SWS GROUP INC - FORM 10-Q/A - September 2, 2011

Large accelerated filer

Accelerated filer

Non-accelerated filer

¨ (Do not check if a smaller reporting company)

Smaller reporting company

UNITED STATES

SECURITIES AND EXCHANGE COMMISSION

WASHINGTON, D.C. 20549

Form 10-Q/A

Amendment No. 1

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

For the quarterly period ended December 31, 2010

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

For the transition period from to

Commission file number 000-19483

SWS GROUP, INC.

(Exact name of registrant as specified in its charter)


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

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

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

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

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

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

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

As of February 4, 2011, there were 32,548,434 shares of the registrant’s common stock, $.10 par value, outstanding.

Explanatory Note

SWS Group, Inc. (together with its subsidiaries, “we,” “us,” “SWS” or the “company”) is filing this Amendment No. 1 on Form 10-Q/A (this “Amendment”) to its Quarterly Report on Form 10-Q for the six months ended December 31, 2010, originally filed on February 9, 2011 (the “Original Filing”). For the convenience of the reader, this Amendment sets forth the Original Filing in its entirety, as amended by this Amendment. However, this Amendment only amends Items 1, 2 and 4 of Part I of the Original Filing. In addition, as required by Rule 12b-15 promulgated under the Securities Exchange Act of 1934, as amended (the “Exchange Act”), new certifications by the company’s principal executive officer and principal financial officer are filed as exhibits to this Amendment.

Item 1 of Part I is being amended to correct an accounting error that resulted in: (i) a dollar-for-dollar overstatement of “loans held for sale” and understatement of “loans, net” on the Consolidated Statements of Financial Condition as of December 31, 2010 and (ii) a dollar-for-dollar misclassification of cash flows related to these loans as “cash flows from operating activities” rather than “cash flows from investing activities” on the Consolidated Statements of Cash Flows for the six months ended December 31, 2010. For additional information regarding this restatement, see “Restatement” contained in Item 1 of Part I. Item 2 of Part I is being amended solely to make conforming changes related to the restatement. Item 4 of Part I is being amended to disclose management’s conclusions regarding the ineffectiveness of the company’s disclosure controls and procedures.

Except for the information described above, this Amendment does not reflect events occurring after the filing of the Original Filing and unless otherwise stated herein, the information contained in the Amendment is current only as of the time of the Original Filing. Except as described above, no other changes have been made to the Original Filing. Accordingly, the Amendment should be read in conjunction with the Company’s filings made with the Securities and Exchange Commission subsequent to the filing of the Original Filing.

SWS GROUP, INC. AND SUBSIDIARIES

INDEX


PART I. FINANCIAL INFORMATION

Item 1. Financial Statements

Consolidated Statements of Financial Condition December 31, 2010 (unaudited) and June 25, 2010			4

Consolidated Statements of Income (Loss) and Comprehensive Income (Loss) For the three and six-months ended December 31, 2010 and 2009 (unaudited)			5

Consolidated Statements of Cash Flows For the six-months ended December 31, 2010 and 2009 (unaudited)			6

Notes to Consolidated Financial Statements (unaudited)			8

Item 2. Management’s Discussion and Analysis of Financial Condition and Results of Operations			42

Item 3. Quantitative and Qualitative Disclosures About Market Risk			79

Item 4. Controls and Procedures			79

PART II. OTHER INFORMATION

Item 1. Legal Proceedings			80

Item 1A. Risk Factors			80

Item 2. Unregistered Sales of Equity Securities and Use of Proceeds			82

Item 3. Defaults Upon Senior Securities			82

Item 4. (Removed and Reserved)			82

Item 5. Other Information			83

Item 6. Exhibits			83

SIGNATURES			84

EXHIBIT INDEX			85

PART I. FINANCIAL INFORMATION

Item 1.

Financial Statements

SWS Group, Inc. and Subsidiaries

CONSOLIDATED STATEMENTS OF FINANCIAL CONDITION

December 31, 2010 and June 25, 2010

(In thousands, except par values and share amounts)


	December (Restated)			June
	(Unaudited)
Assets
Cash and cash equivalents	$	243,375		$	27,190
Assets segregated for regulatory purposes		254,134			284,827
Receivable from brokers, dealers and clearing organizations		1,929,588			1,889,400
Receivable from clients, net		237,693			216,574
Loans held for sale		10,080			424,055
Loans, net		1,143,413			1,154,065
Securities owned, at market value		229,805			245,587
Securities held to maturity		265			87,140
Securities purchased under agreements to resell		30,600			30,507
Goodwill		7,552			7,552
Securities available for sale		44,580			1,388
Other assets		161,883			162,406

	$	4,292,968		$	4,530,691

Liabilities and Stockholders’ Equity
Short-term borrowings	$	200,300		$	110,000
Payable to brokers, dealers and clearing organizations		1,789,228			1,819,995
Payable to clients		394,568			420,672
Deposits		1,272,364			1,488,804
Securities sold under agreements to repurchase		2,513			12,389
Securities sold, not yet purchased, at market value		79,583			67,594
Drafts payable		29,033			27,346
Advances from Federal Home Loan Bank		105,438			132,821
Other liabilities		60,344			67,676

		3,933,371			4,147,297
Stockholders’ equity:
Preferred stock of $1.00 par value. Authorized 100,000 shares; none issued		—			—
Common stock of $0.10 par value. Authorized 60,000,000 shares; issued 33,312,140 and outstanding 32,282,342 shares at December 31, 2010; issued 33,312,140 and outstanding 32,342,190 shares at June 25, 2010		3,331			3,331
Additional paid-in capital		326,442			326,462
Retained earnings		37,584			61,893
Accumulated other comprehensive income – unrealized holding loss, net of tax of $311 at December 31, 2010 and $81 at June 25, 2010		747			304
Deferred compensation, net		3,436			3,176
Treasury stock (1,029,798 shares at December 31, 2010 and 969,950 shares at June 25, 2009, at cost)		(11,943	)		(11,772	)

Total stockholders’ equity		359,597			383,394
Commitments and contingencies

Total liabilities and stockholders’ equity	$	4,292,968		$	4,530,691

See accompanying Notes to Consolidated Financial Statements.

SWS Group, Inc. and Subsidiaries

CONSOLIDATED STATEMENTS OF INCOME (LOSS)

AND COMPREHENSIVE INCOME (LOSS)

For the three and six-months ended December 31, 2010 and 2009

(In thousands, except per share and share amounts)

(Unaudited)


	For the Three-Months Ended					For the Six-Months Ended
	December 31, 2010			December 31, 2009		December 31, 2010			December 31, 2009
Revenues:
Net revenues from clearing operations	$	2,824		$	2,730	$	5,260		$	5,356
Commissions		38,323			42,152		77,095			84,764
Interest		36,734			40,736		75,574			82,173
Investment banking, advisory and administrative fees		13,479			9,018		24,266			18,288
Net gains on principal transactions		7,647			9,656		19,842			24,475
Other		3,226			5,235		9,546			11,356

Total revenue		102,233			109,527		211,583			226,412
Interest expense		11,890			14,350		23,630			31,782

Net revenues		90,343			95,177		187,953			194,630

Non-interest expenses:
Commissions and other employee compensation		57,040			59,802		116,043			121,828
Occupancy, equipment and computer service costs		8,452			8,699		16,945			17,089
Communications		3,319			3,307		6,557			6,555
Floor brokerage and clearing organization charges		1,222			972		2,184			1,931
Advertising and promotional		701			1,170		1,355			2,175
Provision for loan loss		6,729			4,665		46,240			9,420
Other		13,594			7,607		29,620			21,700

Total non-interest expenses		91,057			86,222		218,944			180,698

Income (loss) before income tax expense (benefit)		(714	)		8,955		(30,991	)		13,932
Income tax expense (benefit)		(384	)		3,088		(9,913	)		4,980

Net income (loss)		(330	)		5,867		(21,078	)		8,952
Net gain/(loss) recognized in other comprehensive income (loss), net of tax of $251 and $7 for the three-months ended December 31, 2010 and 2009, respectively and $231 and $7 for the six-months ended December 31, 2010 and 2009, respectively.		509			23		443			(23	)

Comprehensive income (loss)	$	179		$	5,890	$	(20,635	)	$	8,929

Earnings per share – basic
Net income (loss)	$	(0.01	)	$	0.21	$	(0.65	)	$	0.32

Weighted average shares outstanding – basic		32,284,271			28,672,282		32,303,390			28,094,256

Earnings per share – diluted
Net income (loss)	$	(0.01	)	$	0.21	$	(0.65	)	$	0.32

Weighted average shares outstanding – diluted		32,284,271			28,725,022		32,303,390			28,151,941

See accompanying Notes to Consolidated Financial Statements.

SWS Group, Inc. and Subsidiaries

CONSOLIDATED STATEMENTS OF CASH FLOWS

For the six-months ended December 31, 2010 and 2009

(In thousands)

(Unaudited)


	For the Six-Months Ended
	December 31, 2010 (Restated)			December 31, 2009
Cash flows from operating activities:
Net income (loss)	$	(21,078	)	$	8,952
Adjustments to reconcile net income (loss) to net cash provided by (used in) operating activities:
Depreciation and amortization		3,681			3,462
Amortization of premiums/discounts on loans purchased		(67	)		(108	)
Amortization of premiums /discounts on investment securities		146			(14	)
Provision for loan loss/doubtful accounts and write downs on real estate owned properties		58,189			11,822
Deferred income tax benefit		(4,288	)		(674	)
Allowance for deferred tax asset		844			—
Deferred compensation for deferred compensation plan and restricted stock plan		2,522			3,309
Loss (gain) on sale of loans		513			(564	)
Loss on disposition/sale of fixed asset transaction		6			10
Loss on sale of real estate		1,988			484
Gain on the sale of investment securities		(21	)		—
Gain on issuer’s redemption of investment securities		(1,078	)		—
Equity in (earnings) losses of unconsolidated ventures		323			(713	)
Gain on the sale of securities available for sale		—			(16	)
Dividend received on investment in Federal Home Loan Bank stock		(13	)		(6	)
Shortfall for taxes on vesting of restricted stock		310			120
Change in operating assets and liabilities:
Decrease in assets segregated for regulatory purposes		30,693			7,786
Net change in broker, dealer and clearing organization accounts		(70,955	)		(75,385	)
Net change in client accounts		(47,628	)		17,374
Net change in loans held for sale		424,055			(77,855	)
Decrease in securities owned		15,782			25,804
Increase in securities purchased under agreements to resell		(93	)		(1,029	)
Increase in other assets		(6,613	)		(12,981	)
Increase in drafts payable		1,687			1,030
Increase in securities sold, not yet purchased		11,989			(9,872	)
Decrease in other liabilities		(9,733	)		(17,494	)

Net cash provided by (used in) operating activities		391,161			(116,558	)

Cash flows from investing activities:
Purchase of fixed assets and capitalized improvements on real estate owned properties		(1,962	)		(4,422	)
Proceeds from fixed asset transactions		—			17
Proceeds from the sale of real estate		30,096			14,509
Proceeds from the sale of loans		39,518			—
Loan originations and purchases		(3,546,084	)		(196,315	)
Loan repayments		3,423,728			142,276
Cash paid on investments		—			(400	)
Proceeds from the sale of investment securities		32,976			—
Proceeds from the issuer’s redemption of investment securities		7,082			—
Proceeds from the distribution from investment securities		306			—
Proceeds from the sale of investments		5,251			—
Proceeds from the sale of securities available for sale		—			2,925
Proceeds from the sale of Federal Home Loan Bank stock		2,564			267
Purchases of Federal Home Loan Bank stock		(1,460	)		—

Net cash used in investing activities		(7,985	)		(41,143	)


	For the Six-Months Ended
	December 31, 2010 (Restated)			December 31, 2009
Cash flows from financing activities:
Payments on short-term borrowings	$	(2,763,332	)	$	(1,396,700	)
Cash proceeds from short-term borrowings		2,853,632			1,415,200
Increase (decrease) in deposits		(216,440	)		57,596
Advances from the Federal Home Loan Bank		418,644			997
Payments on advances from the Federal Home Loan Bank		(446,027	)		(5,524	)
Payment of cash dividends on common stock		(3,253	)		(5,354	)
Shortfall for taxes on vesting of restricted stock		(310	)		(120	)
Cash receipts on securities sold under agreements to repurchase		(9,876	)		(4,462	)
Net proceeds from secondary offering		—			54,482
Proceeds related to the deferred compensation plan		311			353
Purchase of treasury stock related to the deferred compensation plan		(340	)		(228	)

Net cash (used in) provided by financing activities		(166,991	)		116,240

Net increase (decrease) in cash and cash equivalents		216,185			(41,461	)
Cash and cash equivalents at beginning of period		27,190			96,253

Cash and cash equivalents at end of period	$	243,375		$	54,792

Supplemental schedule of non-cash investing and financing activities:
Granting of restricted stock	$	414		$	1,461

Foreclosures on loans	$	36,724		$	29,035

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

Supplemental disclosure of cash flow information:
Cash paid during the period for:
Interest	$	23,564		$	33,801

Income taxes	$	1,635		$	6,780

See accompanying Notes to Consolidated Financial Statements.

SWS Group, Inc. and Subsidiaries

Notes to Consolidated Financial Statements

Three and Six-Months Ended December 31, 2010 and 2009

(Unaudited)

GENERAL AND BASIS OF PRESENTATION

The interim consolidated financial statements as of December 31, 2010, and for the three and six-months ended December 31, 2010 and 2009, are unaudited; however, in the opinion of management, these interim statements include all adjustments, consisting only of normal recurring adjustments, necessary for a fair presentation of the financial position, results of operations and cash flows. These financial statements should be read in conjunction with the audited consolidated financial statements and related notes as of and for the fiscal year ended June 25, 2010 filed on Form 10-K. Amounts included for June 25, 2010 are derived from the audited consolidated financial statements as filed on Form 10-K. All significant inter-company balances and transactions have been eliminated.

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


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

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

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

The Bank is a federally chartered savings bank regulated by the Office of Thrift Supervision (“OTS”). With the passage of the Dodd-Frank Wall Street Reform Consumer Protection Act, or the Dodd-Frank Act, effective July 21, 2011 (unless extended by up to six months), the OTS will be abolished and the Office of Comptroller of the Currency (“OCC”) will take over supervision and regulation of the Bank and the Federal Reserve Board (“FRB”) will take over supervision and regulation of SWS Group and SWS Banc, which was incorporated as a wholly owned subsidiary of SWS Group and became the sole stockholder of the Bank in 2004.

Consolidated Financial Statements. The quarterly consolidated financial statements of SWS are customarily closed on the last Friday of the month except for the second fiscal quarter which is prepared as of December 31, 2010. All significant inter-company balances and transactions have been eliminated.

SWS Group, Inc. and Subsidiaries

Notes to Consolidated Financial Statements—(Continued)

Three and Six-Months Ended December 31, 2010 and 2009

(Unaudited)

Restatement. In August 2011, SWS determined that loan participations acquired under its standard mortgage purchase program agreement did not meet the new participating interest requirements under amended Accounting Standards Codification (“ASC”) 860, “Transfers and Servicing,” (“ASC 860”), which was effective for SWS for transfers after July 1, 2010. Accordingly, the loan participations in the mortgage purchase program which were previously classified as loans held for sale should have been considered loans held for investment and reported as loans, net on the Consolidated Statements of Financial Condition. As a result, SWS overstated loans held for sale and understated loans, net on the Consolidated Statements of Financial Condition as of December 31, 2010 and misclassified cash flows related to these loans as cash flows from operating activities rather than cash flows from investing activities on the Consolidated Statements of Cash Flows for the six months ended December 31, 2010. This change had no impact on the Consolidated Statements of Income, the allowance for loan losses or Bank regulatory capital ratios. The mortgage purchase program is discussed in detail in “Loans Held for Sale.”

The effect of the revised presentation of the Consolidated Statements of Financial Condition and the Consolidated Statements of Cash Flows are presented below:


(in thousands)	December 31, 2010
(in thousands)	Restated Amount			Previously Reported
Consolidated Statements of Financial Condition:
Loans held for sale	$	10,080		$	172,747
Loans, net		1,143,413			980,746
Consolidated Statements of Cash Flows:
Cash flows provided by operating activities		391,161			228,494
Net change in loans held for sale		424,055			261,388
Cash flows (used in) provided by investing activities		(7,985	)		154,682
Proceeds from the sale of loans		39,518			38,199
Loan originations and purchases		(3,546,084	)		(195,633	)
Loan repayments		3,423,728			237,263

Change in Accounting Estimate. Prior to the third quarter of fiscal 2010, the Bank’s provision for loan loss computation used a three year rolling average of historical loan losses by product type to assess losses in the Bank’s loan portfolio. Product types consist of 1-4 family residential loans, 1-4 family residential construction loans, land and land development loans, commercial real estate loans, commercial loans and consumer loans. Due to accelerated deterioration in the Bank’s loan portfolio, depressed appraised values for collateral, continued high unemployment rates in Texas and deteriorating banking industry loss statistics, the Bank’s management reevaluated its use of historical loan losses in its provision for loan loss computation. As a result of this reevaluation, in the third quarter of fiscal 2010, management reduced the historical loan loss look back period from three years to four quarters.

Due to continued deterioration in the Bank’s loan portfolio, depressed appraised values for collateral, continued high unemployment rates in Texas and deteriorating banking industry loss statistics in the first quarter of fiscal 2011, the Bank’s management reevaluated its problem loan volume trend component in its provision for loan loss computation. The problem loan volume trend component now includes two separate calculations for criticized and classified loans. Prior to the first quarter of fiscal 2011, the Bank had one calculation for these loans. To more appropriately assess these loans, the Bank segregated these loans and applied two separate historical loss ratios, one being the regular historical loan loss ratio applied to criticized and classified loans and the other being based on distressed sale charge-off levels applied to criticized and classified loans. Also, due to the significant increase in classified loans and the Bank’s need to provide a heavier weighting for these types of loans in the Bank’s allowance calculation, the Bank segregated the assets and used the “distressed sell mark,” the fair value mark made on the loans placed in an auction, as a basis for the additional emphasis in the model.

Amortization Expense. The Company has recorded a customer relationship intangible which is amortized over a five year period at a rate based on the estimated future economic benefit of the customer relationships. See additional discussion in “Intangible Assets.”

Income Taxes. SWS and its subsidiaries file a consolidated federal income tax return. Income taxes are accounted for under the asset and liability method. Deferred tax assets and liabilities are

SWS Group, Inc. and Subsidiaries

Notes to Consolidated Financial Statements—(Continued)

Three and Six-Months Ended December 31, 2010 and 2009

(Unaudited)

recognized for the estimated future tax consequences attributable to differences between the financial statement carrying amounts of existing assets and liabilities and their respective tax bases. Deferred tax assets and liabilities are measured using enacted tax rates in effect for the year in which those temporary differences are expected to be recovered or settled. The effect on deferred tax assets and liabilities of a change in tax rates is recognized in income in the period that includes the enactment date.

The Company records net deferred tax assets to the extent the Company believes these assets will more likely than not be realized. In making such determination, the Company considers all available positive and negative evidence, including future reversals of existing taxable temporary differences, projected future taxable income, tax planning strategies and recent financial operations. A valuation allowance is established against deferred tax assets that do not meet the criteria for recognition. In the event the Company were to determine that it would be able to realize deferred income tax assets in the future in excess of their net recorded amount, the Company would make an adjustment to the valuation allowance which would reduce the provision for income taxes.

Certain deferred tax assets are derived from capital losses, which depend on having sufficient capital gain income within the carry-back and carry-forward period available under the tax law. The Company’s deferred tax assets include $844,000 which reflects the benefit of capital losses associated with its investments in certain partnership assets. In the first quarter of fiscal 2010, the Company established a valuation allowance in the amount of $844,000. As of December 31, 2010, the Company did not believe it was more likely than not that sufficient capital gain income would be generated to offset these capital losses.

At December 31, 2010, the Company had approximately $1,283,000 of unrecognized tax benefits. The Company’s net liability increased $162,000 from June 25, 2010 to December 31, 2010 due to unrecognized tax benefits related to tax positions taken on previously filed returns and returns expected to be filed in the current year. While the Company expects that the net liability for uncertain tax positions will change during the next twelve months, the Company does not believe that the change will have a significant impact on its consolidated financial position or results of operations.

The Company recognizes interest and penalties on income taxes in income tax expense. Included in the net liability was accrued interest and penalties, net of federal benefit, of $217,000 as of December 31, 2010 and $273,000 as of June 25, 2010. The total amount of unrecognized income tax benefits that, if recognized, would reduce income tax expense, net of federal benefit, was approximately $1,066,000 as of December 31, 2010 and $848,000 as of June 25, 2010.

With limited exceptions, the Company is no longer subject to U.S. federal, state or local tax audits by taxing authorities for tax years preceding 2006. The examination of the Company’s returns by a state agency for the tax years ended December 31, 2006 through 2008 was concluded with no material adjustments.

Income tax expense (benefit) for the three and six-month periods ended December 31, 2010 and 2009 (effective rate of 53.8% and 34.5% in the three month periods ended December 31, 2010 and 2009, respectively, and 32.0% and 35.7% in the six-month periods ended December 31, 2010 and 2009, respectively) differs from the amount that would otherwise have been calculated by applying the federal corporate tax rate (35% in 2010 and 2009 ) to income (loss) before income tax expense (benefit) and is comprised of the following (in thousands):


	Three-Months Ended						Six-Months Ended
	2010			2009			2010			2009
Income tax expense (benefit) at the statutory rate	$	(250	)	$	3,134		$	(10,847	)	$	4,876
Tax exempt interest		(207	)		(195	)		(420	)		(374	)
Tax exempt income from company-owned life insurance (“COLI”)	$	(238	)	$	(78	)	$	(466	)	$	(431	)
State income taxes, net of federal tax benefit		(16	)		130			440			803
Non-deductible meals and entertainment		44			78			77			140
Non-deductible compensation		280			—			385			—
Valuation allowance		—			—			844			—
Other, net		3			19			74			(34	)

	$	(384	)	$	3,088		$	(9,913	)	$	4,980

SWS Group, Inc. and Subsidiaries

Notes to Consolidated Financial Statements—(Continued)

Three and Six-Months Ended December 31, 2010 and 2009

(Unaudited)

The tax effects of temporary differences that give rise to the deferred tax assets and deferred tax liabilities as of December 31, 2010 and June 30, 2010 are presented below (in thousands):


	December 2010			June 2010
Deferred tax assets:
Employee compensation plans	$	10,298		$	11,787
Allowance for probable loan losses		18,287			12,625
Bad debt reserve		1,895			1,847
Deferred rent		1,678			1,675
Fixed assets, net		—			202
Gain on sale of loans deferred		656			804
Investment in unconsolidated ventures		537			384
Securities available for sale		677			—
State taxes		1,259			1,155
Other		354			643

Total gross deferred tax assets		35,641			31,122

Deferred tax liabilities:
Securities available for sale	$	(376	)	$	(145	)
Extraordinary gain		(239	)		(239	)
Fixed assets, net		(257	)		__
Other		(73	)		(99	)

Total gross deferred tax liabilities		(945	)		(483	)

Valuation allowance		(844	)		—

Net deferred tax assets – included in other assets on the consolidated statements of financial condition	$	33,852		$	30,639

FAIR VALUE OF FINANCIAL INSTRUMENTS

Fair value accounting establishes a framework for measuring fair value and expands disclosures about fair value measurements. Under fair value accounting, fair value refers to the price that would be received to sell an asset or paid to transfer a liability in an orderly transaction between market participants in the primary market in which the reporting entity transacts. The standard clarifies the principle that fair value should be based on the assumptions market participants would use when pricing the asset or liability. In support of this principle, the standard establishes a fair value hierarchy that prioritizes the information used to develop those assumptions. The fair value hierarchy gives the highest priority to quoted prices in active markets and the lowest priority to unobservable data. Under the standard, fair value measurements are separately disclosed by level within the fair value hierarchy. The standard describes three levels of inputs that may be used to measure fair value:

•

Level 1 — Quoted prices in an active market for identical assets or liabilities. Assets and liabilities utilizing Level 1 inputs include the following: a) the Company’s investment in U.S.

SWS Group, Inc. and Subsidiaries

Notes to Consolidated Financial Statements—(Continued)

Three and Six-Months Ended December 31, 2010 and 2009

(Unaudited)

Home Systems, Inc. (“USHS”) common stock; b) the Company’s deferred compensation plan’s investment in Westwood Holdings Group, Inc. (“Westwood”) common stock; c) the Company’s investment in government guaranteed bonds purchased under the Temporary Liquidity Guarantee Program (“TLGP”); and d) certain inventories held in the Company’s securities owned and securities sold, not yet purchased portfolio. Valuation of these instruments does not require a high degree of judgment as the valuations are based on quoted prices in active markets that are readily available.

•

Level 2 — Observable inputs other than Level 1 prices, such as quoted prices for similar assets or liabilities; quoted prices in markets that are not active; or other inputs that are observable or can be corroborated by observable market data for substantially the full term of the assets or liabilities. Assets and liabilities utilizing Level 2 inputs include certain inventories held in the Company’s securities owned and securities sold, not yet purchased portfolio and the Bank’s investment in Government National Mortgage Association (“GNMA”) securities. These financial instruments are valued using quoted prices that are less frequent than those in active markets or by models that use various assumptions that are derived from or supported by data that is generally observable in the marketplace. Valuations in this category are inherently less reliable than quoted market prices due to the degree of subjectivity involved in determining appropriate methodologies and the applicable underlying observable market assumptions.

•

Level 3 — Unobservable inputs that are supported by little or no market activity and that are significant to the fair value of the assets and liabilities. Assets and liabilities utilizing Level 3 inputs include certain inventories held in the Company’s securities owned portfolio. These financial instruments have significant inputs that cannot be validated by readily determinable market data and generally involve considerable judgment by management.

The following is a description of the valuation methodologies used for instruments measured at fair value on a recurring basis and recognized in the accompanying balance sheet, as well as the general classification of such instruments pursuant to the valuation hierarchy.

Assets Segregated for Regulatory Purposes. Because quoted market prices are available in an active market, these securities are classified within Level 1 of the valuation hierarchy. These securities consist of government bonds purchased under the TLGP.

Securities Available for Sale. Because quoted market prices are available in an active market, the Company’s investment in USHS common stock and the Company’s deferred compensation plan’s investment in Westwood common stock are classified within Level 1 of the valuation hierarchy. The Company’s investment in GNMA securities are valued within Level 2 of the valuation hierarchy because they are valued based on models using observable inputs, rather than quoted market prices in an active market.

Securities Owned and Securities Sold, Not Yet Purchased Portfolio. Securities classified as Level 1 securities primarily consist of financial instruments whose value is based on quoted market prices such as corporate equity securities and U.S. government obligations.

Securities classified as Level 2 securities include financial instruments that are valued using models or other valuation methodologies. These models are primarily industry standard models that consider various assumptions, including time value, yield curve, volatility factors, current market and contractual prices for the underlying financial instruments, as well as other relevant economic measures. Substantially all of these assumptions are observable in the marketplace, can be derived from observable data or are supported by observable levels at which transactions are executed in the marketplace. Securities in this category include corporate debt, certain U.S. government and government agency obligations and municipal obligations.

SWS Group, Inc. and Subsidiaries

Notes to Consolidated Financial Statements—(Continued)

Three and Six-Months Ended December 31, 2010 and 2009

(Unaudited)

Securities classified as Level 3 securities are securities whose fair value is estimated based on internally developed models or methodologies, including discounted cash flow, utilizing significant inputs that are generally less readily observable. Included in this category are certain corporate equity securities and municipal auction rate securities.

At both December 31, 2010 and June 25, 2010, the Company held one municipal auction rate bond with a par amount of $23,300,000. This security is an investment grade credit, was valued at 95.7% of par, or $22,298,000, at both December 31, 2010 and June 25, 2010, and yielded less than 1% per year for both periods. The interest rate on the bond is based on the LIBOR rate. The discount on the value of the bond is due to a lack of marketability. While management does not expect any reduction in the cash flow from this bond, the disruption in the credit markets has led to auction failures. The Company currently has the ability to hold this investment until maturity. While the Company expects the issuer of this bond to refinance the debt when LIBOR interest rates rise, there can be no certainty that this refinancing will occur. The Company believes the valuation of this bond at 95.7% of par at December 31, 2010 reflected an appropriate discount for the current lack of liquidity in this investment.

The following tables summarize by level within the fair value hierarchy “Assets segregated for regulatory purposes,” “Securities available for sale,” “Securities owned, at market value” and “Securities sold, not yet purchased, at market value” as of December 31, 2010 and June 25, 2010.


December 31, 2010 (in thousands)
	Level 1		Level 2		Level 3		Total
Assets segregated for regulatory purposes
U.S. government guaranteed obligations	$	61,751	$	—	$	—	$	61,751

	$	61,751	$	—	$	—	$	61,751


Securities available for sale
USHS common stock	$	1,746	$	—	$	—	$	1,746
Westwood common stock		255		—		—		255
GNMA		—		42,579		—		42,579

	$	2,001	$	42,579	$	—	$	44,580


Securities owned, at market value
Corporate equity securities	$	9,965	$	—	$	1,825	$	11,790
Municipal obligations		—		104,592		22,298		126,890
U.S. government agency obligations		4,015		14,283		—		18,298
Corporate obligations		—		62,155		—		62,155
Other		914		9,758		—		10,672

	$	14,894	$	190,788	$	24,123	$	229,805


Securities sold, not yet purchased, at market value
Corporate equity securities	$	493	$	—	$	—	$	493
U.S. government and government agency obligations		45,631		72		—		45,703
Corporate obligations		—		32,282		—		32,282
Other		46		1,059		—		1,105

	$	46,170	$	33,413	$	—	$	79,583


Grand Total	$	32,476	$	199,954	$	24,123	$	256,553

SWS Group, Inc. and Subsidiaries

Notes to Consolidated Financial Statements—(Continued)

Three and Six-Months Ended December 31, 2010 and 2009

(Unaudited)


June 25, 2010
(in thousands)
	Level 1		Level 2		Level 3		Total
Assets segregated for regulatory purposes
U.S. government guaranteed obligations	$	62,167	$	—	$	—	$	62,167

	$	62,167	$	—	$	—	$	62,167

Securities available for sale
USHS stock	$	1,146	$	—	$	—	$	1,146
Westwood stock		242		—		—		242

	$	1,388	$	—	$	—	$	1,388

Securities owned, at market value
Corporate equity securities	$	10,893	$	—	$	1,841	$	12,734
Municipal obligations		—		109,844		22,298		132,142
U.S. government agency obligations		13,710		5,808		—		19,518
Corporate obligations		—		70,844		—		70,844
Other		994		9,355		—		10,349

	$	25,597	$	195,851	$	24,139	$	245,587

Securities sold, not yet purchased, at market value
Corporate equity securities	$	925	$	—	$	—	$	925
Municipal obligations		—		17		—		17
U.S. government and government agency obligations		45,225		101		—		45,326
Corporate obligations		—		20,867		—		20,867
Other		31		428		—		459

	$	46,181	$	21,413	$	—	$	67,594

Grand Total	$	42,971	$	174,438	$	24,139	$	241,548

There were no transfers between Level 1 and Level 2 for the six-months ended December 31, 2010.

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


(in thousands)	Corporate Equity Securities			Municipal Obligations		Total
Beginning balance at June 25, 2010	$	1,841		$	22,298	$	24,139
Unrealized gains		2			—		2

Ending balance at September 24, 2010		1,843			22,298		24,141
Sales		(18	)		—		(18	)

Ending balance at December 31, 2010	$	1,825		$	22,298	$	24,123

Changes in unrealized gains (losses) and realized gains (losses) for corporate and municipal obligations and corporate equity securities are presented in “Net gains on principal transactions” on the consolidated statements of income (loss) and comprehensive income (loss).

The total unrealized gain included in earnings that related to assets still held for the three and six-month periods ended December 31, 2010 was $2,000, respectively.

Substantially all of SWS’s brokerage assets and liabilities are carried at market value or at amounts which, because of their short-term nature, approximate current fair value.

SWS Group, Inc. and Subsidiaries

Notes to Consolidated Financial Statements—(Continued)

Three and Six-Months Ended December 31, 2010 and 2009

(Unaudited)

EMPLOYEE BENEFITS

Stock Option Plans. There were no active stock option plans at December 31, 2010. All outstanding options under the SWS Group, Inc. Stock Option Plan (the “1996 Plan”) may still be exercised until their contractual expiration date occurs. Options granted under the 1996 Plan have a maximum ten-year term, and all options are fully vested.

Restricted Stock Plan. The Restricted Stock Plan allows for awards of up to 1,250,000 shares of SWS Group’s common stock to SWS’s directors, officers and employees. No more than 300,000 of the authorized shares may be newly issued shares of common stock. The Restricted Stock Plan terminates on August 21, 2013. The vesting period is determined on an individual basis by the Compensation Committee of the Board of Directors. In general, restricted stock granted to employees under the Restricted Stock Plan vests pro-rata over a three year period, and restricted stock granted to non-employee directors vests on the one year anniversary of the date of grant.

During the first six-months of fiscal 2011, the Board of Directors approved grants to various officers and employees totaling 39,641 shares with a weighted average market value of $6.18 per share. In the first six months of fiscal 2010, the Board of Directors approved grants to various officers and employees totaling 146,844 shares with a weighted average market value of $14.76 per share. SWS recorded deferred compensation in “Additional paid-in capital” of approximately $245,000 in fiscal 2011 and $2,016,000 in fiscal 2010. For the three and six-months ended December 31, 2010, SWS recognized compensation expense related to restricted stock grants of approximately $322,000 and $547,000, respectively. For the three and six-months ended December 31, 2009, SWS recognized compensation expense related to restricted stock grants of approximately $1,023,000 and $1,621,000, respectively.

At December 31, 2010, the total number of unvested shares outstanding under the Restricted Stock Plan was 190,632 and the total number of shares available for future grants was 375,840.

CASH AND CASH EQUIVALENTS

For the purpose of the consolidated statements of cash flows, SWS considers cash to include cash on hand and in bank accounts. In addition, SWS considers funds due from banks and interest bearing deposits in other banks to be cash. Highly liquid debt instruments purchased with original maturities of three months or less, when acquired, are considered to be cash equivalents. The Federal Deposit Insurance Corporation (“FDIC”) insures accounts up to $250,000. At December 31, 2010 and June 25, 2010, cash balances included $750,000 and $13,988,000, respectively, that were not federally insured because they represented amounts in individual accounts above the federally insured limit for each such account. This at-risk amount is subject to fluctuation on a daily basis, but management does not believe there is significant risk with respect to such deposits. In accordance with the Dodd-Frank Act, non-interest bearing transaction accounts are temporarily covered under FDIC insurance until December 31, 2012.

The Bank is required to maintain balances on hand or with the Federal Reserve Bank. At December 31, 2010 and June 30, 2010, these reserve balances amounted to $7,588,000 and $10,776,000, respectively.

INVESTMENTS

SWS has interests in three investment partnerships that are accounted for under the equity method, which approximates fair value. One is a limited partnership venture capital fund to which SWS has committed $5,000,000. As of December 31, 2010, SWS has fulfilled its $5,000,000 commitment. Based on a review of the fair value of this limited partnership investment, SWS determined that its share of the investments made by the limited partnership should be valued at $2,107,000 as of December 31, 2010. SWS recorded net losses on this investment for the three and

SWS Group, Inc. and Subsidiaries

Notes to Consolidated Financial Statements—(Continued)

Three and Six-Months Ended December 31, 2010 and 2009

(Unaudited)

six-months ended December 31, 2010 of $171,000 and $187,000, respectively. In comparison, during the three and six-months ended December 31, 2009, SWS recorded net gains of $412,000 and $378,000, respectively, on this investment.

The other two investments are limited partnership equity funds to which the Bank committed $3,000,000 in fiscal 2007 and $2,000,000 in fiscal 2009 as a cost effective way of meeting its obligations under the Community Reinvestment Act of 1977 (“CRA”). As of December 31, 2010, the Bank had invested $3,000,000 of its aggregate commitment of $5,000,000 to the two funds. During the three and six-months ended December 31, 2010, the Bank recorded net losses of $9,000 and $136,000 related to these investments. In comparison, during the three and six-months ended December 31, 2009, the Bank recorded losses of $33,000 and gains of $335,000, respectively, related to these investments. During the three and six-months ended December 31, 2010, the Bank received a $306,000 distribution one of these investments.

SECURITIES HELD TO MATURITY

Securities held to maturity consist of the following;


*(in thousands)*	December 31, 2010				June 30, 2010
	Recorded Value		Fair Value		Recorded Value		Fair Value
GNMA securities	$	—	$	—	$	80,875	$	82,149
Municipal bonds		265		268		6,265		6,948

Total	$	265	$	268	$	87,140	$	89,097

In the third quarter of fiscal 2010, the Bank purchased GNMA securities at a cost of $83,047,000 including a premium of $837,000. The premium is amortized over an average life of four years using the interest method. The Bank recorded $53,000 and $151,000 in amortization of the premium during the second quarter and first half of fiscal 2011, respectively. During the second quarter and the first half of fiscal 2011, the Bank received $3,662,000 and $6,208,000 of principal and interest payments, respectively, recording $466,000 and $957,000 in interest, respectively. In December 2010, the Bank sold $32,955,000 of the GNMA securities for $32,976,000, generating a realized gain of $21,000. The Bank sold these securities in order to increase the Bank’s capital ratios by reducing the Bank’s asset base. As a result of this sale, it was determined that the remaining balance of the GNMA securities was no longer held to maturity and was reclassed to securities available for sale. These securities were marked to market as of December 31, 2010 with any unrealized gain/loss being recorded to other comprehensive income.

In addition, at June 30 and December 31, 2010, the Bank held municipal bonds from state and political subdivisions. The Bank recorded amortization of the discount on these securities of $0 and $6,900 for the three-months ended December 31, 2010 and 2009, respectively. The Bank recorded amortization of the discount on these securities of $4,900 and $13,800 for the six-months ended December 31, 2010 and 2009, respectively. During the first half of fiscal 2011, $6,004,000 of these securities were redeemed, resulting in a gain of $1,078,000.

The amortized cost and estimated fair value of investments held to maturity at December 31, 2010, by contractual maturity, are shown below (in thousands). Expected maturities may differ from contractual maturities because borrowers may have the right to call or repay obligations with or without call or prepayment penalties.

SWS Group, Inc. and Subsidiaries

Notes to Consolidated Financial Statements—(Continued)

Three and Six-Months Ended December 31, 2010 and 2009

(Unaudited)


	Securities Held to Maturity
	Amortized Cost		Fair Value
Due in one year or less	$	60	$	61
Due from one year to five years		205		207

	$	265	$	268

ASSETS SEGREGATED FOR REGULATORY PURPOSES

At December 31, 2010, SWS held TLGP bonds with a market value of $61,751,000 and cash of approximately $192,383,000 segregated in special reserve bank accounts for the exclusive benefit of customers under Exchange Act Rule 15c3-3. SWS had no reserve deposits in special reserve bank accounts for the Proprietary Accounts of Introducing Brokers (“PAIB”) at December 31, 2010.

At June 25, 2010, SWS held TLGP bonds with a market value of $62,167,000 and cash of approximately $222,660,000 segregated in special reserve bank accounts for the exclusive benefit of customers under Exchange Act Rule 15c3-3. SWS had no reserve deposits in special reserve bank accounts for the PAIB at June 25, 2010.

SECURITIES AVAILABLE FOR SALE

SWS Group owns shares of common stock of USHS and Westwood, which are classified as securities available for sale. In addition to the shares of common stock owned by SWS Group, the Bank owns GNMA securities. See additional discussion regarding the GNMA securities in “Securities Held to Maturity.” The unrealized holding gains (losses), net of tax, related to these securities are recorded as a separate component of stockholders’ equity on the consolidated statements of financial condition.

The following table summarizes the cost and market value of these investments at December 31, 2010 and June 25, 2010 (dollars in thousands):


	Shares Held		Original Cost		Gross Unrealized Gains		Gross Unrealized Losses		Market Value
December 31, 2010
USHS		357,154	$	914	$	832	$	—	$	1,746
Westwood		6,383		89		166		—		255
GNMA*				42,519		60		—		42,579

Securities available for sale			$	43,522	$	1,058	$	—	$	44,580

*	Subsequent to December 31, 2010, these securities were sold, yielding a gain of $60,000.


	Shares Held		Original Cost		Gross Unrealized Gains		Gross Unrealized Losses		Market Value
June 25, 2010
USHS		357,154	$	914	$	232	$	—	$	1,146
Westwood		6,383		89		153		—		242

Securities available for sale			$	1,003	$	385	$	—	$	1,388

SWS Group, Inc. and Subsidiaries

Notes to Consolidated Financial Statements—(Continued)

Three and Six-Months Ended December 31, 2010 and 2009

(Unaudited)

RECEIVABLE FROM AND PAYABLE TO BROKERS, DEALERS AND CLEARING ORGANIZATIONS

At December 31, 2010 and June 25, 2010, SWS had receivable from and payable to brokers, dealers and clearing organizations related to the following (in thousands):


	December		June
Receivable
Securities failed to deliver	$	22,392	$	11,096
Securities borrowed		1,769,456		1,798,910
Correspondent broker/dealers		67,340		44,998
Clearing organizations		20,815		20,958
Other		49,585		13,438

	$	1,929,588	$	1,889,400


Payable
Securities failed to receive	$	21,389	$	17,705
Securities loaned		1,744,220		1,775,693
Correspondent broker/dealers		12,567		11,669
Other		11,052		14,928

	$	1,789,228	$	1,819,995

SWS participates in the securities borrowing and lending business by borrowing and lending securities other than those of its clients. SWS obtains or releases collateral as prices of the underlying securities fluctuate. At December 31, 2010, SWS had collateral of $1,769,456,000 under securities lending agreements, of which SWS had repledged $1,689,234,000. At June 25, 2010, SWS had collateral of $1,798,791,000 under securities lending agreements, of which SWS had repledged $1,732,411,000.

LOANS HELD FOR SALE

Loans held for sale consist of originated loans that were held for investment that management subsequently decided to sell as well as purchased loans held for sale acquired under the mortgage purchase program.

Originated loans that are held for sale (other loans held for sale) are valued at the lower of cost or fair value as determined by the negotiated sales price or if no sales price is yet determined, at an agreed upon acceptance price as determined by a third party valuation and management.

Other loans held for sale were transferred to the held for sale category in anticipation of immediate disposition. These are classified loans that are being marketed through an international marketing campaign. The fair value of these loans was determined using a discounted cash flow model to reflect the return required for immediate disposition of a distressed loan. These loans are valued using Level 3 valuation methodologies, see further discussion of Level 3 methodologies in “Fair Value of Financial Instruments.”

The loan participations in the mortgage purchase program are acquired from various mortgage companies and valued at the lower of cost or fair value as determined by outstanding commitments from investors or current investor yield requirements calculated on the aggregate note basis. The purchased loans are pre-sold by the mortgage company to secondary investors who have been approved by the Bank. Gains and losses on the sale of loans held for sale in the mortgage purchase program are determined using the specific identification method.

The mortgage purchase program has been in place since 1992. For loans purchased prior to June 30, 2010, the Bank reported these loans as “loans held for sale” under guidance in Financial Accounting Standards Board’s Statement of Financial Accounting Standards (“SFAS”) No. 140, “Accounting for Transfers and Servicing of Financial Assets and Extinguishments of Liabilities.” With the amendment of the accounting guidance under ASC 860, which was effective for the Company on July 1, 2010, the Company determined that the agreements used in its mortgage purchase program no longer met the participating interest requirements of the

SWS Group, Inc. and Subsidiaries

Notes to Consolidated Financial Statements—(Continued)

Three and Six-Months Ended December 31, 2010 and 2009

(Unaudited)

new accounting guidance. As a result, the Company has reported the loans in the mortgage purchase program acquired after July 1, 2010 as loans, net at December 31, 2010 on the Consolidated Statements of Financial Condition. Because these transactions did not qualify for sale accounting, the Bank recognizes these as loans to the mortgage “seller” secured by the individual loans transferred to the Bank rather than as loans to the individual mortgage borrowers as was previously the case. There has been no change to the Company’s mortgage purchase program or its operations.

The recorded and fair values of loans held for sale are as follows:


*(in thousands)*	December 31, 2010 (Restated)				June 30, 2010
	Recorded Value		Fair Value		Recorded Value		Fair Value
Mortgage purchase program	$	—	$	—	$	424,055	$	424,986
Other loans held for sale		10,080		10,080		—		—

Total	$	10,080	$	10,080	$	424,055	$	424,986

LOANS AND ALLOWANCE FOR PROBABLE LOAN LOSSES

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

Loans receivable at December 31, 2010 and June 30, 2010 are summarized as follows (in thousands):


	December (Restated)			June
Loans receivable:
Residential construction	$	111,964		$	128,552
Lot and land development		87,974			121,214
Residential mortgage		298,027			153,031
Commercial real estate		418,000			515,274
Multi-family		66,113			75,481
Commercial loans		204,826			191,694
Consumer loans		4,129			4,692

		1,191,033			1,189,938
Unamortized premiums and discounts		(579	)		(732	)

		1,190,454			1,189,206
Allowance for probable loan losses		(47,041	)		(35,141	)

	$	1,143,413		$	1,154,065

In the second quarter of fiscal 2011, the Company adopted Accounting Standards Update (“ASU”) 2010-20, “Disclosures about the Credit Quality of Financing Receivables and the Allowance for Credit Losses.” The information requested by this ASU is included in the tables below.

The allowance for probable loan loss is increased by charges to income and decreased by charge-offs (net of recoveries). Management periodically evaluates the adequacy of the allowance on the Bank’s

SWS Group, Inc. and Subsidiaries

Notes to Consolidated Financial Statements—(Continued)

Three and Six-Months Ended December 31, 2010 and 2009

(Unaudited)

past loan loss experience, known and inherent risks in the portfolio, adverse situations that may affect the borrower’s ability to repay, the estimated value of any underlying collateral and current economic conditions. In determining the appropriate balance at the balance sheet date, management evaluated the Bank’s historical loss percentage, concentrations of risk in the portfolio, estimated changes in the value of underlying collateral as well as changes in the volume and growth in the portfolio.

The analysis of the allowance for loan losses for the three and six-months ended December 31, 2010 and 2009 and the recorded investment in loans receivable at December 31, 2010 (restated) and 2009 are as follow (in thousands):


	Three-Months Ended December 31, 2010									Three-Months Ended December 31, 2009
	Real-Estate			Non-Real Estate			Total			Real-Estate			Non-Real Estate			Total
Allowance for credit losses:
Balance at beginning of period	$	40,275		$	5,114		$	45,389		$	15,246		$	1,629		$	16,875
Charge-offs		(5,014	)		(136	)		(5,150	)		(2,918	)		(1,051	)		(3,969	)
Recoveries		63			10			73			22			8			30

Net charge-offs		(4,951	)		(126	)		(5,077	)		(2,896	)		(1,043	)		(3,939	)
Additions charged to operations		7,817			(1,088	)		6,729			3,311			1,354			4,665

Balance at end of period	$	43,141		$	3,900		$	47,041		$	15,661		$	1,940		$	17,601

Ending balance: Individually evaluated for impairment	$	1,893		$	118		$	2,011		$	2,728		$	175		$	2,903

Ending balance: Collectively evaluated for impairment	$	41,248		$	3,782		$	45,030		$	12,933		$	1,765		$	14,698


Financing Receivables:
Balance at end of period	$	981,465		$	208,989		$	1,190,454		$	1,006,042		$	166,415		$	1,172,457

Ending balance: Individually evaluated for impairment	$	68,522		$	2,173		$	70,695		$	25,135		$	925		$	26,060

Ending balance: Collectively evaluated for impairment	$	912,943		$	206,816		$	1,119,759		$	980,907		$	165,490		$	1,146,397


	Six-Months Ended December 31, 2010									Six-Months Ended December 31, 2009
	Real-Estate			Non-Real Estate			Total			Real-Estate			Non-Real Estate			Total
Allowance for credit losses:
Balance at beginning of period	$	32,257		$	2,884		$	35,141		$	13,412		$	1,319		$	14,731
Charge-offs		(33,001	)		(1,678	)		(34,679	)		(5,485	)		(1,116	)		(6,601	)
Recoveries		295			44			339			22			29			51

Net charge-offs		(32,706	)		(1,634	)		(34,340	)		(5,463	)		(1,087	)		(6,550	)
Additions charged to operations		43,590			2,650			46,240			7,712			1,708			9,420

Balance at end of period	$	43,141		$	3,900		$	47,041		$	15,661		$	1,940		$	17,601

SWS Group, Inc. and Subsidiaries

Notes to Consolidated Financial Statements—(Continued)

Three and Six-Months Ended December 31, 2010 and 2009

(Unaudited)

The allowance to ending loan balance ratio as of December 31, 2010 and 2009 was 3.95% and 1.50%, respectively.

Loans receivables on non-accrual status as of December 31, 2010 and June 30, 2010 are as follows (in thousands):


	December 31, 2010		June 30, 2010
Real estate:
1-4 family	$	9,554	$	6,065
Lot and land development		11,184		8,776
Multi-family		16,633		2,394
Residential construction		574		3,809
Commercial real estate		20,669		16,911
Non-real estate:
Commercial loans		1,766		462
Consumer loans		134		11

	$	60,514	$	38,428

Loans are classified as non-performing when they are 90 days or more past due as to principal or interest or when reasonable doubt exists as to timely collectability. The Bank uses a standardized review process to determine which loans should be placed on non-accrual status. At the time a loan is placed on non-accrual status, previously accrued and uncollected interest is reversed against interest income. Interest income on non-accrual loans is subsequently recognized to the extent cash payments are received for loans where ultimate full collection is likely. For loans where ultimate collection is not likely, interest payments are applied to the outstanding principal and income is only recognized if full payment is made. The average recorded investment in non-accrual loans was approximately $60,697,000 during the first six-months of fiscal 2011 and $27,373,000 during the first six-months of fiscal 2010. The Bank did not recognize any income on non-accrual loans during the three and six-months ended December 31, 2010 and 2009.

SWS Group, Inc. and Subsidiaries

Notes to Consolidated Financial Statements—(Continued)

Three and Six-Months Ended December 31, 2010 and 2009

(Unaudited)

The following tables highlight the Bank’s recorded investment and unpaid principal balance for impaired loans by type as well as the related allowance, average recorded investment and interest income recognized as of December 31, 2010 and June 30, 2010 (in thousands):


	Recorded Investment		Unpaid Principal Balance		Related Allowance		Average Recorded Investment^(*)		Interest Income Recognized^(#)
December 31, 2010
With no related allowance recorded:
1-4 family	$	7,597	$	8,313	$	—	$	7,359	$	—
Lot and land development		12,080		14,377		—		10,979		122
Multi-family		16,633		16,815		—		4,682		—
Residential construction		574		706		—		2,240		—
Commercial real estate		15,686		17,324		—		12,699		—
Commercial loans		1,257		1,417		—		1,178		—
Consumer loans		134		218		—		120		—

		53,961		59,170		—		39,257		122

With an allowance recorded:
1-4 family		4,783		4,800		909		2,935		107
Lot and land development		410		411		30		1,829		3
Multi-family		—		—		—		7,252		—
Residential construction		469		469		41		78		17
Commercial real estate		10,290		10,290		913		15,888		336
Commercial loans		782		781		118		141		24

		16,734		16,751		2,011		28,123		487

Total
1-4 family		12,380		13,113		909		10,294		107
Lot and land development		12,490		14,788		30		12,808		125
Multi-family		16,633		16,815		—		11,934		—
Residential construction		1,043		1,175		41		2,318		17
Commercial real estate		25,976		27,614		913		28,587		336
Commercial loans		2,039		2,198		118		1,319		24
Consumer loans		134		218		—		120		—

	$	70,695	$	75,921	$	2,011	$	67,380	$	609

^(*)	Represents the average recorded investment for the six-months ended December 31, 2010.

^(#)	Represents interest income recognized on impaired loans for the six-months ended December 31, 2010. No material amount of interest income was recognized on impaired loans for the six-months ended December 31, 2009.

SWS Group, Inc. and Subsidiaries

Notes to Consolidated Financial Statements—(Continued)

Three and Six-Months Ended December 31, 2010 and 2009

(Unaudited)


	Recorded Investment		Unpaid Principal Balance		Related Allowance		Average Recorded Investment^(*)		Interest Income Recognized^(#)
June 30, 2010
With no related allowance recorded:
1-4 family	$	6,177	$	6,915	$	—	$	4,091	$	—
Lot and land development		9,514		10,040		—		5,879		127
Multi-family		2,394		4,896		—		802		—
Residential construction		3,839		4,039		—		4,377		—
Commercial real estate		9,350		12,983		—		7,626		—
Commercial loans		462		997		—		1,297		—
Consumer loans		11		17		—		4		—

		31,747		39,887		—		24,076		127

With an allowance recorded:
1-4 family		—		—		—		1,352		—
Lot and land development		1,626		1,626		450		2,082		—
Multi-family		—		—		—		1,207		—
Residential construction		—		—		—		1,543		—
Commercial real estate		7,561		7,574		2,761		3,130		—
Commercial loans		—		—		—		456		—
Consumer loans		—		—		—		5		—

		9,187		9,200		3,211		9,775		—

Total
1-4 family		6,177		6,915		—		5,443		—
Lot and land development		11,140		11,666		450		7,961		127
Multi-family		2,394		4,896		—		2,009		—
Residential construction		3,839		4,039		—		5,920		—
Commercial real estate		16,911		20,557		2,761		10,756		—
Commercial loans		462		997		—		1,753		—
Consumer loans		11		17		—		9		—

	$	40,934	$	49,087	$	3,211	$	33,851	$	127

^(*)	Represents the average recorded investment for the twelve-months ended June 30, 2010.

^(#)	Represents interest income recognized on impaired loans for the twelve-months ended June 30, 2010.

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

SWS Group, Inc. and Subsidiaries

Notes to Consolidated Financial Statements—(Continued)

Three and Six-Months Ended December 31, 2010 and 2009

(Unaudited)

Office of Thrift Supervision.” One of the reports maintained is the criticized and classified loan report which is used to assist in the calculation of an adequate allowance for loan losses. The following tables summarize this report and highlight the overall quality of the Bank’s financing receivables as of December 31, 2010 (restated) and June 30, 2010 (in thousands):


	Pass		Special Mention^(*)		Substandard^(#)		Total
December 31, 2010
1-4 family	$	276,261	$	174	$	21,380	$	297,815
Lot and land development		36,146		2,223		49,508		87,877
Multi-family		49,843		—		24,099		73,942
Residential construction		32,403		1,552		16,277		50,232
Commercial real estate		348,597		19,099		103,903		471,599
Commercial loans		179,220		12,181		13,459		204,860
Consumer loans		3,995		—		134		4,129

	$	926,465	$	35,229	$	228,760	$	1,190,454


	Pass		Special Mention^(*)		Substandard^(#)		Total
June 30, 2010
1-4 family	$	138,470	$	876	$	13,449	$	152,795
Lot and land development		90,870		—		30,213		121,083
Multi-family		64,169		16,440		2,394		83,003
Residential construction		70,178		—		10,285		80,463
Commercial real estate		463,019		13,462		78,944		555,425
Commercial loans		187,344		—		4,401		191,745
Consumer loans		4,681		—		11		4,692

	$	1,018,731	$	30,778	$	139,697	$	1,189,206

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

^(#)

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

SWS Group, Inc. and Subsidiaries

Notes to Consolidated Financial Statements—(Continued)

Three and Six-Months Ended December 31, 2010 and 2009

(Unaudited)

The following tables highlight the age analysis of the Bank’s financing receivables as of December 31, 2010 (restated) and June 30, 2010 (in thousands):

Age Analysis of Past Due Financing Receivables

As of December 31, 2010


	30-59 Days Past Due		60-89 Days Past Due		90 Days and Greater		Total Past Due		Current		Total Financing Receivables		Recorded Investment >90 Days and Accruing
December 31, 2010
1-4 family	$	172	$	1,808	$	4,211	$	6,191	$	291,624	$	297,815	$	—
Lot and land development		1,994		1,453		5,074		8,521		79,356		87,877		—
Multi-family		—		—		—		—		73,942		73,942		—
Residential construction		—		—		—		—		50,232		50,232		—
Commercial real estate		808		1,850		9,389		12,047		459,552		471,599		—
Commercial loans		84		25		729		838		204,022		204,860		—
Consumer loans		—		—		—		—		4,129		4,129		—

Total	$	3,058	$	5,136	$	19,403	$	27,597	$	1,162,857	$	1,190,454	$	—

SWS Group, Inc. and Subsidiaries

Notes to Consolidated Financial Statements—(Continued)

Three and Six-Months Ended December 31, 2010 and 2009

(Unaudited)

Age Analysis of Past Due Financing Receivables

As of June 30, 2010


	30-59 Days Past Due		60-89 Days Past Due		90 Days and Greater		Total Past Due		Current		Total Financing Receivables		Recorded Investment >90 Days and Accruing
June 30, 2010
1-4 family	$	2,384	$	1,158	$	3,302	$	6,844	$	145,951	$	152,795	$	29
Lot and land development		1,150		4,134		2,708		7,992		113,091		121,083		—
Multi-family		—		—		2,394		2,394		80,609		83,003		—
Residential construction		—		367		1,701		2,068		78,395		80,463		—
Commercial real estate		168		2,845		6,181		9,194		546,231		555,425		—
Commercial Loans		32		—		263		295		191,450		191,745		—
Consumer loans		1		—		—		1		4,691		4,692		—

Total	$	3,735	$	8,504	$	16,549	$	28,788	$	1,160,418	$	1,189,206	$	29

SWS Group, Inc. and Subsidiaries

Notes to Consolidated Financial Statements—(Continued)

Three and Six-Months Ended December 31, 2010 and 2009

(Unaudited)

Fair values of loans receivable are estimated for portfolios of loans with similar characteristics. Loans are segregated by type, such as real estate, commercial and consumer, which are further segregated into fixed and adjustable rate interest terms. The fair value of loans receivable is calculated by discounting scheduled cash flows through the estimated maturity using interest rates currently being offered for loans with similar terms to borrowers of similar credit quality. Loan fair value estimates include judgments regarding future expected loss experience and risk characteristics. The fair value of loans receivable was $1,235,279,000 and $1,264,675,000 at December 31, 2010 (restated) and June 30, 2010.

REAL ESTATE OWNED (“REO”) AND OTHER REPOSSESSED ASSETS

REO and other repossessed assets are valued at the lower of cost or market, less a selling discount, and are included in other assets on the consolidated statement of financial condition. REO and other repossessed assets are valued using Level 3 valuation methodologies, see further discussion of Level 3 methodologies in “Fair Value of Financial Instruments.” For those investments where the REO is valued at market, the value is determined by third party appraisals, or if the REO is being sold in an auction, by accepted bid amount. For those REO assets that are in an auction and a bid has not been accepted, a fair value estimate is derived by utilizing market data including appraised value adjusted for distressed sales. In certain circumstances, the Company adjusts appraised values to more accurately reflect the economic conditions of the area at the time of valuation. These adjustments are largely based on the six-month historical loss on sales of REO properties. Included in other repossessed assets are land leases which are valued using a discounted cash flow analysis. The fair value of REO and other repossessed assets was $39,358,000 and $46,194,000 at December 31, 2010 and June 30, 2010, respectively. The amount of additional write-downs required to reflect current fair value was $4,094,000 and $11,543,000 for the three and six-months ended December 31, 2010, respectively, and $408,000 and $1,921,000 for the three and six-months ended December 31, 2009, respectively.

SECURITIES OWNED AND SECURITIES SOLD, NOT YET PURCHASED

Securities owned and securities sold, not yet purchased at December 31, 2010 and June 25, 2010, which are carried at market value, consist of the following (in thousands):


	December		June
Securities owned
Corporate equity securities	$	11,790	$	12,734
Municipal obligations		126,890		132,142
U.S. government and government agency obligations		18,298		19,518
Corporate obligations		62,155		70,844
Other		10,672		10,349

	$	229,805	$	245,587


Securities sold, not yet purchased
Corporate equity securities	$	493	$	925
Municipal obligations		—		17
U.S. government and government agency obligations		45,703		45,326
Corporate obligations		32,282		20,867
Other		1,105		459

	$	79,583	$	67,594

Certain of the above securities were pledged to secure short-term borrowings and as security deposits at clearing organizations for SWS’s clearing business. See additional discussion in “Short-Term Borrowings.” Securities pledged as security deposits at clearing organizations were $3,448,000 and $2,899,000 at December 31, 2010 and June 25, 2010, respectively. Additionally, at December 31, 2010 and June 25, 2010, SWS had pledged firm securities valued at $3,551,000 and $1,089,000, respectively, in conjunction with securities lending activities.

SWS Group, Inc. and Subsidiaries

Notes to Consolidated Financial Statements—(Continued)

Three and Six-Months Ended December 31, 2010 and 2009

(Unaudited)

SECURITIES PURCHASED UNDER AGREEMENTS TO RESELL

Transactions involving purchases of securities under agreement to resell (“reverse repurchase agreements”) are accounted for as collateralized financings except where SWS does not have an agreement to sell the same or substantially the same securities before maturity at a fixed or determinable price. At December 31, 2010, SWS held reverse repurchase agreements totaling $30,600,000, collateralized by U.S. government and government agency obligations with a market value of approximately $30,638,000. At June 25, 2010, SWS held reverse repurchase agreements totaling $30,507,000, collateralized by U.S. government and government agency obligations with a market value of approximately $30,465,000.

GOODWILL

SWS performed its annual assessment of the fair value of goodwill during fiscal 2010 in June 2010 and, based on the results of the assessment, SWS’s goodwill balance was not impaired. SWS bases its assessment of the fair value of the business units with goodwill on a weighted average of a discounted cash flow model estimate of fair value and a market multiple approach to fair value.

There were no events in the half of fiscal 2011 that would trigger an interim assessment of the fair value of goodwill. SWS’s goodwill balance was $7,552,000 at December 31, 2010, of which $4,254,000 was in the clearing segment and $3,298,000 was in the institutional segment.

INTANGIBLE ASSETS

On March 22, 2006, the Company entered into an agreement with TD Ameritrade Holding Corporation (“Ameritrade”), to transfer its correspondent clients to the Company. This transaction closed in July 2006. Of the maximum agreed upon purchase price of $5,800,000, $2,382,000 was paid upon closing with the remainder paid on the one year anniversary of the closing date. SWS paid an additional $2,678,000 in July 2007 under the terms of the agreement. As a result of these transactions, the Company recorded a customer relationship intangible of $5,060,000. The intangible asset is amortized over a five year period at a rate based on the estimated future economic benefit of the customer relationships. SWS recognized approximately $196,000 and $392,000, respectively, and $235,000 and $471,000, respectively, of amortization expense for the three and six-months ended December 31, 2010 and 2009, respectively. The net intangible asset of $399,000 is included in other assets on the consolidated statements of financial condition. SWS performed its annual analysis of the impairment of its intangible asset in June 2010 and, based on its analysis, SWS’s intangible asset balance was not impaired. Nothing came to SWS’s attention in the first half of fiscal 2011 that would require SWS to reperform this analysis.

SHORT-TERM BORROWINGS

Brokerage. Southwest Securities has credit arrangements with commercial banks, which include broker loan lines up to $300,000,000. These lines of credit are used primarily to finance securities owned, securities held for correspondent broker/dealer accounts, receivables in customers’ margin accounts and underwriting activities. These lines may also be used to release pledged collateral against day loans. These credit arrangements are provided on an “as offered” basis and are not committed lines of credit. These arrangements can be terminated at any time by the lender. Any outstanding balance under these credit arrangements is due on demand and bears interest at rates indexed to the federal funds rate. At December 31, 2010, the amount outstanding under these secured arrangements was $156,000,000, which was collateralized by securities held for firm accounts valued at $137,837,000 and securities held for correspondent accounts valued at $67,474,000. At June 25, 2010, the amount outstanding under these secured arrangements was $110,000,000, which was collateralized by securities held for firm accounts valued at $167,564,000.

SWS Group, Inc. and Subsidiaries

Notes to Consolidated Financial Statements—(Continued)

Three and Six-Months Ended December 31, 2010 and 2009

(Unaudited)

SWS had $250,000 outstanding under unsecured letters of credit at December 31, 2010 and June 25, 2010, pledged to support its open positions with securities clearing organizations. The letters of credit bear a 1% commitment fee and are renewable semi-annually.

At June 25, 2010, SWS had an additional unsecured letter of credit issued for a sub-lease of space previously occupied by Mydiscountbroker.com, a subsidiary of SWS that was dissolved in July 2004, in the amount $143,000. This letter of credit expired September 10, 2010.

SWS also had $500,000 outstanding under an unsecured letter of credit at December 31, 2010 and June 25, 2010, pledged to support its underwriting activities. The letter of credit bears a 1% commitment fee and is renewable annually at SWS’s option.

In addition to the broker loan lines, at December 31, 2010 and June 25, 2010, SWS had a $20,000,000 unsecured line of credit that is due on demand and bears interest at rates indexed to the federal funds rate. This credit arrangement is provided on an “as offered” basis and is not a committed line of credit. The total amount of borrowings available under this line of credit is reduced by the amount outstanding on the line and under any unsecured letters of credit at the time of borrowing. At December 31, 2010, there were no amounts outstanding on this line, other than the $750,000 under unsecured letters of credit referenced above. At June 25, 2010, there were no amounts outstanding on this line, other than the $893,000 under unsecured letters of credit referenced above. At December 31, 2010 and June 25, 2010, the total amount available for borrowing was $19,250,000 and $19,107,000, respectively.

At December 31, 2010 and June 25, 2010, SWS had an irrevocable letter of credit agreement aggregating $50,000,000 and $55,000,000, respectively, pledged to support customer open options positions with an options clearing organization. The letter of credit bears interest at the brokers’ call rate (0.5% at December 31, 2010), if drawn, and is renewable semi-annually. The letter of credit is fully collateralized by marketable securities held in client and non-client margin accounts with a value of $64,444,000 and $80,946,000 at December 31, 2010 and June 25, 2010, respectively.

On January 29, 2010, Southwest Securities entered into an agreement with an unaffiliated bank for a $50,000,000 committed revolving credit facility. The facility includes up to $15,000,000 in unsecured credit. The commitment fee is 37.5 basis points and when drawn, the interest rate is equal to the federal funds rate plus 75 basis points. The agreement provides that Southwest Securities must maintain tangible net worth of $150,000,000. As of December 31, 2010, there was $44,300,000 outstanding under the committed revolving credit facility, of which no amounts were unsecured. The $44,300,000 of secured borrowings was collateralized by securities with a value of $70,190,000 at December 31, 2010. On January 28, 2011, Southwest Securities renewed this facility. The new facility provides up to $45,000,000 of secured borrowings.

In addition to using customer securities to collateralize bank loans, SWS also loans client securities as collateral in conjunction with SWS’s securities lending activities. At December 31, 2010, approximately $309,466,000 of client securities under customer margin loans was available to be pledged, of which SWS had pledged $54,986,000 under securities loan agreements. At June 25, 2010, approximately $275,260,000 of client securities under customer margin loans was available to be pledged, of which SWS had pledged $41,629,000 under securities loan agreements.

Banking. The Bank had an agreement with an unaffiliated bank for a $30,000,000 unsecured line of credit for the purchase of federal funds with a floating interest rate. The unaffiliated bank was not obligated by this agreement to sell federal funds to the Bank. The proceeds from the line of credit were used by the Bank to support short-term liquidity needs. At June 30, 2010, there were no amounts outstanding on this line of credit. In December 2010, this agreement was cancelled.

In the second quarter of fiscal 2010, the Bank entered into a secured line of credit agreement with the Federal Reserve Bank of Dallas. This line of credit is secured by the Bank’s commercial loan portfolio. This line is due on demand and bears interest at a rate equal to the federal funds target rate plus 100 basis points. At December 31, 2010, the total amount available under this line was $105,684,000 and there was no amount outstanding.

SWS Group, Inc. and Subsidiaries

Notes to Consolidated Financial Statements—(Continued)

Three and Six-Months Ended December 31, 2010 and 2009

(Unaudited)

DEPOSITS

Deposits at December 31, 2010 and June 30, 2010 are summarized as follows (dollars in thousands):


	December					June
	Amount		Percent			Amount		Percent
Non-interest bearing demand accounts	$	87,273		6.9	%	$	80,590		5.4	%
Interest bearing demand accounts		10,460		0.8			99,529		6.7
Savings accounts		1,084,644		85.2			1,197,659		80.5
Limited access money market accounts		30,657		2.4			37,929		2.5
Certificates of deposit, less than $100,000		31,814		2.5			38,861		2.6
Certificates of deposit, $100,000 and greater		27,516		2.2			34,236		2.3

	$	1,272,364		100.0	%	$	1,488,804		100.0	%

The weighted average interest rate on deposits was approximately 0.14% at December 31, 2010 and 0.25% at June 30, 2010.

At December 31, 2010, scheduled maturities of certificates of deposit were as follows (in thousands):


	1 Year or Less		> 1 Year Through 2 Years		> 2 Years Through 3 Years		> 3 Years Through 4 Years		Thereafter		Total
Certificates of deposit, less than $100,000	$	22,765	$	3,467	$	1,347	$	1,658	$	2,577	$	31,814
Certificates of deposit, $100,000 and greater		18,849		2,720		1,868		2,084		1,995		27,516

	$	41,614	$	6,187	$	3,215	$	3,742	$	4,572	$	59,330

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

The fair value of deposits with no stated maturity, such as interest-bearing checking accounts, passbook savings accounts and advance payments from borrowers for taxes and insurance, are equal to the amount payable on demand (carrying value), as these deposits are very liquid and can reprice immediately. The fair value of certificates of deposit is based on the discounted value of contractual cash flows. The discount rate is estimated using the rates currently offered for deposits of similar remaining maturities. The fair value of certificates of deposit was $60,152,000 and $74,155,000 at December 31, 2010 and June 30, 2010, respectively. The fair value of other deposits was $1,215,106,000 and $1,415,528,000 at December 31, 2010 and June 30, 2010, respectively.

SECURITIES SOLD UNDER AGREEMENTS TO REPURCHASE

Securities sold under repurchase agreements, which are secured borrowings, generally mature within one to four days from the transaction date. Securities sold under repurchase agreements are reflected at the amount of cash received in connection with the transactions. The Company may be required to provide additional collateral based on the fair value of the underlying securities. The Company monitors the fair value of the underlying securities on a daily basis. Securities sold under repurchase agreements at December 31, 2010 and June 25, 2010 were $2,513,000 and $12,389,000, respectively.

SWS Group, Inc. and Subsidiaries

Notes to Consolidated Financial Statements—(Continued)

Three and Six-Months Ended December 31, 2010 and 2009

(Unaudited)

ADVANCES FROM THE FEDERAL HOME LOAN BANK

At December 31, 2010 and June 30, 2010, advances from the Federal Home Loan Bank (“FHLB”) were due as follows (in thousands):


	December		June
Maturity:
Due within one year	$	9,260	$	33,714
Due within two years		12,997		9,376
Due within five years		40,683		48,050
Due within seven years		4,260		6,274
Due within ten years		10,056		5,486
Due within twenty years		28,182		29,921

	$	105,438	$	132,821

At December 31, 2010 (calculated at September 30, 2010), the advances from the FHLB had interest rates ranging from 2% to 7% and were collateralized by approximately $420,000,000 of collateral value (as defined) in qualifying loans. At June 30, 2010 (calculated at March 31, 2010), the advances from the FHLB had interest rates from 0.1% to 7% and were collateralized by approximately $483,000,000 of collateral value in qualifying loans.

The fair value of advances from the FHLB is based on the discounted value of contractual cash flows. The discount rate is estimated using the rates currently offered for borrowings of similar remaining maturities. The fair value of advances from the FHLB was $117,547,000 and $146,560,000 at December 31, 2010 and June 30, 2010, respectively.

REGULATORY CAPITAL REQUIREMENTS

Brokerage. The Company’s broker/dealer subsidiaries are subject to the SEC’s Uniform Net Capital Rule (the “Rule”), which requires the maintenance of minimum net capital. Southwest Securities has elected to use the alternative method, permitted by the Rule, which requires that it maintain minimum net capital, as defined in Rule 15c3-1 of the Exchange Act, equal to the greater of $1,000,000 or 2% of aggregate debit balances, as defined in Rule 15c3-3 of the Exchange Act. At December 31, 2010, Southwest Securities had net capital of $121,597,000, or approximately 37.5% of aggregate debit balances, which was $115,105,000 in excess of its minimum net capital requirement of $6,492,000 at that date. Additionally, the net capital rule of the NYSE provides that equity capital may not be withdrawn or cash dividends paid if resulting net capital would be less than 5% of aggregate debit items. At December 31, 2010, Southwest Securities had net capital of $105,367,000 in excess of 5% of aggregate debit items.

SWS Financial follows the primary (aggregate indebtedness) method under Exchange Act Rule 15c3-1, which requires the maintenance of the larger of minimum net capital of $250,000 or 1/15 of aggregate indebtedness. At December 31, 2010, the net capital and excess net capital of SWS Financial was $838,000 and $588,000, respectively.

Banking. The Bank is subject to various regulatory capital requirements administered by federal agencies. Quantitative measures, established by regulation to ensure capital adequacy, require maintaining minimum amounts and ratios (set forth in the table below) of total and Tier I capital (as defined in 12 CFR 565 and 12 CFR 567) to risk-weighted assets (as defined ) and of Tier I (core) capital (as defined) to adjusted assets (as defined). Federal statutes and OTS regulations have established five capital categories for federal savings banks: well-capitalized, adequately capitalized, undercapitalized, significantly undercapitalized, and critically undercapitalized. The federal banking agencies have jointly specified by regulation the relevant capital level for each category. An institution is defined as well-capitalized when its total risk-based capital ratio is at least 10.00%, its Tier I risk-based capital ratio is at least 6.00%, its Tier I (core) capital ratio is at least 5.00%, and it is not subject to any federal supervisory order or directive to meet a specific capital level. As of

SWS Group, Inc. and Subsidiaries

Notes to Consolidated Financial Statements—(Continued)

Three and Six-Months Ended December 31, 2010 and 2009

(Unaudited)

December, 31, 2010 and June 30, 2010, the Bank met all capital requirements to which it was subject and satisfied the requirements to be defined as a well-capitalized institution. As of December 31, 2010, the Bank’s total risk-based capital ratio was 14.04%, resulting in $22,957,000 in excess capital over the Order capital requirement of $135,189,000, its Tier I risk-based capital ratio was 12.79% and its Tier I (core) capital ratio was 9.43%, resulting in $21,876,000 in excess capital over the Order capital requirement of $122,188,000. The federal bank regulatory agencies may set capital requirements for a particular banking organization that are higher than the minimum ratios. Should the Bank not meet these minimums, certain mandatory and discretionary supervisory actions (as defined in 12 CFR 565.6) would be applicable.

On February 4, 2011, the Board of Directors of the Bank signed a Stipulation and Consent to Issuance of Order to Cease and Desist (the “Stipulation”) and the OTS issued the Order, which are attached to this filing as exhibits. Accordingly, as a result of the issuance of the Order, effective February 4, 2011, the Bank is deemed to be “adequately capitalized” and no longer meets the definition of “well capitalized” under federal statutes and OTS regulations even though its capital ratios meet or exceed all applicable requirements under Federal law, OTS regulations and the Order. See additional discussion in “Cease and Desist Order with the Office of Thrift Supervision.”

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


	Actual					For Capital Adequacy Purposes					To Be Well Capitalized Under Prompt Corrective Action Provisions					Order Capital Requirements
	Amount		Ratio			Amount		Ratio			Amount		Ratio			Amount		Ratio
December 31, 2010:
Total risk-based capital	$	158,146		14.0	%	$	90,126		8.0	%	$	112,657		10.0	%	$	135,189		12.0	%
Tier I risk-based capital		144,064		12.8			45,063		4.0			67,594		6.0			90,126		8.0
Tier I (core) capital		144,064		9.4			61,160		4.0			76,450		5.0			122,188		8.0

June 30, 2010:
Total risk-based capital	$	172,483		12.2	%	$	113,015		8.0	%	$	141,268		10.0	%
Tier I risk-based capital		154,824		11.0			56,507		4.0			84,761		6.0
Tier I (core) capital		154,824		8.7			71,958		4.0			89,948		5.0

EARNINGS PER SHARE (“EPS”)

A reconciliation between the weighted average shares outstanding used in the calculation of basic and diluted EPS is as follows for the three and six-month periods ended December 31, 2010 and December 31, 2009 (in thousands, except share and per share amounts):


	Three-Months Ended					Six-Months Ended
	December 31, 2010			December 31, 2009		December 31, 2010			December 31, 2009
Net income (loss)	$	(330	)	$	5,867	$	(21,078	)	$	8,952
Dividends on estimated forfeitures-restricted stock		—			3		2			5

Adjusted net income (loss)	$	(330	)	$	5,870	$	(21,076	)	$	8,957

Weighted average shares outstanding – basic^(*)		32,284,271			28,672,282		32,303,390			28,094,256

SWS Group, Inc. and Subsidiaries

Notes to Consolidated Financial Statements—(Continued)

Three and Six-Months Ended December 31, 2010 and 2009

(Unaudited)


	Three-Months Ended					Six-Months Ended
	December 31, 2010			December 31, 2009		December 31, 2010			December 31, 2009
Effect of dilutive securities:
Assumed exercise of stock options		—			52,740		—			57,685

Weighted average shares outstanding – diluted		32,284,271			28,725,022		32,303,390			28,151,941

Earnings per share – basic
Net income (loss)	$	(0.01	)	$	0.21	$	(0.65	)	$	0.32

Earnings per share – diluted
Net income (loss)	$	(0.01	)	$	0.21	$	(0.65	)	$	0.32

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

At December 31, 2010, there were options to acquire approximately 249,000 shares of common stock outstanding under the 1996 Plan. At December 31, 2009, there were options to acquire 428,000 shares of common stock outstanding under the 1996 Plan and the SWS Group, Inc. 1997 Stock Option Plan. See “Employee Benefits.” As a result of the net loss in the three and six-months ended December 31, 2010, all options are anti-dilutive and are not included in the calculation of diluted weighted average shares outstanding and diluted earnings per share. As of December 31, 2009, options to acquire 7,417 shares of common stock were anti-dilutive and were not included in the calculation of weighted average shares outstanding-diluted.

Dividends per share for the three-months ended December 31, 2010 and 2009 were $0.01 and $0.09, respectively.

OFFERING OF COMMON STOCK

On October 16, 2009, the Company filed a shelf registration statement with the SEC in the amount of $150,000,000. On December 9, 2009, the Company closed a public offering of 4,347,827 shares of its common stock at a price of $11.50 per share. On December 16, 2009, the underwriters for the public offering exercised their option to purchase an additional 652,174 shares of SWS Group common stock to cover over-allotments. The Company generated net proceeds from these common stock offerings, after deducting underwriting discounts and commissions, of approximately $54,258,000.

REPURCHASE OF TREASURY STOCK

Periodically, SWS repurchases common stock under a plan approved by our Board of Directors. Currently, SWS is authorized to repurchase 500,000 shares of common stock from time to time in the open market, expiring February 28, 2011. No shares were repurchased by SWS under this program during the six-months ended December 31, 2010 and 2009.

Additionally, the trustee under SWS’s deferred compensation plan periodically purchases common stock in the open market in accordance with the terms of the plan. This stock is classified as treasury stock in the consolidated financial statements, but participates in future dividends declared by SWS. The plan purchased 53,000 shares in the six-months ended December 31, 2010, at a cost of approximately $340,000, or $6.42 per share. The plan purchased 15,099 shares in the six-months ended December 31, 2009, at a cost of approximately $228,000, or $15.09 per share. The plan distributed 3,203 shares to participants in the six-months ended December 31, 2010.

SWS Group, Inc. and Subsidiaries

Notes to Consolidated Financial Statements—(Continued)

Three and Six-Months Ended December 31, 2010 and 2009

(Unaudited)

Upon vesting of the shares granted under the Restricted Stock Plan, the grantees may choose to sell a portion of their vested shares to the Company to cover the tax liabilities arising from the vesting. As a result, 18,183 shares were repurchased with a market value of approximately $131,000, or an average price of $7.22 per share, in the six-months ended December 31, 2010. In the six-months ended December 31, 2009, 31,945 shares were repurchased with a market value of $457,000, or an average of $14.32 per share.

SEGMENT REPORTING

SWS operates four business segments:

•

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

•

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

•

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

•

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

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

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

•

the financial results for each segment are determined using the same policies as those described in Note 1, “Significant Accounting Policies,” to the Company’s audited consolidated financial statements contained in the Company’s Form 10-K for the fiscal year ended June 25, 2010;

•

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

•

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

•

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

•

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

•

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

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

SWS Group, Inc. and Subsidiaries

Notes to Consolidated Financial Statements—(Continued)

Three and Six-Months Ended December 31, 2010 and 2009

(Unaudited)

The “other” category includes SWS Group, corporate administration and SWS Capital. SWS Capital is a dormant entity which holds approximately $25,000 of assets. SWS Group is a holding company that owns various investments, including USHS common stock.

SWS Group, Inc. and Subsidiaries

Notes to Consolidated Financial Statements—(Continued)

Three and Six-Months Ended December 31, 2010 and 2009

(Unaudited)

The following table presents the Company’s operations by the segments outlined above for the three and six-months ended December 31, 2010 and 2009:

UNAUDITED QUARTERLY FINANCIAL INFORMATION


(in thousands)	Clearing			Retail		Institutional		Banking			Other			Consolidated SWS Group, Inc.
Three-months ended December 31, 2010

Operating revenue	$	4,048		$	28,816	$	33,852	$	(1,934	)	$	717		$	65,499
Net intersegment revenues		(245	)		267		92		952			(1,066	)		—
Net interest revenue		1,403			738		4,417		17,917			369			24,844
Net revenues		5,451			29,554		38,269		15,983			1,086			90,343
Operating expenses		5,112			28,030		25,441		21,746			10,728			91,057
Depreciation and amortization		216			241		144		620			612			1,833
Income (loss) before taxes		339			1,524		12,828		(5,763	)		(9,642	)		(714	)

Three-months ended December 31, 2009

Operating revenue	$	3,799		$	29,543	$	35,467	$	(374	)	$	356		$	68,791
Net intersegment revenues		(223	)		421		697		927			(1,822	)		—
Net interest revenue		1,467			731		4,919		19,130			139			26,386
Net revenues		5,266			30,274		40,386		18,756			495			95,177
Operating expenses		5,571			28,983		25,962		15,784			9,922			86,222
Depreciation and amortization		244			269		139		614			503			1,769
Income (loss) before taxes		(305	)		1,291		14,424		2,972			(9,427	)		8,955

SWS Group, Inc. and Subsidiaries

Notes to Consolidated Financial Statements—(Continued)

Three and Six-Months Ended December 31, 2010 and 2009

(Unaudited)

UNAUDITED QUARTERLY FINANCIAL INFORMATION


(in thousands)	Clearing			Retail		Institutional		Banking			Other			Consolidated SWS Group, Inc.
Six-months ended December 31, 2010

Operating revenue	$	7,848		$	56,070	$	71,955	$	(920	)	$	1,056		$	136,009
Net intersegment revenues		(433	)		473		170		1,933			(2,143	)		—
Net interest revenue		2,974			1,555		8,906		38,093			416			51,944
Net revenues		10,822			57,625		80,861		37,173			1,472			187,953
Operating expenses		9,990			55,784		52,939		80,934			19,297			218,944
Depreciation and amortization		430			485		289		1,236			1,241			3,681
Income (loss) before taxes		832			1,841		27,922		(43,761	)		(17,825	)		(30,991	)

Assets^(*)		375,567			191,141		2,057,365		1,531,415			33,298			4,188,786

Six-months ended December 31, 2009

Operating revenue	$	7,481		$	53,907	$	80,586	$	910		$	1,355		$	144,239
Net intersegment revenues		(457	)		671		822		1,816			(2,852	)		—
Net interest revenue		2,941			1,442		8,948		37,148			(88	)		50,391
Net revenues		10,422			55,349		89,534		38,058			1,267			194,630
Operating expenses		16,415			55,055		57,284		32,118			19,826			180,698
Depreciation and amortization		487			538		275		1,219			943			3,462
Income (loss) before taxes		(5,993	)		294		32,250		5,940			(18,559	)		13,932
Assets(*)		357,668			181,501		1,886,046		1,631,941			26,839			4,083,995

^(*)	Assets are reconciled to total assets as presented in the December 31, 2010 and 2009 consolidated statements of financial condition as follows (in thousands):

SWS Group, Inc. and Subsidiaries

Notes to Consolidated Financial Statements—(Continued)

Three and Six-Months Ended December 31, 2010 and 2009

(Unaudited)


	December 31, 2010			December 31, 2009
Amount as presented above	$	4,188,786		$	4,083,995
Reconciling items:
Unallocated assets:
Cash		3,995			6,700
Receivables from brokers, dealers and clearing organizations		71,980			37,576
Receivable from clients, net of allowances		16,646			17,219
Other assets		24,359			17,594
Unallocated eliminations		(12,798	)		(3,083	)

Total assets	$	4,292,968		$	4,160,001

COMMITMENTS, CONTINGENCIES AND GUARANTEES

Commitment and Contingencies.

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

Venture Capital Funds. The Bank has committed to invest $5,000,000 in two limited partnership equity funds. As of December 31, 2010, the Bank had invested $3,000,000 of its commitment. This investment is subject to the Volker rule provisions of the Dodd-Frank Act, which will be finalized prior to October 21, 2011.

Underwriting. Through its participation in underwriting securities, both corporate and municipal, SWS could expose itself to material risk, since the possibility exists that securities SWS has committed to purchase cannot be sold at the initial offering price. Federal and state securities laws and regulations also affect the activities of underwriters and impose substantial potential liabilities for violations in connection with sales of securities by underwriters to the public. There were no potential liabilities due under outstanding underwriting arrangements at December 31, 2010.

Guarantees. As of December 31, 2010, the Bank had issued stand-by letters of credit. The maximum potential amount of future payments the Bank could be required to make under the letters of credit was $1,854,000. The recourse provision of the letters of credit allows the amount of the letters of credit to become part of the fully collateralized loans with total repayment as a first lien. The collateral on these letters of credit consists of real estate, certificates of deposit, equipment, accounts receivable or furniture and fixtures.

Subject to the operating limitations in the Order, in the ordinary course of business, the Bank enters into loan agreements where the Bank commits to lend a specified amount of money to a borrower. At any point in time, there could be amounts that have not been advanced on the loan to the borrower, representing unfunded commitments, as well as amounts that have been disbursed but repaid, which are available for re-borrowing under a revolving line of credit. As of December 31, 2010, the Bank had unfunded commitments of $114,028,000 relating to revolving lines of credit. In addition, as of December 31, 2010, the Bank had unfunded new loans in the amount of $72,483,000.

SWS Group, Inc. and Subsidiaries

Notes to Consolidated Financial Statements—(Continued)

Three and Six-Months Ended December 31, 2010 and 2009

(Unaudited)

The Company provides representations and warranties to counterparties in connection with a variety of commercial transactions and occasionally indemnifies them against potential losses caused by the breach of those representations and warranties. These indemnification obligations generally are standard contractual indemnities and are entered into in the normal course of business. The maximum potential amount of future payments that the Company could be required to make under these indemnities cannot be estimated. However, the Company believes that it is unlikely it will have to make material payments under these arrangements and has not recorded any contingent liability in the consolidated financial statements for these indemnities.

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

AFFILIATE TRANSACTIONS

At June 30, 2010, two directors owned approximately 64% of the ownership interests of a local bank and one of SWS’s executive officers owned less than 1% of the ownership interests in this bank. The Bank sold loan participations with outstanding balances of $1,862,000 and $3,400,000 at December 31, 2010 and June 30, 2010, respectively, to this local bank. The local bank and the Bank had participations in $1,404,000 of foreclosed property at both December 31, 2010 and June 30, 2010. The terms of the participation agreements resulted in payments of interest and fees to the other bank of $39,000 and $86,000 for the three and six-months ended December 31, 2010, respectively, and $44,000 and $77,000 for the three and six-months ended December 31, 2009. The interest rates on these participations were substantially the same as those participations sold by the Bank to unrelated banks. In December 2010, one loan was sold and the local bank was paid $720,762 for its participation share of the net sales price. On July 31, 2010, certain assets of the local bank, including loan participations and foreclosed property, were sold to another affiliated company also owned by the two directors of the Company. Affiliate transactions are subject to limitations specified in the Order. See “Cease and Desist Order with the Office of Thrift Supervision.”

CEASE AND DESIST ORDER WITH THE OFFICE OF THRIFT SUPERVISION

On February 4, 2011 (the “Effective Date”), the Board of Directors of the Bank signed the Stipulation consenting to and agreeing to the issuance by the OTS of the Order without admitting or denying that grounds exist for the OTS to initiate an administrative proceeding against the Bank. The description of the Order and the corresponding Stipulation set forth in this section or elsewhere in this filing is qualified in its entirety by reference to the Order and Stipulation, copies of which are available on the OTS website (www.ots.treas.gov) and are attached as Exhibits 10.1 and 10.2. The Memorandum of Understanding with the Office of Thrift Supervision that was entered into by the Bank and the OTS on July 13, 2010 was terminated effective February 4, 2011. Among other things, the Order provides:

•

Effective immediately, the Bank shall have and maintain a Tier 1 (Core) Capital Ratio equal to or greater than eight percent (8%) after the funding of an adequate Allowance for Loan and Lease Losses (“ALLL”) and a Total Risk-Based Capital Ratio equal to or greater than twelve percent (12%) (the “Minimum Levels”). On December 31, 2010, the Bank complied with these requirements.

SWS Group, Inc. and Subsidiaries

Notes to Consolidated Financial Statements—(Continued)

Three and Six-Months Ended December 31, 2010 and 2009

(Unaudited)

•

By March 31, 2011, the Bank shall submit to the OTS for review and comment a written capital plan to maintain the Bank’s capital at the Minimum Levels for the quarterly periods from January 1, 2011 through December 31, 2013. On a quarterly basis, the Board of Directors of the Bank must review a report prepared by management detailing deviations from the capital plan and related corrective actions (if any).

•

Within 15 days after the Bank fails to meet the Minimum Levels or the Bank fails to submit or comply with the capital plan, the Bank must submit a contingency plan that is acceptable to the OTS that details the actions to be taken to: (a) consummate a merger or acquisition by another federally insured depository institution, or (b) voluntarily liquidate by filing an appropriate application with the OTS. Upon written notification from the OTS, this contingency plan must be implemented immediately and the Bank must provide the OTS with written status reports no later than the 1st and 15th of each month following implementation of the contingency plan.

•

Effective immediately, the Bank shall implement and adhere to the business plan previously submitted by the Bank to the OTS and any material modifications are subject to the prior written approval of the OTS after a 45 day review period. On a quarterly basis starting on March 31, 2011, the Board of Directors of the Bank must review a report prepared by management detailing deviations from the business plan and related corrective actions (if any).

•

Effective immediately, the Bank shall implement and adhere to the classified asset reduction plan previously submitted by the Bank to the OTS and develop individual written specific workout plans for each classified asset in excess of $500,000. On a quarterly basis starting on March 31, 2011, the Board of Directors of the Bank must review an asset status report prepared by management detailing changes to classified assets and the status of workout plans and any revisions to such plans (if any).

•

By March 31, 2011, the Bank shall engage a qualified, experienced, and independent third party, acceptable to the OTS, to perform a review of at least forty percent (40%) of the construction, multi-family, nonresidential and land loan portfolios that were not classified substandard and prepare a written report setting forth their findings, including a detailed analysis for the loan classifications of each asset over $500,000. The Board must review the report and submit it to the OTS no later than September 30, 2011

•

By March 31, 2011, the Bank shall revise and submit to the OTS for review and comment its written program for identifying, monitoring and controlling risks associated with concentrations of credit. Once the Bank is notified that the revised program is acceptable, the Board of Directors of the Bank must adopt the revised program. On a quarterly basis starting on March 31, 2011, the Board of Directors of the Bank must review the appropriateness of the Bank’s concentration limits given current conditions and the Bank’s compliance with the revised program and document the review in the minutes.

•

Effective immediately, the Bank must not, without the prior written non-objection of the OTS, originate or purchase, or commit to originate and purchase construction, nonresidential mortgage or land loans subject to certain exceptions, including: (i) construction loans to facilitate the sale of lots financed by the Bank and loans for the purpose of construction of homes that are pre-sold on lots financed by the Bank; (ii) owner-occupied residential construction loans to qualified customers who have a prior existing banking relationship with the Bank; (iii) loans guaranteed by the Small Business Administration; (iv) loans to facilitate the sale of real estate owned; and (v) commercial real estate workouts. All lending subject to the exceptions must comply with the Bank’s loan policy and all applicable laws, regulations and regulatory guidance. Within 45 days of the Effective Date, the Bank must provide the OTS with a schedule of all legally binding commitments as of January 27, 2011.

•

By March 31, 2011, the Bank’s outside directors shall conduct a management study and submit the study to the Board of Directors. By May 30, 2011, the Board shall adopt a written plan to address any identified weaknesses or deficiencies noted in the management study and specific dates for completion of corrective actions and submit the written plan to the OTS within 10 days of the Board meeting to consider the management plan.

SWS Group, Inc. and Subsidiaries

Notes to Consolidated Financial Statements—(Continued)

Three and Six-Months Ended December 31, 2010 and 2009

(Unaudited)

•

Effective immediately, the Bank must comply with brokered deposit regulatory requirements.

•

Effective immediately, the Bank cannot increase its total assets during any quarter in excess of an amount equal to net interest credited on deposit liabilities during the prior quarter without the prior written notice of non-objection from the OTS.

•

Effective immediately, the Bank cannot declare or pay dividends or make any other capital distributions without the prior approval of the OTS after 30 days prior notice to the OTS.

•

Effective immediately, the Bank must comply with the prior notification requirements for changes in directors and senior executive officers set forth in applicable regulations.

•

Effective immediately, the Bank cannot enter into, renew, extend or revise any contractual arrangement relating to compensation or benefits for any senior executive officer or director of the Bank without providing the OTS with 45 days prior written notice of the proposed transaction. The Bank cannot make any bonus payment or otherwise increase the compensation of any of its senior executive officers or directors without providing the OTS with 45 days prior written notice of the proposed bonus or increase and receiving a written notice of non-objection from the OTS.

•

Effective immediately, the Bank cannot make any golden parachute payment or prohibited indemnification payment unless, with respect to each payment, the Bank complies with applicable regulations.

•

Effective immediately, the Bank shall not enter into any arrangement or contract with a third party service provider that is significant to the overall operation or financial condition of the Bank or outside the Bank’s normal course of business without providing the OTS with 45 days prior written notice of the proposed arrangement including a written determination that the arrangement or contract complies with regulatory guidance and receiving a written notice of non-objection from the OTS.

•

Effective immediately, the Bank cannot engage in new transactions with affiliates unless, with respect to each transaction the Bank complies with applicable regulations.

•

By April 30, 2011, the Bank shall ensure that all violations of law and/or regulation are corrected and adequate policies, procedures and systems are established or revised and thereafter implemented to prevent future violations.

•

Effective immediately, the Board of Directors of the Bank shall monitor and coordinate the Bank’s compliance with the Order, review and adopt all policies and procedures required by this Order prior to submission to the OTS.

•

Within 30 days after the end of each calendar quarter beginning on March 31, 2011, the Bank shall prepare a written compliance tracking report for the Board. Within 45 days after the end of each calendar quarter beginning on March 31, 2011, the Board shall review the compliance tracking report and all other reports required to be prepared by the Order, adopt a resolution certifying that each director has reviewed the compliance tracking report and all required reports and documenting any corrective actions adopted by the Board.

The Order shall remain effective until terminated, modified or suspended in writing by the OTS.