	2,967	$	—	$	125,191

^(*)

In fiscal 2012, the Bank purchased these securities at a cost of $130,305, including a net premium of $3,072. The premium is amortized over the period from the date of purchase to the stated maturity date, (weighted average of 23.6 years), using the interest method. During the three and nine-months ended March 31, 2012, the Bank recorded $262 and $482, respectively, in amortization of the premium and the Bank received $6,049 and $9,782, respectively, in principal and interest payments, recording $651 and $1,263, respectively, in interest income on these securities.


	Shares Held		Original Cost		Gross Unrealized Gains		Gross Unrealized Losses		Market Value
June
USHS		357,154	$	914	$	954	$	—	$	1,868
Westwood		4,216		7		145		—		152

Securities available for sale			$	921	$	1,099	$	—	$	2,020

INVESTMENTS AND VARIABLE INTEREST ENTITIES

SWS has interests in three investment partnerships that it accounts for under the equity method, which approximates fair value. One is a limited partnership venture capital fund in which SWS has invested $5,000,000. Based on a review of the fair value of this limited partnership investment, SWS determined that its share of the investments made by the limited partnership should be valued at $2,251,000 at March 30, 2012 and $2,114,000 at June 24, 2011. SWS recorded a net gain on this investment for the three and nine-months ended March 30, 2012 of $130,000 and $137,000, respectively. SWS recorded a $7,000 net gain on this investment in the three-months ended March 25, 2011 and a $180,000 net loss for the nine-months ended March 25, 2011.

The other two investments are limited partnership equity funds to which the Bank committed $3,000,000 in fiscal 2007 and $2,000,000 in fiscal 2009 as a cost effective way of meeting its obligations under the Community Reinvestment Act of 1977 (“CRA”). As of March 31, 2012, the Bank had invested $2,400,000 of its aggregate $5,000,000 commitment to the two funds. During the three and nine-months ended March 31, 2012, the Bank recorded net gains of $907,000 and $1,103,000, respectively, related to these two investments. During the three and nine-months ended March 31, 2011, the Bank recorded net gains of $493,000 and $357,000, respectively, related to these two investments. During the nine-months ended March 31, 2012 and 2011, the Bank received distributions of $517,000 and $306,000, respectively, from one of these investments.

The Company’s variable interest entity (“VIE”) policies are discussed in Note 11 Investments and Variable Interest Entities of the Fiscal 2011 Form 10-K.

The loans to commercial borrowers noted in the table below meet the definition of a VIE because the legal entities have a total equity investment at risk that is not sufficient to permit the entity to finance its activities without additional subordinated financial support; however, the Company is not the primary beneficiary of the legal entities. The Company has customary lender’s rights and remedies as provided in the related promissory notes and loan agreements, but does not have the power to direct the activities of the legal entities that most significantly impact the borrowers’ economic performance. In addition, the Company has not provided the borrowers with any form of support outside of the contractual loan obligations. Accordingly, the entities are not consolidated in the Company’s financial statements.


(dollars in thousands)	March 31, 2012							June 30, 2011
	Number of VIEs		Carrying Amount of Assets		Maximum Exposure to Loss		Number of VIEs		Carrying Amount of Assets		Maximum Exposure to Loss
Loans to commercial borrowers		6	$	5,938	$	5,790	3		$	6,280	$	6,280

The carrying amount of the Company’s investment in these loans is included in loans, net of allowance for loan losses in the Consolidated Statements of Financial Condition. See additional discussion in “Loans and Allowance for Probable Loan Losses.”

SHORT-TERM BORROWINGS

Brokerage.

Uncommitted lines of credit

Southwest Securities has credit arrangements with commercial banks, which include broker loan lines up to $300,000,000. These lines of credit are used primarily to finance securities owned, securities held for correspondent broker/dealer accounts, receivables in customers’ margin accounts and underwriting activities. These lines may also be used to release pledged collateral against day loans. These credit arrangements are provided on an “as offered” basis and are not committed lines of credit. These arrangements can be terminated at any time by the lender. Any outstanding balance under these credit arrangements is due on demand and bears interest at rates indexed to the federal funds rate (0.09% at March 30, 2012 and 0.08% at June 24, 2011). The total amount of borrowings available under these lines of credit is reduced by the amount available under the options trading unsecured letter of credit, referenced below. At March 30, 2012, the amount outstanding under these secured arrangements was $91,000,000, which was collateralized by securities held for firm accounts valued at $160,353,000. At June 24, 2011, the amount outstanding under these secured arrangements was $72,000,000, which was collateralized by securities held for firm accounts valued at $111,521,000.

In addition to the broker loan lines, at March 30, 2012 and June 24, 2011, SWS had a $20,000,000 unsecured line of credit that is due on demand and bears interest at rates indexed to the federal funds rate. This credit arrangement is provided on an “as offered” basis and is not a committed line of credit. The total amount of borrowings available under this line of credit is reduced by the amount outstanding on the line and under any unsecured letters of credit at the time of borrowing. At March 30, 2011, there were no amounts outstanding on this line. At June 24, 2011, there were no amounts outstanding on this line, other than the $250,000 under unsecured letters of credit referenced below. At March 30, 2012 and June 24, 2011, the total amount available for borrowing was $20,000,000 and $19,750,000, respectively.

Committed lines of credit

On January 28, 2011, Southwest Securities entered into an agreement with an unaffiliated bank for a $45,000,000 committed revolving credit facility. The commitment fee is 37.5 basis points per annum, and when drawn, the interest rate is equal to the federal funds rate plus 75 basis points. The agreement provides that Southwest Securities must maintain a tangible net worth of at least $150,000,000. In January 2012, the agreement was renewed amending the interest rate when drawn to the federal funds rate plus 125 basis points. As of March 30, 2012 and June 24, 2011, there was $35,000,000 and $38,000,000, respectively, outstanding under the committed revolving credit facility. The secured borrowing was collateralized by securities with a value of $60,046,000 and $61,788,000 at March 30, 2012 and June 24, 2011, respectively.

Unsecured letters of credit

SWS had $250,000 outstanding under unsecured letters of credit at June 24, 2011, pledged to support SWS’ open positions with securities clearing organizations. The letters of credit, which had a 1% commitment fee and was renewable semi-annually, expired in October 2011.

At both March 30, 2012 and June 24, 2011, SWS had an irrevocable letter of credit agreement pledged to support customer open options positions with an options clearing organization. Until drawn, the letter of credit bears interest at a rate of 0.5% per annum and is renewable semi-annually. If drawn, the letter of credit bears interest at a rate of 0.5% per annum plus a fee. At March 30, 2012 and June 24, 2011, the maximum amount available under this letter of credit agreement was $75,000,000. At March 30, 2012 and June 24, 2011, the Company had outstanding, undrawn letters of credit of $55,000,000 and $65,000,000, respectively, bearing interest at a rate of 0.5% per annum. The letter of credit is fully collateralized by marketable securities held in client and non-client margin accounts with a value of $76,460,000 and $95,987,000 at March 30, 2012 and June 24, 2011, respectively.

In addition to using customer securities to collateralize short-term borrowings, SWS also loans client securities as collateral in conjunction with SWS’s securities lending activities. At March 30, 2012, approximately $329,849,000 of client securities under customer margin loans was available to be pledged, of which SWS had pledged $32,563,000 under securities loan agreements. At June 24, 2011, approximately $319,885,000 of client securities under customer margin loans was available to be pledged, of which SWS had pledged $35,181,000 under securities loan agreements.

Banking.

In the second quarter of fiscal 2010, the Bank entered into a secured line of credit agreement with the Federal Reserve Bank of Dallas. This line of credit is secured by the Bank’s commercial loan portfolio. This line is due on demand and bears interest at a rate equal to the federal funds target rate plus 100 basis points. At March 31, 2012 and June 30, 2011, the total amount available under this line was $72,277,000 and $82,595,000, respectively. There was no amount outstanding at March 31, 2012 and June 30, 2011.

DEPOSITS

The Bank’s deposits at March 31, 2012 and June 30, 2011 consisted of the following (dollars in thousands):


	March					June
	Amount		Percent			Amount		Percent
Non-interest bearing demand accounts	$	56,237		5.3	%	$	69,131		6.3	%
Interest bearing demand accounts		9,831		0.9			10,288		0.9
Savings accounts		934,714		88.0			952,775		86.1
Limited access money market accounts		21,341		2.0			25,961		2.4
Certificates of deposit, less than $100,000		22,832		2.2			27,002		2.4
Certificates of deposit, $100,000 and greater		16,692		1.6			21,314		1.9

	$	1,061,647		100.0	%	$	1,106,471		100.0	%

The weighted average interest rate on the Bank’s deposits was approximately 0.07% at March 31, 2012 and 0.13% at June 30, 2011.

At March 31, 2012, the scheduled maturities of certificates of deposit were as follows (in thousands):


	1 Year or Less		> 1 Year Through 2 Years		> 2 Years Through 3 Years		> 3 Years Through 4 Years		Thereafter		Total
Certificates of deposit, less than $100,000	$	16,659	$	1,950	$	3,336	$	696	$	191	$	22,832
Certificates of deposit, $100,000 and greater		11,916		866		3,275		425		210		16,692

	$	28,575	$	2,816	$	6,611	$	1,121	$	401	$	39,524

The Bank is funded primarily by core deposits, with interest bearing savings accounts from Southwest Securities’ customers making up a significant source of these deposits.

ADVANCES FROM THE FEDERAL HOME LOAN BANK

At March 31, 2012 and June 30, 2011, advances from the FHLB were due as follows (in thousands):


	March		June
Maturity:
Due within one year	$	13,149	$	8,465
Due within two years		22,488		14,987
Due within five years		14,732		34,081
Due within seven years		6,339		4,803
Due within ten years		7,609		7,218
Due within twenty years		14,429		25,158

	$	78,746	$	94,712

Pursuant to collateral agreements with the FHLB, the advances from the FHLB had interest rates ranging from 2% to 7% and were collateralized by approximately $464,773,000 of collateral value (as defined) in qualifying loans at March 31, 2012 (calculated at December 31, 2011). At June 30, 2011 (calculated at March 31, 2011), the advances from the FHLB had interest rates from 2% to 7% and were collateralized by approximately $354,000,000 of collateral value in qualifying loans.

At March 31, 2012, the Bank had net borrowing capacity with the FHLB of $386,027,000.

DEBT ISSUED WITH STOCK PURCHASE WARRANTS

On March 20, 2011, the Company entered into a Funding Agreement with Hilltop and Oak Hill. On July 29, 2011, after receipt of stockholder and regulatory approval, the Company completed the following transactions contemplated by the Funding Agreement:

•

entered into a $100,000,000, five year, unsecured loan from Hilltop and Oak Hill under the terms of a credit agreement;

•

issued warrants to Hilltop and Oak Hill for the purchase of up to 17,391,304 shares of the Company’s common stock; and

•

granted Hilltop and Oak Hill certain rights, including certain registration rights, preemptive rights, and the right for each to appoint one person to the Company’s Board of Directors for so long as each owns 9.9% or more of all of the outstanding shares of the Company’s common stock or securities convertible into at least 9.9% of the Company’s outstanding common stock.

In connection with the loans made by Hilltop and Oak Hill under the credit agreement, the Company issued a warrant to Hilltop to purchase up to 8,695,652 shares of common stock (and in certain cases described below, shares of Non-Voting Perpetual Participating Preferred Stock, Series (the “Series A Preferred Stock”)) and warrants to Oak Hill to purchase up to 8,695,652 shares of common stock (and in certain cases described below, shares of Series A Preferred Stock). These warrants are exercisable for five years and have a fixed exercise price of $5.75 per share, subject to standard anti-dilution adjustments for extraordinary corporate transactions, such as stock splits, dividends and combinations, the issuance of stock purchase rights, debt or asset distributions (including cash), tender offers or exchange offers and entry into certain business combinations. In addition, the warrants have a weighted average anti-dilution adjustment for the Company’s issuance of common stock at less than 90% of the market price of the common stock on the date prior to the pricing of such shares. For each of Hilltop and Oak Hill, the warrants represent approximately 17% of the Company’s common stock as of March 30, 2012 (assuming that each of Hilltop and Oak Hill exercises its warrant in full).

The warrants provide that the Company would only issue shares of Series A Preferred Stock upon the exercise of warrants if it is necessary to prevent Hilltop or Oak Hill from owning or being deemed to own shares of the Company’s common stock in excess of the “Ownership Limit” provided in the warrants. The “Ownership Limit” is 24.9% of any class of the securities of the Company or such level that Hilltop or Oak Hill reasonably determines would prevent them being deemed to control the Company for purposes of the federal banking laws and regulations specified in the warrants. No shares of Series A Preferred Stock are issued or outstanding. See additional discussion concerning the Series A Preferred Stock in “ Preferred Stock .”

The warrants are recorded as a liability in the Consolidated Statements of Financial Condition at fair value. Initial valuation of the warrants using a binomial valuation model and a closing stock price of $5.45 per share indicated a fair value of $24,136,000. At March 30, 2012, the warrants were valued at $31,067,000. The change in fair value for the three and nine-months ended March 30, 2012, of $12,502,000 and $6,931,000, respectively, was recorded as unrealized (gain) loss on warrant valuation on the Consolidated Statements of Income (Loss) and Comprehensive Income (Loss). The warrants are classified as Level 3 in the fair value hierarchy as disclosed in “ Fair Value of Financial Instruments .”

The loan is recorded as a liability with an 8% interest rate, a five year term and an effective interest rate of 14.9%. The discount on the loan was initially valued at $24,136,000 and is being accreted using the effective interest method. For the three and nine-months ended March 30, 2012, the Company recorded $884,000 and $2,295,000, respectively, in accretion expense on the discount, resulting in a total long-term debt balance of $78,159,000. For the three and nine-months ended

March 30, 2012, interest expense on the loan paid to Hilltop and Oak Hill was $2,000,000 and $5,356,000, respectively.

Legal and accounting fees, printing costs and other expenses associated with the loan and warrants totaled $2,459,000 and are being amortized on the straight-line method over the term of the loan. For the three and nine-months ended March 30, 2012, interest expense charged to operations was $123,000 and $328,000, respectively.

Total interest expense recorded for the three and nine-months ended March 30, 2012 on the Consolidated Statements of Income (Loss) and Comprehensive Income (Loss) was $3,007,000 and $7,979,000, respectively.

The credit agreement contains customary covenants which require the Company to, among other things:

•

maintain a tangible net worth at least equal to the sum of $275,000,000 and 20% of cumulative consolidated net income (as defined in the credit agreement) for each fiscal quarter for which consolidated net income is positive;

•

maintain a minimum unrestricted cash balance (as defined in the credit agreement) of at least $4,000,000;

•

maintain an excess net capital balance at Southwest Securities of at least $100,000,000 as of the end of each calendar month; and

•

adhere to the requirements of the Order.

In addition, the covenants limit the Company’s and certain of the Company’s subsidiaries’ ability to, among other things:

•

incur additional indebtedness;

•

dispose of or acquire certain assets;

•

pay dividends on the Company’s capital stock;

•

make investments, including acquisitions; and

•

enter into transactions with affiliates.

During the first quarter of fiscal 2012, the Company defaulted on two of the provisions of the credit agreement. Specifically, the Company breached the representation and warranty that the Company’s financial statements were prepared in accordance with GAAP due to the Company’s restatement of its quarterly financial statements resulting from an error in the application of GAAP with respect to the Bank’s treatment of mortgage purchase loans held for sale. The Company requested and received a waiver of this event of default. The second event of default arose as a result of a late payment of interest. The credit agreement requires interest payments on the loans to be paid the last day of each of March, June, September and December. The first payment, which was due September 30, 2011, was paid on October 11, 2011, six business days after the required payment date. As a result of this event of default, the Company requested and received a waiver. There were no events of default in the second and third quarters of fiscal 2012.

REGULATORY CAPITAL REQUIREMENTS

Brokerage.

At March 30, 2012 and June 24, 2011, the net capital position of Southwest Securities was as follows (in thousands):


	March 30, 2012			June 24, 2011
Net capital	$	117,247		$	121,928
Less: required net capital		6,654			6,489

Excess net capital	$	110,593		$	115,439

Net capital as a percent of aggregate debit items		35.2	%		37.6	%

Net capital in excess of 5% aggregate debit items	$	100,611		$	105,705

At March 30, 2012 and June 24, 2011, the net capital position of SWS Financial was as follows (in thousands):


	March 30, 2012		June 24, 2011
Net capital	$	778	$	1,056
Less: required net capital		250		250

Excess net capital	$	528	$	806

For more information, see the discussion in Note 18, Regulatory Capital Requirements in the Fiscal 2011 Form 10-K.

Banking. The Bank is subject to various regulatory capital requirements administered by federal agencies. Quantitative measures, established by regulation to ensure capital adequacy, require maintaining minimum amounts and ratios (set forth in the table below) of total and Tier I capital (as defined in 12 CFR 165 and 12 CFR 167) to risk-weighted assets (as defined) and of Tier I (core) capital (as defined) to adjusted assets (as defined). Federal statutes and OCC regulations have established five capital categories for federal savings banks: well-capitalized, adequately capitalized, undercapitalized, significantly undercapitalized, and critically undercapitalized. The federal banking agencies have jointly specified by regulation the relevant capital level for each category. An institution is defined as well-capitalized when its total risk-based capital ratio is at least 10.00%, its Tier I risk-based capital ratio is at least 6.00%, its Tier I (core) capital ratio is at least 5.00%, and it is not subject to any federal supervisory order or directive to meet a specific capital level.

On February 4, 2011, the Board of Directors of the Bank signed a Stipulation and Consent to Issuance of Order to Cease and Desist (the “Stipulation”) and the OTS issued the Order, which is now administered by the OCC. Accordingly, as a result of the issuance of the Order, effective February 4, 2011, the Bank was deemed to be “adequately capitalized” and no longer met the definition of “well capitalized” under federal statutes and OCC regulations even though its capital ratios met or exceeded all applicable requirements under federal law, OCC regulations and the Order. See additional discussion in “ Cease and Desist Order with the Office of the Comptroller of the Currency .” As of March 31, 2012, the Bank met all capital requirements to which it was subject and satisfied the requirements to be defined as a well-capitalized institution. As of March 31, 2012, the Bank’s total risk-based capital ratio was 20.4%, resulting in $71,757,000 in excess capital over the Order’s total risk-based capital requirement of $102,843,000. The Bank’s Tier I risk-based capital ratio was 19.1% and its Tier I (core) capital ratio was 12.3%, resulting in $56,915,000 in excess capital over the Order’s Tier I (core) capital requirement of $106,781,000. The ratios set forth below include the $20,000,000 capital contribution made to the Bank by SWS Group in December 2011. See additional discussion in “ Restricted Cash and Cash Equivalents .”

The Bank’s capital amounts and ratios at March 31, 2012 and June 30, 2011 were as follows (dollars in thousands):


	Actual					For Capital Adequacy Purposes					To Be Well Capitalized Under Prompt Corrective Action Provisions					Order’s Capital Requirements
	Amount		Ratio			Amount		Ratio			Amount		Ratio			Amount		Ratio
March 31, 2012
Total risk-based capital	$	174,600		20.4	%	$	68,562		8.0	%	$	85,703		10.0	%	$	102,843		12.0	%
Tier I risk-based capital		163,696		19.1			34,281		4.0			51,422		6.0			68,562		8.0
Tier I (core) capital		163,696		12.3			53,390		4.0			66,738		5.0			106,781		8.0
June 30, 2011
Total risk-based capital	$	143,798		15.6	%	$	73,946		8.0	%	$	92,433		10.0	%	$	110,920		12.0	%
Tier I risk-based capital		132,244		14.3			36,973		4.0			55,460		6.0			73,946		8.0
Tier I (core) capital		132,244		9.9			53,522		4.0			66,902		5.0			107,043		8.0

REPURCHASE OF TREASURY STOCK

Periodically, SWS repurchases common stock under a plan approved by the Board of Directors. Currently, SWS is authorized to repurchase 500,000 shares of common stock from time to time in the open market. This authorization expires February 28, 2013. During the three and nine-months ended March 30, 2012 and March 25, 2011, SWS Group did not repurchase any shares of common stock under this plan.

Additionally, the trustee under the deferred compensation plan periodically purchases shares of common stock in the open market in accordance with the terms of the plan. This stock is classified as treasury stock in the consolidated financial statements, but participates in dividends declared by SWS. During the nine-months ended March 30, 2012, the plan purchased 32,451 shares of common stock at a cost of approximately $178,000, or $5.49 per share. During the nine-months ended March 25, 2011, the plan purchased 53,000 shares of common stock at a cost of approximately $340,000, or $6.42 per share. The plan distributed 14,787 shares of common stock to participants during the nine-months ended March 30, 2012. The plan distributed 20,560 shares of common stock to participants during the nine-months ended March 25, 2011.

Upon vesting of the shares granted under the Restricted Stock Plan, the grantees may choose to sell a portion of their vested shares to the Company to cover the tax liabilities arising from the vesting. During the nine-months ended March 30, 2012, the Company repurchased 8,463 shares of common stock with a market value of approximately $36,000, or an average price of $4.29 per share, upon vesting of restricted stock grants. During the nine-months ended March 25, 2011, the Company repurchased 18,183 shares of common stock with a market value of approximately $131,000, or an average of $7.22 per share, upon vesting of restricted stock grants.

PREFERRED STOCK

On March 17, 2011 in conjunction with the transaction with Hilltop and Oak Hill, the Board of Directors created the Series A Preferred stock, par value $1.00 per share. The Company has 17,400 authorized shares of Series A Preferred Stock, and no shares are issued or outstanding. If any shares of Series A Preferred Stock are issued, the Series A Preferred Stock will not be entitled to vote with the common stock and will be convertible into shares of common stock at a fixed conversion ratio of 1,000 shares of common stock for each share of Series A Preferred Stock outstanding. The conversion ratio is subject to certain anti-dilution adjustments for extraordinary corporate transactions, such as stock splits, dividends and combinations, the issuance of stock purchase rights, debt or asset distributions (including cash), tender offers or exchange offers and entry into a shareholder rights plan. Each share of Series A Preferred Stock would automatically convert into shares of common stock if such shares were transferred by Hilltop or Oak Hill to a non-affiliate. See additional discussion concerning the Series A Preferred Stock in “ Debt Issued with Stock Purchase Warrants .”

INTEREST INCOME AND INTEREST EXPENSE

For the three and nine-months ended March 30, 2012 and March 25, 2011 and, for the Bank, for the three and nine-months ended March 31, 2012 and 2011, the components of interest income and expense were as follows (in thousands):


	For the Three-Months Ended				For the Nine-Months Ended
	March 2012		March 2011		March 2012		March 2011
Interest income:
Customer margin accounts	$	2,139	$	1,917	$	6,474	$	6,011
Assets segregated for regulatory purposes		46		80		160		281
Stock borrowed		13,698		11,073		41,114		35,830
Loans		11,701		15,514		38,590		56,110
Other		2,415		3,022		8,389		8,948

	$	29,999	$	31,606	$	94,727	$	107,180

Interest expense:
Customer funds on deposit	$	90	$	89	$	277	$	314
Stock loaned		10,825		9,089		32,446		27,199
Deposits		182		308		657		1,372
Federal Home Loan Bank		974		1,147		3,076		3,682
Long-term debt		3,007		—		7,979		—
Other		719		933		2,285		2,629

		15,797		11,566		46,720		35,196

Total net interest revenue	$	14,202	$	20,040	$	48,007	$	71,984

EARNINGS (LOSS) PER SHARE (“EPS”)

The following reconciles the weighted average shares outstanding used in the basic and diluted EPS computation for the three and nine-months ended March 30, 2012 and March 25, 2011 (in thousands, except share and per share amounts):


	Three-Months Ended						Nine-Months Ended
	March 30, 2012			March 25, 2011			March 30, 2012			March 25, 2011
Net income (loss)	$	8,262		$	(2,147	)	$	(4,426	)	$	(23,225	)
Dividends on estimated forfeitures-restricted stock		—			—			—			2
Interest on long-term debt		1,954			—			—			—
Decrease in fair value of warrants		(8,126	)		—			—			—

Adjusted net income (loss)	$	2,090		$	(2,147	)	$	(4,426	)	$	(23,223	)

Weighted average shares outstanding – basic ^(*)		32,716,251			32,501,344			32,589,539			32,510,570
Effect of dilutive securities:
Assumed exercise of stock warrants		17,391,304			—			—			—


	Three-Months Ended					Nine-Months Ended
	March 30, 2012		March 25, 2011			March 30, 2012			March 25, 2011
Weighted average shares outstanding – Diluted		50,107,555		32,501,344			32,589,539			32,510,570

Income (loss) per share – basic
Net income (loss)	$	0.25	$	(0.07	)	$	(0.14	)	$	(0.71	)

Income (loss) per share – diluted
Net income (loss)	$	0.04	$	(0.07	)	$	(0.14	)	$	(0.71	)

^(*)	Unvested share-based payment awards that contain non-forfeitable rights to dividends or dividend equivalents (paid or unpaid) are treated as participating securities and are factored into the calculation of EPS, except in periods with a net loss, when they are excluded.

At March 30, 2012, options to acquire approximately 111,000 shares of common stock were outstanding under SWS’ stock option plans. At March 25, 2011, options to acquire 198,000 shares of common stock were outstanding under SWS’ stock option plans. See “ Employee Benefits .”

During the three and nine-months ended March 30, 2012, options to acquire 29,265 shares of common stock were anti-dilutive and therefore were not included in the calculation of weighted average shares outstanding-diluted and diluted income (loss) per share. As a result of the net loss for the three and nine-months ended March 25, 2011, all options were anti-dilutive and were not included in the calculation of weighted average shares outstanding-diluted and diluted loss per share.

As a result of the net loss for the nine-months ended March 30, 2012, warrants to acquire 17,391,304 shares of common stock were excluded from the calculation of weighted average shares outstanding-diluted and diluted loss per share.

The Company did not declare a dividend in the first nine-months of fiscal 2012. The Company declared dividends of $0.01 per share for both the three-months ended March 25, 2011 and December 31, 2010 and $0.09 per share for the three-months ended September 24, 2010.

SEGMENT REPORTING

SWS operates four business segments:

•

Clearing: The clearing segment provides clearing and execution services (generally on a fully disclosed basis) for general securities broker/dealers, for bank affiliated firms and firms specializing in high volume trading.

•

Retail Brokerage: The retail brokerage segment includes retail securities products and services (equities, mutual funds and fixed income products), insurance products and managed accounts and encompasses the activities of our employee registered representatives and our independent representatives who are under contract with SWS Financial.

•

Institutional Brokerage: The institutional brokerage segment serves institutional customers in securities lending, investment banking and public finance, fixed income sales and trading, proprietary trading and agency execution services.

•

Banking: The Bank offers traditional banking products and services and focuses on small business lending and short-term funding for mortgage bankers.

Clearing and institutional brokerage services are offered exclusively through Southwest Securities. The Bank and its subsidiaries comprise the banking segment. Retail brokerage services are offered through Southwest Securities (the Private Client Group and the Managed Advisors Accounts department), SWS Insurance, and SWS Financial (which contracts with independent representatives for the administration of their securities business).

SWS’ segments are managed separately based on types of products and services offered and their related client bases. The segments are consistent with how the Company manages its resources and assesses its performance. Management assesses performance based primarily on income before income taxes and net interest revenue (expense). As a result, SWS reports net interest revenue (expense) by segment. SWS’ business segment information is prepared using the following methodologies:

•

the financial results for each segment are determined using the same policies as those described in Note 1, Significant Accounting Policies , to the Company’s audited consolidated financial statements contained in the Fiscal 2011 Form 10-K;

•

segment financial information includes the allocation of interest based on each segment’s earned interest spreads;

•

information system and operational expenses are allocated based on each segment’s usage;

•

shared securities execution facilities expenses are allocated to the segments based on production levels;

•

money market fee revenue is allocated based on each segment’s average balances; and

•

clearing charges are allocated based on clearing levels from each segment.

Intersegment balances are eliminated upon consolidation and have been applied to the appropriate segment.

The “other” category includes SWS Group, corporate administration and SWS Capital. SWS Capital is a dormant entity that holds approximately $30,000 of assets. SWS Group is a holding company that owns various investments, including USHS common stock.

The following table presents the Company’s operations by the segments outlined above for the three and nine-months ended March 30, 2012 and March 25, 2011:


UNAUDITED FINANCIAL INFORMATION

(in thousands)	Clearing			Retail			Institutional		Banking			Other			Consolidated SWS Group, Inc.
Three-months ended March 30, 2012

Operating revenue	$	3,297		$	25,108		$	30,158	$	1,430		$	1,565		$	61,558
Net intersegment revenues		(200	)		80			5		905			(790	)		—
Net interest revenue		1,474			836			3,658		11,210			(2,976	)		14,202
Net revenues		4,771			25,944			33,816		12,640			(1,411	)		75,760
Operating expenses		5,308			26,983			23,808		10,028			(3,115	)		63,012
Depreciation and amortization		16			233			97		455			611			1,412
Income (loss) before taxes		(537	)		(1,039	)		10,008		2,612			1,704			12,748

Three-months ended March 25, 2011

Operating revenue	$	3,656		$	24,804		$	29,426	$	(355	)	$	356		$	57,887
Net intersegment revenues		(235	)		258			151		917			(1,091	)		—
Net interest revenue		1,623			792			3,365		14,226			34			20,040
Net revenues		5,279			25,596			32,791		13,871			390			77,927
Operating expenses		5,323			26,246			23,270		17,624			8,865			81,328
Depreciation and amortization		215			229			145		612			595			1,796
Income (loss) before taxes		(44	)		(650	)		9,521		(3,753	)		(8,475	)		(3,401	)


UNAUDITED FINANCIAL INFORMATION

(in thousands)	Clearing			Retail		Institutional		Banking			Other			Consolidated SWS Group, Inc.
Nine-months ended March 30, 2012

Operating revenue	$	9,577		$	77,374	$	84,177	$	1,679		$	116		$	172,923
Net intersegment revenues		(590	)		495		60		2,751			(2,716	)		—
Net interest revenue		4,474			2,952		11,788		36,700			(7,907	)		48,007
Net revenues		14,051			80,326		95,965		38,379			(7,791	)		220,930
Operating expenses		15,478			80,305		67,368		32,508			31,849			227,508
Depreciation and amortization		57			694		318		1,453			1,833			4,355
Income (loss) before taxes		(1,427	)		21		28,597		5,871			(39,640	)		(6,578	)
Assets ^(*)		291,229			211,922		1,502,269		1,338,000			72,438			3,415,858

Nine-months ended March 25, 2011

Operating revenue	$	11,257		$	80,707	$	101,379	$	(1,275	)	$	1,828		$	193,896
Net intersegment revenues		(668	)		731		321		2,850			(3,234	)		—
Net interest revenue		4,844			2,514		12,273		52,319			34			71,984
Net revenues		16,101			83,221		113,652		51,044			1,862			265,880
Operating expenses		15,313			82,030		76,209		98,558			28,162			300,272
Depreciation and amortization		645			714		434		1,848			1,836			5,477
Income (loss) before taxes		788			1,191		37,443		(47,514	)		(26,300	)		(34,392	)
Assets ^(*)		341,375			183,516		2,426,935		1,368,813			35,246			4,355,885

^(*)	The following reconciles assets to total assets as presented in the March 30, 2012 and March 25, 2011 Consolidated Statements of Financial Condition (in thousands):


	March 30, 2012			March 25, 2011
Amount as presented above	$	3,415,858		$	4,355,885
Reconciling items:
Unallocated assets:
Cash		9,488			5,363
Receivables from brokers, dealers and clearing organizations		38,248			31,625
Receivable from clients, net of allowances		30,162			15,696
Other assets		37,789			27,829
Unallocated eliminations		(24,495	)		(12,761	)

Total assets	$	3,507,050		$	4,423,637

COMMITMENTS, CONTINGENCIES AND GUARANTEES

Commitment and Contingencies

Litigation. In the general course of its brokerage business and the business of clearing for other brokerage firms, SWS Group and/or its subsidiaries have been named as defendants in various lawsuits and arbitration and regulatory proceedings. These claims allege violations of various federal and state securities laws among other matters. The Bank is also involved in certain claims and legal actions arising in the ordinary course of business. Management believes that resolution of these claims will not result in any material adverse effect on SWS’ consolidated financial position, results of operations or cash flows.

The Company has been named as a defendant in three lawsuits related to a $35,000,000 bond offering that was 40% underwritten by M.L. Stern & Co., LLC. SWS Group purchased M.L. Stern & Co., LLC in 2008. The offering took place in November 2005, and the lawsuit was filed in November 2009.

The lawsuits are in the discovery stage and the ultimate amount of liability associated with this claim cannot currently be determined. However, the Company believes it is at least reasonably possible that a loss related to this matter will be incurred. As of March 30, 2012, the Company has recorded a liability of approximately $1,000,000 related to this matter.

Contingency. In February 2011, a limited partnership venture capital fund in which the Company invested received a proposed assessment of transferee liability from the IRS for the tax period ended December 31, 2005. The proposed assessment is approximately $8,000,000, not including penalties of approximately $3,000,000. The Company would be responsible for $1,870,000 of the proposed assessment including penalties based on its partnership interest. Interest is also accruing on this proposed assessment. The matter relates to certain transactions that occurred during 2005 relating to one of the limited partnership venture capital fund’s subsidiaries. The limited partnership venture capital fund engaged tax counsel and filed a Letter of Protest with the IRS in April 2011. Management of the limited partnership venture capital fund believes that the ultimate outcome will be favorable; however, the limited partnership venture capital fund can give no assurance that it will prevail.

Venture Capital Funds. The Bank has committed to invest $5,000,000 in two limited partnership equity funds. As of March 31, 2012, the Bank had invested $2,400,000 of its commitment. These investments are subject to the Volcker Rule provisions of the Dodd-

Frank Act, which limits ownership interest in a private equity fund to 3% and the federal agencies that will enforce the rule guaranteed that it will become effective July 21, 2014. Thereafter, financial institutions can request up to three additional one year extensions from the FRB, and the FRB can grant up to a five year extension for investments in illiquid funds made on or before May 21, 2010. Also, funds that are “designed primarily to promote the public welfare” are not subject to the rule as proposed. The Bank’s ownership percentage in one of the limited partnership equity funds is greater than 3% and would qualify as an illiquid fund. In addition, this limited partnership equity fund may qualify as “designed primarily to promote the public welfare” as the Bank invests in this fund as a cost effective way of meeting its obligations under the CRA. The Bank’s ownership percentage in the other limited partnership equity fund is less than 3%.

Underwriting. Through its participation in underwriting corporate and municipal securities, SWS could expose itself to material risk that securities SWS has committed to purchase cannot be sold at the initial offering price. Federal and state securities laws and regulations also affect the activities of underwriters and impose substantial potential liabilities for violations in connection with sales of securities by underwriters to the public. At March 30, 2012, the Company had $1,412,000 in total potential commitments under outstanding underwriting arrangements.

Guarantees. The Bank faces the risk of credit loss under commitments to extend credit and stand-by letters of credit up to the contractual amount of these instruments in the event of breach by the other party to the instrument. The Bank uses the same credit policies in making commitments and conditional obligations as it does for instruments reported on the Consolidated Statements of Financial Condition.

As of March 31, 2012, the Bank had issued stand-by letters of credit in the amount of $280,000. The recourse provision of the letters of credit allows the amount of the letters of credit to become a part of fully collateralized loans with repayment as a first lien. The collateral on these letters of credit consists of real estate, certificates of deposit, equipment, accounts receivable or furniture and fixtures.

Subject to the operating limitations in the Order, in the ordinary course of business, the Bank enters into loan agreements where the Bank commits to lend a specified amount of money to a borrower. At any point in time, there could be amounts that have not been advanced on the loan to the borrower, representing unfunded commitments, as well as amounts that have been disbursed but repaid, which are available for re-borrowing under a revolving line of credit. As of March 31, 2012, the Bank had unfunded commitments of $30,515,000 relating to revolving lines of credit and unfunded commitments. In addition, as of March 31, 2012, the Bank had unfunded new loans in the amount of $4,602,000.

Commitments to extend credit are agreements to lend to a customer as long as there is no violation of any condition established in the contract. Commitments generally have fixed expiration dates or other termination clauses and may require the payment of a fee. Since many of the commitments are expected to expire unused, the Bank’s total commitments do not necessarily represent its future cash requirements. The Bank evaluates the customer’s creditworthiness on a case-by-case basis. The amount and type of collateral obtained, if deemed necessary by the Bank upon extension of credit, varies and is based on management’s credit evaluation of the counterparty. The Bank has not incurred any significant losses on its commitments in fiscal 2012. Further, management believes the Bank will not incur material losses as a result of the commitments existing at March 31, 2012.

The Company provides representations and warranties to counterparties in connection with a variety of commercial transactions and occasionally indemnifies counterparties against potential losses caused by the breach of those representations and warranties. These indemnification obligations generally are standard contractual indemnities and are entered into in the normal course of business. The maximum potential amount of future payments that the Company could be

required to make under these indemnities cannot be estimated. However, the Company believes that it is unlikely it will have to make material payments under these arrangements and has not recorded any contingent liability in the consolidated financial statements for these indemnities.

Southwest Securities is a member of multiple exchanges and clearinghouses. Under the membership agreements, members are generally required to guarantee the performance of other members. Additionally, if a member becomes unable to satisfy its obligations to the clearinghouse, other members would be required to meet shortfalls. To mitigate these performance risks, the exchanges and clearinghouses often require members to post collateral. SWS’ maximum potential liability under these arrangements cannot be quantified. However, the potential for SWS to be required to make payments under these arrangements is unlikely. Accordingly, no contingent liability is recorded in the consolidated financial statements for these arrangements.

AFFILIATE TRANSACTIONS

Clients and correspondents of SWS have the option to invest in a savings account called Bank Insured Deposits at the Bank. These funds are FDIC insured up to $250,000. The funds are considered core deposits and are the primary funding source for the Bank. At March 31, 2012, the Bank had $1,061,647,000 of core deposits, of which $930,789,000 were Bank Insured Deposits.

At June 30, 2010, two directors, together with certain members of their families, owned approximately 64% of a holding company that owned a local bank. The Bank sold this local bank loan participations with outstanding balances of $1,404,000, which was foreclosed property at March 31, 2012. At June 30, 2011, the Bank sold this local bank loan participations with outstanding balances of $3,217,000, of which $1,404,000 was foreclosed property. Pursuant to participation agreements with the local bank, the Bank paid interest and fees to the local bank of $15,000 and $98,000 for the three and nine-months ended March 31, 2012, respectively, and $39,000 and $126,000 for the three and nine-months ended March 31, 2011, respectively. The interest rates on these participations were substantially the same as those participations sold by the Bank to unrelated banks. Affiliate transactions are subject to limitations specified in the Order. See “ Cease and Desist Order with the Office of the Comptroller of the Currency .”

CEASE AND DESIST ORDER WITH THE OFFICE OF THE COMPTROLLER OF THE CURRENCY

On February 4, 2011 (the “Effective Date”), the Board of Directors of the Bank signed the Stipulation consenting to and agreeing to the issuance by the OTS of the Order without admitting or denying that grounds exist for the OTS to initiate an administrative proceeding against the Bank. The description of the Order and the corresponding Stipulation set forth in this section or elsewhere in this filing is qualified in its entirety by reference to the Order and Stipulation, copies of which were filed as exhibits to the Company’s Form10-Q for the quarter ended December 31, 2010, which was filed with the SEC on February 9, 2011. On July 21, 2011, the authority to enforce the terms of the Order was transferred to the OCC.

As of March 31, 2012, the provisions of the Order as described in Note 27 of the Fiscal 2011 Form 10-K have not changed except for the following. On March 16, 2012, the Bank was notified by the OCC that the OCC will allow relief from certain operating and growth restrictions required under the Order. The OCC stated that it has no supervisory objection to any future extensions of Small Business Administration program 504 loans, commercial real estate owner-occupied loans, or mechanic’s lien residential 1-4 family construction loans. The OCC also stated that it has no supervisory objection to a future conservative growth plan for the Bank’s balance sheet provided that the Bank maintain capital ratios above the requirements of the Order and concentration levels within policy guidelines. As of March 31, 2012, the Bank was in compliance with the terms of the Order and the Order will remain in effect until terminated, modified or suspended in writing by the OCC.

Item 2.

Management’s Discussion and Analysis of Financial Condition and Results of Operations

OVERVIEW

SWS Group, Inc. (together with its subsidiaries, “we,” “us,” “SWS” or the “company”) is engaged in full-service securities brokerage and full-service commercial banking. For the nine-months ended March 30, 2012, 84% of our total revenues were generated by our full-service brokerage business and 16% of our total revenues were generated by our commercial banking business. While brokerage and banking revenues are dependent upon trading volumes and interest rates, which may fluctuate significantly, a large portion of our expenses remain fixed. Consequently, net operating results can vary significantly from period to period.

Our business is also subject to substantial governmental regulation, and changes in legal, regulatory, accounting, tax and compliance requirements may have a substantial impact on our business and results of operations. We also face substantial competition in each of our lines of business. See Forward-Looking Statements and Risk Factors in our Form 10-K filed with the Securities and Exchange Commission (“SEC”) on September 2, 2011 (the “Fiscal 2011 Form 10-K”).

We operate through four segments grouped primarily by products, services and customer base: clearing, retail, institutional and banking.

Clearing . We provide clearing and execution services for other broker/dealers (predominantly on a fully disclosed basis). Our clientele includes general securities broker/dealers and firms specializing in high volume trading. We currently support a wide range of clearing clients, including discount and full-service brokerage firms, direct access firms, registered investment advisors and institutional firms. In addition to clearing trades, we tailor our services to meet the specific business needs of our clearing clients (“correspondents”) and offer such products and services as recordkeeping, trade reporting, accounting, general back-office support, securities and margin lending, reorganization assistance and custody of securities.

Revenues in this segment are generated primarily through transaction charges to our correspondent firms for clearing their trades. Revenue is also earned from various fees and other processing charges as well as through net interest earnings on correspondent customer balances.

Retail. We offer retail securities products and services (equities, mutual funds and fixed income products), insurance products and managed accounts through the activities of our employee registered representatives and our independent contractors. As a securities broker, we extend margin credit on a secured basis to our retail customers in order to facilitate securities transactions. This segment generates revenue primarily through commissions charged on securities transactions, fees from managed accounts and the sale of insurance products as well as net interest income from retail customer balances.

Institutional. We serve institutional customers in the areas of securities borrowing and lending, public finance, municipal sales and underwriting, investment banking, fixed income sales and equity trading. Our securities lending business includes borrowing and lending securities for other broker/dealers, lending institutions, and our own clearing and retail operations. Our municipal finance operations assist public bodies in originating, syndicating and distributing securities of municipalities and political subdivisions. Our corporate finance professionals arrange and evaluate mergers and acquisitions, conduct private placements and participate in public offerings of securities with institutional and individual investors, assist clients with raising capital, and provide other consulting and advisory services.

Our fixed income sales and trading group specializes in trading and underwriting U.S. government and government agency bonds, corporate bonds, mortgage-backed, asset-backed and commercial mortgage-backed securities and structured products. The clients of our fixed income group include corporations, insurance companies, banks, mutual funds, money managers and other institutions. Our equity trading department focuses on providing best execution for equity and option orders for clients. We also execute institutional portfolio trades and are a market maker in a limited number of listed securities.

Revenues in the institutional segment are derived from the net interest spread on stock loan transactions, commission and trading income from fixed income and equity products and investment banking fees from corporate and municipal securities transactions.

Banking. We offer traditional banking products and services. We specialize in two primary areas, business banking and mortgage purchase. Our focus in business banking includes small business lending. We originate the majority of our loans internally, and we believe this business model helps us build more valuable relationships with our customers. Our mortgage purchase division purchases participations in newly originated residential loans from various mortgage bankers nationwide. Southwest Securities, FSB (the “Bank”) earns substantially all of its net revenues on the spread between the rates charged to customers on loans and the rates paid to depositors. Our banking operations are currently restricted by and subject to the Order to Cease and Desist, Order No. WN-11-003, effective on February 4, 2011 (the “Order”) with the Office of the Comptroller of the Currency (“OCC”). On March 16, 2012, the Bank was notified in a letter from the OCC that the OCC will allow relief from certain operating and growth restrictions required under the Order. The OCC stated that it has no supervisory objection to any future extensions of Small Business Administration program 504 loans, commercial real estate owner-occupied loans, or mechanics lien residential 1-4 family construction loans provided the Bank’s Board of Directors or designated committee approves and certifies it complies with internal policies, accounting principles generally accepted in the United States (“GAAP”), regulatory guidance, and safe and sound association practices, prior to funding. The OCC also stated that it has no supervisory objection to a future conservative growth plan for the Bank’s balance sheet provided the Bank maintain capital ratios above the requirements of the Order and concentration levels within policy guidelines.

The “other” category includes SWS Group, Inc. (“SWS Group”), corporate administration and SWS Capital Corporation. SWS Capital Corporation is a dormant entity. SWS Group is a holding company that owns various investments, including common stock of U.S. Home Systems, Inc. (“USHS”).

Loan from Hilltop and Oak Hill

In March 2011, we entered into a Funding Agreement with Hilltop Holdings, Inc. (“Hilltop”) and Oak Hill Capital Partners III, L.P. (“OHCP”) and Oak Hill Capital Management Partners III, L.P. (collectively with OHCP, “Oak Hill”). On July 29, 2011, after receipt of stockholder and regulatory approval, we completed the following transactions contemplated by the Funding Agreement:

•

entered into a $100.0 million, five year, unsecured loan with an 8% interest rate from Hilltop and Oak Hill under the terms of a credit agreement;

•

issued warrants to Hilltop and Oak Hill allowing each to purchase up to 8,695,652 shares of our common stock at an exercise price of $5.75 per share (subject to anti-dilution adjustments), representing approximately 17% of the common stock of our company per warrant (assuming each exercises its warrant in full); and

•

granted Hilltop and Oak Hill certain rights, including certain registration rights, preemptive rights, and the right for each to appoint one person to our Board of Directors for so long as each owns 9.9% or more of all of the outstanding shares of our common stock or securities convertible into at least 9.9% of our outstanding common stock. Mr. Gerald J. Ford and Mr. J. Taylor Crandall were elected as directors of SWS Group by our Board of Directors on July 29, 2011.

We entered into this transaction to ensure that the Bank would maintain adequate capital ratios under the Order and could continue to reduce classified assets in a strategic and efficient manner, as well as to ensure that the broker/dealer business lines would operate without disruption. See “ Debt Issued with Stock Purchase Warrants ” in the Notes to the Consolidated Financial Statements contained in this report.

Business Environment

Performance in the financial services industry in which we operate is highly correlated to the overall strength of the economy, financial market activity and interest rates. Overall market conditions are a product of many factors which are beyond our control and can be unpredictable. These factors may affect the financial decisions made by investors, including their level of participation in the financial markets. In turn, these decisions may affect our business results. With respect to financial market activity, our profitability is sensitive to a variety of factors, including the demand for investment banking services, as reflected by the number and size of equity and debt financings and merger and acquisition transactions, the volatility of the equity and fixed income markets, the level and shape of various yield curves, the volume and value of trading in securities, the value of our customers’ assets under management, the demand for loans and the value of real estate in our markets.

As of March 30, 2012, all equity market indices were up versus a year ago with the Dow Jones Industrial Average (the “DJIA”) up 8.1%, the NASDAQ Composite Index (NASDAQ) up 12.7% and the Standards & Poor’s 500 Index (S&P 500) up 7.2%. The DJIA closed at 13,212.04 on March 30, 2012, up from 12,220.59 at March 25, 2011 and 11,934.58 at June 24, 2011. The indexes showed improvement and reached closing prices that haven’t been seen since 2008. However, the market remains volatile due to the slow recovery in the United States and the uncertainty in Europe. The average daily volume on the New York Stock Exchange (NYSE) decreased 25% during the three-months ended March 30, 2012 compared to the same period of our last fiscal year. The continuing uncertainty in the economic environment domestically and in Europe contributed to uncertainty and volatility during the three-months ended March 30, 2012.

Economic and regulatory uncertainty created a challenging operating environment for us in the three and nine-months ended March 30, 2012. The national unemployment rate, which was approximately 8.2% at the end of March 2012, was down from a high of 10.0% at the end of December 2009, and 9.0% at the end of June 2011, but remains at historically high levels. The Federal Reserve Board reduced the federal funds target rate to 0 - 0.25% in December 2008 and announced in January 2012 that rates were unlikely to increase before late 2014.

The disruptions and developments in the world economy and the credit markets over the past three years have resulted in a range of actions by U.S. and foreign governments to attempt to bring liquidity and order to the financial markets and to prevent a long recession in the world economy. For more details regarding some of the actions taken by U.S. and foreign governments, see the discussion under the caption Item 1. Business-Regulation contained in the Fiscal 2011 Form 10-K.

Unemployment and tight credit markets continue to create a fragile economic environment. In addition to the August 2011 downgrade of the United States’ credit rating for the first time in the history of the ratings, global equity markets have been volatile primarily due to debt problems in Europe.

Texas has experienced distress in residential and commercial real estate values as well as elevated unemployment rates since the last quarter of calendar 2010. These factors, while improving, have had, and will continue to have, a negative impact on our banking and brokerage operations.

Impact of Economic Environment

Brokerage. On the brokerage side of the business, volatility in the U.S. credit and mortgage markets, low interest rates and reduced volume in the U.S. stock markets continue to have an adverse impact on several aspects of our business, including depressed net interest margins, reduced liquidity and lower securities valuations.

Exposure to European Sovereign Debt

We have no exposure to European sovereign debt or direct exposure to European banks. However, we do participate in securities lending with U.S. subsidiaries of several European banks. Receivables from securities lending are secured by collateral equal to 102% of the market value of the securities, and the collateral is adjusted daily to maintain the 102% margin.

Net Interest Margins

Historically, the profitability of the brokerage business has been dependent upon net interest income. We earn net interest income on the spread between the rates earned and paid on customer and correspondent balances as well as from our securities lending business. With interest rates at historically low levels, the spread we are able to earn is reduced, primarily from the extremely low yields on our assets segregated for regulatory purposes portfolio. Additionally, the spread in our securities lending business has declined. Lastly, because the yields on money market funds have declined significantly, revenue sharing arrangements with our primary money market fund providers have been substantially reduced. We do not expect any significant changes in these dynamics until short-term interest rates rise.

We have taken actions to mitigate the impact of the margin contraction by renegotiating arrangements with our clearing customers, changing the mix of our assets segregated for regulatory purposes and developing new business in our securities lending portfolio. Despite these actions, profits from net interest remain below historical levels.

Liquidity

Dislocation in the credit markets has led to increased liquidity risk. All but $45.0 million of our borrowing arrangements are uncommitted lines of credit and, as such, can be reduced or eliminated at any time by the banks extending the credit. While we have not experienced any reductions in our uncommitted borrowing capacity, our lenders have previously taken actions that indicate their concerns regarding liquidity in the marketplace. These actions included reduced advance rates for certain security types, more stringent requirements for collateral eligibility and higher interest rates. Should our lenders or investors take any actions that could negatively impact the terms of our lending arrangements, the cost of conducting our business will increase and our volume of business would be limited.

The volatility in the U.S. stock markets is also impacting our liquidity through increased margin requirements at our clearing houses. These margin requirements are determined through a combination of risk factors including volume of business and volatility in the U.S. stock markets. To the extent we are required to post cash or other collateral to meet these requirements, we will have less borrowing capacity to finance our other businesses.

Valuation of Securities

We trade mortgage, asset-backed and other types of fixed income securities on a regular basis. We monitor our trading limits daily to ensure that these securities are maintained at levels we consider to be prudent given current market conditions. We price these securities using a third-party pricing service, and we review the prices monthly to ensure reasonable valuations. At March 30, 2012, we held mortgage and asset-backed securities of approximately $29.6 million included in securities owned, at fair value on the Consolidated Statements of Financial Condition.

Investment in Auction Rate Securities

At March 30, 2012, we held $21.7 million of auction rate municipal bonds which represented one security and 18.1% of our municipal portfolio. This security is an investment grade credit, was valued at 95.7% of par as of March 30, 2012 and was yielding less than 1% per year for the period. We currently have the ability to hold this investment until maturity. While we expect the issuer of this bond to refinance its debt when LIBOR interest rates rise, there can be no certainty that this refinancing will occur. We review this position on a quarterly basis and believe valuation of this bond at 95.7% of par at March 30, 2012 reflects an appropriate discount for the current lack of liquidity in this investment.

Bank. With a $20 million capital contribution to the Bank in December 2011, the Bank has prepared and filed a new capital plan with its regulator. The $20 million contribution and access to additional capital from SWS Group provides the Bank with a sound foundation for future earnings, as well as the flexibility to accelerate the reduction of classified assets.

The Bank has maintained compliance with the terms of the Order since the Bank signed it on February 4, 2011. The diligent efforts by the Bank’s Board, management and employees to adhere to the terms of the Order and plans filed with our regulators have resulted in substantial improvements in credit quality, loan concentration levels and capital ratios. See “Cease and Desist Order with the Office of the Comptroller of the Currency” in the Notes to the Consolidated Financial Statements contained in this report and discussion above under “Overview” regarding the OCC’s relief of certain operating and growth restrictions required under the Order.

While the economic environment remains challenging, the Bank continued to reduce classified assets in the March 2012 quarter. Classified assets were $129.8 million at March 31, 2012, down $98.7 million from $228.5 million at June 30, 2011 and down $39.8 million from $169.6 million at December 31, 2011. Classified assets as a percentage of total capital plus the allowance for loan losses was 67.0% at March 31, 2012, 120.5% at June 30, 2011 and 132.7% at March 31, 2011. Non-performing assets (a subset of classified assets) decreased to $75.1 million at March 31, 2012 down from $89.5 million at June 30, 2011 and up $8.0 million from $67.1 million at December 31, 2011. Though the Bank continues to work diligently to reduce classified assets and improve performance, the volatility of the economic environment remains a significant risk. Should the economic environment worsen, improvement in classified asset reduction could slow and additional migration of loans to problem status could increase.

The Bank’s loan loss allowance at March 31, 2012 was $26.2 million, or 4.13% of loans held for investment, excluding purchased mortgage loans held for investment, as compared to $47.3 million, or 4.93% of loans held for investment, excluding purchased mortgage loans held for investment, at March 31, 2011 and $44.4 million, or 4.99% of loans held for investment, excluding purchased mortgage loans held for investment, at June 30, 2011.

Events and Transactions

A description of the material events and transactions impacting the company’s results of operations in the periods presented are discussed below.

Warrant valuation. The warrants issued to Hilltop and Oak Hill are presented as liabilities carried at fair value on the Consolidated Statement of Financial Condition. During the three-months ended March 30, 2012, the value of these warrants decreased due to the decrease in our stock price from $6.87 at December 30, 2011, to $5.72 at March 30, 2012. The decrease in value resulted in an unrealized pre-tax gain of $12.5 million for the three-months ended March 30, 2012.

During the nine-months ended March 30, 2012, the value of these warrants increased due to the increase in our stock price from $5.45 at July 29, 2011, the issuance date of the warrants, to $5.72 at March 30, 2012 as well as increased volatility. The increase in value resulted in an unrealized pre-tax loss of $6.9 million for the nine-months ended March 30, 2012.

Decrease in provision for loan losses. The provision for loan loss decreased $4.7 million for the three-months ended March 31, 2012 and $48.5 million for the nine-months ended March 31, 2012, from the comparable periods of the prior fiscal year, resulting in an allowance for loan loss of $26.2 million at March 31, 2012.

RESULTS OF OPERATIONS

Consolidated

Net income for the three-months ended March 30, 2012 was $8.3 million and the net loss for the nine-months ended March 30, 2012 was $4.4 million as compared to a net loss of $2.1 million and $23.2 million for the three and nine-months ended March 25, 2011, respectively. The three and nine-month periods ended March 30, 2012 and March 25, 2011 contained 62 and 193 and 58 and 189 trading days, respectively.

Southwest Securities, Inc. (“Southwest Securities”) was custodian for $29.4 billion and $28.1 billion in total customer assets at March 30, 2012 and March 25, 2011, respectively.

The following is a summary of increases (decreases) in categories of net revenues and operating expenses for the three and nine-months ended March 30, 2012 compared to the three and nine-months ended March 25, 2011 (dollars in thousands):


	Three-Months Ended						Nine-Months Ended
	Amount			% Change			Amount			% Change
Net revenues:
Net revenues from clearing operations	$	(434	)		(15	)%	$	(754	)		(9	)%
Commissions		1,496			5			(10,439	)		(9	)
Net interest		(5,838	)		(29	)		(23,977	)		(33	)
Investment banking, advisory and administrative fees		1,500			21			(4,908	)		(16	)
Net gains on principal transactions		(2,015	)		(19	)		(7,942	)		(26	)
Other		3,124			72			3,070			22

	$	(2,167	)		(3	)%	$	(44,950	)		(17	)%

Operating expenses:
Commissions and other employee compensation	$	1,232			2	%	$	(12,372	)		(7	)%
Occupancy, equipment and computer service costs		(241	)		(3	)		(1,460	)		(6	)
Communications		(63	)		(2	)		(595	)		(6	)
Floor brokerage and clearing organization charges		(108	)		(10	)		(185	)		(6	)
Advertising and promotional		347			49			219			11
Provision for loan loss		(4,727	)		(100	)		(48,492	)		(95	)
Unrealized net (gain) loss on warrant valuation		(12,502	)		(100	)		6,931			100
Other		(2,254	)		(22	)		(16,810	)		(42	)

	$	(18,316	)		(23	)%	$	(72,764	)		(24	)%

Pre-tax income (loss)	$	16,149			>100	%	$	27,814			81	%

Net revenues decreased for the three-months ended March 30, 2012 by $2.2 million as compared to the same period of the prior fiscal year. The largest components of the decrease were in net interest and net gains on principal transactions. The $5.8 million decrease in net interest revenue was due primarily to a 16% decrease in the average loan balance at the Bank as compared to the same

quarter in the prior fiscal year. Also, interest expense on the loan from Hilltop and Oak Hill reduced net interest revenue by $3.0 million in the three-months ended March 30, 2012. The $2.0 million decrease in net gains on principal transactions was primarily due to reduced trading profits in our municipal finance business driven by changes in interest rates. Partially offsetting the decreases was a $1.5 million increase in commission revenue, a $1.5 million increase in investment banking, advisory and administrative fees and a $3.1 million increase in other revenues. The increase in commission revenue of $1.5 million for the three-months ended March 30, 2012 compared to the three-months ended March 25, 2011 was due to a $1.0 million increase in portfolio trading and a $0.3 million increase in taxable fixed income. The $1.5 million increase in investment banking, advisory and administrative fees for the three-months ended March 30, 2012 compared to the three-months ended March 25, 2011 was due to a $2.0 million increase in municipal finance fees due to increased new issuances offset by a $0.4 million decrease in fees from corporate finance transactions and Unit Investment Trust (“UIT”) underwritings. The $3.1 million increase in other revenue for the three-months ended March 30, 2012 compared to the three-months ended March 25, 2011 was due to a $1.4 million decrease in losses on the sale of real estate owned (“REO”) from the prior fiscal year third quarter, a $0.2 million increase in gains on the sale of loans, a $0.5 million increase in earnings on equity investments and a $0.7 million increase in the value of the investments in our deferred compensation plan.

Net revenues decreased for the nine-months ended March 30, 2012 by $45.0 million as compared to the same period of the prior fiscal year. The largest components of the decrease were in commissions, net interest, investment banking, advisory, and administrative fees and net gains on principal transactions. The $10.4 million decrease in commissions was due primarily to a $6.0 million decrease in commissions in the institutional segment, primarily in the taxable fixed income business resulting from reduced customer activity due to increased economic uncertainty. In addition, we also experienced a $4.5 million decrease in commissions in the retail segment. This decrease was primarily due to a decrease in retail representative headcount, difficulty in recruiting representatives and reduced activity overall. The $24.0 million decrease in net interest revenue was due primarily to a 28% decrease in the average loan balance at the Bank compared to the same period of the prior fiscal year. Also, interest expense on the loan from Hilltop and Oak Hill reduced net interest revenue by $8.0 million for the nine-months ended March 30, 2012. The $4.9 million decrease in investment banking, advisory, and administrative fees was due primarily to a $1.6 million decline in municipal finance fees on reduced new issue volumes as well as a $1.8 million decrease related to a reduction in UIT underwriting fees and a $1.0 million decrease in corporate finance fees. The $7.9 million decrease in net gains on principal transactions was due primarily to reduced customer trading activity in the taxable fixed income business and reduced underwriting activity in the municipal finance business.

Operating expenses decreased $18.3 million for the three-months ended March 30, 2012 as compared to the same period of the prior fiscal year. This decrease was made up of a $12.5 million decrease in the value of the warrants issued to Hilltop and Oak Hill and a $5.8 million decrease in operating expenses. The decrease in operating expenses was due to a $4.7 million reduction in the provision for loan loss and a decrease in other expense of $2.3 million. The decrease in the Bank’s loan loss provision is discussed in “ Overview—Business Environment—Impact of Economic Environment—Bank .” Other expenses decreased due to a $1.5 million decrease in the REO loss provision, a $0.5 million decrease in legal expenses and a $0.4 million decrease in the Bank’s regulatory assessments. These decreases were offset by a $1.2 million increase in commissions and other employee compensation expense. The increase in commissions and other employee compensation was primarily due to a $619,000 increase in commission expenses resulting from the increase in commission revenue and investment banking, advisory and administrative fees and a $613,000 increase in salaries and incentive compensation. The increase in salaries expense was due to increased deferred compensation of $710,000 and recruiting bonuses of $145,000 offset by decreased employee salary expense of $331,000 and health insurance costs of $213,000. The remaining increase of $321,000 in incentive compensation was primarily due to improved earnings, after adjustments, in the business segments in the three-months ended March 30, 2012 as compared to the same period last fiscal year.

Operating expenses decreased $72.8 million for the nine-months ended March 30, 2012 as compared to the same period of the prior fiscal year due to a $12.4 million decrease in commissions and other employee compensation, a $48.5 million reduction in the provision for loan loss and a $16.8 million decrease in other expenses. The decrease in commissions and other employee compensation was primarily due to an $8.3 million decrease in commission expense related to the decrease in production revenues, commissions and investment banking, advisory and administrative fees. The decrease in the Bank’s loan loss provision is discussed in “ Overview—Business Environment—Impact of Economic Environment—Bank .” The decrease in other expenses was due primarily to a $12.2 million decrease in the REO loss provision, a $1.4 million decrease in third-party loan services and a $2.2 million decrease in legal expenses. All of these decreases were offset by the $6.9 million increase in the unrealized loss on the valuation of the warrants issued to Hilltop and Oak Hill.

Net Interest Income

We generate net interest income from our brokerage and banking segments. Net interest income from the brokerage segments is dependent upon the level of customer and stock loan balances as well as the spread between the rates we earn on those assets compared with the cost of funds. Net interest is the primary source of income for the Bank and represents the amount by which interest and fees generated by earning assets exceed the cost of funds. The Bank’s cost of funds consists primarily of interest paid to the Bank’s depositors on interest-bearing accounts and long-term borrowings from the Federal Home Loan Bank (the “FHLB”). Net interest income from our brokerage, corporate and banking segment were as follows for the three and nine-months ended March 30, 2012 and March 25, 2011 (in thousands):


	Three-Months Ended					Nine-Months Ended
	March 30, 2012			March 25, 2011		March 30, 2012			March 25, 2011
Brokerage	$	5,997		$	5,814	$	19,241		$	19,665
Bank ⁽¹⁾		11,210			14,226		36,700			52,319
SWS Group		(3,005	)		—		(7,934	)		—

Net interest	$	14,202		$	20,040	$	48,007		$	71,984

⁽¹⁾	The net interest reported for the Bank is for the period ended March 31, 2012 and 2011.

Average balances of interest-earning assets and interest-bearing liabilities in our brokerage operations were as follows (in thousands):


	Three-Months Ended				Nine-Months Ended
	March 30, 2012		March 25, 2011		March 30, 2012		March 25, 2011
Daily average interest-earning assets:
Customer margin balances	$	236,000	$	228,000	$	229,000	$	212,000
Assets segregated for regulatory purposes		195,000		238,000		231,000		260,000
Stock borrowed		1,502,000		2,157,000		1,682,000		2,027,000
Daily average interest-bearing liabilities:
Customer funds on deposit, including short credits		328,000		342,000		355,000		351,000
Stock loaned		1,474,000		2,129,000		1,660,000		2,000,000

Net interest revenue generated by each segment is reviewed in detail in the segment analysis below.

Income Tax Expense (Benefit)

For the three-months ended March 30, 2012, income tax expense (effective rate of 35.2%) differed from the amount that would have otherwise been calculated by applying the federal corporate tax rate (35.0%) to income before income tax expense due to state income taxes and non-deductible compensation offset by tax exempt interest and decreases in the value of company-owned life insurance. See further discussion regarding reconciliation of the effective tax rate and the federal corporate tax rate in “ General and Basis of Presentation – Income Taxes ” in the Notes to the Consolidated Financial Statements contained in this report.

For the nine-months ended March 30, 2012, income tax benefit (effective rate of 32.7%) differed from the amount that would have otherwise been calculated by applying the federal corporate tax rate (35.0%) to loss before income tax benefit due to state income taxes and other permanently excluded items, such as tax exempt interest, compensation and decreases in the value of company-owned life insurance. See further discussion regarding reconciliation of the effective tax rate and the federal corporate tax rate in “ General and Basis of Presentation – Income Taxes ” in the Notes to the Consolidated Financial Statements contained in this report.

Segment Information

The following is a summary of net revenues and pre-tax income (loss) by segment for the three and nine-months ended March 30, 2012 as compared to the three and nine-months ended March 25, 2011 (dollars in thousands):


	Three-Months Ended
	March 30, 2012			March 25, 2011			Increase/ (Decrease)			% Change
Net revenues:
Clearing	$	4,771		$	5,279		$	(508	)		(10	)%
Retail		25,944			25,596			348			1
Institutional		33,816			32,791			1,025			3
Banking		12,640			13,871			(1,231	)		(9	)
Other		(1,411	)		390			(1,801	)		>(100	)

Total	$	75,760		$	77,927		$	(2,167	)		(3	)%

Pre-tax income (loss):
Clearing	$	(537	)	$	(44	)	$	(493	)		>(100	)%
Retail		(1,039	)		(650	)		(389	)		(60	)
Institutional		10,008			9,521			487			5
Banking		2,612			(3,753	)		6,365			>100
Other		1,704			(8,475	)		10,179			>100

Total	$	12,748		$	(3,401	)	$	16,149			>100	%


	Nine-Months Ended
	March 30, 2012			March 25, 2011			Increase/ (Decrease)			% Change
Net revenues:
Clearing	$	14,051		$	16,101		$	(2,050	)		(13	)%
Retail		80,326			83,221			(2,895	)		(3	)
Institutional		95,965			113,652			(17,687	)		(16	)
Banking		38,379			51,044			(12,665	)		(25	)
Other		(7,791	)		1,862			(9,653	)		>(100)

Total	$	220,930		$	265,880		$	(44,950	)		(17	)%

Pre-tax income (loss):
Clearing	$	(1,427	)	$	788		$	(2,215	)		>(100	)%
Retail		21			1,191			(1,170	)		(98	)
Institutional		28,597			37,443			(8,846	)		(24	)
Banking		5,871			(47,514	)		53,385			>100
Other		(39,640	)		(26,300	)		(13,340	)		(51)

Total	$	(6,578	)	$	(34,392	)	$	27,814			81	%

Clearing

Three-months Ended:

The following is a summary of the results for the clearing segment for the three-months ended March 30, 2012 as compared to the three-months ended March 25, 2011 (dollars in thousands):


	Three-Months Ended
	March 30, 2012			March 25, 2011			Increase/ (Decrease)			% Change
Net revenue from clearing services	$	2,371		$	2,805		$	(434	)		(15	)%
Net interest		1,474			1,623			(149	)		(9	)
Other		926			851			75			9

Net revenues		4,771			5,279			(508	)		(10	)
Operating expenses		5,308			5,323			(15	)		—

Pre-tax loss	$	(537	)	$	(44	)	$	(493	)	>	(100	)%

Daily average customer margin balance	$	112,000		$	114,000		$	(2,000	)		(2	)%

Daily average customer funds on deposit	$	188,000		$	186,000		$	2,000			1	%

Total correspondent clearing customer assets under custody were $14.9 billion and $14.5 billion at March 30, 2012 and March 25, 2011, respectively.

The following table reflects the number of client transactions processed for the three-months ended March 30, 2012 and March 25, 2011 and the number of correspondents at the end of each period.


	Three-Months Ended
	March 30, 2012		March 25, 2011
Tickets for high-volume trading firms		208,327		408,372
Tickets for general securities broker/dealers		181,235		190,458

Total tickets		389,562		598,830

Correspondents		157		165

For the three-months ended March 30, 2012 as compared to the three-months ended March 25, 2011, net revenues in the clearing segment decreased by 10% and clearing fee revenue decreased 15%.

From March 25, 2011 to March 30, 2012, the overall decrease in clearing revenue is due to changes in market conditions.

Also, for the three-months ended March 30, 2012 as compared to the three-months ended March 25, 2011, tickets processed for high-volume trading firms decreased 49% while tickets processed for general securities broker/dealers decreased 5%. Revenue per ticket increased approximately 30% from $4.68 for the three-months ended March 25, 2011 to $6.09 for the three-months ended March 30, 2012. The change in the mix of tickets processed led to an increase in revenue per ticket as fees charged to high-volume trading firms are discounted substantially from the fees charged to general securities broker/dealers. A four day increase in the number of trading days in the third quarter of fiscal 2012 as compared to the prior fiscal year partially offset the decrease in ticket volume. There were 58 trading days in the quarter ended March 25, 2011 as compared to 62 trading days in the quarter ended March 30, 2012.

Operating expenses remained flat for the three-months ended March 30, 2012 as compared to the same period last fiscal year.

Nine-months Ended:

The following is a summary of the results for the clearing segment for the nine-months ended March 30, 2012 as compared to the nine-months ended March 25, 2011 (dollars in thousands):


	Nine-Months Ended
	March 30, 2012			March 25, 2011		Increase/ (Decrease)			% Change
Net revenue from clearing services	$	7,310		$	8,064	$	(754	)		(9	)%
Net interest		4,474			4,844		(370	)		(8	)
Other		2,267			3,193		(926	)		(29	)

Net revenues		14,051			16,101		(2,050	)		(13	)
Operating expenses		15,478			15,313		165			1

Pre-tax income (loss)	$	(1,427	)	$	788	$	(2,215	)		>(100	)%

Daily average customer margin balance	$	111,000		$	112,000	$	(1,000	)		(1	)%

Daily average customer funds on deposit	$	583,000		$	202,000	$	381,000			>100	%

The following table reflects the number of client transactions processed for the nine-months ended March 30, 2012 and March 25, 2011.


	Nine-Months Ended
	March 30, 2012		March 25, 2011
Tickets for high-volume trading firms		843,032		1,184,030
Tickets for general securities broker/dealers		553,293		581,796

Total tickets		1,396,325		1,765,826

For the nine-months ended March 30, 2012 as compared to the nine-months ended March 25, 2011, net revenues in the clearing segment decreased 13% and clearing fee revenue was down 9%. In addition, other revenue decreased 29% for the nine-months ended March 30, 2012 as compared to the same period last fiscal year due to a 38% decline in administrative fee income from revenue sharing with money market fund providers.

From March 25, 2011 to March 30, 2012, the decrease in clearing revenue is due primarily to changes in market conditions. Approximately 20% of the change is due to the loss of ten correspondents to broker withdrawals from March 25, 2011 to March 30, 2012.

Also, for the nine-months ended March 30, 2012 as compared to the nine-months ended March 25, 2011, tickets processed for high-volume trading firms decreased 29% while tickets processed for general securities broker/dealers decreased by 5%. Revenue per ticket increased approximately 15% from $4.57 for the nine-months ended March 25, 2011 to $5.24 for the nine-months ended March 30, 2012. The change in the mix of tickets processed led to an increase in revenue per ticket as fees charged to high-volume trading firms are discounted substantially from the fees charged to general securities broker/dealers. A four day increase in the number of trading days in the nine-months of fiscal 2012 compared to the prior nine-month period partially offset the decrease in ticket volume. There were 189 trading days in the nine-months ended March 25, 2011 compared to 193 in the nine-months ended March 30, 2012.

Operating expenses increased for the nine-months ended March 30, 2012 as compared to the same period last fiscal year primarily due to a $765,000 increase in operations and information technology expense, partially offset by a $318,000 decrease in legal expenses and professional services and a $202,000 decrease in intangible amortization expense.

Retail

Three-months Ended:

The following is a summary of the results for the retail segment for the three-months ended March 30, 2012 as compared to the three-months ended March 25, 2011 (dollars in thousands):


	Three-Months Ended
	March 30, 2012		March 25, 2011		% Change
Private Client Group (“PCG”)
Commissions	$	12,268	$	12,259		—	%
Advisory fees		1,404		1,275		10
Insurance products		695		728		(5	)
Other		58		2		>100
Net interest revenue		607		545		11

		15,032		14,809		2

Independent registered representatives (“SWS Financial”)
Commissions		6,757		6,697		1
Advisory fees		749		731		2
Insurance products		1,822		1,850		(2	)
Other		277		232		19
Net interest revenue		229		247		(7	)

		9,834		9,757		1

Other
Commissions		105		104		1
Advisory fees		643		614		5
Insurance products		292		282		4
Other		38		30		27

		1,078		1,030		5

Total net revenues		25,944		25,596		1


	Three-Months Ended
	March 30, 2012			March 25, 2011			% Change
Operating expenses	$	26,983		$	26,246			3	%

Pre-tax loss	$	(1,039	)	$	(650	)		(60	)%

Daily average customer margin balances	$	121,000		$	82,000			48	%

Daily average customer funds on deposit	$	100,000		$	86,000			16	%

PCG representatives		167			175			(5	)%

SWS Financial representatives		314			303			4	%

Net revenues in the retail segment increased 1% for the three-months ended March 30, 2012 as compared to the same period last fiscal year. The slight increase was primarily due to an increase in management fees of $176,000. Total customer assets were $12.8 billion at March 30, 2012 as compared to $12.3 billon at March 25, 2011. Assets under management were $705.0 million at March 30, 2012 as compared to $615.0 million at March 25, 2011.

Operating expenses increased 3% for the three-months ended March 30, 2012 as compared to the same period last fiscal year. This increase was primarily due to a $0.7 million increase in commissions and other employee compensation expense, the primary component of operating expenses in the retail segment, consisting of a $311,000 increase in commission expense, due to increased production; a $254,000 increase in salaries, due to cost of living raises; and a $145,000 increase in recruiting bonuses due to our efforts to hire high quality PCG and SWS Financial representatives.

Nine-months Ended:

The following is a summary of the results for the retail segment for the nine-months ended March 30, 2012 as compared to the nine-months ended March 25, 2011 (dollars in thousands):


	Nine-Months Ended
	March 30, 2012			March 25, 2011		% Change
PCG
Commissions	$	36,010		$	40,421		(11	)%
Advisory fees		4,060			3,925		3
Insurance products		3,307			2,785		19
Other		(6	)		66		>(100	)
Net interest revenue		2,277			1,805		26

		45,648			49,002		(7	)

SWS Financial
Commissions		21,934			22,028		—
Advisory fees		2,127			2,232		(5	)
Insurance products		5,856			5,482		7
Other		749			736		2
Net interest revenue		675			709		(5	)

		31,341			31,187		—

Other
Commissions		322			289		11
Advisory fees		1,936			1,748		11
Insurance products		970			866		12


	Nine-Months Ended
	March 30, 2012		March 25, 2011		% Change
Other	$	109	$	129		(16	)%

		3,337		3,032		10

Total net revenues		80,326		83,221		(3	)
Operating expenses		80,305		82,030		(2	)

Pre-tax income	$	21	$	1,191		(98	)%

Daily average customer margin balances	$	112,000	$	79,000		42	%

Daily average customer funds on deposit	$	275,000	$	98,000		>100

Net revenues in the retail segment decreased 3% for the nine-months ended March 30, 2012 as compared to the same period last fiscal year due primarily to a $4.5 million decrease in commissions resulting from a reduction in PCG representative headcount, difficulty in recruiting representatives and reduced activity overall. The increase in insurance product sales in the nine-months ended March 30, 2012 as compared to the nine-months ended March 25, 2011 was due to improved volumes in both our PCG and SWS Financial businesses.

Operating expenses decreased 2% for the nine-months ended March 30, 2012 as compared to the same period last fiscal year. This decrease was primarily due to a $0.9 million decrease in commissions and other employee compensation expense, the primary component of operating expenses in the retail segment and a $0.6 million decrease in occupancy, equipment and computer service costs due to the completion of an M.L. Stern & Co., LLC computer services contract.

Institutional

Three-months Ended:

The following is a summary of the results for the institutional segment for the three-months ended March 30, 2012 as compared to the three-months ended March 25, 2011 (dollars in thousands):


	Three-Months Ended
	March 30, 2012		March 25, 2011		% Change
Commissions
Taxable fixed income	$	7,135	$	6,871		4	%
Municipal finance		3,420		3,270		5
Portfolio trading		4,667		3,647		28
Other		5		8		(38	)

		15,227		13,796		10

Investment banking fees		6,001		4,781		26
Net gains on principal transactions		8,718		10,749		(19	)
Other		212		100		>100
Net interest revenue
Stock loan		2,873		1,984		45
Other		785		1,381		(43	)

Net revenues		33,816		32,791		3
Operating expenses		23,808		23,270		2

Pre-tax income	$	10,008	$	9,521		5	%

Taxable fixed income representatives		33		33		—	%

Municipal distribution representatives		25		24		4	%

Average balances of interest-earning assets and interest-bearing liabilities for the three-months ended March 30, 2012 as compared to the three-months ended March 25, 2011 were as follows (in thousands):


	Three-Months Ended
	March 30, 2012		March 25, 2011
Daily average interest-earning assets:
Stock borrowed	$	1,502,000	$	2,157,000
Daily average interest-bearing liabilities:
Stock loaned		1,474,000		2,129,000

Net interest revenue from stock loan increased 45% despite a decline in the average balance outstanding due to a 32 basis point increase in the spread in this portfolio.

The following table sets forth the number and aggregate dollar amount of new municipal bond underwritings conducted by Southwest Securities, as reported to the Municipal Securities Rulemaking Board, for the three-months ended March 30, 2012 and March 25, 2011:


	Three-Months Ended
	March 30, 2012		March 25, 2011
Number of issues		155		72
Aggregate amount of offerings	$	13,933,616,000	$	5,076,406,000

Net revenues from the institutional segment increased 3% in the three-months ended March 30, 2012 as compared to the three-months ended March 25, 2011, and pre-tax income increased 5%. Commissions increased $1.4 million primarily driven by a $1.0 million increase in portfolio trading commissions due to a one time change in customer business mix.

Investment banking fees were up 26% in the three-months ended March 30, 2012 as compared to the same period in the last fiscal year due to a $2.0 million increase in municipal finance fees offset by a $0.4 million decrease in both our corporate finance and taxable fixed income fees. The increase in municipal finance fees was due to increased volume in the new issue market in the third quarter of fiscal 2012 when compared to the same period last year. Corporate finance fees were lower as no significant transactions were closed during the three-months ended March 30, 2012. The decrease in taxable fixed income fees during the three-months ended March 30, 2012 was due primarily to a decrease in UIT underwritings when compared to the three-months ended March 25, 2011.

Net gains on principal transactions decreased $2.0 million or 19% in the three-months ended March 30, 2012 as compared to the same period last fiscal year. This decrease was primarily due to a $1.9 million decrease in municipal trading gains from March 25, 2011 to March 30, 2012.

Operating expenses increased 2% for the three-months ended March 30, 2012 as compared to the same period last fiscal year primarily due to increased commissions and other employee compensation expense resulting from increased segment revenue.

Nine-months Ended:

The following is a summary of the results for the institutional segment for the nine-months ended March 30, 2012 as compared to the nine-months ended March 25, 2011 (dollars in thousands):


	Nine-Months Ended
	March 30, 2012		March 25, 2011		% Change
Commissions
Taxable fixed income	$	20,615	$	25,477		(19	)%
Municipal finance		9,587		11,673		(18	)
Portfolio trading		10,957		9,976		(10	)
Other		12		16		(25	)

		41,171		47,142		(13	)

Investment banking fees		19,110		23,612		(19	)
Net gains on principal transactions		23,254		30,172		(23	)
Other		642		453		42
Net interest revenue
Stock loan		8,668		8,631		—
Other		3,120		3,642		(14	)

Net revenues		95,965		113,652		(16	)
Operating expenses		67,368		76,209		(12	)

Pre-tax income	$	28,597	$	37,443		(24	)%

Average balances of interest-earning assets and interest-bearing liabilities for the nine-months ended March 30, 2012 as compared to the nine-months ended March 25, 2011 were as follows (in thousands):


	Nine-Months Ended
	March 30, 2012		March 25, 2011
Daily average interest-earning assets:
Stock borrowed	$	1,682,000	$	2,027,000
Daily average interest-bearing liabilities:
Stock loaned		1,660,000		2,000,000

The following table sets forth the number and aggregate dollar amount of new municipal bond underwritings conducted by Southwest Securities, as reported to the Municipal Securities Rulemaking Board, for the nine-months ended March 30, 2012 and March 25, 2011:


	Nine-Months Ended
	March 30, 2012		March 25, 2011
Number of issues		430		447
Aggregate amount of offerings	$	39,273,256,000	$	40,122,450,000

Net revenues from the institutional segment decreased 16% in the nine-months ended March 30, 2012 as compared to the nine-months ended March 25, 2011, and pre-tax income decreased 24%. Commissions decreased $6.0 million due to reduced customer activity, primarily in the taxable fixed income business and fewer new issues in the municipal finance business. These decreases were partially offset by a 10% increase in portfolio trading due to increased customer activity.

Investment banking fees were down 19% in the nine-months ended March 30, 2012 as compared to the same period in the last fiscal year due to a $1.6 million decline in municipal finance fees on reduced new issue volumes, a $1.8 million decrease related to reduced UIT underwritings and a $1.0 million decrease in corporate finance fees as fewer transactions closed in the nine-month period ended March 30, 2012 when compared to the nine-month period ended March 25, 2011.

Net gains on principal transactions decreased $6.9 million, or 23%, in the nine-months ended March 30, 2012 as compared to the same period last fiscal year. Taxable fixed income and municipal finance accounted for $4.7 million and $2.8 million of the decline, respectively.

Operating expenses decreased 12% for the nine-months ended March 30, 2012 as compared to the same period last fiscal year primarily due to decreased commissions and other employee compensation expense from reduced revenue produced by the institutional segment.

Banking

Three-months Ended:

The following is a summary of the results for the banking segment for the three-months ended March 31, 2012 as compared to the three-months ended March 31, 2011 (dollars in thousands):


	Three-Months Ended
	March 31, 2012		March 31, 2011			% Change
Net interest revenue	$	11,210	$	14,226			(21	)%
Other		1,430		(355	)		>100

Total net revenues		12,640		13,871			(9	)
Operating expenses		10,028		17,624			(43	)

Pre-tax income (loss)	$	2,612	$	(3,753	)		>100	%

For the three-months ended March 31, 2012 as compared to the three-months ended March 31, 2011, the Bank’s net revenue decreased 9% but the Bank posted pre-tax income of $2.6 million, up from a pre-tax loss of $3.8 million. The decrease in net interest revenue at the Bank was due primarily to a 16% decrease in average loan balances, as well as a decrease of 71 basis points in the net yield on interest-earning assets. Other revenue for the Bank increased $1.8 million for the three-months ended March 31, 2012 as compared to the same period last fiscal year. This increase was primarily due to a $1.4 million decrease in net losses on the sale of REO and a $0.4 million increase in income earned on the Bank’s equity investments.

The Bank’s operating expenses decreased 43% for the three-months ended March 31, 2012 as compared to the same period last fiscal year. This decrease was due primarily to a $4.7 million decrease in the Bank’s loan loss provision and a $2.2 million decrease in other expense consisting of the following: (i) a $1.5 million decrease in the Bank’s REO loss provision; (ii) a $429,000 decrease in the Bank’s fee assessments from regulatory agencies; (iii) a $271,000 decrease in real-estate related expenses; and (iv) a $192,000 decrease in outside services related to the review of the Bank’s loan files. These decreases were partially offset by a $102,000 increase in loan and non-loan related legal expenses. The decrease in the Bank’s loan loss provision was due to greater stability in commercial real-estate values and a reduction in size of the Bank’s loan portfolio. The allowance computation is discussed in detail in “ Loans and Allowance for Probable Loan Loss ” below.

The following table sets forth an analysis of the Bank’s net interest income by each major category of interest-earning assets and interest-bearing liabilities for the three-months ended March 31, 2012 and 2011 (dollars in thousands):


	Three-Months Ended
	March 31, 2012							March 31, 2011
	Average Balance		Interest Income/ Expense ^(*)		Yield/ Rate			Average Balance		Interest Income/ Expense ^(*)		Yield/ Rate

Assets:
Interest-earning assets:
Loans:
1-4 family	$	312,076	$	4,060		5.2	%	$	213,051	$	3,384		6.4	%
Residential – construction		11,420		134		4.7			46,529		720		6.3
Commercial – real estate		424,833		5,474		5.2			550,751		7,709		5.7
Commercial – loans		131,065		1,630		5.0			195,500		2,628		5.5
Individual		2,557		40		6.3			3,953		62		6.4
Land		29,546		363		4.9			80,435		1,011		5.1
Money market		1,003		1		0.3			1,097		—		—
Federal funds sold		—		—		—			2,441		1		0.2
Interest bearing deposits in banks		1,648		—		—			2,140		—		—
Federal reserve funds		259,970		134		0.2			281,527		151		0.2
Investments – other		133,421		530		1.6			8,846		15		0.7

	$	1,307,539	$	12,366		3.8	%	$	1,386,270	$	15,681		4.6	%
Non-interest-earning assets:
Cash and due from banks		4,493							5,814
Other assets		13,150							28,890

	$	1,325,182						$	1,420,974

Liabilities and Stockholders’ Equity:
Interest-bearing liabilities:
Certificates of deposit	$	40,612	$	107		1.1	%	$	55,665	$	179		1.3	%
Money market accounts		22,281		2		0.1			29,196		4		0.1
Interest-bearing demand accounts		9,998		2		0.1			10,646		2		0.1
Savings accounts		945,799		71		0.1			998,935		123		0.1
Federal Home Loan Bank advances		85,605		974		4.6			99,381		1,147		4.7
Other financed borrowings		—		—		—			2,933		—		—

	$	1,104,295	$	1,156		0.4	%	$	1,196,756	$	1,455		0.5	%
Non-interest-bearing liabilities:
Other liabilities		53,187							74,257

		1,157,482							1,271,013
Stockholders’ equity		167,700							149,961

	$	1,325,182						$	1,420,974

Net interest income			$	11,210						$	14,226

Net yield on interest-earning assets						3.5	%						4.2	%

(*)	Loan fees included in interest income for the three-months ended March 31, 2012 and 2011 were $547 and $951, respectively.

Interest rate trends, changes in the U.S. economy, competition and the scheduled maturities and interest rate sensitivity of the loan portfolios and deposits affect the spreads earned by the Bank.

The following table sets forth a summary of the changes in the Bank’s interest income and interest expense resulting from changes in volume and rate (in thousands):


	Three-Months Ended
	March 31, 2012 as compared to March 31, 2011
	Total			Attributed to
	Change			Volume			Rate			Mix

Interest income:
Loans:
1-4 family	$	676		$	1,573		$	(635	)	$	(262	)
Residential - construction		(586	)		(543	)		(178	)		135
Commercial - real estate		(2,235	)		(1,762	)		(672	)		199
Commercial - loans		(998	)		(866	)		(216	)		84
Individual		(22	)		(22	)		(1	)		1
Land		(648	)		(640	)		(31	)		23
Money market		1			—			1			—
Federal funds sold		(1	)		(1	)		—			—
Federal reserve funds		(17	)		(12	)		(7	)		2
Investments - other		515			300			4			211

	$	(3,315	)	$	(1,973	)	$	(1,735	)	$	393


Interest expense:
Certificates of deposit	$	(72	)	$	(48	)	$	(34	)	$	10
Money market accounts		(2	)		(2	)		—			—
Savings accounts		(52	)		(6	)		(49	)		3
Federal Home Loan Bank advances		(173	)		(159	)		(26	)		12

		(299	)		(215	)		(109	)		25

Net interest income	$	(3,016	)	$	(1,758	)	$	(1,626	)	$	368

Nine-months Ended:

The following is a summary of the results for the banking segment for the nine-months ended March 31, 2012 as compared to the nine-months ended March 31, 2011 (dollars in thousands):


	Nine-Months Ended
	March 31, 2012		March 31, 2011			% Change
Net interest revenue	$	36,700	$	52,319			(30	)%
Other		1,679		(1,275	)		>100

Total net revenues		38,379		51,044			(25	)
Operating expenses		32,508		98,558			(67	)

Pre-tax income (loss)	$	5,871	$	(47,514	)		>100	%

For the nine-months ended March 31, 2012 as compared to the nine-months ended March 31, 2011, the Bank’s net revenue decreased 25% but the Bank posted pre-tax income of $5.9 million, up from a pre-tax loss of $47.5 million. The decrease in net interest revenue at the Bank for the nine-months ended March 31, 2012 as compared to the prior fiscal year was due primarily to a 28% decrease in average loan balances, as well as a decrease in the net yield on interest-earning assets of 72 basis points. Other revenue increased $3.0 million for the nine-months ended March 31, 2012 as compared to the same period last fiscal year. This increase was primarily due to a $2.9 million decrease in net losses on the sale of REO and a $1.0 million net decrease in losses on the sale of loans. These increases were partially offset by a $1.2 million gain on the sale of securities in the nine-months ended March 31, 2011.

The Bank’s operating expenses decreased 67% for the nine-months ended March 31, 2012 as compared to the same period last fiscal year. This decrease was due primarily to a $48.5 million decrease in the Bank’s loan loss provision and a $15.4 million decrease in other expense, which included the following: (i) a $12.2 million decrease in the Bank’s REO loss provision; (ii) a $1.4 million decrease in third-party loan review services; (iii) a $750,000 decrease in real-estate related and other loan related expense; and (iv) a $506,000 decrease in the Bank’s fee assessments from regulatory agencies. The decrease in the Bank’s loan loss provision was due to greater stability in the rate of decline of commercial real-estate values and a reduction in size of the Bank’s loan portfolio. The allowance computation is discussed in detail in “ Loans and Allowance for Probable Loan Loss ” below.

The following table sets forth an analysis of the Bank’s net interest income by each major category of interest-earning assets and interest-bearing liabilities for the nine-months ended March 31, 2012 and 2011 (dollars in thousands):


	Nine-Months Ended
	March 31, 2012							March 31, 2011
	Average Balance		Interest Income/ *Expense ^()**		Yield/ Rate			Average Balance		Interest Income/ *Expense ^()**		Yield/ Rate
	Average Balance		Interest Income/ *Expense ^()**		Yield/ Rate			Average Balance		Interest Income/ *Expense ^()**		Yield/ Rate

Assets:
Interest-earning assets:
Loans:
1-4 family	$	282,242	$	12,056		5.7	%	$	359,407	$	16,797		6.2	%
Residential – construction		17,565		663		5.0			60,935		2,705		5.9
Commercial – real estate		464,300		18,492		5.3			599,238		24,454		5.4
Commercial – loans		150,243		5,835		5.2			201,903		8,306		5.5
Individual		2,867		133		6.2			4,250		221		6.9
Land		41,504		1,411		4.5			98,622		3,627		4.9
Money market		1,003		2		0.3			730		1		0.2
Federal funds sold		—		—		—			4,840		5		0.1
Interest bearing deposits in banks		1,919		—		—			4,403		1		—
Federal reserve funds		252,270		457		0.2			193,235		325		0.2
Investments – other		102,596		1,384		1.8			61,999		931		2.0

	$	1,316,509	$	40,433		4.1	%	$	1,589,562	$	57,373		4.8	%
Non-interest-earning assets:
Cash and due from banks		4,829							7,980
Other assets		15,467							36,680

	$	1,336,805						$	1,634,222

Liabilities and Stockholders’ Equity:
Interest-bearing liabilities:
Certificates of deposit	$	42,893	$	360		1.1	%	$	62,759	$	690		1.5	%
Money market accounts		24,428		9		0.1			34,329		16		0.1
Interest-bearing demand accounts		9,925		5		0.1			61,629		49		0.1
Savings accounts		950,876		283		0.1			1,132,462		617		0.1
Federal Home Loan Bank advances		89,664		3,076		4.6			108,085		3,682		4.5
Federal funds purchased		—		—		—			22		—		—
Other financed borrowings		11		—		—			2,831		—		—

	$	1,117,797	$	3,733		0.4	%	$	1,402,117	$	5,054		0.5	%
Non-interest-bearing liabilities:
Other liabilities		62,941							78,342

		1,180,738							1,480,459
Stockholders’ equity		156,067							153,763

	$	1,336,805						$	1,634,222

Net interest income			$	36,700						$	52,319

Net yield on interest-earning assets						3.7	%						4.4	%

(*)	Loan fees included in interest income for the nine-months ended March 31, 2012 and 2011 were $1,626 and $2,880, respectively.

Interest rate trends, changes in the U.S. economy, competition and the scheduled maturities and interest rate sensitivity of the loan portfolios and deposits affect the spreads earned by the Bank.

The following table sets forth a summary of the changes in the Bank’s interest income and interest expense resulting from changes in volume and rate (in thousands):


	Nine-Months Ended
	March 31, 2012 as compared to March 31, 2011
	Total			Attributed to
	Change			Volume			Rate			Mix

Interest income:
Loans:
1-4 family	$	(4,741	)	$	(3,606	)	$	(1,459	)	$	324
Residential - construction		(2,042	)		(1,925	)		(408	)		291
Commercial - real estate		(5,962	)		(5,506	)		(611	)		155
Commercial - loans		(2,471	)		(2,125	)		(471	)		125
Individual		(88	)		(72	)		(24	)		8
Land		(2,216	)		(2,101	)		(276	)		161
Money market		1			—			1			—
Federal funds sold		(5	)		(5	)		—			—
Interest bearing deposits in banks		(1	)		(1	)		(1	)		1
Federal reserve funds		132			100			24			8
Investments - other		453			579			(70	)		(56	)

	$	(16,940	)	$	(14,662	)	$	(3,295	)	$	1,017


Interest expense:
Certificates of deposit	$	(330	)	$	(218	)	$	(164	)	$	52
Money market accounts		(7	)		(5	)		(3	)		1
Interest-bearing demand accounts		(44	)		(41	)		(20	)		17
Savings accounts		(334	)		(99	)		(280	)		45
Federal Home Loan Bank advances		(606	)		(558	)		(60	)		12

		(1,321	)		(921	)		(527	)		127

Net interest income	$	(15,619	)	$	(13,741	)	$	(2,768	)	$	890

Other Segment

Three-months Ended:

Pre-tax income from the other segment was $1.7 million for the three-months ended March 30, 2012, as compared to a pre-tax loss of $8.5 million in the same period last fiscal year. Net revenues decreased $1.8 million in the three-months ended March 30, 2012 as compared to the same period last fiscal year primarily due to $3.0 million of interest expense related to the $100 million loan from Hilltop and Oak Hill in the three-months ended March 30, 2012, which was partially offset by a $1.2 million increase in other revenue from our deferred compensation plan’s investments. Operating expenses decreased $12.0 million in the three-months ended March 30, 2012 as compared to the same period last fiscal year primarily due to non-cash income from a $12.5 million decrease in the value of the warrants issued to Hilltop and Oak Hill.

Nine-months Ended:

Pre-tax loss from the other segment was $39.6 million for the nine-months ended March 30, 2012, as compared to $26.3 million in the same period last fiscal year. Net revenues decreased $9.7 million in the nine-months ended March 30, 2012 as compared to the same period last fiscal year. The decline in net interest revenue of $8.0 million was primarily due to interest expense related to the $100 million loan from Hilltop and Oak Hill in the nine-months ended March 30, 2012. The decrease in other revenue was primarily due to a $1.5 million decrease in the value of our deferred compensation plan’s investments. Operating expenses increased $3.7 million in the nine-months ended March 30, 2012 as compared to the same period last fiscal year primarily due to a $6.9 million increase in the value of the warrants issued to Hilltop and Oak Hill. This increase was offset by a $1.3 million decrease in commissions and other employee compensation expense and a $1.7 million decrease in legal expenses.

FINANCIAL CONDITION

Investments

In fiscal 2012, the Bank implemented an investment strategy to diversify its balance sheet, absorb excess liquidity, and maximize interest income through investment in a conservative securities portfolio. The securities portfolio is structured to provide cash flows that will mitigate interest rate risk and ensure adequate funds are available for new loan originations. The reported value of the Bank’s investment portfolio at March 31, 2012 and June 30, 2011 was as follows (in thousands):


	March 31, 2012		June 30, 2011
	March 31, 2012		June 30, 2011
Government-sponsored enterprises - held to maturity securities	$	28,408	$	34,176
Government-sponsored enterprises - available for sale securities ^(*)		121,699		—
Other		4,567		4,955

	$	154,674	$	39,131

^(*)

Subsequent to the quarter ended March 31, 2012, the Bank purchased 25 securities classified as available for sale at a cost of $82.7 million. The weighted average yield on these securities is expected to be 1.58%, and the weighted average maturity is expected to be 4.83 years based on the anticipated timing of future cash payments.

Loans and Allowance for Probable Loan Loss

The Bank grants loans to customers primarily within Texas and New Mexico. In the ordinary course of business, the Bank also purchases mortgage loans which have been originated in various areas of the United States. Although the Bank has a diversified loan portfolio, a substantial portion of its debtors’ ability to honor their loan terms is dependent upon the general economic conditions in Texas and New Mexico. Substantially all of the Bank’s loans are collateralized with real estate.

The allowance for loan losses is maintained to absorb management’s estimate of probable loan losses inherent in the loan portfolio at each reporting date. The allowance for loan losses is established as losses are estimated to have occurred through a provision for loan losses charged to earnings. Loan losses are charged against the allowance when management determines the collection of principal is remote. Subsequent recoveries are recorded through the allowance. The determination of an adequate allowance is inherently subjective, as it requires estimates that are susceptible to significant revision as additional information becomes available or circumstances change.

The allowance for loan losses consists of a specific and a general allowance component.

The specific component provides for estimated probable losses for loans identified as impaired. A loan is considered impaired when, based on current information and events, it is probable that the Bank will be unable to collect all amounts of principal and interest when due according to the contractual terms of the loan agreement. Management considers the borrower’s financial condition, payment status, historical payment record and any adverse situations affecting the borrower’s ability to repay when evaluating whether a loan is deemed impaired. Loans that experience insignificant payment delays and shortfalls generally are not classified as impaired. Management determines the significance of payment delays and shortfalls on a case-by-case basis taking into consideration all circumstances surrounding the loan and the borrower, including the length of delay, the reasons for the delay, the borrower’s prior payment record and the amount of shortfall in relation to the principal and interest outstanding.

A specific reserve is recorded when and to the extent the present value of expected future cash flows discounted at the loan’s original effective rate, fair value of collateral if the loan is collateral-dependent or observable market price of the impaired loan is lower than its recorded investment. If the fair value of collateral is used to measure impairment of a collateral-dependent loan and

repayment is dependent on the sale of the collateral, the fair value is adjusted to incorporate estimated costs to sell. Impaired loans that are collateral-dependent are primarily measured for impairment using the fair value of the collateral as determined by third party appraisals using the income approach, recent comparable sales data or a combination thereof. In certain instances it is necessary for management to adjust the appraised value, less estimated costs to sell, to reflect changes in fair value occurring subsequent to the appraisal date. Management considers a guarantor’s capacity and willingness to perform, when appropriate, and the borrower’s resources available for repayment when measuring impairment.

The general allowance provides for estimated and probable losses inherent in the remainder of the Bank’s loan portfolio. The general allowance is determined through a statistical calculation based on the Bank’s historical loss experience adjusted for certain qualitative factors as deemed appropriate by management. The statistical calculation is conducted on a disaggregated basis for groups of homogeneous loans with similar risk characteristics (product types). The historical loss element is calculated as the average ratio of charge-offs, net of recoveries, to the average recorded investment for the current and previous three quarters. Management adjusts the historical loss rates to reflect deterioration in the real estate market, significant concentrations of product types, trends in portfolio volume and the credit quality of the loan portfolio to capture additional risk of loss associated with concentrations of criticized and classified loans in the total loan portfolio. Prevailing economic conditions and specific industry trends are taken into consideration when establishing the adjustments to historical loss rates.

Certain types of loans, such as option ARM products, junior lien mortgages, high loan-to-value ratio mortgages, single family interest only loans, sub-prime loans, and loans with initial “teaser” rates, can have a greater risk of non-collection than other loans. At March 31, 2012, the Bank had $11.4 million in junior lien mortgages. These loans represented less than 2% of total loans at March 31, 2012. At March 31, 2012, the Bank did not have any exposure to sub-prime loans and loans with initial teaser rates. At March 31, 2012, the Bank had $1.9 million of single family interest only loans.

At March 31, 2012, the Bank’s loan portfolio included a total of $7.3 million in loans with a high loan-to-value ratio. High loan-to-value ratios are defined by regulation and range from 75%-90% depending on the type of loan. At March 31, 2012, approximately 35% of these loans were 1-4 single family or lot loans to home builders in North Texas. We addressed the additional risk in these loans in our allowance calculation primarily through our review of the real estate market deterioration adjustment to the historical loss ratio. Additionally, at March 31, 2012, the Bank had three loans with high loan-to-value ratios that were deemed impaired. The impairment analysis on these loans resulted in a partial charge-off of $699,000 and no impairment allocations. Regulatory guidelines suggest that high loan-to-value ratio loans should not exceed 100% of total capital. At March 31, 2012, the Bank’s high loan-to-value ratio loans represented 4% of total capital.

We obtain appraisals on real estate loans at the time of origination from third party appraisers approved by the Bank’s Board of Directors. We may also obtain additional appraisals when the borrower’s performance indicates it may default. After a loan default and foreclosure, we obtain new appraisals to determine the fair value of the foreclosed asset. We obtain updated appraisals on foreclosed properties on an annual basis, or more frequently if required by market conditions, until we sell the property.

Management reviews the loan loss computation methodology on a quarterly basis to determine if the factors used in the calculation are appropriate. Because our problem loans and losses are concentrated in real estate-related loans, we pay particular attention to real estate market deterioration and the concentration of capital in our real estate-related loans. Improvement or additional deterioration in the residential and commercial real estate market may have an impact on these factors in future quarters. To the extent we underestimate the impact of these risks, our allowance account could be materially understated.

Loans receivable and loans held for sale at March 31, 2012 and June 30, 2011 were as follows (in thousands):


	March 31, 2012			June 30, 2011
Residential
Purchased mortgage loans held for investment	$	217,214		$	100,239
1-4 family		95,512			116,799

		312,726			217,038

Lot and land development
Residential land		14,507			40,247
Commercial land		9,829			19,743

		24,336			59,990

Residential construction		8,826			33,296
Commercial construction		10,315			36,117
Commercial real estate		351,332			407,697
Multi-family		17,019			60,813
Commercial loans		123,957			173,195
Consumer loans		2,209			3,055
Loans held for immediate sale
Commercial real estate		—			4,810
Commercial loans		—			326
1-4 family		—			105

		—			5,241

		850,720			996,442
Allowance for probable loan loss (*)		(26,182	)		(44,433	)

	$	824,538		$	952,009

(*)	There is no allowance for probable loan loss for purchased mortgage loans held for investment as these loans are held on average for 25 days or less, substantially eliminating credit risk.

The increase in purchase mortgage loans held for investment from June 30, 2011 to March 31, 2012 is representative of a favorable interest rate environment for home purchases as well as refinancing opportunities. This along with a change in the competitive environment enabled the Bank to grow this business during the quarter ended March 31, 2012. However, the nature of the volume in this business is volatile and subject to significant variation depending on interest rates, competitive environment and general economic conditions.

The following table shows the scheduled maturities of certain loan categories at March 31, 2012 and segregates those loans with fixed interest rates from those with floating or adjustable rates (in thousands):


	1 year or less		1-5 years		Over 5 years		Total
	1 year or less		1-5 years		Over 5 years		Total
Commercial real estate and multi-family	$	49,589	$	195,393	$	123,369	$	368,351
Commercial loans		68,320		35,121		20,516		123,957
Construction loans		8,266		1,554		9,321		19,141

Total	$	126,175	$	232,068	$	153,206	$	511,449


	1 year or less		1-5 years		Over 5 years		Total
	1 year or less		1-5 years		Over 5 years		Total
Amount of loans based upon
Floating or adjustable interest rates	$	114,820	$	181,292	$	123,199	$	419,311
Fixed interest rates		11,355		50,776		30,007		92,138

Total	$	126,175	$	232,068	$	153,206	$	511,449

We maintain an internally classified loan list that helps us assess the overall quality of the loan portfolio and the adequacy of the allowance for loan losses. Loans on this list are classified as substandard, doubtful or loss based on the probability of repayment, collateral valuation and related collectability. This list is used to identify loans that are considered non-performing.

We classify loans as non-performing when they are 90 days or more past due as to principal or interest or when reasonable doubt exists as to timely collectability. The Bank uses a standardized review process to determine which non-performing loans should be placed on non-accrual status. At the time a loan is placed on non-accrual status, we reverse previously accrued and uncollected interest against interest income. We recognize interest income on non-accrual loans to the extent we receive cash payments for the loans with respect to which ultimate full collection is likely. For loans where ultimate collection is not likely, we apply interest payments to the outstanding principal and we recognize income only if full payment is made.

Non-performing assets and classified loans as of March 31, 2012 and June 30, 2011 were as follows (dollars in thousands):


	March 31, 2012			June 30, 2011
Loans accounted for on a non-accrual basis
1-4 family	$	16,186		$	3,377
Lot and land development		3,983			17,888
Multi-family		1,199			14,493
Residential construction		3,895			4,799
Commercial real estate		13,806			20,626
Commercial loans		6,075			3,166
Consumer loans		3			21

		45,147			64,370

Non-performing loans as a percentage of total loans		5.3	%		6.5	%

REO
1-4 family		90			686
Lot and land development		11,002			17,957
Multi-family		8,950			—
Residential construction		1,282			1,021
Commercial real estate		7,778			3,658
Commercial loans		45			135
Consumer loans		—			73

		29,147			23,530


	March 31, 2012			June 30, 2011
Other repossessed assets (ORA)	$	126		$	1,032
Performing troubled debt restructuring		641			540

Non-performing assets	$	75,061		$	89,472

Non-performing assets as a percentage of total assets		5.6	%		6.6	%

Current classified assets
1-4 family	$	3,003		$	14,963
Lot and land development		4,263			13,533
Multi-family		780			5,751
Residential construction		500			7,174
Commercial real estate		43,197			86,017
Commercial loans		3,025			11,570

		54,768			139,008

Total classified assets
1-4 family		19,279			19,076
Lot and land development		19,672			49,868
Multi-family		10,929			20,244
Residential construction		5,678			12,994
Commercial real estate		64,780			110,301
Commercial loans		9,474			15,903
Consumer loans		17			94

	$	129,829		$	228,480

Approximately $690,000 and $1,319,000 and $686,000 and $1,518,000 of gross interest income would have been recorded in the three and nine-month periods ended March 31, 2012 and 2011, respectively, had the non-accrual loans been recorded in accordance with their original terms. Interest income recorded on the non-accrual loans, prior to being placed on non-accrual status, in the three and nine-month periods ended March 31, 2012 and 2011 totaled approximately $45,000 and $903,000 and $7,000 and $591,000, respectively.

In fiscal 2011, the Bank hired additional staff and allocated additional resources to manage the growth in REO and non-performing assets. To reduce these loans and properties expeditiously, management prepared an asset-by-asset plan for these asset categories. Management’s focus on the continued reduction of these asset classes may have a material impact on the Bank’s future results of operations.

Total classified assets to Bank capital plus allowance for loan loss was 67.0% at March 31, 2012. Classified assets decreased $98.7 million from June 30, 2011 and substantially all classified loans by collateral location are in Texas. Bank management is focused on reducing the classified asset ratio through the disposal of these assets. Depending on the method used, the Bank may be required to record additional write-downs of these assets. While management is diligently working to dispose of these assets quickly, lack of demand for certain property types, length of sales cycle and manpower limitations will impact the time required to ultimately reduce the classified assets to a more acceptable level.

The following table presents an analysis of REO for the three and nine-months ended March 31, 2012 and 2011 (dollars in thousands):


	Three-Months Ended March 31,						Nine-Months Ended March 31,
	2012			2011			2012			2011
Balance at beginning of period	$	18,636		$	38,201		$	23,530		$	44,862
Foreclosures		14,801			3,365			19,291			40,089
Sales		(3,959	)		(12,691	)		(12,555	)		(44,739	)
Write downs		(331	)		(1,806	)		(1,106	)		(13,349	)
Other		—			(17	)		(13	)		189

Balance at end of period	$	29,147		$	27,052		$	29,147		$	27,052

The following table presents classified assets as of March 31, 2012 by year of origination (in thousands):


Year Originated	Non- Performing Loans		REO		ORA		Performing Troubled Debt Restructuring		Current Classified Assets		Total



Fiscal 2007 or prior	$	9,799	$	8,886	$	—	$	424	$	16,401	$	35,510
Fiscal 2008		18,002		13,288		—		217		8,865		40,372
Fiscal 2009		4,275		4,717		112		—		16,531		25,635
Fiscal 2010		11,820		2,256		—		—		11,013		25,089
Fiscal 2011		838		—		14		—		1,884		2,736
Fiscal 2012		413		—		—		—		74		487

	$	45,147	$	29,147	$	126	$	641	$	54,768	$	129,829

An analysis of the allowance for probable loan losses for the three and nine-months ended March 31, 2012 and 2011 was as follows (dollars in thousands):


	Three-Months Ended March 31,						Nine-Months Ended March 31,
	2012			2011			2012			2011
Balance at beginning of period	$	33,111		$	47,041		$	44,433		$	35,141
Charge-offs:
Residential construction		(457	)		—			(1,477	)		(1,999	)
Lot and land development		(478	)		(2,690	)		(2,365	)		(5,350	)
1-4 family		(1,779	)		(588	)		(1,963	)		(4,225	)
Commercial real estate		(3,363	)		(1,020	)		(7,418	)		(25,163	)
Multi-family		(801	)		—			(6,854	)		(562	)
Commercial loans		(541	)		(297	)		(1,700	)		(1,975	)
Consumer loans		—			(1	)		(10	)		(1	)

Total charge-offs		(7,419	)		(4,596	)		(21,787	)		(39,275	)
Recoveries:
Residential construction		8			59			143			216
Lot and land development		85			57			194			153


	Three-Months Ended March 31,						Nine-Months Ended March 31,
	2012			2011			2012			2011
1-4 family	$	131		$	13		$	168		$	27
Commercial real estate		139			1			357			29
Commercial loans		120			12			192			55
Consumer loans		7			—			7			1

Total recoveries		490			142			1,061			481


Net charge-offs		(6,929	)		(4,454	)		(20,726	)		(38,794	)
Additions charged to operations		—			4,727			2,475			50,967

Balance at end of period	$	26,182		$	47,314		$	26,182		$	47,314

Ratio of net charge-offs during the period to average loans outstanding during the period		0.8	%		0.41	%		2.2	%		2.94	%

With the continued challenging economic environment and persistent high unemployment rate, the Bank frequently reviews and updates its processes and procedures for the extension of credit, allowance for loan loss computation and internal asset review and classification. Recent changes include more stringent underwriting guidelines for loan-to-value ratios, guarantor’s financial condition, owner-occupied versus investor loans and speculative versus custom construction. The Bank currently requires more extensive documentation and data than it did in prior years in order to reclassify existing non-performing loans as performing loans. The Bank is also updating appraisals more frequently, including on performing loans, to serve as an early indicator of loan deterioration. See further discussion regarding the calculation of our provision for loan loss in “ Loans and Allowance for Probable Loan Loss es ” in the Notes to the Consolidated Financial Statements contained in this report.

As a result of the current economic environment and the Order, the Bank significantly limited the growth of its loan portfolio in fiscal 2011 and the first three quarters of fiscal 2012 in order to allocate the time, resources and capital necessary to support the existing loan portfolio and comply with the terms of the Order. With the OCC’s recent relief from certain lending restrictions, the Bank plans to reestablish marketing efforts to implement a conservative loan growth plan which we believe will enhance our core earnings in future years.

The allowance for probable loan losses by loan type as of March 31, 2012 and June 30, 2011 was as follows (dollars in thousands):


	March 31, 2012								June 30, 2011
	Amount		Percent of loans to total loans			Percent of the allowance for loan loss			Amount		Percent of loans to total loans			Percent of the allowance for loan loss
Residential construction	$	675		2.2	%		2.6	%	$	531		3.4	%		1.2	%
Lot and land development		1,702		2.9			6.5			3,168		6.0			7.1
1-4 family		4,120		36.8			15.7			6,107		21.9			13.7
Commercial real estate		14,817		41.3			56.6			28,306		44.8			63.7
Multi-family		2,322		2.0			8.9			871		6.1			2.0
Commercial loans		2,538		14.5			9.7			5,417		17.5			12.2
Consumer loans		8		0.3			—			33		0.3			0.1

	$	26,182		100.0	%		100.0	%	$	44,433		100.0	%		100.0	%

At March 31, 2012, approximately 57% of the Bank’s loan loss allowance was allocated to its commercial real estate loan portfolio while the Bank’s commercial real estate loan portfolio represented approximately 41% of its total loan portfolio. Because commercial real estate loans tend to be individually larger than residential loans, deterioration in this portfolio leads to more volatility in our earnings.

The Bank’s written loan policies address specific underwriting standards for commercial real estate loans. These policies include loan to value requirements, cash flow requirements, acceptable amortization periods and appraisal guidelines. In addition, specific covenants, unique to each relationship, may be used where deemed appropriate to further protect the lending relationship. Collateral in the commercial real estate portfolio varies from owner-occupied properties to investor properties. We periodically review the portfolio for concentrations by industry as well as geography. All commercial relationships are stress tested at the time of origination and major relationships are then stress tested on an annual basis.

Deposits

Average deposits and the average interest rate paid on the deposits for the three and nine-months ended March 31, 2012 can be found in the discussion of the Bank’s net interest income under the caption “ Results of Operations-Segment Information-Banking .”

The Bank had $16.7 million and $21.3 million of certificates of deposit of $100,000 or greater at March 31, 2012 and June 30, 2011, respectively. The Bank is funded primarily by deposits from SWS brokerage customers, which are classified as core deposits. These core deposits provide the Bank with a stable and low cost funding source. The Bank also utilizes long-term FHLB borrowings to match long-term fixed rate loan funding. At March 31, 2012, the Bank had $930.8 million in funds on deposit from customers of Southwest Securities, representing approximately 88% of the Bank’s total deposits.

Short Term Borrowings and Advances from Federal Home Loan Bank

The table below presents short term borrowings and advances from the FHLB which were due within one year during the three and nine-months ended March 31, 2012 and 2011 (dollars in thousands):


	Three-Months Ended March 31,										Nine-Months Ended March 31,
	2012					2011					2012					2011
			Interest					Interest					Interest					Interest
	Amount		Rate			Amount		Rate			Amount		Rate			Amount		Rate
At end of period	$	13,149		4.8	%	$	4,872		5.1	%	$	13,149		4.8	%	$	4,872		5.1	%
Average balance during period		12.767		4.8	%		5,612		5.1	%		12,650		4.9	%		11,018		3.9	%
Maximum balance during period		13,474		—			10,291		—			15,046		—			79,570		—

LIQUIDITY AND CAPITAL RESOURCES

Credit Agreement

On July 29, 2011, we entered into a credit agreement with Hilltop and Oak Hill pursuant to which we obtained a $100.0 million, five year, unsecured loan with an 8% interest rate. In addition, we issued warrants to Hilltop and Oak Hill allowing each to purchase up to 8,695,652 shares of common stock at an exercise price of $5.75 per share (subject to anti-dilution adjustments), representing approximately 17% of the common stock of our company per investor as of July 29, 2011. The credit agreement contains restrictions and covenants to which we must adhere as long as the unsecured loan is outstanding. As of March 30, 2012, SWS Group had utilized $70.0 million of the $100.0

million by contributing $20.0 million in capital to the Bank to promote growth in their loan portfolio and lending $50.0 million to Southwest Securities to fund daily securities operations. See “ Debt Issued with Stock Purchase Warrants ” in the Notes to the Consolidated Financial Statements contained in this report.

Brokerage

A substantial portion of our assets are highly liquid in nature and consist mainly of cash or assets readily convertible into cash. Our equity capital, short-term bank borrowings, interest bearing and non-interest bearing client credit balances, correspondent deposits and other payables finance these assets. We maintain an allowance for doubtful accounts that represents amounts that are necessary, in the judgment of management, to adequately absorb losses from known and inherent risks in receivables from clients, clients of correspondents and correspondents. The highly liquid nature of our assets provides us with flexibility in financing and managing our anticipated operating needs. Management believes that the brokerage business’ present liquidity position is adequate to meet its needs over the next twelve months.

Short-Term Borrowings . At March 30, 2012, we had short-term borrowing availability under broker loan lines, a $20.0 million unsecured line of credit, an irrevocable letter of credit agreement and a $45.0 million committed revolving credit facility, each of which is described below.

Broker Loan Lines. At March 30, 2012, we had uncommitted broker loan lines of up to $300.0 million. We have not received notification from the banks indicating a change in the amount of our broker lines since June 2011. These lines of credit are used primarily to finance securities owned, securities held for correspondent broker/dealer accounts and receivables in customers’ margin accounts. These lines may also be used to release pledged collateral against day loans. These credit arrangements are provided on an “as offered” basis, are not committed lines of credit and can be terminated at any time by the lender. Any outstanding balances under these credit arrangements are due on demand and bear interest at rates indexed to the federal funds rate. At March 30, 2012, the amount outstanding under these secured arrangements was $91.0 million, which was collateralized by securities held for firm accounts valued at $160.4 million. Our ability to borrow additional funds is limited by our eligible collateral. See additional discussion under Risk Factors in the Fiscal 2011 Form 10-K.

Unsecured Line of Credit. We also have a $20.0 million unsecured line of credit that is due on demand and bears interest at rates indexed to the federal funds rate. This credit arrangement is provided on an “as offered” basis and is not a committed line of credit. The total amount of borrowings available under this line of credit is reduced by the amount outstanding under any unsecured letters of credit at the time of borrowing. At March 30, 2012, we had no outstanding unsecured letters of credit. At March 30, 2012, there were no amounts outstanding on this line, and we had $20.0 million available for borrowing under this line of credit.

Letter of Credit Agreement. At March 30, 2012, we had an irrevocable letter of credit agreement aggregating $75.0 million pledged to support our open options positions with an options clearing organization. Until drawn, the letter of credit bears interest at a rate of 0.5% per annum. If drawn, the letter of credit bears interest at a rate of 0.5% per annum plus a fee. The letter of credit agreement is renewable semi-annually. This letter of credit is fully collateralized by marketable securities held in client and non-client margin accounts with a value of $76.5 million at March 30, 2012.

Revolving Credit Facility . On January 28, 2011, Southwest Securities entered into an agreement with an unaffiliated bank for a $45.0 million committed revolving credit facility. The commitment fee is 37.5 basis points per annum and, when drawn, the interest rate is equal to the federal funds rate plus 125 basis points based on a renewal of the agreement in January 2012. The agreement requires Southwest Securities to maintain a minimum tangible net worth of $150.0 million. As of March 30, 2012, there was $35.0 million outstanding under this credit facility. The $35.0 million of secured borrowings was collateralized by securities with a value of $60.0 million at March 30, 2012.

Net Capital Requirements . Our broker/dealer subsidiaries are subject to the requirements of the SEC relating to liquidity, capital standards and the use of client funds and securities. The amount of broker/dealer subsidiaries’ net assets that may be distributed to the parent of the broker/dealer is subject to restrictions under applicable net capital rules. Historically, we have operated in excess of the minimum net capital requirements. See “ Regulatory Capital Requirements ” in the Notes to the Consolidated Financial Statements contained in this report.

Banking

Liquidity is monitored daily to ensure the Bank’s ability to meet deposit withdrawals, maintain reserve requirements and otherwise sustain operations. The Bank’s liquidity is maintained in the form of readily marketable loans and investment securities, balances with the FHLB, Federal Reserve Bank of Dallas, federal funds sold to correspondent banks and vault cash. At March 31, 2012, the Bank had net borrowing capacity with the FHLB of $386.0 million. In addition, at March 31, 2012, the Bank had the ability to borrow up to $72.3 million in funds from the Federal Reserve Bank of Dallas under their secondary credit program.

In the second quarter of fiscal 2010, the Bank entered into a secured line of credit agreement with the Federal Reserve Bank of Dallas. This line of credit is secured by the Bank’s commercial loan portfolio. This line is due on demand and bears interest at a rate equal to 100 basis points over the federal funds target rate. This line is used to support short-term liquidity needs and, at March 31, 2012, there were no amounts outstanding.

The Bank’s asset and liability management policy is intended to manage interest rate risk. The Bank accomplishes this through management of the periodic repricing of its interest-earning assets and its interest-bearing liabilities. Overall interest rate risk is monitored through reports showing both sensitivity ratios, a simulation model and existing “GAP” data. (See the Bank’s GAP analysis in “ Risk Management-Market Risk-Interest Rate Risk-Banking .”) At March 31, 2012, $930.8 million of the Bank’s deposits were from brokerage customers of Southwest Securities. Current events in the securities markets could impact the amount of these funds available to the Bank.

Capital Requirements . The Bank is subject to various regulatory capital requirements administered by federal agencies. Quantitative measures, established by regulation to ensure capital adequacy, require maintaining minimum amounts and ratios of total and Tier I capital (as defined in 12 CFR 165 and 12 CFR 167) to risk-weighted assets (as defined) and of Tier I (core) capital (as defined) to adjusted assets (as defined). At March 31, 2012, the Bank had a total risk-based capital ratio of 20.4%, which resulted in excess capital of $71.8 million over the Order’s total risk-based capital requirement of $102.8 million, and the Bank had a Tier I (core) capital ratio of 12.3% or $56.9 million over the Order’s Tier I (core) capital requirement of $106.8 million. At March 31, 2012, the Bank had a Tier I risk-based capital ratio of 19.1%. Under federal law, the OCC may require the Bank to apply another measure of risk-weight or capital ratio that the OCC deems appropriate.

The Bank has historically met all capital adequacy requirements and, as of March 31, 2012, the Bank met all capital requirements to which it was subject and satisfied the requirements to be defined as a “well-capitalized institution.” However, on February 4, 2011, the Board of Directors of the Bank signed a Stipulation and Consent to Issuance of the Order. As a result of the issuance of the Order, effective February 4, 2011, the Bank is deemed to be “adequately capitalized” and no longer meets the definition of “well capitalized” under federal statutes and OCC regulations even though its capital ratios meet or exceed all applicable requirements under Federal law, OCC regulations and the Order. See additional discussion in “ Cease and Desist Order with the Office of the Comptroller of the Currency ” in the Notes to the Consolidated Financial Statements contained in this report. Should the Bank not meet these requirements, certain mandatory and discretionary supervisory actions (as defined in 12 CFR 165.6) could be applicable.

Off-Balance Sheet Arrangements

We generally do not enter into off-balance sheet arrangements, as defined by the SEC. However, our broker/dealer subsidiaries enter into transactions in the normal course of business that expose us to off-balance sheet risk. See Note 25 of the Notes to Consolidated Financial Statements in the Fiscal 2011 Form 10-K.

Contractual Obligations

In April 2012, the Bank acquired an interest in a private investment fund to obtain additional credit for its obligations under the Community Reinvestment Act of 1977. The Bank has committed to invest $3,000,000 in the fund. This investment is subject to the Volker Rule as described in “Commitments, Contingencies and Guarantees – Venture Capital Funds” in the Notes to the Consolidated Financial Statements contained in this report.

Cash Flow

Net cash used in operating activities was $16.5 million and net cash provided by operating activities was $409.7 million for the nine-months ended March 30, 2012 and March 25, 2011, respectively. The decrease in net cash provided by operating activities was primarily due to the change in cash flow classification of the Bank’s purchased mortgage program loans. In fiscal 2010, the cash flow from these loans were classified as operating cash flows, while in fiscal 2011, the cash flows were presented as investing cash flows.

Net cash used in investing activities was $28.2 million and net cash provided by investing activities was $175.5 million for the nine-months ended March 30, 2012 and March 25, 2011, respectively. The primary reason for the decrease in cash provided by investing activities was a $64.4 million increase in the net amount invested in loans at the Bank, a $94.8 million increase in investment securities, a $75.6 million decrease in proceeds from the sale of investment securities and the investment of $30.0 million of proceeds from the credit agreement with Hilltop and Oak Hill.

Net cash provided by financing activities totaled $49.2 million for the nine-months ended March 30, 2012 and net cash used in financing activities totaled $338.3 million for the nine-months ended March 25, 2011. The primary reason for the increase in the cash provided by financing activities was the $100.0 million loan from Oak Hill and Hilltop in July 2011 and a reduction in deposits of $44.8 million for the nine-months ended March 30, 2012 versus a reduction in deposits of $368.7 million for the nine-months ended March 25, 2011. Offsetting this increase in cash provided by financing activities was a decrease in net short-term borrowings.

We expect that cash flows provided by operating activities and short-term borrowings will be the primary source of working capital for the next twelve months.

Treasury Stock

Periodically, we repurchase our shares of common stock under a plan approved by our Board of Directors. In August 2011, the Board of Directors of SWS Group approved a plan authorizing us to purchase up to 500,000 shares of common stock from time to time in the open market for an 18-month time period ending on February 28, 2013. During the nine-months ended March 30, 2012, no shares were purchased under this program.

The trustee under our deferred compensation plan periodically purchases shares of our common stock in the open market in accordance with the terms of the plan. This stock is classified as treasury stock in our consolidated financial statements, but participates in future dividends declared by us. During the nine-months ended March 30, 2012, the plan purchased 32,451 shares at a cost of approximately $178,000, or $5.49 per share. The plan distributed 14,787 shares to participants during the nine-months ended March 30, 2012.

As restricted stock grants vest, grantees may sell a portion of their vested shares to us to cover the tax liabilities arising from vesting. As a result, in the nine-months ended March 30, 2012, we purchased 8,463 shares of common stock with a market value of $36,000, or an average of $4.29 per share, to cover tax liabilities.

Inflation

Our financial statements included herein have been prepared in accordance with GAAP. GAAP requires us to measure financial position and operating results primarily in terms of historic dollars. Changes in the relative value of money due to inflation or recession are generally not considered under GAAP. Our assets are primarily monetary, consisting of cash, securities inventory, and receivables from customers and broker/dealers. These monetary assets are generally liquid and turn over rapidly and, consequently, are not significantly affected by inflation. The rate of inflation affects various expenses of the company, such as employee compensation and benefits, communications, and occupancy and equipment, which may not be readily recoverable in the price of our services. The rate of inflation can also have a significant impact on securities prices and on investment preferences by our customers generally. In management’s opinion, changes in interest rates affect the financial condition of a financial services firm to a greater degree than changes in the inflation rate. While interest rates are greatly influenced by changes in the inflation rate, they do not necessarily change at the same rate or in the same magnitude as the inflation rate. Interest rates are highly sensitive to many factors that are beyond our control, including changes in the expected rate of inflation, the influence of general and local economic conditions and the monetary and fiscal policies of the United States government, its agencies and various other governmental regulatory authorities among other things.

RISK MANAGEMENT

In an effort to assist the Company in managing enterprise risk, in 2010, the Company engaged a firm at the Board of Director’s request to perform an analysis of the Company’s enterprise risk management process. During fiscal 2011, based on the board’s recommendations, we initiated an enterprise risk management program and committee. Enterprise risk is viewed as the threat from an event, action or loss of opportunity that, if it occurs or has occurred, may adversely affect any, or any combination of, our company objectives, business strategies, business model, regulatory compliance, reputation and existence. The committee works with our various departments and committees to manage our enterprise risk management program and reports the results of this work to the Audit Committee of the Board of Directors on a quarterly basis.

We manage risk exposure through the involvement of various levels of management. We establish, maintain and regularly monitor maximum securities positions by industry and issuer in both trading and inventory accounts. Current and proposed underwriting, banking and other commitments are subject to due diligence reviews by senior management, as well as professionals in the appropriate business and support units involved. The Bank seeks to reduce the risk of significant adverse effects of market rate fluctuations by minimizing the difference between rate-sensitive assets and liabilities, referred to as “GAP”, and maintaining an interest rate sensitivity position within a particular timeframe. Credit risk related to various financing activities is reduced by the industry practice of obtaining and maintaining collateral. We monitor our exposure to counterparty risk through the use of credit information, the monitoring of collateral values and the establishment of credit limits. We have established various risk management committees that are responsible for reviewing and managing risk related to interest rates, trading positions, margin and other credit risk and risks from capital market transactions.

Credit Risk

A description of the credit risk for our brokerage and banking segments is as follows:

Brokerage . Credit risk arises from the potential nonperformance by counterparties, customers or debt security issuers. We are exposed to credit risk as a trading counterparty and as a stock loan counterparty to dealers and customers, as a holder of securities and as a member of clearing organizations. We have established credit risk committees to review our credit exposure in our various business units. These committees are composed of senior management of the company. Credit exposure is also associated with customer margin accounts, which are monitored daily. We monitor exposure to individual securities and perform sensitivity analysis on a regular basis in connection with our margin lending activities. We adjust our margin requirements if we believe our risk exposure is not appropriate based on market conditions.

Banking . Credit risk is the possibility that a borrower or counterparty will fail to meet its obligations in accordance with agreed terms and is inherent in all types of lending. The Bank has developed and continues to enhance its policies and procedures to provide a process for managing credit risk. These policies and procedures include underwriting guidelines, credit and collateral tracking and detailed loan approval procedures which include officer and director loan committees. The Bank also maintains a detailed loan review process to monitor the quality of the loan portfolio. The Bank grants loans to customers primarily within Texas and New Mexico. The Bank also purchases mortgage loans which have been originated in other areas of the United States. Although the Bank has a diversified loan portfolio, a substantial portion of its debtors’ ability to honor their contracts is dependent upon the general economic conditions in Texas and New Mexico. Policies and procedures, which are in place to manage credit risk, are designed to be responsive to changes in these economic conditions.

Operational Risk

Operational risk refers generally to risk of loss resulting from our operations, including but not limited to, improper or unauthorized execution and processing of transactions, deficiencies in our operating systems, and inadequacies or breaches in our control processes. We operate in diverse markets and rely on the ability of our employees and systems to process large numbers of transactions. In order to mitigate and control operational risk, we have developed and continue to enhance specific policies and procedures that are designed to identify and manage operational risk at appropriate levels. We also use periodic self-assessments and internal audit examinations as further review of the effectiveness of our controls and procedures in mitigating our operational risk.

Legal Risk

Legal risk includes the risk of non-compliance with applicable legal and regulatory requirements. We are subject to extensive regulation in the various jurisdictions in which we conduct business. We have established procedures based on legal and regulatory requirements that are designed to reasonably ensure compliance with all applicable statutory and regulatory requirements. We also have established procedures that are designed to ensure that executive management’s policies relating to conduct, ethics and business practices are followed. In connection with our business, we have various procedures addressing significant issues such as regulatory capital requirements, sales and trading practices, new products, use and safekeeping of customer funds and securities, granting credit, collection activities, money laundering, privacy and record keeping.

Market Risk

Market risk generally represents the risk of loss that may result from a potential change in value of a financial instrument as a result of fluctuations in interest rates, market prices, investor expectations and changes in credit ratings of the issuer. Our exposure to market risk is directly related to our role as a financial intermediary in customer-related transactions and to our proprietary trading and securities lending activities.

Interest Rate Risk. A description of the interest rate risk for the brokerage and banking segments is as follows:

Brokerage. Interest rate risk is a consequence of maintaining inventory positions, trading in interest rate sensitive financial instruments and maintaining a matched stock loan book. Our fixed income activities also expose us to the risk of loss related to changes in credit spreads. Credit spread risk arises from the potential that changes in an issuer’s credit rating or credit perception could affect the value of financial instruments.

Banking. Our primary emphasis in interest rate risk management for the Bank is the matching of assets and liabilities of similar cash flow and re-pricing time frames. This matching of assets and liabilities reduces exposure to rate movements and aids in stabilizing positive interest spreads. We strive to structure our balance sheet as a natural hedge by matching floating rate assets with variable short term funding and by matching fixed rate liabilities with similar longer term fixed rate assets. The Bank has established percentage change limits in both interest margin and net portfolio value. To verify that the Bank is within the limits established for interest margin, the Bank prepares an analysis of net interest margin based on various shifts in interest rates. To verify that the Bank is within the limits established for net portfolio value, the Bank analyzes data prepared by the Office of Thrift Supervision (“OTS”) for interest rate sensitivity of the Bank’s net portfolio. Beginning with March 2012, the OTS data will no longer be available and the Bank will begin using internal modeling data for net portfolio value. These analyses are conducted on a quarterly basis for the Bank’s Board of Directors.

The following table illustrates the estimated change in net interest margin based on shifts in interest rates of positive 300 basis points and negative 100 basis points:


Hypothetical Change in Interest Rates		Projected Change in Net Interest Margin
+300		9.73%
+200		5.77%
+100		1.65%
0		0%
-50		-4.41%
-100		-8.75%

The following GAP analysis table indicates the Bank’s interest rate sensitivity position at March 31, 2012:


	Repricing Opportunities
(in thousands)	0-6 months		7-12 months			1-3 years		3+ years
Earning assets:
Loans-gross	$	698,321	$	15,065		$	46,679	$	90,655
Securities and FHLB stock		28,169		—			—		126,505
Interest bearing deposits		289,045		—			—		—

Total earning assets		1,015,535		15,065			46,679		217,160

Interest bearing liabilities:
Transaction accounts and savings		965,886		—			—		—
Certificates of deposit		15,976		12,599			9,427		1,522
Borrowings		8,844		4,305			34,008		31,589

Total interest bearing liabilities		990,706		16,904			43,435		33,111

GAP	$	24,829	$	(1,839	)	$	3,244	$	184,049

Cumulative GAP	$	24,829	$	22,990		$	26,234	$	210,283

Market Price Risk. We are exposed to market price risk as a result of making markets and taking proprietary positions in securities. Market price risk results from changes in the level or volatility of prices, which affect the value of securities or instruments that derive their value from a particular stock or bond, a basket of stocks or bonds or an index.

The following table categorizes “Securities owned, at fair value” net of “Securities sold, not yet purchased, at fair value,” which are in our securities owned and securities sold, not yet purchased, portfolios and “Securities available for sale” in our available-for-sale portfolio, which are subject to interest rate and market price risk at March 30, 2012 (dollars in thousands):


	Years to Maturity
	1 or less			1 to 5			5 to 10			Over 10			Total
Trading securities, at fair value
Municipal obligations	$	3,893		$	12,745		$	21,149		$	60,017		$	97,804
Auction rate municipal bonds		—			—			—			21,676			21,676
U.S. government and government agency obligations		2,610			(7,356	)		11,687			(3,445	)		3,496
Corporate obligations		(822	)		2,279			2,872			30,696			35,025

Total debt securities		5,681			7,668			35,708			108,944			158,001
Corporate equity securities		—			—			—			1,408			1,408
Other		23,365			—			—			—			23,365

	$	29,046		$	7,668		$	35,708		$	110,352		$	182,774

Restricted cash and cash equivalents	$	30,044		$	—		$	—		$	—		$	30,044

Assets segregated for regulatory purposes	$	—		$	35,307		$	—		$	—		$	35,307


Weighted average yield
Municipal obligations		2.7	%		2.0	%		2.3	%		4.0	%		3.3	%
Auction rate municipal bonds		—			—			—			0.7	%		0.7	%
U.S. government and government agency obligations		0.1	%		0.5	%		1.4	%		3.0	%		1.2	%
Corporate obligations		0.2	%		3.1	%		5.7	%		5.4	%		4.5	%
Assets segregated for regulatory purposes		—			0.3	%		—			—			0.3	%

Available-for-sale securities, at fair value
Securities available for sale	$	125,191		$	—		$	—		$	—		$	125,191

CRITICAL ACCOUNTING POLICIES AND ESTIMATES

Our discussion and analysis of our financial condition and results of operations are based on our consolidated financial statements, which have been prepared in accordance with GAAP. The preparation of these consolidated financial statements requires management to make estimates and assumptions that affect reported amounts of assets, liabilities, revenues, expenses and related disclosures. We review our estimates on an on-going basis. We base our estimates on our experience and on various other assumptions that we believe to be reasonable under the circumstances. Actual results may differ from these estimates under different assumptions or conditions. Our accounting policies and methodology used in establishing estimates have not changed materially since June 24, 2011. See the Fiscal 2011 Form 10-K for a discussion of our critical accounting policies.

FORWARD-LOOKING STATEMENTS

From time to time, we make statements (including some contained in this report) that predict or forecast future events, depend on future events for their accuracy, or otherwise contain “forward-looking” information and constitute “forward-looking statements” within the meaning of applicable U.S. securities legislation. Such statements are generally identifiable by the terminology used such as “plans,” “expects,” “estimates,” “budgets,” “intends,” “anticipates,” “believes,” “projects,” “indicates,” “targets,” “objective,” “could,” “should,” “may” or other similar words. By their very nature, forward-looking statements require us to make assumptions that may not materialize or that may not be accurate. Readers should not place undue reliance on any forward-looking statement and should recognize that the statements are predictions of future results, which may not occur as anticipated. Actual results may differ materially as a result of various factors, some of which are outside of our control, including:

•

the interest rate environment;

•

the volume of trading in securities;

•

the liquidity in capital markets;

•

the volatility and general level of securities prices and interest rates;

•

the ability to meet regulatory capital requirements administered by federal agencies, including without limitation, those established by the Order;

•

the level of customer margin loan activity and the size of customer account balances;

•

the demand for real estate in Texas, New Mexico and the national market;

•

the credit-worthiness of our correspondents, counterparties in securities lending transactions and of our banking and margin customers;

•

the demand for investment banking services;

•

general economic conditions, especially in Texas and New Mexico and investor sentiment and confidence;

•

the value of collateral securing the loans we hold;

•

competitive conditions in each of our business segments;

•

changes in accounting, tax and regulatory compliance requirements;

•

changes in federal, state and local tax rates;

•

the ability to attract and retain key personnel;

•

the availability of credit lines;

•

the potential misconduct or errors on the part of employees or entities with whom we conduct business;

•

the ability of borrowers to meet their contractual obligations and the adequacy of our allowance for loan losses; and

•

the potential of litigation and other regulatory liability.

Our future operating results also depend on our operating expenses, which are subject to fluctuation due to:

•

variations in the level of compensation expense incurred as a result of changes in the number of total employees, competitive factors, or other market variables;

•

variations in expenses and capital costs, including depreciation, amortization and other non-cash charges incurred to maintain our infrastructure; and

•

unanticipated costs which may be incurred from time to time in connection with litigation, regulation and compliance, loan analyses and modifications or other contingencies.

Other factors, risks and uncertainties that could cause actual results to differ materially from our expectations discussed in this report are described in this report under the headings “ Overview ,” “ Risk Management ”, “ Risk Factors ” and “ Critical Accounting Policies and Estimates ,” in the Fiscal 2011 Form 10-K under the heading Risk Factors and our other reports filed with and available from the SEC. Our forward-looking statements are based on our current beliefs, assumptions and expectations, taking into account information that we reasonably believe to be reliable. All such forward-looking statements speak only as of the date on which they are made, and except as required by law, we expressly disclaim any obligation or undertaking to disseminate any updates or revisions to any forward-looking statements contained herein to reflect any change in our expectations with regard thereto or any change in events, conditions or circumstances upon which any statement is based.

Item 3.

Quantitative and Qualitative Disclosures About Market Risk

The information required by this item is incorporated from “ Item 2. Management’s Discussion and Analysis of Financial Condition and Results of Operations ” under the caption “ Risk Management .”

Item 4.

Controls and Procedures

Evaluation of Disclosure Controls and Procedures

Our management, including the principal executive officer and principal financial officer, has evaluated the effectiveness of the design and operation of our disclosure controls and procedures (as defined in Rule 13a-15(e) pursuant to the Exchange Act) as of March 30, 2012. Based on such evaluation, our management, including the principal executive officer and principal financial officer, has concluded that, as of March 30, 2012, our 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 Exchange Act is (i) recorded, processed, summarized, and reported within the time periods specified in the SEC’s rules and forms and (ii) accumulated and communicated to management, including our principal executive officer and principal financial officer, as appropriate, to allow timely decisions regarding required disclosure.

Change in Internal Control over Financial Reporting

There have not been any changes in our internal control over financial reporting (as defined in Rule 13a-15(f) pursuant to the Exchange Act) during the three months ended March 30, 2012 that have materially affected or are reasonably likely to materially affect our internal control over financial reporting.

PART II. OTHER INFORMATION

Item 1.

Legal Proceedings

In the general course of our brokerage business and the business of clearing for other brokerage firms, we have been named as a defendant in various pending lawsuits and arbitration and regulatory proceedings. These claims allege violations of various federal and state securities laws, among other matters. The Bank is also involved in certain claims and legal actions arising in the ordinary course of business. We believe that resolution of these claims will not result in any material adverse effect on our business, consolidated financial condition, results of operations or cash flows.

Item 1A.

Risk Factors

There have been no material changes from the risk factors disclosed in the Fiscal 2011 Form 10-K.

Item 2.

Unregistered Sales of Equity Securities and Use of Proceeds

None.

Item 3.

Defaults upon Senior Securities

None.

Item 4.

Mine Safety Disclosures

Not applicable.

Item 5.

Other Information

None.

Item 6.

Exhibits

The exhibits required to be furnished pursuant to Item 6 are listed in the Exhibit Index filed herewith, which Exhibit Index is incorporated herein by reference.

SIGNATURES

Pursuant to the requirements of the Securities Exchange Act of 1934, the registrant has duly caused this report to be signed on its behalf by the undersigned thereunto duly authorized.


				SWS Group, Inc.
				(Registrant)

May 9, 2012				/s/ James H. Ross
Date				(Signature)
				James H. Ross
				Director, President and Chief Executive Officer
				(Principal Executive Officer)

May 9, 2012				/s/ Stacy M. Hodges
Date				(Signature)
				Stacy M. Hodges
				Chief Financial Officer
				(Principal Financial Officer)
				(Principal Accounting Officer)

SWS GROUP, INC. AND SUBSIDIARIES

INDEX TO EXHIBITS


Exhibit Number		Description

3.1		Restated Certificate of Incorporation of the Registrant incorporated by reference to Exhibit 3.1 to the Registrant’s Current Report on Form 8-K filed October 15, 2009

3.2		Restated By-laws of the Registrant incorporated by reference to Exhibit 3.2 to the Registrant’s Current Report on Form 8-K filed March 7, 2012

3.3		Certificate of Designations of Non-Voting Perpetual Participating Preferred Stock, Series A of SWS Group, Inc., incorporated by reference to Exhibit 3.1 to the Registrant’s Current Report on Form 8-K filed August 1, 2011

4.1		Warrant to purchase up to 8,695,652 shares of Common Stock, issued on July 29, 2011 to Hilltop Holdings Inc., incorporated by reference to Exhibit 4.1 to the Registrant’s Current Report on Form 8-K filed August 1, 2011

4.2		Warrant to purchase up to 8,419,148 shares of Common Stock, issued on July 29, 2011 to Oak Hill Capital Partners III, L.P., incorporated by reference to Exhibit 4.2 to the Registrant’s Current Report on Form 8-K filed August 1, 2011

4.3		Warrant to purchase up to 276,504 shares of Common Stock, issued on July 29, 2011 to Oak Hill Capital Management Partners III, L.P., incorporated by reference to Exhibit 4.3 to the Registrant’s Current Report on Form 8-K filed August 1, 2011

4.4		Investor Rights Agreement dated as of July 29, 2011 among SWS Group, Inc., Hilltop Holdings Inc., Oak Hill Capital Partners III, L.P. and Oak Hill Capital Management Partners III, L.P., incorporated by reference to Exhibit 4.4 to the Registrant’s Current Report on Form 8-K filed August 1, 2011

10.1		Form of SWS Group, Inc. Restricted Stock Plan Agreement for Employees for the 2003 Restricted Stock Plan

31.1*		Chief Executive Officer Certification filed pursuant to Section 302 of the Sarbanes-Oxley Act of 2002

31.2*		Chief Financial Officer Certification filed pursuant to Section 302 of the Sarbanes-Oxley Act of 2002

32.1*		Chief Executive Officer Certification furnished pursuant to Section 906 of the Sarbanes-Oxley Act of 2002

32.2*		Chief Financial Officer Certification furnished pursuant to Section 906 of the Sarbanes-Oxley Act of 2002

101 ^#		The following materials from SWS Group, Inc.’s quarterly report on Form 10-Q for the quarter ended March 30, 2012, formatted in XBRL (Extensible Business Reporting Language): (i) Consolidated Statements of Financial Condition as of March 30, 2012 and June 24, 2011; (ii) Consolidated Statements of Income (Loss) and Comprehensive Income (Loss) for the three and nine-months ended March 30, 2012 and March 25, 2011; (iii) Consolidated Statements of Cash Flows for the nine-months ended March 30, 2012 and March 25, 2011 and (iv) Notes to Consolidated Financial Statements tagged as blocks of text

*	Filed herewith

Pursuant to Rule 406T of Regulation S-T, the XBRL related information in Exhibit 101 to this Quarterly Report on Form 10-Q shall not be deemed to be “filed” for purposes of Section 18 of the Securities Exchange Act of 1934 (the Exchange Act”), or otherwise subject to the liability of that section, and shall not be part of any registration statement or other document filed under the Securities Act of 1933 or the Exchange Act, except as shall be expressly set forth by specific reference in such filing.