UNITED STATES

                      SECURITIES AND EXCHANGE COMMISSION

                            WASHINGTON, D.C. 20549

                                  FORM 10-Q

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

                       Securities Exchange Act of 1934

                For the quarterly period ended March 31, 2006

                        Commission file number 0-16090


                      Hallmark Financial Services, Inc.
                      ---------------------------------
            (Exact name of registrant as specified in its charter)


                 Nevada                                 87-0447375
     -------------------------------               -------------------
     (State or other jurisdiction of                (I.R.S. Employer
     Incorporation or organization)                Identification No.)

  777 Main Street, Suite 1000, Fort Worth, Texas           76102
  ----------------------------------------------        ----------
     (Address of principal executive offices)           (Zip Code)

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

 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 ___  No  X

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

 Indicate the number of shares outstanding of each of the issuer's classes of
 common stock,  as of  the latest  practicable date: Common Stock, par  value
 $.03 per share - 86,909,647 shares outstanding as of May 12, 2006.

<PAGE>
                                      PART I
                               FINANCIAL INFORMATION

 Item 1.   Financial Statements


                      INDEX TO FINANCIAL STATEMENTS

                                                           Page Number
                                                           -----------

 Consolidated Balance Sheets at March 31, 2006
 (unaudited) and December 31, 2005                               3

 Consolidated Statements of Operations (unaudited) for
 the three months ended March 31, 2006 and March 31, 2005        4

 Consolidated Statements of Stockholders' Equity and
 Comprehensive Income (unaudited) for the three months
 ended March 31, 2006 and March 31, 2005                         5

 Consolidated Statements of Cash Flows (unaudited) for
 the three months ended March 31, 2006 and March 31, 2005        6

 Notes to Consolidated Financial Statements (unaudited)          7

<PAGE>

              Hallmark Financial Services, Inc. and Subsidiaries
                         Consolidated Balance Sheets
                               ($ in thousands)

                                                      March 31    December 31
                    ASSETS                              2006          2005
                    ------                           ----------    ----------
                                                     (unaudited)    (audited)
 Investments:
   Debt securities, available-for-sale,
     at market value                                $    97,210   $    79,360
   Equity securities, available-for-sale,
     at market value                                      4,513         3,403
   Short-term investments, available-for-sale,
     at market value                                        335        12,281
                                                     ----------    ----------
            Total investments                           102,058        95,044

 Cash and cash equivalents                               65,034        44,528
 Restricted cash and investments                         41,762        13,802
 Premiums receivable                                     45,078        26,530
 Accounts receivable                                     32,364         2,083
 Prepaid reinsurance premium                              1,314           767
 Reinsurance recoverable                                  1,577           444
 Deferred policy acquisition costs                       11,091         9,164
 Excess of cost over fair value
   of net assets acquired                                31,781         4,836
 Intangible assets                                       27,794           459
 Deferred federal income taxes                                -         3,992
 Other assets                                             9,290         7,257
                                                     ----------    ----------
            Total assets                            $   369,143   $   208,906
                                                     ==========    ==========

     LIABILITIES AND STOCKHOLDERS' EQUITY
     ------------------------------------
 Liabilities:
   Notes payable                                    $    48,968   $    30,928
   Note payable to related party                         12,500             -
   Convertible notes payable (net of
     $8,453 unamortized discount)                        16,547             -
   Structured settlements                                23,804             -
   Unpaid losses and loss adjustment expenses            43,672        26,321
   Unearned premiums                                     57,853        36,027
   Unearned revenue                                      11,184         4,055
   Reinsurance balances payable                             310           116
   Accrued agent profit sharing                             519         2,173
   Accrued ceding commission payable                     11,650        11,430
   Pension liability                                      2,954         2,932
   Deferred federal income taxes                          6,081             -
   Current federal income tax payable                     2,220           300
   Accounts payable and other accrued expenses           38,017         9,436
                                                     ----------    ----------
            Total liabilities                           276,279       123,718

 Commitments and Contingencies

 Stockholders' equity:
   Common stock, $.03 par value (authorized
     100,000,000 shares; issued 86,956,610
     shares in 2006 and 86,856,610 shares in 2005)        2,609         2,606
   Additional paid in capital                            69,034        62,907
   Retained earnings                                     24,715        22,289
   Accumulated other comprehensive income (loss)         (3,417)       (2,597)
   Treasury stock, at cost (46,963 shares in 2006
     and 14,819 in 2005)                                    (77)          (17)
                                                     ----------    ----------
            Total stockholders' equity                   92,864        85,188
                                                     ----------    ----------
                                                    $   369,143   $   208,906
                                                     ==========    ==========

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

<PAGE>

              Hallmark Financial Services, Inc. and Subsidiaries
                    Consolidated Statements of Operations
                                 (Unaudited)
                 ($ in thousands, except per share amounts)

                                                        Three Months Ended
                                                             March 31
                                                     ------------------------
                                                        2006          2005
                                                     ----------    ----------
 Gross premiums written                             $    47,735   $    10,634
 Ceded premiums written                                  (1,956)            -
                                                     ----------    ----------
   Net premiums written                                  45,779        10,634
   Change in unearned premiums                          (17,345)         (594)
                                                     ----------    ----------
   Net premiums earned                                   28,434        10,040

 Investment income, net of expenses                       2,357           411
 Realized loss                                              (83)            -
 Finance charges                                            687           540
 Commission and fees                                     12,264         4,812
 Processing and service fees                                857         1,634
 Other income                                                 4             8
                                                     ----------    ----------
    Total revenues                                       44,520        17,445

 Losses and loss adjustment expenses                     16,690         6,026
 Other operating costs and expenses                      21,026         8,705
 Interest expense                                         1,585             3
 Interest expense from amortization
   of discount on convertible notes                       1,117             -
 Amortization of intangible asset                           573             7
                                                     ----------    ----------
    Total expenses                                       40,991        14,741

 Income before tax                                        3,529         2,704

 Income tax expense                                       1,103           889
                                                     ----------    ----------
 Net income                                         $     2,426   $     1,815
                                                     ==========    ==========

 Common stockholders net income per share:
       Basic                                        $      0.02   $      0.04
                                                     ==========    ==========
       Diluted                                      $      0.02   $      0.04
                                                     ==========    ==========
 Convertible noteholders net income per share:
       Basic                                        $      0.02           n/a
                                                     ==========
       Diluted                                      $      0.02           n/a
                                                     ==========

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

<PAGE>

              Hallmark Financial Services, Inc. and Subsidiaries
   Consolidated Statements of Stockholders' Equity and Comprehensive Income
                                (Unaudited)
                             ($ in thousands)

                                                        Three Months Ended
                                                              March 31,
                                                     ------------------------
                                                        2006          2005
                                                     ----------    ----------
 Common Stock
 Balance, beginning of period                       $     2,606   $     1,106
 Issuance of common stock upon option exercises               3             -
                                                     ----------    ----------
 Balance, end of period                                   2,609         1,106

 Additional Paid-In Capital
 Balance, beginning of period                            62,907        19,647
 Discount on convertible notes                            6,032             -
 Equity based compensation                                   24             9
 Exercise of stock options                                   71           (16)
                                                     ----------    ----------
 Balance, end of period                                  69,034        19,640

 Retained Earnings
 Balance, beginning of period                            22,289        13,103
 Net income                                               2,426         1,815
                                                     ----------    ----------
 Balance, end of period                                  24,715        14,918

 Accumulated Other Comprehensive Income (Loss)
 Balance, beginning of period                            (2,597)         (759)
 Additional minimum pension liability, net of tax             -            30
 Unrealized gains (losses) on securities, net of tax       (820)         (511)
                                                     ----------    ----------
 Balance, end of period                                  (3,417)       (1,240)

 Treasury Stock
 Balance, beginning of period                               (17)         (441)
 Acquisition of treasury shares                            (100)            -
 Exercise of stock options                                   40            29
                                                     ----------    ----------
 Balance, end of period                                     (77)         (412)
                                                     ------------------------
 Stockholders' Equity                               $    92,864   $    34,012
                                                     ========================

 Net income                                         $     2,426   $     1,815
 Additional minimum pension liability, net of tax             -            30
 Unrealized gains (losses) on securities, net of tax       (820)         (511)
                                                     ------------------------
 Comprehensive Income                               $     1,606   $     1,334
                                                     ========================

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

<PAGE>

              Hallmark Financial Services, Inc. and Subsidiaries
                    Consolidated Statement of Cash Flows
                                 (Unaudited)
                              ($ in thousands)

                                                        Three Months Ended
                                                              March 31
                                                     ------------------------
                                                        2006          2005
                                                     ----------    ----------
 Cash flows from operating activities:
   Net income                                       $     2,426   $     1,815

 Adjustments to reconcile net income to cash
   provided by (used in) operating activities:
    Depreciation and amortization expense                   800            72
    Interest expense related to amortization
      of discount on convertible notes                    1,117             -
    Deferred federal income tax expense                  (1,756)          266
    Realized loss on investments                             83             -
    Change in prepaid reinsurance premiums                 (547)            -
    Change in premiums receivable                       (17,430)         (255)
    Change in accounts receivable                        (4,230)        1,103
    Change in deferred policy acquisition costs          (1,927)         (372)
    Change in unpaid losses and loss
      adjustment expenses                                 7,861          (443)
    Change in unearned premiums                          17,882           594
    Change in unearned revenue                           (2,230)          229
    Change in accrued agent profit sharing               (1,654)       (1,417)
    Change in reinsurance recoverable                      (493)        1,146
    Change in reinsurance balances payable                 (455)            -
    Change in current federal income tax
      payable/recoverable                                 1,033        (1,177)
    Change in accrued ceding commission payable             220            (4)
    Change in all other liabilities                       7,906        (1,618)
    Change in all other assets                              976          (180)
                                                     ----------    ----------
     Net cash provided by (used in)
       operating activities                               9,582          (241)
                                                     ----------    ----------
 Cash flows from investing activities:
   Purchases of property and equipment                     (106)          (52)
   Premium finance notes repaid, net of
     finance notes originated                            (1,745)            -
   Acquisition of subsidiaries,
     net of cash acquired                               (25,964)            -
   Change in restricted cash and investments            (25,138)           29
   Purchases of debt and equity securities               (4,532)       (5,076)
   Maturities and redemptions
     of investment securities                             3,923             1
   Net redemptions (purchases)
     of short-term investments                           11,946        (1,297)
                                                     ----------    ----------
      Net cash used in investing activities             (41,616)       (6,395)
                                                     ----------    ----------
 Cash flows from financing activities:
   Proceeds from exercise of employee stock options          40            13
   Proceeds from issuance of convertible debt            25,000             -
   Proceeds from note payable to related party           12,500             -
   Proceeds from revolving loan on credit facility       15,000             -
                                                     ----------    ----------
     Net cash provided by financing activities           52,540            13
                                                     ----------    ----------
 Increase (decrease) in cash and cash equivalents        20,506        (6,623)
 Cash and cash equivalents at beginning of period        44,528        12,901
                                                     ----------    ----------
 Cash and cash equivalents at end of period         $    65,034   $     6,278
                                                     ==========    ==========
 Supplemental Cash Flow Information:
   Interest paid                                    $       983   $         3
                                                     ----------    ----------
   Taxes paid                                       $     1,800   $     1,800
                                                     ----------    ----------

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

<PAGE>
              Hallmark Financial Services, Inc. and Subsidiaries
           Notes to Consolidated Financial Statements (Unaudited)

 1. General

     Hallmark  Financial  Services,  Inc.  ("Hallmark"  and,  together   with
 subsidiaries, "we", "us", "our") is an insurance holding company engaged  in
 the sale  of property  and casualty  insurance  products to  businesses  and
 individuals.  Our  business involves marketing  and underwriting  commercial
 insurance in  Texas,  New  Mexico, Idaho,  Oregon,  Montana,  Louisiana  and
 Washington; marketing  and  underwriting  non-standard  personal  automobile
 insurance in  Texas,  New Mexico  and  Arizona; marketing  general  aviation
 insurance in 44 states; claims  administration; and other insurance  related
 services.  We  pursue  our business  activities through  subsidiaries  whose
 operations are organized  by producing companies  into our Hallmark  General
 Agency operating  segment ("HGA  Segment"),  which includes  the  commercial
 insurance products and  services handled  by Hallmark  General Agency,  Inc.
 ("HGA") and  Effective Claims  Management, Inc.;  our Texas  General  Agency
 operating segment ("TGA Segment"),  which includes the commercial  insurance
 products and services  handled by Texas  General Agency,  Inc. ("TGA"),  Pan
 American  Acceptance  Corporation  ("PAAC")  and  TGA  Special  Risk,   Inc.
 ("TGASRI"); our Phoenix  General Agency operating  segment ("PGA  Segment"),
 which includes the non-standard  personal automobile insurance products  and
 services handled  by American  Hallmark General  Agency, Inc.  and  Hallmark
 Claims  Services,  Inc.  (both  of  which  do  business  as  Phoenix General
 Agency);  and  our aviation  operating segment ("Aerospace Segment"),  which
 includes the general aviation insurance products  and  services  handled  by
 Aerospace Holdings LLC ("Aerospace") and its wholly owned subsidiaries.  The
 subsidiary companies  in  our TGA  Segment  and  Aerospace Segment  were all
 acquired effective January 1,  2006.  The retained  premium produced by  our
 operating segments  is  supported  by our  insurance  company  subsidiaries:
 American Hallmark  Insurance Company  of Texas  ("AHIC"); Phoenix  Indemnity
 Insurance Company ("PIIC");  and Gulf States  Insurance Company ("GSIC"),  a
 wholly owned  subsidiary of  TGA which  was acquired  by Hallmark  effective
 January 1, 2006.


 2. Basis of Presentation

     Our  unaudited consolidated  financial statements  included herein  have
 been prepared in accordance with accounting principles generally accepted in
 the United  States of  America ("GAAP")  and include  our accounts  and  the
 accounts of our  subsidiaries.   All significant  intercompany accounts  and
 transactions have been eliminated in consolidation.  Certain information and
 footnote  disclosures  normally  included  in  financial statements prepared
 in  accordance  with GAAP have  been condensed or omitted  pursuant to rules
 and  regulations  of  the  Securities  and  Exchange  Commission ("SEC") for
 interim financial reporting.  These  financial  statements should be read in
 conjunction with  our  audited  financial  statements  for  the  year  ended
 December 31, 2005 included in our Annual Report on Form 10-K filed with  the
 SEC.

     The interim financial data as of  March 31, 2006 and 2005 is  unaudited.
 However,  in  the  opinion of  management,  the interim  data  includes  all
 adjustments, consisting only of normal recurring adjustments, necessary  for
 a fair statement of  the results for  the interim periods.   The results  of
 operations  for  the  period  ended  March  31,  2006  are  not  necessarily
 indicative of the operating results to be expected for the full year.

     Reclassification

     Certain previously reported  amounts have been reclassified in order  to
 conform to current year presentation.  Such reclassification had  no  effect
 on net income or stockholders' equity.

     Use of Estimates in the Preparation of the Financial Statements

     Our  preparation  of  financial  statements  in  conformity  with   GAAP
 requires us  to make  estimates and  assumptions  that affect  our  reported
 amounts of assets and  liabilities and our  disclosure of contingent  assets
 and liabilities at  the date  of our financial  statements, as  well as  our
 reported  amounts  of  revenues  and expenses  during the  reporting period.
 Actual results could differ materially from those estimates.

     Recently Issued Accounting Standards

     In  December 2002,  the Financial  Accounting Standards  Board  ("FASB")
 issued Statement of Financial Accounting Standards No. 148, "Accounting  for
 Stock-Based Compensation  -  Transition and Disclosure"  ("SFAS 148").  SFAS
 148 amended  FASB  Statement  of Financial  Accounting  Standards  No.  123,
 "Accounting  for   Stock-Based  Compensation"   ("SFAS  123")   to   provide
 alternative methods of  transition for voluntary  change to  the fair  value
 based  method  of  accounting  for  stock-based  employee  compensation.  In
 addition, SFAS  148  amended the  disclosure  requirements of  SFAS  123  to
 require  prominent  disclosures  in   both  annual  and  interim   financial
 statements  about  the  method   of  accounting  for  stock-based   employee
 compensation  and  the  effect of  the  method  used  on  reported  results.
 Effective January 1, 2003, we adopted  the prospective method provisions  of
 SFAS 148.   Under the  prospective method, we  have applied  the fair  value
 based method of accounting  for our stock-based  payments for option  grants
 after December 31, 2002.

     In  December  2004,  FASB  issued  Statement  of  Financial   Accounting
 Standards No. 123R "Share-Based Payment"  ("SFAS 123R"), which revises  SFAS
 123 and supersedes Accounting Principles Board ("APB") Opinion No. 25  ("APB
 25").   SFAS 123R eliminates an entity's ability to account for  share-based
 payments using APB 25 and requires  that all such transactions be  accounted
 for using a fair value based  method.  In April  2005, the SEC deferred  the
 effective date  of  SFAS  123R  from the  first  interim  or  annual  period
 beginning after June 15, 2005 to  the next fiscal year beginning after  June
 15, 2005.   We adopted  SFAS 123R  on  January 1, 2006  using the  modified-
 prospective transition method.  Under  the  modified-prospective  transition
 method, compensation  cost  recognized  during  the  period  should  include
 compensation cost  for all  share-based payments  granted  to, but  not  yet
 vested as of January 1, 2006,  based on grant  date fair value estimates  in
 accordance with the original  provisions of SFAS  123 and compensation  cost
 for all share-based  payments granted  after  January 1, 2006 in  accordance
 with SFAS 123R.  Since we  adopted the fair value  method of SFAS 123  under
 the prospective method provision of SFAS  148 beginning January 1, 2003,  we
 have a  small  amount of  unvested  share-based payments  granted  prior  to
 January 1, 2003.  During the  first three  months  of  2006,  we  recognized
 approximately  $3 thousand of  additional  compensation expense  under  SFAS
 123R.  SFAS 123R also requires the  benefits of tax deductions in excess  of
 recognized stock compensation cost to be reported as a financing cash  flow,
 rather than as an operating cash flow as previously required.  (See  Note 4,
 "Share-Based Payment Arrangements.")

     Had  compensation cost  for all  of our  stock option  grants under  our
 stock compensation plans been  determined based on fair  value at the  grant
 date in  accordance with  the fair  value provisions  of SFAS  123, our  net
 income and earnings  per share  for the three  months ended  March 31,  2005
 would have been the pro forma  amounts indicated below.  Actual results  for
 the three months  ended March 31, 2006 have been  determined  in  accordance
 with the  fair value  provisions  of  SFAS 123R  and,  therefore,  pro forma
 results for such period are not necessary.

                                                             Three Months
                                                                 Ended
                                                               March 31,
        (in thousands)                                           2005
                                                                ------
        Net income as reported                                 $ 1,815

        Add:  Stock-based compensation expenses
        included in reported net income, net of
        related tax effects                                          6

        Deduct:  Total stock-based employee
        compensation expense determined under
        fair value based method for all awards, net
        of related tax effects                                      (9)
                                                                ------
        Pro forma net income                                   $ 1,812
                                                                ======
        Earnings per share:
          Basic-as reported                                    $  0.04
                                                                ======
          Basic-pro forma                                      $  0.04
                                                                ======
          Diluted-as reported                                  $  0.04
                                                                ======
          Diluted-pro forma                                    $  0.04
                                                                ======

 3. Business Combinations

      We account  for  business combinations  using  the purchase  method  of
 accounting.  The cost  of  an  acquired entity  is allocated  to the  assets
 acquired (including identified  intangible assets)  and liabilities  assumed
 based on their estimated fair values.  The excess of the cost of an acquired
 entity over  the  net  of  the  amounts  assigned  to  assets  acquired  and
 liabilities assumed is  an asset  referred to as  "excess of  cost  over net
 assets acquired" or "goodwill."  Indirect  and  general expenses  related to
 business combinations are expensed as incurred.

      Effective  January  1,  2006,  we  acquired  all  of  the  issued   and
 outstanding  capital  stock   of  TGA  and   certain  affiliated   companies
 (collectively, the "TGA Group") for  an  aggregate  cash  purchase price  of
 up  to  $45.6  million,  consisting of unconditional consideration of  $37.6
 million and contingent consideration  of $8.0 million.  Of the unconditional
 consideration, $13.9 million was paid at  closing and $14.3 million will  be
 paid on or before January 1, 2007 and $9.5 million will be paid on or before
 January 1, 2008.  The payment of any contingent consideration is conditioned
 on the sellers complying  with certain restrictive  covenants and TGA  Group
 achieving certain operational objectives  related to premium production  and
 loss ratios.  The  contingent consideration, if any,  will be payable on  or
 before March 30, 2009, unless the sellers elect to defer payment until March
 30 of any subsequent year in order to permit further development of the loss
 ratios.  In addition to the purchase price, we will pay $2.0 million to  the
 sellers in  consideration  of  their  compliance  with  certain  restrictive
 covenants, including a covenant  not to compete for  a period of five  years
 after  closing.  Of  this  additional  amount,  $750 thousand  was  paid  at
 closing,  $750 thousand will be  paid on or before  January 1, 2007 and $500
 thousand will be paid on or before January 1, 2008.

      TGA  is  a   managing  general  agency   involved  in  the   marketing,
 underwriting  and  servicing  of property  and  casualty insurance products,
 with  a particular emphasis on commercial automobile  and  general liability
 risks produced on an excess  and  surplus lines basis.  The other affiliated
 companies  in the  TGA  Group are  TGA's wholly  owned insurance subsidiary,
 GSIC,  which  reinsures a  portion  of  the business written by TGA; TGASRI,
 which brokers mobile home insurance;  and PAAC, which  finances premiums  on
 property  and  casualty insurance products marketed  by TGA and TGASRI.  The
 acquisition is expected to significantly expand the scope  of  our insurance
 marketing operations and provide opportunities for increased underwriting by
 our  insurance company subsidiaries.  Interim GAAP financial statements  for
 TGA Group are not available  for 2005 and, therefore, quarterly supplemental
 pro forma disclosures are not included in this report.

      Effective January 1, 2006,  we  also  acquired all  of the  issued  and
 outstanding membership interests in Aerospace for an aggregate consideration
 of up to $15.0 million, consisting  of unconditional consideration of  $12.5
 million due in cash  at closing and contingent  consideration of up to  $2.5
 million.  The unconditional  consideration  of  $12.5 million  is  allocated
 $11.9 million  to  the purchase  price  and  $0.6 million  to  the  seller's
 compliance with certain restrictive covenants,  including a covenant not  to
 compete for a period of five years after closing.  The payment of contingent
 consideration is conditioned  on the seller  complying with its  restrictive
 covenants and Aerospace achieving certain operational objectives related  to
 premium production and loss ratios.   The contingent consideration, if  any,
 will be payable  in cash  on or  before March  30, 2009,  unless the  seller
 elects to  defer  a  portion of  the  payment  in order  to  permit  further
 development of loss ratios.

      Aerospace,  through  various   wholly  owned  subsidiaries,   including
 Aerospace Insurance  Managers,  Inc.,  is  involved  in  the  marketing  and
 servicing of general aviation property and casualty insurance products  with
 a particular emphasis on  private and small commercial  aircraft.  With  the
 acquisition of Aerospace,  Hallmark entered the  general aviation market  as
 part of our continuing strategy to expand into specialty  lines  businesses.
 Interim GAAP financial statements for Aerospace  are not available for  2005
 and,  therefore,  quarterly  supplemental  pro  forma  disclosures  are  not
 included in this report.


 4. Supplemental Cash Flow Information

      Effective January 1, 2006,  we acquired TGA  Group and Aerospace.  (See
 Note 3, "Business  Combinations.")  In  conjunction  with the  acquisitions,
 cash  and  cash  equivalents  were used in the acquisitions  as follows  (in
 thousands):

                                                         TGA Group  Aerospace
                                                         --------------------
        Fair value of tangible assets excluding
          cash and cash equivalents                      $ 52,906    $  8,391
        Fair value of intangible assets acquired           31,585      12,575
        Capitalized direct expenses                           232          36
        Structured settlement                             (23,542)          -
        Liabilities assumed                               (48,522)     (7,697)
                                                         --------------------
        Cash and cash equivalents used in acquisitions   $ 12,659    $ 13,305
                                                         ====================

      For  the  three  months ended March 31, 2006  and  2005,  we  had  non-
 cash  stock-based  compensation  expense of  $25 thousand  and  $9 thousand,
 respectively.


 5. Share-Based Payment Arrangements

      Our 2005 Long Term Incentive Plan ("2005 LTIP") is a stock compensation
 plan for key employees and non-employee  directors that was approved by  the
 shareholders  on  May 26, 2005.  There are 5,000,000  shares authorized  for
 issuance under the  2005 LTIP.  Our 1994  Key  Employee Long Term  Incentive
 Plan (the "Employee Plan") and 1994 Non-Employee Director Stock Option  Plan
 (the "Director Plan") both expired in 2004.

      As of March 31, 2006,  there were incentive  stock options to  purchase
 530,000 shares of our common stock outstanding under the 2005 LTIP,  leaving
 4,470,000 shares reserved for future issuance.  As of March 31, 2006,  there
 were incentive stock  options to purchase  611,500 shares outstanding  under
 the Employee Plan and non-qualified stock options to purchase 150,000 shares
 outstanding under the  Director Plan.  In addition,  as  of  March 31, 2006,
 there were  outstanding  non-qualified  stock options  to  purchase  100,000
 shares of our common stock granted to certain non-employee directors outside
 the Director Plan in lieu of fees for  service on our board of directors  in
 1999.  The exercise price of all such outstanding stock options  is equal to
 the fair market value of our common stock on the date of grant.

      Options granted under the Employee Plan prior to October 31, 2003, vest
 40% six months from the date of grant and  an additional 20% on each of  the
 first three anniversary dates of the grant and terminate ten years from  the
 date of grant.  Options  granted under the 2005  LTIP and the Employee  Plan
 after October 31, 2003,  vest 10%, 20%,  30% and 40%  on the first,  second,
 third and fourth anniversary dates of the grant, respectively, and terminate
 five years from the date of grant.  All options granted under  the  Director
 Plan vest 40% six  months from the date  of grant and  an additional 10%  on
 each of the first six anniversary dates of the grant and terminate ten years
 from the  date of  grant.  The  options  granted to  non-employee  directors
 outside the Director Plan  fully vested six months  after the date of  grant
 and terminate ten years from the date of grant.

      A summary of the status of our  stock options as of and changes  during
 the year-to-date ended March 31, 2006 is presented below:

                                                        Weighted
                                                        Average
                                             Weighted   Remaining   Aggregate
                                             Average   Contractual  Intrinsic
                                 Number of   Exercise     Term        Value
                                  Shares      Price      (Years)     ($000)
                                 --------------------------------------------
 Outstanding at January 1, 2006  1,516,500   $   0.82         -            -
 Granted                                 -   $      -         -            -
 Exercised                        (125,000)  $   0.92         -            -
 Forfeited or expired                    -   $      -         -            -
                                 ---------
 Outstanding at March 31, 2006   1,391,500   $   0.81       5.6     $  1,226
 Exercisable at March 31, 2006     487,000   $   0.55       3.7     $    553


      There were no options  granted in either the  first quarter of 2006  or
 2005.   The total  intrinsic value  of options  exercised during  the  first
 quarter of 2006 and 2005  was $103 thousand and $19 thousand,  respectively.
 The total cost of share-based payments charged against income before  income
 tax benefit for the first quarter of 2006  and 2005 was $22 thousand and  $9
 thousand, respectively.  The amount of related income tax benefit recognized
 in income for  the first quarter  of 2006 and  2005 was $8  thousand and  $3
 thousand,  respectively.  As of March 31, 2006,  there  was $0.4 million  of
 total unrecognized  compensation  cost  related  to  non-vested  share-based
 compensation arrangements granted under our plans, of which  $0.1 million is
 expected to be recognized in each of 2006, 2007, 2008 and 2009.

      The fair value of each stock option granted is estimated on the date of
 grant using the Black-Scholes option  pricing model.  Expected  volatilities
 are  based  on  historical volatility of  Hallmark's shares.  The  risk-free
 interest rates for periods  within the contractual term  of the options  are
 based on rates for U.S. Treasury Notes with maturity dates corresponding  to
 the options expected lives on the dates of grant.


 6. Segment Information

     The following is business segment information for the three months ended
 March 31, 2006 and 2005 (in thousands):

                                             Three Months Ended
                                                  March 31,
                                             2006          2005
                                           --------      --------
        Revenues:
        ---------
        HGA Segment                       $  17,540     $   6,280
        TGA Segment                          14,099             -
        PGA Segment                          10,797        11,161
        Aerospace Segment                     1,869             -
        Corporate                               215             4
                                           --------      --------
          Consolidated                    $  44,520     $  17,445
                                           ========      ========
        Pre-tax income (loss):
        HGA Segment                       $   3,360     $   1,068
        TGA Segment                           1,728             -
        PGA Segment                           2,051         2,442
        Aerospace Segment                      (109)            -
        Corporate                            (3,501)         (806)
                                           --------      --------
          Consolidated                    $   3,529     $   2,704
                                           ========      ========

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

                                           Mar. 31,      Dec. 31,
                                             2006          2005
                                           --------      --------
                  Assets
                  ------
        HGA Segment                       $ 141,198     $ 136,220
        TGA Segment                         109,655             -
        PGA Segment                          68,187        68,264
        Aerospace Segment                    22,112             -
        Corporate                            27,991         4,422
                                           --------      --------
          Consolidated                    $ 369,143     $ 208,906
                                           ========      ========

 7. Reinsurance

     We reinsure a portion of the risk we underwrite in order to control  the
 exposure to losses and to protect capital resources.  We cede to  reinsurers
 a portion of these risks and pay  premiums based upon the risk and  exposure
 of the policies  subject  to such  reinsurance.  Ceded reinsurance  involves
 credit risk and is generally subject to aggregate loss limits.  Although the
 reinsurer is liable to  us to the  extent of the  reinsurance ceded, we  are
 ultimately liable as the direct insurer on all risks reinsured.  Reinsurance
 recoverables are reported  after allowances for  uncollectible amounts.   We
 monitor the financial condition of reinsurers on an ongoing basis and review
 our reinsurance arrangements periodically.  Reinsurers are selected based on
 their financial condition, business practices and the price of their product
 offerings.  Refer to Note 6 of our Form 10-K for the year ended December 31,
 2005 for more discussion of our reinsurance.

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

                                             Three Months Ended
                                                  March 31,
                                             2006          2005
                                           --------      --------
        Ceded earned premiums             $   1,397     $       -
        Reinsurance recoveries            $     776     $    (391)


 8. Notes Payable

      On June 21, 2005, our newly formed trust subsidiary completed a private
 placement  of  $30.0  million  of  30-year  floating  rate  trust  preferred
 securities.  Simultaneously,  we  borrowed  $30.9  million  from  the  trust
 subsidiary and  contributed  $30.0  million to  AHIC in  order  to  increase
 policyholder surplus.  The note  bears  an initial interest  rate of  7.725%
 until June 15,  2015, at which  time interest will  adjust quarterly to  the
 three month LIBOR rate plus 3.25 percentage  points.  As of March 31,  2006,
 the note balance was $30.9 million.

      On January 27, 2006,  we borrowed  $15.0  million  under the  revolving
 credit facility with The  Frost National Bank to  fund the cash  required to
 close the TGA Group acquisition.  As of  March 31, 2006, the balance on  the
 revolving note was $15.0 million. (See  Note 3, "Business  Combinations" and
 Note 12, "Credit Facility.")

      Also included in notes  payable is $3.0  million of various  short-term
 notes payable to banks by PAAC, bearing variable interest rates ranging from
 4.75% to 7.75%. These notes are secured by PAAC's finance notes receivables.
 The line of credit available under PAAC's current borrowing arrangements  is
 $5.0 million, approximately $3.0 million of which was borrowed at March  31,
 2006.  PAAC's borrowing  arrangements contain various restrictive  covenants
 which, among  other  things,  require  maintenance  of  minimum  amounts  of
 tangible net worth and working capital. At  March 31, 2006, PAAC was not  in
 compliance with certain of such covenants but had received a waiver for  the
 violations.


 9.  Note Payable to Related Party

      On January 3, 2006, we executed a promissory note payable to  Newcastle
 Partners, L.P. in the amount of $12.5 million in order to obtain funding  to
 complete the acquisition  of Aerospace.  The promissory note bears  interest
 at  the  rate  of  10%  per  annum.  The unpaid  principal  balance  of  the
 promissory note, together with all accrued  and unpaid interest, is due  and
 payable on demand at any time after June 30, 2006.  As of March 31, 2006 the
 promissory note balance was $12.5 million.


 10.  Convertible Notes Payable

      On  January  27,  2006,  we   issued  $25.0  million  in   subordinated
 convertible promissory notes to Newcastle  Special Opportunity Fund I,  L.P.
 and Newcastle  Special  Opportunity  Fund II,  L.P.,  which  are  investment
 partnerships  managed  by  an  entity  controlled  by  Mark E. Schwarz,  our
 Chairman and Chief Executive Officer.  Each  convertible note bears interest
 at 4% per annum  until paid or  converted, which rate  increases to 10%  per
 annum  in the  event of default.  Interest is  payable quarterly in  arrears
 commencing March 31, 2006.  The  convertible notes mature on July 27,  2007,
 and may not  be prepaid.  Conversion  of the  convertible  notes  is in  all
 events subject to shareholder approval.  Following shareholder approval, the
 principal of the  convertible notes must  be converted by  the holders  into
 shares of our common  stock on or  before maturity at  a conversion rate  of
 $1.28 per share (subject to certain anti-dilution provisions).

      In accordance with the FASB Emerging  Issues Task Force ("EITF")  Issue
 No. 98-5 "Accounting for  Convertible Securities with Beneficial  Conversion
 Features or Contingently  Adjustable Conversion Ratios"  and EITF Issue  No.
 00-27 "Application of  Issue No. 98-5  to Certain Convertible  Instruments,"
 the convertible notes  contain a beneficial  conversion feature requiring  a
 discount to the  carrying amount of  the notes equal  to (i) the  difference
 between the stated conversion rate and the market price of our common  stock
 on the date of issuance, multiplied by (ii) the number of shares into  which
 the notes are convertible.  Per EITF Issue  No. 98-5 and EITF Issue No.  00-
 27, upon issuance  we recorded a  $9.6 million discount  to the  convertible
 notes which  will be  amortized straight line as  interest expense  over the
 term of the convertible notes,  with any unamortized balance of the discount
 expensed  upon  conversion  of the notes.  The discount  to  the convertible
 notes  was  offset  by  increases  to  deferred  federal  income  taxes  and
 additional paid in capital, resulting in  a temporary  increase in  our book
 value which  will decline as  the discount  is  amortized.  Ultimately,  the
 discount on the convertible notes will have no effect on our book value.

      Interest expense resulting  from amortization  of the  discount on  the
 convertible notes during the first fiscal quarter of 2006 was $1.1  million,
 resulting in a convertible  notes balance of $16.5  million as  of March 31,
 2006.  This interest expense had the effect of reducing our operating income
 for the period, but had no effect on our cash flow.


 11.  Structured Settlements

      In connection with  the acquisition  of the  TGA Group,  we  recorded a
 payable  for  the  future  guaranteed  payments of  $25.0 million discounted
 at 4.4%,  the rate of two year  US Treasuries (the only investment permitted
 on the  trust  account  securing  such  future payments  which is classified
 in  restricted  cash  and  investments  on  our  balance sheet).  (See  Note
 3, "Business Combinations.")   As  of March 31, 2006,  the  balance  of  the
 structured settlements was $23.8 million.


 12. Credit Facility

      On June 29, 2005,  we  entered into a  credit facility  with The  Frost
 National Bank.  The credit facility was amended and restated on  January 27,
 2006 to  a $20.0  million revolving  credit facility,  with a  $5.0  million
 letter  of  credit  sub-facility.   We  borrowed  $15.0  million  under  the
 revolving credit facility to fund the  cash required to close the TGA  Group
 acquisition.  Principal  outstanding  under  the revolving  credit  facility
 generally bears  interest at  the three  month Eurodollar  rate plus  2.00%,
 payable quarterly in arrears.  We pay letter  of credit fees at the rate  of
 1.00% per annum.  Our  obligations under the  revolving credit facility  are
 secured by  a  security  interest  in  the  capital  stock  of  all  of  our
 subsidiaries, guaranties  of  all of  our  subsidiaries and  the  pledge  of
 substantially  all of  our assets.  The revolving  credit facility  contains
 covenants  which,  among  other  things,  require  us  to  maintain  certain
 financial  and  operating   ratios  and   restrict  certain   distributions,
 transactions  and  organizational  changes.  The amended and restated credit
 agreement terminates on January 27, 2008.  As of March 31, 2006,  there  was
 $15.0 million outstanding under our revolving  credit facility, and we  were
 in compliance with or had obtained waivers of all of our covenants.  In  the
 third quarter of 2005, we issued a $4.0 million letter of credit under  this
 facility to  collateralize certain  obligations under  the agency  agreement
 between HGA and Clarendon National Insurance Company effective July 1, 2004.


 13. Deferred Policy Acquisition Costs

    The following table shows total deferred and amortized policy acquisition
 costs by period (in thousands):

                                             Three Months Ended
                                                  March 31,
                                             2006          2005
                                           --------      --------
        Deferred                          $  (8,720)    $  (6,087)
        Amortized                             6,793         5,715
                                           --------      --------
        Net Deferred                      $  (1,927)    $    (372)
                                           ========      ========


 14. Earnings per Share

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

                                                    Three Months Ended
                                                         March 31,
                                                    2006          2005
                                                  --------      --------
  Common Stockholders:
  --------------------
  Weighted average shares - basic                   86,874        42,471
  Effect of dilutive securities                        788           694
                                                  --------      --------
  Weighted average shares - assuming dilution       87,662        43,165
                                                  ========      ========
  Convertible Noteholders:
  ------------------------
  Weighted average shares - basic and assuming
                            dilution                19,531           n/a
                                                  ========      ========

      For the basic and diluted earnings per share calculation for the  three
 months ended March 31, 2006, net income was allocated $2.0 million to common
 stockholders  and  $0.4  million to holders of  convertible notes.  For  the
 three  months  ended March 31, 2006  and  2005,  no shares  attributable  to
 outstanding stock  options were  excluded from  the calculation  of  diluted
 earnings per share.

      In accordance with FASB Statement of Financial Accounting Standards No.
 128, "Earnings  Per Share"  ("SFAS 128"),  we have  restated the  basic  and
 diluted weighted average shares outstanding for the three months ended March
 31, 2005  for the  effect of  a bonus  element from  our stockholder  rights
 offering completed in the  second quarter of 2005.   According to SFAS  128,
 there is an assumed bonus element in a rights issue whose exercise price  is
 less than the market value of the stock at the close of the rights  offering
 period.  This  bonus element is  treated as a  stock dividend for  reporting
 earnings per share.


 15. Net Periodic Pension Cost

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

                                             Three Months Ended
                                                  March 31,
                                             2006          2005
                                           --------      --------
        Interest cost                     $     171     $     181
        Amortization of net loss                 40            19
        Expected return on plan assets         (157)         (184)
                                           --------      --------
        Net periodic pension cost         $      54     $      16
                                           ========      ========

     We contributed $32 thousand  and  $36  thousand  to  our  frozen defined
 benefit  cash balance  plan  during the first three months of 2006 and 2005,
 respectively.  Refer to Note 13 of our Form 10-K for the year ended December
 31, 2005 for more discussion of our retirement plans.


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

 Introduction

     Hallmark  Financial  Services,  Inc.  ("Hallmark"  and,  together   with
 subsidiaries, "we", "us", "our") is an insurance holding company engaged  in
 the sale  of property  and casualty  insurance  products to  businesses  and
 individuals.  Our  business involves marketing  and underwriting  commercial
 insurance in  Texas,  New  Mexico, Idaho,  Oregon,  Montana,  Louisiana  and
 Washington; marketing  and  underwriting  non-standard  personal  automobile
 insurance in  Texas,  New Mexico  and  Arizona; marketing  general  aviation
 insurance in 44 states; claims  administration; and other insurance  related
 services.   We pursue  our business  activities through  subsidiaries  whose
 operations are organized  by producing companies  into our Hallmark  General
 Agency operating  segment ("HGA  Segment"),  which includes  the  commercial
 insurance products and  services handled  by Hallmark  General Agency,  Inc.
 ("HGA") and  Effective Claims  Management, Inc.;  our Texas  General  Agency
 operating segment ("TGA Segment"),  which includes the commercial  insurance
 products and services  handled by Texas  General Agency,  Inc. ("TGA"),  Pan
 American  Acceptance  Corporation  ("PAAC")  and  TGA  Special  Risk,   Inc.
 ("TGASRI"); our Phoenix  General Agency operating  segment ("PGA  Segment"),
 which includes the non-standard  personal automobile insurance products  and
 services handled  by American  Hallmark General  Agency, Inc.  and  Hallmark
 Claims Services, Inc. (both of which do business as Phoenix General Agency);
 and our aviation operating segment ("Aerospace Segment"), which includes the
 general aviation  insurance  products  and  services  handled  by  Aerospace
 Holdings LLC ("Aerospace") and its wholly owned subsidiaries. The subsidiary
 companies  in  our TGA  Segment  and  Aerospace Segment  were  all  acquired
 effective January 1, 2006.  The retained  premium produced by  our operating
 segments  is  supported  by our  insurance  company  subsidiaries:  American
 Hallmark  Insurance Company  of Texas  ("AHIC"); Phoenix Indemnity Insurance
 Company ("PIIC"); and Gulf States Insurance Company ("GSIC"), a wholly owned
 subsidiary of TGA which was acquired by Hallmark effective January 1, 2006.

 Financial Condition and Liquidity

     Sources  and  uses of funds.  Our sources  of funds  are from  insurance
 related operations,  financing  activities and investing  activities.  Major
 sources of funds from operations include  premiums collected  (net of policy
 cancellations and premiums  ceded),  commissions, and processing and service
 fees.   On  a  consolidated  basis,  our  cash  and  investments  (excluding
 restricted cash  and investments)  at  March 31, 2006  were  $167.1  million
 compared to $139.6 million  at December 31, 2005.  Most of this increase  is
 attributable to the  acquisitions of  TGA and  certain affiliated  companies
 (collectively, the "TGA Group") on January 1, 2006, which contributed  $20.0
 million in cash and investments as of March 31, 2006.

     Net  cash provided  by our  consolidated operating  activities was  $9.6
 million for the first three months of 2006 compared to net cash used of $0.2
 million for the first three months of 2005.  The increase in operating  cash
 flow primarily resulted from  the retention of HGA  Segment and TGA  Segment
 business in the first quarter 2006 that was not retained by us in the  first
 quarter of 2005.  The net effect on operating cash flows was an increase  of
 $9.8 million resulting from  an increase in collected  premiums net of  paid
 loss and  loss  adjustment  expenses partially  offset  by  lower  collected
 commission and claim fee revenue.

     Cash used by investing activities during the first three months of  2006
 was  $41.6  million as compared to $6.4 million for the same period in 2005.
 The increase  in cash  used by  investing activities  is mostly  due to  the
 acquisitions of TGA Group and Aerospace in the first quarter  of 2006  which
 used $26.0 million, net of cash acquired.  Also contributing to the increase
 in cash used by investing activities  was the funding of $25.0 million to  a
 trust account  securing the  future guaranteed  payments  to the  TGA  Group
 sellers, as well as PAAC's $1.7 million repayment of premium finance  notes,
 net of premium finance  notes originated.  Partially offsetting  these  uses
 was a $13.2 million increase in net redemptions of short-term investments in
 the first quarter of 2006 versus the same period in 2005 and $3.9 million in
 maturities and redemptions of investment securities in 2006.

     Cash provided by financing  activities during the first three months  of
 2006 was $52.5 million as  compared to $13 thousand  for the same period  of
 2005.  The cash provided  in 2006 was primarily  from the issuance of  three
 debt instruments in  January.  The  first was a  promissory note payable  to
 Newcastle Partners, L.P.  in the amount  of $12.5 million  to fund the  cash
 required to close the  Aerospace acquisition.  This  note bears interest  at
 the rate  of 10% per annum.  The unpaid principal balance of the  promissory
 note, together with all accrued and  unpaid interest, is due and payable  on
 demand at any  time after  June 30, 2006.  The  second  debt instrument  was
 $25.0 million in subordinated convertible promissory notes to the  Newcastle
 Special Opportunity Fund I, L.P. and Newcastle Special Opportunity Fund  II,
 L.P.  Each convertible  note bears interest  at 4% per  annum until paid  or
 converted,  which  rate increases to 10% per  annum in the event of default.
 Interest  is  payable  quarterly  in  arrears  commencing  March  31,  2006.
 Conversion of the notes  is  in  all events subject to shareholder approval.
 Following shareholder approval, the principal of the notes must be converted
 by the holders into  approximately 19.5 million shares  of our common  stock
 (subject to certain anti-dilution provisions) on or before maturity on  July
 27, 2007.  Absent shareholder approval, principal and all accrued but unpaid
 interest is  due  at maturity.  The notes  may not  be  prepaid.  The  $25.0
 million raised with these  notes was used to  fund a trust account  securing
 future  guaranteed  payments  to the  TGA  Group  sellers.  The  third  debt
 instrument was $15.0  million borrowed under  our revolving credit  facility
 with  Frost  Bank  to  fund  the  cash  required  to  close  the  TGA  Group
 acquisition.

     As a  holding company, Hallmark  is dependent on  dividend payments  and
 management fees from its  subsidiaries to meet  operating expenses and  debt
 obligations.  As of March  31, 2006, Hallmark had  $1.5 million in cash  and
 invested assets.  Cash and invested assets of our non-insurance subsidiaries
 were $3.9 million as of March 31, 2006.

     Property  and casualty  insurance companies  domiciled in  the State  of
 Texas are limited in the payment  of dividends to their shareholders in  any
 twelve-month  period,  without  the  prior  written  consent  of  the  Texas
 Department of Insurance,  to the  greater of  statutory net  income for  the
 prior calendar year  or 10% of  statutory policyholders' surplus  as of  the
 prior year end.  Dividends  may only  be paid from unassigned surplus funds.
 During 2006,  AHIC's ordinary  dividend  capacity  is  $6.4  million.  PIIC,
 domiciled in Arizona, is limited in  the payment of dividends to the  lesser
 of 10% of prior year policyholder's  surplus or prior year's net  investment
 income, without  prior  written  approval from  the  Arizona  Department  of
 Insurance.  During 2006, PIIC's ordinary dividend capacity is $1.6  million.
 GSIC,  domiciled  in  Oklahoma,  is  limited  in the payment of dividends to
 the greater of 10% of prior year  policyholder's  surplus  or  prior  year's
 statutory  net  income,  without  prior written  approval  from the Oklahoma
 Insurance Department.  During  2006,  GSIC's  ordinary  dividend capacity is
 $0.1 million.  None of AHIC, PIIC or GSIC paid a dividend to Hallmark during
 the first three months of 2006.

      Credit facility.  On June 29,  2005, we entered into a credit  facility
 with The Frost National Bank.  The credit facility was amended and  restated
 on January 27,  2006 to a  $20.0 million revolving  credit facility, with  a
 $5.0 million letter of credit sub-facility.  We borrowed $15.0 million under
 the  revolving  credit  facility  to  fund  the cash required  to close  the
 TGA  Group  acquisition.  Principal outstanding  under  the revolving credit
 facility generally bears interest  at the three  month Eurodollar rate  plus
 2.00%, payable quarterly in arrears.   We pay letter  of credit fees at  the
 rate  of  1.00%  per  annum.  Our  obligations under  the  revolving  credit
 facility are secured by a security interest  in the capital stock of all  of
 our subsidiaries, guaranties of  all of our subsidiaries  and the pledge  of
 substantially  all of  our assets.  The revolving  credit facility  contains
 covenants  which,  among  other  things,  require  us  to  maintain  certain
 financial  and  operating   ratios  and   restrict  certain   distributions,
 transactions  and  organizational  changes.  The amended and restated credit
 agreement terminates  on January 27, 2008.  As of March 31, 2006, there  was
 $15.0 million outstanding under our revolving  credit facility, and we  were
 in compliance with or had obtained waivers of all of our covenants.  In  the
 third quarter of 2005, we issued a $4.0 million letter of credit under  this
 facility to  collateralize certain  obligations under  the agency  agreement
 between HGA and Clarendon National Insurance Company effective July 1, 2004.

     Trust preferred securities.   On June 21,  2005, our newly formed  trust
 subsidiary completed  a  private  placement  of  $30.0  million  of  30-year
 floating rate trust preferred securities.  Simultaneously, we borrowed $30.9
 million from the trust subsidiary and  contributed $30.0 million to AHIC  in
 order to increase policyholder surplus.  The note bears an initial  interest
 rate of  7.725% until  June 15,  2015, at  which time  interest will  adjust
 quarterly to the three month LIBOR rate plus 3.25 percentage points.  As  of
 March 31, 2006, the note balance was $30.9 million.

     Conclusion.  Based  on budgeted and year-to-date cash flow  information,
 we believe that we have sufficient liquidity to meet our projected insurance
 obligations, operational expenses and  capital expenditure requirements  for
 the  foreseeable  future.  However,  we  expect  additional  capital  to  be
 required to satisfy the debt obligations  to Newcastle which are payable  on
 demand  after  June 30, 2006.  We have previously  indicated  our  intent to
 obtain such additional  capital  through  a  rights offering of  our  common
 stock to existing shareholders during  2006.  While  a  rights  offering  is
 still  being  considered,  we  are also exploring additional alternatives to
 satisfy  our  capital needs.  There can be no assurance that we will be able
 to obtain the required additional capital on advantageous terms.

 Results of Operations

     Management Overview.   During  the  first quarter  of fiscal  2006,  our
 total revenues were $44.5 million, representing  a 155.2% increase over  the
 $17.4  million  in total revenues for  the comparable period of fiscal 2005.
 The increase in total revenues for the first three months of fiscal 2006  as
 compared to the first three months of fiscal 2005 was primarily attributable
 to the acquisitions of TGA Group and Aerospace in the first quarter of 2006,
 which contributed  $16.0  million  in  revenue.  The retention  of  business
 produced by the  HGA Segment and  underwritten by AHIC  that was  previously
 retained by third parties also contributed $10.3 million to the increase  in
 quarterly revenue.

       We reported  net income of  $2.4 million  for the  three months  ended
 March 31, 2006, as compared to $1.8 million in the same period in the  prior
 year.  The increase in net income for the first three months of 2006  versus
 the same period in 2005 was  primarily attributable to the retention of  the
 HGA Segment business  and quarterly results  from the  TGA Group,  partially
 offset by interest  expense from the  amortization of a  deemed discount  on
 convertible promissory notes.

     During the  first quarter  of fiscal 2006,  we recorded  a $1.1  million
 interest expense from  amortization attributable to  the deemed discount  on
 convertible  promissory  notes  issued  in January,  2006.   (See  Note  10,
 "Convertible Notes Payable.")  In the absence of this non-cash expense,  our
 net income for the three  months ended March 31,  2006 would have been  $3.1
 million, representing a  72.5% increase  over the similar  period  of fiscal
 2005.

    The following is a reconciliation of our net income without such interest
 expense to our reported  results  (in thousands).  Management believes  this
 reconciliation  provides useful supplemental information  in  evaluating the
 operating results of our  business.  This disclosure should not be viewed as
 a substitute for net income determined in accordance with GAAP:

                                                            Quarter Ended
                                                            March 31, 2006
                                                            --------------
        Income excluding interest expense from
          amortization of discount, net of tax                   $ 3,130

        Interest expense from amortization of discount             1,117
        Less related tax effect                                     (413)
                                                            --------------
                                                                     704
                                                            --------------
       Net income                                                $ 2,426
                                                            ==============

     On  a  common  stockholder diluted per share basis, net income was $0.02
 for the three months ended March 31, 2006 and $0.04 for the same  period  in
 2005.  The decrease in diluted earnings per share to common stockholders was
 due to the combined impact of issuing 50.0 million shares  in  a stockholder
 rights  offering in the second quarter of 2005  and  allocating a portion of
 net income to the holders of convertible notes in the first quarter of 2006.
 (See Note 14, "Earnings Per Share.")

     The following is additional  business segment information for the  three
 months ended March 31, 2006 and 2005 (in thousands):

                                             Three Months Ended
                                                  March 31,
                                             2006          2005
                                           --------      --------
        Revenues:
        ---------
        HGA Segment                       $  17,540     $   6,280
        TGA Segment                          14,099             -
        PGA Segment                          10,797        11,161
        Aerospace Segment                     1,869             -
        Corporate                               215             4
                                           --------      --------
          Consolidated                    $  44,520     $  17,445
                                           ========      ========
        Pre-tax income (loss):
        HGA Segment                       $   3,360     $   1,068
        TGA Segment                           1,728             -
        PGA Segment                           2,051         2,442
        Aerospace Segment                      (109)            -
        Corporate                            (3,501)         (806)
                                           --------      --------
          Consolidated                    $   3,529     $   2,704
                                           ========      ========


 First Quarter 2006 as compared to the First Quarter 2005

 HGA Segment

       Beginning in  the third  quarter of  2005, our  HGA Segment  (formerly
 known as the  Commercial Lines  Operation) began  retaining written  premium
 through AHIC that was previously retained  by third parties.  This  resulted
 in net written premium for the HGA Segment of $21.7 million for the  quarter
 ended March 31, 2006.

     Total  revenue for  the  HGA Segment  of  $17.5 million  for  the  first
 quarter of 2006 was $11.2 million more than the $6.3 million reported in the
 first quarter of 2005.  This 179.3% increase in total revenue was  primarily
 due to  net  premiums earned  of  $14.3 million  for  the quarter  from  the
 issuance  of  AHIC  policies  produced  by the  HGA  Segment.  Increased net
 investment income contributed an additional $0.9 million to the increase  in
 revenue for the quarter.  These  increases in revenue were partially  offset
 by lower ceding commission revenue of $3.3 million and lower processing  and
 service fees of $0.7 million, in  both cases due to  the shift from a  third
 party agency structure to an insurance underwriting structure.

     Pre-tax  income for  Hallmark General  Agency of  $3.4 million  for  the
 first quarter  of 2006  increased $2.3  million,  or 214.6%, over  the  $1.1
 million  reported  for the  first quarter  of 2005.  Increased  revenue,  as
 discussed above, was the primary reason for the increase in pre-tax  income,
 partially offset  by increased  loss and  loss adjustment  expenses of  $7.8
 million and additional production expenses of $0.9 million.

 TGA Segment

     The members of  the TGA Segment were  all acquired effective  January 1,
 2006.  The  $14.1 million of  revenues was derived  mostly from third  party
 commission revenue of $9.2  million on the portion  of business produced  by
 the TGA Segment that was retained by third parties and from $4.3 million  of
 earned premium on produced business that  was  assumed by GSIC or AHIC.  The
 remaining $0.6 million  of revenue was  derived from  investment  income and
 finance charges.

     Pre-tax income for  the TGA Segment of $1.7  million was due to  revenue
 as discussed above less  (i) incurred loss and  loss adjustment expenses  of
 $2.6 million on the portion  of the business assumed  by GSIC or AHIC,  (ii)
 $9.7 million in operating expenses,  comprised mostly of commission  expense
 and salary  related expenses,  and (iii)  $0.5  million of  amortization  of
 intangible assets acquired in the acquisition of the TGA Group.

 PGA Segment

     Net premium written for our PGA Segment (formerly known as the  Personal
 Lines Operation) increased $0.5 million during the first quarter of 2006  to
 $11.1 million compared to $10.6 million in the first quarter of 2005.

     Revenue for  the PGA  Segment decreased 3.3%  to $10.8  million for  the
 first quarter of 2006 from $11.2 million for the same period in 2005.  Lower
 earned premium of $0.3 million was  primarily due to the timing and  pattern
 of written premium.  Also contributing  to the decrease in revenue was  $0.1
 million of third party commission revenue recognized in the first quarter of
 2005 that was  discontinued due  to the 100%  assumption of  the Texas  non-
 standard automobile premium beginning late in 2004.

     Pre-tax income  for the PGA  Segment decreased $0.4  million, or  16.0%,
 for the first quarter of 2006 compared to the first quarter of 2005.   Lower
 revenue as discussed above was the primary cause of the decrease in  pre-tax
 income for the quarter.

 Aerospace Segment

     The members of the Aerospace Segment were all acquired effective January
 1, 2006.  The $1.9 million of  revenues was derived mostly from third  party
 commission revenue of $1.7  million on the portion  of business produced  by
 Aerospace Insurance Managers,  Inc. ("AIM"),  a wholly  owned subsidiary  of
 Aerospace,  which is retained by third parties.  An additional  $0.1 million
 of revenue was derived from earned premium on business assumed by  Mannequin
 PCC Ltd. Cell A-22 ("Mannequin"),  a wholly owned captive cell  of Aerospace
 located in Guernsey.  Mannequin currently assumes approximately 2.5% of  the
 business produced by AIM.

     Pre-tax loss  for the  Aerospace Segment of $0.1 million  for the  first
 quarter of  2006 was  due  to revenue  discussed  above less  (i)  operating
 expenses of $1.7 million, comprised mostly of commission expense and  salary
 related expenses, (ii) loss  and loss adjustment  expenses of $0.2  million,
 and (iii) $0.1 million of amortization of intangible assets acquired in  the
 acquisition of Aerospace.

 Corporate

      Corporate pre-tax loss was $3.5 million  for the first quarter of  2006
 as compared to $0.8 million for the same period in 2005.  The increased loss
 was primarily due to interest expense  of $1.5 million in the first  quarter
 of 2006 comprised of  (i) $0.6 million from  the trust preferred  securities
 issued in the  second quarter of  2005 (see Note  8, "Notes Payable"),  (ii)
 $0.3 million from the related party  promissory note issued in January  2006
 (see Note  9,  "Note Payable  to  Related  Party"), (iii)  $0.2  million  of
 amortization of the discount  on the future guaranteed  payments to the  TGA
 Group sellers (see  Note 11,  "Structured Settlements"),  (iv) $0.2  million
 from borrowings under our revolving credit facility with The Frost  National
 Bank in  January 2006  (see Note  8, "Notes  Payable" and  Note 12,  "Credit
 Facility"), and  (v) $0.2  million from  the issuance  of convertible  notes
 issued  in January  2006 (see Note  10, "Convertible Notes  Payable").  Also
 contributing to  the increase  in  pre-tax  loss  for  the quarter  was $1.1
 million in interest  expense from  amortization attributable  to the  deemed
 discount on convertible promissory notes issued in January, 2006.  (See Note
 10, "Convertible Notes Payable.")   This expense had  no impact on our  cash
 flow and will ultimately have no effect on our book value.


 Item 3.  Quantitative and Qualitative Disclosures About Market Risk.

      As of March 31, 2006, there had been no material changes in the  market
 risks described in the Company's Form  10-K for the year ended  December 31,
 2005.


 Item 4.  Controls and Procedures.

     The Chief Executive Officer  and Chief Financial Officer of the  Company
 have evaluated the  Company's disclosure  controls  and  procedures and have
 concluded that, as of  the end of  the period covered  by this report,  such
 disclosure  controls  and  procedures   were  effective  in  ensuring   that
 information required to be disclosed  by  the Company in the reports that it
 files or  submits  under the  Securities  Exchange  Act of  1934  is  timely
 recorded, processed, summarized  and reported. The  Chief Executive  Officer
 and Chief Financial Officer also concluded that such disclosure controls and
 procedures were  effective  in  ensuring that  information  required  to  be
 disclosed by the Company in the reports that it files or submits under  such
 Act is accumulated and communicated  to the Company's management,  including
 its Chief Executive Officer and Chief Financial Officer, as appropriate,  to
 allow timely  decisions  regarding required  disclosure.   During  the  most
 recent fiscal quarter, there have been no changes in the Company's  internal
 controls over  financial reporting  that have  materially affected,  or  are
 reasonably likely to materially affect, the Company's internal control  over
 financial reporting.

 Risks Associated with Forward-Looking Statements Included in this Form 10-Q

     This Form  10-Q contains certain  forward-looking statements within  the
 meaning of Section 27A of the Securities Act of 1933 and Section 21E of  the
 Securities Exchange Act  of  1934, which  are intended to  be covered by the
 safe  harbors  created  thereby.  These  statements include  the  plans  and
 objectives  of  management  for  future  operations,  including  plans   and
 objectives relating to  future growth of  the Company's business  activities
 and availability of funds.  The  forward-looking statements included  herein
 are  based  on  current  expectations   that  involve  numerous  risks   and
 uncertainties.  Assumptions relating to the foregoing involve judgments with
 respect to,  among other  things, future  economic, competitive  and  market
 conditions, regulatory framework, weather-related events and future business
 decisions, all of which  are difficult or  impossible to predict  accurately
 and many of  which are  beyond the  control of  the  Company.  Although  the
 Company  believes  that  the  assumptions  underlying  the   forward-looking
 statements are reasonable, any of the  assumptions could be inaccurate  and,
 therefore, there can  be no  assurance that  the forward-looking  statements
 included in this  Form 10-Q  will prove to  be accurate.  In  light  of  the
 significant  uncertainties  inherent   in  the  forward-looking   statements
 included herein, the inclusion of such information should not be regarded as
 a representation by the Company or any other person that the objectives  and
 plans of the Company will be achieved.


                                   PART II
                              OTHER INFORMATION

 Item 1. Legal Proceedings.

    The Company is  engaged in legal  proceedings in the  ordinary course  of
 business, none  of  which, either  individually  or in  the  aggregate,  are
 believed likely  to  have a  material  adverse effect  on  the  consolidated
 financial position  of the  Company or  the results  of operations,  in  the
 opinion of management.  The various  legal proceedings to which the  Company
 is a party are routine in nature and incidental to the Company's business.

 Item 1A. Risk Factors.

    In addition  to the  other  information set  forth  in this  report,  you
 should carefully consider the  risk factors discussed in  Part I, "Item  1A.
 Risk Factors" in our Annual Report on Form 10-K for the year ended  December
 31, 2005, which could materially affect our business, financial condition or
 future results.  There have been  no material changes from the risk  factors
 described in such Annual Report on Form 10-K, except as follows:

 If we are unable to raise additional capital or restructure our indebtedness
 to  Newcastle,  we   may  have  difficulty   satisfying  current   liquidity
 requirements.

    We funded the acquisition  of Aerospace  by borrowing $12.5 million  from
 Newcastle  on January 3, 2006.  The principal  and  accrued interest of this
 bridge loan are payable on demand at any time after June 30, 2006.  We  have
 previously announced  our intention  to retire  this debt  through a  rights
 offering of our common stock to existing shareholders during 2006.  Although
 such a rights offering is still  under consideration, we are also  exploring
 other alternatives to satisfy our capital needs.  If we are unable to obtain
 additional capital or restructure the payment  schedule of the bridge  loan,
 we may be unable to repay the bridge loan when demand is made.  Any  default
 under the bridge loan to Newcastle would  also be an event of default  under
 our primary secured credit  facility and, therefore,  could have a  material
 adverse affect on our liquidity and operations.

 The  failure  to  maintain   favorable  financial  strength  ratings   could
 negatively impact  our ability  to compete  successfully.

    Third party rating agencies assess and rate the claims-paying ability  of
 insurers  based  upon  criteria  established  by  the  agencies.   Financial
 strength ratings are  used by agents  and clients as  an important means  of
 assessing  the financial  strength and quality  of  insurers.  During  2005,
 A.M. Best, a  nationally recognized  insurance industry  rating service  and
 publisher, upgraded the financial strength rating of PIIC from "B (Fair)" to
 "B+ (Very Good)" and upgraded the financial strength rating of AHIC from  "B
 (Fair)" to "A- (Excellent)".  To maintain these ratings, the  capitalization
 and operating performance of our  insurance subsidiaries must be  consistent
 with projections provided to A.M. Best.  Our failure to maintain our current
 financial  strength  ratings  could  adversely  affect  our ability  to sell
 insurance policies and inhibit us from competing effectively.


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

    Information previously furnished in our Current Report on Form 8-K  filed
 February 2, 2006.


 Item 3. Defaults Upon Senior Securities.

    None.


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

    None.


 Item 5. Other Information.

    None.


 Item 6. Exhibits.

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


 Exhibit
 Number                          Description
 ------                          -----------
 3(a)         Articles of Incorporation of the registrant, as amended
              (incorporated by reference to Exhibit 3(a) to the
              registrant's Annual Report on Form 10-KSB for the fiscal
              year ended December 31, 1993).

 3(b)         By-Laws of the registrant, as amended (incorporated by
              reference to Exhibit 3(b) to the registrant's Quarterly
              Report on Form 10-Q for the quarter ended June 30, 2005).

 3(c)         Amendment of Article VII of the Amended and Restated Bylaws
              of Hallmark Financial Services, Inc., adopted July 19, 2002
              (incorporated by reference to Exhibit 10(b) to the registrant's
              Quarterly Report on Form 10-QSB for the quarter ended September
              30, 2002).

 4(a)         Specimen certificate for Common Stock, $0.03 par value
              per share, of the registrant (incorporated by reference to
              Exhibit 4 to the registrant's Annual Report on Form 10-KSB
              for the fiscal year ended December 31, 1991).

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

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

 4(d)         Form of Junior Subordinated Debt Security Due 2035
              (incorporated by reference to Exhibit 4.1 to the
              registrant's Current Report on Form 8-K filed June 27,
              2005).

 4(e)         Form of Capital Security Certificate (incorporated by
              reference to Exhibit 4.2 to the registrant's Current Report
              on Form 8-K filed June 27, 2005).

 4(f)         Promissory Note dated January 3, 2006, between Hallmark
              Financial Services, Inc. and Newcastle Partners, L.P.
              (incorporated by reference to Exhibit 4.1 to the registrant's
              Current Report on Form 8-K filed January 5, 2006).

 4(g)         First Restated Credit Agreement dated January 27, 2006,
              between Hallmark Financial Services, Inc. and The Frost
              National Bank (incorporated by reference to Exhibit 4.1 to
              the registrant's Current Report on Form 8-K filed February
              2, 2006).

 4(h)         Convertible Promissory Note dated January 27, 2006,
              between Hallmark Financial Services, Inc. and Newcastle
              Special Opportunity Fund I, L.P. and Newcastle Special
              Opportunity Fund II, L.P. (incorporated by reference to
              Exhibit 4.2 to the registrant's Current Report on Form
              8-K filed February 2, 2006).

 10(a)        Form of Purchase Agreement dated January 27, 2006,
              between Hallmark Financial Services, Inc. and Newcastle
              Special Opportunity Fund I, Ltd. and Newcastle Special
              Opportunity Fund II, L.P. (incorporated by reference to
              Exhibit 10.1 to the registrant's Current Report on Form
              8-K filed February 2, 2006).

 10(b)        Form of Registration Rights Agreement dated January 27,
              2006, between Hallmark Financial Services, Inc. and
              Newcastle Special Opportunity Fund I, Ltd. and Newcastle
              Special Opportunity Fund II, L.P. (incorporated by
              reference to Exhibit 10.2 to the registrant's Current
              Report on Form 8-K filed February 2, 2006).

 31(a)        Certification of Chief Executive Officer required by
              Rule 13a-14(a) or Rule 15d-14(a).

 31(b)        Certification of Chief Financial Officer required by
              Rule 13a-14(a) or Rule 15d-14(a).

 32(a)        Certification of Chief Executive Officer Pursuant to
              18 U.S.C. 1350.

 32(b)        Certification of Chief Financial Officer Pursuant to
              18 U.S.C. 1350.


                                  SIGNATURES

 In accordance with the requirements of the Exchange Act, the registrant  has
 caused this report to be signed on its behalf by the undersigned,  thereunto
 duly authorized.

                      HALLMARK FINANCIAL SERVICES, INC.
                                 (Registrant)


 Date: May 15, 2006          /s/ Mark E. Schwarz
                             ---------------------------------------------
                             Mark E. Schwarz, Chairman
                             (Chief Executive Officer)


 Date: May 15, 2006          /s/ Mark J. Morrison
                             ---------------------------------------------
                             Mark J. Morrison, President
                             (Chief Operating Officer and
                             Chief Financial Officer)