##### Table of Contents

---

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 September 30, 2005



OR



| ̈ | 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 0-19483



---



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





(Former name, former address and former fiscal year, if changed since last report)



---



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 is an accelerated filer (as defined in Rule 12b-2 of the Exchange Act).    Yes  x    No ̈



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 November 4, 2005, there were 17,501,740 shares of
the registrants common stock, $.10 par value, outstanding.



---



---

##### Table of Contents

SWS GROUP, INC. AND SUBSIDIARIES

INDEX



|                                                                                              |  |                                                                                                                                            |  |  
|--------------------------------------------------------------------------------------------- |  | ------------------------------------------------------------------------------------------------------------------------------------------ |  | -
|PART I. FINANCIAL INFORMATION                                                                 |  |                                                                                                                                           
|                                                                                              | 
|Item 1. Financial Statements                                                                  |  |                                                                                                                                           
|                                                                                              |  |                                                                                                                                           
|                                                                                              |  | Consolidated Statements of Financial ConditionSeptember 30, 2005 and June 24, 2005 (unaudited)                                             |  | 1
|                                                                                              |  |                                                                                                                                           
|                                                                                              |  | Consolidated Statements of Income and Comprehensive IncomeFor the three months ended September 30, 2005 and September 24, 2004 (unaudited) |  | 2
|                                                                                              |  |                                                                                                                                           
|                                                                                              |  | Consolidated Statements of Cash FlowsFor the three months ended September 30, 2005 and September 24, 2004 (unaudited)                      |  | 3
|                                                                                              |  |                                                                                                                                           
|                                                                                              |  | Notes to Consolidated Financial Statements (unaudited)                                                                                     |  | 5
|                                                                                              | 
|Item 2.
Managements Discussion and Analysis of Financial Condition and Results of Operations |  | 20                                                                                                                                        
|                                                                                              | 
|Item 3.
Quantitative and Qualitative Disclosures About Market Risk                            |  | 38                                                                                                                                        
|                                                                                              | 
|Item 4.
Controls and Procedures                                                               |  | 38                                                                                                                                        
|                                                                                              | 
|PART II.
OTHER INFORMATION                                                                    |  |                                                                                                                                           
|                                                                                              | 
|Item 1.
Legal Proceedings                                                                     |  | 38                                                                                                                                        
|                                                                                              | 
|Item 2.
Unregistered Sales of Equity Securities and Use of Proceeds                           |  | 39                                                                                                                                        
|                                                                                              | 
|Item 3.
Defaults Upon Senior Securities                                                       |  | 39                                                                                                                                        
|                                                                                              | 
|Item 4.
Submission of Matters to a Vote of Security Holders                                   |  | 39                                                                                                                                        
|                                                                                              | 
|Item 5.
Other Information                                                                     |  | 39                                                                                                                                        
|                                                                                              | 
|Item 6.
Exhibits                                                                              |  | 39                                                                                                                                        
|                                                                                              | 
|SIGNATURES                                                                                    |  | 40                                                                                                                                        
|                                                                                              | 
|EXHIBIT INDEX                                                                                 |  | 41                                                                                                                                        



---

##### Table of Contents

SWS Group, Inc. and Subsidiaries

CONSOLIDATED STATEMENTS OF FINANCIAL CONDITION

September 30, 2005 and June 24, 2005

(In thousands, except par values and share amounts)

(Unaudited)



|                                                                                                                                                                                                              |  |           |           |   |      |   |           |  
|------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------- |  | --------- | --------- | - | ---- | - | --------- | -
|                                                                                                                                                                                                              |  | September |           |   | June |  
|Assets                                                                                                                                                                                                        |  |           |           |   |      |   |           |  
|Cash                                                                                                                                                                                                          |  | $         | 27,255    |   |      | $ | 23,045    |  
|Assets segregated for regulatory purposes                                                                                                                                                                     |  |           | 320,546   |   |      |   | 330,788   |  
|Marketable equity securities available for sale                                                                                                                                                               |  |           | 2,770     |   |      |   | 2,372     |  
|Receivable from brokers, dealers and clearing organizations                                                                                                                                                   |  |           | 2,395,330 |   |      |   | 2,855,296 |  
|Receivable from clients, net                                                                                                                                                                                  |  |           | 353,944   |   |      |   | 372,143   |  
|Loans held for sale, net                                                                                                                                                                                      |  |           | 158,149   |   |      |   | 172,023   |  
|Loans, net                                                                                                                                                                                                    |  |           | 621,242   |   |      |   | 591,857   |  
|Securities owned, at market value                                                                                                                                                                             |  |           | 177,304   |   |      |   | 166,954   |  
|Securities purchased under agreements to resell                                                                                                                                                               |  |           | 41,715    |   |      |   | 28,890    |  
|Goodwill                                                                                                                                                                                                      |  |           | 11,746    |   |      |   | 11,660    |  
|Other assets                                                                                                                                                                                                  |  |           | 71,444    |   |      |   | 76,116    |  
|                                                                                                                                                                                                              |  |           |           |   |      |   |           |  
|                                                                                                                                                                                                              |  | $         | 4,181,445 |   |      | $ | 4,631,144 |  
|                                                                                                                                                                                                              |  |           |           |   |      |   |           |  
|Liabilities and Stockholders Equity                                                                                                                                                                          |  |           |           |   |      |   |           |  
|Short-term borrowings                                                                                                                                                                                         |  | $         | 82,200    |   |      | $ | 68,400    |  
|Payable to brokers, dealers and clearing organizations                                                                                                                                                        |  |           | 2,259,136 |   |      |   | 2,755,076 |  
|Payable to clients                                                                                                                                                                                            |  |           | 617,621   |   |      |   | 609,477   |  
|Deposits                                                                                                                                                                                                      |  |           | 629,966   |   |      |   | 587,978   |  
|Securities sold under agreements to repurchase                                                                                                                                                                |  |           | 20,423    |   |      |   | 8,061     |  
|Securities sold, not yet purchased, at market value                                                                                                                                                           |  |           | 108,120   |   |      |   | 106,163   |  
|Drafts payable                                                                                                                                                                                                |  |           | 32,436    |   |      |   | 32,018    |  
|Advances from Federal Home Loan Bank                                                                                                                                                                          |  |           | 82,982    |   |      |   | 93,539    |  
|Bank borrowings                                                                                                                                                                                               |  |           | 30,375    |   |      |   | 47,150    |  
|Other liabilities                                                                                                                                                                                             |  |           | 45,265    |   |      |   | 56,346    |  
|                                                                                                                                                                                                              |  |           |           |   |      |   |           |  
|                                                                                                                                                                                                              |  |           | 3,908,524 |   |      |   | 4,364,208 |  
|                                                                                                                                                                                                              |  |          
|Minority interest in consolidated subsidiaries                                                                                                                                                                |  |           | 1,193     |   |      |   | 1,166     |  
|                                                                                                                                                                                                              |  |          
|Stockholders equity:                                                                                                                                                                                         |  |           |           |   |      |   |           |  
|Preferred stock of $1.00 par value. Authorized 100,000 shares; none issued                                                                                                                                    |  |           |          |   |      |   |          |  
|Common stock of $.10 par value. Authorized 60,000,000 shares; issued 17,986,460 and outstanding 17,406,679 shares at September 30, 2005;
issued 17,977,240 and outstanding 17,329,779 shares at June 24, 2005 |  |           | 1,798     |   |      |   | 1,797     |  
|Additional paid-in capital                                                                                                                                                                                    |  |           | 249,217   |   |      |   | 248,955   |  
|Retained earnings                                                                                                                                                                                             |  |           | 29,333    |   |      |   | 23,920    |  
|Accumulated other comprehensive income  unrealized holding gain net of tax of $213 at September 30, 2005 and $74 at June 24,
2005                                                                            |  |           | 396       |   |      |   | 138       |  
|Deferred compensation, net                                                                                                                                                                                    |  |           | (130      | ) |      |   | 529       |  
|Treasury stock (579,781 shares at September 30, 2005 and 647,461 shares at June 24, 2005, at cost)                                                                                                            |  |           | (8,886    | ) |      |   | (9,569    | )
|                                                                                                                                                                                                              |  |           |           |   |      |   |           |  
|Total stockholders equity                                                                                                                                                                                    |  |           | 271,728   |   |      |   | 265,770   |  
|Commitments and contingencies                                                                                                                                                                                 |  |           |           |   |      |   |           |  
|                                                                                                                                                                                                              |  |           |           |   |      |   |           |  
|                                                                                                                                                                                                              |  | $         | 4,181,445 |   |      | $ | 4,631,144 |  
|                                                                                                                                                                                                              |  |           |           |   |      |   |           |  



See accompanying Notes to
Consolidated Financial Statements.



1



---

##### Table of Contents

SWS Group, Inc. and Subsidiaries

CONSOLIDATED STATEMENTS OF INCOME AND COMPREHENSIVE INCOME

For the three months ended September 30, 2005 and September 24, 2004

(In thousands, except per share and share amounts)

(Unaudited)



|                                                                                                                                                     |  |                            |            |   |                    |   |            |  
|---------------------------------------------------------------------------------------------------------------------------------------------------- |  | -------------------------- | ---------- | - | ------------------ | - | ---------- | -
|                                                                                                                                                     |  | For the Three Months Ended |           
|                                                                                                                                                     |  | September 30, 2005         |            |   | September 24, 2004 |  
|Net revenues from clearing operations                                                                                                                |  | $                          | 3,717      |   |                    | $ | 3,667      |  
|Commissions                                                                                                                                          |  |                            | 21,070     |   |                    |   | 19,225     |  
|Interest                                                                                                                                             |  |                            | 56,868     |   |                    |   | 27,352     |  
|Investment banking, advisory and administrative fees                                                                                                 |  |                            | 9,176      |   |                    |   | 6,847      |  
|Net gains on principal transactions                                                                                                                  |  |                            | 5,000      |   |                    |   | 22,316     |  
|Other                                                                                                                                                |  |                            | 5,968      |   |                    |   | 5,216      |  
|                                                                                                                                                     |  |                            |            |   |                    |   |            |  
|                                                                                                                                                     |  |                            | 101,799    |   |                    |   | 84,623     |  
|                                                                                                                                                     |  |                            |            |   |                    |   |            |  
|Commissions and other employee compensation                                                                                                          |  |                            | 39,018     |   |                    |   | 31,493     |  
|Interest                                                                                                                                             |  |                            | 33,191     |   |                    |   | 10,280     |  
|Occupancy, equipment and computer service costs                                                                                                      |  |                            | 5,760      |   |                    |   | 6,867      |  
|Communications                                                                                                                                       |  |                            | 2,484      |   |                    |   | 3,087      |  
|Floor brokerage and clearing organization charges                                                                                                    |  |                            | 1,295      |   |                    |   | 1,582      |  
|Advertising and promotional                                                                                                                          |  |                            | 689        |   |                    |   | 832        |  
|Other                                                                                                                                                |  |                            | 8,253      |   |                    |   | 5,826      |  
|                                                                                                                                                     |  |                            |            |   |                    |   |            |  
|                                                                                                                                                     |  |                            | 90,690     |   |                    |   | 59,967     |  
|                                                                                                                                                     |  |                            |            |   |                    |   |            |  
|Income before income tax expense and minority interest in consolidated subsidiaries                                                                  |  |                            | 11,109     |   |                    |   | 24,656     |  
|Income tax expense                                                                                                                                   |  |                            | 3,983      |   |                    |   | 8,506      |  
|                                                                                                                                                     |  |                            |            |   |                    |   |            |  
|Income before minority interest in consolidated subsidiaries                                                                                         |  |                            | 7,126      |   |                    |   | 16,150     |  
|Minority interest in consolidated subsidiaries                                                                                                       |  |                            | (29        | ) |                    |   | (262       | )
|                                                                                                                                                     |  |                            |            |   |                    |   |            |  
|Income before cumulative effect of a change in accounting principle                                                                                  |  |                            | 7,097      |   |                    |   | 15,888     |  
|Cumulative effect of a change in accounting principle, net of tax of $40.                                                                            |  |                            | 75         |   |                    |   |           |  
|                                                                                                                                                     |  |                            |            |   |                    |   |            |  
|Net income                                                                                                                                           |  |                            | 7,172      |   |                    |   | 15,888     |  
|Other comprehensive income (loss):                                                                                                                   |  |                            |            |   |                    |   |            |  
|Holding gains and losses net of tax of $139 and $(32) arising during the three months ended September 30, 2005 and September 24,
2004, respectively. |  |                            | 258        |   |                    |   | (161       | )
|Reclassification for hedging activities, net of tax of $9.                                                                                           |  |                            |           |   |                    |   | 17         |  
|Reclassification for delivery of Knight shares in settlement of DARTSSMobligation, net of tax of $6,262.                                             |  |                            |           |   |                    |   | (12,471    | )
|                                                                                                                                                     |  |                            |            |   |                    |   |            |  
|Net income (loss) recognized in other comprehensive income                                                                                           |  |                            | 258        |   |                    |   | (12,615    | )
|                                                                                                                                                     |  |                            |            |   |                    |   |            |  
|Comprehensive income                                                                                                                                 |  | $                          | 7,430      |   |                    | $ | 3,273      |  
|                                                                                                                                                     |  |                            |            |   |                    |   |            |  
|Earnings per share - basic                                                                                                                           |  |                            |            |   |                    |   |            |  
|Income before cumulative effect of change in accounting principles                                                                                   |  | $                          | 0.41       |   |                    | $ | 0.93       |  
|Cumulative effect of change in accounting principles                                                                                                 |  |                            |           |   |                    |   |           |  
|                                                                                                                                                     |  |                            |            |   |                    |   |            |  
|Net income                                                                                                                                           |  | $                          | 0.41       |   |                    | $ | 0.93       |  
|                                                                                                                                                     |  |                            |            |   |                    |   |            |  
|Weighted average shares outstanding  basic                                                                                                          |  |                            | 17,328,934 |   |                    |   | 17,139,822 |  
|                                                                                                                                                     |  |                            |            |   |                    |   |            |  
|Earnings per share  diluted                                                                                                                         |  |                            |            |   |                    |   |            |  
|Income before cumulative effect of change in accounting principles                                                                                   |  | $                          | 0.41       |   |                    | $ | 0.92       |  
|Cumulative effect of change in accounting principles                                                                                                 |  |                            |           |   |                    |   |           |  
|                                                                                                                                                     |  |                            |            |   |                    |   |            |  
|Net income                                                                                                                                           |  | $                          | 0.41       |   |                    | $ | 0.92       |  
|                                                                                                                                                     |  |                            |            |   |                    |   |            |  
|Weighted average shares outstanding  diluted                                                                                                        |  |                            | 17,517,023 |   |                    |   | 17,242,589 |  
|                                                                                                                                                     |  |                            |            |   |                    |   |            |  



See accompanying Notes to
Consolidated Financial Statements.



- 2 -



---

##### Table of Contents

SWS Group, Inc. and Subsidiaries

CONSOLIDATED STATEMENTS OF CASH FLOWS

For the three months ended September 30, 2005 and September 24, 2004

(In thousands)

(Unaudited)



|                                                                              |  |                            |          |   |                    |   |          |  
|----------------------------------------------------------------------------- |  | -------------------------- | -------- | - | ------------------ | - | -------- | -
|                                                                              |  | For the Three Months Ended |         
|                                                                              |  | September 30, 2005         |          |   | September 24, 2004 |  
|Cash flows from operating activities:                                         |  |                            |          |   |                    |   |          |  
|Net income                                                                    |  | $                          | 7,172    |   |                    | $ | 15,888   |  
|Cumulative effect of a change in accounting principle                         |  |                            | (75      | ) |                    |   |         |  
|Adjustments to reconcile net income to net cash used in operating activities: |  |                            |          |   |                    |   |          |  
|Depreciation and amortization                                                 |  |                            | 1,456    |   |                    |   | 1,668    |  
|Amortization of discounts on loans purchased                                  |  |                            | (71      | ) |                    |   | (367     | )
|Provision for doubtful accounts                                               |  |                            | 2,934    |   |                    |   | 885      |  
|Deferred income tax benefit (expense)                                         |  |                            | 1,082    |   |                    |   | (1,680   | )
|Deferred compensation                                                         |  |                            | 525      |   |                    |   | 89       |  
|Gain on sale of loans                                                         |  |                            | (691     | ) |                    |   | (108     | )
|(Gain) loss on sale of fixed assets                                           |  |                            | 50       |   |                    |   | (8       | )
|Loss on sale of real estate                                                   |  |                            | 89       |   |                    |   | 24       |  
|Gain on delivery of Knight shares in settlement of DARTSSMobligation          |  |                            |         |   |                    |   | (18,732  | )
|Equity in undistributed losses on investments                                 |  |                            | 11       |   |                    |   | 566      |  
|Net change in minority interest in consolidated subsidiaries                  |  |                            | 27       |   |                    |   | 144      |  
|Change in operating assets and liabilities:                                   |  |                            |          |   |                    |   |          |  
|(Increase) decrease in assets segregated for regulatory purposes              |  |                            | 10,242   |   |                    |   | (34,457  | )
|Net change in broker, dealer and clearing organization accounts               |  |                            | (35,974  | ) |                    |   | (23,446  | )
|Net change in client accounts                                                 |  |                            | 26,103   |   |                    |   | 52,248   |  
|Net change in loans held for sale                                             |  |                            | 13,874   |   |                    |   | (17,925  | )
|Increase in securities owned                                                  |  |                            | (10,350  | ) |                    |   | (51,883  | )
|(Increase) decrease in securities purchased under agreements to resell        |  |                            | (12,825  | ) |                    |   | 4,909    |  
|Decrease in other assets                                                      |  |                            | 3,035    |   |                    |   | 784      |  
|Increase in drafts payable                                                    |  |                            | 418      |   |                    |   | 183      |  
|Increase in securities sold, not yet purchased                                |  |                            | 1,957    |   |                    |   | 19,472   |  
|Decrease in other liabilities                                                 |  |                            | (11,440  | ) |                    |   | (447     | )
|Windfall tax benefits                                                         |  |                            | (24      | ) |                    |   |         |  
|                                                                              |  |                            |          |   |                    |   |          |  
|Net cash used in operating activities                                         |  |                            | (2,475   | ) |                    |   | (52,193  | )
|                                                                              |  |                            |          |   |                    |   |          |  
|Cash flows from investing activities:                                         |  |                            |          |   |                    |   |          |  
|Purchase of fixed assets                                                      |  |                            | (830     | ) |                    |   | (1,109   | )
|Purchase of real estate                                                       |  |                            | (12      | ) |                    |   | (186     | )
|Proceeds from the sale of fixed assets                                        |  |                            | 76       |   |                    |   | 9        |  
|Proceeds from the sale of real estate                                         |  |                            | 1,110    |   |                    |   | 604      |  
|Loan originations and purchases                                               |  |                            | (160,748 | ) |                    |   | (131,719 | )
|Loan repayments                                                               |  |                            | 128,429  |   |                    |   | 117,839  |  
|Cash paid for purchase of OConnor                                            |  |                            | (86      | ) |                    |   | (175     | )
|Cash paid on investments                                                      |  |                            | (500     | ) |                    |   | (721     | )
|Cash received on investments                                                  |  |                            |         |   |                    |   | 20       |  
|Purchases of Federal Home Loan Bank stock                                     |  |                            | (63      | ) |                    |   | (47      | )
|                                                                              |  |                            |          |   |                    |   |          |  
|Net cash used in investing activities                                         |  |                            | (32,624  | ) |                    |   | (15,485  | )
|                                                                              |  |                            |          |   |                    |   |          |  
|Cash flows from financing activities:                                         |  |                            |          |   |                    |   |          |  
|Payments on short-term borrowings                                             |  |                            | (643,200 | ) |                    |   | (350,840 | )
|Cash proceeds from short-term borrowings                                      |  |                            | 657,000  |   |                    |   | 367,640  |  
|Payments on capital leases                                                    |  |                            |         |   |                    |   | (253     | )
|Increase (decrease) in deposits                                               |  |                            | 41,988   |   |                    |   | (2,930   | )
|Decrease in advances from Federal Home Loan Bank                              |  |                            | (10,557  | ) |                    |   | (1,895   | )
|Cash payments on notes payable  Bank                                         |  |                            | (16,787  | ) |                    |   |         |  
|Cash proceeds on notes payable  Bank                                         |  |                            |         |   |                    |   | 2,500    |  



- 3 -



---

##### Table of Contents

|                                                                      |  |                            |        |   |                   |   |         |  
|--------------------------------------------------------------------- |  | -------------------------- | ------ | - | ----------------- | - | ------- | -
|                                                                      |  | For the Three Months Ended |       
|                                                                      |  | September 30,2005          |        |   | September 24,2004 |  
|Payment of cash dividends on common stock  SWS Group                 |  |                            | (1,749 | ) |                   |   | (1,717  | )
|Windfall tax benefits                                                 |  |                            | 24     |   |                   |   |        |  
|Cash proceeds on securities sold under agreements to repurchase       |  |                            | 12,362 |   |                   |   |        |  
|Net proceeds from exercise of stock options                           |  |                            | 127    |   |                   |   | 28      |  
|Proceeds related to the Deferred Compensation Plan                    |  |                            | 101    |   |                   |   | 125     |  
|Purchase of treasury stock                                            |  |                            |       |   |                   |   | (125    | )
|                                                                      |  |                            |        |   |                   |   |         |  
|Net cash provided by financing activities                             |  |                            | 39,309 |   |                   |   | 12,533  |  
|                                                                      |  |                            |        |   |                   |   |         |  
|Net increase (decrease) in cash                                       |  |                            | 4,210  |   |                   |   | (55,145 | )
|Cash at beginning of period                                           |  |                            | 23,045 |   |                   |   | 88,589  |  
|                                                                      |  |                            |        |   |                   |   |         |  
|Cash at end of period                                                 |  | $                          | 27,255 |   |                   | $ | 33,444  |  
|                                                                      |  |                            |        |   |                   |   |         |  
|Supplemental schedule of non-cash investing and financing activities: |  |                            |        |   |                   |   |         |  
|Granting of Restricted Stock                                          |  | $                          | 1,029  |   |                   | $ | 948     |  
|                                                                      |  |                            |        |   |                   |   |         |  
|Delivery of Knight shares in settlement of DARTSSMobligation          |  | $                          |       |   |                   | $ | 18,732  |  
|                                                                      |  |                            |        |   |                   |   |         |  
|Supplemental disclosure of cash flow information:                     |  |                            |        |   |                   |   |         |  
|                                                                      |  |                           
|Cash paid during the period for:                                      |  |                            |        |   |                   |   |         |  
|Interest                                                              |  | $                          | 33,824 |   |                   | $ | 9,891   |  
|                                                                      |  |                            |        |   |                   |   |         |  
|Taxes                                                                 |  | $                          | 2,150  |   |                   | $ | 300     |  
|                                                                      |  |                            |        |   |                   |   |         |  



See accompanying Notes to
Consolidated Financial Statements.



- 4 -



---

##### Table of Contents

SWS Group, Inc. and Subsidiaries

Notes to Consolidated Financial Statements

Three Months Ended September 30, 2005 and September 24, 2004

(Unaudited)



GENERAL AND BASIS OF
PRESENTATION



The interim consolidated financial statements as of
September 30, 2005, and for the three-month periods ended September 30, 2005 and September 24, 2004, 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 year ended June 24, 2005 filed on Form 10-K. Amounts included for June 24, 2005 are derived from the audited consolidated financial statements as filed on Form 10-K. All significant intercompany balances and transactions
have been eliminated. Certain amounts in fiscal 2005 have been reclassified to conform to the 2006 presentation.



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



|                                            |  |                              
|------------------------------------------- |  | -----------------------------
|Brokerage Group                             |  |                              
|Southwest Securities, Inc.                  |  | Southwest Securities       
|SWS Financial Services, Inc.                |  | SWS Financial              
|                                            | 
|Asset Management Group                      |  |                              
|SWS Capital Corporation                     |  | SWS Capital                
|Southwest Investment Advisors, Inc.         |  | Southwest Advisors         
|                                            | 
|Banking Group                               |  |                              
|SWS Banc Holdings, Inc.                     |  | SWS Banc                   
|Southwest Securities Bank                   |  | Bank                       
|FSBF, LLC (90%)                             |  | FSBF                       
|FSB Financial, LTD (88.2%)                  |  | FSB Financial              
|FSB Development, LLC                        |  | FSB Development            
|                                            | 
|Other                                       |  |                              
|Southwest Financial Insurance Agency, Inc.  |  |                              
|Southwest Insurance Agency, Inc.            |  |                              
|Southwest Insurance Agency of Alabama, Inc. |  | collectively, SWS Insurance



Brokerage Group.Southwest
Securities is a New York Stock Exchange (NYSE) member broker/dealer and SWS Financial is a National Association of Securities Dealers (NASD) member broker/dealer. Each is registered under the Securities Exchange Act of 1934
(1934 Act). Southwest Securities and SWS Financial are also registered with the Securities and Exchange Commission (SEC) as registered investment advisors.



SWS filed a broker/dealer withdrawal with the NASD for May Financial Corporation (May Financial) on October 26, 2004. The
effective date of the withdrawal was November 1, 2004. May Financial was dissolved December 31, 2004.



Asset Management Group.Asset management services are offered through SWS Capital, which administered the Local Government Investment Cooperative
(LOGIC) fund for cities, counties, schools and other local governments across Texas through September 4, 2005. LOGIC is an investment program tailored to the investing needs of local governments within the state of Texas. SWS
Capital did not renew its contract as General Manager of LOGIC upon the expiration of the original agreement on September 4, 2005. LOGIC represented 100% of the assets under management at June 24, 2005. At September 30, 2005, SWS
Capital had no assets under management.



Southwest Advisors, although dormant, is a registered investment advisor under the Investment Advisors Act of 1940.



- 5 -



---

##### Table of Contents

Banking Group.The Bank is a federally chartered savings association regulated by the Office of Thrift
Supervision. SWS Banc was incorporated as a wholly owned subsidiary of SWS Group in the state of Delaware and became the sole shareholder of the Bank in 2004. SWS Banc was created to facilitate future potential financial transactions. FSBF is a 2%
general partner of FSB Financial which purchases non-prime automobile loans. FSB Development develops single-family residential lots.



In January 2005, the Bank purchased an additional 15% of FSBF at a cost of $84,000, bringing the Banks percentage ownership to 90%. Also, the Bank purchased an
additional 14.7% of FSB Financial at a cost of $4,367,000 bringing the Banks percentage of ownership to 88.2%. FSBF owns 2% of FSB Financial effectively giving the Bank a 90% interest in FSB Financial. Of the $4,451,000 total purchase price,
$3,062,000 was paid in cash and the remaining $1,389,000 was given in the form of a promissory note. As of September 30, 2005, $987,000 is still outstanding on this note. The monthly note payment is 35% of the monthly after-tax income allocated
to the Bank from FSB Financial until the amount has been paid in full.



The
Banks quarterly financial statements are prepared as of September 30 for each period presented. All significant intercompany balances and transactions have been eliminated.



Other Consolidated Entities.SWS Insurance holds insurance agency licenses in 44 states for the purpose of facilitating the sale of
insurance and annuities for customers of Southwest Securities and its correspondents.



STOCK OPTION AND RESTRICTED STOCK PLANS



Stock Option
Plans. At September 30, 2005, SWS had two stock option plans, the SWS Group, Inc. Stock Option Plan (the 1996 Plan) and the SWS Group, Inc. 1997 Stock Option Plan (the 1997 Plan). The 1996 Plan reserves shares of SWS
Groups common stock for issuance to eligible officers, directors and employees of SWS Group or its subsidiaries, as well as to non-employee members of the Board of Directors. The 1997 Plan reserves shares of SWS Groups common stock for
eligible employees or potential employees of SWS Group or its subsidiaries. Officers and directors are not eligible to receive options under the 1997 Plan. Options granted under the 1996 and 1997 Plans have a maximum ten-year term, and the vesting
period is determined on an individual basis by the Compensation Committee of the Board of Directors. However, options granted to non-employee directors under the 1996 Plan are fully vested six months after grant and have a five-year term.



On June 7, 2005, the vesting of all outstanding options was accelerated
to 100% upon approval by the Board of Directors. The Company has substantially eliminated the use of options as a compensation tool and currently grants restricted stock to reward management and employees. Consequently, no stock options were granted
during the three months ended September 30, 2005.



As of June 25,
2005, SWS accounts for the plans under the recognition and measurement principles of the Financial Accounting Standards Board (FASB) Statement of Financial Accounting Standards (SFAS) No. 123R, Share-Based
Payment. For all periods prior to June 25, 2005, SWS accounted for the plans under the recognition and measurement principles of Accounting Principles Board (APB) Opinion No. 25, Accounting for Stock Issued
to Employees.



- 6 -



---

##### Table of Contents

The following table illustrates the effect on net income and earnings per share if SWS had applied the fair value
recognition provisions of SFAS No. 123, Accounting for Stock-Based Compensation, to stock-based employee compensation for the three months ended September 24, 2004 (in thousands, except per share amounts):



|                                                                                                                                        |  |                                      |        |  
|--------------------------------------------------------------------------------------------------------------------------------------- |  | ------------------------------------ | ------ | -
|                                                                                                                                        |  | Three MonthsEnded September 24, 2004 |       
|                                                                                                                                       
|Net income:                                                                                                                             |  |                                      |        |  
|As reported                                                                                                                             |  | $                                    | 15,888 |  
|Total stock-based employee compensation expense determined under the fair value based method for all awards, net of related tax
effects |  |                                      | (206   | )
|                                                                                                                                        |  |                                      |        |  
|Pro forma                                                                                                                               |  | $                                    | 15,682 |  
|                                                                                                                                        |  |                                      |        |  



|                              |  |   |     
|----------------------------- |  | - | ----
|Earnings per share - basic:   |  |   |     
|As reported                   |  | $ | 0.93
|Pro forma                     |  |   | 0.91
|                              | 
|Earnings per share - diluted: |  |   |     
|As reported                   |  | $ | 0.92
|Pro forma                     |  |   | 0.91



The fair value of each option was
estimated on the date of grant using the Black-Scholes option-pricing model with the following assumptions for the three months ended September 24, 2004:



|                        |  |                    |  
|----------------------- |  | ------------------ | -
|                        |  | September 24, 2004 |  
|Expected volatility     |  | 64                 | %
|Risk-free interest rate |  | 3.23               | %
|Expected dividend yield |  | 2.66               | %
|Expected life           |  | 5 years            |  



Restricted Stock Plan. The SWS
Group, Inc. 2003 Restricted Stock Plan (Restricted Stock Plan) allows for awards of up to 500,000 shares of SWS Groups common stock to SWS directors, officers and employees. No more than 200,000 of the authorized shares may
be newly issued shares of common stock. The Restricted Stock Plan terminates on August 21, 2013. The vesting period is determined on an individualized basis by the Compensation Committee of the Board of Directors. In general, restricted stock
granted to employees under the Restricted Stock Plan is fully vested after three years, and restricted stock granted to non-employee directors vests on the one year anniversary of the date of grant.



On November 12, 2003, the Board of Directors approved grants to various officers and
employees totaling 44,729 shares with a fair market value of $20.33 per share. On August 18, 2004, a second grant was approved totaling 65,950 shares at a price of $13.85. On August 25, 2005, a third grant was approved totaling 72,199
shares at a price of $16.65. As a result of these grants, SWS recorded deferred compensation of approximately $2,852,000 and for the three months ended September 30, 2005 and September 24, 2004, SWS has recognized compensation expense of
approximately $166,000 and $112,000, respectively.



On June 25, 2005, SWS
adopted the provisions of SFAS No. 123R in relation to the Restricted Stock Plan. This adoption resulted in income of $75,000 recorded as a cumulative effect of a change in accounting principle, net of tax. The adoption affected SWS
accounting for forfeitures. The adoption required SWS to estimate and record future forfeitures on previously granted restricted stock awards. Also, the adoption of SFAS No. 123R required SWS to change its accounting for dividends paid to
restricted stock stockholders. Under APB Opinion No. 25, dividends paid to restricted stock stockholders were recorded in equity. SFAS No. 123R requires dividends paid to restricted stock stockholders to be recorded as compensation
expense.



- 7 -



---

##### Table of Contents

CASH



The Company considers cash to include cash on hand and in depository accounts.



INVESTMENTS



In 1993, SWS became a part owner of Comprehensive Software Systems, Inc. (CSS), a software development company formed to develop
a new brokerage front and back office system. By fiscal 2002, SWS held a 25.08% ownership interest in CSS, and implemented the equity method of accounting, prescribed by APB Opinion No. 18, The Equity Method of Accounting for
Investments in Common Stock. SWS was the first company, and to date the only company, to fully implement the CSS system. SWS completed its installation of the system in September 2002. In June 2002, SWS determined that the investment in
CSS and its related goodwill were fully impaired based on an analysis of the projected cash flow from the investment.



To facilitate the continued enhancement of the CSS system, SWS entered into an agreement in December 2002, amended in June 2003, to loan CSS $3,500,000 under a note
bearing interest at 6% per annum. In December 2003, SWS agreed to an additional equity investment in CSS of $2,900,000, resulting in the purchase of 5.8 million shares of CSS common stock. The purchases were made in equal quarterly
installments (two purchases totaling approximately $1,443,000 were made in fiscal years 2004 and 2005) and ultimately resulted in increasing SWS position in CSS to 30.22%. In January 2005, SWS forgave the $3,500,000 loan made in fiscal 2003,
converting it to an equity contribution. These investments were made to insure the continued operation of CSS while needed enhancements to the system were built.



In January 2005, SWS did not participate in CSS equity offering because SWS is no longer dependent on CSS for enhancements to the
system. SWS has developed many of the functions needed to run the CSS system in-house. Subsequent to the equity offering in January 2005, SWS owned 13.7% of CSS. SWS has not made any additional investments in CSS since January 2005.



SWS share of the undistributed losses of CSS for the three months ended
September 30, 2005 was $191,000. From inception of the loan to date, SWS pro-rata percentage of losses of $7,924,000 was greater than the $6,386,000 loaned and invested by $1,538,000. As a result, there is no recorded equity investment or
loan receivable from CSS at September 30, 2005.



Summarized financial information of CSS is as follows (in thousands):



|                     |  |                    |        |   |                    |   |        |  
|-------------------- |  | ------------------ | ------ | - | ------------------ | - | ------ | -
|                     |  | September 30, 2005 |        |   | June 30, 2005      |  
|Total assets         |  | $                  | 6,254  |   |                    | $ | 7,719  |  
|Total liabilities    |  |                    | 4,208  |   |                    |   | 4,273  |  
|Shareholders equity |  |                    | 2,046  |   |                    |   | 3,446  |  
|                     | 
|                     |  | Three Months Ended |       
|                     |  | September 30,2005  |        |   | September 30, 2004 |  
|Total revenues       |  | $                  | 1,480  |   |                    | $ | 1,344  |  
|Net loss             |  |                    | (1,394 | ) |                    |   | (2,592 | )



SWS has two other investment vehicles
that are accounted for under the equity method. One is a limited partnership venture capital fund to which SWS has committed $5,000,000. As of September 30, 2005, SWS had contributed $4,000,000 from inception to date. During the three months
ended September 30, 2005 and September 24, 2004, SWS recorded losses of $9,000 and income of $158,000, respectively, related to this investment.



- 8 -



---

##### Table of Contents

SWS remaining equity investment had total losses for the three months ended September 30, 2005 and
September 24, 2004 of $1,600 and $2,600, respectively.



The FASB issued
Financial Interpretation (FIN) No. 46 on January 17, 2003 and the revised version, FIN No. 46R, in December 2003. Upon review of its investments, SWS determined that it has one Variable Interest Entity (VIE),
as defined by FIN No. 46R, that should be consolidated. In March 2005, FSB Development contributed $475,000 for a limited partnership interest in a land development limited partnership. The Bank has established a $2,400,000 line of credit with
this limited partnership. If drawn this line bears a rate of prime plus 1%. At September 30, 2005, $1,456,000 was outstanding on this line of credit. The line allows the limited partnership to purchase the land to be used in the development and
is payable on May 10, 2006. This entity is consolidated at the Bank level through FSB Development. As of September 30, 2005, the Bank consolidated $1,945,000 in assets and $27,000 in net losses for this investment.



FSB Development had a limited partnership interest of $1,000,000 in a land development
limited partnership at December 2004. FSB Developments interest in the limited partnership was sold on February 3, 2005 for $1,125,000, resulting in a gain of $223,000. The Bank had loaned this limited partnership $3,000,000 with an
interest rate of prime plus 1% payable on December 17, 2005 to allow the limited partnership to purchase the land and finance the second phase of the development. This loan was paid off on August 4, 2005. For the three months ended
September 24, 2004, the Bank consolidated $35,000 in net losses for this investment.



SWS also has an investment in Archipelago Holdings, L.L.C., an electronic stock exchange, (Archipelago), recorded at its cost of zero. During the second quarter of fiscal 2004, SWS tendered half of its
stake in Archipelago, or 303,456 shares of Archipelago common stock, for cash. After the tender, SWS owned 303,456 shares of Archipelago. In August 2004, Archipelago declared an approximately 1 for 4.5 reverse stock split. After the split, SWS owned
67,435 shares of Archipelago stock. On August 19, 2004, Archipelago completed an initial public offering of its common stock. SWS sold 23,714 shares at $10.695, yielding a gain of $254,000 in the offering. On May 24, 2005, SWS sold 20,000
shares at an average price of $32.97 for a gain of $659,000. After giving effect to these transactions, SWS owns 23,721 shares of Archipelago stock. This stock is included in securities owned and marked to market. At September 30, 2005 and
June 24, 2004, the market value of Archipelago was $937,000 and $948,000, respectively. See -Securities Owned and Securities Sold, Not Yet Purchased.



Southwest Securities has been a member of the NYSE since 1972 and as such owns one seat on the NYSE carried at a cost of $230,000.



ASSETS SEGREGATED FOR REGULATORY PURPOSES



At September 30, 2005, SWS had reverse repurchase agreements of approximately
$163,871,000 and related cash and accrued interest of approximately $155,375,000 segregated in special reserve bank accounts for the exclusive benefit of customers under Rule 15c3-3 of the 1934 Act. These reverse repurchase agreements were
collateralized by U.S. Government securities with a market value of approximately $165,069,000. At September 30, 2005, SWS also had approximately $1,300,000 in cash in special reserve bank accounts for the Proprietary Accounts of Introducing
Brokers (PAIB).



At June 24, 2005, SWS had U.S. Treasury
securities with a market value of approximately $25,620,000, reverse repurchase agreements of approximately $140,696,000 and related cash and accrued interest of approximately $164,472,000 segregated in special reserve bank accounts for the
exclusive benefit of customers under Rule 15c3-3 of the 1934 Act. These reverse repurchase agreements were collateralized by U.S. Government securities with a market value of approximately $141,720,000. SWS had no positions in special reserve bank
accounts for the PAIB at June 24, 2005.



- 9 -



---

##### Table of Contents

MARKETABLE EQUITY SECURITIES



SWS owns shares of common stock that are classified as marketable equity securities available for sale. Consequently, the unrealized holding
gains (losses), net of tax, are recorded as a separate component of stockholders equity on the consolidated statements of financial condition.



At September 30, 2005 and June 24, 2005, SWS held 457,154 shares of U.S. Home Systems, Inc. (USHS) with a cost basis of $2,018,000. The market value
of the USHS shares was $2,606,000 at September 30, 2005 and $2,208,000 at June 24, 2005. There were no sales of USHS stock in the three-month periods ended September 30, 2005 and September 24, 2004.



At September 30, 2005 and June 24, 2005, SWS held 8,954 shares of Westwood Holdings
Group, Inc. (Westwood) within the deferred compensation plan with a cost basis of $150,650. The market value of the Westwood shares was $164,000 at September 30, 2005 and June 24, 2005.



RECEIVABLE FROM AND PAYABLE TO BROKERS, DEALERS AND CLEARING ORGANIZATIONS



At September 30, 2005 and June 24, 2005, SWS had receivable from and payable to
brokers, dealers and clearing organizations related to the following (in thousands):



|                             |  |           |           |      |   |          
|---------------------------- |  | --------- | --------- | ---- | - | ---------
|                             |  | September |           | June
|Receivable                   |  |           |           |      |   |          
|Securities failed to deliver |  | $         | 51,824    |      | $ | 21,459   
|Securities borrowed          |  |           | 2,275,357 |      |   | 2,768,922
|Correspondent broker/dealers |  |           | 20,143    |      |   | 39,940   
|Clearing organizations       |  |           | 8,281     |      |   | 8,196    
|Other                        |  |           | 39,725    |      |   | 16,779   
|                             |  |           |           |      |   |          
|                             |  | $         | 2,395,330 |      | $ | 2,855,296
|                             |  |           |           |      |   |          
|Payable                      |  |           |           |      |   |          
|Securities failed to receive |  | $         | 46,096    |      | $ | 42,916   
|Securities loaned            |  |           | 2,190,303 |      |   | 2,688,266
|Correspondent broker/dealers |  |           | 14,035    |      |   | 14,064   
|Other                        |  |           | 8,702     |      |   | 9,830    
|                             |  |           |           |      |   |          
|                             |  | $         | 2,259,136 |      | $ | 2,755,076
|                             |  |           |           |      |   |          



SWS participates in the securities
borrowing and lending business by borrowing and lending securities other than those of its clients. SWS adjusts open positions to market value according to standard industry practices. SWS received collateral of $2,275,348,000 under securities
lending agreements, of which the Company repledged $2,164,823,000 at September 30, 2005. SWS received collateral of $2,768,921,000 under securities lending agreements, of which SWS repledged $2,655,647,000 at June 24, 2005.



- 10 -



---

##### Table of Contents

LOANS AND ALLOWANCE FOR PROBABLE LOAN LOSSES



Loans receivable, excluding loans held for sale, at September 30, 2005 and June 30, 2005 are summarized as follows (in thousands):



|                                                 |  |           |         |   |      |   |         |  
|------------------------------------------------ |  | --------- | ------- | - | ---- | - | ------- | -
|                                                 |  | September |         |   | June |  
|First mortgage loans (principally conventional): |  |           |         |   |      |   |         |  
|Real estate                                      |  | $         | 323,255 |   |      | $ | 308,517 |  
|Construction                                     |  |           | 158,029 |   |      |   | 135,444 |  
|                                                 |  |           |         |   |      |   |         |  
|                                                 |  |           | 481,284 |   |      |   | 443,961 |  
|                                                 |  |           |         |   |      |   |         |  
|Consumer and other loans:                        |  |           |         |   |      |   |         |  
|Commercial                                       |  |           | 59,259  |   |      |   | 51,312  |  
|Other                                            |  |           | 91,629  |   |      |   | 109,125 |  
|                                                 |  |           |         |   |      |   |         |  
|                                                 |  |           | 150,888 |   |      |   | 160,437 |  
|                                                 |  |           |         |   |      |   |         |  
|Factored receivables                             |  |           | 7,802   |   |      |   | 7,803   |  
|                                                 |  |           |         |   |      |   |         |  
|                                                 |  |           | 639,974 |   |      |   | 612,201 |  
|Unearned income                                  |  |           | (11,174 | ) |      |   | (12,894 | )
|Allowance for probable loan losses               |  |           | (7,558  | ) |      |   | (7,450  | )
|                                                 |  |           |         |   |      |   |         |  
|                                                 |  | $         | 621,242 |   |      | $ | 591,857 |  
|                                                 |  |           |         |   |      |   |         |  



Impairment of loans with a recorded
investment of approximately $5,591,000 and $4,949,000 at September 30, 2005 and June 30, 2005, respectively, has been recognized in conformity with SFAS No. 114, Accounting by Creditors for Impairment of a Loanan
Amendment of SFAS No. 5 and SFAS No. 15, as amended.



An
analysis of the allowance for probable loan losses for the three-month periods ended September 30, 2005 and September 30, 2004 is as follows (in thousands):



|                                    |  |                    |        |   |                   |   |       |  
|----------------------------------- |  | ------------------ | ------ | - | ----------------- | - | ----- | -
|                                    |  | Three Months Ended |       
|                                    |  | September 30,2005  |        |   | September 30,2004 |  
|Balance at beginning of period      |  | $                  | 7,450  |   |                   | $ | 4,643 |  
|Provision for loan losses           |  |                    | 2,489  |   |                   |   | 646   |  
|Loans charged to the allowance, net |  |                    | (2,381 | ) |                   |   | (662  | )
|                                    |  |                    |        |   |                   |   |       |  
|Balance at end of period            |  | $                  | 7,558  |   |                   | $ | 4,627 |  
|                                    |  |                    |        |   |                   |   |       |  



SECURITIES OWNED AND SECURITIES
SOLD, NOT YET PURCHASED



At September 30, 2005 and June 24,
2005, SWS held securities owned and securities sold, not yet purchased as follows (in thousands):



|                                                  |  |           |         |      |   |        
|------------------------------------------------- |  | --------- | ------- | ---- | - | -------
|                                                  |  | September |         | June
|Securities owned                                  |  |           |         |      |   |        
|Corporate equity securities                       |  | $         | 7,837   |      | $ | 7,259  
|Municipal obligations                             |  |           | 36,715  |      |   | 32,894 
|U.S. Government and Government agency obligations |  |           | 39,158  |      |   | 30,079 
|Corporate obligations                             |  |           | 85,158  |      |   | 88,877 
|Other                                             |  |           | 8,436   |      |   | 7,845  
|                                                  |  |           |         |      |   |        
|                                                  |  | $         | 177,304 |      | $ | 166,954
|                                                  |  |           |         |      |   |        



- 11 -



---

##### Table of Contents

|                                                  |  |           |         |      |   |        
|------------------------------------------------- |  | --------- | ------- | ---- | - | -------
|                                                  |  | September |         | June
|Securities sold, not yet purchased                |  |           |         |      |   |        
|Corporate equity securities                       |  | $         | 3,410   |      | $ | 3,121  
|Municipal obligations                             |  |           | 7       |      |   | 277    
|U.S. Government and Government agency obligations |  |           | 46,602  |      |   | 43,933 
|Corporate obligations                             |  |           | 57,453  |      |   | 58,451 
|Other                                             |  |           | 648     |      |   | 381    
|                                                  |  |           |         |      |   |        
|                                                  |  | $         | 108,120 |      | $ | 106,163
|                                                  |  |           |         |      |   |        



During the quarter, certain of the
above securities were pledged to secure short-term borrowings or as security deposits at clearing organizations for SWS clearing business. Securities deposited as security at clearing organizations were $3,781,000 and $4,669,000 at
September 30, 2005 and June 24, 2005, respectively. Additionally, at September 30, 2005 and June 24, 2005, SWS had deposited firm securities valued at $196,000 and $130,000, respectively, in conjunction with securities lending
activities.



SECURITIES PURCHASED UNDER AGREEMENTS TO RESELL



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 September 30,
2005, SWS held reverse repurchase agreements totaling $41,715,000, collateralized by U.S. Government and Government agency obligations with a market value of approximately $41,304,000. At June 24, 2005, SWS held reverse repurchase agreements
totaling $28,890,000, collateralized by U.S. Government and Government agency obligations with a market value of approximately $28,885,000.



GOODWILL



SWS accounts for goodwill under the provisions of SFAS No. 142, Goodwill and Other Intangible Assets. SWS performed its annual assessment of the fair value of goodwill during fiscal 2005 in
June 2005, as required by SFAS No. 142 and based on the results of the valuation, SWS goodwill balance was not impaired. There have been no events in the last three months that would trigger an interim assessment on the fair value of
goodwill.



SWS has two reporting units with goodwill: Southwest Securities in
the Brokerage Group segment and the Bank in the Banking Group segment. Changes in the carrying value of goodwill during the three-month period ended September 30, 2005, by segment and in the aggregate, are summarized in the following table (in
thousands):



|                                                                  |  |                |       |              |   |                              |  |   |       
|----------------------------------------------------------------- |  | -------------- | ----- | ------------ | - | ---------------------------- |  | - | ------
|                                                                  |  | BrokerageGroup |       | BankingGroup |   | Consolidated SWS Group, Inc.
|Balance, June 24, 2005                                            |  | $              | 7,466 |              | $ | 4,194                        |  | $ | 11,660
|Arising from earn-out provision of completed business combination |  |                | 86    |              |   |                             |  |   | 86    
|                                                                  |  |                |       |              |   |                              |  |   |       
|Balance, September 30, 2005                                       |  | $              | 7,552 |              | $ | 4,194                        |  | $ | 11,746
|                                                                  |  |                |       |              |   |                              |  |   |       



In August 2001, SWS Group acquired
OConnor & Company Securities, Inc. (OConnor) and recorded approximately $744,000 of goodwill on the transaction. SWS Group transferred the goodwill to Southwest Securities after the adoption of SFAS No. 142. Per
the terms of the acquisition agreement, contingent consideration based upon future operating performance of OConnor is to be calculated on an annual basis extending through July 2005. The maximum additional earn-out consideration per the
acquisition agreement is $2,500,000. In July 2005 both the period for earn-out consideration ended and the $2,500,000 maximum was reached. As such, no additional goodwill will be recorded under the acquisition agreement.



- 12 -



---

##### Table of Contents

SHORT-TERM BORROWINGS



Southwest Securities has credit arrangements with commercial banks, which include broker loan lines up to $275,000,000. 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 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. At September 30, 2005, the amount outstanding under these secured arrangements was $77,200,000, which was collateralized by securities held for firm accounts valued at $127,245,000. At June 24, 2005, the
amount outstanding under these secured arrangements was $63,400,000, which was collateralized by securities held for firm accounts valued at $88,488,000.



In addition to the broker loan lines, SWS has a $20,000,000 unsecured line of credit that is due on demand and bears interest at rates indexed to the federal funds rate.
The total amount of borrowings available under this line of credit is reduced by the amount outstanding under the unsecured letters of credit at the time of borrowing. At September 30, 2005 and June 24, 2005, the total amount available for
borrowings was $12,036,000 and $11,893,000, respectively. There was $5,000,000 outstanding on this line at each of September 30, 2005 and June 24, 2005.



SWS has an irrevocable letter of credit agreement aggregating $45,000,000 and $49,000,000 at September 30, 2005 and June 24, 2005,
respectively, pledged to support its open options positions with an options clearing organization. The letter of credit bears interest at the brokers call rate, if drawn, and is renewable semi-annually. The letter of credit is fully
collateralized by marketable securities held in client and non-client margin accounts with a value of $59,361,000 and $66,974,000 at September 30, 2005 and June 24, 2005, respectively.



SWS also has unsecured letters of credit, aggregating $2,250,000 at both September 30,
2005 and June 24, 2005, pledged to support its open positions with securities clearing organizations. The unsecured letters of credit bear a 1% commitment fee and are renewable semi-annually.



At September 30, 2005 and June 24, 2005, SWS had an additional unsecured letter of
credit issued for a sub-lease to the sub-lessee of space previously occupied by Mydiscountbroker.com, Inc., a subsidiary of SWS that was dissolved in July 2004, in the amount of $714,000 and $857,000, respectively. The letter of credit bears a 1%
commitment fee and is renewable annually.



In addition to using customer
securities to finance bank loans, SWS also pledges client securities as collateral in conjunction with SWS securities lending activities. At September 30, 2005, approximately $448,448,000 of client securities under customer margin loans
was available to be repledged, of which SWS has pledged $25,208,000 under securities loan agreements. At June 24, 2005, approximately $469,399,000 of client securities under customer margin loans was available to be repledged, of which SWS had
pledged $32,156,000 under securities loan agreements.



- 13 -



---

##### Table of Contents

DEPOSITS



Deposits at September 30, 2005 and June 30, 2005 are summarized as follows (dollars in thousands):



|                                              |  |           |         |         |       |   |        |   |         |  |       |  
|--------------------------------------------- |  | --------- | ------- | ------- | ----- | - | ------ | - | ------- |  | ----- | -
|                                              |  | September |         |         | June  |  
|                                              |  | Amount    |         | Percent |       |   | Amount |   | Percent | 
|Noninterest bearing demand accounts           |  | $         | 42,867  |         | 6.8   | % |        | $ | 34,504  |  | 5.9   | %
|Interest bearing demand accounts              |  |           | 52,977  |         | 8.4   |   |        |   | 48,524  |  | 8.2   |  
|Savings accounts                              |  |           | 394,405 |         | 62.6  |   |        |   | 359,520 |  | 61.1  |  
|Limited access money market accounts          |  |           | 20,130  |         | 3.2   |   |        |   | 19,172  |  | 3.3   |  
|Certificates of deposit, less than $100,000   |  |           | 63,951  |         | 10.2  |   |        |   | 67,704  |  | 11.5  |  
|Certificates of deposit, $100,000 and greater |  |           | 55,636  |         | 8.8   |   |        |   | 58,554  |  | 10.0  |  
|                                              |  |           |         |         |       |   |        |   |         |  |       |  
|                                              |  | $         | 629,966 |         | 100.0 | % |        | $ | 587,978 |  | 100.0 | %
|                                              |  |           |         |         |       |   |        |   |         |  |       |  



The
weighted average interest rate on deposits was approximately 3.26% at September 30, 2005 and 2.92% at June 30, 2005.



At September 30, 2005, scheduled maturities of certificates of deposit were as follows (in thousands):



|                                              |  |            |        |            |   |            |  |            |       |       |   |        |  |   |        
|--------------------------------------------- |  | ---------- | ------ | ---------- | - | ---------- |  | ---------- | ----- | ----- | - | ------ |  | - | -------
|                                              |  | Fiscal2006 |        | Fiscal2007 |   | Fiscal2008 |  | Thereafter |       | Total
|Certificates of deposit, less than $100,000   |  | $          | 45,192 |            | $ | 9,091      |  | $          | 2,609 |       | $ | 7,059  |  | $ | 63,951 
|Certificates of deposit, $100,000 and greater |  |            | 47,843 |            |   | 2,386      |  |            | 868   |       |   | 4,539  |  |   | 55,636 
|                                              |  |            |        |            |   |            |  |            |       |       |   |        |  |   |        
|                                              |  | $          | 93,035 |            | $ | 11,477     |  | $          | 3,477 |       | $ | 11,598 |  | $ | 119,587
|                                              |  |            |        |            |   |            |  |            |       |       |   |        |  |   |        



SECURITIES SOLD UNDER AGREEMENTS TO
REPURCHASE



Securities sold under agreements to repurchase, 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 September 30, 2005 and
June 24, 2005 were $20,423,000 and $8,061,000, respectively.



ADVANCES
FROM THE FEDERAL HOME LOAN BANK (FHLB)



At September 30, 2005 and June 30, 2005, advances from the FHLB were due as follows (in thousands):



|                        |  |           |        |      |   |       
|----------------------- |  | --------- | ------ | ---- | - | ------
|                        |  | September |        | June
|Maturity:               |  |           |        |      |   |       
|Due within one year     |  | $         | 47,064 |      | $ | 58,731
|Due within two years    |  |           | 11,380 |      |   | 12,487
|Due within five years   |  |           | 6,628  |      |   | 6,556 
|Due within seven years  |  |           | 5,147  |      |   | 3,787 
|Due within ten years    |  |           | 5,967  |      |   | 4,746 
|Due within twenty years |  |           | 6,796  |      |   | 7,232 
|                        |  |           |        |      |   |       
|                        |  | $         | 82,982 |      | $ | 93,539
|                        |  |           |        |      |   |       



Pursuant to collateral agreements, the
advances from the FHLB, with interest rates ranging from 2% to 8%, are collateralized by approximately $181,000,000 of collateral value (as defined by the credit policy of the FHLB) in qualifying loans at September 30, 2005 (calculated at
June 30, 2005).



At June 30, 2005 (calculated at March 31,
2005), advances with interest rates from 2% to 8% were collateralized by approximately $170,000,000 of collateral value in qualifying loans.



- 14 -



---

##### Table of Contents

BANK BORROWINGS



In June 2005, the Bank entered into an agreement with a bank for the availability of a $20,000,000 unsecured line of credit for the purchase of federal funds. The line
bears interest at a rate equal to the rate of interest of federal funds plus 0.25%. The line is being used by the Bank to support short-term liquidity needs and expires on May 31, 2006. At September 30, 2005 and June 30, 2005, there
were no amounts outstanding on this line of credit.



On June 8, 2005, FSB
Financial obtained a secured line of credit from a bank in the amount of $75,000,000. At September 30, 2005 and June 30, 2005, $19,525,000 and $35,300,000 were outstanding on this line of credit, respectively. The note related to this line
of credit matures on June 7, 2008. Interest is paid on a monthly basis at a rate of 30-day LIBOR plus a variable rate that is determined by the status of certain financial ratios at the time of the advance. The interest rate was 5.95% and 5.38%
at September 30, 2005 and June 30, 2005, respectively. This line of credit contains certain restrictive covenants that, among other things, limit the ability of FSB Financial to incur indebtedness, engage in transactions with affiliates,
create liens, engage in mergers and consolidations, or sell collateral. The line of credit also requires FSB Financial and the Bank to maintain certain financial ratios. FSB Financial and the Bank were in compliance with all covenants and provisions
of the agreement at September 30, 2005. This line of credit is secured by automobile loans totaling $37,233,000.



FSB Financial also has a line of credit with its parent Bank. At September 30, 2005, the total credit line is $45,850,000 of which FSB Financial has drawn
$37,950,000. At June 30, 2005, the total credit line was $46,000,000 of which FSB Financial had drawn $37,250,000. $10,850,000 and $11,850,000 was provided by participations from third parties at September 30, 2005 and June 30, 2005,
respectively. Since June 8, 2005, the loan bears interest for unaffiliated participants at 30-day LIBOR plus 2.25% and matures March 27, 2006. The loan bears interest for the Bank at the Bank Insured Funds rate plus 0.9%, 3.83% at
September 30, 2005. From January 1, 2005 to June 7, 2005, the loan bore interest at prime plus 0.75%. Prior to January 1, 2005, the loan bore interest at prime plus 1.5%. SWS Group guarantees $10,000,000 of this credit line to
the Bank. See -Commitments and Contingencies  Guarantees. The portion of the credit line from the Bank to FSB Financial is eliminated in consolidation.



On November 7, 2003, FSB Financial borrowed $5,000,000, in the form of an unsecured note, from CN 2003 Partners, a partnership. A
member of SWS management has an interest in an entity that is one of the partners in CN 2003 Partners. The note matured on May 7, 2005. Interest was paid on a monthly basis at a floating rate of prime plus 2%. The applicable annual
interest rate was not more than 18%. The terms of the loan were no more favorable to the lenders than the terms of similar contemporaneous loans made by non-affiliated lenders.



The loan from CN 2003 Partners was repaid on June 8, 2005. Simultaneously, FSB Financial financed the repayment through an unsecured
subordinated note issued by SWS Group. The loan from SWS Group bears interest at prime plus 100 bps and matures on June 8, 2008. This loan does not violate the covenants of FSB Financials $75,000,000 line of credit. At September 30,
2005 and June 30, 2005, $5,000,000 is outstanding on this loan, which is eliminated in consolidation.



NET CAPITAL REQUIREMENTS



Brokerage
Group. The broker/dealer subsidiaries are subject to the Securities and Exchange Commissions (SEC) Uniform Net Capital Rule (the Net Capital Rule), which requires the maintenance of minimum net capital. Southwest
Securities has elected to use the alternative method, permitted by the Net Capital Rule, which requires that it maintain minimum net capital, as defined in Rule 15c3-1 under the 1934 Act, equal to the greater of $1,000,000 or 2% of aggregate



- 15 -



---

##### Table of Contents

debit balances, as defined in Rule 15c3-3 under the 1934 Act. At September 30, 2005, Southwest Securities had net
capital of $119,021,000, or approximately 25.3% of aggregate debit balances, which was $109,600,000 in excess of its minimum net capital requirement of $9,421,000 at that date. Additionally, the net capital rule of the NYSE provides that equity
capital may not be withdrawn and cash dividends may not be paid if resulting net capital would be less than 5% of aggregate debit items. At September 30, 2005, Southwest Securities had net capital of $95,468,000 in excess of 5% of aggregate
debit items.



SWS Financial follows the primary (aggregate indebtedness) method
under Rule 15c3-1, which requires the maintenance of minimum net capital of $250,000. At September 30, 2005, the net capital and excess net capital of SWS Financial were $1,080,000 and $830,000, respectively.



Banking Group. 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 to risk-weighted assets, and of
Tier I capital to adjusted total assets (all as defined in 12 CFR 565 and 12 CFR 567). Management believes, as of September 30, 2005 and June 30, 2005, that the Bank meets all capital adequacy requirements to which it is subject.



As of September 30, 2005 and June 30, 2005, the Bank is considered
well capitalized under the regulatory framework for prompt corrective action. To be categorized as well capitalized, the Bank must maintain minimum total risk-based, Tier I risk-based and Tier I leverage ratios.



The Banks actual capital amounts and ratios are
presented in the following tables (dollars in thousands):



|                                        |  |        |        |       |                              |   |        |                                                                  |        |  |     |        |  |       |        |  |      |  
|--------------------------------------- |  | ------ | ------ | ----- | ---------------------------- | - | ------ | ---------------------------------------------------------------- | ------ |  | --- | ------ |  | ----- | ------ |  | ---- | -
|                                        |  | Actual |        |       | For Capital AdequacyPurposes |   |        | To Be Well Capitalized Under Prompt Corrective Action Provisions |       
|                                        |  | Amount |        | Ratio |                              |   | Amount |                                                                  | Ratio  |  |     | Amount |  | Ratio |       
|September 30, 2005:                     |  |        |        |       |                              |   |        |                                                                  |        |  |     |        |  |       |        |  |      |  
|Total capital to risk weighted assets   |  | $      | 72,885 |       | 10.8                         | % |        | $                                                                | 54,171 |  | 8.0 | %      |  | $     | 67,713 |  | 10.0 | %
|Tier I capital to risk weighted assets  |  |        | 65,328 |       | 9.6                          |   |        |                                                                  | 27,085 |  | 4.0 |        |  |       | 40,628 |  | 6.0  |  
|Tier I capital to adjusted total assets |  |        | 65,328 |       | 8.0                          |   |        |                                                                  | 32,728 |  | 4.0 |        |  |       | 40,911 |  | 5.0  |  
|                                        |  |        |        |       |                              |  
|June 30, 2005:                          |  |        |        |       |                              |   |        |                                                                  |        |  |     |        |  |       |        |  |      |  
|Total capital to risk weighted assets   |  | $      | 69,874 |       | 10.6                         | % |        | $                                                                | 52,817 |  | 8.0 | %      |  | $     | 66,021 |  | 10.0 | %
|Tier I capital to risk weighted assets  |  |        | 62,425 |       | 9.5                          |   |        |                                                                  | 26,409 |  | 4.0 |        |  |       | 39,613 |  | 6.0  |  
|Tier I capital to adjusted total assets |  |        | 62,425 |       | 7.8                          |   |        |                                                                  | 32,198 |  | 4.0 |        |  |       | 40,247 |  | 5.0  |  



EARNINGS PER SHARE



A reconciliation between the weighted average shares outstanding used in the basic and
diluted EPS computations is as follows for the three-month periods ended September 30, 2005 and September 24, 2004 (in thousands, except share and per share amounts):



|                                                                     |  |                    |       |                    |   |       
|-------------------------------------------------------------------- |  | ------------------ | ----- | ------------------ | - | ------
|                                                                     |  | Three Months Ended
|                                                                     |  | September 30, 2005 |       | September 24, 2004
|Income before cumulative effect of a change in accounting principles |  | $                  | 7,097 |                    | $ | 15,888
|Cumulative effect of a change in accounting principles               |  |                    | 75    |                    |   |      
|                                                                     |  |                    |       |                    |   |       
|Net income                                                           |  | $                  | 7,172 |                    | $ | 15,888
|                                                                     |  |                    |       |                    |   |       



- 16 -



---

##### Table of Contents

|                                                                     |  |                    |            |                    |   |           
|-------------------------------------------------------------------- |  | ------------------ | ---------- | ------------------ | - | ----------
|                                                                     |  | Three Months Ended
|                                                                     |  | September 30, 2005 |            | September 24, 2004
|Weighted average shares outstanding  basic                          |  |                    | 17,328,934 |                    |   | 17,139,822
|Effect of dilutive securities:                                       |  |                    |            |                    |   |           
|Assumed exercise of stock options                                    |  |                    | 82,640     |                    |   | 31,966    
|Restricted stock                                                     |  |                    | 105,449    |                    |   | 70,801    
|                                                                     |  |                    |            |                    |   |           
|Weighted average shares outstanding  diluted                        |  |                    | 17,517,023 |                    |   | 17,242,589
|                                                                     |  |                    |            |                    |   |           
|Earnings per share  basic                                           |  |                    |            |                    |   |           
|Income before cumulative effect of a change in accounting principles |  | $                  | 0.41       |                    | $ | 0.93      
|Cumulative effect of a change in accounting principles               |  |                    |           |                    |   |          
|                                                                     |  |                    |            |                    |   |           
|Net income                                                           |  | $                  | 0.41       |                    | $ | 0.93      
|                                                                     |  |                    |            |                    |   |           
|Earnings per share  diluted                                         |  |                    |            |                    |   |           
|Income before cumulative effect of a change in accounting principles |  | $                  | 0.41       |                    | $ | 0.92      
|Cumulative effect of a change in accounting principles               |  |                    |           |                    |   |          
|                                                                     |  |                    |            |                    |   |           
|Net income                                                           |  | $                  | 0.41       |                    | $ | 0.92      
|                                                                     |  |                    |            |                    |   |           



At September 30, 2005 and
September 24, 2004, there were approximately 1.3 million and 1.6 million options outstanding under the two stock option plans, respectively. See -Stock Option and Restricted Stock Plans. As of September 30, 2005 and
September 24, 2004, approximately 167,868 and 307,296 outstanding options, respectively, were anti-dilutive and therefore were not included in the calculation of weighted average shares outstanding-dilutive.



REPURCHASE OF TREASURY STOCK



The Board of Directors has authorized the repurchase of up to 500,000 shares of SWS common
stock for which authorization expires December 31, 2006. No shares were repurchased by SWS under this program from February 2003 through September 30, 2005. SWS did repurchase shares during October 2005. See - Subsequent Event.



Additionally, the trustee under SWS deferred compensation plan
periodically purchases 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 future dividends declared by SWS. The plan did not
purchase any shares in the three-month period ended September 30, 2005. The plan purchased 8,768 shares in the three-month period ended September 24, 2004 at a cost of $125,000, or $14.26 per share. During the three-month period ended
September 24, 2004, 544 shares were sold or withdrawn from the plan and 1,442 shares were removed from treasury for future withdrawals for terminated employees. On August 18, 2005, one third of the shares previously granted under the
restricted stock plan vested. The fair value of the vested shares was $391,000. Upon vesting, a portion of the grantees chose to sell a portion of their vested shares to cover the tax liabilities arising from the vesting. As a result, 3,468 shares
were repurchased with a market value of $58,000 or $16.84 per share.



SEGMENT REPORTING



SWS operates three principal segments
within the financial services industry: the Brokerage Group, the Asset Management Group and the Banking Group. There have been no changes in the basis of segmentation or in the basis of measurement of segment profit or loss since last reported. The
Brokerage Group no longer includes May Financial as this entity was dissolved on December 31, 2004. The balances for this entity are included in the amounts presented for the three month period ended and as of September 24, 2004, but are
not included in the September 30, 2005 amounts.



- 17 -



---

##### Table of Contents

SWS Capital, an entity within the Asset Management Group, determined that it would not renew its contract as General
Manager of LOGIC upon the expiration of the original agreement on September 4, 2005. LOGIC represented 100% of the assets under management for this entity through the expiration of the agreement.



The category other consolidated entities includes SWS Group and SWS Insurance.
SWS Group is a holding company that owns various investments, including the investment in USHS common stock. See -Marketable Equity Securities. SWS Insurance facilitates the sale of insurance and annuities for customers of Southwest
Securities and its correspondents. There are no material reconciling adjustments included in this category.



|                                                                              |  |                 |           |   |                      |   |              |  |                           |         |  |                            |        |   |  |   |          
|----------------------------------------------------------------------------- |  | --------------- | --------- | - | -------------------- | - | ------------ |  | ------------------------- | ------- |  | -------------------------- | ------ | - |  | - | ---------
|(in thousands)                                                                |  | Brokerage Group |           |   | AssetManagementGroup |   | BankingGroup |  | OtherConsolidatedEntities |         |  | ConsolidatedSWS Group,Inc.
|Three months ended September 30, 2005                                         |  |                 |           |   |                      |   |              |  |                           |         |  |                            |        |   |  |   |          
|Net revenues from external sources                                            |  | $               | 80,571    |   |                      | $ | 131          |  | $                         | 20,541  |  | $                          | 556    |   |  | $ | 101,799  
|Net intersegment revenue (expense)                                            |  |                 | (913      | ) |                      |   |             |  |                           | 1,019   |  |                            | (106   | ) |  |   |         
|Net interest revenue (expense)                                                |  |                 | 9,536     |   |                      |   |             |  |                           | 14,191  |  |                            | (50    | ) |  |   | 23,677   
|Depreciation and amortization                                                 |  |                 | 1,220     |   |                      |   | 1            |  |                           | 235     |  |                            |       |   |  |   | 1,456    
|Income before income taxes and minority interest in consolidated subsidiaries |  |                 | 7,047     |   |                      |   |             |  |                           | 5,459   |  |                            | (1,397 | ) |  |   | 11,109   
|Net income                                                                    |  |                 | 4,095     |   |                      |   |             |  |                           | 3,880   |  |                            | (803   | ) |  |   | 7,172    
|Segment assets                                                                |  |                 | 3,332,260 |   |                      |   | 585          |  |                           | 825,467 |  |                            | 23,133 |   |  |   | 4,181,445
|Expenditures for long-lived assets                                            |  |                 | 355       |   |                      |   |             |  |                           | 475     |  |                            |       |   |  |   | 830      
|                                                                              |  |                 |           |   |                     
|Three months ended September 24, 2004                                         |  |                 |           |   |                      |   |              |  |                           |         |  |                            |        |   |  |   |          
|Net revenues from external sources                                            |  | $               | 52,588    |   |                      | $ | 149          |  | $                         | 12,713  |  | $                          | 19,173 |   |  | $ | 84,623   
|Net intersegment revenue (expense)                                            |  |                 | (747      | ) |                      |   |             |  |                           | 760     |  |                            | (13    | ) |  |   |         
|Net interest revenue (expense)                                                |  |                 | 7,286     |   |                      |   |             |  |                           | 9,806   |  |                            | (20    | ) |  |   | 17,072   
|Depreciation and amortization                                                 |  |                 | 1,500     |   |                      |   | 2            |  |                           | 166     |  |                            |       |   |  |   | 1,668    
|Income before income taxes and minority interest in consolidated subsidiaries |  |                 | 2,234     |   |                      |   | 5            |  |                           | 4,697   |  |                            | 17,720 |   |  |   | 24,656   
|Net income                                                                    |  |                 | 1,251     |   |                      |   | 3            |  |                           | 3,123   |  |                            | 11,511 |   |  |   | 15,888   
|Segment assets                                                                |  |                 | 4,442,806 |   |                      |   | 574          |  |                           | 622,912 |  |                            | 21,249 |   |  |   | 5,087,541
|Expenditures for long-lived assets                                            |  |                 | 654       |   |                      |   |             |  |                           | 455     |  |                            |       |   |  |   | 1,109    



On the consolidated statements of
income and comprehensive income, minority interest is solely related to the Banking Group and other comprehensive income (loss) is solely related to SWS Group, which is included in the Other Consolidated Entities category, above.



COMMITMENTS, CONTINGENCIES and GUARANTEES



Commitments and Contingencies. 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 proceedings. These claims allege violation of federal and state securities laws. 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, other than as described below, will not result in any material adverse effect on SWS consolidated
financial position, results of operations or cash flows.



Fraudulent
Mortgages:During the first quarter of fiscal 2003, the Bank provided $3,400,000 ($2,200,000 after tax impact on earnings) to establish a reserve for fraudulent mortgages purchased from one New York based mortgage bank. Sixteen loans,
aggregating approximately $3,400,000 were sold twice by the mortgage bank and the Bank is not receiving payments on these loans. At this time, the likelihood of recovery cannot be estimated.



- 18 -



---

##### Table of Contents

Venture Capital Fund: SWS has committed $5,000,000 to invest in a limited partnership venture capital fund.
As of September 30, 2005, SWS had contributed $4,000,000 of its commitment. Under the terms of the agreement, no more than 30% of the commitment will be drawn in any 12-month period.



Underwriting: Through its participation in underwriting, both corporate and municipal, SWS could expose itself to material
risk since the possibility exists 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. Total open underwritings at September 30, 2005 were $277,268,000. All open underwritings are generally scheduled to be settled within the
next 60 days and are expected to have no material effect on the consolidated financial statements.



Guarantees.In March 2002, SWS issued a loan guarantee for FSB Financial for $10,000,000. The guarantee is based on a loan agreement between FSB Financial and the Bank. SWS has agreed to guarantee funds drawn
on the loan in excess of $25,000,000, up to a maximum of $35,000,000. At September 30, 2005, the Bank had loaned $27,100,000 to FSB Financial. As a result of this loan, if FSB Financial defaults on the loan to the Bank, SWS would be liable for
$2,100,000 of the total loan outstanding. SWS has not recorded a liability for the guarantee in its financial statements, as FIN No. 45 Guarantors Accounting and Disclosure Requirements for Guarantees, Including Indirect
Guarantees of Indebtedness of Others, an interpretation of SFAS No. 5-Contingencies, SFAS No. 57-Related Party, and SFAS No. 107-Disclosure of Fair Value of Financial Instruments and rescission of Financial Accounting Standards Board
Interpretation No. 34 requires disclosure only of guarantees issued between parents and their subsidiaries.



In connection with the 2002 spin-off of SWS primary asset management subsidiary, the Westwood Holdings Group, Inc., SWS agreed to indemnify the Westwood Holdings
Group, Inc. from and against any and all past and future liabilities or expenses in excess of $500,000 arising from the Richard A. Boykin Jr. Family Trust (Boykin Trust), for which Westwood Trust currently serves as trustee. The Boykin
Trust is currently in bankruptcy. SWS settled litigation with the beneficiaries of the Boykin Trust in May 2002 for $2,000,000. SWS management believes that the resolution of the remaining issues associated with the Boykin Trust in bankruptcy
will not have a material impact on SWS consolidated financial statements.



The Bank has stand-by letters of credit primarily issued for assigned notes and real estate. The maximum potential amount of future payments the Bank could be required to make under the letters of credit is $446,000. The recourse provisions
of the letters of credit allow the amount of the letters of credit to become a part of the fully collateralized loans with total repayment. The collateral on these letters of credit consist of assigned notes, real estate, equipment, accounts
receivable or furniture and fixtures.



SWS is a member of an exchange and
multiple 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 exchange 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.



- 19 -



---

##### Table of Contents

ACCOUNTING PRONOUNCEMENTS



In December 2004, the Accounting Standards Executive Committee of the American Institute of Certified Public Accountants issued Statement of
Position (SOP) 03-3, Accounting for Certain Loans or Debt Securities Acquired in a Transfer (SOP 03-3). This SOP requires loans acquired in a transfer, including loans acquired in the acquisition of a bank
or branch, to be accounted for at fair value. SOP 03-3 was adopted during the first quarter of fiscal 2006 and did not have a material impact on the Companys consolidated financial statements.



SUBSEQUENT EVENT



In October 2005, SWS repurchased 31,090 shares at a cost of $478,000 or $15.36 per share, in accordance with the repurchase plan. See
-Repurchase of Treasury Stock.



In October 2005, FSB Financial sold
$3.6 million of their Dan Nelson Automotive Group, Inc. loan portfolio, recognizing a $47,000 loss. After the sale, $4.2 million of the original Dan Nelson Automotive Group, Inc. loan portfolio remains with FSB Financial.



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



OVERVIEW



SWS Group, Inc. (we, us, SWS or the Company) is engaged in full-service securities brokerage primarily through Southwest Securities, Inc. (Southwest
Securities) and full-service commercial banking through Southwest Securities Bank (the Bank). 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 that 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.



We are currently focused on three aspects of our business: growing our clearing business,
taking advantage of our prominence in the Southwest to become a nationally recognized full-service regional brokerage firm and growing the Banks business.



Brokerage Group



Growth in the U.S. equities market increased in the first quarter of fiscal 2006 as the Dow Jones Industrial Average rose from 10,297.83 at June 24, 2005 to
10,568.70 at September 30, 2005. Trading volumes also increased with average daily volume on the New York Stock Exchange (NYSE) of 1.5 billion shares for the first quarter of fiscal 2006 compared to 1.3 billion in the same period
last year.



The revenues generated by our clearing business are dependent on
active markets. Sustained growth in volumes is necessary for growth in our clearing business. While the volume of trades we processed in the first three months of fiscal 2006 was down compared to the same period in the prior year, the decrease was a
result of one of our high volume trading customers clearing through an affiliate of its parent beginning in the second quarter of fiscal 2005. Trading volume from our general securities customers increased 43% over last year due to a more active
market.



Month-end margin balances reported by NYSE member firms averaged $212
billion in the first quarter of fiscal 2006 versus $177 billion in fiscal 2005. We rely on margin lending to our customers to generate revenue. Sustained improvement in stock prices are necessary to promote growth in margin balances and to
facilitate earnings growth from margin lending to our customers. Our margin balances averaged $322,990,000, down 11.9% over the comparable period last year. This decrease is primarily related to decreased margin balances of our clearing customers.



- 20 -



---

##### Table of Contents

Stock loan balances are also influenced by the volumes in the market as well as interest rates. Our stock lending
balances decreased more than 9% over the comparable period last year. As markets improve, these balances generally increase subject to credit limits imposed by our counter-parties and us. Stock lending generates an interest spread that is impacted
by the overall interest rate environment. As rates have risen, we have had the opportunity to widen the interest spread we earn.



The interest rate environment also impacts our fixed income business. In the first three months of fiscal 2006, the Federal Reserve Board continued to increase the
discount rate with the rate rising 50 basis points. This negatively impacted revenues in our fixed income business. The volume of our fixed income business is driven by market perception of the direction and volatility of rates and economic
expectations. Management constantly monitors our exposure to interest rate fluctuations to mitigate risk of loss in volatile interest rate environments.



To realize our goal of becoming a nationally recognized full-service regional brokerage firm, it is essential to grow the retail brokerage distribution network. This will
be accomplished by hiring additional registered representatives and, secondarily, by opening new branch office locations in the Southwest. Opening new branch offices requires an outlay of capital that may not be immediately offset by revenues, which
will negatively impact results of operations until new locations become positive contributors. However, we are currently focused on filling our existing offices with producing registered representatives and have no present intentions to open any
branch offices. We hired 4 new registered representatives in the first quarter of fiscal 2006.



Equity capital markets is an integral part of a full-service regional firm. Revenue from this area is cyclical and varies significantly with the vitality of the equity markets. Investment in personnel could negatively
impact earnings in periods of limited equity capital markets activity.



Our
emphasis on the full-service brokerage aspect of our business is expected to diversify our revenue stream and to enhance areas of our business that have relatively higher margins than our traditional clearing business. In the full-service brokerage
section of our business, we retain more of each dollar of commission than in a traditional clearing arrangement. As the full-service business grows, we expect to be able to take advantage of the increased margins. Management will be reviewing
profitability as well as productivity by registered representatives, transactions processed and deals completed to measure success in our full service brokerage business.



We continue to upgrade and enhance the core operating system with investments in technology. Management continually reviews equipment and
communications in an effort to offset some of the costs of software enhancement. Our system was developed by Comprehensive Software Systems, Inc. (CSS), an entity that is backed by a consortium of brokerage firms, including Southwest
Securities. The development of the system required more time and capital from these brokerage firms than was originally anticipated. While the system is fully functional at SWS, other consortium members have yet to completely install the system.
Decisions by these other firms will impact CSS ability to continue to deliver new modules and enhancements and could impact the cost of technology to us.



Banking Group



A substantial portion of the Banks revenue is generated from the single-family construction loan and single-family mortgage loan markets. While the Banks purchased mortgage loan and auto loan programs are
nationwide, the majority of the Banks other lending is concentrated in North Texas. A strong housing market in North Texas is important to growing the Banks loan portfolio.



Mortgage interest rates increased slightly in the first quarter of fiscal 2006 as compared to the first quarter of fiscal 2005. The average
balances in the Banks purchased mortgage loan program, increased 63% over the average balances in the first quarter of fiscal 2005. In the event mortgage interest rates increase, the Bank could experience lower revenues from these operations.



- 21 -



---

##### Table of Contents

To fund loan growth in excess of the existing liquidity, the Bank utilized Federal Home Loan Bank (FHLB)
short-term borrowings and brokered certificates of deposit.



The Bank continued
to diversify its lending base through increased commercial lending. The Banks commercial real estate lending was up 17% from the comparable quarter last year due to a continued focus on the Banks Community Banking division, and consumer
loans were up approximately 18% over the comparable quarter last year.



Events and Transactions



Several material events and
transactions impacted the results of operations in the periods presented. A description of the facts and circumstances surrounding these transactions and the impact on our results are discussed below.



Archipelago. In August 2004, Archipelago Holdings, L.L.C.
(Archipelago) declared an approximately 1 for 4.5 reverse stock split. After the split, we owned 67,435 shares of Archipelago stock. On August 19, 2004, Archipelago completed an initial public offering of its common stock in which
we sold 23,714 shares at $10.695 per share, yielding a gain of $254,000 (an after-tax gain of $165,100). On May 24, 2005, SWS sold 20,000 shares at an average price of $32.97 for a gain of $659,000. After giving effect to these transactions, we
own 23,721 shares of Archipelago stock. We recorded a gain of $658,000 in the first quarter of fiscal 2005 from the market appreciation of the remaining Archipelago shares. Comparably, we recorded a loss of $11,000 in the first quarter of fiscal
2006 from a decline in the market price.



Maturity of DARTSSM.In June 1999, we issued 5% Exchangeable Subordinated
Notes in the form of DARTSSM(or, Derivative Adjustable Ratio SecuritiesSM). The DARTSSMcontained an equity-based derivative designed to hedge changes in the fair value of our investment in Knight Trading Group, Inc. common stock. The embedded derivative was designated as a fair value hedge of our investment in Knight
shares. The DARTSSMmatured June 30, 2004, at which time we delivered 373,550 shares of Knight stock to the
DARTSSMholders in satisfaction of our obligation in accordance with the terms of the governing agreements. Delivery
of the Knight shares upon maturity of this obligation resulted in a gain of $18,732,000, equal to the difference in the fair value of the Knight stock upon acquisition and the fair value of the Knight stock on the issuance date of the
DARTSSM(i.e. the hedging date).



Investment in Comprehensive Software Systems, Inc.In 1993, SWS became a part owner of CSS, a software development company
formed to develop a new brokerage front and back office system. We initially acquired a 7.96% interest in CSS and accounted for the investment on the cost basis. Through subsequent investments, our ownership in CSS increased to 25.08% in fiscal
2002. Consequently, we implemented the equity method of accounting prescribed by APB Opinion No. 18, The Equity Method of Accounting for Investments in Common Stock. We were the first company, and to date the only company, to
fully implement the CSS system. We completed our installation of the system in September 2002. At June 28, 2002, we determined that the investment in CSS and its related goodwill were fully impaired based on an analysis of the projected cash
flow from the investment.



To facilitate the continued enhancement of the CSS
system, we entered into an agreement in December 2002, amended in June 2003, to loan CSS $3,500,000. In December 2003, we agreed to an additional equity investment of $2,900,000, resulting in the purchase of 5.8 million shares of CSS common
stock. The purchases were made in four equal quarterly installments totaling $2,885,900 (two purchases totaling approximately $1,443,000 were made in fiscals 2004 and 2005) and ultimately resulted in increasing our position in CSS to 30.22%. In
January 2005, we forgave the $3,500,000 loan made in fiscal 2003, converting it to an equity contribution. These investments were made to insure the continued operation of CSS while development of needed enhancements to the system was built.



- 22 -



---

##### Table of Contents

In January 2005, we did not participate in CSS equity offering because we were no longer dependent on CSS for
enhancements to the system. We have developed many of the functions needed to run the CSS system in-house. Subsequent to the equity offering in January 2005, we own 13.7% of CSS. Because no additional investments were made in CSS in the last half of
fiscal 2005, we did not record any equity in losses of CSS. As of September 30, 2005, there is no recorded equity investment in CSS.



For the three-month period ended September 24, 2004, our pro-rata share of CSS losses was $767,000, which was greater than the $721,000 purchased by $46,000.
For the three-month period ended September 30, 2005, our pro-rata share of CSS losses was $191,000. From inception of the loan to date, based on our percentage of ownership, our pro-rata share of losses of $7,924,000 was greater than the
$6,386,000 loaned and invested by $1,538,000.



RESULTS OF OPERATIONS



Net income for the three-month period ended September 30, 2005 was
$7,172,000 representing a decrease of $8,895,000 over net income for the comparable three-month period ended September 24, 2004 of $15,888,000. The three-month period ended September 30, 2005 contained 68 trading days as compared to the 63
trading days in the comparable period last year.



Our pretax income was
$11,109,000 and $24,656,000 for the three months ended September 30, 2005 and September 24, 2004, respectively.



The following is a summary of increases (decreases) in categories of net revenues and operating expenses for the three-month period ended September 30, 2005 compared
to the three-month period ended September 24, 2004 (dollars in thousands):



|                                                     |  |        |         |   |   |     |   
|---------------------------------------------------- |  | ------ | ------- | - | - | --- | --
|                                                     |  | Amount |         |   | % |    
|Net revenues:                                        |  |        |         |   |   |     |   
|Net revenues from clearing operations                |  | $      | 50      |   |   | 1   | % 
|Commissions                                          |  |        | 1,845   |   |   | 10  |   
|Net interest                                         |  |        | 6,605   |   |   | 39  |   
|Investment banking, advisory and administrative fees |  |        | 2,329   |   |   | 34  |   
|Net gains on principal transactions                  |  |        | (17,316 | ) |   | (78 | ) 
|Other                                                |  |        | 752     |   |   | 14  |   
|                                                     |  |        |         |   |   |     |   
|                                                     |  |        | (5,735  | ) |   | (8  | ) 
|                                                     |  |        |         |   |   |     |   
|Operating expenses:                                  |  |        |         |   |   |     |   
|Commissions and other employee compensation          |  |        | 7,525   |   |   | 24  |   
|Occupancy, equipment and computer service costs      |  |        | (1,107  | ) |   | (16 | ) 
|Communications                                       |  |        | (603    | ) |   | (20 | ) 
|Floor brokerage and clearing organization charges    |  |        | (287    | ) |   | (18 | ) 
|Advertising and promotional                          |  |        | (143    | ) |   | (17 | ) 
|Other                                                |  |        | 2,427   |   |   | 42  |   
|                                                     |  |        |         |   |   |     |   
|                                                     |  |        | 7,812   |   |   | 16  |   
|                                                     |  |        |         |   |   |     |   
|Pretax income                                        |  | $      | (13,547 | ) |   | (55 | )%
|                                                     |  |        |         |   |   |     |   



Net revenues decreased for the first
quarter of fiscal 2006 by $5,735,000. The largest component of the decrease was in net gains on principal transactions, which decreased $17,316,000, due primarily to the $18,732,000 gain attributable to the DARTSSMmaturity recorded in the first quarter of fiscal 2005. Commissions revenue increased as a result of increased registered representatives within the
Private Client Group and increased production within Portfolio Trading. Net interest revenue increased primarily due to increased spreads in the stock lending business as well as an increase in the Banks average loans outstanding. An increase
in public finance fees resulted in increased investment banking, advisory and administrative fees.



- 23 -



---

##### Table of Contents

Operating expenses increased $7,812,000 for the three months ended September 30, 2005. The largest increases were in
commissions and other employee compensation and other expenses. The increase in commissions and other employee compensation is due primarily to increased business line revenues. The increase in other expenses was due primarily to the Banks
increase in its allowance for probable loan losses and an increase in other tax expenses.



Net Revenues from Clearing Operations. Net clearing revenues increased $50,000 when compared to the three months ended September 24, 2004. We processed 2,409,901 transactions during the first
quarter of fiscal 2006 compared to 4,870,482 transactions during the comparable period of the prior year. The reduction in transactions was primarily in the day trader business, which has a lower fee per ticket. The reduction in day trader
transactions was offset slightly by an increase in the general securities business which has a higher fee per ticket. Consequently, revenue per transaction increased to $1.54 for the three months ended September 30, 2005 from $0.75 for the
three months ended September 24, 2004.



Commissions.Commission revenue increased 10% for the three-month period ended September 30, 2005 compared to the three-month period ended September 24, 2004 as a result of increased trading volumes. The largest increases were recorded in Portfolio
Trading, Private Client Group and SWS Financial Representatives. The increases were offset by decreases in commission revenue in Institutional Equity Sales and Fixed Income Sales and Trading. Improved market conditions and revenue from newly
recruited representatives were the primary reasons for the increased revenue. Commission revenue by type of representative is as follows (dollars in thousands):



|                              |  |                    |        |                    |   |                   |  |                   |  |    
|----------------------------- |  | ------------------ | ------ | ------------------ | - | ----------------- |  | ----------------- |  | ---
|                              |  | Commission Revenue |        | No. of Reps       
|                              |  | Three Months Ended |        | Three Months Ended
|                              |  | September 30,2005  |        | September 24,2004  |   | September 30,2005 |  | September 24,2004
|Southwest Securities brokers: |  |                    |        |                    |   |                   |  |                   |  |    
|Private Client Group          |  | $                  | 5,367  |                    | $ | 4,653             |  | 98                |  | 89 
|Fixed Income Sales & Trading  |  |                    | 5,610  |                    |   | 5,861             |  | 35                |  | 37 
|Institutional Equity Sales    |  |                    | 1,266  |                    |   | 1,863             |  | 8                 |  | 10 
|SWS Financial Representatives |  |                    | 5,446  |                    |   | 4,753             |  | 384               |  | 402
|Portfolio Trading             |  |                    | 3,302  |                    |   | 1,855             |  |                   |  |    
|Other                         |  |                    | 79     |                    |   | 240               |  |                   |  |    
|                              |  |                    |        |                    |   |                   |  |                   |  |    
|                              |  | $                  | 21,070 |                    | $ | 19,225            |  |                   |  |    
|                              |  |                    |        |                    |   |                   |  |                   |  |    



Net Interest Income.Net interest income from the Brokerage Group 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 from the Bank and represents the amount by which interest and fees generated by earning assets exceed the cost of funds, primarily interest paid to the Banks depositors on interest-bearing accounts.



- 24 -



---

##### Table of Contents

The components of interest earnings are as follows for the three-month periods ended September 30, 2005 and
September 24, 2004 (in thousands):



|                                                                       |  |                    |        |                   |   |       
|---------------------------------------------------------------------- |  | ------------------ | ------ | ----------------- | - | ------
|                                                                       |  | Three Months Ended
|                                                                       |  | September 30,2005  |        | September 24,2004
|Interest revenue:                                                      |  |                    |        |                   |   |       
|Customer margin accounts and assets segregated for regulatory purposes |  | $                  | 9,059  |                   | $ | 5,865 
|Stock borrowed                                                         |  |                    | 27,034 |                   |   | 9,022 
|Bank loans                                                             |  |                    | 19,431 |                   |   | 11,867
|Other                                                                  |  |                    | 1,344  |                   |   | 598   
|                                                                       |  |                    |        |                   |   |       
|                                                                       |  | $                  | 56,868 |                   | $ | 27,352
|                                                                       |  |                    |        |                   |   |       
|Interest expense:                                                      |  |                    |        |                   |   |       
|Customer funds on deposit                                              |  | $                  | 4,058  |                   | $ | 1,066 
|Stock loaned                                                           |  |                    | 23,109 |                   |   | 6,659 
|Bank deposits                                                          |  |                    | 3,845  |                   |   | 1,498 
|Federal Home Loan Bank advances                                        |  |                    | 908    |                   |   | 385   
|Notes payable                                                          |  |                    | 691    |                   |   | 333   
|DARTSSMand Other                                                       |  |                    | 580    |                   |   | 339   
|                                                                       |  |                    |        |                   |   |       
|                                                                       |  |                    | 33,191 |                   |   | 10,280
|                                                                       |  |                    |        |                   |   |       
|Net interest                                                           |  | $                  | 23,677 |                   | $ | 17,072
|                                                                       |  |                    |        |                   |   |       



Brokerage
Group:For the three months ended September 30, 2005 and September 24, 2004, net interest income from the Brokerage Group accounted for approximately 13.8% and 9.8%, respectively, of our net revenue. Average balances of
interest-earning assets and interest-bearing liabilities are as follows (in thousands):



|                                          |  |                    |           |                   |   |          
|----------------------------------------- |  | ------------------ | --------- | ----------------- | - | ---------
|                                          |  | Three Months Ended
|                                          |  | September 30,2005  |           | September 24,2004
|Average interest-earning assets:          |  |                    |           |                   |   |          
|Customer margin balances                  |  | $                  | 323,000   |                   | $ | 367,000  
|Assets segregated for regulatory purposes |  |                    | 341,000   |                   |   | 379,000  
|Stock borrowed                            |  |                    | 2,573,000 |                   |   | 2,845,000
|                                          |  |                   
|Average interest-bearing liabilities:     |  |                    |           |                   |   |          
|Customer funds on deposit                 |  |                    | 547,000   |                   |   | 607,000  
|Stock loaned                              |  |                    | 2,490,000 |                   |   | 2,745,000



Net interest revenue from customer
balances increased 4% for the three months ended September 30, 2005 over the first quarter of fiscal 2005 due primarily to increased earnings on assets segregated for regulatory purposes. The increase in net interest revenue generated from
securities lending activities for the quarter of 66% is due to an increase in the net interest spread of 17 basis points, offset slightly by decreased average balances. The type of securities borrowed or loaned and the interest rate environment
influence the spread earned in this business.



Banking
Group:Net interest revenue generated by the Bank accounted for approximately 20.7% and 13.2% of net revenue in the three-month periods ended September 30, 2005 and September 24,



- 25 -



---

##### Table of Contents

2004, respectively. At the Bank, changes in net interest revenue are generally attributable to the timing of loan payoffs
and volume. Changes in net interest revenue are also a result of average balance changes and the overall interest rate environment.



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-month periods ended September 30, 2005 and September 30, 2004 (dollars in thousands):



|                                                                                            |  |                    |         |                        |                    |            |  |      |                |  |                        |         |            |   |        |  |      |  
|------------------------------------------------------------------------------------------- |  | ------------------ | ------- | ---------------------- | ------------------ | ---------- |  | ---- | -------------- |  | ---------------------- | ------- | ---------- | - | ------ |  | ---- | -
|                                                                                            |  | Three Months Ended |        
|                                                                                            |  | September 30, 2005 |         |                        | September 30, 2004 |           
|                                                                                            |  | AverageBalance     |         | InterestIncome/Expense |                    | Yield/Rate |  |      | AverageBalance |  | InterestIncome/Expense |         | Yield/Rate |  
|Assets:                                                                                     |  |                    |         |                        |                    |            |  |      |                |  |                        |         |            |   |        |  |      |  
|Interest-earning assets:                                                                    |  |                    |         |                        |                    |            |  |      |                |  |                        |         |            |   |        |  |      |  
|Real estate  mortgage                                                                      |  | $                  | 225,380 |                        | $                  | 4,523      |  | 8.0  | %              |  | $                      | 144,210 |            | $ | 2,155  |  | 5.9  | %
|Real estate  construction                                                                  |  |                    | 147,179 |                        |                    | 3,278      |  | 8.8  |                |  |                        | 111,847 |            |   | 1,856  |  | 6.6  |  
|Commercial                                                                                  |  |                    | 237,033 |                        |                    | 4,832      |  | 8.1  |                |  |                        | 186,500 |            |   | 3,418  |  | 7.3  |  
|Individual(*)                                                                               |  |                    | 86,281  |                        |                    | 4,925      |  | 22.7 |                |  |                        | 71,159  |            |   | 3,571  |  | 19.9 |  
|Land                                                                                        |  |                    | 82,717  |                        |                    | 1,873      |  | 9.0  |                |  |                        | 48,988  |            |   | 867    |  | 7.0  |  
|Investments                                                                                 |  |                    | 10,606  |                        |                    | 98         |  | 3.7  |                |  |                        | 44,635  |            |   | 143    |  | 1.3  |  
|                                                                                            |  |                    |         |                        |                    |            |  |      |                |  |                        |         |            |   |        |  |      |  
|                                                                                            |  |                    | 789,196 |                        | $                  | 19,529     |  | 9.8  | %              |  |                        | 607,339 |            | $ | 12,010 |  | 7.9  | %
|Noninterest-earning assets:                                                                 |  |                    |         |                        |                    |            |  |      |                |  |                        |         |            |   |        |  |      |  
|Cash and due from banks                                                                     |  |                    | 8,915   |                        |                    |            |  |      |                |  |                        | 7,923   |            |   |        |  |      |  
|Other assets                                                                                |  |                    | 17,036  |                        |                    |            |  |      |                |  |                        | 12,111  |            |   |        |  |      |  
|                                                                                            |  |                    |         |                        |                    |            |  |      |                |  |                        |         |            |   |        |  |      |  
|                                                                                            |  | $                  | 815,147 |                        |                    |            |  |      |                |  | $                      | 627,373 |            |   |        |  |      |  
|                                                                                            |  |                    |         |                        |                    |            |  |      |                |  |                        |         |            |   |        |  |      |  
|(*)Individual interest-earning assets are primarily composed of sub-prime automobile
loans. | 
|                                                                                            |  |                    |         |                        |                    |           
|Liabilities and Stockholders Equity:                                                       |  |                    |         |                        |                    |            |  |      |                |  |                        |         |            |   |        |  |      |  
|Interest-bearing liabilities:                                                               |  |                    |         |                        |                    |            |  |      |                |  |                        |         |            |   |        |  |      |  
|Certificates of deposit                                                                     |  | $                  | 122,295 |                        | $                  | 1,001      |  | 3.3  | %              |  | $                      | 110,519 |            | $ | 870    |  | 3.1  | %
|Money market accounts                                                                       |  |                    | 19,667  |                        |                    | 116        |  | 2.3  |                |  |                        | 16,940  |            |   | 33     |  | 0.8  |  
|Interest-bearing demand accounts                                                            |  |                    | 55,628  |                        |                    | 287        |  | 2.1  |                |  |                        | 54,129  |            |   | 77     |  | 0.6  |  
|Savings accounts                                                                            |  |                    | 368,384 |                        |                    | 2,441      |  | 2.6  |                |  |                        | 295,031 |            |   | 518    |  | 0.7  |  
|Federal Home Loan Bank advances                                                             |  |                    | 93,307  |                        |                    | 908        |  | 3.9  |                |  |                        | 35,843  |            |   | 385    |  | 4.3  |  
|Notes payable                                                                               |  |                    | 41,558  |                        |                    | 691        |  | 6.6  |                |  |                        | 22,250  |            |   | 333    |  | 5.9  |  
|                                                                                            |  |                    |         |                        |                    |            |  |      |                |  |                        |         |            |   |        |  |      |  
|                                                                                            |  |                    | 700,839 |                        |                    | 5,444      |  | 3.1  | %              |  |                        | 534,712 |            |   | 2,216  |  | 1.6  | %
|Noninterest-bearing liabilities:                                                            |  |                    |         |                        |                    |            |  |      |                |  |                        |         |            |   |        |  |      |  
|Non interest-bearing demand accounts                                                        |  |                    | 36,277  |                        |                    |            |  |      |                |  |                        | 26,425  |            |   |        |  |      |  
|Other liabilities                                                                           |  |                    | 9,362   |                        |                    |            |  |      |                |  |                        | 5,812   |            |   |        |  |      |  
|                                                                                            |  |                    |         |                        |                    |            |  |      |                |  |                        |         |            |   |        |  |      |  
|                                                                                            |  |                    | 746,478 |                        |                    |            |  |      |                |  |                        | 566,949 |            |   |        |  |      |  
|Stockholders equity                                                                        |  |                    | 68,669  |                        |                    |            |  |      |                |  |                        | 60,424  |            |   |        |  |      |  
|                                                                                            |  |                    |         |                        |                    |            |  |      |                |  |                        |         |            |   |        |  |      |  
|                                                                                            |  | $                  | 815,147 |                        |                    |            |  |      |                |  | $                      | 627,373 |            |   |        |  |      |  
|                                                                                            |  |                    |         |                        |                    |            |  |      |                |  |                        |         |            |   |        |  |      |  
|Net interest income                                                                         |  |                    |         |                        | $                  | 14,085     |  |      |                |  |                        |         |            | $ | 9,794  |  |      |  
|                                                                                            |  |                    |         |                        |                    |            |  |      |                |  |                        |         |            |   |        |  |      |  
|Net yield on interest-earning assets                                                        |  |                    |         |                        |                    |            |  | 7.1  | %              |  |                        |         |            |   |        |  | 6.4  | %
|                                                                                            |  |                    |         |                        |                    |            |  |      |                |  |                        |         |            |   |        |  |      |  



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



- 26 -



---

##### Table of Contents

The following table sets forth a summary of the changes in the Banks interest earned and interest paid resulting
from changes in volume and rate (in thousands):



|                                 |  |                                                  |        |   |               |      |       |   |     |   |       |   |  |   |      |  
|-------------------------------- |  | ------------------------------------------------ | ------ | - | ------------- | ---- | ----- | - | --- | - | ----- | - |  | - | ---- | -
|                                 |  | Three months ended                               |       
|                                 |  | September 30, 2005 compared toSeptember 30, 2004 |       
|                                 |  | Total Change                                     |        |   | Attributed to |     
|                                 |  |                                                  | Volume |   |               | Rate |       |   | Mix |  
|Interest income:                 |  |                                                  |        |   |               |      |       |   |     |   |       |   |  |   |      |  
|Real estate - mortgage           |  | $                                                | 2,368  |   |               | $    | 1,212 |   |     | $ | 740   |   |  | $ | 416  |  
|Real estate - construction       |  |                                                  | 1,422  |   |               |      | 587   |   |     |   | 634   |   |  |   | 201  |  
|Commercial                       |  |                                                  | 1,414  |   |               |      | 926   |   |     |   | 384   |   |  |   | 104  |  
|Individual                       |  |                                                  | 1,354  |   |               |      | 759   |   |     |   | 491   |   |  |   | 104  |  
|Land                             |  |                                                  | 1,006  |   |               |      | 597   |   |     |   | 242   |   |  |   | 167  |  
|Investments                      |  |                                                  | (45    | ) |               |      | (97   | ) |     |   | 217   |   |  |   | (165 | )
|                                 |  |                                                  |        |   |               |      |       |   |     |   |       |   |  |   |      |  
|                                 |  | $                                                | 7,519  |   |               | $    | 3,984 |   |     | $ | 2,708 |   |  | $ | 827  |  
|                                 |  |                                                  |        |   |               |      |       |   |     |   |       |   |  |   |      |  
|Interest expense:                |  |                                                  |        |   |               |      |       |   |     |   |       |   |  |   |      |  
|Certificates of deposit          |  | $                                                | 131    |   |               | $    | 92    |   |     | $ | 35    |   |  | $ | 4    |  
|Money market accounts            |  |                                                  | 83     |   |               |      | 5     |   |     |   | 67    |   |  |   | 11   |  
|Interest-bearing demand accounts |  |                                                  | 210    |   |               |      | 2     |   |     |   | 202   |   |  |   | 6    |  
|Savings accounts                 |  |                                                  | 1,923  |   |               |      | 129   |   |     |   | 1,437 |   |  |   | 357  |  
|Federal Home Loan Bank advances  |  |                                                  | 523    |   |               |      | 259   |   |     |   | (1    | ) |  |   | 265  |  
|Notes payable                    |  |                                                  | 358    |   |               |      | 289   |   |     |   | 37    |   |  |   | 32   |  
|                                 |  |                                                  |        |   |               |      |       |   |     |   |       |   |  |   |      |  
|                                 |  |                                                  | 3,228  |   |               |      | 776   |   |     |   | 1,777 |   |  |   | 675  |  
|                                 |  |                                                  |        |   |               |      |       |   |     |   |       |   |  |   |      |  
|Net interest income              |  | $                                                | 4,291  |   |               | $    | 3,208 |   |     | $ | 931   |   |  | $ | 152  |  
|                                 |  |                                                  |        |   |               |      |       |   |     |   |       |   |  |   |      |  



Investment Banking, Advisory and
Administrative Fees.Investment banking, advisory and administrative fees include revenue generated by the Asset Management Group, as well as revenue derived from underwriting or distribution of corporate and municipal securities,
unit trusts and money market and other mutual funds. The primary reason for the increase for the first quarter of fiscal 2006 over the comparable quarter in the prior year is an increase in public finance fees of $2,275,000.



Average assets under management by the Asset Management Group were $672,000,000 in the first
quarter of fiscal 2005. SWS Capital did not renew its contract as General Manager of LOGIC upon the expiration of the original agreement on September 4, 2005. As a result, there were no assets under management at September 30, 2005.
Revenue generated from the management of these assets was $131,000 and $149,000 for the three months ended September 30, 2005 and September 24, 2004, respectively.



Net Gains on Principal Transactions.The decrease in net gains on principal transactions of $17,316,000 for the
three-months ended September 30, 2005 versus September 24, 2004 was due primarily to the $18,732,000 recognized upon the maturity of the DARTSSMduring the first quarter of fiscal 2005. This amount represents the difference between the fair value of the Knight stock upon acquisition and the Knight stock on the hedging date. Offsetting this
decrease was an increase in fixed income trading revenue of $1,864,000 primarily from the mortgage-backed area.



Other Revenue. Other revenue increased approximately $752,000 for the three-month period ended September 30, 2005 compared to the three-month period
ended September 24, 2004. The increase is due primarily to the $339,000 increase in fees from insurance products and a $308,000 increase in SBA loan sales and other portfolio sales at FSB Financial.



Commissions and Other Employee Compensation.Commissions and other employee
compensation is generally the most significant expense, other than interest expense, on our Consolidated Statements of Income and Comprehensive Income. The commission portion is variable in nature based on the level of operating revenues, earnings
and the number of registered representatives employed.



- 27 -



---

##### Table of Contents

Overall, commissions and other employee compensation increased $7,525,000 for the quarter over the comparable period in
fiscal 2005. An increase of $2,953,000 was due to commissions paid to revenue-producing employees generating higher levels of commission revenue. We also experienced an increase of $2,548,000 in incentive compensation due to increased business line
profitability. Additionally, an increase of $2,024,000 in other compensation expense is a result of annual raises and increases in profit sharing and deferred compensation plan expenses.



Occupancy, Equipment and Computer Services.The $1,107,000 decrease in the three-month period ended September 30, 2005
from the comparable period in the prior year is primarily due to decreases of $324,000 in statement processing costs, $210,000 in depreciation, $189,000 in computer services costs, and $174,000 in equipment rental costs. The reduction in statement
processing costs is a result of favorable contract negotiations. The depreciation decrease is due to the completion of our capital lease obligations at the end of the first quarter of fiscal 2005. The primary reason for the decrease in computer
service costs is the termination of certain software maintenance contracts since the fiscal 2005 first quarter. Equipment rental costs decreased as certain operating lease contracts expired in October 2004 and were not renewed.



Communications. Communications expense decreased $603,000 for the three-month
period ended September 30, 2005 as compared to the same period of the prior year. This decrease is primarily due to the closing of the May Financial office in Brighton, Michigan resulting in the elimination of communication and quote contracts.



Floor Brokerage and Clearing Organization Charges. Floor
brokerage and clearing organization charges change in relation to the transactions processed in our clearing business as well as changes in the costs from our clearing agencies. These charges decreased $287,000 when comparing the three-month period
ended September 30, 2005 to the same period in the prior year. The decrease is due primarily to rebates received from the Depository Trust Company.



Advertising and Promotional. Advertising and promotional expense decreased $143,000 when comparing the first quarter of fiscal 2005 to the first quarter of
fiscal 2006. This decrease reflects the reduction in advertising and external recruiting costs.



Other Expense.The increase in other expense for the first quarter of fiscal 2006 was $2,427,000 compared to the first quarter of last year. The rise is primarily composed of a $1,500,000 increase
in the Banks provision for loan losses due to an increasing portfolio size, a $694,000 increase in other taxes due to a large state gross receipts tax refund in fiscal 2005 and a $582,000 increase related to the resolution of items from the
Southwest Clearing purchase in the prior year that credited other expense, offset by a decrease of $274,000 in licenses and fees. The decrease in licenses and fees relates primarily to reduced trading volumes in the current quarter, thereby reducing
the related fees.



Income Tax Expense. For the first quarter of
fiscal 2006, income tax expense (effective rate was 35.9%) differed from the amount that would have otherwise been calculated by applying the federal corporate tax rate (35%) to income before income taxes and minority interest in consolidated
subsidiaries. The effective rate was higher than the statutory rate because of permanently excluded items, primarily the state income tax provision.



Minority Interest in Consolidated Subsidiaries. The decrease in minority interest in consolidated subsidiaries of $233,000 is primarily due to the increase
in the Banks total investment in FSB Financial from 75% in the first quarter of fiscal 2005 to 90% in January of fiscal 2005.



- 28 -



---

##### Table of Contents

FINANCIAL CONDITION



Loans and Allowance for Probable Loan Losses. The Bank grants loans to customers primarily within North Texas. The Bank also purchases loans, in the
ordinary course of business, which have been originated in various 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 of North Texas. Substantially all of the Banks loans are collateralized with real estate.



The allowance for probable loan losses is increased by charges to income and decreased by charge-offs (net of recoveries). Managements periodic evaluation of the
adequacy of the allowance is based on 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.



Loans
receivable at September 30, 2005 and June 30, 2005 are summarized as follows (in thousands):



|                           |  |                    |         |               |   |        
|-------------------------- |  | ------------------ | ------- | ------------- | - | -------
|                           |  | September 30, 2005 |         | June 30, 2005
|Real estate  mortgage     |  | $                  | 209,404 |               | $ | 225,256
|Real estate  construction |  |                    | 199,263 |               |   | 168,343
|Commercial                 |  |                    | 199,363 |               |   | 197,045
|Individuals                |  |                    | 79,851  |               |   | 95,382 
|Land                       |  |                    | 91,510  |               |   | 77,854 
|                           |  |                    |         |               |   |        
|                           |  | $                  | 779,391 |               | $ | 763,880
|                           |  |                    |         |               |   |        



The following table shows the expected
life of certain loans at September 30, 2005, 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 5Years |  | Total
|Real estate  construction            |  | $              | 161,799 |           | $ | 23,522      |  | $     | 13,942  |  | $ | 199,263
|Commercial                            |  |                | 30,207  |           |   | 79,722      |  |       | 89,434  |  |   | 199,363
|                                      |  |                |         |           |   |             |  |       |         |  |   |        
|Total                                 |  | $              | 192,006 |           | $ | 103,244     |  | $     | 103,376 |  | $ | 398,626
|                                      |  |                |         |           |   |             |  |       |         |  |   |        
|Amount of loans based upon:           |  |                |         |           |   |             |  |       |         |  |   |        
|Floating or adjustable interest rates |  | $              | 189,538 |           | $ | 84,117      |  | $     | 80,989  |  | $ | 354,644
|Fixed interest rates                  |  |                | 2,468   |           |   | 19,127      |  |       | 22,387  |  |   | 43,982 
|                                      |  |                |         |           |   |             |  |       |         |  |   |        
|Total                                 |  | $              | 192,006 |           | $ | 103,244     |  | $     | 103,376 |  | $ | 398,626
|                                      |  |                |         |           |   |             |  |       |         |  |   |        



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 collectibility. 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 credited to income on a cash basis.



- 29 -



---

##### Table of Contents

Non-performing assets as of September 30, 2005 and June 30, 2005 are as
follows (dollars in thousands):



|                                                          |  |                   |       |   |               |   |       |  
|--------------------------------------------------------- |  | ----------------- | ----- | - | ------------- | - | ----- | -
|                                                          |  | September 30,2005 |       |   | June 30, 2005 |  
|Loans accounted for on a non-accrual basis                |  | $                 | 5,591 |   |               | $ | 4,949 |  
|                                                          |  |                   |       |   |               |   |       |  
|Non-performing loans as a percentage of total gross loans |  |                   | 0.8   | % |               |   | 0.7   | %
|                                                          |  |                   |       |   |               |   |       |  
|Loans past due 90 days or more, not included above        |  | $                 | 391   |   |               | $ | 804   |  
|                                                          |  |                   |       |   |               |   |       |  
|Troubled debt restructurings                              |  | $                 | 1,830 |   |               | $ | 2,027 |  
|                                                          |  |                   |       |   |               |   |       |  



An analysis of the allowance for
probable loan losses for the three-month periods ended September 30, 2005 and September 30, 2004 is as follows (dollars in thousands):



|                                                                                          |  |                    |        |   |                   |   |       |  
|----------------------------------------------------------------------------------------- |  | ------------------ | ------ | - | ----------------- | - | ----- | -
|                                                                                          |  | Three Months Ended |       
|                                                                                          |  | September 30,2005  |        |   | September 30,2004 |  
|Balance at beginning of period                                                            |  | $                  | 7,450  |   |                   | $ | 4,643 |  
|Charge-offs  individual                                                                  |  |                    | (2,476 | ) |                   |   | (688  | )
|Charge-offs  real estate-mortgage                                                        |  |                    | (52    | ) |                   |   |      |  
|Recoveries  individual                                                                   |  |                    | 102    |   |                   |   | 26    |  
|Recoveries  commercial, financial and agricultural                                       |  |                    | 45     |   |                   |   |      |  
|                                                                                          |  |                    |        |   |                   |   |       |  
|Net charge-offs                                                                           |  |                    | (2,381 | ) |                   |   | (662  | )
|Additions charged to operations                                                           |  |                    | 2,489  |   |                   |   | 646   |  
|                                                                                          |  |                    |        |   |                   |   |       |  
|Balance at end of period                                                                  |  | $                  | 7,558  |   |                   | $ | 4,627 |  
|                                                                                          |  |                    |        |   |                   |   |       |  
|Ratio of net charge-offs during the period to average loans outstanding during the period |  |                    | 0.31   | % |                   |   | 0.10  | %
|                                                                                          |  |                    |        |   |                   |   |       |  



The allowance for probable loan losses
is applicable to the following types of loans as of September 30, 2005 and June 30, 2005 (dollars in thousands):



|                              |  |                    |       |                              |               |   |        |   |                              |  |       |  
|----------------------------- |  | ------------------ | ----- | ---------------------------- | ------------- | - | ------ | - | ---------------------------- |  | ----- | -
|                              |  | September 30, 2005 |       |                              | June 30, 2005 |  
|                              |  | Amount             |       | Percentof loansto totalloans |               |   | Amount |   | Percentof loansto totalloans | 
|Commercial                    |  | $                  | 1,543 |                              | 25.5          | % |        | $ | 1,446                        |  | 25.7  | %
|Real estate  construction    |  |                    | 1,264 |                              | 25.5          |   |        |   | 1,033                        |  | 22.0  |  
|Real estate  mortgage & land |  |                    | 1,526 |                              | 38.4          |   |        |   | 1,313                        |  | 39.5  |  
|Individuals                   |  |                    | 3,225 |                              | 10.6          |   |        |   | 3,658                        |  | 12.8  |  
|                              |  |                    |       |                              |               |   |        |   |                              |  |       |  
|                              |  | $                  | 7,558 |                              | 100.0         | % |        | $ | 7,450                        |  | 100.0 | %
|                              |  |                    |       |                              |               |   |        |   |                              |  |       |  



- 30 -



---

##### Table of Contents

Deposits.Average deposits and the average interest rate paid on the deposits for the three-month periods
ended September 30, 2005 and September 30, 2004 can be found in the discussion of the Banking Groups net interest income under the caption -Results of Operations-Net Interest Income-Banking Group.



Certificates of deposit of $100,000 or greater were $55,636,000 and $58,554,000 at
September 30, 2005 and June 30, 2005, respectively. The Bank funds its loans through short-term borrowings at the Federal Home Loan Bank (FHLB), internally generated deposits, brokered certificates of deposit and funds on
deposit in an FDIC insured interest bearing checking account from Southwest Securities brokerage customers. The Bank has in excess of $400 million ($435,000,000 at September 30, 2005) in funds on deposit from customers of Southwest
Securities. This funding source has reduced the Banks reliance on short-term borrowings from the FHLB and brokered certificates of deposit.



Advances from Federal Home Loan Bank.The Bank has historically financed its short-term borrowing needs through advances from the FHLB. This table
represents advances from the FHLB which were due within one year (generally two to seven days) during the three-month periods ended September 30, 2005 and September 30, 2004 (dollars in thousands):



|                                        |  |                    |        |              |                    |   |        |   |              |  |     |  
|--------------------------------------- |  | ------------------ | ------ | ------------ | ------------------ | - | ------ | - | ------------ |  | --- | -
|                                        |  | Three Months Ended |       
|                                        |  | September 30, 2005 |        |              | September 30, 2004 |  
|                                        |  | Amount             |        | InterestRate |                    |   | Amount |   | InterestRate | 
|At end of period                        |  | $                  | 47,064 |              | 4.1                | % |        | $ | 2,298        |  | 6.9 | %
|Average during period                   |  |                    | 57,961 |              | 3.6                | % |        |   | 1,687        |  | 6.8 | %
|Maximum month-end balance during period |  |                    | 73,228 |              |                   |   |        |   | 3,500        |  |    |  



LIQUIDITY AND CAPITAL RESOURCES



Brokerage Group



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 which represents amounts, in the judgment of management, that are necessary 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.



Short-Term Borrowings.We have credit arrangements with commercial banks, which include broker loan lines up to $275,000,000. 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 credit arrangements are provided on an as offered basis and are not committed lines of credit. Outstanding balances
under these credit arrangements are due on demand, bear interest at rates indexed to the federal funds rate and are collateralized by securities of Southwest Securities and its clients. At September 30, 2005, the amount outstanding under these
secured arrangements was $77,200,000, which was collateralized by securities held for firm accounts valued at $127,245,000.



In addition to the broker loan lines, SWS has a $20,000,000 unsecured line of credit that is due on demand and bears interest at rates indexed to the federal funds rate.
The total amount of



- 31 -



---

##### Table of Contents

borrowings available under this line of credit is reduced by the amount outstanding under the unsecured letters of credit
at the time of borrowing. At September 30, 2005, the total amount available for borrowings was $12,036,000. There was no amount outstanding on this line at September 30, 2005.



We also have an irrevocable letter of credit agreement aggregating $45,000,000 at September 30, 2005 pledged to support our open
options positions with an options clearing organization. The letter of credit bears interest at the brokers call rate, if drawn, and 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 $59,361,000 at September 30, 2005. We also have unsecured letters of credit, aggregating $2,250,000 at September 30, 2005, pledged to support our open positions with securities clearing
organizations. The unsecured letters of credit bear a 1% commitment fee and are renewable semi-annually. At September 30, 2005, we had an additional unsecured letter of credit issued for a sub-lease to the sub-lessee of space previously
occupied by Mydiscountbroker.com, Inc., a subsidiary of SWS dissolved in July 2004, in the amount of $714,000. This letter of credit bears a 1% commitment fee and is renewable annually.



In the opinion of management, these credit arrangements are adequate to meet our operating capital needs of the Brokerage Group for the
foreseeable future.



Off-Balance Sheet Arrangements.Off-balance sheet
arrangements, as defined by the SEC, include certain contractual arrangements pursuant to which a company has a binding obligation which is not reflected on the balance sheet. Included are contingent obligations, certain guaranteed contracts,
retained or contingent interest in assets transferred to an unconsolidated entity, certain derivative investments classified as equity or material variable interests in unconsolidated entities that provide financing, liquidity, market risk or credit
risk support. We generally do not enter into off-balance sheet arrangements, as defined, other than those described in the Contractual Obligations and Contingent Payments section of our annual report on Form 10-K for the fiscal year ended
June 24, 2005. In addition, 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 contained in our annual
report on Form 10-K for the fiscal year ended June 24, 2005.



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 is subject to restrictions under applicable net capital rules. Historically, we have operated in excess of the minimum net capital requirements. See Net Capital Requirements in the Notes to the Consolidated Financial
Statements contained in this Report.



Banking Group



Liquidity is monitored daily to ensure the Banks ability to support asset growth, meet
deposit withdrawals, maintain reserve requirements and otherwise sustain operations. The Banks liquidity is maintained in the form of readily marketable loans, balances with the FHLB and vault cash. In addition, the Bank has borrowing capacity
with the FHLB and a $20,000,000 federal funds line of credit for the purpose of purchasing short-term funds should additional liquidity be needed. Current net available borrowing capacity at FHLB is $144,400,000. Management believes that the
Banks present position is adequate to meet its current and future liquidity needs.



The Banks asset and liability management policy is intended to manage interest rate risk. The Bank accomplishes this through management of the 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 Group. At September 30, 2005, $435,000,000 of the Banks deposits was from broker customers of Southwest Securities. Events in the securities markets could impact the amount of these funds available to the Bank.



- 32 -



---

##### Table of Contents

FSB Financial has borrowing capacity of $75,000,000 through a secured line of credit for the purpose of purchasing pools
of loans.



The Bank is subject to capital standards imposed by regulatory
bodies, including the Office of Thrift Supervision and the Federal Deposit Insurance Corporation. The Bank has historically met all the capital adequacy requirements to which it is subject.



We created a new bank holding company that could be used to issue trust-preferred securities
to facilitate additional capital at the Bank. There is no current plan for the holding company to issue securities.



Bank Borrowings. In June 2005, the Bank entered into an agreement with an unaffiliated bank for the availability of a $20,000,000 unsecured line of credit
for the purchase of federal funds. The line bears interest at a rate equal to the rate of interest of federal funds plus 0.25%. The line is being used by the Bank to support short-term liquidity needs and expires on May 31, 2006. At
September 30, 2005, there were no amounts outstanding on this line of credit.



On June 8, 2005, FSB Financial obtained a secured line of credit from an unaffiliated bank in the amount of $75,000,000. At September 30, 2005, $19,525,000 was outstanding on this line of credit. The note related to this line of
credit matures on June 7, 2008. Interest is paid on a monthly basis at a rate of 30-day LIBOR plus a variable rate that is determined by the status of certain financial ratios at the time of the advance. The interest rate was
5.95% September 30, 2005. This line of credit is secured by automobile loans totaling $37,233,000.



FSB Financial also has a line of credit with its parent Bank. At September 30, 2005, the total credit line is $45,850,000 of which FSB Financial has drawn $37,950,000. $10,850,000 was provided by participations
from third parties at September 30, 2005. Since June 8, 2005, the loan bears interest for unaffiliated participants at 30-day LIBOR plus 2.25% and matures March 27, 2006. The loan bears interest for the Bank at the Bank Insured Funds
rate plus 0.9%, 3.83% at September 30, 2005. SWS Group guarantees $10,000,000 of this credit line to the Bank. See -Commitments and Contingencies  Guarantees.



Cash Flow



Net cash used in operating activities was $2,475,000 and $52,193,000 for the three months ended September 30, 2005 and September 24, 2004, respectively. The
primary reasons for the decreased use of cash were increases in assets segregated for regulatory purposes, loans held for sale, securities owned, and other assets, offset partially by decreases in securities sold not yet purchased, other
liabilities, securities purchased under agreements to resell, net client accounts, and net broker, dealer and clearing organization accounts.



Net cash used in investing activities for the three-month periods ended September 30, 2005 and September 24, 2004 was $32,624,000 and $15,485,000, respectively.
The primary reason for the increase in cash used for investing activities was increased mortgage funding.



Net cash flows provided by financing activities totaled $39,309,000 for the three-month period ended September 30, 2005 compared to $12,533,000 for the three-month period ended September 24, 2004. The
primary differences were the increases in cash proceeds from securities sold under agreements to repurchase and in deposits at the Bank, offset by reduced reliance on borrowings by the Bank from the FHLB due to cash inflows from Southwest
Securities customers.



We expect that cash flows provided by operating
activities as well as short-term borrowings will be the primary source of working capital for fiscal 2006.



- 33 -



---

##### Table of Contents

Treasury Stock



Periodically, we repurchase our common stock under a plan approved by our Board of Directors. Currently, we have authorization, which will expire in December 31,
2006, to repurchase 500,000 shares. In October 2005, we repurchased 31,090 shares at a cost of $478,000 or $15.36 per share.



Additionally, the trustee under our deferred compensation plan periodically purchases 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. There was no treasury stock activity related to the deferred compensation plan during the three months ended
September 30, 2005. See Part II. Other Information-Item 2. Unregistered Sales of Equity Securities and Use of Proceeds.



RISK MANAGEMENT



We manage risk exposure through the involvement of various levels of management. Position limits in trading and inventory accounts are well established and monitored on an ongoing basis. 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, by 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 counter-party risk through the use of credit exposure 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



Brokerage Group. Credit risk arises from the potential nonperformance by
counter-parties, customers or debt security issuers. We are exposed to credit risk as a trading counter-party and as a stock loan counter-party to dealers and customers, as a holder of securities and as a member of exchanges and clearing
organizations. 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 Group. Credit risk is the possibility that a borrower or counter party will fail to meet its obligations in accordance with agreed terms. Therefore
credit risk is inherent in all types of lending provided by the Bank. The Bank has developed and implemented extensive policies and procedures to provide a robust process for proactively 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 the Dallas / Fort Worth metropolitan area. Also, the Bank purchases 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 of the area. Policies and procedures, which are in place to manage credit risk, are designed to be responsive to changes in
these economic conditions.



At FSB Financial, the valuation of residual
non-prime auto loans involves both credit risk and collateral value risk. Non-prime loans involve higher loss risk due to the lower credit quality of the borrower. Creditors mitigate this risk in pricing the loan at origination; generally, the
interest rate is higher to compensate for the higher credit risk. FSB Financial further mitigates credit risk by purchasing bulk loans at a discount to increase the overall yield which compensates for inherent



- 34 -



---

##### Table of Contents

losses in the purchased portfolios. We also purchase seasoned loans, which reduce credit losses due to early defaults, or
seek indemnifications from the seller for early defaults. Collateral value risk is addressed by adhering to established criteria regarding vehicle age, loan-to-value ratio and vehicle mileage limitations. In addition, we will not purchase a loan if
the borrower has not provided proof of insurance on the collateral vehicle.



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 are reliant 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 reviews 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 different jurisdictions in which we conduct business. We have established procedures based on legal and regulatory requirements that are designed to 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 the potential change in value of a financial instrument as a result of fluctuations in interest rates, equity prices, 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 activities.



Interest Rate Risk/Brokerage Group. Interest rate risk is a consequence of maintaining inventory positions and trading in interest-rate-sensitive financial instruments. 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 Group. 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 and Supervision (OTS) for interest rate sensitivity of the Banks net portfolio. These analyses are conducted on a monthly
basis for the Banks Board of Directors.



- 35 -



---

##### Table of Contents

The following table illustrates the estimated change in net interest margin based on shifts in interest rates of positive
300 basis points and negative 200 basis points:



|                                      |  |                                        
|------------------------------------- |  | ---------------------------------------
|Hypothetical Change in Interest Rates |  | Projected Change in Net Interest Margin
|+300                                  |  | 4.29%                                  
|+200                                  |  | 2.86%                                  
|+100                                  |  | 1.44%                                  
|0                                     |  | 0%                                     
|-100                                  |  | -1.44%                                 
|-200                                  |  | -3.22%                                 



The
following GAP Analysis table indicates the Banks interest rate sensitivity position at September 30, 2005:



|                                   |  |                         |         |             |   |         |           |  |          |        |  |   |       
|---------------------------------- |  | ----------------------- | ------- | ----------- | - | ------- | --------- |  | -------- | ------ |  | - | ------
|                                   |  | Repricing Opportunities
|(in thousands)                     |  | 0-6 months              |         | 7-12 months |   |         | 1-3 years |  | 3+ years
|Earning Assets:                    |  |                         |         |             |   |         |           |  |          |        |  |   |       
|Loans                              |  | $                       | 658,097 |             | $ | 32,170  |           |  | $        | 60,691 |  | $ | 35,991
|Securities and FHLB Stock          |  |                         | 6,445   |             |   |        |           |  |          |       |  |   | 269   
|Interest Bearing Deposits          |  |                         | 5,087   |             |   |        |           |  |          |       |  |   |      
|                                   |  |                         |         |             |   |         |           |  |          |        |  |   |       
|Total Earning Assets               |  |                         | 669,629 |             |   | 32,170  |           |  |          | 60,691 |  |   | 36,260
|                                   |  |                         |         |             |   |         |           |  |          |        |  |   |       
|Interest Bearing Liabilities:      |  |                         |         |             |   |         |           |  |          |        |  |   |       
|Transaction Accounts and Savings   |  |                         | 467,512 |             |   |        |           |  |          |       |  |   |      
|Certificates of Deposit            |  |                         | 30,596  |             |   | 62,438  |           |  |          | 14,955 |  |   | 11,598
|Borrowings                         |  |                         | 81,875  |             |   | 564     |           |  |          | 11,380 |  |   | 24,538
|                                   |  |                         |         |             |   |         |           |  |          |        |  |   |       
|Total Interest Bearing Liabilities |  |                         | 579,983 |             |   | 63,002  |           |  |          | 26,335 |  |   | 36,136
|                                   |  |                         |         |             |   |         |           |  |          |        |  |   |       
|GAP                                |  | $                       | 89,646  |             | $ | (30,832 | )         |  | $        | 34,356 |  | $ | 124   
|                                   |  |                         |         |            
|Cumulative GAP                     |  | $                       | 89,646  |             | $ | 58,814  |           |  | $        | 93,170 |  | $ | 93,294



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



The following table categorizes securities owned, net of securities sold, not yet purchased, which are in our trading portfolio, marketable equity securities in our available-for-sale portfolio, which are subject to
interest rate and equity price risk, as well as net securities purchased under agreements to resell, repurchase which are also subject to interest rate and equity price risk (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                                |  | $                 |       |   |        | $ | 6,019  |         |  | $ | 10,565  |   |  | $     | 20,124 |   |  | $ | 36,708 |  
|U.S. Government and Government agency obligations    |  |                   | 4,223  |   |        |   | (2,466 | )       |  |   | 293     |   |  |       | (9,494 | ) |  |   | (7,444 | )
|Corporate obligations                                |  |                   | (1,443 | ) |        |   | (156   | )       |  |   | (6,993  | ) |  |       | 36,297 |   |  |   | 27,705 |  
|                                                     |  |                   |        |   |        |   |        |         |  |   |         |   |  |       |        |   |  |   |        |  
|Total debt securities                                |  |                   | 2,780  |   |        |   | 3,397  |         |  |   | 3,865   |   |  |       | 46,927 |   |  |   | 56,969 |  
|Corporate equity                                     |  |                   |       |   |        |   |       |         |  |   |        |   |  |       | 4,427  |   |  |   | 4,427  |  
|Securities purchased under agreements to resell, net |  |                   |       |   |        |   | 3,099  |         |  |   | 15,182  |   |  |       | 3,011  |   |  |   | 21,292 |  
|Other                                                |  |                   | 7,788  |   |        |   |       |         |  |   |        |   |  |       |       |   |  |   | 7,788  |  
|                                                     |  |                   |        |   |        |   |        |         |  |   |         |   |  |       |        |   |  |   |        |  
|                                                     |  | $                 | 10,568 |   |        | $ | 6,496  |         |  | $ | 19,047  |   |  | $     | 54,365 |   |  | $ | 90,476 |  
|                                                     |  |                   |        |   |        |   |        |         |  |   |         |   |  |       |        |   |  |   |        |  



- 36 -



---

##### Table of Contents

|                                                     |  |                   |     |   |        |   |     |         |  |   |         |   |  |       |       |   |  |   |       |  
|---------------------------------------------------- |  | ----------------- | --- | - | ------ | - | --- | ------- |  | - | ------- | - |  | ----- | ----- | - |  | - | ----- | -
|                                                     |  | Years to Maturity |    
|                                                     |  | 1 or less         |     |   | 1 to 5 |   |     | 5 to 10 |  |   | Over 10 |   |  | Total |      
|Weighted average yield                               |  |                   |     |   |        |   |     |         |  |   |         |   |  |       |       |   |  |   |       |  
|Municipal obligations                                |  |                   |    | % |        |   | 3.5 | %       |  |   | 3.8     | % |  |       | 3.3   | % |  |   | 3.5   | %
|U.S. Government and Government agency obligations    |  |                   | 3.3 | % |        |   | 4.1 | %       |  |   | 3.9     | % |  |       | 5.1   | % |  |   | 4.1   | %
|Corporate obligations                                |  |                   | 6.3 | % |        |   | 4.7 | %       |  |   | 4.9     | % |  |       | 5.9   | % |  |   | 5.2   | %
|Securities purchased under agreements to resell, net |  |                   |    | % |        |   | 3.9 | %       |  |   | 2.5     | % |  |       | 4.5   | % |  |   | 3.6   | %
|                                                     |  |                   |     |   |       
|Available-for-sale securities, at fair value         |  |                   |     |   |        |   |     |         |  |   |         |   |  |       |       |   |  |   |       |  
|Marketable equity securities                         |  | $                 |    |   |        | $ |    |         |  | $ |        |   |  | $     | 2,770 |   |  | $ | 2,770 |  
|                                                     |  |                   |     |   |        |   |     |         |  |   |         |   |  |       |       |   |  |   |       |  



CRITICAL ACCOUNTING POLICIES AND
ESTIMATES



The preparation of financial statements in accordance with
accounting principles generally accepted in the United States requires management to make estimates and assumptions that affect reported amounts and disclosures. Actual results may differ from these estimates under different assumptions or
conditions. Our accounting policies and methodology used in establishing estimates (primarily related to loan loss reserves and other contingency estimates) have not changed materially since June 24, 2005. (See our Annual Report on Form 10-K
for the fiscal year then ended.)



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. These statements may relate to anticipated changes in revenues or earnings per share, anticipated changes in
our businesses or in anticipated expense levels, or in expectations regarding financial market conditions.



We caution readers that any forward-looking information we provide is not a guarantee of future performance. Actual results may differ materially as a result of various factors, some of which are outside of our
control.



Our business and future prospects
may fluctuate due to numerous factors, such as:



| |  |  | the interest rate environment;
| | - |  | ------------------------------



| |  |  | the volume of trading in securities;
| | - |  | ------------------------------------



| |  |  | the volatility and general level of securities prices and interest rates;
| | - |  | -------------------------------------------------------------------------



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



| |  |  | the demand for housing in the North Texas area and the national market;
| | - |  | -----------------------------------------------------------------------



| |  |  | the credit-worthiness of our correspondents, counter-parties in securities lending transactions and of our banking and margin customers;
| | - |  | ----------------------------------------------------------------------------------------------------------------------------------------



| |  |  | the demand for investment banking services;
| | - |  | -------------------------------------------



| |  |  | general economic conditions and investor sentiment and confidence;
| | - |  | ------------------------------------------------------------------



| |  |  | competitive conditions in each of our business segments;
| | - |  | --------------------------------------------------------



| |  |  | changes in accounting, tax and regulatory compliance requirements; and
| | - |  | ----------------------------------------------------------------------



| |  |  | the ability to attract and retain key personnel.
| | - |  | ------------------------------------------------



- 37 -



---

##### Table of Contents

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 or other contingencies.
| | - |  | -----------------------------------------------------------------------------------------------------------------



Additionally, factors which may cause actual results to differ materially from our
forward-looking statements include those factors discussed in this Report in Managements Discussion and Analysis of Financial Condition and Results of Operations Overview, -Risk Management and -Critical
Accounting Policies and Estimates and those discussed in our other reports filed with and available from the SEC. All forward-looking statements we make speak only as of the date on which they are made, and we undertake no obligation to update
them to reflect events or circumstances occurring after the date on which they were made or to reflect the occurrence of unanticipated events.



Item 3. Quantitative and Qualitative Disclosures About Market Risk



The information required by this item is incorporated in Item 2. Managements Discussion and Analysis of Financial Condition and Results of Operations under the caption -Risk Management.



Item 4. Controls and Procedures



The
management of SWS, including the principal executive officer and principal financial officer, has evaluated the effectiveness of our disclosure controls and procedures (as defined in Rule 13a-15(e) of the Securities Exchange Act of 1934) as of
September 30, 2005. Based on such evaluation, the principal executive officer and principal financial officer have concluded that, as of September 30, 2005, such disclosure controls and procedures were effective for the purpose of ensuring
that material information required to be in the reports SWS submits, files, furnishes or otherwise provides to the SEC is made known to them by others on a timely basis and is recorded, processed, summarized and reported within the time periods
specified in the SECs rules and forms. There have not been any changes in our internal control over financial reporting (as defined in Exchange Act Rule 13a-15(f) of the Securities Exchange Act of 1934) during the three-month period ended
September 30, 2005 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, SWS Group and/or our subsidiaries have been named as defendants in various pending lawsuits and arbitration proceedings. These claims allege violation
of federal and state securities laws. 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.



- 38 -



---

##### Table of Contents

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



The following table provides information about purchases by SWS during the quarter ended September 30, 2005 of equity securities that are registered by SWS pursuant to Section 12 of the Exchange Act:



ISSUER PURCHASES OF EQUITY SECURITIES



|                   |  |                               |  |                           |   |                                                               |   |                                                                 |        
|------------------ |  | ----------------------------- |  | ------------------------- | - | ------------------------------------------------------------- | - | --------------------------------------------------------------- | -------
|                   |  | TotalNumber ofSharesPurchased |  | AveragePricePaid perShare |   | Total Numberof SharesPurchased asPart ofPubliclyAnnouncedPlan |   | MaximumNumber ofShares thatMay Yet bePurchasedUnder thePlans(1)
|6/25/05 to 7/29/05 |  |                              |  | $                         |  |                                                               |  |                                                                 | 500,000
|7/30/05 to 8/26/05 |  |                              |  |                           |  |                                                               |  |                                                                 | 500,000
|8/27/05 to 9/30/05 |  |                              |  |                           |  |                                                               |  |                                                                 | 500,000
|                   |  |                               |  |                           |   |                                                               |   |                                                                 |        
|                   |  |                              |  | $                         |  |                                                               |  |                                                                 |        
|                   |  |                               |  |                           |   |                                                               |   |                                                                 |        

---

|(1) | Represents 500,000 shares available for purchase under a stock repurchase program approved by our Board of Directors pursuant to which SWS has authorization, which
will expire on December 31, 2006, to repurchase 500,000 shares. No shares were repurchased under the Stock Repurchase Program in the quarter ended September 30, 2005.
|--- | ------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------



Item 3. Defaults upon Senior Securities



None Reportable.



Item 4. Submission of Matters to a Vote of Security Holders



None Reportable.



Item 5. Other Information



None Reportable.



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.



- 39 -



---

##### Table of Contents

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)                                       
|                 | 
|November 9, 2005 |  | /S/ Donald W. Hultgren                             
|Date             |  | (Signature)                                        
|                 |  | Donald W. Hultgren                                 
|                 |  | Chief Executive Officer and Duly Authorized Officer
|                 |  | (Principal Executive Officer)                      
|                 | 
|November 9, 2005 |  | /S/ Kenneth R. Hanks                               
|Date             |  | (Signature)                                        
|                 |  | Kenneth R. Hanks                                   
|                 |  | Treasurer and Chief Financial Officer              
|                 |  | (Principal Financial Officer)                      
|                 | 
|November 9, 2005 |  | /S/ Stacy Hodges                                   
|Date             |  | (Signature)                                        
|                 |  | Stacy Hodges                                       
|                 |  | Executive Vice President                           
|                 |  | (Principal Accounting Officer)                     



- 40 -



---

##### Table of Contents

SWS GROUP, INC. AND SUBSIDIARIES

INDEX TO EXHIBITS



|              |  |                                                                                                                                                                        
|------------- |  | -----------------------------------------------------------------------------------------------------------------------------------------------------------------------
|ExhibitNumber |  | Description                                                                                                                                                            
|3.1           |  | Restated Certificate of Incorporation of the Registrant incorporated by reference to Exhibit 3.1 to the Registrants Annual Report on Form 10-K filed September 8, 2004
|              | 
|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 November 12, 2004                     
|              | 
|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                                                              

---

|* | Filed herewith
|- | --------------



- 41 -