**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, 2008





Commission
      file number 001-11252





**Hallmark
      Financial Services, Inc.**





(Exact
      name of registrant as specified in its charter)


Nevada
              
              87-0447375(State
                  or other jurisdiction of
              
              (I.R.S.
                  EmployerIncorporation
                  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
o





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


Large
                  accelerated filer ̈
              Accelerated
                  filer ̈Non-accelerated
                  filer ̈
              Smaller
                  reporting companyx




Indicate
      by check mark whether the registrant is a shell company (as defined in Rule
      12b-2 of the Exchange Act). Yes oNo
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 $.18 per
      share
      - 20,808,954 shares outstanding as of May 14, 2008.





**PART
      I**


**FINANCIAL
      INFORMATION**





**Item
      1.**  **Financial
      Statements**




**INDEX
                TO FINANCIAL STATEMENTS**Page NumberConsolidated
                Balance Sheets at March 31, 2008 (unaudited) and December 31,
                2007
            3Consolidated
                Statements of Operations (unaudited) for the three months ended March
                31,
                2008 and March 31, 2007
            4Consolidated
                Statements of Stockholders’ Equity and Comprehensive Income (unaudited)
                for the three months ended March 31, 2008 and March 31,
                2007
            5Consolidated
                Statements of Cash Flows (unaudited) for the three months ended March
                31,
                2008 and March 31, 2007
            6Notes
                to Consolidated Financial Statements (unaudited)
            7


2





**Hallmark
      Financial Services, Inc. and Subsidiaries**


**Consolidated
      Balance Sheets**


($
      in
      thousands)




**March
                31**
            
            **December
                31****2008**
            
            **2007**ASSETS
            
            
            (unaudited
            )Investments:Debt
                securities, available-for-sale, at fair value
            
            $
            167,108
            
            $
            248,069Equity
                securities, available-for-sale, at fair value
            
            
            35,566
            
            
            15,166Short-term
                investments, available-for-sale, at fair value
            
            
            95,060
            
            
            2,625Total
                investments
            
            
            297,734
            
            
            265,860Cash
                and cash equivalents
            
            
            61,303
            
            
            145,884Restricted
                cash and cash equivalents
            
            
            4,682
            
            
            16,043Premiums
                receivable
            
            
            47,740
            
            
            46,026Accounts
                receivable
            
            
            5,344
            
            
            5,219Receivable
                for securities
            
            
            -
            
            
            27,395Prepaid
                reinsurance premiums
            
            
            2,197
            
            
            274Reinsurance
                recoverable
            
            
            4,469
            
            
            4,952Deferred
                policy acquisition costs
            
            
            20,416
            
            
            19,757Excess
                of cost over fair value of net assets acquired
            
            
            30,025
            
            
            30,025Intangible
                assets
            
            
            23,208
            
            
            23,781Deferred
                federal income taxes
            
            
            1,075
            
            
            275Prepaid
                expenses
            
            
            1,319
            
            
            1,240Other
                assets
            
            
            19,541
            
            
            19,583Total
                assets
            
            $
            519,053
            
            $
            606,314LIABILITIES
                AND STOCKHOLDERS' EQUITYLiabilities:Notes
                payable
            
            $
            60,921
            
            $
            60,814Structured
                settlements
            
            
            -
            
            
            10,000Reserves
                for unpaid losses and loss adjustment expenses
            
            
            133,748
            
            
            125,338Unearned
                premiums
            
            
            106,009
            
            
            102,998Unearned
                revenue
            
            
            2,447
            
            
            2,949Accrued
                agent profit sharing
            
            
            667
            
            
            2,844Accrued
                ceding commission payable
            
            
            12,185
            
            
            12,099Pension
                liability
            
            
            1,584
            
            
            1,669Current
                federal income tax payable
            
            
            3,418
            
            
            630Payable
                for securities
            
            
            -
            
            
            91,401Accounts
                payable and other accrued expenses
            
            
            12,410
            
            
            16,385Total
                liabilities
            
            
            333,389
            
            
            427,127Commitments
                and Contingencies (Note 15)Stockholders'
                equity:Common
                stock, $.18 par value (authorized 33,333,333 shares in 2008 and 2007;
                issued 20,809,415 and 20,776,080 shares in 2008 and 2007)
            
            
            3,746
            
            
            3,740Capital
                in excess of par value
            
            
            119,120
            
            
            118,459Retained
                earnings
            
            
            65,961
            
            
            58,909Accumulated
                other comprehensive loss
            
            
            (3,086
            )
            
            (1,844
            )Treasury
                stock, at cost (7,828 shares in 2008 and 2007)
            
            
            (77
            )
            
            (77
            )Total
                stockholders' equity
            
            
            185,664
            
            
            179,187$
            519,053
            
            $
            606,314





The
      accompanying notes are an integral part


of
      the
      consolidated financial statements


3


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




**Three
                Months Ended****March
                31****2008**
            
            **2007**Gross
                premiums written
            
            $
            64,237
            
            $
            64,658Ceded
                premiums written
            
            
            (2,332
            )
            
            (3,887
            )Net
                premiums written
            
            
            61,905
            
            
            60,771Change
                in unearned premiums
            
            
            (2,989
            )
            
            (9,123
            )Net
                premiums earned
            
            
            58,916
            
            
            51,648Investment
                income, net of expenses
            
            
            3,625
            
            
            2,990Gain
                on investments
            
            
            859
            
            
            53Finance
                charges
            
            
            1,264
            
            
            1,086Commission
                and fees
            
            
            6,484
            
            
            7,905Processing
                and service fees
            
            
            42
            
            
            272Other
                income
            
            
            3
            
            
            4Total
                revenues
            
            
            71,193
            
            
            63,958Losses
                and loss adjustment expenses
            
            
            35,504
            
            
            32,185Other
                operating expenses
            
            
            23,465
            
            
            22,701Interest
                expense
            
            
            1,185
            
            
            786Amortization
                of intangible asset
            
            
            573
            
            
            573Total
                expenses
            
            
            60,727
            
            
            56,245Income
                before tax
            
            
            10,466
            
            
            7,713Income
                tax expense
            
            
            3,414
            
            
            2,743Net
                income
            
            $
            7,052
            
            $
            4,970Net
                income per share:Basic
            
            $
            0.34
            
            $
            0.24Diluted
            
            $
            0.34
            
            $
            0.24








The
      accompanying notes are an integral part


of
      the
      consolidated financial statements


4


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




**Three
                Months Ended****March
                31,****2008**
            
            **2007****Common
                Stock**Balance,
                beginning of period
            
            $
            3,740
            
            $
            3,740Issuance
                of common stock upon option exercises
            
            
            6
            
            
            -Balance,
                end of period
            
            
            3,746
            
            
            3,740**Additional
                Paid-In Capital**Balance,
                beginning of period
            
            
            118,459
            
            
            117,932Equity
                based compensation
            
            
            547
            
            
            51Exercise
                of stock options
            
            
            114
            
            
            -Balance,
                end of period
            
            
            119,120
            
            
            117,983**Retained
                Earnings**Balance,
                beginning of period
            
            
            58,909
            
            
            31,480Net
                income
            
            
            7,052
            
            
            4,970Balance,
                end of period
            
            
            65,961
            
            
            36,450**Accumulated
                Other Comprehensive Loss**Balance,
                beginning of period
            
            
            (1,844
            )
            
            (2,344
            )Amortization
                of net actuarial loss, net of tax
            
            
            10
            
            
            -Unrealized
                (losses) gains on securities, net of tax
            
            
            (1,252
            )
            
            362Balance,
                end of period
            
            
            (3,086
            )
            
            (1,982
            )**Treasury
                Stock**Balance,
                beginning and end of period
            
            
            (77
            )
            
            (77
            )**Stockholders'
                Equity**
            
            $
            185,664
            
            $
            156,114Net
                income
            
            $
            7,052
            
            $
            4,970Amortization
                of net actuarial loss, net of tax
            
            
            10
            
            
            -Unrealized
                (losses) gains on securities, net of tax
            
            
            (1,252
            )
            
            362**Comprehensive
                Income**
            
            $
            5,810
            
            $
            5,332





The
      accompanying notes are an integral part


of
      the
      consolidated financial statements


5





**Hallmark
      Financial Services, Inc. and Subsidiaries**


**Consolidated
      Statement of Cash Flows**


(Unaudited)


($
      in
      thousands)





**Three
                Months Ended****March
                31****2008**
            
            **2007**Cash
                flows from operating activities:Net
                income
            
            $
            7,052
            
            $
            4,970Adjustments
                to reconcile net income to cash provided by operating
                activities:Depreciation
                and amortization expense
            
            
            767
            
            
            781Amortization
                of discount on structured settlement
            
            
            -
            
            
            104Deferred
                federal income tax expense (benefit)
            
            
            (156
            )
            
            1,200Gain
                on investments
            
            
            (859
            )
            
            (53
            )Change
                in prepaid reinsurance premiums
            
            
            (1,923
            )
            
            (8
            )Change
                in premiums receivable
            
            
            (1,714
            )
            
            (4,853
            )Change
                in accounts receivable
            
            
            (125
            )
            
            1,798Change
                in deferred policy acquisition costs
            
            
            (659
            )
            
            (1,784
            )Change
                in unpaid losses and loss adjustment expenses
            
            
            8,410
            
            
            13,276Change
                in unearned premiums
            
            
            3,011
            
            
            8,975Change
                in unearned revenue
            
            
            (502
            )
            
            (1,226
            )Change
                in accrued agent profit sharing
            
            
            (2,177
            )
            
            (1,190
            )Change
                in reinsurance recoverable
            
            
            483
            
            
            647Change
                in reinsurance balances payable
            
            
            -
            
            
            (6,143
            )Change
                in current federal income tax payable
            
            
            2,788
            
            
            (449
            )Change
                in accrued ceding commission payable
            
            
            86
            
            
            3,250Change
                in all other liabilities
            
            
            (4,059
            )
            
            2,503Change
                in all other assets
            
            
            1,965
            
            
            (2,836
            )Net
                cash provided by operating activities
            
            
            12,388
            
            
            18,962Cash
                flows from investing activities:Purchases
                of property and equipment
            
            
            (174
            )
            
            (72
            )Change
                in restricted cash
            
            
            11,361
            
            
            14,815Purchases
                of debt and equity securities
            
            
            (135,411
            )
            
            (48,251
            )Maturities
                and redemptions of investment securities
            
            
            129,463
            
            
            8,643Net
                purchases of short-term investments
            
            
            (92,435
            )
            
            15,000Net
                cash used in investing activities
            
            
            (87,196
            )
            
            (9,865
            )Cash
                flows from financing activities:Proceeds
                from exercise of employee stock options
            
            
            120
            
            
            -Premium
                finance notes originated, net of finance notes repaid
            
            
            107
            
            
            252Payment
                of structured settlement
            
            
            (10,000
            )
            
            (15,000
            )Net
                cash used by financing activities
            
            
            (9,773
            )
            
            (14,748
            )Decrease
                in cash and cash equivalents
            
            
            (84,581
            )
            
            (5,651
            )Cash
                and cash equivalents at beginning of period
            
            
            145,884
            
            
            81,474Cash
                and cash equivalents at end of period
            
            $
            61,303
            
            $
            75,823Supplemental
                Cash Flow Information:Interest
                paid
            
            $
            1,190
            
            $
            687Taxes
                paid
            
            $
            781
            
            $
            1,992


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


6


**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”
or “our”) is an insurance holding company which, through its subsidiaries,
      engages in the sale of property/casualty insurance products to businesses and
      individuals. Our business involves marketing, distributing, underwriting and
      servicing commercial insurance, non-standard automobile insurance and general
      aviation insurance, as well as providing other insurance related services.
      Our
      business is geographically concentrated in the south central and northwest
      regions of the United States, except for our general aviation business which
      is
      written on a national basis.





We
      pursue
      our business activities through subsidiaries whose operations are organized
      into
      four operating units which are supported by our three insurance company
      subsidiaries. Our HGA Operating Unit handles standard lines commercial insurance
      products and services and is comprised of American Hallmark Insurance Services,
      Inc. and Effective Claims Management, Inc. Our TGA Operating Unit handles
      primarily excess and surplus lines commercial insurance products and services
      and is comprised of TGA Insurance Managers, Inc., Pan American Acceptance
      Corporation (“PAAC”) and TGA Special Risk, Inc. Our Aerospace Operating Unit
      handles general aviation insurance products and services and is comprised of
      Aerospace Insurance Managers, Inc., Aerospace Special Risk, Inc. and Aerospace
      Claims Management Group, Inc. Our Phoenix Operating Unit handles non-standard
      personal automobile insurance products and services and is comprised solely
      of
      American Hallmark General Agency, Inc. (which does business as Phoenix Indemnity
      Insurance Company).





These
      four operating units are segregated into three reportable industry segments
      for
      financial accounting purposes. The Standard Commercial Segment presently
      consists solely of the HGA Operating Unit and the Personal Segment presently
      consists solely of our Phoenix Operating Unit. The Specialty Commercial Segment
      includes both our TGA Operating Unit and our Aerospace Operating Unit.





**2.
      Basis of Presentation**





Our
      unaudited consolidated financial statements included herein have been prepared
      in accordance with U.S. generally accepted accounting principles (“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, 2007 included in our Annual Report on Form 10-K filed with the
      SEC.





The
      interim financial data as of March 31, 2008 and 2007 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, 2008 are not necessarily indicative of the operating results to be
      expected for the full year.


7





***Reclassification***





Certain
      previously reported amounts have been reclassified in order to conform to our
      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
      September 2005, the American Institute of Certified Public Accountants issued
      Statement of Position 05-1, “Accounting by Insurance Enterprises for Deferred
      Acquisition Costs in Connection With Modifications or Exchanges of Insurance
      Contracts” (“SOP 05-1”). This Statement provides guidance on accounting for
      deferred acquisition costs on internal replacements of insurance and investment
      contracts other than those specifically described in Statement of Financial
      Accounting Standards No. 97, “Accounting and Reporting by Insurance Enterprises
      for Certain Long-Duration Contracts and for Realized Gains and Losses from
      the
      Sale of Investments,” previously issued by the Financial Accounting Standards
      Board (“FASB”). SOP 05-01 is effective for internal replacements occurring in
      fiscal years beginning after December 15, 2006. The adoption of SOP 05-01 had
      no
      material impact on our financial condition or results of
      operations.





In
      June
      2006, FASB Interpretation No. 48, “Accounting for Uncertainty in Income Taxes -
      An Interpretation of FASB Statement No. 109” (“FIN 48”), was issued. FIN 48
      clarifies the accounting for uncertainty in income taxes recognized in a
      company’s financial statements in accordance with FASB Statement of Financial
      Accounting Standards No. 109, “Accounting for Income Taxes”. FIN 48 also
      prescribes a recognition threshold and measurement attribute for the financial
      statement recognition and measurement of a tax position taken or expected to
      be
      taken in a tax return, as well as providing guidance on derecognition,
      classification, interest and penalties, accounting in interim periods,
      disclosure and transition. FIN 48 is effective for fiscal years beginning after
      December 15, 2006 with earlier application permitted as long as the company
      has
      not yet issued financial statements, including interim financial statements,
      in
      the period of adoption. We adopted the provisions of FIN 48 on January 1, 2007.
      Since we had no unrecognized tax benefits, we recognized no additional liability
      or reduction in deferred tax asset as a result of the adoption of FIN 48. We
      are
      no longer subject to U. S. federal, state, local or non-U.S. income tax
      examinations by tax authorities for years prior to 2003.





In
      September 2006, FASB issued Statement of Financial Accounting Standards No.
      157,
“Fair Value Measurements” (“SFAS 157”). SFAS 157 establishes a separate
      framework for determining fair values of assets and liabilities that are
      required by other authoritative GAAP pronouncements to be measured at fair
      value. In addition, SFAS 157 incorporates and clarifies the guidance in FASB
      Concepts Statement 7 regarding the use of present value techniques in measuring
      fair value. SFAS 157 does not require any new fair value measurements. SFAS
      157
      is effective for financial statements issued for fiscal years beginning after
      November 15, 2007. The adoption of SFAS 157 had no impact on our financial
      statements or results of operations but did require additional disclosures.
      (See
      Note 3, “Fair Value”).


8


In
      February 2007, FASB issued Statement of Financial Accounting Standards No.
      159,
“The Fair Value Option for Financial Assets and Liabilities” (“SFAS 159”). SFAS
      159 permits entities to choose to measure many financial instruments and certain
      other items at fair value with changes in fair value included in current
      earnings. The election is made on specified election dates, can be made on
      an
      instrument-by- instrument basis, and is irrevocable. SFAS 159 is effective
      for
      financial statements issued for fiscal years beginning after November 15, 2007.
      The adoption of SFAS 159 had no impact on our financial statements or results
      of
      operations as the Company did not elect to apply SFAS 159 to any eligible
      items.




In
      December 2007, the FASB issued Revised Statement of Financial Accounting
      Standards No. 141R, “Business Combinations” (“SFAS 141R”), a replacement of
      Statement of Financial Accounting Standards No. 141, “Business Combinations”.
      SFAS 141R provides revised guidance on how an acquirer recognizes and measures
      in its financial statements the identifiable assets acquired, the liabilities
      assumed, and any noncontrolling interest in the acquiree. In addition, it
      provides revised guidance on the recognition and measurement of goodwill
      acquired in the business combination. SFAS 141R also provides guidance specific
      to the recognition, classification, and measurement of assets and liabilities
      related to insurance and reinsurance contracts acquired in a business
      combination. SFAS 141R applies to business combinations for acquisitions
      occurring on or after January 1, 2009. We do not expect the provisions of SFAS
      141R to have a material effect on its results of operations, financial position
      or liquidity. However, SFAS 141R will impact the accounting for any future
      acquisitions.





In
      December 2007, the FASB issued Statement of Financial Accounting Standards
      No.
      160, “Noncontrolling Interests in Consolidated Financial Statements—an amendment
      of Accounting Research Bulletin No. 51” (“SFAS 160”). SFAS 160 amends Accounting
      Research Bulletin No. 51 to establish accounting and reporting standards for
      the
      noncontrolling interest in a subsidiary and for the deconsolidation of a
      subsidiary. In addition, it clarifies that a noncontrolling interest in a
      subsidiary is an ownership interest in the consolidated entity that should
      be
      reported as a component of equity in the consolidated financial statements.
      SFAS
      160 is effective on a prospective basis beginning January 1, 2009, except for
      the presentation and disclosure requirements which are applied on a
      retrospective basis for all periods presented. We do not expect the provisions
      of SFAS 160 to have a material effect on its results of operations, financial
      position or liquidity.





**3.
      Fair Value**





SFAS 157
      defines fair value, establishes a consistent framework for measuring fair value
      and expands disclosure requirements about fair value measurements.
      SFAS 157, among other things, requires us to maximize the use of observable
      inputs and minimize the use of unobservable inputs when measuring fair value.
      In
      addition, SFAS 157 precludes the use of block discounts when measuring the
      fair value of instruments traded in an active market, which were previously
      applied to large holdings of publicly traded equity securities. It also requires
      recognition of trade-date gains related to certain derivative transactions
      whose
      fair value has been determined using unobservable market inputs. This guidance
      supersedes the guidance in Emerging Issues Task Force Issue No. 02-3,
”Issues Involved in Accounting for Derivative Contracts Held for Trading
      Purposes and Contracts Involved in Energy Trading and Risk Management
      Activities”, which prohibited the recognition of trade-date gains for such
      derivative transactions when determining the fair value of instruments not
      traded in an active market.


9





***Assets
      and Liabilities Recorded at Fair Value on a Recurring
      Basis***





Effective
      January 1, 2008, the Company determines the fair value of its financial
      instruments based on the fair value hierarchy established in SFAS 157 which
      requires an entity to maximize the use of observable inputs and minimize the
      use
      of unobservable inputs. Observable inputs reflect market data obtained from
      independent sources, while unobservable inputs reflect our market assumptions.
      In accordance with SFAS 157, these two types of inputs have created the
      following fair value hierarchy:




·
            Level
                1: quoted prices in active markets for identical assets





·
            Level
                2: inputs to the valuation methodology include quoted prices for
                similar
                assets and liabilities in active markets, inputs of identical assets
                for
                less active markets, and inputs that are observable for the asset
                or
                liability, either directly or indirectly, for substantially the full
                term
                of the instrument





·
            Level
                3: inputs to the valuation methodology are unobservable for the asset
                or
                liability





This
      hierarchy requires the use of observable market data when available.





Under
      SFAS 157, we determine fair value based on the price that would be received
      for
      an asset or paid to transfer a liability in an orderly transaction between
      market participants on the measurement date. It is our policy to maximize the
      use of observable inputs and minimize the use of unobservable inputs when
      developing fair value measurements, in accordance with the fair value hierarchy
      as described above. Fair value measurements for assets and liabilities where
      there exists limited or no observable market data are calculated based upon
      our
      pricing policy, the economic and competitive environment, the characteristics
      of
      the asset or liability and other factors as appropriate. These estimated fair
      values may not be realized upon actual sale or immediate settlement of the
      asset
      or liability.





Where
      quoted prices are available on active exchanges for identical instruments,
      investment securities are classified within Level 1 of the valuation hierarchy.
      Level 1 investment securities include common and preferred stock. If quoted
      prices are not available from active exchanges for identical instruments, then
      fair values are estimated using quoted prices from less active markets, quoted
      prices of securities with similar characteristics or by pricing models utilizing
      other significant observable inputs. Examples of such instruments, which would
      generally be classified within Level 2 of the valuation hierarchy, include
      corporate bonds, municipal bonds and U.S. Treasury securities. In cases where
      there is limited activity or less transparency around inputs to the valuation,
      investment securities are classified within Level 3 of the valuation hierarchy.
      Level 3 investments are valued based on the best available data in order to
      approximate fair value. This data may be internally developed and considers
      risk
      premiums that a market participant would require. Investment securities
      classified within Level 3 include other less liquid investment
      securities.




The
      following table presents for each of the fair value hierarchy levels, our assets
      that are measured at fair value on a recurring basis at March 31, 2008. (in
      thousands)


10




Quoted Prices in
            
            OtherActive Markets for
            
            Observable
            
            UnobservableIdentical Assets
            
            Inputs
            
            Inputs(Level 1)
            
            (Level 2)
            
            (Level 3)
            
            TotalDebt
                securities
            
            $
            -
            
            $
            163,108
            
            $
            4,000
            
            $
            167,108Equity
                securities
            
            
            35,566
            
            
            -
            
            
            -
            
            
            35,566Short-term
                investments
            
            
            -
            
            
            95,060
            
            
            -
            
            
            95,060Total
                Assets
            
            $
            35,566
            
            $
            258,168
            
            $
            4,000
            
            $
            297,734








The
      following table summarizes the changes in fair value for all financial assets
      measured at fair value on a recurring basis using significant unobservable
      inputs (Level 3) during the three months ended March 31, 2008.





Beginning
                balance as of January 1, 2008
            
            $
            4,000Purchases,
                issuances, sales and settlements
            
            
            -Total
                realized/unrealized gains/(losses) included in net income
            
            
            -Net
                gains/(losses) included on other comprehensive income
            
            
            -Transfers
                in and/or out of Level 3
            
            
            -Ending
                balance as of March 31, 2008
            
            $
            4,000





**4.
      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.




**5.
      Pledged Investments**





We
      have
      certain of our securities pledged for the benefit of various state insurance
      departments and reinsurers. These securities are included with our
      available-for-sale debt securities because we have the ability to trade these
      securities. We retain the interest earned on these securities. These securities
      had a carrying value of $15.4 million at March 31, 2008.





**6.
      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 833,333 shares authorized for issuance under the 2005
      LTIP. Our 1994 Key Employee Long Term Incentive Plan (the “1994 Employee Plan”)
      and 1994 Non-Employee Director Stock Option Plan (the “1994 Director Plan”) both
      expired in 2004 but have unexercised options outstanding.


11





As
      of
      March 31, 2008, there were incentive stock options to purchase 677,499 shares
      of
      our common stock outstanding and non-qualified stock options to purchase 40,000
      shares of our common stock outstanding under the 2005 LTIP, leaving 115,834
      shares reserved for future issuance. As of March 31, 2008, there were incentive
      stock options to purchase 59,666 shares outstanding under the 1994 Employee
      Plan
      and non-qualified stock options to purchase 20,834 shares outstanding under
      the
      1994 Director Plan. In addition, as of March 31, 2008, there were outstanding
      non-qualified stock options to purchase 16,666 shares of our common stock
      granted to certain non-employee directors outside the 1994 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 1994 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.
      Incentive stock options granted under the 2005 LTIP and the 1994 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
      to
      ten years from the date of grant. Non-qualified stock options granted under
      the
      2005 LTIP vested 100% six months after the date of grant and terminate ten
      years
      from the date of grant. All non-qualified stock options granted under the 1994
      Director Plan vested 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 1994 Director Plan fully vested six months after the date of grant and
      terminate ten years from the date of grant.





During
      the first quarter of 2008, we determined our previous recognition of
      compensation expense on share based arrangements did not conform to GAAP. As
      a
      result, we corrected our calculation to properly record compensation expense
      on
      a straight line basis over the requisite service period for the entire award
      in
      accordance with SFAS No. 123R “Share-Based Payment”. The cumulative impact of
      this correction was recorded during the first quarter of 2008 resulting in
      additional compensation expense of approximately $354 thousand which is not
      considered to have a material impact on our financial position or results of
      operations.





A
      summary
      of the status of our stock options as of and changes during the year-to-date
      ended March 31, 2008 is presented below:


12





Average
            
            Contractual
            
            IntrinsicNumber of
            
            Exercise
            
            Term
            
            ValueShares
            
            Price
            
            (Years)
            
            ($000)Outstanding
                at January 1, 2008
            
            
            848,000
            
            $
            10.41Granted
            
            
            -
            
            $
            -Exercised
            
            
            (33,335
            )
            $
            3.61Forfeited
                or expired
            
            
            -
            
            $
            -Outstanding
                at March 31, 2008
            
            
            814,665
            
            $
            10.69
            
            
            7.9
            
            $
            1,110Exercisable
                at March 31, 2008
            
            
            174,582
            
            $
            6.56
            
            
            4.6
            
            $
            861





The
      following table details the intrinsic value of options exercised, total cost
      of
      share-based payments charged against income before income tax benefit and the
      amount of related income tax benefit recognized in income for the periods
      indicated (in thousands):





Three Months EndedMarch
                31,2008
            
            2007Intrinsic
                value of options exercised
            
            $
            278
            
            $
            -Cost
                of share-based payments (non-cash)
            
            $
            547
            
            $
            51Income
                tax benefit of share-basedpayments
                recognized in income
            
            $
            191
            
            $
            18








As
      of
      March 31, 2008 there was $2.1 million of total unrecognized compensation cost
      related to non-vested share-based compensation arrangements granted under our
      plans, of which $0.6 million is expected to be recognized in the remainder
      of
      2008, $0.7 million is expected to be recognized in 2009, $0.6 million is
      expected to be recognized in 2010 and $0.2 million is expected to be recognized
      in 2011.





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 our common stock. 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. There were no options granted in either the first quarter
      of 2008 or 2007.





**7.
      Segment Information**





The
      following is business segment information for the three months ended March
      31,
      2008 and 2007
      (in
      thousands):


13





Three Months EndedMarch 31,2008
            
            2007Revenues:Standard
                Commercial Segment
            
            $
            21,829
            
            $
            21,767Specialty
                Commercial Segment
            
            
            32,087
            
            
            28,098Personal
                Segment
            
            
            15,726
            
            
            13,773Corporate
            
            
            1,551
            
            
            320Consolidated
            
            $
            71,193
            
            $
            63,958Pre-tax
                income (loss):Standard
                Commercial Segment
            
            $
            3,881
            
            $
            2,759Specialty
                Commercial Segment
            
            
            5,293
            
            
            4,686Personal
                Segment
            
            
            2,590
            
            
            2,118Corporate
            
            
            (1,298
            )
            
            (1,850
            )Consolidated
            
            $
            10,466
            
            $
            7,713





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





March 31,
              2008
            
            December 31,
              2007AssetsStandard
                Commercial Segment
            
            $
            163,569
            
            $
            211,428Specialty
                Commercial Segment
            
            
            192,764
            
            
            229,138Personal
                Segment
            
            
            87,995
            
            
            100,986Corporate
            
            
            74,725
            
            
            64,762$
            519,053
            
            $
            606,314





**8.
      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.


14


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


Three Months EndedMarch 31,2008
              
              2007Ceded
                  earned premiums
              
              $
              2,310
              
              $
              3,879Reinsurance
                  recoveries
              
              $
              107
              
              $
              1,084





Our
      insurance company subsidiaries presently retain 100% of the risk associated
      with
      all non-standard personal automobile policies marketed by our Phoenix Operating
      Unit. We currently reinsure the following exposures on business generated by
      our
      HGA Operating Unit, our TGA Operating Unit and our Aerospace Operating
      Unit:





·
            **Property****catastrophe**.
                Our property catastrophe reinsurance reduces the financial impact
                a
                catastrophe could have on our commercial property insurance lines.
                Catastrophes might include multiple claims and policyholders. Catastrophes
                include hurricanes, windstorms, earthquakes, hailstorms, explosions,
                severe winter weather and fires. Our property catastrophe reinsurance
                is
                excess-of-loss reinsurance, which provides us reinsurance coverage
                for
                losses in excess of an agreed-upon amount. We utilize catastrophe
                models
                to assist in determining appropriate retention and limits to purchase.
                The
                terms of our property catastrophe reinsurance, effective July 1,
                2007,
                are:





o
            We
                retain the first $2.0 million of property catastrophe losses; and





o
            Our
                reinsurers reimburse us 100% for each $1.00 of loss in excess of
                our $2.0
                million retention up to $28.0 million for each catastrophic occurrence,
                subject to a maximum of two events for the contractual
                term.





·
            **Commercial
                property.**Our
                commercial property reinsurance is excess-of-loss coverage intended
                to
                reduce the financial impact a single-event or catastrophic loss may
                have
                on our results. The terms of the commercial property reinsurance,
                effective July 1, 2007, are:





o
            We
                retain the first $1.0 million of loss for each commercial property
                risk;





o
            Our
                reinsurers reimburse us for the next $5.0 million for each commercial
                property risk; and





o
            Individual
                risk facultative reinsurance is purchased on any commercial property
                with
                limits above $6.0 million.





·
            **Commercial
                casualty.**Our
                commercial casualty reinsurance is excess-of-loss coverage intended
                to
                reduce the financial impact a single-event loss may have on our results.
                The terms of our commercial casualty reinsurance, effective July
                1, 2007,
                are:





o
            We
                retain the first $1.0 million of loss for each commercial casualty
                risk;
                and


15





o
            Our
                reinsurers reimburse us for the next $5.0 million for each commercial
                casualty risk.





·
            **Aviation**.
                We purchase reinsurance specific to the aviation risks underwritten
                by our
                Aerospace Operating Unit. This reinsurance provides aircraft hull
                and
                liability coverage and airport liability coverage on a per occurrence
                basis on the following terms:





o
            We
                retain the first $350,000 of each aircraft hull or liability or airport
                liability loss;





o
            Our
                reinsurers reimburse us for the next $1.15 million of each aircraft
                hull
                or liability loss and for the next $650,000 of each airport liability
                loss; and





o
            Our
                reinsurers provide additional reimbursement of $4.0 million for each
                airport liability loss and aircraft liability loss, excluding passenger
                liability.





**9.
      Notes Payable**




On
      June
      21, 2005, an unconsolidated 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 one of our insurance company subsidiaries 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. Under the terms of the
      note,
      we pay interest only each quarter and the principal of the note at maturity.
      As
      of March 31, 2008, the note balance was $30.9 million.





On
      January 27, 2006, we borrowed $15.0 million under our revolving credit facility
      to fund the cash required to close the acquisition of the subsidiaries
      comprising our TGA Operating Unit. As of March 31, 2008, the balance on the
      revolving note was $2.8 million, which currently bears interest at 6.50% per
      annum. Also included in notes payable is $1.4 million outstanding as of March
      31, 2008 under PAAC’s revolving credit sub-facility, which also currently bears
      interest at 6.50% per annum. (See Note 11, “Credit Facilities”). ****





On
      August
      23, 2007, an unconsolidated trust subsidiary completed a private placement
      of
      $25.0 million of 30-year floating rate trust preferred securities.
      Simultaneously, we borrowed $25.8 million from the trust subsidiary for working
      capital and general corporate purposes. The note bears an initial interest
      rate
      at 8.28% until September 15, 2017, at which time interest will adjust quarterly
      to the three-month LIBOR rate plus 2.90 percentage points. Under the terms
      of
      the note, we pay interest only each quarter and the principal of the note at
      maturity. As of March 31, 2008 the note balance was $25.8 million.





**10.
      Structured Settlements**





In
      connection with the acquisition of the subsidiaries comprising our TGA Operating
      Unit, we recorded a payable for future guaranteed payments of $25.0 million
      discounted at 4.4%, the rate of two-year U.S. Treasuries (the only investment
      permitted on the trust account securing such future payments). As of March
      31,
      2008 we had fully repaid our obligation to the sellers.


16





**11.
      Credit Facilities**





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.
      The credit facility was further amended effective May 31, 2007 to increase
      the
      revolving credit facility to $25.0 million and establish a new $5.0 million
      revolving credit sub-facility for the premium finance operations of PAAC. The
      credit agreement was again amended effective February 20, 2008 to extend the
      termination to January 27, 2010, revise various affirmative and negative
      covenants and decrease the interest rate in most instances to the three month
      Eurodollar rate plus 1.90 percentage points, 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. As of March 31, 2008, we were in compliance with
      all
      of our covenants. (See Note 9, “Notes Payable”).





**12.
      Deferred Policy Acquisition Costs**





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




Three Months EndedMarch 31,2008
            
            2007Deferred
            
            $
            (14,405
            )
            $
            (12,360
            )Amortized
            
            
            13,746
            
            
            10,576Net
            
            $
            (659
            )
            $
            (1,784
            )





**13.
      Earnings per Share**





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


17





Three Months EndedMarch
                  31,2008
              
              2007Weighted
                  average shares - basic
              
              
              20,781
              
              
              20,768Effect
                  of dilutive securities
              
              
              106
              
              
              23Weighted
                  average shares - assuming dilution
              
              
              20,887
              
              
              20,791





For
      the
      three months ended March 31, 2008 and 2007, 140,494 shares and 109,166 shares,
      respectively, of common stock potentially issuable upon the exercise of employee
      stock options were excluded from the weighted average number of shares
      outstanding on a diluted basis because the effect of such options would be
      anti-dilutive.





**14.
      Net Periodic Pension Cost**





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





Three Months EndedMarch
                31,2008
            
            2007Interest
                cost
            
            $
            167
            
            $
            180Amortization
                of net (gain) loss
            
            
            (168
            )
            
            50Expected
                return on plan assets
            
            
            16
            
            
            (161
            )Net
                periodic pension cost
            
            $
            15
            
            $
            69





We
      contributed $84 thousand and $74 thousand to our frozen defined benefit cash
      balance plan during each of the three months ended March 31, 2008 and 2007,
      respectively. Refer to Note 13 to the consolidated financial statements in
      our
      Annual Report on Form 10-K for the year ended December 31, 2007 for more
      discussion of our retirement plans.





**15.
      Contingencies**





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





*The
      following discussion should be read together with our consolidated financial
      statements and the notes thereto. This discussion contains forward-looking
      statements. Please see “Risks Associated with Forward-Looking Statements in this
      Form 10-Q” and “Item 1A. Risk Factors” for a discussion of some of the
      uncertainties, risks and assumptions associated with these
      statements.*


18


**Introduction**





Hallmark
      Financial Services, Inc. (“Hallmark” and, together with subsidiaries, “we,” “us”
or “our”) is an insurance holding company which, through its subsidiaries,
      engages in the sale of property/casualty insurance products to businesses and
      individuals. Our business involves marketing, distributing, underwriting and
      servicing commercial insurance, non-standard automobile insurance and general
      aviation insurance, as well as providing other insurance related services.
      Our
      business is geographically concentrated in the south central and northwest
      regions of the United States, except for our general aviation business which
      is
      written on a national basis. We
      pursue
      our business activities through subsidiaries whose operations are organized
      into
      four operating units which are supported by our insurance company
      subsidiaries.




Our
      non-carrier insurance activities are segregated by operating units into the
      following reportable segments:




·
            ***Standard
                Commercial Segment.***Our Standard Commercial Segment includes the standard lines commercial
                property/casualty insurance products and services handled by our
                HGA
                Operating Unit which is comprised of our American Hallmark Insurance
                Services, Inc. and Effective Claims Management, Inc. subsidiaries.





·
            ***Specialty
                Commercial Segment.***Our Specialty Commercial Segment includes the excess and surplus
                lines
                commercial property/casualty insurance products and services handled
                by
                our TGA Operating Unit and the general aviation insurance products
                and
                services handled by our Aerospace Operating Unit. Our TGA Operating
                Unit
                is comprised of our TGA Insurance Managers, Inc., Pan American Acceptance
                Corporation (“PAAC”) and TGA Special Risk, Inc. subsidiaries. Our
                Aerospace Operating Unit is comprised of our Aerospace Insurance
                Managers,
                Inc., Aerospace Special Risk, Inc. and Aerospace Claims Management
                Group,
                Inc. subsidiaries.





·
            ***Personal
                Segment.***Our Personal Segment includes the non-standard personal automobile
                insurance products and services handled by our Phoenix Operating
                Unit
                which is comprised solely of American Hallmark General Agency, Inc.,
                which
                does business as Phoenix Indemnity Insurance
                Company.





The
      retained premium produced by our operating units is supported by the following
      insurance company subsidiaries:





·
            ***American
                Hallmark Insurance Company of Texas********(“AHIC”)*******presently
                retains all of the risks on the commercial property/casualty policies
                marketed by our HGA Operating Unit, assumes a portion of the risks
                on the
                commercial property/casualty policies marketed by our TGA Operating
                Unit
                and assumes a portion of the risks on the aviation property/casualty
                products marketed by our Aerospace Operating Unit.





·
            ***Hallmark
                Specialty Insurance Company (“HSIC”)***presently
                assumes a portion of the risks on the commercial property/casualty
                policies marketed by our TGA Operating
                Unit.


19


·
            ***Hallmark
                Insurance Company (“HIC”) (formerly known as Phoenix Indemnity Insurance
                Company)***presently assumes all of the risks on the non-standard personal automobile
                policies marketed by our Phoenix Operating Unit and assumes a portion
                of
                the risks on the aviation property/casualty products marketed by
                our
                Aerospace Operating Unit.





Effective
      January 1, 2006, our insurance company subsidiaries entered into a pooling
      arrangement, which was subsequently amended on December 15, 2006, pursuant
      to
      which AHIC retains 46% of the total net premiums written by all of our operating
      units, HIC retains 34% of our total net premiums written and HSIC retains 20%
      of
      our total net premiums written.  The impact of this pooling arrangement had
      no impact on our consolidated financial statements under GAAP.




**Results
      of Operations**





**Management
      Overview.** During
      the three months ended March 31, 2008, our total revenues were $71.2 million,
      representing an 11% increase over the $64.0 million in total revenues for the
      same period of 2007. Increased retention of business produced by our Specialty
      Commercial Segment, increased production by our Personal Segment and increased
      Corporate revenue were the primary causes of the increase in revenue. Specialty
      Commercial Segment revenues increased $4.0 million, or 14%, during the three
      months ended March 31, 2008 as compared to the same period of 2007. Revenues
      from our Personal Segment increased $2.0 million, or 14%, during the three
      months ended March 31, 2008 as compared to the same period during 2007, due
      largely to geographic expansion into new states. Net gains on investments of
      $0.9 million for the three months ended March 31, 2008, as compared to net
      gains
      on investments of $0.1 million for the same period the prior year, were the
      primary reason for the $1.2 million increase in revenue for
      Corporate.





We
      reported net income of $7.1 million for the three months ended March 31, 2008,
      which was $2.1 million higher than the $5.0 million reported for the same period
      in 2007. On a basic and diluted basis, net income was $0.34 per share for the
      three months ended March 31, 2008 as compared to $0.24 per share for the same
      period in 2007. The increase in net income was primarily attributable to the
      increased revenue discussed above as well as favorable prior year loss reserve
      development of $1.6 million during the first quarter of 2008. We did not record
      any prior year loss development during the first quarter of
      2007.


20


**First
      Quarter 2008 as Compared to First Quarter 2007**





The
      following is additional business segment information for the three months ended
      March 31, 2008 and 2007 (in thousands):





**Hallmark
      Financial Services, Inc.**


**Consolidated
      Segment Data**





**Three
                Months Ended March 31, 2008****Standard**
            
            **Specialty****Commercial**
            
            **Commercial**
            
            **Personal****Segment**
            
            **Segment**
            
            **Segment**
            
            **Corporate**
            
            **Consolidated**Produced
                premium
            
            $
            21,749
            
            $
            32,020
            
            $
            17,727
            
            $
            -
            
            $
            71,496Gross
                premiums written
            
            
            21,749
            
            
            24,761
            
            
            17,727
            
            
            -
            
            
            64,237Ceded
                premiums written
            
            
            (1,364
            )
            
            (968
            )
            
            -
            
            
            -
            
            
            (2,332
            )Net
                premiums written
            
            
            20,385
            
            
            23,793
            
            
            17,727
            
            
            -
            
            
            61,905Change
                in unearned premiums
            
            
            404
            
            
            (155
            )
            
            (3,238
            )
            
            -
            
            
            (2,989
            )Net
                premiums earned
            
            
            20,789
            
            
            23,638
            
            
            14,489
            
            
            -
            
            
            58,916Total
                revenues
            
            
            21,829
            
            
            32,087
            
            
            15,726
            
            
            1,551
            
            
            71,193Losses
                and loss adjustment expenses
            
            
            11,310
            
            
            15,003
            
            
            9,191
            
            
            -
            
            
            35,504Pre-tax
                income (loss)
            
            
            3,881
            
            
            5,293
            
            
            2,590
            
            
            (1,298
            )
            
            10,466Net
                loss ratio (1)
            
            
            54.4
            %
            
            63.5
            %
            
            63.4
            %
            
            
            
            
            60.3
            %Net
                expense ratio (1)
            
            
            27.4
            %
            
            30.7
            %
            
            22.5
            %
            
            
            
            
            29.0
            %Net
                combined ratio (1)
            
            
            81.8
            %
            
            94.2
            %
            
            85.9
            %
            
            
            
            
            89.3
            %





**Three
                Months Ended March 31, 2007****Standard**
            
            **Specialty****Commercial**
            
            **Commercial**
            
            **Personal****Segment**
            
            **Segment**
            
            **Segment**
            
            **Corporate**
            
            **Consolidated**Produced
                premium
            
            $
            23,550
            
            $
            39,357
            
            $
            15,076
            
            $
            -
            
            $
            77,983Gross
                premiums written
            
            
            23,481
            
            
            26,101
            
            
            15,076
            
            
            -
            
            
            64,658Ceded
                premiums written
            
            
            (2,635
            )
            
            (1,252
            )
            
            -
            
            
            -
            
            
            (3,887
            )Net
                premiums written
            
            
            20,846
            
            
            24,849
            
            
            15,076
            
            
            -
            
            
            60,771Change
                in unearned premiums
            
            
            (924
            )
            
            (5,756
            )
            
            (2,443
            )
            
            -
            
            
            (9,123
            )Net
                premiums earned
            
            
            19,922
            
            
            19,093
            
            
            12,633
            
            
            -
            
            
            51,648Total
                revenues
            
            
            21,767
            
            
            28,098
            
            
            13,773
            
            
            320
            
            
            63,958Losses
                and loss adjustment expenses
            
            
            12,841
            
            
            11,081
            
            
            8,267
            
            
            (4
            )
            
            32,185Pre-tax
                income (loss)
            
            
            2,759
            
            
            4,686
            
            
            2,118
            
            
            (1,850
            )
            
            7,713Net
                loss ratio (1)
            
            
            64.5
            %
            
            58.0
            %
            
            65.4
            %
            
            
            
            
            62.3
            %Net
                expense ratio (1)
            
            
            28.0
            %
            
            31.5
            %
            
            23.6
            %
            
            
            
            
            28.2
            %Net
                combined ratio (1)
            
            
            92.5
            %
            
            89.5
            %
            
            89.0
            %
            
            
            
            
            90.5
            %


(1)
      The
      net loss ratio is calculated as incurred losses and loss adjustment expenses
      divided by net premiums earned, each determined in accordance with GAAP. The
      net
      expense ratio is calculated as total underwriting expenses of our insurance
      company subsidiaries, including allocated overhead expenses and offset by agency
      fee income, divided by net premiums earned, each determined in accordance with
      GAAP. Net combined ratio is calculated as the sum of the net loss ratio and
      the
      net expense ratio.


21


***Standard
      Commercial Segment***




Gross
      premiums written for the Standard Commercial Segment were $21.7 million for
      the
      three months ended March 31, 2008, which was $1.8 million less than the $23.5
      million for the three months ended March 31, 2007. Net premiums written were
      $20.4 million for the three months ended March 31, 2008 as compared to the
      $20.8
      million reported for the same period in 2007. The primary reasons for the
      decline in premiums were increased competition and rate pressure in the standard
      commercial markets.





Total
      revenue for the Standard Commercial Segment was $21.8 million for the first
      quarter of 2008 and 2007. Net premiums earned increased $0.9 million for the
      quarter due to increased retention of business and net investment income
      increased $0.1 million. These increases in revenue were offset by lower ceding
      commission revenue and processing fees of $0.9 million due primarily to profit
      sharing commission adjustments for historical premiums produced for third
      parties.





Pre-tax
      income for our Standard Commercial Segment of $3.9 million for the first quarter
      of 2008 increased $1.1 million from the $2.8 million reported for the first
      quarter of 2007. Lower losses and loss adjustment expense of $1.5 million
      contributed to the increase in pre-tax income for the quarter, partially offset
      by increased operating expenses of $0.5 million due to production related costs
      attributable to increased earned premium as well as new hires. The lower loss
      and loss adjustment expense is evidenced by a net loss ratio of 54.4% for the
      three months ended March 31, 2008 as compared to 64.5% for the same period
      of
      2007.





The
      gross
      loss ratio before reinsurance was 50.4% for the three months ended March 31,
      2008 as compared to 57.8% for the same period the prior year. The gross loss
      results for the three months ended March 31, 2008 included $1.8 million of
      favorable prior year development. We did not recognize any prior accident year
      development during the first quarter of 2007. Absent prior year development,
      the
      gross incurred losses and loss adjustment expense before reinsurance for the
      Standard Commercial Segment were lower by $0.1 million. The Standard Commercial
      Segment reported net expense ratios of 27.4% and 28.0% for the first quarters
      of
      2008 and 2007, respectively.





***Specialty
      Commercial Segment***





Gross
      premiums written for the Specialty Commercial Segment for the first quarter
      of
      2008 were $24.8 million, which was $1.3 million less than the $26.1 million
      reported for the same period in 2007. Net premiums written for the first quarter
      of 2008 were $23.8 million, which was $1.0 million less than the $24.8 million
      reported for the same period in 2007. The decrease in premium volume was due
      to
      increased competition and rate pressure in both the excess and surplus and
      general aviation markets.




Total
      revenue for the Specialty Commercial Segment of $32.1 million for the first
      quarter of 2008 was $4.0 million more than the $28.1 million reported in the
      first quarter of 2007. This 14% increase in revenue was largely due to increased
      net premiums earned of $4.5 million for the quarter as a result of the increased
      retention of business. The Specialty Commercial Segment also recognized $2.0
      million of profit sharing commission during the first quarter of 2008 as
      compared to $0.4 million during the first quarter of 2007. Increased net
      investment income contributed an additional $0.1 million to the increase in
      revenue for the quarter. These increases in revenue were partially offset by
      lower provisional ceding commission revenue of $2.2 million due to the shift
      from a third party agency structure to an insurance underwriting structure.


22





Pre-tax
      income for the Specialty Commercial Segment of $5.3 million for the first
      quarter of 2008 increased $0.6 million from the $4.7 million reported for the
      same period in 2007. Increased revenue, discussed above, as well as lower other
      operating expenses of $0.5 million were the primary reasons for the increase
      in
      pre-tax income, partially offset by increased losses and loss adjustment
      expenses of $3.9 million.





The
      Specialty Commercial Segment reported a net loss ratio of 63.5% for the first
      quarter of 2008 as compared to 58.0% for the first quarter of 2007. The gross
      loss results for the three months ended March 31, 2008 included $0.5 million
      of
      unfavorable prior year development. We did not recognize any prior accident
      year
      development during the first quarter of 2007. Absent prior year development,
      the
      gross incurred losses and loss adjustment expense before reinsurance were higher
      by $2.8 million primarily due to increased pricing pressure reflected in our
      current accident year loss estimates. The Specialty Commercial Segment reported
      a net expense ratio of 30.7% for the first quarter of 2008, as compared to
      31.5%
      for the first quarter of 2007.





***Personal
      Segment***





Net
      premium written for our Personal Segment increased $2.6 million during the
      first
      quarter of 2008 to $17.7 million compared to $15.1 million in the first quarter
      of 2007. The increase in net premium was due mostly to continued geographic
      expansion.





Total
      revenue for the Personal Segment increased 14% to $15.7 million for the first
      quarter of 2008 from $13.8 million for the same period in 2007. The primary
      reason for the increase was higher earned premium of $1.9 million.





Pre-tax
      income for the Personal Segment was $2.6 million for the three months ended
      March 31, 2008 as compared to $2.1 million for the same period in 2007. The
      increased revenue, as discussed above, was partially offset by increased losses
      and loss adjustment expenses of $0.9 million and increased operating expenses
      of
      $0.5 million due mostly to production related expenses attributable to the
      increased earned premium.





The
      Personal Segment reported a net loss ratio of 63.4% for the first quarter of
      2008 as compared to 65.4% for the same period in 2007. The maturing of our
      business in states into which we expanded beginning in 2006 was the primary
      reason for the decline in our net loss ratio during the quarter. We recognized
      $0.3 million of favorable prior accident year development in the first quarter
      2008 as compared to $0.2 million of favorable prior year development in the
      first quarter of 2007. The Personal Segment reported a net expense ratio of
      22.5% for the first quarter of 2008 as compared to 23.6% for the first quarter
      of 2007. The decrease in the net expense ratio was mainly due to increased
      finance charges and fixed overhead allocations in relation to earned
      premium.





***Corporate***





Corporate
      revenue increased $1.2 million for the first quarter of 2008 as compared to
      the
      same period in 2007. The increase was primarily due to increased recognized
      gains on our investment portfolio of $0.8 million and increased investment
      income of $0.4 million due to changes in capital allocation.





Corporate
      pre-tax loss was $1.3 million for the first quarter of 2008 as compared to
      $1.9
      million for the same period in 2007. Contributing to the decreased loss was
      increased revenue discussed above partially offset by increased interest expense
      of $0.4 million due primarily to the issuance of trust preferred securities
      in
      August 2007 and increased operating expense of $0.2 million.


23




**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. 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, 2008, Hallmark had $24.0 million
      in unrestricted cash and invested assets at the holding company. Unrestricted
      cash and invested assets of our non-insurance subsidiaries were $5.6 million
      as
      of March 31, 2008.





AHIC,
      domiciled in Texas, is limited in the payment of dividends in any 12-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 surplus as of the prior year end. Dividends may only be paid from
      unassigned surplus funds. HIC, domiciled in Arizona, is limited in the payment
      of dividends to the lesser of 10% of prior year surplus or prior year’s net
      investment income, without prior written approval from the Arizona Department
      of
      Insurance. HSIC, domiciled in Oklahoma, is limited in the payment of dividends
      to the greater of 10% of prior year surplus or prior year’s statutory net
      income, without prior written approval from the Oklahoma Insurance Department.
      During 2008, our insurance company subsidiaries’ ordinary dividend capacity is
      $16.3 million. None of our insurance company subsidiaries paid a dividend to
      Hallmark during the first three months of 2008 or the 2007 fiscal
      year.





***Comparison
      of March 31, 2008 to December 31, 2007***





On
      a
      consolidated basis, our cash and investments (excluding restricted cash) at
      March 31, 2008 were $359.0 million compared to $411.7 million at December 31,
      2007. Settlement of receivables and payables for securities during the first
      quarter of 2008 contributed to this decrease in our cash and
      investments.




***Comparison
      of Three Months Ended March 31, 2008 and March 31,
      2007***





Net
      cash
      provided by our consolidated operating activities was $12.4 million for the
      first three months of 2008 compared to $19.0 million for the first three months
      of 2007. The decrease in operating cash flow was primarily due to increased
      paid
      loss and loss adjustment expense development on retained business.





Net
      cash
      used in investing activities during the first three months of 2008 was $87.2
      million as compared to $9.9 million for the same period in 2007. Contributing
      to
      the increase in cash used by investing activities was an increase of $87.2
      million in purchases of debt and equity securities and a $107.4 million increase
      in net purchases of short-term securities, partially offset by a $120.8 million
      increase in maturities and redemptions of investment securities.




Cash
      used
      in financing activities during the first three months of 2008 was $9.8 million
      as compared to $14.7 million used by financing activities for the same period
      of
      2007. The cash used in both periods was primarily for the payment of deferred
      guaranteed consideration to the sellers of the subsidiaries comprising our
      TGA
      Operating Unit. As of March 31, 2008 we had fully repaid our obligation to
      the
      sellers.


24


***Credit
      Facilities***





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.
      The credit facility was further amended effective May 31, 2007 to increase
      the
      revolving credit facility to $25.0 million and establish a new $5.0 million
      revolving credit sub-facility for the premium finance operations of PAAC. The
      credit agreement was again amended effective February 20, 2008 to extend the
      termination to January 27, 2010, revise various affirmative and negative
      covenants and decrease the interest rate in most instances to the three month
      Eurodollar rate plus 1.90 percentage points, 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. As of March 31, 2008, we were in compliance with
      all
      of our covenants. As of March 31, 2008, we had $4.2 million outstanding under
      this credit facility.





***Trust
      Preferred Securities***





On
      June
      21, 2005, an unconsolidated 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 one of our insurance company subsidiaries 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, 2008, the
      note balance was $30.9 million. Under the terms of the note, we pay interest
      only each quarter and the principal of the note at maturity.





On
      August
      23, 2007, an unconsolidated trust subsidiary completed a private placement
      of
      $25.0 million of 30-year floating rate trust preferred securities.
      Simultaneously, we borrowed $25.8 million from the trust subsidiary for working
      capital and general corporate purposes. The note bears an initial interest
      rate
      at 8.28% until September 15, 2017, at which time interest will adjust quarterly
      to the three-month LIBOR rate plus 2.90 percentage points. As of March 31,
      2008,
      the note balance was $25.8 million. Under the terms of the note, we pay interest
      only each quarter and the principal of the note at maturity.





***Structured
      Settlements***





In
      connection with our acquisition of the subsidiaries now comprising our TGA
      Operating Unit, we issued to the sellers promissory notes in the aggregate
      principal amount of $23.7 million, of which $14.2 million was paid on January
      2,
      2007, and $9.5 million was paid on January 2, 2008. We were also obligated
      to
      pay to the sellers an additional $1.3 million, of which $0.8 million was paid
      on
      January 2, 2007 and an additional $0.5 million was paid on January 2, 2008,
      in
      consideration of the sellers’ compliance with certain restrictive covenants,
      including a covenant not to compete for a period of five years after closing.
      We
      secured payment of these installments of purchase price and restrictive covenant
      consideration by depositing $25.0 million in a trust account for the benefit
      of
      the sellers. We recorded a payable for future guaranteed payments to the sellers
      of $25.0 million discounted at 4.4%, the rate of two-year U.S. Treasuries (the
      only permitted investment of the trust account). As of March 31, 2008 we had
      fully repaid our obligation to the sellers.


25


***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 next 12 months.





**Item
      3. Quantitative and Qualitative Disclosures About Market
      Risk.**





As
      of
      March 31, 2008, there had been no material changes in the market risks described
      in our Annual Report on Form 10-K for the year ended December 31,
      2007.





**Item
      4T. Controls and Procedures.**





The
      principal executive officer and principal financial officer of Hallmark have
      evaluated our 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 us in the reports that we file or submit under the Securities Exchange Act
      of
      1934 is timely recorded, processed, summarized and reported. The principal
      executive officer and principal financial officer also concluded that such
      disclosure controls and procedures were effective in ensuring that information
      required to be disclosed by us in the reports that we file or submit under
      such
      Act is accumulated and communicated to our management, including our principal
      executive officer and principal financial officer, as appropriate, to allow
      timely decisions regarding required disclosure. During the most recent fiscal
      quarter, there have been no changes in our internal controls over financial
      reporting that have materially affected, or are reasonably likely to materially
      affect, our 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 our
      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 our control. Although we believe 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 us or any other person that our objectives
      and
      plans will be achieved.


26


**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 following risk factors:





***Our
      success depends on our ability to price accurately the risks we
      underwrite*** .





Our
      results of operations and financial condition depend on our ability to
      underwrite and set premium rates accurately for a wide variety of risks.
      Adequate rates are necessary to generate premiums sufficient to pay losses,
      loss
      settlement expenses and underwriting expenses and to earn a profit. To price
      our
      products accurately, we must collect and properly analyze a substantial amount
      of data; develop, test and apply appropriate pricing techniques; closely monitor
      and timely recognize changes in trends; and project both severity and frequency
      of losses with reasonable accuracy. Our ability to undertake these efforts
      successfully, and as a result price our products accurately, is subject to
      a
      number of risks and uncertainties, some of which are outside our control,
      including:





•
            the
                availability of sufficient reliable data and our ability to properly
                analyze available data;





•
            the
                uncertainties that inherently characterize estimates and
                assumptions;





•
            our
                selection and application of appropriate pricing techniques;
                and





•
            changes
                in applicable legal liability standards and in the civil litigation
                system
                generally.





Consequently,
      we could under-price risks, which would adversely affect our profit margins,
      or
      we could overprice risks, which could reduce our sales volume and
      competitiveness. In either case, our profitability could be materially and
      adversely affected.





***Our
      results may fluctuate as a result of cyclical changes in the property/casualty
      insurance industry.***





Our
      revenue is primarily attributable to property/casualty insurance, which as
      an
      industry is cyclical in nature and has historically been characterized by soft
      markets followed by hard markets. A soft market is a period of relatively high
      levels of price competition, less restrictive underwriting standards and
      generally low premium rates. A hard market is a period of capital shortages
      resulting in lack of insurance availability, relatively low levels of
      competition, more selective underwriting of risks and relatively high premium
      rates. If we find it necessary to reduce premiums or limit premium increases
      due
      to competitive pressures on pricing in a softening market, we may experience
      a
      reduction in our premiums written and in our profit margins and revenues, which
      could adversely affect our financial results.


27


***Estimating
      reserves is inherently uncertain. If our loss reserves are not adequate, it
      will
      have an unfavorable impact on our results.***





We
      maintain loss reserves to cover our estimated ultimate liability for unpaid
      losses and loss adjustment expenses for reported and unreported claims incurred
      as of the end of each accounting period. Reserves represent management’s
      estimates of what the ultimate settlement and administration of claims will
      cost
      and are not reviewed by an independent actuary. These estimates, which generally
      involve actuarial projections, are based on management’s assessment of facts and
      circumstances then known, as well as estimates of future trends in claim
      severity and frequency, judicial theories of liability, and other factors.
      These
      variables are affected by both internal and external events, such as changes
      in
      claims handling procedures, inflation, judicial trends and legislative changes.
      Many of these factors are not quantifiable. Additionally, there may be a
      significant reporting lag between the occurrence of an event and the time it
      is
      reported to us. The inherent uncertainties of estimating reserves are greater
      for certain types of liabilities, particularly those in which the various
      considerations affecting the type of claim are subject to change and in which
      long periods of time may elapse before a definitive determination of liability
      is made. Reserve estimates are continually refined in a regular and ongoing
      process as experience develops and further claims are reported and settled.
      Adjustments to reserves are reflected in the results of the periods in which
      such estimates are changed. For example, a 1% change in March 31, 2008 unpaid
      losses and loss adjustment expenses would have produced a $1.3 million change
      to
      pretax earnings. Our gross loss and loss adjustment expense reserves totaled
      $133.7 million at March 31, 2008. Our loss and loss adjustment expense reserves,
      net of reinsurance recoverables, were $129.3 million at that date. Because
      setting reserves is inherently uncertain, there can be no assurance that the
      current reserves will prove adequate.





***Our
      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. During 2005, A.M. Best, a nationally
      recognized insurance industry rating service and publisher, upgraded the
      financial strength rating of HIC, from “B” (Fair) to “B+” (Very Good), and
      upgraded the financial strength rating of AHIC, from “B” (Fair) to “A-”
(Excellent). Our insurance company subsidiaries have historically been rated
      on
      an individual basis. However, effective January 1, 2006, our insurance company
      subsidiaries entered into a pooling arrangement, which was subsequently amended
      December 15, 2006, whereby AHIC would retain 46% of the net premiums written,
      HIC would retain 34% of the net premiums written and HSIC would retain 20%
      of
      the net premiums written. As a result, in June 2006, A.M. Best notified us
      that
      our insurance company subsidiaries would be rated on a pooled basis and assigned
      a rating of “A-” (Excellent) to each of our individual insurance company
      subsidiaries and to the pool formed by our insurance company
      subsidiaries.





These
      financial strength ratings are used by policyholders, insurers, reinsurers
      and
      insurance and reinsurance intermediaries as an important means of assessing
      the
      financial strength and quality of insurers. These ratings are not evaluations
      directed to potential purchasers of our common stock and are not recommendations
      to buy, sell or hold our common stock. Our ratings are subject to change at
      any
      time and could be revised downward or revoked at the sole discretion of the
      rating agencies. We believe that the ratings assigned by A.M. Best are an
      important factor in marketing our products. Our ability to retain our existing
      business and to attract new business in our insurance operations depends largely
      on these ratings. Our failure to maintain our ratings, or any other adverse
      development with respect to our ratings, could cause our current and future
      independent agents and insureds to choose to transact their business with more
      highly rated competitors. If A.M. Best downgrades our ratings or publicly
      indicates that our ratings are under review, it is likely that we would not
      be
      able to compete as effectively with our competitors, and our ability to sell
      insurance policies could decline. If that happens, our sales and earnings would
      decrease. For example, many of our agencies and insureds have guidelines that
      require us to have an A.M. Best financial strength rating of “A-” or higher. A
      reduction of our A.M. Best rating below “A-” would prevent us from issuing
      policies to insureds or potential insureds with such ratings requirements.
      Because lenders and reinsurers will use our A.M. Best ratings as a factor in
      deciding whether to transact business with us, the failure of our insurance
      company subsidiaries to maintain their current ratings could dissuade a lender
      or reinsurance company from conducting business with us or might increase our
      interest or reinsurance costs. In addition, a ratings downgrade by A.M. Best
      below “A-” would require us to post collateral in support of our obligations
      under certain of our reinsurance agreements pursuant to which we assume
      business.




28


***The
      loss of key executives could disrupt our business.***





Our
      success will depend in part upon the continued service of certain key
      executives. Our success will also depend on our ability to attract and retain
      additional executives and personnel. We do not have employment agreements with
      our Chief Executive Officer or any other of our executive officers other than
      employment agreements entered into in connection with the acquisitions of the
      subsidiaries now comprising our TGA Operating Unit and our Aerospace Operating
      Unit. The loss of key personnel, or our inability to recruit and retain
      additional qualified personnel, could cause disruption in our business and
      could
      prevent us from fully implementing our business strategies, which could
      materially and adversely affect our business, growth and
      profitability.





***Our
      industry is very competitive, which may unfavorably impact our results of
      operations.***





The
      property/casualty insurance market, our primary source of revenue, is highly
      competitive and, except for regulatory considerations, has very few barriers
      to
      entry. According to A.M. Best, there were 3,141 property/casualty insurance
      companies and 2,017 property/casualty insurance groups operating in North
      America as of July 23, 2007. Our HGA Operating Unit competes with a variety
      of
      large national standard commercial lines carriers such as The Hartford, Zurich
      North America, St. Paul Travelers and Safeco, as well as numerous smaller
      regional companies. The primary competition for our TGA Operating Unit’s excess
      and surplus lines products includes such carriers as Atlantic Casualty Insurance
      Company, Colony Insurance Company, Burlington Insurance Company, Penn America
      Insurance Group and, to a lesser extent, a number of national standard lines
      carriers such as Zurich North America and The Hartford. Our Aerospace Operating
      Unit considers its primary competitors to be Houston Casualty Corp., Phoenix
      Aviation, W. Brown & Company, AIG and London Aviation Underwriters. Although
      our Phoenix Operating Unit competes with large national insurers such as
      Allstate, State Farm and Progressive, as a participant in the non-standard
      personal automobile marketplace its competition is most directly associated
      with
      numerous regional companies and managing general agencies. Our competitors
      include entities which have, or are affiliated with entities which have, greater
      financial and other resources than we have. In addition, competitors may attempt
      to increase market share by lowering rates. In that case, we could experience
      reductions in our underwriting margins, or sales of our insurance policies
      could
      decline as customers purchase lower-priced products from our competitors. Losing
      business to competitors offering similar products at lower prices, or having
      other competitive advantages, could adversely affect our results of
      operations.




29


***Our
      results may be unfavorably impacted if we are unable to obtain adequate
      reinsurance*** .





As
      part
      of our overall risk and capacity management strategy, we purchase reinsurance
      for significant amounts of risk, especially catastrophe risks that we and our
      insurance company subsidiaries underwrite. Our catastrophe and non-catastrophe
      reinsurance facilities are subject to annual renewal. We may be unable to
      maintain our current reinsurance facilities or to obtain other reinsurance
      facilities in adequate amounts and at favorable rates. The amount, availability
      and cost of reinsurance are subject to prevailing market conditions beyond
      our
      control and may affect our ability to write additional premiums as well as
      our
      profitability. If we are unable to obtain adequate reinsurance protection for
      the risks we have underwritten, we will either be exposed to greater losses
      from
      these risks or we will reduce the level of business that we underwrite, which
      will reduce our revenue.





***If
      the companies that provide our reinsurance do not pay our claims in a timely
      manner, we could incur severe losses.***





We
      purchase reinsurance by transferring, or ceding, part of the risk we have
      assumed to a reinsurance company in exchange for part of the premium we receive
      in connection with the risk. Although reinsurance makes the reinsurer liable
      to
      us to the extent the risk is transferred or ceded to the reinsurer, it does
      not
      relieve us of our liability to our policyholders. Accordingly, we bear credit
      risk with respect to our reinsurers. We cannot assure that our reinsurers will
      pay all of our reinsurance claims, or that they will pay our claims on a timely
      basis. At March 31, 2008, we had a total of $4.5 million due us from reinsurers
      for recovery of losses. The largest amount due us from a single reinsurer as
      of
      March 31, 2008 was $1.6 million from QBE Reinsurance Corporation. If any of
      our
      reinsurers are unable or unwilling to pay amounts they owe us in a timely
      fashion, we could suffer a significant loss or a shortage of liquidity, which
      would have a material adverse effect on our business and results of
      operations.





***Catastrophic
      losses are unpredictable and may adversely affect our results of operations,
      liquidity and financial condition*** .





Property/casualty
      insurance companies are subject to claims arising out of catastrophes that
      may
      have a significant effect on their results of operations, liquidity and
      financial condition. Catastrophes can be caused by various events, including
      hurricanes, windstorms, earthquakes, hail storms, explosions, severe winter
      weather and fires, and may include man-made events, such as the September 11,
      2001 terrorist attacks on the World Trade Center. The incidence, frequency,
      and
      severity of catastrophes are inherently unpredictable. The extent of losses
      from
      a catastrophe is a function of both the total amount of insured exposure in
      the
      area affected by the event and the severity of the event. Claims from
      catastrophic events could reduce our net income, cause substantial volatility
      in
      our financial results for any fiscal quarter or year or otherwise adversely
      affect our financial condition, liquidity or results of operations. Catastrophes
      may also negatively affect our ability to write new business. Increases in
      the
      value and geographic concentration of insured property and the effects of
      inflation could increase the severity of claims from catastrophic events in
      the
      future.





***Catastrophe
      models may not accurately predict future losses*** .





Along
      with other insurers in the industry, we use models developed by third-party
      vendors in assessing our exposure to catastrophe losses that assume various
      conditions and probability scenarios. However, these models do not necessarily
      accurately predict future losses or accurately measure losses currently
      incurred. Catastrophe models, which have been evolving since the early 1990s,
      use historical information about various catastrophes and detailed information
      about our in-force business. While we use this information in connection with
      our pricing and risk management activities, there are limitations with respect
      to their usefulness in predicting losses in any reporting period. Examples
      of
      these limitations are significant variations in estimates between models and
      modelers and material increases and decreases in model results due to changes
      and refinements of the underlying data elements and assumptions. Such
      limitations lead to questionable predictive capability and post-event
      measurements that have not been well understood or proven to be sufficiently
      reliable. In addition, the models are not necessarily reflective of company
      or
      state-specific policy language, demand surge for labor and materials or loss
      settlement expenses, all of which are subject to wide variation by catastrophe.
      Because the occurrence and severity of catastrophes are inherently unpredictable
      and may vary significantly from year to year, historical results of operations
      may not be indicative of future results of operations.




30


***We
      are subject to comprehensive regulation, and our results may be unfavorably
      impacted by these regulations.***





We
      are
      subject to comprehensive governmental regulation and supervision. Most insurance
      regulations are designed to protect the interests of policyholders rather than
      of the stockholders and other investors of the insurance companies. These
      regulations, generally administered by the department of insurance in each
      state
      in which we do business, relate to, among other things:





•
            approval
                of policy forms and rates;





• standards
        of solvency, including risk-based capital measurements, which are a measure
        developed by the National Association of Insurance Commissioners and used
        by the
        state insurance regulators to identify insurance companies that potentially
        are
        inadequately capitalized;





•
            licensing
                of insurers and their agents;





•
            restrictions
                on the nature, quality and concentration of
                investments;





•
            restrictions
                on the ability of insurance company subsidiaries to pay
                dividends;





•
            restrictions
                on transactions between insurance company subsidiaries and their
                affiliates;





•
            requiring
                certain methods of accounting;





•
            periodic
                examinations of operations and finances;





•
            the
                use of non-public consumer information and related privacy
                issues;





•
            the
                use of credit history in underwriting and rating;





•
            limitations
                on the ability to charge policy fees;





•
            the
                acquisition or disposition of an insurance company or of any company
                controlling an insurance
                company;


31


•
            involuntary
                assignments of high-risk policies, participation in reinsurance facilities
                and underwriting associations, assessments and other governmental
                charges;





•
            restrictions
                on the cancellation or non-renewal of policies and, in certain
                jurisdictions, withdrawal from writing certain lines of
                business;





•
            prescribing
                the form and content of records of financial condition to be
                filed;





•
            requiring
                reserves for unearned premium, losses and other purposes;
                and





• with
        respect to premium finance business, the federal Truth-in-Lending Act and
        similar state statutes. In states where specific statutes have not been enacted,
        premium finance is generally subject to state usury laws that are applicable
        to
        consumer loans.





State
      insurance departments also conduct periodic examinations of the affairs of
      insurance companies and require filing of annual and other reports relating
      to
      the financial condition of insurance companies, holding company issues and
      other
      matters. Our business depends on compliance with applicable laws and regulations
      and our ability to maintain valid licenses and approvals for our operations.
      Regulatory authorities may deny or revoke licenses for various reasons,
      including violations of regulations. Changes in the level of regulation of
      the
      insurance industry or changes in laws or regulations themselves or
      interpretations by regulatory authorities could have a material adverse affect
      on our operations. In addition, we could face individual, group and class-action
      lawsuits by our policyholders and others for alleged violations of certain
      state
      laws and regulations. Each of these regulatory risks could have an adverse
      effect on our profitability.





***State
      statutes limit the aggregate amount of dividends that our subsidiaries may
      pay
      Hallmark, thereby limiting its funds to pay expenses and
      dividends.***





Hallmark
      is a holding company and a legal entity separate and distinct from its
      subsidiaries. As a holding company without significant operations of its own,
      Hallmark’s principal sources of funds are dividends and other sources of funds
      from its subsidiaries. State insurance laws limit the ability of Hallmark’s
      insurance company subsidiaries to pay dividends and require our insurance
      company subsidiaries to maintain specified minimum levels of statutory capital
      and surplus. The aggregate maximum amount of dividends permitted by law to
      be
      paid by an insurance company does not necessarily define an insurance company’s
      actual ability to pay dividends. The actual ability to pay dividends may be
      further constrained by business and regulatory considerations, such as the
      impact of dividends on surplus, by our competitive position and by the amount
      of
      premiums that we can write. Without regulatory approval, the aggregate maximum
      amount of dividends that could be paid to Hallmark in 2008 by our insurance
      company subsidiaries is $16.3 million. State insurance regulators have broad
      discretion to limit the payment of dividends by insurance companies and
      Hallmark’s right to participate in any distribution of assets of one of our
      insurance company subsidiaries is subject to prior claims of policyholders
      and
      creditors except to the extent that its rights, if any, as a creditor are
      recognized. Consequently, Hallmark’s ability to pay debts, expenses and cash
      dividends to our stockholders may be limited.


32


***Our
      insurance company subsidiaries are subject to minimum capital and surplus
      requirements. Failure to meet these requirements could subject us to regulatory
      action.***





Our
      insurance company subsidiaries are subject to minimum capital and surplus
      requirements imposed under the laws of their respective states of domicile
      and
      each state in which they issue policies. Any failure by one of our insurance
      company subsidiaries to meet minimum capital and surplus requirements imposed
      by
      applicable state law will subject it to corrective action, which may include
      requiring adoption of a comprehensive financial plan, revocation of its license
      to sell insurance products or placing the subsidiary under state regulatory
      control. Any new minimum capital and surplus requirements adopted in the future
      may require us to increase the capital and surplus of our insurance company
      subsidiaries, which we may not be able to do.





***We
      are subject to assessments and other surcharges from state guaranty funds,
      mandatory reinsurance arrangements and state insurance facilities, which may
      reduce our profitability.***





Virtually
      all states require insurers licensed to do business therein to bear a portion
      of
      the unfunded obligations of impaired or insolvent insurance companies. These
      obligations are funded by assessments, which are levied by guaranty associations
      within the state, up to prescribed limits, on all member insurers in the state
      on the basis of the proportionate share of the premiums written by member
      insurers in the lines of business in which the impaired, insolvent or failed
      insurer was engaged. Accordingly, the assessments levied on us by the states
      in
      which we are licensed to write insurance may increase as we increase our
      premiums written. In addition, as a condition to the ability to conduct business
      in certain states, insurance companies are required to participate in mandatory
      reinsurance funds. The effect of these assessments and mandatory reinsurance
      arrangements, or changes in them, could reduce our profitability in any given
      period or limit our ability to grow our business.





We
      are
      currently monitoring developments with respect to various state facilities,
      such
      as the Texas FAIR Plan and the Texas Windstorm Insurance Association, and the
      various guaranty funds in which we participate. The ultimate impact of recent
      catastrophe experience on these facilities is currently uncertain but could
      result in the facilities recognizing a financial deficit or a financial deficit
      greater than the level currently estimated. They may, in turn, have the ability
      to assess participating insurers when financial deficits occur, adversely
      affecting our results of operations. While these facilities are generally
      designed so that the ultimate cost is borne by policyholders, the exposure
      to
      assessments and the availability of recoupments or premium rate increases from
      these facilities may not offset each other in our financial statements.
      Moreover, even if they do offset each other, they may not offset each other
      in
      financial statements for the same fiscal period due to the ultimate timing
      of
      the assessments and recoupments or premium rate increases, as well as the
      possibility of policies not being renewed in subsequent years.





***Adverse
      securities market conditions can have a significant and negative impact on
      our
      investment portfolio*** .





Our
      results of operations depend in part on the performance of our invested assets.
      As of March 31, 2008, 88% of our investment portfolio was invested in
      fixed-income securities. Certain risks are inherent in connection with
      fixed-income securities, including loss upon default and price volatility in
      reaction to changes in interest rates and general market factors. In general,
      the fair market value of a portfolio of fixed-income securities increases or
      decreases inversely with changes in the market interest rates, while net
      investment income realized from future investments in fixed-income securities
      increases or decreases along with interest rates. In addition, 74% of our
      fixed-income securities have call or prepayment options. This subjects us to
      reinvestment risk should interest rates fall and issuers call their securities.
      Furthermore, actual net investment income and/or cash flows from investments
      that carry prepayment risk, such as mortgage-backed and other asset-backed
      securities, may differ from those anticipated at the time of investment as
      a
      result of interest rate fluctuations. An investment has prepayment risk when
      there is a risk that cash flows from the repayment of principal might occur
      earlier than anticipated because of declining interest rates or later than
      anticipated because of rising interest rates. The fair value of our fixed-income
      securities as of March 31, 2008 was $262.2 million. If market rates were to
      change 1%, for example, from 5% to 6%, the fair value of our fixed-income
      securities would change approximately $13.0 million as of March 31, 2008. The
      calculated change in fair value was determined using duration modeling assuming
      no prepayments.


33


As
      of
      March 31, 2008, our fixed-income portfolio included approximately 36% of
      municipal auction rate securities (“ARS”) that were all acquired in March 2008.
      These ARS have long-term stated maturities, with the interest rate reset based
      on auctions every 7 to 35 days depending on the specific security. At the
      auction date, if the quantity of sell orders exceeds the quantity of purchase
      orders, the auction “fails” and the issuers are forced to pay a “maximum rate”
as defined for each issue. The maximum rate is designed so that its prolonged
      use is an incentive to the issuer to call and refinance the long-term bonds.
      The
      effect of this incentive may be lessened to the extent that the maximum rate
      is
      closer to current market rates. When auctions are successfully completed, the
      interest rate reset normally corresponds with the short-term rate associated
      with the reset period. Our ARS holdings have an average credit rating of AA
      and
      fair value was estimated at the corresponding par value at March 31, 2008.
      None
      of the auctions for the ARS held at March 31, 2008 have failed. However, the
      current trend is for ARS issuers to either call or refinance these
      securities.





In
      addition to the general risks described above, although 92% of our fixed-income
      portfolio is investment-grade, our fixed-income securities are nonetheless
      subject to credit risk. If any of the issuers of our fixed-income securities
      suffer financial setbacks, the ratings on the fixed-income securities could
      fall
      (with a concurrent fall in market value) and, in a worst case scenario, the
      issuer could default on its obligations. Hallmark has no exposure in its
      investment portfolio to sub-prime mortgages and $1 thousand total exposure
      in
      mortgage backed securities. Future changes in the fair market value of our
      available-for-sale securities will be reflected in other comprehensive income.
      Similar treatment is not available for liabilities. Therefore, interest rate
      fluctuations could adversely affect our stockholders’ equity, total
      comprehensive income and/or our cash flows.





As
      of
      March 31, 2008, 12% of our investment portfolio was invested in equity
      securities. The equity securities that we hold are subject to economic loss
      from
      a decline in share price. As a result, the values of these equity securities
      are
      heavily influenced by the specific financial prospects of each issuer. In
      addition, general economic conditions, stock market conditions and other factors
      may adversely affect the value of our equity investments. As a result, we may
      not realize the desired returns on our equity investments may incur losses
      on
      sales of our equity securities or may be required to write down the value of
      our
      equity securities.





***We
      rely on independent agents and specialty brokers to market our products and
      their failure to do so would have a material adverse effect on our results
      of
      operations.***





We
      market
      and distribute our insurance programs exclusively through independent insurance
      agents and specialty insurance brokers. As a result, our business depends in
      large part on the marketing efforts of these agents and brokers and on our
      ability to offer insurance products and services that meet the requirements
      of
      the agents, the brokers and their customers. However, these agents and brokers
      are not obligated to sell or promote our products and many sell or promote
      competitors’ insurance products in addition to our products. Some of our
      competitors have higher financial strength ratings, offer a larger variety
      of
      products, set lower prices for insurance coverage and/or offer higher
      commissions than we do. Therefore, we may not be able to continue to attract
      and
      retain independent agents and brokers to sell our insurance products. The
      failure or inability of independent agents and brokers to market our insurance
      products successfully could have a material adverse impact on our business,
      financial condition and results of operations.




34


***We
      may experience difficulty in integrating future acquisitions into our
      operations.***





The
      successful integration of any newly acquired businesses into our operations
      will
      require, among other things, the retention and assimilation of their key
      management, sales and other personnel; the coordination of their lines of
      insurance products and services; the adaptation of their technology, information
      systems and other processes; and the retention and transition of their
      customers. Unexpected difficulties in integrating any acquisition could result
      in increased expenses and the diversion of management time and resources. If
      we
      do not successfully integrate any acquired business into our operations, we
      may
      not realize the anticipated benefits of the acquisition, which could have a
      material adverse impact on our financial condition and results of operations.
      Further, any potential acquisitions may require significant capital outlays
      and,
      if we issue equity or convertible debt securities to pay for an acquisition,
      the
      issuance may be dilutive to our existing stockholders.





***Our
      geographic concentration ties our performance to the business, weather, economic
      and regulatory conditions of certain states*** .





The
      following five states accounted for 74% of our gross written premiums for the
      three months ended March 31, 2008: Texas (41%), Oregon (11%), New Mexico (10%),
      Idaho (6%) and Arizona (6%). Our revenues and profitability are subject to
      the
      prevailing regulatory, legal, economic, political, demographic, competitive,
      weather and other conditions in the principal states in which we do business.
      Changes in any of these conditions could make it less attractive for us to
      do
      business in such states and would have a more pronounced effect on us compared
      to companies that are more geographically diversified. In addition, our exposure
      to severe losses from localized natural perils, such as windstorms or
      hailstorms, is increased in those areas where we have written significant
      numbers of property/casualty insurance policies.





***The
      exclusions and limitations in our policies may not be
      enforceable.***





Many
      of
      the policies we issue include exclusions or other conditions that define and
      limit coverage, which exclusions and conditions are designed to manage our
      exposure to certain types of risks and expanding theories of legal liability.
      In
      addition, many of our policies limit the period during which a policyholder
      may
      bring a claim under the policy, which period in many cases is shorter than
      the
      statutory period under which these claims can be brought by our policyholders.
      While these exclusions and limitations help us assess and control our loss
      exposure, it is possible that a court or regulatory authority could nullify
      or
      void an exclusion or limitation, or legislation could be enacted modifying
      or
      barring the use of these exclusions and limitations. This could result in higher
      than anticipated losses and loss adjustment expenses by extending coverage
      beyond our underwriting intent or increasing the number or size of claims,
      which
      could have a material adverse effect on our operating results. In some
      instances, these changes may not become apparent until some time after we have
      issued the insurance policies that are affected by the changes. As a result,
      the
      full extent of liability under our insurance contracts may not be known for
      many
      years after a policy is issued.


35


***We
      rely on our information technology and telecommunications systems and the
      failure or disruption of these systems could disrupt our operations and
      adversely affect our results of operations*** .





Our
      business is highly dependent upon the successful and uninterrupted functioning
      of our information technology and telecommunications systems. We rely on these
      systems to process new and renewal business, provide customer service, make
      claims payments and facilitate collections and cancellations, as well as to
      perform actuarial and other analytical functions necessary for pricing and
      product development. Our systems could fail of their own accord or might be
      disrupted by factors such as natural disasters, power disruptions or surges,
      computer hackers or terrorist attacks. Failure or disruption of these systems
      for any reason could interrupt our business and adversely affect our results
      of
      operations.





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





None.





**Item
      3.**  **Defaults
      Upon Senior Securities.**





None.





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




None.





**Item
      5.**  **Other
      Information.**





None.


36


**Item
      6.**  **Exhibits.**





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





Exhibit
              Number
            
            Description3(a)
            
            Restated
                Articles of Incorporation of the registrant, as amended (incorporated
                by
                reference to Exhibit 3.1 to the registrant’s Registration Statement on
                Form S-1 [Registration No. 333-136414] filed September 8,
                2006.3(b)
            
            Amended
                and Restated By-Laws of the registrant (incorporated by reference
                to
                Exhibit 3.1 to the registrant’s Current Report on Form 8-K filed October
                1, 2007).4(a)
            
            Specimen
                certificate for Common Stock, $0.18 par value per share, of the registrant
                (incorporated by reference to Exhibit 4.1 to Amendment No. 1 to the
                registrant’s Registration Statement on Form S-1 [Registration No.
                333-136414] filed September 8, 2006).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)
            
            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(g)
            
            Form
                of Registration Rights Agreement 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 4.1 to the registrant’s Current Report on Form 8-K filed
                February 2, 2006).4(h)
            
            Indenture
                dated as of August 23, 2007, between Hallmark Financial Services,
                Inc. and
                The Bank of New York Trust Company, National Association (incorporated
                by
                reference to Exhibit 4.1 to the registrant’s Current Report on Form 8-K
                filed August 24, 2007).4(i)
            
            Amended
                and Restated Declaration of Trust of Hallmark Statutory Trust II
                dated as
                of August 23, 2007, among Hallmark Financial Services, Inc., as sponsor,
                The Bank of New York (Delaware), as Delaware trustee, and The Bank
                of New
                York Trust Company, 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 August 24, 2007).


37




Exhibit
              Number
            
            Description


4(j)
            
            Form
                of Junior Subordinated Debt Security Due 2037 (incorporated by reference
                to Exhibit 4.1 to the registrant’s Current Report on Form 8-K filed August
                24, 2007).4(k)
            
            Form
                of Capital Security Certificate (incorporated by reference to Exhibit
                4.2
                to the registrant’s Current Report on Form 8-K filed August 24,
                2007).31(a)
            
            Certification
                of principal executive officer required by Rule 13a-14(a) orRule
                15d-14(a).31(b)
            
            Certification
                of principal financial officer required by Rule 13a-14(a) orRule
                15d-14(a).32(a)
            
            Certification
                of principal executive officer Pursuant to 18 U.S.C.
                1350.32(b)
            
            Certification
                of principal financial officer Pursuant to 18 U.S.C.
                1350.


38


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, 2008
            
            /s/
              Mark J. MorrisonMark
                J. Morrison, Chief Executive Officer and President
              (Principal
                Executive Officer)Date:
                May 15, 2008
            
            /s/
              Jeffrey R. PassmoreJeffrey
                R. Passmore, Chief Accounting Officer and Senior Vice
                President(Principal
                Financial Officer)


39