CONFORMED COPY
SECURITIES AND EXCHANGE COMMISSION
WASHINGTON, D.C. 20549
FORM 10-QSB
Quarterly report under Section 13 or 15(d) of the
Securities Exchange Act of 1934
For the quarterly period ended September 30, 1997
Commission file number 0-16090
Hallmark Financial Services, Inc.
(Exact name of small business issuer as specified in its charter)
Nevada 87-0447375
(State or other jurisdiction of (I.R.S.Employer
incorporation or organization) (Identification No.)
14651 Dallas Parkway, Suite 900
Dallas, Texas 75240
(Address of principal executive offices) (Zip Code)
Issuer's telephone number, including area code: (972) 404-1637
Check whether the issuer (1) has filed all reports required to be filed
by Section 13 or 15(d) of the Securities Exchange Act during the past 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
APPLICABLE ONLY TO CORPORATE ISSUERS
State the number of shares outstanding of each of the issuer's classes
of common equity, as of the latest practicable date: Common Stock, par
value $.03 per share - 10,662,277 shares outstanding as of November 13,
1997.
<PAGE>
PART I
FINANCIAL INFORMATION
Item 1. Financial Statements
INDEX TO FINANCIAL STATEMENTS
Sequential Page
Consolidated balance sheets at
September 30, 1997 (unaudited) and
December 31, 1996 3
Consolidated statements of income
(unaudited) for the three and nine
months ended September 30, 1997
and September 30, 1996 4
Consolidated statements of cash flows
(unaudited) for the nine months
ended September 30, 1997 and
September 30, 1996 5
Notes to consolidated financial statements
(unaudited) 6
<PAGE>
HALLMARK FINANCIAL SERVICES, INC. AND SUBSIDIARIES
CONSOLIDATED BALANCE SHEETS
<TABLE>
September 30 December 31
ASSETS 1997 1996
(Unaudited)
<S> <C> <C>
Investments:
Debt securities, held-to-
maturity $ 4,843,973 $ 5,160,137
Equity securities, available-
for-sale 151,484 152,246
Short-term investments, at
cost which approximates
market value 3,491,868 3,380,059
Total investments 8,487,325 8,692,442
Cash and cash equivalents 6,077,626 4,749,388
Prepaid reinsurance premiums 8,410,402 8,480,257
Premium finance notes receivable 6,703,779 2,524,938
Note receivable 3,518,708 -
Reinsurance recoverable 16,129,766 20,058,062
Deferred policy acquisition
costs 3,247,589 2,536,564
Excess of cost over net
assets acquired, net of
accumulated amortization 5,098,144 5,215,905
Deferred federal income taxes 168,325 330,718
Accrued investment income 67,549 46,606
Other assets 834,716 1,128,882
Total assets $ 58,743,929 $ 53,763,762
LIABILITIES AND STOCKHOLDERS' EQUITY
Liabilities:
Notes payable $ 7,551,320 $ 590,853
Unpaid losses and loss
adjustment expenses 17,187,039 20,697,393
Unearned premiums 11,542,683 11,310,250
Reinsurance balances payable 3,104,834 2,946,034
Deferred ceding commissions 2,574,737 2,368,264
Drafts outstanding 917,302 838,007
Accounts payable and other
accrued expenses 3,730,084 3,591,597
Total liabilities $ 46,607,999 $ 42,342,398
<PAGE>
Stockholders' equity:
Common stock, $.03 par value,
authorized 100,000,000 shares;
issued 10,962,277 shares in
1997 and 1996 328,868 328,868
Capital in excess of par value 10,349,665 10,349,665
Retained earnings 2,057,397 1,342,831
Treasury stock, 300,000 shares,
at cost (600,000) (600,000)
Total stockholders' equity 12,135,930 11,421,364
Total liabilities and
stockholders' equity $ 58,743,929 $ 53,763,762
The accompanying notes are an integral part
of the consolidated financial statements.
</TABLE>
<PAGE>
HALLMARK FINANCIAL SERVICES, INC. AND SUBSIDIARIES
CONSOLIDATED STATEMENTS OF OPERATIONS
(Unaudited)
<TABLE>
Three Months Ended Nine Months Ended
September 30 September 30
1997 1996 1997 1996
<S> <C> <C> <C> <C>
Gross premiums
written 9,830,845 $10,880,687 $30,639,244 $33,135,617
Ceded premiums
written (6,720,261) (7,716,384) (21,314,811) (24,404,903)
Net premiums
written $ 3,110,584 $ 3,164,303 $ 9,324,433 $8,730,714
Revenues:
Premiums
earned $ 9,827,280 $11,898,965 $30,098,572 $36,480,706
Premiums
ceded (6,849,751) (8,479,588) (21,076,427) (26,899,707)
Net pre-
miums
earned 2,977,529 3,419,377 9,022,145 9,580,999
Investment
income,
net of
expenses 164,602 224,912 563,882 671,996
Finance
interest
charges 312,084 1,194 312,084 25,509
Interest
income -
note
receivable 130,098 - 320,343 -
Processing
fees 64,428 423,584 773,433 1,477,834
Service fees 173,525 28,419 360,787 73,714
Other income 36,404 15,954 321,374 41,187
<PAGE>
Total
revenues 3,958,670 4,113,440 11,674,048 11,871,239
Benefits,
losses and
expenses:
Losses and
loss adjust-
ment
expenses 6,420,718 8,492,819 20,149,936 24,909,437
Reinsurance
recoveries (4,672,376) (6,393,702) (14,859,824) (18,759,990)
Net losses and
loss adjust-
ment expenses 1,748,342 2,099,117 5,290,112 6,149,447
Acquisition
costs, net ( 11,549) (278,921) (504,552) (422,422)
Other acquisi-
tion and
underwrit-
ing expenses 1,219,114 1,512,525 4,056,735 3,430,840
Operating
expenses 351,092 550,664 1,194,879 1,474,115
Interest
expense 155,664 10,449 354,237 32,308
Amortization
of intan-
gible assets 74,435 40,566 198,928 123,364
Total benefits,
losses and
expenses 3,537,098 3,934,400 10,590,339 10,787,652
Income from
operations
before federal
income taxes 421,572 179,040 1,083,709 1,083,587
Federal income
tax 136,488 61,014 369,143 376,356
Net income $ 285,084 $ 118,026 $ 714,566 $ 707,231
Net income
per share
of common
stock $ .02 $ .01 $ .06 $ .06
Weighted
average
shares out-
standing 11,578,029 12,167,846 11,578,029 12,167,846
</TABLE>
The accompanying notes are an integral part
of the consolidated financial statements.
<PAGE>
HALLMARK FINANCIAL SERVICES, INC. AND SUBSIDIARIES
CONSOLIDATED STATEMENTS OF CASH FLOWS
(Unaudited)
<TABLE>
Nine Months Ended
September 30
1997 1996
<S> <C> <C>
Cash flows from operating activities:
Net income $ 714,566 $ 707,231
Adjustments to reconcile net income to
cash provided by operating activities:
Depreciation and amortization expense 299,035 208,447
Change in deferred federal income taxes 162,393 114,775
Change in prepaid reinsurance premiums 69,855 2,494,804
Change in premium finance notes
receivable (4,178,841) 2,232,408
Change in deferred policy acquisition
costs (711,025) 463,790
Change in deferred ceding commissions 206,473 (886,212)
Change in unpaid losses and loss
adjustment expenses (3,510,354) 3,001,637
Change in unearned premiums 232,433 (3,345,090)
Change in reinsurance recoverable 3,928,296 (3,956,917)
Change in reinsurance balances payable 158,800 204,095
Change in all other liabilities 217,782 218,236
Change in all other assets 233,947 118,952
Net cash provided by operating
activities (2,176,640) 1,576,156
Cash flows from investing activities:
Purchases of property and equipment (48,603) (320,839)
Purchase of note receivable (6,513,156) -
Repayment of note receivable 2,994,448 -
Purchases of debt securities (1,022,229) (526,020)
Maturities, redemptions and
capital distributions
of investment securities 1,339,155 1,219,867
Purchase of short-term investments (6,517,834) (3,300,389)
Maturities of short-term investments 6,406,025 3,139,555
Net cash used in investing activities (3,362,194) 212,174
Cash flows from financing activities:
Proceeds from note payable 7,000,000 -
Payment of borrowing cost (93,395) -
Repayment of short-term borrowings (39,533) (35,786)
Cash provided by (used in) financing
activities 6,867,072 (35,786)
Increase in cash and cash equivalents 1,328,238 1,752,544
Cash and cash equivalents at beginning
of period 4,749,388 4,257,755
Cash and cash equivalents at end
of period $ 6,077,626 $ 6,010,299
Supplemental cash flow information:
Interest paid $ 354,237 $ 32,308
Income taxes paid $ 100,000 $ 300,790
</TABLE>
The accompanying notes are an integral part
of the consolidated financial statements.
<PAGE>
HALLMARK FINANCIAL SERVICES, INC. AND SUBSIDIARIES
Notes to Consolidated Financial Statements (Unaudited).
Note 1 - Summary of Accounting Policies
In the opinion of management, the accompanying consolidated financial
statements contain all adjustments, consisting primarily of normal
recurring adjustments, necessary to present fairly the financial
position of Hallmark Financial Services, Inc. and subsidiaries (the
"Company") as of September 30, 1997 and the consolidated results of
operations and cash flows for the periods presented. The accompanying
financial statements have been prepared by the Company without audit.
Certain information and disclosures normally included in financial
statements prepared in accordance with generally accepted accounting
principles ("GAAP") have been condensed or omitted. Reference is made
to the Company's annual consolidated financial statements for the year
ended December 31, 1996 for a description of all other accounting
policies. Certain items in the 1996 interim financial statements have
been reclassified to conform to the 1997 presentation.
The results of operations for the period ended September 30, 1997 are
not necessarily indicative of the operating results to be expected for
the full year.
Recognition of Premium Revenues
Insurance premiums are earned pro rata over the terms of the policies.
Policy fees are recognized when received. Premiums written include
gross policy fees of $3,114,680 and $3,833,860 and policy fees of
$1,959,290 and $1,402,141 net of reinsurance, for the nine months ended
September 30, 1997 and 1996, respectively.
New Accounting Pronouncements
In February 1997, the FASB issued SFAS No. 128, "Earnings Per Share."
SFAS No. 128 is designed to improve the earnings per share information
provided in financial statements by simplifying the existing computation
guidelines provided for in APB Opinion No. 15, "Earnings Per Share".
SFAS No. 128 is effective for financial statement periods ending after
December 15, 1997.
In February 1997, the FASB issued SFAS No. 129, "Disclosure of
Information about Capital Structure." SFAS 129 is applicable to all
entities and requires that disclosure about an entity's capital
structure include a brief discussion of rights and privileges for
securities outstanding. SFAS No. 129 is effective for financial
statements for periods ending after December 15, 1997.
In June 1997, the FASB issued SFAS No. 130, "Reporting Comprehensive
Income". SFAS No. 130 requires that all items that are required to be
recognized under accounting standards as components of comprehensive
income be reported in a financial statement that is displayed with the
same prominence as other financial statements. SFAS No. 130 is
effective for financial statement periods ending after December 15,
1997.
<PAGE>
In June 1997, the FASB issued SFAS No. 131, "Disclosures about
Segments of an Enterprise and Related Information". SFAS No. 131
establishes standards for reporting information about operating segments
in annual financial statements and requires reporting of selected
information about operating segments in interim financial reports issued
to stockholders. It also establishes standards for related disclosures
about products and services, geographic areas, and major customers.
SFAS No. 131 is effective for financial statement periods ending after
December 15, 1997.
Management does not anticipate that the above pronouncements will have
a material effect on the Company's consolidated financial condition or
results of operations.
Note 2 - Investments
Debt securities, held-to-maturity, as of September 30, 1997 include
investments in U.S. Government securities of $2,850,787 and special
revenue bonds of $1,993,186. Short-term investments consist of U.S.
Government agency securities of $3,491,868. Short-term investments
mature within one year.
Realized investment gains and losses are recognized in operations on
the specific identification method. The Company has the ability and
intent to hold all debt investments to maturity. Provisions for
possible losses are recorded only on other-than-temporary declines in
the value of an investment.
Note 3 - Notes Payable
A summary of the Company s notes payable as of September 30, 1997 is
as follows:
Note payable to Dorinco $ 7,000,000
Note payable to unaffiliated finance company 380,187
Note payable to individual 171,133
Total $ 7,551,320
Effective March 11, 1997, the Company entered into a loan agreement
with Dorinco Reinsurance Company ("Dorinco"), an unaffiliated company,
whereby the Company borrowed $7,000,000 to contribute to its premium
finance subsidiary, Hallmark Finance Corporation ("HFC"). Proceeds from
this loan have been used by HFC primarily to fund premium finance notes.
(See Note 4.) The loan agreement provides for a seven-year term at a
fixed interest rate of 8.25%. Interest is payable monthly through
February 28, 1999, with principal and interest payments commencing March
31, 1999 through March 31, 2004. A penalty ranging from $80,000 to
$120,000 is charged for prepaying the loan prior to the fourth
anniversary date except that after the second anniversary date, up to
40% of the outstanding balance may be prepaid without penalty.
As long as certain financial covenants defined as "triggering events"
are maintained, collateral for the loan is limited to the stock of HFC
and a covenant by the Company not to pledge the stock of American
Hallmark Insurance Company of Texas ("Hallmark") and American Hallmark
General Agency, Inc. ("AHGA"). To avoid a triggering event, Hallmark
must (1) maintain a combined ratio and loss ratio which do not exceed
<PAGE>
107% and 83%, respectively; (2) maintain statutory surplus of $4,200,000
and experience no decreases to surplus in any one year that exceeds 15%
of the prior year surplus; and (3) cause HFC to maintain a certain
interest coverage ratio and stockholders equity levels as defined in
the agreement. If a triggering event should occur, the Company has ten
days to pledge the stock of AHGA and Hallmark as additional collateral
for the Dorinco loan. The loan agreement also contains covenants which
require the Company to satisfy certain financial ratios which are less
restrictive than the triggering event ratios and, among other things,
restrict capital expenditures, payment of dividends, and incurrence of
additional debt. For the nine month period ended September 30, 1997,
the Company is in compliance with the covenants of the loan.
Effective March 17, 1997, HFC entered into a loan agreement ("Bank
Credit Line") with a bank whereby the bank committed to provide a
revolving credit facility of $8,000,000 for funding of up to 60% of
premium finance notes outstanding for State and County policies.
Beginning late-June 1997, upon completion of a required 90-day
cancellation notification period to Peregrine, HFC commenced funding all
new notes issued by HFC with proceeds from both the Dorinco loan and the
Bank Credit Line.
The Bank Credit Line provides for an eighteen-month term which expires
September 17,1998. Fundings under this line are limited to a 60%
advance rate against a borrowing base of eligible premium finance notes
receivable as defined in the agreement. The agreement provides for
monthly interest payments with interest rate options of prime plus
three-eighths floating or the London Interbank Offered Rate ("LIBOR")
plus two and eight-tenths with fixed rate tranches of three, six and/or
twelve months in $250,000-minimum increments up to a total of twelve
tranches. A one-fourth of one percent per annum usage fee is payable on
any unused portion of the Bank Credit Line. To collateralize advances
under the line, HFC must grant the bank a security interest in the
premium finance notes and the Company must guarantee HFC s indebtedness.
The Bank Credit Line agreement also contains covenants which, among
other things, require the Company to satisfy the same financial ratios
as in the Dorinco loan agreement, and includes, but is not limited to,
restrictions on capital expenditures, payment of dividends, and
incurring of additional debt, and requires that the Company be in
compliance with all terms and covenants of the Dorinco loan agreement.
There have been no fundings under the Bank Credit Line as of September
30, 1997.
The note payable to unaffiliated finance company with interest at
prime plus one percent was due March 31, 1993. The Company has not made
payments on the note since November 1992, and is in technical default.
The note provides for an interest rate after maturity of the maximum
statutory interest rate. The Company believes it has the right to
offset $240,000 which is on deposit with a subsidiary of the
unaffiliated finance company. The total principal and interest in
arrears aggregates $818,780 at September 30, 1997. Both the lender and
its subsidiary are currently in bankruptcy proceedings. Upon final
settlement, management believes the cost, if any, to the Company will
not exceed amounts accrued in these financial statements.
The note payable to an individual is collateralized by most assets of
AHGA and requires monthly principal and interest payments of $6,000
through May 1, 2000, with interest at 10%.
<PAGE>
Note 4 - Note Receivable
Proceeds of $5,915,109 from the Dorinco loan (discussed in Note 3)
were loaned to Peregrine Premium Finance L.C. ("Peregrine") to repay
external borrowing incurred by Peregrine to fund premium finance notes
pursuant to the financing and servicing arrangement between HFC and
Peregrine. In addition, $598,047 of internally generated funds were
loaned to Peregrine to fund new premium finance notes. The Peregrine
note principal varies in proportion to the amount used by Peregrine to
fund premium finance notes, and is repaid from the insured's payments on
such premium finance notes. Commencing in late June 1997, HFC began
issuing its own premium finance notes. As a result, the balance of the
note receivable from Peregrine declined to $3,518,708 at September 30,
1997. The note is collateralized by the premium finance notes and bears
interest at prime plus 1% (9.5% at September 30, 1997).
Note 5 - Federal Income Taxes
The composition of deferred tax assets and liabilities and the related
tax effects as of September 30, 1997 and December 31, 1996 is as
follows:
1997 1996
Deferred Tax Assets:
Property and equipment basis $ 34,000 $ 32,607
Unearned premiums 212,995 192,439
Loss reserve discounting 68,455 65,207
Deferred ceding commissions,
non-deductible for tax (228,770) (57,222)
Net operating loss carryforward 33,171 33,171
Other 81,645 97,694
Net deferred tax assets 201,496 363,896
Valuation allowance ( 33,171) ( 33,178)
Net deferred tax asset $ 168,325 $ 330,718
A reconciliation of the income tax provisions based on the prevailing
corporate tax rate of thirty-four percent (34%) to the provision
reflected in the consolidated financial statements for the nine month
period ended September 30, 1997 and 1996 is as follows:
1997 1996
Computed expected income tax expense
at statutory regulatory tax rate $ 368,461 $ 368,420
Amortization of excess cost 40,198 39,837
Tax-exempt interest ( 1,477) ( 1,477)
Change in valuation allowance - (48,288)
Other ( 38,039) 17,864
Income tax expense $ 369,143 $ 376,356
The Company has available, for federal income tax purposes, unused net
operating losses of $97,562 at September 30, 1997, which may be used to
offset future taxable income. The operating losses will expire, if
unused, as follows:
<PAGE>
Year
2002 $ 1,325
2003 96,237
$ 97,562
Note 6 - Options and Warrants Outstanding
The Company has two stock option plans for key employees, the 1991 Key
Employee Stock Option Plan and the 1994 Key Employee Long Term Incentive
Plan, and a non-qualified plan for non-employee directors. The number
of shares reserved for future issuance under the 1991 employee plan, the
1994 employee plan and the non-employee director plan are 500,000,
1,500,000 and 1,350,000, respectively. The option prices under the
plans are not to be less than the closing price of the common stock on
the day preceding the grant date. Pursuant to the stock option plans,
the Company has granted incentive stock options under Section 422 of the
Internal Revenue Code of 1986. The stock options granted to employees
vest over a 3 year period on a graded schedule, 40% in the first 6
months and 20% on each anniversary date of the grant date. The stock
options granted to the directors vest over a 6 year period on a graded
schedule, 40% in the first 6 months and 10% on each anniversary date of
the grant date. In accordance with APB No. 25, the Company has not
recognized compensation expense for the stock options granted in 1996
and 1995.
In October 1992, the Company issued warrants to purchase 981,333
shares of its Common Stock ("Guaranty Warrants") to executive officers
and directors in consideration for the recipients' agreement to pledge
outstanding shares of the Company's common stock they owned as security
for a working capital line of credit the Company proposed to obtain from
a commercial bank. The Company subsequently abandoned its efforts to
obtain the working capital line of credit. Each Guaranty Warrant
covered the same number of shares the recipient agreed to pledge. No
value was assigned to these warrants. The Guaranty Warrants were fully
exercisable between October 2, 1992 and October 1, 1996, at which time
they would have expired to the extent not exercised. On March 28, 1996,
the Board of Directors extended the exercisability of the Guaranty
Warrants through October 1, 1998. This resulted in a new exercise
period from October 1, 1996 (new measurement date) to October 1, 1998.
The value of the warrants of $107,000 is being amortized over the new
exercise period. The exercise price is $.50 per share, an amount equal
to the last reported sale price of the Common Stock on the American
Stock Exchange's Emerging Company Marketplace prior to October 2, 1992.
The Guaranty Warrants are not transferrable, but may be exercised only
by their recipients (or by a recipient's estate in the event of his/her
death).
Note 7 - Reinsurance
Hallmark is involved in the assumption and cession of reinsurance
from/to other companies. The Company remains obligated to its
policyholders in the event that reinsurers do not meet their obligations
under the reinsurance agreements.
Effective March 1, 1992, Hallmark entered into a reinsurance
arrangement with State & County Mutual Fire Insurance Company ("State &
County"), an unaffiliated company, to assume 100% of the nonstandard
<PAGE>
auto business produced by AHGA and written on State & County policies.
The arrangement was supplemented by a separate retrocession agreement
between Hallmark and Vesta Fire Insurance Corporation ("Vesta").
Hallmark and Vesta shared the risk on the State & County policies with
Hallmark retaining 25%. This retrocession agreement with Vesta was
terminated on a run-off basis effective June 30, 1996.
Effective July 1, 1996, Hallmark renewed its reinsurance arrangement
with State & County and entered into a new retrocession agreement with
Kemper Reinsurance Company ("Kemper"), Dorinco and Odyssey Reinsurance
Corporation ("Odyssey"). Under the new retrocession agreement, Hallmark
continues to retain 25%.
Effective July 1, 1997, the retrocession agreement was renewed with
Kemper and Dorinco under substantially the same terms and conditions,
except that Kemper and Dorinco will each assume a 50% pro rata share of
the business under the retrocession agreement to replace Odyssey's
share.
Note 8 - Commitments and Contingencies
In March 1997, a jury returned a verdict against the Company and in
favor of a former director and officer of Hallmark in the amount of
approximately $517,000 on the basis of contractual and statutory
indemnification claims. The court subsequently granted the plaintiff's
motion for attorneys' fees of approximately $271,000, court costs of
approximately $39,000 and pre-judgment and post-judgment interest, and
rendered final judgment on the verdict. The Company believes the
judgment in this case was both legally and factually incorrect and filed
a motion for new trial. The motion for a new trial was overruled by
operation of law, and subsequently the Company filed a notice of appeal.
The Company is presently unable to determine the likelihood of an
unfavorable outcome to such appeal.
On October 3, 1997, in order to stay execution of the judgment, the
Company deposited $1,248,758 into the registry of the court. This
deposit includes the amount of the compensatory judgment and attorneys'
fees, pre-judgment interest, post-judgment interest, and other related
court costs in accordance with procedures required for appeal. With
the consent of the Company's lenders, HFC advanced the funds necessary
for such deposit.
Item 2. Management's Discussion and Analysis or Plan of Operation.
Introduction. Hallmark Financial Services, Inc. ("HFS") and its
wholly owned subsidiaries (collectively referred to herein as the
"Company") engage in the sale of insurance products on credit terms,
primarily to lower and middle income customers. Its target market
encompasses the substantial number of Americans who either are denied
credit from banks, credit card companies and other conventional credit
sources, or have never established a bank account or credit history.
Currently, the Company's business primarily involves marketing,
underwriting and premium financing of non-standard automobile insurance.
Secondarily, the Company provides fee-based claims adjusting and related
services for affiliates and third parties.
<PAGE>
The Company conducts these activities through an integrated insurance
group, the dominant members of which are a property and casualty
insurance company, American Hallmark Insurance Company of Texas
("Hallmark"); a managing general agent, American Hallmark General
Agency, Inc. ("AHGA"); a network of affiliated insurance agencies known
as the American Hallmark Agencies ("Hallmark Agencies"); a commercial
excess and surplus lines affiliated managing general agency, Hallmark
Underwriters, Inc. ("HUI"); a premium finance company, Hallmark Finance
Corporation ("HFC"); and a claims handling and adjustment firm, Hallmark
Claims Service, Inc. ("HCS"). The Company operates only in Texas.
Hallmark provides non-standard automobile liability and physical
damage insurance through reinsurance arrangements with several
unaffiliated companies. Through arrangements with State & County Mutual
Fire Insurance Company ("State & County"), Hallmark provides insurance
primarily for high risk drivers who do not qualify for standard-rate
insurance. Under supplementary quota-share reinsurance agreements,
Hallmark cedes a substantial portion of its risk and retains the
balance. From March 1, 1992 through June 30, 1996, Hallmark ceded a
portion of its risk to Vesta Fire Insurance Corporation ( Vesta ) (60%
between March 31, 1992 and July 31, 1993 and 75% between August 1, 1993
and June 30, 1996). Effective July 1, 1996, Hallmark entered into a new
reinsurance treaty with Kemper Reinsurance Company ("Kemper"), Dorinco
Reinsurance Company ("Dorinco"), and Odyssey Reinsurance Corporation
("Odyssey"), ceding a total of 75% of its risk. Effective July 1, 1997,
the treaty was renewed with Kemper and Dorinco under substantially the
same terms and conditions except that the Company was allowed to retain
100% of the policy fees on a new six-month program commenced during
late-July 1997 (versus 62.5% for monthly and annual programs).
Additionally, effective July 1, 1997 Kemper and Dorinco assumes a 50%
pro-rata share of the business under the treaty to replace Odyssey's 25%
share. Previously, HFC offered premium financing to Hallmark
policyholders through a financing and servicing arrangement with an
unaffiliated premium finance company. Beginning late-June 1997, HFC
began issuing its own premium finance notes funded by $15 million in
funds available pursuant to agreements executed in March 1997. (See
Notes 3 and 4 to the Consolidated Financial Statements.) AHGA manages
the marketing of Hallmark policies through a network of retail insurance
agencies which operate under the American Hallmark Agencies name, and
through independent agents operating under their own respective names.
HUI, formed to market and produce commercial excess and surplus lines
("E&S") insurance on behalf of unaffiliated E&S insurers, began
operations in late April 1996. HUI generates commission income by
producing E&S insurance business through the network of the Company's
thirteen retail agencies, certain agents from the Company's current
independent agent group, and other selected independent agents.
Financial Condition and Liquidity
The Company's sources of funds are principally derived from insurance
related operations. Major sources of funds are from premiums collected
(net of policy cancellations and premiums ceded), external funding of
premium notes, ceding commissions, processing fees, premium finance
service charges and investment activities. Net cash flow used by the
Company s consolidated operations for the nine months ended September
30, 1997 was $2,176,640 and net cash flow provided by consolidated
operations for the nine months ended September 30, 1996 was $1,576,156.
<PAGE>
As discussed in the Introduction above, HFC began issuing its own
premium finance notes in late-June 1997. Premiums receivable as of
September 30, 1997, includes premium note receivables from insureds of
$5,162,649 thus accounting for the majority of operational cash flow
usage during 1997. On a consolidated basis, the Company's liquidity
improved somewhat as of September 30, 1997 as compared to December 31,
1996. The Company s total cash and investments increased approximately
8% to $14,564,951 as of September 30, 1997 from $13,441,830 as of
December 31, 1996. This increase is due primarily to the cumulative
effect of increased cash flow from the Company's premium finance program
commenced during 1995 and unused loan proceeds (discussion of Dorinco
loan agreement follows).
Under HFC s premium finance program, premiums for annual policies due
Hallmark are funded-in-full in approximately 30 days and immediately
invested. Premiums receivable is primarily composed of premium finance
notes receivables from insureds on policies financed by HFC directly and
unfunded premium balances attributable to the business with the
unaffiliated premium finance company. As previously noted, HFC began
issuing its own premium finance notes at the end of June 1997. Premium
finance notes receivables from insureds totaled $5,162,649 as of
September 30, 1997. Unfunded premium balances due as of September 30,
1997 and December 31, 1996, respectively, were $992,276 and $2,437,024.
This decrease in unfunded premium balances is attributable to the run-
off of the unaffiliated premium finance company business.
At September 30, 1997, the Company reported $7,551,320 in notes
payable as compared to $590,853 at December 31, 1996. Effective March
11, 1997, the Company entered into a loan agreement with Dorinco
( Dorinco Loan Agreement ), an unaffiliated company and principal
reinsurer of Hallmark, whereby the Company borrowed $7,000,000 to
contribute to HFC. (See Note 3 to the Consolidated Financial
Statements.) Proceeds from the Dorinco Loan Agreement were used to
repay $5,915,109 of off-balance sheet financing of premium notes and to
fund additional premium notes under HFC's financing and servicing
arrangement with an unaffiliated premium finance company. As a result,
the Company recorded notes receivable in the amount of $3,518,708 as of
September 30, 1997. (See Note 4 to the Consolidated Financial
Statements.) Of the outstanding notes payable balance, $393,835 is due
before December 31, 1997. The Company expects to make these note
payments with cash from operations. However, the amount to be paid in
1997 may be less than the $393,835 reflected in the notes payable
balance. Included in this amount is a disputed obligation of $380,000
to an unaffiliated finance company in connection with a financing
transaction which occurred prior to the Company's acquisition of the
insurance group. Further, if any portion of the approximately $380,000
is ultimately deemed owing, the Company believes that it has the right
to offset $240,000 which is on deposit with a subsidiary of the
unaffiliated finance company.
A substantial portion of the Company's liquid assets are held by
Hallmark and are not available for general corporate purposes. Of the
Company's consolidated liquid assets at September 30, 1997, $1,847,826
represents non-restricted cash (compared to $991,095 at December 31,
1996 and $1,486,016 at September 30, 1996). Since state insurance
regulations restrict financial transactions between an insurance company
and its affiliates, the Company is limited in its ability to use
Hallmark funds for its own working capital purposes. Furthermore,
<PAGE>
dividends and loans by Hallmark to the Company are restricted and
subject to Texas Department of Insurance ("TDI") approval. However, TDI
has sanctioned the payment of management fees, commissions and claims
handling fees by Hallmark to the Company and affiliates. During the
first nine months of 1997, Hallmark paid or accrued $770,000 in
management fees as compared to $675,000 for the first nine months of
1996. For the year ended December 31, 1996, Hallmark paid or accrued
$1,050,000 in management fees. It is anticipated that paid or accrued
management fees for 1997 should be less than the amounts authorized by
TDI. Management fees from Hallmark should continue to be a moderate
source of unrestricted liquidity. However, management intends to
continue to restrict payment of management fees, as necessary, to ensure
the surplus strength of Hallmark.
Commissions from the Company's annual policy program for independent
agents represent a source of unrestricted liquidity. Under this
program, AHGA offers independent agents the ability to write annual
policies, but commissions to substantially all independent agents are
paid monthly on an "earned" basis. However, consistent with customary
industry practice, Hallmark is paying total commissions up-front to AHGA
based on the entire annual premiums written. Independent agent
production of annual policies was approximately $11.4 million for the
nine months ended September 30, 1997. During the first nine months of
1997, AHGA received $2.3 million in commissions related to this program
from Hallmark, and will pay earned commissions of $1.7 million to
independent agents. During the twelve months of 1996, AHGA received
approximately $2.7 million in commissions related to this annual policy
program from Hallmark, of which approximately $1.6 million was paid to
independent agents in 1996 and approximately $1.1 million is being paid
to independent agents during 1997 as earned.
Ceding commission income represents a significant source of funds to
the Company. In accordance with GAAP, a portion of ceding commission
income and policy acquisition costs is deferred and recognized as income
and expense, respectively, as related net annual premiums are earned.
Deferred ceding commission income increased slightly to $2,574,737 at
September 30, 1997 from $2,368,264 at December 31, 1996. This slight
increase is principally attributable to an improved loss ratio during
1997 which resulted in the Company recognizing a slightly higher ceding
commission percentage during 1997 than during the last half of 1996.
Deferred policy acquisition costs of $3,247,589 as of September 30, 1997
were $711,025 greater than at December 31, 1996 primarily as a result of
the change in reinsurance terms with regard to front fees and premium
taxes.
At September 30, 1997, Hallmark reported statutory capital and surplus
of $5,685,979, which shows an increase of $507,985 over the $5,177,994
reported at December 31, 1996. On an annualized-premium basis,
Hallmark's premium-to-surplus ratio at September 30, 1997 was 2.19 to 1
as compared to 2.21 to 1 at December 31, 1996, and 2.29 to 1 at
September 30, 1996. Management does not presently expect Hallmark to
require additional capital during 1997. Management anticipates that
Hallmark is positioned to maintain and strengthen statutory surplus
through increased earnings from insurance operations. For the nine
months ended September 30, 1997, the statutory loss ratio was
approximately 63.4% compared to 64.1% and 81.8% for the twelve months
ended December 31, 1996 and 1995, respectively. See Results of
Operations for discussion of loss ratio improvement.
<PAGE>
As previously mentioned, effective July 1, 1996, Hallmark entered into
new reinsurance treaties with Kemper, Dorinco, and Odyssey. Certain
provisions of the reinsurance treaty could impact the Company's
liquidity. Under the agreement between Hallmark and the reinsurers,
Hallmark retains 62.5% and cedes only 37.5% of the policy fees (rather
than ceding 75% of the policy fees as under the Vesta treaty), pays
premium taxes and front fees on 100% of the business produced (rather
than premium taxes and front fees on only its retained business under
the Vesta treaty), and receives a 30% provisional commission on the
portion of the business ceded (rather than a guaranteed 30% ceding
commission under the Vesta treaty). Policy fees are up-front, fully
earned fees that the Company is permitted by law to charge in addition
to premiums to cover or defray certain costs associated with producing
policies. Terms of the July 1, 1996 agreement include that the
provisional commission paid under the new treaty will be adjusted
annually over a three-year rating period on a sliding scale based on
annual loss ratios. Based upon its loss experience, Hallmark can earn a
maximum commission of 33.5% and is guaranteed a minimum commission of
26% regardless of loss experience. Under the July 1, 1997 renewal, the
first of the three-year annual adjustment periods as defined under the
original agreement has been extended to two years (with the exception of
the percentage insured by Odyssey).
Pursuant to the loan agreement dated March 11, 1997 between the
Company and Dorinco effective January 1, 1997, the commission structure
of Dorinco s pro-rata share of the July 1, 1996 reinsurance treaty was
amended to include terms that allow Hallmark to earn an additional 1%
commission at a higher loss ratio than under the previous structure and
also increase the maximum ceding commission that Hallmark may earn by 1%
up to 34.5%, but reduce the minimum ceding commission from 26% to 23%.
In addition, the Dorinco Loan Agreement requires that effective July 1,
1997, Hallmark increase future volume of business ceded to Dorinco under
the July 1, 1996 reinsurance treaty and satisfy certain annual volume
levels ceded over the seven year term of the loan agreement. Based on
current loss experience, the Company is currently recognizing ceding
commission percentages of 29% on business ceded to Dorinco and 28% on
the cessions to Kemper.
Effective June 30, 1997, Odyssey's participation in the treaty was
terminated on a run-off basis. As such, the ceding commission
adjustment related to Odyssey s one year participation was settled on
August 29, 1997. Based on the calculation as of June 30, 1997, the
Company earned a 29% ceding commission based on a 66% loss ratio for
the period of July 1, 1996 through June 30, 1997. The Company retains
100% of all policy fees related to a new six-month program which began
in late-July 1997. While this increased retention of policy fees did
not have a significant impact during the third quarter of 1997, it is
expected to positively impact the remainder of 1997 as well as the
future as the volume related to this six-month program increases.
Unpaid losses and loss adjustment expenses ("LAE") decreased
approximately 17% primarily due to the combined effect of a continued
decrease in average claim payments during the first nine months of 1997
as compared to the first nine months of 1996 as well as a decrease in
the number of days to process and pay new and pending claims.
Accordingly, reinsurance recoverable decreased proportionately.
<PAGE>
During 1997, management expects that the Company's liquidity will
continue to be favorably impacted by a continued focus on the
performance of the Company's core State & County business with emphasis
on claims operations. During late 1995 and early 1996, the Company
increased its claims staff and hired additional experienced claims
adjusters and supervisory personnel that, in turn, have contributed to
lower loss and LAE payments and favorably impacted the Company's
profitability. However, changing market conditions in the non-standard
industry have adversely impacted premium volumes during the second and
third quarters of 1997. Although management has taken steps to stimulate
premium volumes, any decrease in premium volume could negatively impact
liquidity. Among other things, the Company has expanded its contingent
commission program to certain independent agents, has rolled out a new
six-month program in late-July 1997, continues to appoint and retain
quality independent agents and has implemented a reduction in physical
damage rates effective early-September 1997. Additionally, revised
reinsurance terms related to the Dorinco financing, as well as reduced
borrowing costs for the Company's premium finance program from both the
Dorinco financing and Bank Credit Line, should positively impact
liquidity and earnings beginning late-1997. As discussed in Note 3 to
the Consolidated Financial Statements, the Company has $8,000,000
available under the Bank Credit Line to fund premium finance notes.
Management also anticipates that an integrated cash management system
implemented in late-1995 will continue to positively impact 1997
liquidity.
The Company continues to pursue third party claims handling and
administrative contracts. Effective January 1, 1997, the Company entered
into a new agreement with an unaffiliated managing general agency (the
unaffiliated MGA ). Under this three-year contract, the Company, as
program administrator, performs certain administrative functions,
including but not limited to, cash management, underwriting and rate-
setting reviews, and claims handling. In addition, Hallmark assumed a
10% pro-rata share of the business produced under the unaffiliated MGA's
program. Effective July 1, 1997, Hallmark increased its pro-rata share
of business assumed under this contract to 20%. Also, effective July 1,
1997, the remaining 80% share of this business is being reinsured by
Hallmark's principal reinsurers, Dorinco and Kemper. The related
premium volume will be considered as part of Hallmark's premium volume
commitments to its principal reinsurers. It is anticipated that fees
under this contract could positively impact liquidity increasingly
throughout the year.
Beginning late-April 1996, the Company began marketing E&S insurance
through HUI. This business is produced by the Hallmark Agencies and
certain independent agents, and some portion of the premiums are
financed by HFC. No entity within the Company bears any underwriting
risk. The E&S policies are written on behalf of A.M. Best A-rated
unaffiliated insurance companies. HFC offers premium financing for E&S
business produced by HUI, and is currently financing E&S premium notes
with internally generated funds. As anticipated, the growth of this
business has been gradual due, in part, to increased competition from
the standard insurance market. Management remains committed to the
development of its E&S program, and HUI is increasing its appointments
of qualified independent agents. In addition, HUI entered into a
relationship with a London broker in 1997 and has begun producing
business on behalf of two London-based carriers. HCS will perform
<PAGE>
claims handling functions on a fee basis. Nonetheless, it is not
anticipated that the E&S program will significantly impact liquidity
during 1997.
Subsequent to September 30, 1997, HFC advanced to HFS $1,248,758 for
deposit into the registry of the court in order to stay execution
pending apeal of an unfavorable judgment in certain litigation. (See
Note 8 to the Consolidated Financial Statements and Legal Proceedings.)
Since such funds could be deemed proceeds of the Dorinco loan, the
Company secured the consent of its lenders prior to such deposit. The
deposit of such funds into the registry of the court is not expected to
materially impact liquidity during 1997.
Management intends to continue to investigate opportunities for future
growth and expansion. However, the Company currently has no growth
plans which would require significant external funding during 1997.
Results of Operations
Gross premiums written (prior to reinsurance) for the three and nine
months ended September 30, 1997 decreased 10% and 8%, respectively, in
relation to gross premiums written during the same period in 1996. The
respective decreases in gross premiums written were primarily due to
changing market conditions in the non-standard industry which have
adversely impacted premium volumes during the second and third quarters
of 1997. Net written premiums (after reinsurance) for the three months
ended September 30, 1997, remained relatively constant as the same
period in 1996, while net written premiums (after reinsurance) for the
nine months ended September 30, 1997, increased approximately 7% over
the same period in 1996. The increase in net written premiums for the
nine months ended September 30, 1997, in relation to the same period of
1996, is due to (1) higher gross premiums written during the first
quarter of 1997 as compared to the first quarter of 1996, (2) higher
retention of policy fees to 62.5% during the first six months of 1997 as
compared to 25% during the same period of 1996 and (3) assumption of
business written by the unaffiliated MGA effective January 1, 1997.
Premiums earned (prior to reinsurance) for the three and nine months
ended September 30, 1997, respectively, were $2,071,685 and $6,382,134
lower than for the comparable periods in 1996 representing respective
decreases of 17% and 18%. For the three and nine months ended September
30, 1997, respectively, net premiums earned (after reinsurance) were
$441,848 and $558,854 lower than for the comparable periods in 1996
representing respective decreases of 13% and 6%, respectively. During
the first nine months of 1996, premiums earned (prior to reinsurance)
were high due to the 1996 earning of premium written during high-volume
months of late 1995 as well as the increase in monthly policy production
during 1996 from 39% in 1995 to 52% in 1996. Hallmark did not
experience any unusually high-volume months during 1996 and
additionally, annual/six-month policy production has been on the rise
during the first nine months of 1997 (52% for 1997 as compared to 48%
for the same period of 1996). The disproportionate decrease between
premiums earned (prior to and after reinsurance) resulted from the
change discussed in the paragraph above.
The net incurred loss ratio (computed on net premiums earned after
reinsurance) for the three and nine months ended September 30, 1997 was
<PAGE>
approximately 59% as compared to approximately 61% and 64%,
respectively, for the same 1996 periods. The decrease in the loss
ratios between 1997 and 1996 was primarily attributable to the increase
in retention of policy fees and a continued emphasis on effective claims
handling procedures, adequate rates, and responsive rate-setting
procedures. Reinsurance recoveries decreased accordingly.
Net acquisition costs represents the amortization of acquisition costs
(and credits) deferred over the past twelve months and the deferral of
acquisition costs (and credits) incurred in the current period. While
the credit balance of net acquisition costs has decreased during the
three months ended September 30, 1997, the credit balance of net
acquisition costs has increased during the nine months ended September
30, 1997. The principal reason for this phenomenon is that the third
quarters of both 1997 and 1996 are governed by comparable treaty terms
effective July 1, 1996. Conversely, the comparability of the nine month
periods ended September 30, 1997 and 1996 is significantly affected by
different treaty terms in effect during the first six months of the
respective years. The decrease in the credit balance of net acquisition
costs for the three month period is due to decreased deferral of premium
taxes and front fees due to lower premium volumes as well as an increase
in ceding commission income due to an improved loss ratio over the same
three month period of 1996. The increase in the credit balance of net
acquisition costs, for the nine months of 1997 is primarily due to
deferral of increased premium taxes and reduced ceding commission income
(due to different treaty terms) during 1997 as compared to the same
period in 1996.
Other acquisition and underwriting expenses decreased $293,411 for the
three months ended September 30, 1997, while other acquisition and
underwriting expenses increased $625,895 for the nine months ended
September 30, 1997 as compared to the same respective periods of 1996.
In light of consistent treaty terms as previously discussed, the
decrease for the three months is primarily attributable to the decrease
in premium taxes and front fees which is directly related to decreased
premium volume during the third quarter of 1997 as compared to the same
period of 1996. The increase in other acquisition and underwriting
expenses for the nine months ended September 30, 1997 is primarily due
to an increase in the Company s share of premium taxes and front fees,
and a decrease in ceding commission income (especially in the second
quarter) due to the combined effect of lower premium volumes during the
second and third quarters of 1997 and the change in treaty terms
effective July 1, 1996. These adverse fluctuations for the nine months
ended September 30, 1997 are partially offset by decreases in bad debt
expense, commissions paid, salaries, contract labor and related costs,
as well as other underwriting expense categories.
Operating expenses decreased during the three and nine months ended
September 30, 1997 as compared to the same respective periods in 1996
primarily due to decreases in salary and related expenses, particularly
in the second and third quarters. These decreases are primarily due to
staff attrition as well as decreased management expenditure of time on
non-insurance operations.
Interest expense for the three and nine months ended September 30,
1997 increased in relation to the same periods in 1996 as a result of
the Dorinco loan which closed early-March to fund premium finance
operations. Previous premium financing was through an unaffiliated
<PAGE>
premium finance company and thus interest expense was not reflected on
the Company s financial statements. (See Note 3 to the Consolidated
Financial Statements.)
Investment income decreased approximately 27% and 16% for the three
and nine months ended September 30, 1997 in relation to the comparable
periods of 1996 primarily as a result of a decrease in funds available
for investment (due to decreased premium volumes) and the maturity of
some higher-yielding long-term investments. Long-term invested funds
have decreased principally due to recent maturities and to changing
market conditions whereby long-term rates were less favorable for 1997
as compared to 1996.
Finance interest charges represent interest earned on premium notes
issued by HFC. During 1996, HFC only directly financed premium notes
for HUI. Beginning late June 1997, HFC began financing premiums for
Hallmark which has resulted in increased finance interest income during
1997.
Interest income on note receivable represents income received from an
unaffiliated premium finance company in connection with the Company's
use of proceeds from the Dorinco loan to lend funds to the unaffiliated
premium finance company to extinguish its premium finance bank debt.
Interest expense on the Dorinco loan accounts for the significant
increase in interest expense for the three and nine months ended
September 30, 1997.
Processing fees decreased approximately 85% and 48% for the three and
nine months ended September 30, 1997 over the same respective periods of
1996. These fees represent income earned by HFC pursuant to its
financing and servicing arrangement with an unaffiliated premium finance
company. This arrangement was terminated in June 1997 as HFC began
issuing its own premium finance notes. As expected, these fees have
significantly decreased during the third quarter of 1997 as the premium
finance notes of the unaffiliated premium finance company continue to
run-off. The decrease in processing fees for the nine months ended
September 30, 1997 was also affected by lower annual premium volumes
(and hence, fewer premium notes) in 1997 than in 1996. This was
particularly significant during the first half of the year due to the
large volume of notes generated in connection with unusually high
premium volumes during the third quarter of 1995 (that, in turn,
generated notes that were still outstanding as of June 30, 1996).
Service and consulting fees for the three and nine months ended
September 30, 1997, increased by $145,106 and $287,073, respectively, in
relation to the comparable periods of 1996. These increases are
primarily due to fees earned in connection with the Company's contract
to act as program administrator for the unaffiliated MGA.
Other income for the three and nine months ended September 30, 1997,
increased by $120,450 and $280,187, respectively, as compared to the
same periods of 1996 principally as a result of additional outside
commissions earned by the Hallmark Agencies and HUI, the Company's
excess and surplus lines agency.
<PAGE>
Risks Associated with Forward-Looking Statements Included in this Form
10-QSB
This Form 10-QSB contains certain forward-looking statements within
the meaning of Section 27A of the Securities Act of 1933 and Section 21E
of the Securities Exchange Act of 1934, which are intended to be covered
by the safe harbors created thereby. These statements include the plans
and objectives of management for future operations, including plans and
objectives relating to future growth of the Company's business
activities and availability of funds. The forward-looking statements
included herein are based on current expectations that involve numerous
risks and uncertainties. Assumptions relating to the foregoing involve
judgments with respect to, among other things, future economic,
competitive and market conditions, regulatory framework, and future
business decisions, all of which are difficult or impossible to predict
accurately and many of which are beyond the control of the Company.
Although the Company believes that the assumptions underlying the
forward-looking statements are reasonable, any of the assumptions could
be inaccurate and, therefore, there can be no assurance that the
forward-looking statements included in this Form 10-QSB will prove to be
accurate. In light of the significant uncertainties inherent in the
forward-looking statements included herein, the inclusion of such
information should not be regarded as a representation by the Company or
any other person that the objectives and plans of the Company will be
achieved.
PART II
OTHER INFORMATION
Item 1. Legal Proceedings.
In March 1997, a jury returned a verdict against the Company and in
favor of a former director and officer of Hallmark in the amount of
approximately $517,000 on the basis of contractual and statutory
indemnification claims. The court subsequently granted the plaintiff's
motion for attorneys' fees of approximately $271,000, court costs of
approximately $39,000 and pre-judgment and post-judgment interest, and
rendered final judgment on the verdict. The Company believes the
judgment in this case was both legally and factually incorrect and filed
a motion for new trial. The motion for a new trial was overruled by
operation of law, and subsequently the Company filed a notice of appeal.
The Company is presently unable to determine the likelihood of an
unfavorable outcome to such motion or appeal.
On October 3, 1997, in order to stay execution of the above judgment
during the Company s appeal of the unfavorable verdict, the Company
deposited $1,248,758 into the registry of the court. This deposit
includes the amount of the compensatory judgement and attorneys fees,
prejudgment interest, post-judgement interest, and other related court
costs in accordance with procedures required for appeal.
Except for routine litigation incidental to the business of the
Company, neither the Company, nor any of the properties of the Company
was subject to any other material pending or threatened legal
proceedings as of the date of this report.
<PAGE>
Item 2. Changes in Securities.
None.
Item 3. Defaults upon Security Securities.
None.
Item 4. Submission of Matters to a Vote of Security-Holders.
None.
Item 5. Other Information.
None.
Item 6. Exhibits and Reports on Form 8-K.
(a) The exhibits listed in the Exhibit Index which appears on
sequential page 19 are filed herewith.
(b) The Company did not file a Current Report on Form 8-K to
report any events which occurred during the quarter ended
September 30, 1997.
<PAGE>
Exhibit Description Sequential Page No.
10(a) Form of First Amendment to Loan ____
Agreement between Hallmark Finance
Corporation and NationsBank of
Texas, N.A., dated July 31, 1997.
10(b) Form of Second Amendment to Loan ____
Agreement between Hallmark Finance
Corporation and NationsBank of
Texas, N.A., dated October 1, 1997.
<PAGE>
SIGNATURES
In accordance with the requirements of the Exchange Act, the
registrant has caused this report to be signed on its behalf by the
undersigned, thereunto duly authorized.
HALLMARK FINANCIAL SERVICES, INC.
(Registrant)
Date: November 13, 1997 /s/ Ramon D. Phillips
Ramon D. Phillips, President
(Chief Executive Officer)
Date: November 13, 1997 /s/ John J. DePuma
John J. DePuma,
Chief Financial Officer
<TABLE> <S> <C>
<ARTICLE> 7
<LEGEND>
Due to format constraints of this Financial Data Schedule (FDS) certain
Balance Sheet items were omitted: i.e. Prepaid reinsurance premiums,
Premium notes receivable, Installment premiums receivable, Excess of cost
over net assets acquired and Other assets. Refer to actual 10KSB submis-
sion.
</LEGEND>
<S> <C>
<PERIOD-TYPE> 9-MOS
<FISCAL-YEAR-END> DEC-31-1997
<PERIOD-END> SEP-30-1997
<DEBT-HELD-FOR-SALE> 0
<DEBT-CARRYING-VALUE> 4,843,973
<DEBT-MARKET-VALUE> 8,335,841
<EQUITIES> 151,484
<MORTGAGE> 0
<REAL-ESTATE> 0
<TOTAL-INVEST> 8,487,325
<CASH> 6,077,626
<RECOVER-REINSURE> 16,129,766
<DEFERRED-ACQUISITION> 672,852
<TOTAL-ASSETS> 58,743,929
<POLICY-LOSSES> 0
<UNEARNED-PREMIUMS> 11,542,683
<POLICY-OTHER> 3,104,834
<POLICY-HOLDER-FUNDS> 4,647,386
<NOTES-PAYABLE> 7,551,320
0
0
<COMMON> 328,868
<OTHER-SE> 11,807,062
<TOTAL-LIABILITY-AND-EQUITY> 58,743,929
9,022,145
<INVESTMENT-INCOME> 563,882
<INVESTMENT-GAINS> 0
<OTHER-INCOME> 2,088,021
<BENEFITS> 5,290,112
<UNDERWRITING-AMORTIZATION> (504,552)
<UNDERWRITING-OTHER> 5,804,779
<INCOME-PRETAX> 1,083,709
<INCOME-TAX> 369,143
<INCOME-CONTINUING> 714,566
<DISCONTINUED> 0
<EXTRAORDINARY> 0
<CHANGES> 0
<NET-INCOME> 714,566
<EPS-PRIMARY> 0.06
<EPS-DILUTED> 0.06
<RESERVE-OPEN> 20,697,393
<PROVISION-CURRENT> 18,489,021
<PROVISION-PRIOR> 1,500,158
<PAYMENTS-CURRENT> (9,438,518)
<PAYMENTS-PRIOR> (14,061,015)
<RESERVE-CLOSE> 17,187,039
<CUMULATIVE-DEFICIENCY> 0
</TABLE>
FIRST AMENDMENT TO LOAN AGREEMENT AND GUARANTOR CONSENT
THIS FIRST AMENDMENT TO LOAN AGREEMENT AND GUARANTOR CONSENT (the
First Amendment ) is made as of July ___, 1997, among HALLMARK FINANCE
CORPORATION, referred to herein as the "Borrower," HALLMARK FINANCIAL
SERVICES, INC., HALLMARK CLAIMS SERVICE, INC., AMERICAN HALLMARK GENERAL
AGENCY, INC., ACO HOLDINGS, INC., and AMERICAN HALLMARK AGENCIES, INC.
(collectively, the Guarantors ), and NATIONSBANK OF TEXAS, N.A., a
national banking association, referred to herein as the "Lender."
R E C I T A L S:
A. The Borrower and the Lender are parties to a Loan Agreement
dated as of March 17, 1997 (the "Original Loan Agreement").
B. The Guarantors executed Guaranty Agreements in favor of the
Lender pursuant to the Original Loan Agreement.
C. The parties desire to amend the Original Loan Agreement as
hereinafter provided, and the Guarantors desire to consent to such
amendment.
NOW, THEREFORE, in consideration of the premises and for other good
and valuable consideration, the receipt and sufficiency of which are
hereby acknowledged, the parties hereto agree as follows:
1. Same Terms. All terms used herein which are defined in the
Original Loan Agreement have the same meanings when used herein unless
the context hereof otherwise requires or provides. In addition, all
references in the Loan Documents to the "Agreement" mean the Original
Loan Agreement, as amended by this First Amendment, as the same are
hereafter amended from time to time.
2. Amendment to Original Loan Agreement. Effective as of the
date above, the Original Loan Agreement is hereby amended as follows:
(a) Section 1.0 is amended to add the following:
CGA Agreement means an agreement arising out of a transaction
where Crown Managing General Insurance Agency, Inc. is the managing
agent and by which an insured or prospective insured promises to pay the
Borrower the amount advanced to AH with respect to liability policies on
behalf of State and County Mutual Fire Insurance Company or with respect
to physical damage policies on behalf of Adriatic Insurance Company,
Bismark, North Dakota, so long as Adriatic Insurance Company maintains
an A.M. Best rating of A or higher.
(b) Section 1.0 is amended to delete the definition of Eligible
Premium Finance Agreements contained therein and substituting in lieu
thereof the following:
"Eligible Premium Finance Agreements" means all amounts (subject to
the proviso hereafter) due from makers pursuant to Premium Finance
Agreements and CGA Agreements, all prepared on forms approved by the
Texas Department of Insurance which comply with all requirements of the
Texas Insurance Code and the Texas Department of Insurance Regulations
and which have been created in the ordinary course of Borrower's
<PAGE>
business and upon which Borrower's right to receive payment is absolute,
unconditional and not contingent upon the fulfillment of any condition
whatsoever, and shall not include any of the following:
(a) any Premium Finance Agreement or CGA Agreement, the payment of
which an insurer or reinsurer has disputed or denied;
(b) any Premium Finance Agreement or CGA Agreement, the payment of
which an insurer or reinsurer has a right of setoff, defense or discount;
(c) any Premium Finance Agreement or CGA Agreement which reflects
a transaction having less than ten percent (10%) equity in the premium
(i.e., representing the financing of more than 90% of the insurance
premium of the particular insurance product);
(d) any Premium Finance Agreement or CGA Agreement in default
which has a balance due from its maker after realization against all
collateral securing such Premium Finance Agreement;
(e) any Premium Finance Agreement or CGA Agreement arising out of
the funding of an insurance premium for an insurance product issued by,
pursuant to, or in the Texas Automobile Insurance Plan;
(f) any Premium Finance Agreement or CGA Agreement arising out of
the funding of an insurance premium for any insurance product originated
by an agent doing business outside of the State of Texas or which is an
insurance product otherwise governed by or subject to the laws of a
state other than the State of Texas;
(g) any Premium Finance Agreement other than an CGA Agreement
arising out of a transaction where the insurance product is issued or
written by an entity other than AH on behalf of State and County Mutual
Fire Insurance Company;
(h) any Premium Finance Agreement or CGA Agreement which does not
have 75% or more of the premium balance reinsured by a third party
insurance company with an A.M. Best rating of A- or higher; or
(i) any Premium Finance Agreement other than an CGA Agreement
arising out of a transaction where the managing agent therefor is an
entity other than AHGA provided that not more than $150,000 of amounts
due under CGA Agreements shall be included in determining the amount of
Eligible Premium Finance Agreements.
(c) Exhibit B is amended by deleting the form attached to the
Original Loan Agreement and substituting in lieu thereof the form
attached hereto as Appendix A.
3. Certain Representations.
(a) The Borrower represents and warrants that, as of the date
hereof: (i) the Borrower has full power and authority to execute this
First Amendment, and this First Amendment constitutes the legal, valid
and binding obligation of the Borrower enforceable in accordance with
its terms, except as enforceability may be limited by applicable
bankruptcy, insolvency, reorganization, moratorium, and other similar
laws affecting the enforcement of creditors' rights generally; and (ii)
no authorization, approval, consent or other action by, notice to, or
<PAGE>
filing with, any governmental authority or other person is required for
the execution, delivery and performance by the Borrower of this First
Amendment.
(b) Each Guarantor represents and warrants that, as of the date
hereof: (i) such Guarantor has full power and authority to execute this
First Amendment, and this First Amendment constitutes the legal, valid
and binding obligation of such Guarantor enforceable in accordance with
its terms, except as enforceability may be limited by applicable
bankruptcy, insolvency, reorganization, moratorium, and other similar
laws affecting the enforcement of creditors' rights generally; and (ii)
no authorization, approval, consent or other action by, notice to, or
filing with, any governmental authority or other person is required for
the execution, delivery and performance by such Guarantor of this First
Amendment.
4. Concerning the Guaranty Agreements. By its execution below,
each Guarantor reaffirms the obligations under each Guaranty Agreement
executed and delivered by it in connection with the Loan Documents and
acknowledges that the execution and delivery of this First Amendment
shall not reduce or modify in any respect such Guarantor s liability
under such Guaranty Agreement.
5. Limitation on Agreements. The modifications set forth herein
are limited precisely as written and shall not be deemed (a) to be a
consent under or a waiver of or an amendment to any other term or
condition in the Original Loan Agreement or any of the Loan Documents,
or (b) to prejudice any right or rights which the Lender now has or may
have in the future under or in connection with the Original Loan
Agreement and the Loan Documents, each as amended hereby, or any of the
other documents referred to herein or therein. This First Amendment
constitutes a Loan Document for all purposes.
6. Entirety, Etc. This instrument together with all of the other
Loan Documents embodies the entire agreement between the parties. THIS
AGREEMENT AND ALL OF THE OTHER LOAN DOCUMENTS REPRESENT THE FINAL
AGREEMENT BETWEEN THE PARTIES AND MAY NOT BE CONTRADICTED BY EVIDENCE OF
PRIOR, CONTEMPORANEOUS OR SUBSEQUENT ORAL AGREEMENTS OF THE PARTIES.
THERE ARE NO UNWRITTEN ORAL AGREEMENTS BETWEEN THE PARTIES.
IN WITNESS WHEREOF, the parties hereto have executed this First
Amendment to Loan Agreement to be effective as of the date and year
first above written.
BORROWER:
Address: HALLMARK FINANCE CORPORATION
__________________________
__________________________
__________________________ By:
Name:
Title:
<PAGE>
GUARANTORS:
Address: HALLMARK FINANCIAL SERVICES,
INC.
__________________________
__________________________
__________________________
By:
Name:
Title:
Address: HALLMARK CLAIMS SERVICE, INC.
__________________________
__________________________
__________________________ By:
Name:
Title:
Address: AMERICAN HALLMARK GENERAL
AGENCY, INC.
__________________________
__________________________
__________________________
By:
Name:
Title:
Address: ACO HOLDINGS, INC.
__________________________
__________________________
__________________________ By:
Name:
Title:
Address: AMERICAN HALLMARK AGENCIES,
INC.
__________________________
__________________________
__________________________
By:
Name:
Title:
<PAGE>
LENDER:
Address: NATIONSBANK OF TEXAS, N.A.
__________________________
__________________________
__________________________ By:
Name:
Title:
EXHIBIT B
BORROWING BASE CERTIFICATE
Status as of , 199__
In accordance with the terms of the Loan Agreement dated March 17,
1997, by and between HALLMARK FINANCE CORPORATION, and NATIONSBANK OF
TEXAS, N.A., we hereby represent and warrant as follows:
Prior Period Balance of Eligible
Premium Finance Agreements $
PLUS: ELIGIBLE PREMIUM FINANCE AGREEMENTS
ISSUED DURING THE PERIOD ENDING
___________, 19__ $
PLUS/LESS THE FOLLOWING ADJUSTMENTS WITH
RESPECT TO ELIGIBLE PREMIUM FINANCE AGREEMENTS:
(+/-) Eligible Premium Finance Agreement Amendments $
(+/-) Miscellaneous Eligible Premium Finance Agreement
Corrections $
(+/-) Cash Receipts $
(+/-) Cancellations $
(+/-) Earned Late Charges $
(+/-) Earned Setup Fees $
(+/-) Returned Checks (Uncollected) $
(+/-) Returned Check Charges $
(+/-) Interest and Write-offs $
(-) Change in Unearned Interest $
(+) Return Premiums in Course of Collections $
(-) Amount of Eligible Premium Finance Agreements
Constituting CGA Agreements in Excess of
$150,000 $
<PAGE>
Total Adjusted Eligible Premium Finance Agreements $
LESS THE FOLLOWING NON-ELIGIBLE PREMIUM
FINANCE AGREEMENTS AND CGA AGREEMENTS:
Premium Finance Agreements and CGA Agreements disputed
or denied by insurer or reinsurer $
Premium Finance Agreements and CGA Agreements subject to
a right of insurer or reinsurer to setoff, defense or
discount $
Premium Finance Agreements and CGA Agreements with less
than 10% equity in the premium $
Premium Finance Agreements and CGA Agreements in default
which have balances due from makers after realization of
all collateral $
Premium Finance Agreements and CGA Agreements resulting
from TAIP $
Premium Finance Agreements and CGA Agreements funding
policies outside Texas $
Premium Finance Agreements other than CGA Agreements where
AH is not the issuer on behalf of State and County Mutual $
Premium Finance Agreements and CGA Agreements which do not
have 75% or more premium balances reinsured with third
party reinsurer with A. M. Best Rating of A- or higher $
Premium Finance Agreements other than CGA Agreements where
AHGA is not the Managing Agent $
Return premiums in course of collection greater than
five (5) days past due from the original due date as
required by applicable Governmental Authorities $
Total Adjusted Eligible Premium Finance Agreements $
LESS:
Bank Reserve $
CALCULATION OF BORROWING BASE:
[(Total Adjusted Eligible Premium Finance Agreements - Bank
Reserve) x 60%] = Maximum amount of borrowings
(not to exceed $8,000,000) $
LESS: Outstandings $
Available Amount/Overadvance Due Bank
(Amount of Borrowing Base - Outstandings) $
<PAGE>
BORROWER:
HALLMARK FINANCE CORPORATION
By:
Name:
Title:
SECOND AMENDMENT TO LOAN AGREEMENT
AND GUARANTOR CONSENT
THIS SECOND AMENDMENT TO LOAN AGREEMENT AND GUARANTOR CONSENT (the
"Second Amendment") is made as of October 1, 1997, among HALLMARK
FINANCE CORPORATION, referred to herein as the "Borrower," HALLMARK
FINANCIAL SERVICES, INC., HALLMARK CLAIMS SERVICE, INC., AMERICAN
HALLMARK GENERAL AGENCY, INC., ACO HOLDINGS, INC., and AMERICAN HALLMARK
AGENCIES, INC. (collectively, the "Guarantors"), and NATIONSBANK OF
TEXAS, N.A., a national banking association, referred to herein as the
"Lender."
R E C I T A L S:
A. The Borrower and the Lender are parties to a Loan Agreement
dated as of March 17, 1997 (the "Original Loan Agreement").
B. The Guarantors executed Guaranty Agreements in favor of the
Lender pursuant to
the Original Loan Agreement.
C. The Original Loan Agreement has been amended pursuant to that
certain First Amendment to Loan Agreement and Guarantor Consent (the
"First Amendment") dated as of July 31, 1997, among the Borrower, the
Guarantors, and the Lender (the Original Loan Agreement, as amended by
the First Amendment, is hereinafter called the "Loan Agreement").
D. The Borrower has advanced the sum of $1,248,757.77 (the
"Advance") to Hallmark Financial Services, Inc. ("HFS"), the result of
which has affected various provisions of the Loan Agreement.
Accordingly, the Borrower has requested certain amendments to the Loan
Agreement in order to assure that the Advance to HFS is not in violation
of the Loan Agreement. The Borrower has also requested that the Lender
waive any defaults under the Loan Agreement as a result of the Advance,
and the Lender is willing to do so subject to the terms and provisions
contained herein.
E. The parties desire to amend the Loan Agreement as hereinafter
provided, and the Guarantors desire to consent to such amendment.
NOW, THEREFORE, in consideration of the premises and for other good
and valuable consideration, the receipt and sufficiency of which are
hereby acknowledged, the parties hereto agree as follows:
1. Same Terms. All terms used herein which are defined in the
Loan Agreement have the same meanings when used herein unless the
context hereof otherwise requires or provides. In addition, all
references in the Loan Documents to the "Agreement" mean the Original
Loan Agreement, as amended by the First Amendment and as amended by this
Second Amendment, as the same are hereafter amended from time to time.
2. Amendments to Loan Agreement. Effective as of the date
above, the Loan Agreement is hereby amended as follows:
(a) Section 6.3 of the Loan Agreement is amended by substituting
the following paragraph in place of paragraph 6.3 in the Loan Agreement:
<PAGE>
"6.3 Minimum Tangible Net Worth. Permit the Tangible Net Worth of
Borrower at any time during 1997 to be less than $6,650,000 or at
any time during 1998 to be less than $6,950,000."
(b) Section 7.2 of the Loan Agreement is hereby amended by
substituting the following paragraph in place of paragraph 7.2 in the
Loan Agreement:
"7.2 Minimum Tangible Net Worth. Neither HFS nor ACO will permit
at any time Borrower's Tangible Net Worth as of the day of any
reporting period required by law or required by the Texas
Department of Insurance during the following calendar years to be
less than the following amounts:
1997 $6,650,000
1998 $6,950,000."
3. Waivers of Default. The Lender hereby waives the following
Events of Default (if any) as a result of the Advance:
(a) Any Event of Default under Section 6.4 pertaining to a
disposition of or transfer of any assets of the Borrower;
(b) Any Event of Default under Section 6.6 pertaining to making
any loan or advance to any person or entity except as otherwise
specified in the Loan Agreement;
(c) Any Event of Default under Section 6.10 pertaining to engaging
in any transaction with any Affiliate of Borrower or making an
assignment or other transfer of its properties or assets to any
Affiliate; and
(d) Any other Event of Default under the Loan Agreement which may
be triggered as a result of the Advance.
Such waiver of Events of Default as a result of such Advance is
limited precisely as written, is a one-time-only waiver and shall not be
deemed to be a waiver of such covenants in the Loan Agreement to any
future or other actions by the Borrower and except as otherwise provided
herein, Borrower hereby reaffirms all such covenants in the Loan
Agreement to be binding and enforceable against the Borrower as written.
4. Certain Representations.
(a) The Borrower represents and warrants that, as of the date
hereof: (i) the Borrower has full power and authority to execute this
Second Amendment, and this Second Amendment constitutes the legal, valid
and binding obligation of the Borrower enforceable in accordance with
its terms, except as enforceability may be limited by applicable
bankruptcy, insolvency, reorganization, moratorium, and other similar
laws affecting the enforcement of creditors' rights generally; and (ii)
no authorization, approval, consent or other action by, notice to, or
filing with, any governmental authority or other person is required for
the execution, delivery and performance by the Borrower of this Second
Amendment.
(b) Each Guarantor represents and warrants that, as of the date
hereof: (i) such Guarantor has full power and authority to execute this
<PAGE>
Second Amendment, and this Second Amendment constitutes the legal, valid
and binding obligation of such Guarantor enforceable in accordance with
its terms, except as enforceability may be limited by applicable
bankruptcy, insolvency, reorganization, moratorium, and other similar
laws affecting the enforcement of creditors' rights generally; and (ii)
no authorization, approval, consent or other action by, notice to, or
filing with, any governmental authority or other person is required for
the execution, delivery and performance by such Guarantor of this Second
Amendment.
5. Concerning the Guaranty Agreements. By its execution below,
each Guarantor reaffirms the obligations under each Guaranty Agreement
executed and delivered by it in connection with the Loan Documents and
acknowledges that the execution and delivery of this Second Amendment
shall not reduce or modify in any respect such Guarantor's liability
under such Guaranty Agreement.
6. Limitation on Agreements. The modifications set forth herein
are limited precisely as written and shall not be deemed (a) to be a
consent under or a waiver of or an amendment to any other term or
condition in the Loan Agreement or any of the Loan Documents, or (b) to
prejudice any right or rights which the Lender now has or may have in
the future under or in connection with the Loan Agreement and the Loan
Documents, each as amended hereby, or any of the other documents
referred to herein or therein. This Second Amendment constitutes a Loan
Document for all purposes.
7. Entirety, Etc. This instrument together with all of the other
Loan Documents embodies the entire agreement between the parties. THIS
AGREEMENT AND ALL OF THE OTHER LOAN DOCUMENTS REPRESENT THE FINAL
AGREEMENT BETWEEN THE PARTIES AND MAY NOT BE CONTRADICTED BY EVIDENCE OF
PRIOR, CONTEMPORANEOUS OR SUBSEQUENT ORAL AGREEMENTS OF THE PARTIES.
THERE ARE NO UNWRITTEN ORAL AGREEMENTS BETWEEN THE PARTIES.
IN WITNESS WHEREOF, the parties hereto have executed this Second
Amendment to Loan Agreement to be effective as of the date and year
first above written.
BORROWER:
Address: HALLMARK FINANCE CORPORATION
14651 Dallas Parkway By:
Dallas, Texas 75240 Name:
Title:
GUARANTORS:
Address: HALLMARK FINANCIAL SERVICES, INC.
14651 Dallas Parkway By:
Dallas, Texas 75240 Name:
Title:
<PAGE>
Address: HALLMARK CLAIMS SERVICE, INC.
14651 Dallas Parkway By:
Dallas, Texas 75240 Name:
Title:
Address: AMERICAN HALLMARK GENERAL AGENCY,
INC.
14651 Dallas Parkway By:
Dallas, Texas 75240 Name:
Title:
Address: ACO HOLDINGS, INC.
14651 Dallas Parkway By:
Dallas, Texas 75240 Name:
Title:
Address: AMERICAN HALLMARK AGENCIES, INC.
14651 Dallas Parkway By:
Dallas, Texas 75240 Name:
Title:<PAGE>
LENDER:
Address: NATIONSBANK OF TEXAS, N.A.
NationsBank Plaza, 7th Floor By:
901 Main Street Name: Susan M. Raher
Dallas, Texas 75202 Title: Vice President
