UNITED STATES

SECURITIES AND EXCHANGE COMMISSION

WASHINGTON, D.C. 20549

Form 10-Q

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

For the quarterly period ended September 28, 2012

OR

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

For the transition period from             to             

Commission file number 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.)
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  x    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.

Large accelerated filer	¨	Accelerated filer	x
Non-accelerated filer	¨  (Do not check if a smaller reporting company)	Smaller reporting company	¨

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 October 31, 2012, there were 32,877,467 shares of the registrant’s common stock, $0.10 par value, outstanding.

SWS GROUP, INC. AND SUBSIDIARIES

INDEX

PART I. FINANCIAL INFORMATION
Item 1. Financial Statements
Consolidated Statements of Financial Condition September 28, 2012 (unaudited) and June  29, 2012	3
Consolidated Statements of Income (Loss) and Comprehensive Income (Loss) For the three-months ended September 28, 2012 and September 30, 2011 (unaudited)	4
Consolidated Statements of Cash Flows For the three-months ended September  28, 2012 and September 30, 2011 (unaudited)	5
Notes to Consolidated Financial Statements (unaudited)	7
Item 2. Management’s Discussion and Analysis of Financial Condition and Results of Operations	46
Item 3. Quantitative and Qualitative Disclosures About Market Risk	78
Item 4. Controls and Procedures	78
PART II. OTHER INFORMATION
Item 1. Legal Proceedings	78
Item 1A. Risk Factors	79
Item 2. Unregistered Sales of Equity Securities and Use of Proceeds	79
Item 3. Defaults Upon Senior Securities	79
Item 4. Mine Safety Disclosure	79
Item 5. Other Information	79
Item 6. Exhibits	79
SIGNATURES	80
EXHIBIT INDEX	81

PART I. FINANCIAL INFORMATION

Item 1. Financial Statements

SWS Group, Inc. and Subsidiaries

CONSOLIDATED STATEMENTS OF FINANCIAL CONDITION

September 28, 2012 and June 29, 2012

(In thousands, except par values and share amounts)

	September			June
	(Unaudited)
Assets
Cash and cash equivalents	$	71,153		$	81,826
Restricted cash and cash equivalents		30,045			30,044
Assets segregated for regulatory purposes		213,636			176,299
Receivable from brokers, dealers and clearing organizations		1,261,812			1,425,697
Receivable from clients, net of allowance		251,328			256,840
Loans, net		796,578			833,640
Securities owned, at fair value		265,562			231,151
Securities held to maturity		23,880			25,904
Securities purchased under agreements to resell		21,823			25,186
Goodwill		7,552			7,552
Securities available for sale		356,713			307,789
Other assets		145,118			144,915
	$	3,445,200		$	3,546,843
Liabilities and Stockholders’ Equity
Short-term borrowings	$	126,500		$	67,500
Payable to brokers, dealers and clearing organizations		1,167,808			1,349,370
Payable to clients		378,074			347,574
Deposits		1,059,250			1,062,233
Securities sold under agreements to repurchase		23,173			27,465
Securities sold, not yet purchased, at fair value		77,046			70,155
Drafts payable		24,586			24,970
Advances from Federal Home Loan Bank (the “FHLB”)		67,318			68,641
Long-term debt, net		80,027			79,076
Stock purchase warrants (“Warrants”)		35,995			27,810
Other liabilities		52,787			66,347
		3,092,564			3,191,141
Commitments and contingencies
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 32,557,735 shares at September 28, 2012; issued 33,312,140 and outstanding 32,576,307 shares at June 29, 2012		3,331			3,331
Additional paid-in capital		324,895			324,556
Retained earnings		24,440			30,084
Accumulated other comprehensive income – unrealized holding gain (loss), net of tax of $2,630 at September 28, 2012 and $1,398 at June 29, 2012		5,043			2,745
Deferred compensation, net		3,436			3,427
Treasury stock (754,405 shares at September 28, 2012 and 735,833 shares at June 29, 2012, at cost)		(8,509	)		(8,441	)
Total stockholders’ equity		352,636			355,702
Total liabilities and stockholders’ equity	$	3,445,200		$	3,546,843

See accompanying Notes to Consolidated Financial Statements.

3

SWS Group, Inc. and Subsidiaries

CONSOLIDATED STATEMENTS OF INCOME (LOSS)

AND COMPREHENSIVE INCOME (LOSS)

For the three-months ended September 28, 2012 and September 30, 2011

(In thousands, except per share and share amounts)

(Unaudited)

	For the Three-Months Ended
	September 28, 2012			September 30, 2011
Revenues:
Net revenues from clearing operations	$	2,139		$	2,660
Commissions		32,323			35,639
Interest		26,625			33,661
Investment banking, advisory and administrative fees		9,794			9,876
Net gains on principal transactions		9,358			6,271
Other		6,185			4,490
Total revenue		86,424			92,597
Interest expense		12,315			15,858
Net revenues		74,109			76,739
Non-interest expenses:
Commissions and other employee compensation		54,259			53,158
Occupancy, equipment and computer service costs		7,697			7,877
Communications		3,219			2,919
Floor brokerage and clearing organization charges		1,023			1,073
Advertising and promotional		668			549
Unrealized loss on Warrants valuation		8,185			171
Other		8,090			7,296
Total non-interest expenses		83,141			73,043
Income (loss) before income tax expense (benefit)		(9,032	)		3,696
Less: Income tax expense (benefit)		(3,388	)		2,044
Net income (loss)		(5,644	)		1,652
Net gain (loss) recognized in other comprehensive income (loss), net of tax of $1,234 and $(38) for the three-months ended September 28, 2012 and September 30, 2011, respectively, on available for sale securities		2,298			(78	)
Comprehensive income (loss)	$	(3,346	)	$	1,574
Earnings (loss) per share – basic
Net income (loss)	$	(0.17	)	$	0.05
Weighted average shares outstanding – basic		32,801,381			32,506,613
Earnings (loss) per share – diluted
Net income (loss)	$	(0.17	)	$	0.05
Weighted average shares outstanding – diluted		32,801,381			32,506,613

See accompanying Notes to Consolidated Financial Statements.

4

SWS Group, Inc. and Subsidiaries

CONSOLIDATED STATEMENTS OF CASH FLOWS

For the three-months ended September 28, 2012 and September 30, 2011

(In thousands)

(Unaudited)

	For the Three-Months Ended
	September 28, 2012			September 30, 2011
Cash flows from operating activities:
Net income (loss)	$	(5,644	)	$	1,652
Adjustments to reconcile net income (loss) to net cash used in operating activities:
Depreciation and amortization		1,392			1,506
Accretion of discount on long-term debt		951			559
Amortization of deferred debt issuance costs		123			82
Increase in fair value of Warrants		8,185			171
Amortization of premiums/discounts on loans purchased		(23	)		(19	)
Amortization of premiums/discounts on investment securities		422			73
Provision for doubtful accounts on receivables from customers		240			—
Provision for loan loss and write downs on real estate owned (“REO”) and other repossessed assets		559			574
Deferred income tax expense		409			6,717
Allowance for deferred tax asset		—			(265	)
Deferred compensation for deferred compensation plan and restricted stock plan		(400	)		1,533
(Gain) loss on sale of loans		(54	)		77
Loss (gain) on fixed assets transactions		1			(3	)
Loss (gain) on sale of REO and other repossessed assets		186			(128	)
Gain on issuer’s redemption of investment securities		(7	)		—
Equity in earnings of unconsolidated ventures		(82	)		(37	)
Dividend received on investments		(4	)		(4	)
Shortfall for taxes on vesting of restricted stock		—			62
Change in operating assets and liabilities:
Increase in assets segregated for regulatory purposes		(37,337	)		(42,231	)
Net change in broker, dealer and clearing organization accounts		(17,677	)		(2,904	)
Net change in client accounts		35,772			29,130
Increase in securities owned		(34,411	)		(7,733	)
Decrease in securities purchased under agreements to resell		3,363			21,531
Increase in other assets		(2,779	)		(2,515	)
(Decrease) increase in drafts payable		(384	)		553
Increase (decrease) in securities sold, not yet purchased		6,891			(23,455	)
Decrease in other liabilities		(12,832	)		(15,096	)
Net cash used in operating activities		(53,140	)		(30,170	)
Cash flows from investing activities:
Purchase of fixed assets and capitalized improvements on real estate owned		(1,070	)		(749	)
Proceeds from the sale of fixed assets and real estate		1,715			2,489
Proceeds from the sale of loans		—			215
Loan originations and purchases		(1,659,658	)		(844,908	)
Loan repayments		1,694,312			853,471
Purchase of investment securities		(64,277	)		(79,775	)
Proceeds from the issuer’s redemption of investment securities		12,000			—
Cash received on investments		8,643			1,668
Proceeds from the sale of FHLB stock		428			—
(continued)

5

	For the Three-Months Ended
	September 28, 2012			September 30, 2011
(continued)
Investment of proceeds received from Hilltop Holdings, Inc., Oak Hill Capital Partners III, L.P. and Oak Hill Capital Management Partners III, L.P. in restricted fund	$	—		$	(100,022	)
Net cash used in investing activities		(7,907	)		(167,611	)
Cash flows from financing activities:
Payments on short-term borrowings		(559,000	)		(1,059,300	)
Cash proceeds from short-term borrowings		618,000			1,101,300
Decrease in deposits		(2,983	)		(20,739	)
Payments on advances from the FHLB		(1,297	)		(1,750	)
Fee payment for FHLB restructuring		(26	)		—
Shortfall for taxes on vesting of restricted stock		—			(62	)
Cash payments on securities sold under agreements to repurchase		(4,292	)		(2,293	)
Cash proceeds received from Hilltop Holdings, Inc., Oak Hill Capital Partners III, L.P. and Oak Hill Capital Management Partners III, L.P.		—			100,000
Proceeds related to the deferred compensation plan		93			123
Purchase of treasury stock related to the deferred compensation plan		(121	)		—
Net cash provided by financing activities		50,374			117,279
Net decrease in cash and cash equivalents		(10,673	)		(80,502	)
Cash and cash equivalents at beginning of period		81,826			298,903
Cash and cash equivalents at end of period	$	71,153		$	218,401
Supplemental schedule of non-cash investing and financing activities:
Foreclosure on loans	$	2,486		$	1,204
Supplemental disclosure of cash flow information:
Cash paid during the period for:
Interest	$	14,815		$	14,098
Income taxes	$	—		$	—

See accompanying Notes to Consolidated Financial Statements.

6

SWS Group, Inc. and Subsidiaries

Notes to Consolidated Financial Statements

Three-Months Ended September 28, 2012 and September 30, 2011

(Unaudited)

GENERAL AND BASIS OF PRESENTATION

The interim consolidated financial statements as of September 28, 2012, and for the three-months ended September 28, 2012 and September 30, 2011, 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 29, 2012 filed on Form 10-K. Amounts as of June 29, 2012 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	the “Bank”

Southwest Securities is a New York Stock Exchange (NYSE) member broker/dealer. Southwest Securities and SWS Financial are members of the Financial Industry Regulatory Authority (FINRA). Southwest Securities and SWS Financial are also registered with the Securities and Exchange Commission (the “SEC”) as broker/dealers 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 44 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 since July 21, 2011 by the Office of the Comptroller of the Currency (“OCC”). As of July 21, 2011, the Federal Reserve Board (“FRB”) began supervising and regulating SWS Group and SWS Banc. SWS Banc is a wholly owned subsidiary of SWS Group and became the sole shareholder 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. The Bank’s first quarter financial statements are prepared as of September 30, 2012. Any individually material transactions are reviewed and recorded in the appropriate quarterly period. All significant intercompany balances and transactions have been eliminated.

Update of Significant Accounting Policies. A summary of the Company’s significant accounting policies is included in Note 1 of the Company’s Form 10-K for the fiscal year ended June 29, 2012 filed on September 7, 2012 (the “Fiscal 2012 Form 10-K”). Except as discussed in the individual notes to the Consolidated Financial Statements, there have been no significant accounting changes since June 29, 2012.

7

Accounting Pronouncements. The Financial Accounting Standards Board (“FASB”) and the SEC recently issued the following statements, which are applicable to SWS. Any other new accounting pronouncements not specifically identified in our disclosures are not applicable to SWS:

Accounting Standards Update (“ASU”) 2011-11, “Disclosures about Offsetting Assets and Liabilities.” In December 2011, the FASB issued ASU 2011-11 which requires entities to disclose both gross and net information about instruments and transactions eligible for offset in the statement of financial position and instruments and transactions subject to an agreement similar to a master netting agreement. The purpose of ASU 2011-11 is to facilitate comparison between entities that prepare their financial statements on the basis of accounting principles generally accepted in the United States (“GAAP”) and entities that prepare their financial statements on the basis of International Financial Reporting Standards (“IFRS”). ASU 2011-11 applies to derivatives, sale and repurchase agreements and reverse sale and repurchase agreements and securities borrowing and lending arrangements. ASU 2011-11 is effective for annual reporting periods beginning on or after January 1, 2013, and interim periods within those annual periods, the Company’s first quarter of fiscal 2014. The Company is in the process of evaluating the impact of ASU 2011-11 on its financial statements and processes.

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 maturities of three-months or less, when acquired, are considered to be cash equivalents. The Federal Deposit Insurance Corporation (“FDIC”) insures interest-bearing cash accounts up to $250,000. Also, non-interest bearing transaction accounts have unlimited coverage under FDIC insurance until December 31, 2012 in accordance with the Dodd-Frank Wall Street Reform and Consumer Protection Act (the “Dodd-Frank Act”). At September 28, 2012 and June 29, 2012, cash balances included $26,197,000 and $30,504,000, respectively, that were not federally insured because they exceeded federal insurance limits. This at-risk amount is subject to fluctuation on a daily basis, but management does not believe there is significant risk of loss on these deposits.

The Bank is required to maintain balances on hand or with the Federal Reserve Bank. At September 30, 2012 and June 30, 2012, these reserve balances amounted to $1,606,000 and $1,503,000, respectively.

RESTRICTED CASH AND CASH EQUIVALENTS

Restricted cash and cash equivalents represents funds received from Hilltop Holdings, Inc. (“Hilltop”) and Oak Hill Capital Partners III, L.P. (“OHCP”) and Oak Hill Capital Management Partners III, L.P. (collectively with OHCP, “Oak Hill”) upon completion of the $100,000,000 loan contemplated by the Funding Agreement entered into on March 20, 2011. The Company is required to keep these funds in a restricted account until the Company’s Board of Directors, Hilltop and Oak Hill determine the amount(s) to be distributed to the Company’s subsidiaries. See additional discussion in “Debt Issued with Stock Purchase Warrants.” Upon approval of the Board of Directors, Hilltop and Oak Hill, SWS Group contributed $20,000,000 of this cash to the Bank as capital in December 2011, loaned Southwest Securities $20,000,000 in the third quarter of fiscal 2012 to use in general operations by reducing Southwest Securities’ use of short-term borrowings for the financing of its day-to-day cash management needs, reduced its intercompany

8

payable to Southwest Securities by $20,000,000 and contributed $10,000,000 in capital to Southwest Securities in the fourth quarter of fiscal 2012. The remaining $30,000,000 remains in a restricted account at SWS Group to be used for general corporate purposes subject to approval by the Board of Directors, Hilltop and Oak Hill. Restricted cash and cash equivalents are excluded from cash and cash equivalents in the Consolidated Statements of Financial Condition and Consolidated Statements of Cash Flows. The Company holds restricted cash and cash equivalents in money market funds.

ASSETS SEGREGATED FOR REGULATORY PURPOSES

At September 28, 2012, SWS held Temporary Liquidity Guarantee Program (“TLGP”) bonds with a fair value of $10,062,000 and cash of approximately $203,574,000 segregated in special reserve bank accounts for the exclusive benefit of customers under Rule 15c3-3 of the Exchange Act. SWS had no reserve deposits in special reserve bank accounts for the Proprietary Accounts of Introducing Brokers (“PAIB”) at September 28, 2012.

At June 29, 2012, SWS held TLGP bonds with a fair value of $10,114,000 and cash of approximately $166,185,000 segregated in special reserve bank accounts for the exclusive benefit of customers under Rule 15c3-3 of the Exchange Act. SWS had no reserve deposits in special reserve bank accounts for the PAIB at June 29, 2012.

RECEIVABLE FROM AND PAYABLE TO BROKERS, DEALERS AND CLEARING ORGANIZATIONS

At September 28, 2012 and June 29, 2012, SWS had receivable from and payable to brokers, dealers and clearing organizations related to the following (in thousands):

	September		June
Receivable
Securities failed to deliver	$	13,616	$	23,220
Securities borrowed		1,156,099		1,320,274
Correspondent broker/dealers		35,839		41,941
Clearing organizations		20,474		18,705
Other		35,784		21,557
	$	1,261,812	$	1,425,697
Payable
Securities failed to receive	$	22,342	$	28,879
Securities loaned		1,122,308		1,289,198
Correspondent broker/dealers		16,676		10,753
Other		6,482		20,540
	$	1,167,808	$	1,349,370

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 September 28, 2012, SWS had collateral of $1,156,100,000 under securities lending agreements, of which SWS had repledged $1,100,442,000. At June 29, 2012, SWS had collateral of $1,320,024,000 under securities lending agreements, of which SWS had repledged $1,250,328,000.

9

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 loan obligations is dependent upon the general economic conditions of Texas and New Mexico.

Net loans receivable at September 30, 2012 and June 30, 2012 are summarized as follows and include unamortized discounts and premiums of $332,000 and $385,000 at September 30, 2012 and June 30, 2012, respectively, and deferred loan fees and costs of $594,000 and $709,000 at September 30, 2012 and June 30, 2012, respectively (in thousands):

	September			June
Loans receivable:
Residential construction	$	2,351		$	3,954
Lot and land development		14,820			18,431
1-4 family		413,231			383,167
Commercial real estate		292,074			326,997
Multifamily		24,565			20,110
Commercial loans		68,418			101,440
Consumer loans		2,011			1,943
		817,470			856,042
Allowance for probable loan losses		(20,892	)		(22,402	)
	$	796,578		$	833,640

At September 30, 2012 and June 30, 2012, the 1-4 family loans included $329,251,000 and $294,341,000, respectively, of purchased mortgage loans held for investment. The loans consisted of participations and sub-participations in newly originated residential loans from various mortgage bankers nationwide purchased at par.

10

The analysis of the allowance for loan losses for the three-months ended September 30, 2012 and 2011 and the recorded investment in loans receivable at September 30, 2012 and 2011 were as follows (in thousands):

	Three-Months Ended September 30, 2012
	Residential Construction			Lot and  Land Development			1-4 Family			Commercial Real Estate			Multifamily			Commercial			Consumer		Total
Allowance for credit losses:
Balance at beginning of period	$	350		$	1,310		$	3,235		$	10,628		$	2,866		$	4,004		$	9	$	22,402
Charge-offs		—			(182	)		(151	)		(703	)		—			(928	)		—		(1,964	)
Recoveries		19			133			56			63			—			183			—		454
Net charge-offs		19			(49	)		(95	)		(640	)		—			(745	)		—		(1,510	)
Additions/(reductions) charged to operations		(182	)		(286	)		65			603			(47	)		(153	)		—		—
Balance at end of period	$	187		$	975		$	3,205		$	10,591		$	2,819		$	3,106		$	9	$	20,892
Ending balance: individually evaluated for impairment	$	23		$	152		$	300		$	1,854		$	—		$	137		$	—	$	2,466
Ending balance: collectively evaluated for impairment	$	164		$	823		$	2,905		$	8,737		$	2,819		$	2,969		$	9	$	18,426
Financing receivables:
Balance at end of period	$	2,351		$	14,820		$	413,231		$	292,074		$	24,565		$	68,418		$	2,011	$	817,470
Ending balance: individually evaluated for impairment	$	648		$	2,756		$	18,690		$	22,139		$	—		$	2,010		$	1	$	46,244
Ending balance: collectively evaluated for impairment	$	1,703		$	12,064		$	394,541		$	269,935		$	24,565		$	66,408		$	2,010	$	771,226

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	Three-Months Ended September 30, 2011
	Residential Construction			Lot and Land Development			1-4 Family			Commercial Real Estate			Multifamily			Commercial			Consumer			Total
Allowance for credit losses:
Balance at beginning of period	$	531		$	3,168		$	6,107		$	28,306		$	871		$	5,417		$	33		$	44,433
Charge-offs		(345	)		(1,040	)		(184	)		(1,483	)		(1,660	)		(468	)		—			(5,180	)
Recoveries		120			56			22			217			—			42			—			457
Net charge-offs		(225	)		(984	)		(162	)		(1,266	)		(1,660	)		(426	)		—			(4,723	)
Additions/(reductions) charged to operations		1,104			2,393			(856	)		(5,307	)		3,803			(1,122	)		(15	)		—
Balance at end of period	$	1,410		$	4,577		$	5,089		$	21,733		$	3,014		$	3,869		$	18		$	39,710
Ending balance: individually evaluated for impairment	$	833		$	1,209		$	607		$	4,373		$	653		$	1,136		$	—		$	8,811
Ending balance: collectively evaluated for impairment	$	577		$	3,368		$	4,482		$	17,360		$	2,361		$	2,733		$	18		$	30,899
Financing receivables:
Balance at end of period	$	19,347		$	43,177		$	273,866		$	423,426		$	58,765		$	155,193		$	2,973		$	976,747
Ending balance: individually evaluated for impairment	$	6,310		$	8,448		$	4,649		$	44,487		$	18,266		$	5,136		$	69		$	87,365
Ending balance: collectively evaluated for impairment	$	13,037		$	34,729		$	269,217		$	378,939		$	40,499		$	150,057		$	2,904		$	889,382

12

As of September 30, 2012 and 2011, the ratio of loan loss allowance to ending loan balance, excluding purchased mortgage loans held for investment, was 4.28% and 4.90%, respectively. There is no loan loss allowance for purchased mortgage loans held for investment because they are held on average for 25 days or less, which substantially eliminates credit risk.

Loans receivable on non-accrual status as of September 30, 2012 and June 30, 2012 were as follows (in thousands):

	September 30, 2012		June 30, 2012
Residential construction	$	648	$	648
Lot and land development		2,338		2,965
1-4 family		17,243		18,443
Commercial real estate		9,660		12,175
Commercial loans		1,880		3,120
Consumer loans		1		3
	$	31,770	$	37,354

Loans are classified as non-performing when they are 90 days or more past due as to principal or interest or when reasonable doubt exists as to timely collectibility. The Bank uses a standardized review process to determine which loans should be placed on non-accrual status. At the time a loan is placed on non-accrual status, previously accrued and uncollected interest is reversed against interest income. Interest income on non-accrual loans is subsequently recognized to the extent cash payments are received for loans where full collection is likely. For loans where full 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 at September 30, 2012 and June 30, 2012 was approximately $34,804,000 and $51,663,000, respectively. Interest income recorded on non-accrual loans prior to being placed on non-accrual status totaled approximately $2,000 and $39,000 for the three-months ended September 30, 2012 and 2011, respectively.

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 September 30, 2012 and June 30, 2012 (in thousands):

	Recorded Investment(1)		Unpaid Principal Balance(1)		Related Allowance		Average Recorded Investment(*)		Interest Income Recognized(#)
September 30, 2012
With no related allowance recorded:
Residential construction	$	411	$	411	$	—	$	569	$	—
Lot and land development		1,190		1,571		—		2,106		—
1-4 family		11,008		13,117		—		15,408		87
Commercial real estate		7,861		11,194		—		9,728		121
Commercial loans		1,478		2,211		—		1,666		4
Consumer loans		1		8		—		1		—
		21,949		28,512		—		29,478		212

13

	Recorded Investment(1)		Unpaid Principal Balance(1)		Related Allowance		Average Recorded Investment(*)		Interest Income Recognized(#)
September 30, 2012
With an allowance recorded:
Residential construction	$	237	$	237	$	23	$	79	$	—
Lot and land development		1,566		1,663		152		975		22
1-4 family		7,682		8,206		300		3,763		83
Commercial real estate		14,278		14,360		1,854		13,585		734
Commercial loans		532		536		137		957		3
		24,295		25,002		2,466		19,359		842
September 30, 2012
Total
Residential construction	$	648	$	648	$	23	$	648	$	—
Lot and land development		2,756		3,234		152		3,081		22
1-4 family		18,690		21,323		300		19,171		170
Commercial real estate		22,139		25,554		1,854		23,313		855
Commercial loans		2,010		2,747		137		2,623		7
Consumer loans		1		8		—		1		—
	$	46,244	$	53,514	$	2,466	$	48,837	$	1,054

⁽¹⁾ The difference between the unpaid principal balance and the recorded investment of impaired loans with no related allowance recorded is primarily comprised of partial charge-offs previously recognized.

^(*) Represents the average recorded investment for the three-months ended September 30, 2012

^(#) Represents interest income recognized on impaired loans for the three-months ended September 30, 2012

14

	Recorded Investment(1)		Unpaid Principal Balance(1)		Related Allowance		Average Recorded Investment(*)		Interest Income Recognized(#)
June 30, 2012
With no related allowance recorded:
Residential construction	$	648	$	648	$	—	$	2,525	$	—
Lot and land development		2,964		3,408		—		6,514		32
1-4 family		17,938		20,387		—		8,540		89
Commercial real estate		10,715		13,662		—		14,308		127
Multifamily		—		—		—		6,659		—
Commercial loans		1,738		2,361		—		4,157		5
Consumer loans		2		9		—		30		—
		34,005		40,475		—		42,733		253
June 30, 2012
With an allowance recorded:
Residential construction		—		—		—		1,473		—
Lot and land development		691		700		92		1,084		33
1-4 family		1,822		1,843		120		1,866		7
Commercial real estate		13,345		13,345		1,736		24,174		490
Multifamily		—		—		—		4,831		—
Commercial loans		1,183		1,183		495		1,047		7
Consumer loans		1		1		1		—		—
		17,042		17,072		2,444		34,475		537

15

	Recorded Investment(1)		Unpaid Principal Balance(1)		Related Allowance		Average Recorded Investment(*)		Interest Income Recognized(#)
June 30, 2012
Total
Residential construction	$	648	$	648	$	—	$	3,998	$	—
Lot and land development		3,655		4,108		92		7,598		65
1-4 family		19,760		22,230		120		10,406		96
Commercial real estate		24,060		27,007		1,736		38,482		617
Multifamily		—		—		—		11,490		—
Commercial loans		2,921		3,544		495		5,204		12
Consumer loans		3		10		1		30		—
	$	51,047	$	57,547	$	2,444	$	77,208	$	790

⁽¹⁾ The difference between the unpaid principal balance and the recorded investment of impaired loans with no related allowance recorded is primarily comprised of partial charge-offs previously recognized.

^(*) Represents the average recorded investment for the fiscal year ended June 30, 2012.

^(#) Represents interest income recognized on impaired loans for the fiscal year ended June 30, 2012.

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

The Bank prepares a criticized and classified loan report that it uses to assist in calculating 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 September 30, 2012 and June 30, 2012 (in thousands):

16

	Pass		Special Mention(*)		Substandard(#)		Total
September 30, 2012
Residential construction	$	1,703	$	—	$	648	$	2,351
Lot and land development		9,700		1,348		3,772		14,820
1-4 family		391,129		759		21,343		413,231
Commercial real estate		241,892		11,737		38,445		292,074
Multifamily		23,858		—		707		24,565
Commercial loans		63,620		1,466		3,332		68,418
Consumer loans		2,010		—		1		2,011
	$	733,912	$	15,310	$	68,248	$	817,470

	Pass		Special Mention(*)		Substandard(#)		Total
June 30, 2012
Residential construction	$	3,306	$	—	$	648	$	3,954
Lot and land development		11,511		1,131		5,789		18,431
1-4 family		359,041		1,634		22,492		383,167
Commercial real estate		268,931		15,372		42,694		326,997
Multifamily		18,220		1,176		714		20,110
Commercial loans		93,626		1,729		6,085		101,440
Consumer loans		1,940		—		3		1,943
	$	756,575	$	21,042	$	78,425	$	856,042

^(*) 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.

^(#) These loans exhibit well defined weaknesses that could jeopardize the ultimate collection of all or part 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 as “Substandard”.

17

The following tables highlight the age analysis of the Bank’s past due financing receivables as of September 30, 2012 and June 30, 2012 (in thousands):

	30-59 Days Past Due		60-89 Days Past Due		90 Days and Greater Past Due		Total Past Due		Current		Total Financing Receivables		Recorded Investment > 90 Days and Accruing
September 30, 2012
Residential construction	$	—	$	—	$	648	$	648	$	1,703	$	2,351	$	—
Lot and land development		660		205		1,693		2,558		12,262		14,820		—
1-4 family		245		268		3,276		3,789		409,442		413,231		3
Commercial real estate		156		406		3,426		3,988		288,086		292,074		—
Multifamily		—		—		—		—		24,565		24,565		—
Commercial loans		75		1,767		1,234		3,076		65,342		68,418		—
Consumer loans		—		—		—		—		2,011		2,011		—
	$	1,136	$	2,646	$	10,277	$	14,059	$	803,411	$	817,470	$	3

18

	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, 2012
Residential construction	$	—	$	—	$	648	$	648	$	3,306	$	3,954	$	—
Lot and land development		121		218		2,183		2,522		15,909		18,431		—
1-4 family		918		1,991		3,205		6,114		377,053		383,167		—
Commercial real estate		5,016		1,517		3,916		10,449		316,548		326,997		—
Multifamily		—		—		—		—		20,110		20,110		—
Commercial loans		1,306		926		498		2,730		98,710		101,440		—
Consumer loans		2		—		1		3		1,940		1,943		—
	$	7,363	$	4,652	$	10,451	$	22,466	$	833,576	$	856,042	$	—

19

In certain circumstances, the Bank modifies the terms of its loans to a troubled borrower. Modifications may include extending the maturity date, reducing the stated interest rate or rescheduling future cash flows. The Bank accounts for the modification as a troubled debt restructuring (“TDR”).

Loans that have been modified in a TDR continue to be considered restructured until paid in full. These loans, including loans restructured in the prior 12 months that defaulted during the period, are individually evaluated for impairment taking into consideration payment status, collateral value, and the probability of collecting scheduled principal and interest payments when due. A specific allowance for an impaired loan that has been modified in a TDR is established when the loan’s fair value is lower than its recorded investment. In addition, the historical loss rate of loans modified in TDR’s, by portfolio segment, are factored into the formula utilized to determine the general allowance for probable loan losses.

The table below presents the recorded investment in loans modified in TDRs as of September 30, 2012 and June 30, 2012 (in thousands):

	September 30, 2012		June 30, 2012
Lot and land development	$	5,089	$	1,902
1-4 family		14,566		14,364
Commercial real-estate		1,408		1,450
Commercial		402		411
	$	21,465	$	18,127

The allowance for loan losses, excluded from the recorded investment, associated with loans modified in TDRs as of September 30, 2012 and June 30, 2012, was $323,000 and $168,000, respectively. The recorded investment includes $3,517,000 and $3,102,000 of loans on accrual status as of September 30, 2012 and June 30, 2012, respectively. Loans modified in TDRs are placed on accrual status when a reasonable period of payment performance by the borrower demonstrates the ability and capacity to meet the restructured terms.

The following table summarizes the financial effects of loan modifications accounted for as TDRs that occurred during the three-months ended September 30, 2012 and 2011 (dollars in thousands):

	Three-Months Ended September 30, 2012						Three-Months Ended September 30, 2011
	Number  of Contracts		Pre- Modification Outstanding Recorded Investment		Post- Modification Outstanding Recorded Investment(*)		Number  of Contracts		Pre- Modification Outstanding Recorded Investment		Post- Modification Outstanding Recorded Investment(*)
Lot and land development		7	$	3,228	$	3,228		—	$	—	$	—
1-4 family		1		413		413		—		—		—
Commercial		—		—		—		2		600		600
		8	$	3,641	$	3,641		2	$	600	$	600

(*) Post modification balances include direct charge-offs recorded at the time of modification.

20

The table below summarizes the type of loan modification made and the post modification outstanding recorded investment for TDR’s during the three-months ended September 30, 2012 and 2011 (in thousands):

	Amount of Loan Modifications
Type of Modification	Three-Months Ended September 30, 2012		Three-Months Ended September 30, 2011
Extended maturity date	$	114	$	600
Rescheduled future cash flows		705		—
Combination of maturity date extension and rescheduling of future cash flows		1,945		—
Combination of maturity date extension and reduction of the stated interest rate		26		—
Combination of maturity date extension, reduction of the stated interest rate, and rescheduling of future cash flows		851		—
	$	3,641	$	600

Loan modifications accounted for as TDRs within the previous 12 months that subsequently defaulted (a payment default is defined as a loan 60 days or more past due) during the three-months ended September 30, 2012 and 2011 are summarized in the following table (dollars in thousands):

	Three-Months Ended September 30, 2012				Three-Months Ended September 30, 2011
	Number of Contracts		Recorded Investment		Number of Contracts		Recorded Investment
Lot and land development		—	$	—		1	$	745
1-4 family		1		1,514		—		—
Commercial real estate		—		—		1		2,063
Commercial		—		—		2		424
		1	$	1,514		4	$	3,232

SECURITIES OWNED AND SECURITIES SOLD, NOT YET PURCHASED

Securities owned and securities sold, not yet purchased at September 28, 2012 and June 29, 2012 consisted of the following (in thousands):

	September		June
Securities owned
Corporate equity securities	$	1,372	$	1,312
Municipal obligations		100,010		117,868
U.S. government and government agency obligations		30,720		41,329
Corporate obligations		90,326		59,092
Other		43,134		11,550
	$	265,562	$	231,151
Securities sold, not yet purchased
Corporate equity securities	$	19	$	—
U.S. government and government agency obligations		41,302		30,462
Corporate obligations		35,583		39,348
Other		142		345
	$	77,046	$	70,155

21

Securities owned and securities sold, not yet purchased are carried at fair value. See additional discussion in “Fair Value of Financial Instruments.”

Some of these securities were pledged to secure short-term borrowings (see “Short-Term Borrowings”) and as security deposits at clearing organizations for SWS’s clearing business. At September 28, 2012 and June 29, 2012, securities pledged as security deposits at clearing organizations were $1,999,000 and $1,850,000, respectively.

SECURITIES HELD TO MATURITY

Securities held to maturity consisted of the following (in thousands):

	September 30, 2012		June 30, 2012
Government National Mortgage Association (“GNMA”) securities	$	23,880	$	25,904

In March 2011, the Bank purchased GNMA securities at a cost of $35,525,000, including a premium of $525,000. The premium is amortized over the period from the date of purchase to the stated maturity date (15 years) of the GNMA securities using the interest method. These securities are classified as held to maturity and are accounted for at amortized cost. The weighted average yield on this investment is expected to be 2.5% and the weighted average maturity is expected to be 2.7 years.

The Bank recorded $29,000 and $40,000 in amortization of the premiums during the three-months ended September 30, 2012 and 2011, respectively. During the three-months ended September 30, 2012 and 2011, the Bank received $2,182,000 and $1,671,000 of principal and interest payments, respectively, recording $187,000 and $242,000 in interest, respectively.

SECURITIES PURCHASED/SOLD UNDER AGREEMENTS TO RESELL/REPURCHASE

At September 28, 2012, SWS held reverse repurchase agreements totaling $21,823,000, collateralized by U.S. government and government agency obligations with a fair value of approximately $21,785,000. At June 29, 2012, SWS held reverse repurchase agreements totaling $25,186,000, collateralized by U.S. government and government agency obligations with a fair value of approximately $25,036,000.

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. Interest on these amounts is accrued and is included in the Consolidated Statements of Financial Condition in other liabilities. Securities sold under repurchase agreements at September 28, 2012 and June 29, 2012 were $23,173,000 and $27,465,000, respectively.

SECURITIES AVAILABLE FOR SALE

SWS Group owns shares of common stock of U.S. Home Systems, Inc. (“USHS”) and Westwood Group, Inc. (“Westwood”), which it classifies as securities available for sale. In addition to the shares of common stock owned by SWS Group, the Bank owns U.S. government and government agency and municipal obligations that are available for sale. 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.

22

The following table summarizes the cost of equity securities, amortized cost of debt securities and market value of these investments at September 28, 2012 and June 29, 2012 and for the Bank at September 30, 2012 and June 30, 2012 (dollars in thousands):

	Shares Held		Original/ Amortized Cost		Gross Unrealized Gains		Gross Unrealized Losses			Gross Realized Losses			Market Value
September 2012
USHS		357,514	$	914	$	3,540	$	—		$	—		$	4,454
Westwood		3,682		7		156		—			(19	)		144
U.S. government and government agency obligations		N/A		335,016		4,178		(235	)		—			338,959
Municipal obligations		N/A		13,122		63		(29	)		—			13,156
Securities available for sale			$	349,059	$	7,937	$	(264	)	$	(19	)	$	356,713

	Shares Held		Original/ Amortized Cost		Gross Unrealized Gains		Gross Unrealized Losses			Market Value
June 2012
USHS		357,154	$	914	$	2,711	$	—		$	3,625
Westwood		4,216		7		150		—			157
U.S. government and government agency obligations		N/A		299,762		1,525		(216	)		301,071
Municipal obligations		N/A		2,963		—		(27	)		2,936
Securities available for sale			$	303,646	$	4,386	$	(243	)	$	307,789

On October 26, 2012, a special meeting of the stockholders of USHS stockholders was held requesting an affirmative vote of the stockholders to adopt a proposed acquisition agreement, among other proposals. USHS announced on October 29, 2012 that the acquisition agreement between USHS and The Home Depot, Inc. was approved and that, as a result, all outstanding shares of its common stock, including the shares of USHS common stock held by SWS, will be purchased for a price of $12.50 per share. The USHS shares were valued at $12.47 per share as of September 28, 2012. As a result of the proposed acquisition, the Company would recognize a realized gain of $3,550,000.

In fiscal 2013 and 2012, the Bank purchased U.S. government, government agency and municipal obligations at a cost of $64,277,000 and $384,730,000, including a net premium of $1,838,000 and $8,387,000, respectively. The premium is amortized over the period from the date of purchase to the stated maturity date (weighted average of 4.05 years at September 30, 2012 and 4.04 years at June 30, 2012) using the interest method. The Bank also sold $66,936,000 in securities in the fourth quarter of fiscal 2012, recognizing a gain of $557,000 in other revenue and a $362,000 ($557,000 net of tax) reclassification adjustment from accumulated other comprehensive income.

During the three-months ended September 30, 2012 and 2011, the Bank recorded $393,000 and $33,000, respectively, in amortization of premium and the Bank received $8,116,000 and $296,000, respectively, in principal and interest payments, recording $1,638,000 and $57,000, respectively, in interest income.

23

During the first quarter of fiscal 2013, the issuer redeemed $12,000,000 of U.S. government agency securities, purchased at a discount in fiscal 2012, at par, resulting in a gain of $7,000.

INVESTMENTS AND VARIABLE INTEREST ENTITIES

Investments.

SWS has interests in three investment partnerships that it accounts for under the equity method, which approximates fair value. One is a limited partnership venture capital fund in which SWS has invested $5,000,000. 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 $1,356,000 at September 28, 2012 and $1,494,000 at June 29, 2012. SWS recorded a net gain on this investment for the three-months ended September 28, 2012 and September 30, 2011 of $32,000 and $3,000, respectively. In August 2012, SWS received a cash distribution of $170,000 from this investment. The limited partnership venture capital fund has entered into an agreement with the small business administration (SBA) for a self-liquidation plan.

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 September 30, 2012 and June 30, 2012, the Bank had invested $2,400,000 of its aggregate $5,000,000 commitment to the two funds. During the three-months ended September 30, 2012 and 2011, the Bank recorded net gains of $50,000 and $34,000, respectively, related to these investments. On January 28, 2009, the Bank executed a loan agreement with one of the partnerships for $4,500,000. The loan was amended on November 16, 2009 to increase the note amount to $5,000,000. The loan was renewed on September 26, 2012 with a maturity date of January 2, 2013. At September 30, 2012, the outstanding balance was $4,318,000. The loan bears interest at the Wall Street Journal Prime Rate with a floor of 5% and interest is due monthly. The Bank earned approximately $56,000 and $63,000 in interest income in the three-months ended September 30, 2012 and 2011, respectively on the loan.

In April 2012, the Bank acquired an interest in a private investment fund to obtain additional credit for its obligations under the CRA. The Bank has committed to invest $3,000,000 in the fund. This investment is subject to the Volcker Rule as described in “Commitments, Contingencies and Guarantees – Venture Capital Funds” in the Notes to the Consolidated Financial Statements contained in this report. As of September 30, 2012, no contributions have been made to this investment.

Variable Interest Entities.

The Company’s variable interest entity (“VIE”) policies are discussed in Note 11 Investments and Variable Interest Entities of the Fiscal 2012 Form 10-K.

The loans to commercial borrowers noted in the table below meet the definition of a VIE because the legal entities have a total equity investment at risk that is not sufficient to permit the entity to finance its activities without additional subordinated financial support; however, the Company is not the primary beneficiary of the legal entities. The Company has customary lender’s rights and remedies, as provided in the related promissory notes and loan agreements, but does not have the power to direct the activities of the legal entities that most significantly impact the borrowers’ economic performance. In addition, the Company has not provided the borrowers with any form of support outside of the contractual loan obligations. Accordingly, the entities are not consolidated in the Company’s financial statements.

24

The following table presents the carrying amount and maximum exposure to loss associated with the Company’s variable interests in unconsolidated VIEs as of September 30, 2012 and June 30, 2012 (dollars in thousands):

	September 30, 2012						June 30, 2012
	Number of VIEs		Carrying Amount of Assets		Maximum Exposure to Loss		Number of VIEs		Carrying Amount of Assets		Maximum Exposure to Loss
Loans to commercial borrowers		8	$	5,864	$	4,310		5	$	2,766	$	1,339

The carrying amount of the Company’s recorded investment in these loans is included in loans, net of allowance for loan losses in the Consolidated Statements of Financial Condition. See additional discussion in “Loans and Allowance for Probable Loan Losses” for information related to the loans modified in TDR’s.

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 in the Consolidated Statements of Financial Condition. 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 the 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 discounted for selling the asset in a distressed sale. In addition, in certain circumstances, the Bank adjusts appraised values to more accurately reflect the economic conditions of the area at the time of valuation or to reflect changes in market value occurring subsequent to the appraisal date. The amount of subsequent write-downs required to reflect current fair value was $559,000 and $574,000 for the three-months ended September 30, 2012 and September 30, 2011, respectively.

SHORT-TERM BORROWINGS

Brokerage.

Uncommitted lines of credit

Southwest Securities has credit arrangements with commercial banks, which include broker loan lines up to $375,000,000. 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 (0.09% at September 28, 2012 and June 29, 2012). The total amount of borrowings available under these lines of credit is reduced by the amount available under the options trading unsecured letter of credit, referenced below. At September 28, 2012, the amount outstanding under these secured arrangements was $81,500,000, which was collateralized by securities held for firm accounts valued at $121,254,000. At June 29, 2012, the amount outstanding under these secured arrangements was $22,500,000, which was collateralized by securities held for firm accounts valued at $80,125,000.

At September 28, 2012 and June 29, 2012, Southwest Securities 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 September 28, 2012 and June 29, 2012, there were no amounts outstanding on this line. At September 28, 2012 and June 29, 2012, the total amount available for borrowing was $20,000,000.

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Committed lines of credit

On January 28, 2011, Southwest Securities entered into an agreement with an unaffiliated bank for a $45,000,000 committed revolving credit facility. The commitment fee is 37.5 basis points per annum, and when drawn, the interest rate is equal to the federal funds rate plus 125 basis points. The agreement provides that Southwest Securities must maintain a tangible net worth of at least $150,000,000. As of both September 28, 2012 and June 29, 2012, there was $45,000,000 outstanding under the committed revolving credit facility. The secured borrowing was collateralized by securities with a value of $73,118,000 and $71,277,000 at September 28, 2012 and June 29, 2012, respectively.

Unsecured letters of credit

At both September 28, 2012 and June 29, 2012, SWS had an irrevocable letter of credit agreement pledged to support customer open options positions with an options clearing organization. Until drawn, the letter of credit bears interest at a rate of 0.5% per annum and is renewable semi-annually. If drawn, the letter of credit bears interest at a rate of 0.5% per annum plus a fee. At September 28, 2012 and June 29, 2012, the maximum amount available under this letter of credit agreement was $75,000,000. At September 28, 2012 and June 29, 2012, the Company had outstanding, undrawn letters of credit of $65,000,000 and $63,000,000, respectively, bearing interest at a rate of 0.5% per annum. The letter of credit was fully collateralized by marketable securities held in client and non-client margin accounts with a value of $83,701,000 and $86,106,000 at September 28, 2012 and June 29, 2012, respectively.

In addition to using customer securities to collateralize short-term borrowings, SWS also loans client securities as collateral in conjunction with SWS’s securities lending activities. At September 28, 2012, approximately $321,777,000 of client securities under customer margin loans was available to be pledged, of which SWS had pledged $ 21,866,000 under securities loan agreements. At June 29, 2012, approximately $335,453,000 of client securities under customer margin loans was available to be pledged, of which SWS had pledged $38,870,000 under securities loan agreements.

Banking.

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 September 30, 2012 and June 30, 2012, the total amount available under this line was $33,607,000 and $61,956,000, respectively. There was no amount outstanding at September 30, 2012 and June 30, 2012.

DEPOSITS

The Bank’s deposits at September 30, 2012 and June 30, 2012 consisted of the following (dollars in thousands):

	September					June
	Amount		Percent			Amount		Percent
Non-interest bearing demand accounts	$	57,571		5.4	%	$	55,403		5.2	%
Interest bearing demand accounts		8,959		0.9			8,862		0.8
Savings accounts		935,424		88.3			934,636		88.0
Limited access money market accounts		21,979		2.1			26,232		2.5
Certificates of deposit, less than $100,000		21,263		2.0			21,680		2.0
Certificates of deposit, $100,000 and greater		14,054		1.3			15,420		1.5
	$	1,059,250		100.0	%	$	1,062,233		100.0	%

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The weighted average interest rate on the Bank’s deposits was approximately 0.05% at September 30, 2012 and 0.07% at June 30, 2012.

At September 30, 2012, the 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	$	14,983	$	2,589	$	3,164	$	302	$	225	$	21,263
Certificates of deposit, $100,000 and greater		9,477		1,502		2,648		226		201		14,054
	$	24,460	$	4,091	$	5,812	$	528	$	426	$	35,317

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

ADVANCES FROM THE FEDERAL HOME LOAN BANK

At September 30, 2012 and June 30, 2012, advances from the FHLB were due as follows (in thousands):

	September		June
Maturity:
Due in one year	$	16,703	$	9,267
Due in two years		17,969		26,491
Due in five years		6,467		6,721
Due in seven years		5,139		4,850
Due in ten years		8,175		8,304
Due in twenty years		12,865		13,008
	$	67,318	$	68,641

The advances from the FHLB had interest rates ranging from 1% to 7% and were collateralized by approximately $398,267,000 in qualifying loans at September 30, 2012 (calculated at June 30, 2012). At June 30, 2012 (calculated at March 31, 2012), the advances from the FHLB had interest rates ranging from 2% to 7% and were collateralized by approximately $382,000,000 in qualifying loans. The weighted average interest rate was 4.4% at September 30, 2012 and June 30, 2012.

At September 30, 2012, the Bank had net borrowing capacity with the FHLB of $330,949,000.

DEBT ISSUED WITH STOCK PURCHASE WARRANTS

On March 20, 2011, the Company entered into a Funding Agreement with Hilltop and Oak Hill. On July 29, 2011, after receipt of stockholder and regulatory approval, the Company completed the following transactions contemplated by the Funding Agreement:

• entered into a $100,000,000, five year, unsecured loan from Hilltop and Oak Hill under the terms of a credit agreement;

• issued Warrants to Hilltop and Oak Hill for the purchase of up to 17,391,304 shares of the Company’s common stock; and

• granted Hilltop and Oak Hill certain rights, including certain registration rights, preemptive rights, and the right for each to appoint one person to the Company’s Board of Directors for so long as each owns 9.9% or more of all of the outstanding shares of the Company’s common stock or securities convertible into at least 9.9% of the Company’s outstanding common stock.

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At July 29, 2011, in connection with the loans made by Hilltop and Oak Hill under the credit agreement, the Company issued a warrant to Hilltop to purchase up to 8,695,652 shares of common stock (and in certain cases described below, shares of Non-Voting Perpetual Participating Preferred Stock, Series A (the “Series A Preferred Stock”)) and warrants to Oak Hill to purchase up to 8,695,652 shares of common stock (and in certain cases described below, shares of Series A Preferred Stock). These Warrants are exercisable for five years and have a fixed exercise price of $5.75 per share, subject to standard anti-dilution adjustments for extraordinary corporate transactions, such as stock splits, dividends and combinations, the issuance of stock purchase rights, debt or asset distributions (including cash), tender offers or exchange offers and entry into certain business combinations. In addition, the Warrants have a weighted average anti-dilution adjustment in the event the Company issues shares of common stock at less than 90% of the market price of the Company’s common stock on the date prior to the pricing of such shares. For each of Hilltop and Oak Hill, the Warrants represent approximately 17% of the Company’s common stock as of September 28, 2012 (assuming that each of Hilltop and Oak Hill exercises its Warrant in full).

The Warrants provide that the Company would only issue shares of Series A Preferred Stock upon the exercise of Warrants if it is necessary to prevent Hilltop or Oak Hill from owning or being deemed to own shares of the Company’s common stock in excess of the “Ownership Limit” provided in the Warrants. The “Ownership Limit” is 24.9% of any class of the securities of the Company or such level that Hilltop or Oak Hill reasonably determines would prevent them from being deemed to control the Company for purposes of the federal banking laws and regulations specified in the Warrants. No shares of Series A Preferred Stock were issued or outstanding at September 28, 2012 and June 29, 2012 respectively. See additional discussion concerning the Series A Preferred Stock in “Preferred Stock.”

The Warrants are recorded as a liability in the Consolidated Statements of Financial Condition at fair value. Initial valuation of the Warrants using a binomial valuation model and a closing stock price at July 29, 2011 of $5.45 per share indicated a fair value of $24,136,000. At September 28, 2012 and June 29, 2012, the Warrants were valued at $35,995,000 and $27,810,000, respectively. The change in fair value for the three-months ended September 28, 2012 and September 30, 2011 of $8,185,000 and $171,000, respectively, was recorded as unrealized loss on Warrant valuation, on the Consolidated Statements of Income (Loss) and Comprehensive Income (Loss). The Warrants are classified as Level 3 in the fair value hierarchy as disclosed in “Fair Value of Financial Instruments.”

The loan is recorded as a liability with an 8% interest rate, a five year term and an effective interest rate of 14.9%. At July 29, 2011, the discount on the loan was initially valued at $24,136,000 and is being accreted using the effective interest method. For the three-months ended September 28, 2012 and September 30, 2011, the Company recorded $951,000 and $559,000, respectively, in accretion expense on the discount. The resulting long-term debt balance at September 30, 2012 and June 30, 2012 was $80,027,000 and $79,076,000, respectively. For the three-months ended September 28, 2012 and September 30, 2011, interest expense on the loan to Hilltop and Oak Hill was $2,000,000 and $1,356,000, respectively.

At July 29, 2011, legal and accounting fees, printing costs and other expenses associated with the loan and Warrants totaled $2,459,000 and are being amortized on the straight-line method over the term of the loan. For the three-months ended September 28, 2012 and September 30, 2011, interest expense charged to operations was $123,000 and $82,000, respectively.

The Company recorded total interest expense for this obligation for the three-months ended September 28, 2012 and September 30, 2011, on the Consolidated Statements of Income (Loss) and Comprehensive Income (Loss) of $3,074,000 and $1,997,000, respectively.

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The credit agreement contains customary covenants which require the Company to, among other things:

• maintain a tangible net worth at least equal to the sum of $275,000,000 and 20% of cumulative consolidated net income (as defined in the credit agreement) for each fiscal quarter for which consolidated net income is positive;

• maintain a minimum unrestricted cash balance (as defined in the credit agreement) of at least $4,000,000;

• maintain an excess net capital balance at Southwest Securities of at least $100,000,000 as of the end of each calendar month; and

• adhere to the requirements of the Order.

In addition, the covenants limit the Company’s and certain of the Company’s subsidiaries’ ability to, among other things:

• incur additional indebtedness;

• dispose of or acquire certain assets;

• pay dividends on the Company’s capital stock;

• make investments, including acquisitions; and

• enter into transactions with affiliates.

There were no events of default in the first quarter of fiscal 2013.

INCOME TAXES

Income tax expense (benefit) for the three-month periods ended September 28, 2012 and September 30, 2011 (effective rate of 37.5% and 55.3% in the three-month periods ended September 28, 2012 and September 30, 2011, respectively) differs from the amount that would otherwise have been calculated by applying the federal corporate tax rate (35% in fiscal 2013 and 2012) to income (loss) before income tax expense (benefit) and is comprised of the following (in thousands):

	Three-Months Ended
	September 28,			September 30,
	2012			2011
Income tax expense (benefit) at the statutory rate	$	(3,161	)	$	1,293
Tax exempt interest		(246	)		(212	)
Tax exempt income from company-owned life insurance (“COLI”)		(206	)		499
State income taxes, net of federal tax benefit		21			361
Non-deductible meals and entertainment		37			32
Non-deductible compensation		250			374
Reduction of valuation allowance		—			(265	)
Other, net		(83	)		(38	)
	$	(3,388	)	$	2,044

The tax effects of temporary differences that give rise to the deferred tax assets and deferred tax liabilities as of September 28, 2012 and June 29, 2012 are presented below (in thousands):

	September 28,		June 29,
	2012		2012
Deferred tax assets:
Employee compensation plans	$	9,842	$	12,704
Allowance for probable loan losses		6,564		7,131
Bad debt reserve		2,173		2,078
Deferred rent		1,608		1,608
Deferred income on loans		634		582
Investment in unconsolidated ventures		915		915
Long-term debt		4,113		1,262
State taxes		1,017		1,152
Other		566		645
Gross deferred tax assets		27,432		28,077

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	September 28,			June 29,
	2012			2012
Valuation allowance	$	(872	)	$	(872	)
Net deferred tax asset		26,560			27,205
Deferred tax liabilities:
Securities available for sale	$	(2,695	)	$	(1,462	)
Extraordinary gain related to the M.L. Stern & Co., LLC acquisition		(238	)		(239	)
Fixed assets, net		(695	)		(668	)
REO		(210	)		(387	)
Investment in unconsolidated ventures		(661	)		(742	)
Other		(52	)		(56	)
Total gross deferred tax liabilities		(4,551	)		(3,554	)
Net deferred tax assets – included in other assets on the Consolidated Statements of Financial Condition	$	22,009		$	23,651

At September 28, 2012, the Company’s deferred tax assets included $915,000 and $6,564,000 related to capital losses from investments in various partnership assets and the allowance for probable loan losses at the Bank, respectively. At June 29, 2012, the balances for these deferred tax assets were $915,000 and $7,131,000, respectively. To use the deferred tax asset related to the capital losses from investments, the Company must generate sufficient capital gain income within the carry-back and carry-forward period available under the tax law. As of September 28, 2012, the Company did not believe it was more likely than not that it would generate sufficient capital gain income to offset all of its capital losses. Accordingly, the Company has an $872,000 valuation allowance to reflect the amount of the deferred tax assets that it believes is more likely than not to not be recognized. This valuation allowance was unchanged from June 29, 2012. For the deferred tax asset related to the allowance for probable loan losses at the Bank, management believes it is more likely than not that the Company will realize this deferred tax asset due to the Company’s strong earnings history and management’s belief that the loss that created the deferred asset was an aberration rather than a continuing condition. In addition, management considered its expectation that the Company’s other subsidiaries will be profitable and generate future taxable income at the consolidated level. However, the amount of deferred tax assets considered realizable could be reduced if estimates of future taxable income during the carry-forward period are reduced.

At September 28, 2012, the Company had approximately $1,134,000 of unrecognized tax benefits. The Company’s net liability for unrecognized tax benefits increased $9,000 from June 29, 2012 to September 28, 2012 primarily due to increases related to tax positions taken on previously filed returns. While the Company expects that the net liability for uncertain tax positions will change during the next 12 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 is accrued interest and penalties of $300,000, net of federal benefit, as of September 28, 2012 and $280,000, net of federal benefit, as of June 29, 2012. For the three-months ended September 28, 2012 and September 30, 2011, the Company recognized approximately $20,000 and $31,000, net of federal benefit, respectively, in interest and penalties in income tax expense. The total amount of unrecognized income tax benefits that, if recognized, would reduce income tax expense was approximately $834,000 as of September 28, 2012 and $845,000 as of June 29, 2012.

With limited exception, SWS is no longer subject to U.S. federal, state or local tax audits by taxing authorities for years preceding 2008. Two state agencies have begun examinations for the Company’s tax years ended December 31, 2008 through 2010. One state examination concluded in June 2012 with no material adjustments. The examination of the Company’s federal tax returns for 2008-2010 is expected to continue until early 2013.

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REGULATORY CAPITAL REQUIREMENTS

Brokerage.

At September 28, 2012 and June 29, 2012, the net capital position of Southwest Securities was as follows (in thousands):

	September 28, 2012			June 29, 2012
Net capital	$	143,056		$	150,328
Less: required net capital		6,449			6,693
Excess net capital	$	136,607		$	143,635
Net capital as a percent of aggregate debit items		44.4	%		44.9	%
Net capital in excess of 5% aggregate debit items	$	126,934		$	133,595

At September 28, 2012 and June 29, 2012, the net capital position of SWS Financial was as follows (in thousands):

	September 28, 2012		June 29, 2012
Net capital	$	741	$	651
Less: required net capital		250		250
Excess net capital	$	491	$	401

For more information, see the discussion in Note 18, Regulatory Capital Requirements in the Fiscal 2012 Form 10-K.

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 165 and 12 CFR 167) to risk-weighted assets (as defined) and of Tier I (core) capital (as defined) to adjusted assets (as defined). Federal statutes and OCC 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.

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 Office of Thrift Supervision (the “OTS”) issued the Order, which is now administered by the OCC. At September 30, 2012, as a result of the issuance of the Order, the Bank was deemed to be “adequately capitalized” as the Bank no longer met the definition of “well capitalized” under federal statutes and OCC regulations even though its capital ratios met or exceeded all applicable requirements under federal law to be defined as a well-capitalized institution. See additional discussion in “Cease and Desist Order with the Office of the Comptroller of the Currency.” As of September 30, 2012, the Bank’s total risk-based capital ratio was 19.2%, resulting in $66,409,000 in excess capital over the Order’s total risk-based capital requirement of $110,194,000. The Bank’s Tier I risk-based capital ratio was 18.0% and its Tier I (core) capital ratio was 12.7%, resulting in $61,343,000 in excess capital over the Order’s Tier I (core) capital requirement of $103,665,000. As of June 30, 2012, the Bank’s total risk-based capital ratio was 19.2%, resulting in $65,828,000 in excess capital over the Order’s total risk-based capital requirement of $110,001,000. The Bank’s Tier I risk-based capital ratio was 17.9% and its

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Tier I (core) capital ratio was 12.6%, resulting in $60,055,000 in excess capital over the Order’s Tier I (core) capital requirement of $104,180,000. The ratios set forth below include the $20,000,000 capital contribution made to the Bank by SWS Group in December 2011. See additional discussion in “Restricted Cash and Cash Equivalents.”

The Bank’s capital amounts and ratios at September 30, 2012 and June 30, 2012 were as follows (dollars in thousands):

	Actual					For Capital Adequacy Purposes					To Be Well Capitalized Under Prompt Corrective Action Provisions					Order’s Capital Requirements
	Amount		Ratio			Amount		Ratio			Amount		Ratio			Amount		Ratio
September 30, 2012
Total risk-based capital	$	176,603		19.2	%	$	73,463		8.0	%	$	91,828		10.0	%	$	110,194		12.0	%
Tier I risk-based capital		165,008		18.0			36,731		4.0			55,097		6.0			73,463		8.0
Tier I (core) capital		165,008		12.7			51,832		4.0			64,791		5.0			103,665		8.0
June 30, 2012
Total risk-based capital	$	175,829		19.2	%	$	73,334		8.0	%	$	91,667		10.0	%	$	110,001		12.0	%
Tier I risk-based capital		164,235		17.9			36,677		4.0			55,000		6.0			73,334		8.0
Tier I (core) capital		164,235		12.6			52,090		4.0			65,112		5.0			104,180		8.0

EMPLOYEE BENEFITS

Restricted Stock Plan. During the first three-months of fiscal 2013 and 2012, no restricted stock grants were approved by SWS Group’s Board of Directors. For the three-months ended September 28, 2012, SWS recognized compensation expense related to restricted stock grants of approximately $342,000. For the three-months ended September 30, 2011, SWS recognized compensation expense related to restricted stock grants of approximately $220,000.

At September 28, 2012, the total number of shares outstanding under the SWS Group, Inc. 2003 Restricted Stock Plan (“Restricted Stock Plan”) was 373,163 and the total number of shares available for future grants was 24,682.

REPURCHASE OF TREASURY STOCK

Periodically, SWS repurchases common stock under a plan approved by the 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, 2013. During the three-months ended September 28, 2012 and September 30, 2011, SWS Group did not repurchase any shares of common stock under this plan. The Company does not currently intend to repurchase any shares of common stock under this plan and would be required to obtain Hilltop, Oak Hill and regulatory approval to repurchase shares under this plan.

Additionally, the trustee under the deferred compensation plan periodically purchases shares of 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 dividends declared by SWS. During the three-months ended September 28, 2012, the plan purchased 20,675 shares of common stock at a cost of approximately $121,000, or $5.86 per share. During the three-months ended September 30, 2011, no shares of common stock were purchased. The plan distributed 6,795 shares to participants in the three-months ended September 28, 2012. The plan did not distribute any shares to participants in the three-months ended September 30, 2011.

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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. During the three-months ended September 28, 2012, the Company repurchased 4,647 shares of common stock with a market value of approximately $27,000, or an average price of $5.78 per share, in connection with income tax withholding obligations arising from vesting of restricted stock grants. During the three-months ended September 30, 2011, the Company repurchased 8,463 shares of common stock with a market value of approximately $36,000, or an average of $4.29 per share, in connection with income tax withholding obligations arising from vesting of restricted stock grants.

PREFERRED STOCK

On March 17, 2011, in conjunction with the transaction with Hilltop and Oak Hill, the Board of Directors created the Series A Preferred Stock, par value $1.00 per share. The Company has 17,400 authorized shares of Series A Preferred Stock, and no shares were issued or outstanding at September 28, 2012 and June 29, 2012. If any shares of Series A Preferred Stock are issued, the Series A Preferred Stock will not be entitled to vote with the common stock and will be convertible into shares of common stock at a fixed conversion ratio of 1,000 shares of common stock for each share of Series A Preferred Stock outstanding. The conversion ratio is subject to certain anti-dilution adjustments for extraordinary corporate transactions, such as stock splits, dividends and combinations, the issuance of stock purchase rights, debt or asset distributions (including cash), tender offers or exchange offers and entry into a shareholder rights plan. Each share of Series A Preferred Stock would automatically convert into shares of common stock if such shares were transferred by Hilltop or Oak Hill to a non-affiliate. See additional discussion concerning the Series A Preferred Stock in “Debt Issued with Stock Purchase Warrants.”

INTEREST INCOME AND INTEREST EXPENSE

For the three-months ended September 28, 2012 and September 30, 2011 and, for the Bank, for the three-months ended September 30, 2012 and 2011, the components of interest income and expense were as follows (in thousands):

	September 28,		September 30,
	2012		2011
Interest income:
Customer margin accounts	$	2,140	$	2,258
Assets segregated for regulatory purposes		28		59
Stock borrowed		9,994		14,778
Loans		10,807		13,515
Bank investments		1,657		493
Other		1,999		2,558
	$	26,625	$	33,661

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	September 28,		September 30,
	2012		2011
Interest expense:
Customer funds on deposit	$	55	$	90
Stock loaned		7,508		11,622
Deposits		147		261
FHLB		750		1,073
Long-term debt		3,074		1,997
Other		781		815
		12,315		15,858
Total net interest revenue	$	14,310	$	17,803

EARNINGS (LOSS) PER SHARE (“EPS”)

The following reconciles the weighted average shares outstanding used in the basic and diluted EPS computation for the three-months ended September 28, 2012 and September 30, 2011 (in thousands, except share and per share amounts):

	Three-Months Ended
	September 28, 2012			September 30, 2011
Net income (loss)	$	(5,644	)	$	1,652
Weighted average shares outstanding – basic		32,801,381			32,506,613
Effect of dilutive securities		—			—
Weighted average shares outstanding – diluted		32,801,381			32,506,613
Income (loss) per share – basic
Net income (loss)	$	(0.17	)	$	0.05
Income (loss) per share – diluted
Net income (loss)	$	(0.17	)	$	0.05

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.

As of September 28, 2012 and September 30, 2011, warrants to acquire 17,391,304 shares of common stock were not included in the calculation of diluted EPS because they were anti-dilutive.

At September 30, 2011, options to acquire 111,000 shares of common stock were outstanding under SWS’s stock option plan. As of September 30, 2011, options to acquire 53,282 shares of common stock were anti-dilutive and were excluded from the calculation of diluted weighted average shares outstanding and diluted EPS. As all options to acquire shares of common stock expired on August 22, 2012, there was no effect on the calculation of diluted weighted average shares outstanding or diluted EPS in the first quarter of fiscal 2013.

The Company did not declare a dividend during the three-months ended September 28, 2012 or September 30, 2011, respectively.

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On a quarterly basis, the Board of Directors will determine whether the Company will pay a cash dividend. The payment and rate of dividends on the Company’s common stock is subject to several factors including limitations imposed by the terms of the Credit Agreement with Hilltop and Oak Hill, regulatory approval, operating results, the Company’s financial requirements, and the availability of funds from the Company’s subsidiaries, including the broker/dealer subsidiaries, which may be subject to restrictions under the net capital rules of the SEC and FINRA, and the Bank, which may be subject to restrictions by federal banking agencies and the Order. Specifically, the Credit Agreement with Hilltop and Oak Hill limits the Company’s quarterly cash dividend to $0.01 per share and only so long as the Company is not in default of any terms of the Credit Agreement. The Company currently intends to retain earnings to fund growth and does not plan to pay dividends on its common stock in the near future.

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 Brokerage: 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 Brokerage: 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 subsidiary comprise the banking segment. Retail brokerage services are offered through Southwest Securities (the Private Client Group and the Investment Management Group department), SWS Insurance, and SWS Financial (which contracts with independent representatives for the administration of their securities business).

SWS’ 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’ 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 Fiscal 2012 Form 10-K;

• 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.

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

The “other” category includes SWS Group, corporate administration and SWS Capital. SWS Capital is a dormant entity that holds approximately $30,000 of assets. SWS Group is a holding company that owns various investments, including USHS common stock.

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The following table presents the Company’s operations by the segments outlined above for the three-months ended September 28, 2012 and September 30, 2011:

UNAUDITED FINANCIAL INFORMATION
(in thousands)	Clearing			Retail		Institutional		Banking		Other			Consolidated SWS Group, Inc.
Three-months ended September 28, 2012
Operating revenue	$	3,263		$	27,197	$	29,712	$	66	$	(439	)	$	59,799
Net intersegment revenues		(187	)		202		111		896		(1,022	)		—
Net interest revenue		1,695			869		3,183		11,567		(3,004	)		14,310
Net revenues		4,958			28,066		32,895		11,633		(3,443	)		74,109
Operating expenses		4,763			27,747		22,970		10,352		17,309			83,141
Depreciation and amortization		17			219		101		431		624			1,392
Income (loss) before taxes		195			319		9,925		1,281		(20,752	)		(9,032	)
Assets(*)		291,302			212,641		1,469,516		1,301,437		74,421			3,349,317
Three-months ended September 30, 2011
Operating revenue	$	3,349		$	28,112	$	28,881	$	347	$	(1,753	)	$	58,936
Net intersegment revenues		(213	)		220		94		936		(1,037	)		—
Net interest revenue		1,617			1,098		4,391		12,674		(1,977	)		17,803
Net revenues		4,966			29,210		33,272		13,021		(3,730	)		76,739
Operating expenses		5,042			27,931		23,112		10,273		6,685			73,043
Depreciation and amortization		23			222		126		533		602			1,506
Income (loss) before taxes		(76	)		1,279		10,160		2,748		(10,415	)		3,696
Assets(*)		330,237			241,530		1,985,467		1,329,353		136,964			4,023,551

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^(*)  Assets are reconciled to total assets as presented in the September 28, 2012 and September 30, 2011 Consolidated Statements of Financial Condition as follows (in thousands):

	September 28, 2012			September 30, 2011
Amount as presented above	$	3,349,317		$	4,023,551
Reconciling items:
Unallocated assets:
Cash		10,422			9,982
Receivables from brokers, dealers and clearing organizations		49,402			49,360
Receivable from clients, net of allowances		21,487			34,419
Other assets		19,524			33,476
Unallocated eliminations		(4,952	)		(17,648	)
Total assets	$	3,445,200		$	4,133,140

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 among other matters. 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’ consolidated financial position, results of operations or cash flows.

The Company has been named as a defendant in three lawsuits related to a $35,000,000 bond offering that was 40% underwritten by M.L. Stern & Co., LLC. SWS Group purchased M.L. Stern & Co., LLC in 2008. The offering took place in November 2005, and the lawsuit was filed in November 2009.

The lawsuits are in the discovery stage and the ultimate amount of liability associated with this claim cannot currently be determined. However, the Company believes it is at least reasonably possible that a loss related to this matter will be incurred. At September 28, 2012 and June 29, 2012, the Company had a liability recorded of approximately $1,000,000 related to this matter.

Contingency. In February 2011, a limited partnership venture capital fund in which the Company invested received a proposed assessment of transferee liability from the IRS for the tax period ended December 31, 2005. The proposed assessment is approximately $8,000,000, not including penalties of approximately $3,000,000. The Company would be responsible for $1,870,000 of the proposed assessment including penalties based on its partnership interest. Interest is also accruing on this proposed assessment. The matter relates to certain transactions that occurred during 2005 concerning one of the limited partnership venture capital fund’s subsidiaries. The limited partnership venture capital fund engaged tax counsel and filed a Letter of Protest with the IRS in April 2011. Management of the limited partnership venture capital fund believes that the ultimate outcome will be favorable; however, the limited partnership venture capital fund can give no assurance that it will prevail.

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Venture Capital Funds. The Bank has committed to invest $5,000,000 in two limited partnership equity funds. As of September 30, 2012, the Bank had invested $2,400,000 of its commitment. Also, in April 2012, the Bank acquired an interest in a private investment fund to obtain additional credit for its obligations under the CRA. The Bank has committed to invest $3,000,000 in the fund. As of September 30, 2012, no contributions have been made by the Bank to this fund. These investments are subject to the Volcker Rule provisions of the Dodd-Frank Act, which limits the Bank to a 3% ownership interest in any private equity fund and the federal agencies that will enforce the rule guaranteed that it will become effective July 21, 2014. Thereafter, financial institutions can request up to three additional one year extensions from the FRB, and the FRB can grant up to a five year extension for investments in illiquid funds made on or before May 21, 2010. Also, funds that are “designed primarily to promote the public welfare” are not subject to the rule as proposed. The Bank’s ownership percentage in one of the limited partnership equity funds and the private investment fund are greater than 3% and would qualify as illiquid funds. In addition, these investments may qualify as “designed primarily to promote the public welfare” as the Bank invests in these funds as a cost effective way of meeting its obligations under the CRA. The Bank’s ownership percentage in the other limited partnership equity fund is less than 3%.

Underwriting. Through its participation in underwriting corporate and municipal securities, SWS could expose itself to material risk 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. At September 28, 2012, the Company had $162,500 in total potential liabilities due under outstanding underwriting arrangements.

Sub-Participation. In the fourth quarter of fiscal 2012, the Bank signed a sub-participation agreement with a non-affiliate bank to sub-participate in its mortgage purchase program. The Company has a maximum total commitment of $50,000,000 under the sub-participation agreement.

Guarantees. The Bank faces the risk of credit loss under commitments to extend credit and stand-by letters of credit up to the contractual amount of these instruments in the event of breach by the other party to the instrument. The Bank uses the same credit policies in making commitments and conditional obligations as it does for instruments reported on the Consolidated Statements of Financial Condition.

As of September 30, 2012, the Bank had issued stand-by letters of credit in the amount of $413,000. The recourse provision of the letters of credit allows the amount of the letters of credit to become a 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 September 30, 2012, the Bank had commitments of $20,313,000 relating to revolving lines of credit and unfunded commitments. In addition, as of September 30, 2012, the Bank had unfunded new loans in the amount of $10,284,000.

Commitments to extend credit are agreements to lend to a customer as long as there is no violation of any condition established in the contract. Commitments generally have fixed expiration dates or other termination clauses and may require the payment of a fee. Since many of the commitments are expected to expire unused, the Bank’s total commitments do not necessarily represent its future cash requirements. The Bank evaluates the customer’s creditworthiness on a case-by-case basis. The amount and type of collateral obtained, if deemed necessary by the Bank upon extension of

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credit, varies and is based on management’s credit evaluation of the counterparty. The Bank did not incur any significant losses on its commitments in the first three months of fiscal 2013. In addition, management does not believe that the Bank will incur material losses as a result of the commitments existing at September 30, 2012.

The Company provides representations and warranties to counterparties in connection with a variety of commercial transactions and occasionally indemnifies counterparties 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’ 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

Clients and correspondents of SWS have the option to invest in a savings account called Bank Insured Deposits at the Bank. These funds are FDIC insured up to $250,000. These funds are considered core deposits and are the primary funding source for the Bank. The Bank’s total core deposits were $1,059,362,000 and $1,062,491,000 at September 30, 2012 and June 30, 2012, respectively. At September 30, 2012 and June 30, 2012, clients of Southwest Securities had invested $930,920,000 and $930,741,000, respectively, in Bank Insured Deposits.

At June 30, 2010, two directors together with certain members of their families, owned approximately 64% of a holding company that owned a local bank. The Bank sold this local bank loan participations with outstanding balances of $1,404,000, which were collateralized by foreclosed property at September 30, 2012 and June 30, 2012, respectively. Pursuant to participation agreements with the local bank, the Bank paid no interest and fees to the local bank for the three-months ended September 30, 2012 and $24,000 for the three-months ended September 30, 2011. The interest rates on these participations were substantially the same as those participations sold by the Bank to unrelated banks. Affiliate transactions are subject to limitations specified in the Order. See “Cease and Desist Order with the Office of the Comptroller of the Currency” for additional information.

FAIR VALUE OF FINANCIAL INSTRUMENTS

The Company’s fair value policies are discussed in Note 1 (y), Fair Value of Financial Instruments of the Fiscal 2012 Form 10-K.

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Recurring Fair Value Measurements.

The following tables summarize by level within the fair value hierarchy “Assets segregated for regulatory purposes,” “Securities owned, at fair value”, “Securities available for sale,” “Securities sold, not yet purchased, at fair value” and “Warrants” which were measured at fair value on a recurring basis at September 28, 2012 and June 29, 2012 and for the Bank at September 30, 2012 and June 30, 2012:

(in thousands)	Level 1			Level 2		Level 3			Total
September 2012
ASSETS
Assets segregated for regulatory purposes
U.S. government guaranteed obligations	$	10,062		$	—	$	—		$	10,062
	$	10,062		$	—	$	—		$	10,062
Securities owned, at fair value
Corporate equity securities	$	697		$	—	$	675		$	1,372
Municipal obligations		—			79,706		20,304			100,010
U.S. government and government agency obligations		3,507			27,213		—			30,720
Corporate obligations		—			90,326		—			90,326
Other		692			42,442		—			43,134
	$	4,896		$	239,687	$	20,979		$	265,562
Securities available for sale
USHS common stock	$	4,454		$	—	$	—		$	4,454
Westwood common stock		144			—		—			144
U.S. government and government agency obligations		—			338,959		—			338,959
Municipal obligations		—			13,156		—			13,156
	$	4,598		$	352,115	$	—		$	356,713
LIABILITIES
Securities sold, not yet purchased, at fair value
Corporate equity securities	$	19		$	—	$	—		$	19
U.S. government and government agency obligations		41,135			167		—			41,302
Corporate obligations		—			35,583		—			35,583
Other		—			142		—			142
	$	41,154		$	35,892	$	—		$	77,046
Warrants
Warrants	$	—		$	—	$	35,995		$	35,995
	$	—		$	—	$	35,995		$	35,995
Net assets (liabilities)	$	(21,598	)	$	555,910	$	(15,016	)	$	519,296

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(in thousands)	Level 1		Level 2		Level 3			Total
June 2012
ASSETS
Assets segregated for regulatory purposes
U.S. government guaranteed obligations	$	10,114	$	—	$	—		$	10,114
	$	10,114	$	—	$	—		$	10,114
Securities owned, at fair value
Corporate equity securities	$	637	$	—	$	675		$	1,312
Municipal obligations		—		96,862		21,006			117,868
U.S. government and government agency obligations		6,577		34,752		—			41,329
Corporate obligations		—		59,092		—			59,092
Other		691		10,859		—			11,550
	$	7,905	$	201,565	$	21,681		$	231,151
Securities available for sale
USHS stock	$	3,625	$	—	$	—		$	3,625
Westwood stock		157		—		—			157
U.S. government and government agency obligations		—		301,071		—			301,071
Municipal obligations		—		2,936		—			2,936
	$	3,782	$	304,007	$	—		$	307,789
LIABILITIES
Securities sold, not yet purchased, at fair value
U.S. government and government agency obligations	$	16,825	$	13,637	$	—		$	30,462
Corporate obligations		—		39,348		—			39,348
Other		—		345		—			345
	$	16,825	$	53,330	$	—		$	70,155
Warrants
Warrants	$	—	$	—	$	27,810		$	27,810
	$	—	$	—	$	27,810		$	27,810
Net assets (liabilities)	$	4,976	$	452,242	$	(6,129	)	$	451,089

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			Warrants			Total
Ending balance at June 29, 2012	$	675	$	21,006		$	(27,810	)	$	(6,129	)
Realized loss from write-down in fair value of auction rate securities		—		(702	)		—			(702	)
Increase in Warrants valuation (unrealized loss)		—		—			(8,185	)		(8,185	)
Ending balance at September 28, 2012	$	675	$	20,304		$	(35,995	)	$	(15,016	)

At the end of each respective quarterly reporting period, the Company recognizes transfers of financial instruments between levels. During three-months ended September 28, 2012, there were no transfers between levels.

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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). Changes in unrealized gain (loss) for the Warrants are presented in unrealized (gain) loss on Warrants valuation on the Consolidated Statements of Income (Loss) and Comprehensive Income (Loss). The total realized loss included in earnings related to assets and liabilities still held for the three-months ended September 28, 2012 was $702,000. The total unrealized loss included in earnings related to assets and liabilities still held for the three-months ended September 28, 2012 was $8,185,000. The total unrealized loss included in earnings related to assets and liabilities still held for the three-month period ended September 30, 2011 was $171,000.

The following table highlights, for each asset and liability measured at fair value on a recurring basis and categorized within Level 3 of the fair value hierarchy, the significant unobservable inputs used in the fair value measurement as of September 28, 2012 (dollars in thousands):

Asset/ Liability	Fair Value		Valuation Technique(s)	Unobservable Inputs	Range (Weighted Average)
Securities owned, at fair value
Corporate equity securities – auction rate preferred	$	675	Analysis of comparable securities	N/A	N/A
Municipal obligations – auction rate bonds		20,304	Discounted Cash Flow	Holding Period	one to five years (3 years)
Warrants
Stock purchase warrants		35,995	Binomial Model	Derived Volatility	56% - 70% (56%)

At September 28, 2012, the Company held 27 auction rate preferred securities that, based on observed values of comparable securities, were valued at their par value of $675,000. Since June 2010, the Company has held up to $1,800,000 in Level 3 auction rate preferred securities, of which $1,200,000 million have been redeemed at par. The remaining $675,000 of auction rate preferred securities are similar to those that were previously redeemed, and the Company anticipates that the remaining securities will also be redeemed at par. While a liquidity discount has been considered for these securities, the Company does not believe a discount is warranted. To the extent these securities are redeemed at a price below par, the Company would consider revaluing any remaining securities at a discounted price.

The Company holds one municipal auction rate bond valued at $20,304,000 at September 28, 2012. This security matures in 2032 and pays interest on a weekly basis that is indexed to a variable short term interest rate. The Company performs a discounted cash flow analysis quarterly to value this bond. This analysis considers the coupon in light of market yields on similar municipal securities. A probability weighted matrix is used to determine what the theoretical value of this security would be if it were redeemed at par in one to five years. In addition, the Company reviews recent market activity in similar securities. The final valuation is derived by applying a weight to the discounted cash flow valuation and observed market values. In the future, there could be further reduction in the valuation of the bond if the spread widens between the coupon paid on the bond and the required market yield, there are changes in observed discounts due to market transactions or there are extensions in the estimated holding period.

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The Warrants are valued quarterly using a binomial model that considers the following variables: price and volatility of the Company’s stock, treasury yield, annual dividend and the remaining life of the Warrants. The derived volatility estimate considers both the historical and implied forward volatility of the Company’s common stock. The primary drivers of value of the Warrants are the price and volatility of the Company’s common stock. As the volatility and/or stock price increase, the value of the Warrants increase as well. The movement of these two variables will amplify or offset one another depending on the direction and velocity of their movements. In addition, the Warrants will lose time value as they near their contractual expiration date.

Non-Recurring Fair Value Measurements.

Certain financial and non-financial instruments are not measured at fair value on an ongoing basis but are subject to fair value measurement only in certain circumstances; for example, when there is evidence of impairment or in other situations where the lower of cost or fair value method of accounting is applied.

The following tables summarize by level within the fair value hierarchy the Company’s financial and non-financial instruments which were measured at fair value on a non-recurring basis at September 30, 2012 and June 30, 2012 (in thousands):

	Level 1		Level 2		Level 3		Total
September 2012
Impaired loans (1)	$	—	$	—	$	38,317	$	38,317
REO		—		—		32,488		32,488
	$	—	$	—	$	70,805	$	70,805
June 2012
Impaired loans (1)	$	—	$	—	$	32,553	$	32,553
REO		—		—		32,257		32,257
	$	—	$	—	$	64,810	$	64,810

(1) Includes certain impaired loans measured at fair value through the allocation of specific valuation allowances or principal charge-offs.

Other Fair Value Disclosures.

The Company’s fair value policies for instruments measured at fair value in accordance with the disclosure requirements of Accounting Standards Codification (“ASC”) 820-Fair Value Measurements and Disclosures are discussed in Note 1 (y), Fair Value of Financial Instruments—Other Fair Value Disclosures of the Fiscal 2012 Form 10-K.

The recorded amounts, fair value and level of the fair value hierarchy of the Company’s financial instruments at September 28, 2012 and June 29, 2012 and for the Bank at September 30, 2012 and June 30, 2012 were as follows (in thousands):

			September				June
	Level		Recorded Value		Fair Value		Recorded Value		Fair Value
Financial assets:
Cash and cash equivalents		1	$	71,153	$	71,153	$	81,826	$	81,826
Restricted cash and cash equivalents		1		30,045		30,045		30,044		30,044
Securities held to maturity:
GNMA securities		2		23,880		24,785		25,904		26,818
Loans, net:
Purchased mortgage loans held for investment		3		329,251		328,527		294,341		294,877
Other loans held for investment		3		467,327		490,693		539,299		620,121

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			September				June
	Level		Recorded Value		Fair Value		Recorded Value		Fair Value
Financial liabilities:
Short-term borrowings		1	$	126,500	$	126,500	$	67,500	$	67,500
Deposits:
Deposits with no stated maturity		2		1,023,933		1,023,933		1,025,133		1,025,133
Time deposits		2		35,317		35,716		37,100		37,613
Advances from the FHLB		2		67,318		67,352		68,641		80,184
Long-term debt		3		80,027		88,141		79,076		81,345

CEASE AND DESIST ORDER WITH THE OFFICE OF THE COMPTROLLER OF THE CURRENCY

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 section or elsewhere in this filing is qualified in its entirety by reference to the Order and Stipulation, copies of which were filed as exhibits to the Company’s Form10-Q for the quarter ended December 31, 2010, which was filed with the SEC on February 9, 2011. On July 21, 2011, the authority to enforce the terms of the Order was transferred to the OCC. On March 16, 2012, the Bank was notified by the OCC that the OCC will allow relief from certain operating and growth restrictions required under the Order. The OCC stated that it has no supervisory objection to any future extensions of Small Business Administration program 504 loans, commercial real estate owner-occupied loans or mechanic’s lien residential 1-4 family construction loans. The OCC also stated that it has no supervisory objection to a future conservative growth plan for the Bank’s balance sheet provided that the Bank maintains capital ratios above the requirements of the Order and concentration levels within policy guidelines. As of September 30, 2012, the provisions of the Order as described in Note 29 of the Fiscal 2012 Form 10-K have not changed. As of September 30, 2012, the Bank was in compliance with the terms of the Order and the Order will remain in effect until terminated, modified or suspended in writing by the OCC.

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

OVERVIEW

SWS Group, Inc. (together with its subsidiaries, “we,” “us,” “SWS” or the “company”) is engaged in full-service securities brokerage and full-service commercial banking. For the three-months ended September 28, 2012, 85% of our total revenues were generated by our full-service brokerage business and 15% of our total revenues were generated by our commercial banking business. While brokerage and banking revenues are dependent upon trading volumes and interest rates, which may fluctuate significantly, a large portion of our expenses remain fixed. Consequently, net operating results can vary significantly from period to period.

Our business is also subject to substantial governmental regulation, and changes in legal, regulatory, accounting, tax and compliance requirements may have a substantial impact on our business and results of operations. We also face substantial competition in each of our lines of business. See Forward-Looking Statements and Risk Factors in our Form 10-K filed with the Securities and Exchange Commission (the “SEC”) on September 7, 2012 (the “Fiscal 2012 Form 10-K”).

We operate through four segments grouped primarily by products, services and customer base: clearing, retail, institutional and banking.

Clearing. We provide clearing and execution services for other broker/dealers (predominantly on a fully disclosed basis). Our clientele includes general securities broker/dealers and firms specializing in high volume trading. We currently support a wide range of clearing clients, including discount and full-service brokerage firms, direct access firms, registered investment advisers and institutional firms. In addition to clearing trades, we tailor our services to meet the specific business needs of our clearing correspondents (“correspondents”) and offer such products and services as recordkeeping, trade reporting, accounting, general back-office support, securities and margin lending, reorganization assistance and custody of securities.

Revenues in this segment are generated primarily through transaction charges to our correspondent firms for clearing their trades. Revenue is also earned from various fees and other processing charges as well as through net interest earnings on correspondent customer balances.

Retail. We offer retail securities products and services (equities, mutual funds and fixed income products), insurance products and managed accounts through the activities of our employee registered representatives and our independent contractors. As a securities broker, we extend margin credit on a secured basis to our retail customers in order to facilitate securities transactions. This segment generates revenue primarily through commissions charged on securities transactions, fees from managed accounts and the sale of insurance products as well as net interest income from retail customer balances.

Institutional. We serve institutional customers in the areas of securities borrowing and lending, public finance, municipal sales and underwriting, investment banking, fixed income sales and equity trading. Our securities lending business includes borrowing and lending securities for other broker/dealers, lending institutions, and our own clearing and retail operations. Our municipal finance operations assist public bodies in originating, syndicating and distributing securities of municipalities and political subdivisions. Our corporate finance professionals arrange and evaluate mergers and acquisitions, conduct private placements and participate in public offerings of securities with institutional and individual investors, assist clients with raising capital, and provide other consulting and advisory services.

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Our fixed income sales and trading group specializes in trading and underwriting U.S. government and government agency bonds, corporate bonds, mortgage-backed, asset-backed and commercial mortgage-backed securities and structured products. The clients of our fixed income group include corporations, insurance companies, banks, mutual funds, money managers and other institutions. Our equity trading department focuses on providing the best execution for equity and option orders for clients. We also execute institutional portfolio trades and are a market maker in a limited number of listed securities.

Revenues in the institutional segment are derived from the net interest spread on stock loan transactions, commission and trading income from fixed income and equity products and investment banking fees from corporate and municipal securities transactions.

Banking. We offer traditional banking products and services. We specialize in two primary areas, business banking and mortgage purchase. Our focus in business banking includes commercial and industrial lending along with small business lending. We originate the majority of our loans internally, and we believe this business model helps us build more valuable relationships with our customers. Our mortgage purchase division purchases participations and sub-participations in newly originated residential loans from various mortgage bankers nationwide.

Southwest Securities, FSB (the “Bank”) earns substantially all of its net revenues on the spread between the rates charged to customers on loans and the rates paid to depositors. Our banking operations are currently restricted by and subject to the Order to Cease and Desist, Order No. WN-11-003, effective on February 4, 2011 (the “Order”) originally issued by the Office of Thrift Supervision and now administered by the Office of the Comptroller of the Currency (the “OCC”). On March 16, 2012, the Bank was notified in a letter from the OCC that the OCC will allow relief from certain operating and growth restrictions required under the Order. Specifically, the OCC currently has no supervisory objection to any future extensions of Small Business Administration program 504 loans, commercial real estate owner-occupied loans, or mechanics lien residential 1-4 family construction loans so long as, prior to funding, the Bank’s Board of Directors or a designated committee of the Bank approves and certifies that it complies with internal policies, accounting principles generally accepted in the United States (“GAAP”), regulatory guidance, and safe and sound association practices. In addition, the OCC currently has no supervisory objection to a future conservative growth plan for the Bank’s balance sheet so long as the Bank maintains capital ratios above the requirements of the Order and concentration levels within policy guidelines.

The “other” category includes SWS Group, Inc. (“SWS Group”), corporate administration and SWS Capital Corporation, which is a dormant entity. SWS Group is a holding company that owns various investments, including common stock of U.S. Home Systems, Inc. (“USHS”).

Loan from Hilltop and Oak Hill

In March 2011, we entered into a Funding Agreement (the “Funding Agreement”) with Hilltop Holdings, Inc. (“Hilltop”) and Oak Hill Capital Partners III, L.P. (“OHCP”) and Oak Hill Capital Management Partners III, L.P. (collectively with OHCP, “Oak Hill”). On July 29, 2011, after receipt of stockholder and regulatory approval, we completed the following transactions contemplated by the Funding Agreement:

• entered into a $100.0 million, five year, unsecured loan with an 8% interest rate from Hilltop and Oak Hill under the terms of a credit agreement;

• issued warrants to Hilltop and Oak Hill allowing each to purchase up to 8,695,652 shares of our common stock at an exercise price of $5.75 per share (subject to anti-dilution adjustments), representing approximately 17% of the common stock of our company per warrant (assuming each exercises its warrant in full); and

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• granted Hilltop and Oak Hill certain rights, including certain registration rights, preemptive rights, and the right for each to appoint one person to our Board of Directors for so long as each owns 9.9% or more of all of the outstanding shares of our common stock or securities convertible into at least 9.9% of our outstanding common stock. Mr. Gerald J. Ford and Mr. J. Taylor Crandall have been appointed and elected as directors of SWS Group pursuant to this right.

We entered into this transaction to ensure that the Bank would maintain adequate capital ratios under the Order and could continue to reduce classified assets in a strategic and efficient manner, as well as to ensure that the broker/dealer business lines would operate without disruption. See “Debt Issued with Stock Purchase Warrants” in the Notes to the Consolidated Financial Statements contained in this report for additional discussion on the loan from Hilltop and Oak Hill.

The funds received from Hilltop and Oak Hill upon completion of the transaction were recorded on our Consolidated Statements of Financial Condition as restricted cash. We are required to keep these funds in a restricted account until our Board of Directors, Hilltop and Oak Hill determine the amount(s) to be distributed to our subsidiaries. Upon approval of the Board of Directors, Hilltop and Oak Hill, SWS Group contributed $20.0 million of this cash to the Bank as capital in December 2011, loaned $20.0 million to Southwest Securities, Inc. (“Southwest Securities”) in the third quarter of fiscal 2012 to use in general operations by reducing Southwest Securities’ use of short-term borrowings for the financing of the company’s day-to-day cash management needs, paid $20.0 million toward its intercompany payable to Southwest Securities and contributed $10.0 million in capital to Southwest Securities in the fourth quarter of fiscal 2012. The remaining $30.0 million remains in a restricted account at SWS Group to be used for general corporate purposes, subject to approval by the Board of Directors, Hilltop and Oak Hill.

Business Environment

Performance in the financial services industry in which we operate is highly correlated to the overall strength of the economy and financial market activity. Overall market conditions are a product of many factors which are beyond our control and can be unpredictable. These factors may affect the financial decisions made by investors, including their level of participation in the financial markets. In turn, these decisions may affect our business results. With respect to financial market activity, our profitability is sensitive to a variety of factors including the volatility of the equity and fixed income markets, the level and shape of various yield curves, the volume and value of trading in securities, the value of our customers’ assets under management, the demand for loans and the value of real estate in our markets.

As of September 28, 2012, all equity market indices were up versus a year ago with the Dow Jones Industrial Average (the “DJIA”) up 23.1%, the NASDAQ Composite Index (NASDAQ) up 29.0% and the Standards & Poor’s 500 Index (S&P 500) up 27.3%. The DJIA closed at 13,437.13 on September 28, 2012, up from 10,913.38 at September 30, 2011 and 12,880.09 at June 29, 2012. While the indexes showed improvement and reached closing prices that haven’t been reached since 2008, the average daily volume on the New York Stock Exchange (NYSE) decreased 36% during the three-months ended September 28, 2012 compared to the same period of our prior fiscal year. The continuing uncertainty in the economic environment domestically and in Europe, as well as continued high unemployment, contributed to uncertainty and volatility during the three-months ended September 28, 2012.

Economic and regulatory uncertainty created a challenging operating environment for us during the three-months ended September 28, 2012. The national unemployment rate, which was approximately 7.8% at the end of September 2012, was down from a high of 10.0% at the end of December 2009, and 8.2% at the end of June 2012, but remains at historically high levels. The Federal Reserve Board reduced the federal funds target rate to 0 - 0.25% in December 2008 and announced in January 2012 and reemphasized in its August 2012 meeting that rates were unlikely to increase at least through mid-2015.

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The disruptions and developments in the world economy and the credit markets over the past three years also resulted in a range of actions by U.S. and foreign governments to attempt to bring liquidity and order to the financial markets and to prevent a long recession in the world economy. For more details regarding some of the actions taken by U.S. and foreign governments, see the discussion under the caption Item 1. Business-Regulation contained in the Fiscal 2012 Form 10-K.

Unemployment and tight credit markets continue to create a fragile economic environment. As indicated by the August 2011 downgrade of the United States’ credit rating and the June 2012 Moody’s Investor Services downgrade of the 15 largest U.S. financial institutions including Bank of America Corp., Citigroup Inc., The Goldman Sachs Group, Inc., and JP Morgan Chase & Co., global equity markets have been volatile primarily due to ongoing debt problems in Europe.

In addition, Texas experienced distress in residential and commercial real estate values as well as elevated unemployment rates since the last calendar quarter of 2010. These factors, while improving, have had, and will continue to have, a negative impact on our banking and brokerage operations.

Impact of Economic Environment

Brokerage. Volatility in the U.S. credit and mortgage markets, low interest rates and reduced volume in the U.S. stock markets continue to have an adverse impact on several aspects of our brokerage business, including depressed net interest margins, reduced liquidity and lower trading volumes.

Exposure to European Sovereign Debt

We have no direct exposure to European sovereign debt or to European banks. However, we do participate in securities lending with U.S. subsidiaries of several European banks. Receivables from securities lending are secured by collateral equal to 102% of the market value of the securities, and the collateral is adjusted daily to maintain the 102% margin.

Net Interest Margins

Historically, the profitability of the brokerage business has been primarily dependent upon net interest income. We earn net interest income on the spread between the rates earned and paid on customer and correspondent balances as well as from our securities lending business. With interest rates at historically low levels, the spread we are able to earn has been reduced, primarily from the extremely low yields on our portfolio of assets segregated for regulatory purposes. Additionally, the spread in our securities lending business has declined. Lastly, because the yields on money market funds have declined significantly, revenue sharing arrangements with our primary money market fund providers have been substantially reduced. We do not expect any significant changes in these dynamics until short-term interest rates rise.

We have taken actions to mitigate the impact of the margin contraction by renegotiating arrangements with our clearing customers, changing the mix of our assets segregated for regulatory purposes and developing new business in our securities lending portfolio. Despite these actions, profits from net interest income remain below historical levels.

Liquidity

Dislocation in the credit markets has led to increased liquidity risk. All but $45.0 million of our borrowing arrangements are uncommitted lines of credit and, as such, can be reduced or eliminated at any time by the banks extending the credit. While we have not experienced any reductions in our uncommitted borrowing capacity, our lenders have taken actions that indicate their concerns regarding liquidity and risk in the marketplace. These actions include reduced advance rates for certain security types, more stringent requirements for collateral eligibility and higher interest rates. Should our lenders take any actions that could negatively impact the terms of our lending arrangements, the cost of conducting our business will increase and our volume of business could be limited.

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The volatility in the U.S. stock markets has also impacted our liquidity through increased margin requirements at our clearing houses. These margin requirements are determined by the clearing houses through a combination of risk formulas that are periodically adjusted to reflect perceived risk in the market. To the extent we are required to post cash or other collateral to meet these requirements, we will have less liquidity to finance our other businesses.

Valuation of Securities

We trade mortgage, asset-backed and other types of fixed income securities on a regular basis. We monitor our trading limits daily to ensure that these securities are maintained at levels we consider to be prudent given current market conditions. We price these securities using a third-party pricing service, and we review the prices monthly to ensure reasonable valuations. At September 28, 2012, we held mortgage and asset-backed securities of approximately $33.0 million included in securities owned, at fair value on the Consolidated Statements of Financial Condition.

Investment in Auction Rate Securities

At September 28, 2012, we held $20.3 million of auction rate municipal bonds which represented one security and 20.3% of our municipal portfolio. This security is an investment grade credit, was valued at 92.5% of par as of September 28, 2012 and was yielding less than 1% per year for the three-months ended September 28, 2012. We currently have the ability to hold this investment until maturity. While we expect the issuer of this bond to refinance its debt when London Interbank Offered Rates (LIBOR) rise, there can be no certainty that this refinancing will occur. We review this position on a quarterly basis and believe valuation of this bond at 92.5% of par at September 28, 2012 reflects an appropriate discount for the current lack of liquidity in this investment.

Bank. Shortly after closing the Hilltop and Oak Hill transaction, we contributed $20.0 million in capital to the Bank and filed a revised capital plan with the Bank’s regulator. We believe the $20 million capital contribution and access to additional capital from SWS Group provides the Bank with a sound foundation for future earnings, as well as the flexibility to accelerate the reduction of classified assets.

The Bank has maintained compliance with the terms of the Order since it was issued on February 4, 2011. The diligent efforts by the Bank’s Board of Directors, management and employees to adhere to the terms of the Order and plans filed with our regulators have resulted in substantial improvements in credit quality, loan concentration levels and capital ratios. As a result, on March 16, 2012, the Bank was notified in a letter from the OCC that the OCC will allow relief from certain operating and growth restrictions required under the Order. See “Cease and Desist Order with the Office of the Comptroller of the Currency” in the Notes to the Consolidated Financial Statements contained in this report and discussion above under “Overview” regarding the OCC’s grant of relief from certain operating and growth restrictions required under the Order.

The Bank continued to reduce classified assets in the September 2012 quarter. Classified assets were $100.7 million at September 30, 2012, down from $110.7 million at June 30, 2012 and $206.7 million at September 30, 2011. Classified assets as a percentage of total capital plus the allowance for loan losses was 52.7% at September 30, 2012, 58.0% at June 30, 2012 and 111.0% at September 30, 2011. Non-performing assets (a subset of classified assets) decreased to $67.8 million at September 30, 2012, down from $72.7 million at June 30, 2012 and $78.3 million at September 30, 2011. Though the Bank continues to work diligently to reduce classified assets and improve performance, the slow pace of economic recovery remains a significant risk. Should the economic environment worsen, improvement in classified assets could slow and additional migration of loans to problem status could increase.

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The Bank’s loan loss allowance at September 30, 2012 was $20.9 million, or 4.28% of loans held for investment, excluding purchased mortgage loans held for investment, as compared to $22.4 million, or 3.99% of loans held for investment, at June 30, 2012 and $39.7 million, or 4.90% of loans held for investment, at September 30, 2011.

The Bank’s capital ratios at September 30, 2012 were significantly stronger than those at September 30, 2011 and steady with our June 30, 2012 ratios. The Tier 1 core ratio was 12.7% and the total risk-based capital ratio was 19.2% at September 30, 2012, as compared to 12.6% and 19.2%, respectively, at June 30, 2012 and 10.4% and 15.4%, respectively, at September 30, 2011. With the stability of these capital ratios and the $20.0 million capital contribution from SWS Group, the Bank’s management has focused on diversifying the balance sheet by reducing loan concentrations and building an investment portfolio.

With the relief granted by the OCC in March 2012, the Bank has been actively filling open lending positions in our market areas. New lenders have been added in Houston, Austin, Dallas and Arlington, Texas as well as in Albuquerque, New Mexico. Given the economic environment and the lag in the process of hiring lenders and actual production, the Bank anticipates loan balances to begin a modest growth rate through fiscal 2013. The Bank’s available for sale investment portfolio was $352.1 million and $304.0 million at September 30, 2012 and June 30, 2012, respectively. The Bank also anticipates growth in its mortgage purchase program which continues to perform well despite the current economic environment. Though there is uncertainty in the market, we believe there are also opportunities. With mortgage rates at historical lows, finance and re-finance opportunities are significant for qualified borrowers. At September 30, 2012 and June 30, 2012, the Bank’s mortgage purchase program loan balance was $329.3 million and $294.3 million, respectively. These loans are held for investment on average for 25 days or less, which substantially limits credit risk.

The primary funding source for the Bank’s balance sheet growth are core deposits from Southwest Securities’ brokerage customers. These core deposits provide the Bank with a stable and low cost funding source. At September 30, 2012 and June 30, 2012, the Bank had $930.9 million and $930.7 million, respectively, in funds on deposit from customers of Southwest Securities, representing approximately 87.9% and 87.6%, respectively, of the Bank’s total deposits.

Events and Transactions

A description of the material events and transactions impacting the company’s results of operations in the periods presented are discussed below.

Warrant valuation. The warrants issued to Hilltop and Oak Hill are presented as liabilities carried at fair value on the Consolidated Statement of Financial Condition. During the three-months ended September 28, 2012, the value of these warrants increased due to the increase in our stock price from $5.33 at June 29, 2012, to $6.11 at September 28, 2012. The increase in value resulted in an $8.2 million unrealized pre-tax loss for the three-months ended September 28, 2012 compared to a $171,000 unrealized pre-tax loss for the three-months ended September 30, 2011.

Auction rate security. We hold an auction rate municipal bond that has been held at 95.7% of par since fiscal 2010. As a result of a recent trade in a similar security at a value less than par and an increase in volatility, we determined that our security should be written down to a value at 92.5% of par as of September 28, 2012. The result was a write down of $702,000 at September 28, 2012. See additional discussion of our valuation of the auction rate security in “Fair Value of Financial Instruments” in the Notes to the Consolidated Financial Statements contained in this report.

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RESULTS OF OPERATIONS

Consolidated

Net loss for the three-months ended September 28, 2012 was $5.6 million and net income for the three-months ended September 30, 2011 was $1.7 million. The three-month periods ended September 28, 2012 and September 30, 2011 contained 63 and 68 trading days, respectively.

Southwest Securities was custodian for $30.0 billion and $26.8 billion in total customer assets at September 28, 2012 and September 30, 2011, respectively.

The following is a summary of increases (decreases) in categories of net revenues and operating expenses for the three-months ended September 28, 2012 compared to the three-months ended September 30, 2011 (dollars in thousands):

	Three-Months Ended
	Amount			% Change
Net revenues:
Net revenues from clearing operations	$	(521	)		(20	)%
Commissions		(3,316	)		(9	)
Net interest		(3,493	)		(20	)
Investment banking, advisory and administrative fees		(82	)		(1	)
Net gains on principal transactions		3,087			49
Other		1,695			38
	$	(2,630	)		(3	)%
Operating expenses:
Commissions and other employee compensation	$	1,101			2	%
Occupancy, equipment and computer service costs		(180	)		(2	)
Communications		300			10
Floor brokerage and clearing organization charges		(50	)		(5	)
Advertising and promotional		119			22
Unrealized net loss on warrant valuation		8,014			>100
Other		794			11
	$	10,098			14	%
Pre-tax loss	$	(12,728	)		>100	%

Net revenues decreased $2.6 million for the three-months ended September 28, 2012 as compared to the same period of the prior fiscal year. The largest components of the decrease were in net interest and commissions. The $3.5 million decrease in net interest revenue was due primarily to a 16% decrease in the average loan balance and a 20 basis point decrease in the net yield at the Bank as compared to the same period of the prior fiscal year. Also, interest expense on the loan from Hilltop and Oak Hill reduced net interest revenue by $3.1 million in the three-months ended September 28, 2012 as compared to $2.0 million in the three-months ended September 30, 2011. Additionally, interest revenue in our institutional business decreased $1.2 million due to a 20% decrease in the average stock loan portfolio balances as well as the decreased volume of trades in our taxable fixed income business. The $3.3 million decrease in commission revenue was due primarily to a $1.5 million decrease in our independent registered representatives commission revenue related to the loss of two top producers, a decrease in the number of trading days from 68 days in the first quarter

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of fiscal 2012 to 63 days in the first quarter of fiscal 2013 and a $1.8 million decrease in taxable fixed income commission revenue as we believe that the uncertainty surrounding political and economic events have reduced client activity. The decreases in net interest revenue and commission revenue were partially offset by an increase in net gains on principal transactions as well as an increase in other revenue. The increase in net gains on principal transactions was primarily due to a $3.9 million increase in trading gains in taxable fixed income partially offset by a decrease in municipal trading revenue of $0.4 million. The increase in other revenue was due to a $2.0 million increase in other revenue from our deferred compensation plan’s investment, partially offset by a decrease in other revenue at the Bank of $0.2 million due to increases in net losses on the sale of real estate owned (“REO”) for the three-months ended September 28, 2012 as compared to the three-months ended September 30, 2011.

Operating expenses increased $10.1 million for the three-months ended September 28, 2012 as compared to the same period of the prior fiscal year. This increase was primarily made up of an $8.0 million increase in the unrealized loss on the warrant valuation for the warrants held by Hilltop and Oak Hill and a $1.1 million increase in commissions and other employee compensation. The increase in commissions and other employee compensation was due to a $2.0 million increase in our liability to participants in the deferred compensation plan and a $0.5 million increase in salary and incentive compensation at the Bank due to increased headcount. These increases were partially offset by a $1.0 million decrease in retail commission expense due to lower production and a $0.6 million decrease in the institutional segment commission expense resulting from decreased segment revenue.

Net Interest Income

We generate net interest income from our brokerage and banking segments. Net interest income from the brokerage segments is dependent upon the level of customer and stock loan balances as well as the spread between the rates we earn on those assets compared with the cost of funds. Net interest is the primary source of income for the Bank and represents the amount by which interest and fees generated by earning assets exceed the cost of funds. The Bank’s cost of funds consists primarily of interest paid to the Bank’s depositors on interest-bearing accounts and long-term borrowings from the Federal Home Loan Bank (the “FHLB”). Net interest income from our brokerage, corporate and banking segment were as follows for the three-months ended September 28, 2012 and September 30, 2011 (in thousands):

	Three-Months Ended
	September 28, 2012			September 30, 2011
Brokerage	$	5,747		$	7,104
Bank(1)		11,567			12,674
SWS Group(2)		(3,004	)		(1,975	)
Net interest	$	14,310		$	17,803

⁽¹⁾ The net interest reported for the Bank is for the periods ended September 30, 2012 and 2011, respectively.

⁽²⁾ Consists of interest expense on the loan from Hilltop and Oak Hill.

Average balances of interest-earning assets and interest-bearing liabilities in our brokerage operations were as follows (in thousands):

	Three-Months Ended
	September 28, 2012		September 30, 2011
Daily average interest-earning assets:
Customer margin balances	$	236,000	$	228,000
Assets segregated for regulatory purposes		192,000		243,000
Stock borrowed		1,475,000		1,830,000

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	Three-Months Ended
	September 28, 2012		September 30, 2011
Daily average interest-bearing liabilities:
Customer funds on deposit, including short credits	$	331,000	$	368,000
Stock loaned		1,442,000		1,813,000

Net interest revenue generated by each segment is reviewed in detail in the segment analysis below.

Income Tax Expense (Benefit)

For the three-months ended September 28, 2012, income tax benefit (effective rate of 37.5%) differed from the amount that would have otherwise been calculated by applying the federal corporate tax rate (35.0%) to income before income tax benefit due to non-deductible compensation offset by tax exempt interest and income from company-owned life insurance. See further discussion regarding reconciliation of the effective tax rate and the federal corporate tax rate in “Income Taxes” in the Notes to the Consolidated Financial Statements contained in this report.

We have certain deferred tax assets that were derived from capital losses. To use the deferred tax assets, we must have sufficient capital gain income within the carry-back and carry-forward period available under applicable tax laws. Our deferred tax assets as of September 28, 2012 and September 30, 2011 included $872,000, which reflected the benefit of capital losses associated with our investments in certain partnership assets. We do not believe it is more likely than not that we will generate sufficient capital gain income within the carry-forward period to recognize the benefit of the capital losses. Accordingly, we have an $872,000 valuation allowance to reflect the amount of the deferred tax assets that we believe is more likely than not to not be recognized. See additional discussion in “Income Taxes” in the Notes to the Consolidated Financial Statements contained in this report.

Segment Information

The following is a summary of net revenues and pre-tax income (loss) by segment for the three-months ended September 28, 2012 as compared to the three-months ended September 30, 2011 (dollars in thousands):

	Three-Months Ended
	September 28, 2012			September 30, 2011			Increase/ (Decrease)			% Change
Net revenues:
Clearing	$	4,958		$	4,966		$	(8	)		—	%
Retail		28,066			29,210			(1,144	)		(4	)
Institutional		32,895			33,272			(377	)		(1	)
Banking(1)		11,633			13,021			(1,388	)		(11	)
Other		(3,443	)		(3,730	)		287			8
Total	$	74,109		$	76,739		$	(2,630	)		(3	)%
Pre-tax income (loss):
Clearing	$	195		$	(76	)	$	271			>100	%
Retail		319			1,279			(960	)		(75	)
Institutional		9,925			10,160			(235	)		(2	)
Banking(1)		1,281			2,748			(1,467	)		(53	)
Other		(20,752	)		(10,415	)		(10,337	)		(99	)
Total	$	(9,032	)	$	3,696		$	(12,728	)		>(100	)%

⁽¹⁾ The net revenues and pre-tax income reported for the banking segment is for the periods ended September 30, 2012 and 2011, respectively.

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Clearing

The following is a summary of the results for the clearing segment for the three-months ended September 28, 2012 as compared to the three-months ended September 30, 2011 (dollars in thousands):

	Three-Months Ended
	September 28, 2012		September 30, 2011			Increase/ (Decrease)			% Change
Net revenue from clearing services	$	2,139	$	2,659		$	(520	)		(20	)%
Net interest		1,695		1,617			78			5
Other		1,124		690			434			63
Net revenues		4,958		4,966			(8	)		—
Operating expenses		4,763		5,042			(279	)		(6	)
Pre-tax income (loss)	$	195	$	(76	)	$	271			>100	%
Daily average customer margin balance	$	106,000	$	112,000		$	(6,000	)		(5	)%
Daily average customer funds on deposit	$	172,000	$	190,000		$	(18,000	)		(9	)%

Total correspondent clearing customer assets under custody were $15.2 billion and $13.5 billion at September 28, 2012 and September 30, 2011, respectively.

The following table reflects the number of client transactions processed for the three-months ended September 28, 2012 and September 30, 2011 and the number of correspondents at the end of each period.

	Three-Months Ended
	September 28, 2012		September 30, 2011
Tickets for high-volume trading firms		92,888		362,594
Tickets for general securities broker/dealers		157,509		198,093
Total tickets		250,397		560,687
Correspondents		150		167

For the three-months ended September 28, 2012 as compared to the three-months ended September 30, 2011, net revenues in the clearing segment remained flat while clearing fee revenue decreased 20%.

The $0.5 million decrease in clearing fee revenue was primarily due to adverse market conditions for existing correspondents in the first quarter of fiscal 2013 as compared to the first quarter of fiscal 2012. The remainder of the decrease was due to the decline in net correspondents, driven by broker withdrawals, and a five-day decrease in the number of trading days from 68 trading days in the quarter ended September 30, 2011 to 63 trading days in the quarter ended September 28, 2012. The decrease in clearing fee revenue was partially offset by an increase in other revenue primarily due to an increase in administrative fee income from revenue sharing with money market fund providers.

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For the three-months ended September 28, 2012 as compared to the three-months ended September 30, 2011, tickets processed for high-volume trading firms decreased 74% while tickets processed for general securities broker/dealers decreased 20%. Revenue per ticket increased approximately 80% from $4.74 for the three-months ended September 28, 2011 to $8.54 for the three-months ended September 28, 2012. The change in the mix of tickets processed led to an increase in revenue per ticket as fees charged to high-volume trading firms are discounted substantially from the fees charged to general securities broker/dealers.

Operating expenses decreased slightly for the three-months ended September 28, 2012 as compared to the same period last fiscal year primarily due to a decrease in operations and information technology expenses allocated to the segment.

Retail

The following is a summary of the results for the retail segment for the three-months ended September 28, 2012 as compared to the three-months ended September 30, 2011 (dollars in thousands):

	Three-Months Ended
	September 28, 2012		September 30, 2011			% Change
Net revenues:
Private Client Group (“PCG”)
Commissions	$	12,495	$	12,648			(1	)%
Advisory fees		1,650		1,403			18
Insurance products		986		1,551			(36	)
Other		106		(46	)		>100
Net interest revenue		570		845			(33	)
		15,807		16,401			(4	)
Independent registered representatives (“SWS Financial”)
Commissions		6,670		8,219			(19	)
Advisory fees		908		692			31
Insurance products		2,816		2,200			28
Other		259		239			8
Net interest revenue		299		253			18
		10,952		11,603			(6	)
Other
Commissions		110		112			(2	)
Advisory fees		778		680			14
Insurance products		368		387			(5	)
Other		51		27			89
		1,307		1,206			8
Total		28,066		29,210			(4	)
Operating expenses		27,747		27,931			(1	)
Pre-tax income	$	319	$	1,279			(75	)%
Daily average customer margin balances	$	127,000	$	104,000			22	%
Daily average customer funds on deposit	$	111,000	$	84,000			32	%
PCG representatives		167		164			2	%
SWS Financial representatives		313		304			3	%

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Net revenues in the retail segment decreased 4% for the three-months ended September 28, 2012 as compared to the same period last fiscal year. This decrease was primarily due to a $1.7 million decrease in commission revenue from September 30, 2011 to September 28, 2012. The decrease in commission revenue was due to the following: (i) a $0.8 million decrease from the loss of two top SWS Financial producers; (ii) a $0.4 million decrease due to PCG representative attrition; (iii) a $0.4 million decrease due to adverse market conditions and (iv) a $0.1 million decrease due to the decrease in the number of trading days from 68 in the first quarter of fiscal 2012 to 63 in the first quarter of fiscal 2013. Total customer assets were $13.8 billion at September 28, 2012 as compared to $12.6 billon at September 30, 2011. Assets under management were $818.0 million at September 28, 2012 as compared to $648.0 million at September 30, 2011.

While operating expenses remained flat for the three-months ended September 28, 2012 as compared to the same period last fiscal year, commission and other employee compensation expense decreased $1.0 million due to lower total production. This decrease was offset by an increase in legal expense of $0.4 million, an increase in licenses and fees of $0.1 million and an increase in operations and information technology expenses allocated to the segment of $0.3 million.

Institutional

The following is a summary of the results for the institutional segment for the three-months ended September 28, 2012 as compared to the three-months ended September 30, 2011 (dollars in thousands):

	Three-Months Ended
	September 28, 2012			September 30, 2011			% Change
Net revenues:
Commissions
Taxable fixed income	$	5,989		$	7,789			(23	)%
Municipal finance		2,812			3,746			(25	)
Portfolio trading		4,205			3,080			37
		13,006			14,615			(11	)
Investment banking fees
Taxable fixed income		1,625			1,586			2
Municipal finance		4,694			3,960			19
Corporate finance		124			1,827			(93	)
Other		19			10			90
		6,462			7,383			(12	)
Net gains on principal transactions
Taxable fixed income		5,268			1,370			>100
Municipal finance		4,834			5,281			(8	)
Other		(14	)		(18	)		22
		10,088			6,633			52
Other		156			250			(38	)
Net interest revenue
Stock loan		2,486			3,156			(21	)
Other		697			1,235			(44	)
Net revenues		32,895			33,272			(1	)
Operating expenses		22,970			23,112			(1	)
Pre-tax income	$	9,925		$	10,160			(2	)%
Taxable fixed income representatives		32			32			—	%
Municipal finance representatives		24			24			—	%

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Average balances of interest-earning assets and interest-bearing liabilities for the institutional segment for the three-months ended September 28, 2012 as compared to the three-months ended September 30, 2011 were as follows (in thousands):

	Three-Months Ended
	September 28, 2012		September 30, 2011
Daily average interest-earning assets:
Stock borrowed	$	1,475,000	$	1,830,000
Daily average interest-bearing liabilities:
Stock loaned		1,442,000		1,813,000

Net interest revenue from stock loaned decreased 21% due to a decline in the average balances. The decline in average balances from September 30, 2011 to September 28, 2012 was primarily due to differences in market conditions during such period.

Other net interest decreased $538,000 or 44% from the three-months ended September 30, 2011. This decrease was driven by a decrease in the interest earned on taxable fixed income inventories and higher borrowing costs.

The following table sets forth the number and aggregate dollar amount of new municipal bond underwritings conducted by Southwest Securities, for the three-months ended September 28, 2012 and September 30, 2011:

	Three-Months Ended
	September 28, 2012		September 30, 2011
Number of issues		159		141
Aggregate amount of offerings	$	18,604,466,000	$	15,315,186,000

Net revenues from the institutional segment decreased 1% for the three-months ended September 28, 2012 as compared to the three-months ended September 30, 2011, and pre-tax income decreased 2%. This decrease was in part due to the fact there were 63 trading days in the first quarter of fiscal 2013 as compared to 68 trading days in the first quarter of fiscal 2012. Commissions decreased $1.6 million primarily driven by a $1.8 million decrease in taxable fixed income and a $0.9 million decrease in municipal finance, partially offset by a $1.1 million increase in portfolio trading. The decrease in taxable fixed income was primarily due to the current political environment and economic uncertainty which we believe has reduced client activity, as well as lower interest rates and volatility in the market. The decrease in municipal finance was primarily due to a 41% decrease in the aggregate amount of senior managed municipal offerings and a 17% reduction in the aggregate amount of co-managed municipal offerings. The increase in portfolio trading was due to an increase in shares executed for the three-months ended September 28, 2012 when compared to the same period in the prior fiscal year.

Investment banking fees decreased 12% for the three-months ended September 28, 2012 as compared to the same period in the last fiscal year due to a $1.7 million decrease in corporate finance fees due to a decrease in merger and acquisition activity in the first quarter of fiscal 2013 when compared to the first quarter of fiscal 2012. This decrease was partially offset by a $0.7 million increase in municipal finance fees due to a 69% increase in the number of new issue financial advisor deals during the three-months ended September 28, 2012 when compared to the three-months ended September 30, 2011.

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Net gains on principal transactions increased $3.5 million, or 52%, for the three-months ended September 28, 2012 as compared to the same period last fiscal year. This increase was primarily due to a $3.9 million increase in taxable fixed income trading gains due to additional capital invested in fixed income inventories from September 30, 2011 to September 28, 2012 partially offset by a $0.4 million decrease in municipal finance trading gains.

Operating expenses decreased 1% for the three-months ended September 28, 2012 as compared to the same period last fiscal year primarily due to decreased commissions and other employee compensation expense resulting from decreased segment revenue.

Banking

The following is a summary of the results for the banking segment for the three-months ended September 30, 2012 as compared to the three-months ended September 30, 2011 (dollars in thousands):

	Three-Months Ended
	September 30, 2012		September 30, 2011		% Change
Net revenues:
Net interest revenue	$	11,567	$	12,674		(9	)%
Other		66		347		(81	)
Total net revenues		11,633		13,021		(11	)
Operating expenses		10,352		10,273		1
Pre-tax income	$	1,281	$	2,748		(53	)%

For the three-months ended September 30, 2012 as compared to the three-months ended September 30, 2011, the Bank’s net revenue decreased 11% due primarily to a 16% decrease in average loan balances, as well as a decrease of 20 basis points in the net yield on interest-earning assets. Other revenue for the Bank decreased $0.3 million for the three-months ended September 30, 2012 as compared to the same period last fiscal year. This decrease was primarily due to a $0.2 million increase in net losses on the sale of REO.

The Bank’s pretax profit was $1.3 million for the three-months ended September 30, 2012. The slight increase in operating expenses for the three-months ended September 30, 2012 was attributed to a $0.5 million increase in salary expense due to the Bank’s investment in new loan officers and a $0.2 million increase in the Bank’s costs related to outside services. The increase in salary expense was offset by a $0.2 million decrease in occupancy, equipment and computer service costs, a $0.2 million decrease in legal fees and a $0.1 million decrease in our regulatory assessments.

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The following table sets forth an analysis of the Bank’s net interest income by each major category of interest-earning assets and interest-bearing liabilities for the three-months ended September 30, 2012 and 2011 (dollars in thousands):

	Three-Months Ended
	September 30, 2012							September 30, 2011
	Average Balance		Interest Income/ Expense (*)		Yield/ Rate			Average Balance		Interest Income/ Expense(*)		Yield/ Rate
Assets:
Interest-earning assets:
Loans:
Residential construction	$	3,372	$	42		5.0	%	$	25,576	$	356		5.5	%
Lot and land development		16,898		206		4.9			57,464		548		3.8
1-4 family		383,362		4,851		5.0			217,468		3,451		6.3
Commercial real estate and multifamily		332,207		4,656		5.6			500,502		6,902		5.5
Commercial		82,189		1,022		4.9			168,101		2,211		5.2
Consumer	$	2,000	$	30		6.0	%	$	3,102	$	47		6.0	%
Total loans		820,028		10,807					972,213		13,515
Investments:
Money market		23,733		31		0.5			1,002		1		0.3
U.S. government and government agency obligations – held to maturity		24,926		153		2.4			33,526		242		2.9
U.S. government and government agency obligations – available for sale		341,039		1,419		1.7			20,834		73		1.4
Interest bearing deposits in banks		2,245		—		—			2,537		—		—
Federal reserve funds		68,864		50		0.3			288,460		172		0.2
Investments – other		3,541		4		0.4			4,955		5		0.4
Total interest-earning assets	$	1,284,376	$	12,464		3.9	%	$	1,323,527	$	14,008		4.2	%
Non-interest-earning assets:
Cash and due from banks		3,878							4,978
Other assets		41,856							16,461
	$	1,330,110						$	1,344,966
Liabilities and Stockholders’ Equity:
Interest-bearing liabilities:
Certificates of deposit	$	35,749	$	94		1.0	%	$	45,835	$	136		1.2	%
Money market accounts		24,853		3		0.1			25,711		3		0.1
Interest-bearing demand accounts		9,005		1		0.1			9,763		2		0.1
Savings accounts		959,867		49		0.1			952,250		120		0.1
FHLB advances		67,700		750		4.4			93,485		1,073		4.6
Other financed borrowings		—		—		—			32		—		—
	$	1,097,174	$	897		0.3	%	$	1,127,076	$	1,334		0.5	%
Non-interest-bearing liabilities:
Non interest-bearing demand accounts		55,174							66,921
Other liabilities		7,639							3,784
		1,159,987							1,197,781
Stockholders’ equity		170,123							147,185
	$	1,330,110						$	1,344,966
Net interest income			$	11,567						$	12,674
Net yield on interest-earning assets						3.6	%						3.8	%

(*) Loan fees included in interest income for the three-months ended September 30, 2012 and 2011 were $672 and $591, respectively.

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

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The following table sets forth a summary of the changes in the Bank’s interest income and interest expense resulting from changes in volume and rate (in thousands):

	Three-Months Ended
	September 30, 2012 as compared to September 30,  2011
	Total			Attributed to
	Change			Volume			Rate			Mix
Interest income:
Loans:
Residential - construction	$	(314	)	$	(309	)	$	(35	)	$	30
Lot and land development		(342	)		(387	)		154			(109	)
1-4 family		1,400			2,632			(699	)		(533	)
Commercial real estate and multifamily		(2,246	)		(2,321	)		112			(37	)
Commercial		(1,189	)		(1,130	)		(120	)		61
Consumer		(17	)		(17	)		—			—
Investments:
Money market		30			14			1			15
U.S. government and government agency obligations – held to maturity		(89	)		(62	)		(36	)		9
U.S. government and government agency obligations – available for sale		1,346			1,132			13			201
Federal reserve funds		(122	)		(131	)		38			(29	)
Investments - other		(1	)		(1	)		—			—
	$	(1,544	)	$	(580	)	$	(572	)	$	(392	)
Interest expense:
Certificates of deposit	$	(42	)	$	(30	)	$	(16	)	$	4
Interest bearing demand accounts		(1	)		(1	)		—			—
Savings accounts		(71	)		1			(72	)		—
FHLB advances		(323	)		(296	)		(37	)		10
		(437	)		(326	)		(125	)		14
Net interest income	$	(1,107	)	$	(254	)	$	(447	)	$	(406	)

Other

The following discusses the financial results for SWS Group and corporate administration.

Pre-tax loss from the other segment was $20.8 million for the three-months ended September 28, 2012, as compared to a pre-tax loss of $10.4 million in the same period last fiscal year. Net revenues increased 8% in the three-months ended September 28, 2012 as compared to the same period last fiscal year. Net revenues increased due to a $2.0 million increase in value from our deferred compensation plan’s investments. This increase was partially offset by a $1.1 million increase in interest expense related to the $100 million loan from Hilltop and Oak Hill in the three-months ended September 28, 2012 as compared to the same period last fiscal year because the $100 million loan was effective July 29, 2011 resulting in one less month of interest expense for the three-months ended September 30, 2011. In addition, net gains on principal transactions decreased due to the $0.7 million write down in fair value of an auction rate municipal bond. Operating expenses increased $11.0 million in the three-months ended September 28, 2012 as compared to the same period last fiscal year primarily due to the $8.0 million increase in the unrealized loss on the warrant valuation for the warrants held by Hilltop and Oak Hill. Additionally, commission and other employee compensation increased as a result of a $2.0 million increase in the liability to participants in the deferred compensation plan.

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FINANCIAL CONDITION

Investments

In fiscal 2012, the Bank implemented an investment strategy to diversify its balance sheet, absorb excess liquidity, and maximize interest income through an investment in a conservative securities portfolio. The securities portfolio is structured to provide cash flows that will mitigate interest rate risk and ensure that adequate funds are available for new loan originations. The book value of the Bank’s investment portfolio at September 30, 2012 and June 30, 2012 was as follows (in thousands):

	September 30, 2012		June 30, 2012
Government-sponsored enterprises - held to maturity securities	$	23,880	$	25,904
Government-sponsored enterprises - FHLB stock		3,405		3,830
Government-sponsored enterprises - available for sale securities		338,959		301,071
Municipal obligations - available for sale securities		13,156		2,936
	$	379,400	$	333,741

Loans and Allowance for Probable Loan Loss

The Bank grants loans to customers primarily within Texas and New Mexico. In the ordinary course of business, the Bank also purchases mortgage loans which have been originated in various areas of the United States. Although the Bank has a diversified loan portfolio, a substantial portion of its debtors’ ability to honor their loan terms is dependent upon the general economic conditions in Texas and New Mexico. Substantially all of the Bank’s loans are collateralized with real estate.

The allowance for loan losses is maintained to absorb management’s estimate of probable loan losses inherent in the loan portfolio at each reporting date. The allowance for loan losses is established as losses are estimated to have occurred through a provision for loan losses charged to earnings. Loan losses are charged against the allowance when management determines the collection of principal is remote. Subsequent recoveries are recorded through the allowance. The determination of an adequate allowance is inherently subjective, as it requires estimates that are susceptible to significant revision as additional information becomes available or circumstances change.

The allowance for loan losses consists of a specific and a general allowance component.

The specific component provides for estimated probable losses for loans identified as impaired. A loan is considered impaired when, based on current information and events, it is probable that the Bank will be unable to collect all amounts of principal and interest when due according to the contractual terms of the loan agreement. Management considers the borrower’s financial condition, payment status, historical payment record and any adverse situations affecting the borrower’s ability to repay when evaluating whether a loan is deemed impaired. Loans that experience insignificant payment delays and shortfalls generally are not classified as impaired. Management determines the significance of payment delays and shortfalls on a case-by-case basis taking into consideration all circumstances surrounding the loan and the borrower, including the length of delay, the reasons for the delay, the borrower’s prior payment record and the amount of any shortfall in relation to the principal and interest outstanding.

A specific reserve is recorded when and to the extent the present value of expected future cash flows discounted at the loan’s original effective rate, the fair value of collateral if the loan is collateral-dependent or the observable market price of the impaired loan is lower than its recorded investment. If the fair value of collateral is used to measure impairment of a collateral-dependent loan and

62

repayment is dependent on the sale of the collateral, the fair value is adjusted to incorporate estimated costs to sell. Impaired loans that are collateral-dependent are primarily measured for impairment using the fair value of the collateral as determined by third party appraisals using the income approach, recent comparable sales data or a combination thereof. In certain instances it is necessary for management to adjust the appraised value, less estimated costs to sell, to reflect changes in fair value occurring subsequent to the appraisal date. Management considers a guarantor’s capacity and willingness to perform, when appropriate, and the borrower’s resources available for repayment when measuring impairment.

The general component provides for estimated and probable losses inherent in the remainder of the Bank’s loan portfolio. The general allowance is determined through a statistical calculation based on the Bank’s historical loss experience adjusted for certain qualitative factors as deemed appropriate by management. The statistical calculation is conducted on a disaggregated basis for groups of homogeneous loans with similar risk characteristics (product types). The historical loss element is calculated as the average ratio of charge-offs, net of recoveries, to the average recorded investment for the current and previous three quarters. Management adjusts the historical loss rates to reflect deterioration in the real estate market, significant concentrations of product types, trends in portfolio volume and the credit quality of the loan portfolio to capture additional risk of loss associated with concentrations of criticized and classified loans in the total loan portfolio. Prevailing economic conditions and specific industry trends are taken into consideration when establishing the adjustments to historical loss rates.

Certain types of loans, such as adjustable rate mortgage (ARM) products, junior lien mortgages, high loan-to-value ratio mortgages, single family interest only loans, sub-prime loans and loans with initial “teaser” rates, can have a greater risk of non-collection than other loans. At September 30, 2012, the Bank had $10.9 million in junior lien mortgages. These loans represented less than 2% of total loans at September 30, 2012. At September 30, 2012, the Bank did not have any exposure to sub-prime loans and loans with initial teaser rates. At September 30, 2012, the Bank had $1.9 million of single family interest only loans.

At September 30, 2012, the Bank’s loan portfolio included a total of $5.3 million in loans with a high loan-to-value ratio. High loan-to-value ratios are defined by regulation and range from 75%-90% depending on the type of loan. At September 30, 2012, approximately 22% of these loans were 1-4 single family or lot loans to home builders in North Texas. We addressed the additional risk in these loans in our allowance calculation primarily through our review of the real estate market deterioration adjustment to the historical loss ratio. Additionally, at September 30, 2012, the Bank had one loan with high loan-to-value ratios that was deemed impaired. The impairment analysis on this loan resulted in no partial charge-off and an impairment allocation of $2,000. Regulatory guidelines suggest that high loan-to-value ratio loans should not exceed 100% of total capital. At September 30, 2012, the Bank’s high loan-to-value ratio loans represented 3% of total capital.

We obtain appraisals on real estate loans at the time of origination from third party appraisers approved by the Bank’s Board of Directors. We may also obtain additional appraisals when the borrower’s performance indicates it may default. After a loan default and foreclosure, we obtain new appraisals to determine the fair value of the foreclosed asset. We obtain updated appraisals on foreclosed properties on an annual basis, or more frequently if required by market conditions, until we sell the property.

Management reviews the loan loss computation methodology on a quarterly basis to determine if the factors used in the calculation are appropriate. Because our problem loans and losses are concentrated in real estate-related loans, we pay particular attention to real estate market deterioration and the concentration of capital in our real estate related loans. Improvement or additional deterioration in the residential and commercial real estate market may have an impact on these factors in future quarters. To the extent we underestimate the impact of these risks, our allowance account could be materially understated.

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Loans receivable at September 30, 2012 and June 30, 2012 are summarized as follows (in thousands):

	September 30, 2012			June 30, 2012
Residential
Purchased mortgage loans held for investment	$	329,251		$	294,341
1-4 family		83,980			88,826
		413,231			383,167
Lot and land development
Residential land		5,401			10,459
Commercial land		9,419			7,972
		14,820			18,431
Residential construction		2,351			3,954
Commercial construction		10,787			10,605
Commercial real estate		281,287			316,392
Multifamily		24,565			20,110
Commercial loans		68,418			101,440
Consumer loans		2,011			1,943
		817,470			856,042
Allowance for probable loan loss (*)		(20,892	)		(22,402	)
	$	796,578		$	833,640

(*) There is no allowance for probable loan loss for purchased mortgage loans held for investment as these loans are held on average for 25 days or less, which substantially reduces credit risk.

The increase in purchased mortgage loans held for investment from June 30, 2012 to September 30, 2012 is representative of a favorable interest rate environment for home purchases as well as refinancing opportunities. This along with a change in the competitive environment enabled the Bank to grow this business during the three-months ended September 30, 2012. As part of the growth of this business, in the fourth quarter of fiscal 2012, the Bank entered into a sub-participation agreement with a non-affiliate bank for a maximum commitment of $50.0 million. This sub-participation represents 9% of the total purchased mortgage loans held for investment balance at September 30, 2012. However, the nature of the volume in this business is volatile and subject to significant variation depending on interest rates, competition and general economic conditions.

The following table shows the scheduled maturities of certain loan categories at September 30, 2012 and segregates those loans with fixed interest rates from those with floating or adjustable rates (in thousands):

	1 year or less		1-5 years		Over 5 years		Total
Commercial construction, commercial real estate and multifamily	$	43,101	$	164,498	$	109,040	$	316,639
Commercial loans		30,528		22,326		15,564		68,418
Residential construction loans		1,668		587		96		2,351
Total	$	75,297	$	187,411	$	124,700	$	387,408

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	1 year or less		1-5 years		Over 5 years		Total
Amount of loans based upon:
Floating or adjustable interest rates	$	59,609	$	145,725	$	96,664	$	301,998
Fixed interest rates		15,688		41,686		28,036		85,410
Total	$	75,297	$	187,411	$	124,700	$	387,408

We maintain an internally classified loan list that helps us assess the overall quality of the loan portfolio and the adequacy of the allowance for loan losses. Loans on this list are classified as substandard, doubtful or loss based on the probability of repayment, collateral valuation and related collectability. This list is used to identify loans that are considered non-performing.

We classify loans 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 non-performing loans should be placed on non-accrual status. At the time a loan is placed on non-accrual status, we reverse previously accrued and uncollected interest against interest income. We recognize interest income on non-accrual loans to the extent we receive cash payments for the loans with respect to which ultimate full collection is likely. For loans where full collection is not likely, we apply interest payments to the outstanding principal and we recognize income only if full payment is made.

Non-performing assets and classified loans as of September 30, 2012 and June 30, 2012 were as follows (dollars in thousands):

	September 30, 2012			June 30, 2012
Loans accounted for on a non-accrual basis
1-4 family	$	17,243		$	18,443
Lot and land development		2,338			2,965
Residential construction		648			648
Commercial real estate		9,660			12,175
Commercial loans		1,880			3,120
Consumer loans		1			3
		31,770			37,354
Non-performing loans as a percentage of total loans		3.9	%		4.4	%
Loans past due 90 days or more, not included above
1-4 family		3			—
		3			—
REO
1-4 family		1,413			495
Lot and land development		9,171			10,513
Multifamily		7,821			8,367
Residential construction		1,283			1,607
Commercial real estate		12,530			11,005
Commercial loans		270			270
		32,488			32,257

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	September 30, 2012			June 30, 2012
Performing troubled debt restructuring(*)	$	3,517		$	3,102
Non-performing assets	$	67,778		$	72,713
Non-performing assets as a percentage of total assets		5.2	%		5.6	%
Current classified assets
1-4 family	$	2,823		$	2,912
Lot and land development		1,016			2,401
Multifamily		707			714
Commercial real estate		27,393			29,126
Commercial loans		1,019			2,816
		32,958			37,969
Total classified assets
1-4 family		22,756			22,987
Lot and land development		12,943			16,301
Multifamily		8,528			9,081
Residential construction		1,931			2,255
Commercial real estate		50,975			53,700
Commercial loans		3,602			6,355
Consumer loans		1			3
	$	100,736		$	110,682

(*) The remaining balance of loans modified as a troubled debt restructuring is included in non-performing loans. See the discussion of the Bank’s troubled debt restructuring loans in “Loans and Allowance for Probable Loan Loss” in the Notes to the Consolidated Financial Statements contained in this report.

Approximately $480,000 and $268,000 of gross interest income would have been recorded in the three-month periods ended September 30, 2012 and 2011, respectively, had the non-accrual loans been recorded in accordance with their original terms. Interest income recorded on the non-accrual loans, prior to being placed on non-accrual status, in the three-month periods ended September 30, 2012 and 2011 totaled approximately $2,000 and $39,000, respectively.

In fiscal 2011, the Bank hired additional staff and allocated additional resources to manage the growth in REO and non-performing assets. To reduce these loans and properties expeditiously, management prepared an asset-by-asset plan for these asset categories. Management’s focus on the continued reduction of these asset classes may have a material impact on the Bank’s future results of operations.

Total classified assets to Bank capital plus allowance for loan loss was 52.7% at September 30, 2012. Classified assets decreased $10.0 million from June 30, 2012 and substantially all classified loans by collateral location are in Texas. Bank management is focused on reducing the classified asset ratio through the disposal of these assets. Depending on the method used, the Bank may be required to record additional write-downs of these assets. While management is diligently working to dispose of these assets quickly, lack of demand for certain property types, length of sales cycle and manpower limitations will impact the time required to ultimately reduce the classified assets to a more acceptable level.

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The following table presents an analysis of REO for the three-months ended September 30, 2012 and 2011 (dollars in thousands):

	Three-Months Ended September 30,
	2012			2011
Balance at beginning of period	$	32,257		$	23,530
Foreclosures		2,486			1,204
Sales		(1,901	)		(1,441	)
Write downs		(559	)		(574	)
Other		205			(13	)
Balance at end of period	$	32,488		$	22,706

The following table presents classified assets as of September 30, 2012 by year of origination (in thousands):

Year Originated	Non- Performing Loans		Loans Past Due 90 Days or More, Not Included In Non- Performing Loans		REO		Performing Troubled  Debt Restructuring		Current Classified Assets			Total
Fiscal 2007 or prior	$	2,969	$	3	$	13,300	$	443	$	5,256		$	21,971
Fiscal 2008		16,541		—		11,810		1,135		7,791			37,277
Fiscal 2009		3,737		—		4,921		400		17,588			26,646
Fiscal 2010		7,557		—		2,457		1,392		702			12,108
Fiscal 2011		552		—		—		—		1,645			2,197
Fiscal 2012		414		—		—		147		(24	)		537
	$	31,770	$	3	$	32,488	$	3,517	$	32,958		$	100,736

The following table presents an analysis of the allowance for probable loan losses for the three-months ended September 30, 2012 and 2011 (dollars in thousands):

	Three-Months Ended September 30,
	2012			2011
Balance at beginning of period	$	22,402		$	44,433
Charge-offs:
Residential construction		—			(345	)
Lot and land development		(182	)		(1,040	)
1-4 family		(151	)		(184	)
Commercial real estate		(703	)		(1,483	)
Multifamily		—			(1,660	)
Commercial loans		(928	)		(468	)
Total charge-offs		(1,964	)		(5,180	)
Recoveries:
Residential construction		19			120
Lot and land development		133			56
1-4 family		56			22
Commercial real estate		63			217

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	Three-Months Ended September 30,
	2012			2011
Commercial loans	$	183		$	42
Total recoveries		454			457
Net charge-offs		(1,510	)		(4,723	)
Additions charged to operations		—			—
		(1,510	)		(4,723	)
Balance at end of period	$	20,892		$	39,710
Ratio of net charge-offs during the period to average loans outstanding during the period		0.18	%		0.49	%

With the continued challenging economic environment and persistent high unemployment rate, the Bank frequently reviews and updates its processes and procedures for the extension of credit, allowance for loan loss computation and internal asset review and classification. Recent changes include more stringent underwriting guidelines for loan-to-value ratios, guarantor’s financial condition, owner-occupied versus investor loans and speculative versus custom construction. The Bank currently requires more extensive documentation and data than it did in prior years in order to reclassify existing non-performing loans as performing loans. The Bank is also updating appraisals more frequently, including for performing loans, to serve as an early indicator of loan deterioration. See further discussion regarding the calculation of our provision for loan loss in “Loans and Allowance for Probable Loan Losses” in the Notes to the Consolidated Financial Statements contained in this report.

As a result of the current economic environment and the Order, the Bank significantly limited the growth of its loan portfolio in fiscal 2012 in order to allocate the time, resources and capital necessary to support the existing loan portfolio and comply with the terms of the Order. With the OCC’s recent relief from certain lending restrictions, the Bank plans to reestablish marketing efforts to implement a conservative loan growth plan which we believe will enhance our core earnings in future years.

The allowance for probable loan losses by loan type as of September 30, 2012 and June 30, 2012 was as follows (dollars in thousands):

	September 30, 2012								June 30, 2012
	Amount		Percent of loans to total loans			Percent of the allowance for loan loss			Amount		Percent of loans to total loans			Percent of the allowance for loan loss
Residential construction	$	187		0.3	%		0.9	%	$	350		0.5	%		1.6	%
Lot and land development		975		1.8			4.7			1,310		2.1			5.9
1-4 family		3,205		50.5			15.3			3,235		44.8			14.4
Commercial real estate		10,591		35.7			50.7			10,628		38.2			47.4
Multifamily		2,819		3.0			13.5			2,866		2.3			12.8
Commercial loans		3,106		8.4			14.9			4,004		11.9			17.9
Consumer loans		9		0.3			—			9		0.2			—
	$	20,892		100.0	%		100.0	%	$	22,402		100.0	%		100.0	%

At September 30, 2012, approximately 51% of the Bank’s loan loss allowance was allocated to its commercial real estate loan portfolio while the Bank’s commercial real estate loan portfolio represented approximately 36% of its total loan portfolio. This is up from June 30, 2012 when

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approximately 47% of the Bank’s loan loss allowance was allocated to its commercial real estate loan portfolio. Even though our concentration in commercial real estate loans has decreased, because commercial real estate loans tend to be individually larger than residential loans, deterioration in this portfolio can lead to volatility in our earnings.

The Bank’s written loan policies address specific underwriting standards for commercial real estate loans. These policies include loan to value requirements, cash flow requirements, acceptable amortization periods and appraisal guidelines. In addition, specific covenants, unique to each relationship, may be used where deemed appropriate to further protect the lending relationship. Collateral in the commercial real estate portfolio varies from owner-occupied properties to investor properties. We periodically review the portfolio for concentrations by industry as well as geography. All commercial relationships are stress tested at the time of origination and major relationships are then stress tested on an annual basis.

Deposits

Average deposits and the average interest rate paid on deposits for the three-months ended September 30, 2012 can be found in the discussion of the Bank’s net interest income under the caption “Results of Operations-Segment Information-Banking.”

The Bank had $14.1 million and $15.4 million of certificates of deposit of $100,000 or greater at September 30, 2012 and June 30, 2012, respectively. The Bank is funded primarily by deposits from Southwest Securities’ brokerage customers, which are classified as core deposits. These core deposits provide the Bank with a stable and low cost funding source. The Bank also utilizes long-term FHLB borrowings to match long-term fixed rate loan funding. At September 30, 2012, the Bank had $930.9 million in funds on deposit from customers of Southwest Securities, representing approximately 88% of the Bank’s total deposits.

Short Term Borrowings and Advances from Federal Home Loan Bank

The table below presents short term borrowings and advances from the FHLB which were due within one year during the three-months ended September 30, 2012 and 2011 (dollars in thousands):

	Three-Months Ended September 30,
	2012					2011
			Interest					Interest
	Amount		Rate			Amount		Rate
At end of period	$	16,703		4.3	%	$	12,828		5.0	%
Average balance during period		15,060		4.3	%		13,034		4.9	%
Maximum month-end balance during period		16,703		—			13,349		—

LIQUIDITY AND CAPITAL RESOURCES

Management believes that our current assets and available liquidity are adequate to meet our liquidity needs over the next 12 months. However, there is no assurance our forecast will prove to be accurate or that we will not be required to raise additional capital. As a result, from time to time, management evaluates various opportunities to supplement the company’s sources of liquidity and capital. In fiscal 2012, this evaluation led to our entrance into the credit agreement with Hilltop and Oak Hill, as discussed below. Should we determine we need to obtain additional debt at SWS Group, we would be required to obtain regulatory approval and approval from Hilltop and Oak Hill.

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Credit Agreement

On July 29, 2011, we entered into a credit agreement with Hilltop and Oak Hill pursuant to which we obtained a $100.0 million, five year, unsecured loan that accrues interest at a rate of 8% per annum. In addition, we issued warrants to Hilltop and Oak Hill allowing each to purchase up to 8,695,652 shares of common stock at an exercise price of $5.75 per share (subject to anti-dilution adjustments), representing approximately 17% of the common stock of our company per investor as of July 29, 2011. The credit agreement contains restrictions and covenants to which we must adhere as long as the unsecured loan is outstanding. As of September 28, 2012, SWS Group had utilized $70.0 million of the $100.0 million by: (i) contributing $20.0 million in capital to the Bank to promote growth in the Bank’s loan portfolio; (ii) loaning $20.0 million to Southwest Securities to use in general operations by reducing Southwest Securities’ use of short-term borrowings for the financing of its day-to-day cash management needs; (iii) reducing SWS Group’s intercompany payable to Southwest Securities by $20.0 million and (iv) contributing $10.0 million in capital to Southwest Securities. See “Debt Issued with Stock Purchase Warrants” in the Notes to the Consolidated Financial Statements contained in this report.

Brokerage

A substantial portion of our assets are highly liquid in nature and consist mainly of cash or assets that are readily convertible into cash. Our equity capital, short-term bank borrowings, interest bearing and non-interest bearing client credit balances, correspondent deposits and other payables finance these assets. We maintain an allowance for doubtful accounts that represents amounts that are necessary in the judgment of management to adequately absorb losses from known and inherent risks in receivables from clients, clients of correspondents and correspondents. The highly liquid nature of our assets provides us with flexibility in financing and managing our anticipated operating needs. Management believes that the brokerage business’ present liquidity position is adequate to meet its needs over the next twelve months.

Short-Term Borrowings. At September 28, 2012, we had short-term borrowing availability under broker loan lines, a $20.0 million unsecured line of credit, an irrevocable letter of credit agreement and a $45.0 million revolving committed credit facility, each of which is described below.

Broker Loan Lines. At September 28, 2012, we had uncommitted broker loan lines of up to $375.0 million. These lines of credit are used primarily to finance securities owned, securities held for correspondent broker/dealer accounts and receivables in customers’ margin accounts. These lines may also be used to release pledged collateral against day loans. These credit arrangements are provided on an “as offered” basis, are not committed lines of credit and can be terminated at any time by the lender. Any outstanding balances under these credit arrangements are due on demand and bear interest at rates indexed to the federal funds rate. At September 28, 2012, $81.5 million was outstanding under these secured arrangements, which was collateralized by securities held for firm accounts valued at $121.3 million. Our ability to borrow additional funds is limited by our eligible collateral. See additional discussion under Risk Factors in the Fiscal 2012 Form 10-K.

Unsecured Line of Credit. We also have a $20.0 million 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 under any unsecured letters of credit at the time of borrowing. At September 28, 2012, we had no outstanding unsecured letters of credit. At September 28, 2012, there were no amounts outstanding on this line, and we had $20.0 million available for borrowing under this line of credit.

Letter of Credit Agreement. At September 28, 2012, we had an irrevocable letter of credit agreement aggregating $75.0 million pledged to support our open options positions with an options clearing organization. Until drawn, the letter of credit bears interest at 0.5% per annum. If drawn, the

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letter of credit bears interest at 0.5% per annum plus a fee. The letter of credit agreement is renewable semi-annually. This letter of credit is fully collateralized by marketable securities held in client and non-client margin accounts with a value of $83.7 million at September 28, 2012.

Revolving Credit Facility. On January 28, 2011, Southwest Securities entered into an agreement with an unaffiliated bank for a $45.0 million committed revolving credit facility. The commitment fee is 37.5 basis points per annum and, when drawn, the interest rate is equal to the federal funds rate plus 125 basis points. The agreement requires Southwest Securities to maintain tangible net worth of $150.0 million. As of September 28, 2012, there was $45.0 million outstanding under this credit facility. The $45.0 million of secured borrowings was collateralized by securities with a value of $73.1 million at September 28, 2012.

Net Capital Requirements. Our broker/dealer subsidiaries are subject to the requirements of the SEC relating to liquidity, capital standards and the use of client funds and securities. The amount of any broker/dealer subsidiaries’ net assets that may be distributed to the parent of the broker/dealer is subject to restrictions under applicable net capital rules. Historically, we have operated in excess of the minimum net capital requirements. See “Regulatory Capital Requirements” in the Notes to the Consolidated Financial Statements contained in this report.

Secured Borrowings. We participate in transactions involving securities sold under repurchase agreements (“repos”), which are secured borrowings that we record in our Statement of Financial Condition as other liabilities. These securities 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. We may be required to provide additional collateral based on the fair value of the underlying securities.

Banking

Liquidity is monitored daily to ensure the Bank’s ability to meet deposit withdrawals, maintain reserve requirements and otherwise sustain operations. The Bank’s liquidity is maintained in the form of readily marketable loans and investment securities, balances with the FHLB, Federal Reserve Bank of Dallas, federal funds sold to correspondent banks and vault cash. At September 30, 2012, the Bank had net borrowing capacity with the FHLB of $330.9 million. In addition, at September 30, 2012, the Bank had the ability to borrow up to $33.6 million in funds from the Federal Reserve Bank of Dallas under their secondary credit program.

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 of credit is due on demand and bears interest at a rate 100 basis points over the federal funds target rate. This line of credit is used to support short-term liquidity needs and, at September 30, 2012, there were no amounts outstanding.

The Bank’s asset and liability management policy is intended to manage interest rate risk. The Bank accomplishes this through management of the periodic repricing of its interest-earning assets and its interest-bearing liabilities. Overall interest rate risk is monitored through reports showing both sensitivity ratios, a simulation model and existing “GAP” data. (See the Bank’s GAP analysis in “Risk Management-Market Risk-Interest Rate Risk-Banking.”) At September 30, 2012, $930.9 million of the Bank’s deposits were from brokerage customers of Southwest Securities. Current events in the securities markets could impact the amount of these funds available to the Bank.

Capital Requirements. 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 of total and Tier I capital (as defined in 12 CFR 165 and 12 CFR 167) to risk-weighted assets (as defined) and of Tier I (core) capital (as defined) to adjusted assets (as defined). At September 30, 2012, the Bank had a total risk-based

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capital ratio of 19.2%, which resulted in excess capital of $66.4 million over the Order’s total risk-based capital requirement of $110.2 million, and the Bank had a Tier I (core) capital ratio of 12.7% or $61.3 million over the Order’s Tier I (core) capital requirement of $103.7 million. At September 30, 2012, the Bank had a Tier I risk-based capital ratio of 18.0%. Under federal law, the OCC may require the Bank to apply another measure of risk-weight or capital ratio that the OCC deems appropriate.

The Bank has historically met all capital adequacy requirements. As of September 30, 2012, the Bank met all capital requirements to which it was subject and satisfied the requirements to be defined as a “well-capitalized institution.” However, as a result of the issuance of the Order, the Bank is deemed to be “adequately capitalized” and no longer meets the definition of “well capitalized” under federal statutes and OCC regulations even though its capital ratios meet or exceed all applicable requirements under Federal law, OCC regulations and the Order. See additional discussion in “Cease and Desist Order with the Office of the Comptroller of the Currency” in the Notes to the Consolidated Financial Statements contained in this report. Should the Bank not meet these requirements, certain mandatory and discretionary supervisory actions (as defined in 12 CFR 165.6) could be applicable.

Off-Balance Sheet Arrangements

We generally do not enter into off-balance sheet arrangements, as defined by the SEC. However, our broker/dealer subsidiaries enter into transactions in the normal course of business that expose us to off-balance sheet risk. See Note 28 of the Notes to Consolidated Financial Statements in the Fiscal 2012 Form 10-K.

Cash Flow

Net cash used in operating activities was $53.1 million and $30.2 million for the three-months ended September 28, 2012 and September 30, 2011, respectively. The net cash used in operating activities was primarily due to an increase in assets segregated for regulatory purposes as well as a $34.4 million increase in securities owned.

Net cash used in investing activities was $7.9 million and $167.6 million for the three-months ended September 28, 2012 and September 30, 2011, respectively. The primary reason for the cash used in investing activities was the investment by the Bank in its securities portfolio.

Net cash provided by financing activities totaled $50.4 million and $117.3 million for the three-months ended September 28, 2012 and September 30, 2011, respectively. The primary driver of the cash provided by financing activities was an increase in short term borrowings.

We expect that cash flows provided by operating activities and short-term borrowings will be the primary source of working capital for the next 12 months.

Treasury Stock

Periodically, we repurchase our shares of common stock under a plan approved by our Board of Directors. In August 2011, the Board of Directors of SWS Group approved a plan authorizing us to repurchase up to 500,000 shares of common stock from time to time in the open market for an 18-month period ending on February 28, 2013. During the three-months ended September 28, 2012, no shares were purchased under this program. We do not currently intend to repurchase any shares of common stock under this plan, which would require the approval of Hilltop, Oak Hill and regulatory authorities to repurchase shares under this plan.

The trustee under our deferred compensation plan periodically purchases shares of our common stock in the open market in accordance with the terms of the plan. This stock is classified as treasury stock in our consolidated financial statements, but participates in future dividends declared

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by us. During the three-months ended September 28, 2012, the plan purchased 20,675 shares at a cost of approximately $121,000, or $5.86 per share, and 6,795 shares were sold or distributed to participants pursuant to the plan during the three-months ended September 28, 2012.

As restricted stock grants vest, grantees may sell a portion of their vested shares to us to cover the tax liabilities arising from vesting. As a result, in the three-months ended September 28, 2012, we purchased 4,647 shares of common stock with a market value of approximately $27,000, or an average of $5.78 per share, to cover tax liabilities.

Inflation

Our financial statements included herein have been prepared in accordance with GAAP. GAAP requires us to measure our financial position and operating results primarily in terms of historic dollars. Changes in the relative value of money due to inflation or recession are generally not considered under GAAP. Our assets are primarily monetary, consisting of cash, securities inventory, and receivables from customers and broker/dealers. These monetary assets are generally liquid and turn over rapidly and, consequently, are not significantly affected by inflation. The rate of inflation affects various expenses of the company, such as employee compensation and benefits, communications, and occupancy and equipment, which may not be readily recoverable in the price of our services. The rate of inflation can also have a significant impact on securities prices and on investment preferences by our customers generally. In management’s opinion, changes in interest rates affect the financial condition of a financial services firm to a greater degree than changes in the inflation rate. While interest rates are greatly influenced by changes in the inflation rate, they do not necessarily change at the same rate or in the same magnitude as the inflation rate. Interest rates are highly sensitive to many factors that are beyond our control, including changes in the expected rate of inflation, the influence of general and local economic conditions and the monetary and fiscal policies of the United States government, its agencies and various other governmental regulatory authorities among other things.

RISK MANAGEMENT

In an effort to assist the company in managing enterprise risk, in 2010 and at the Board of Director’s request, the company engaged a firm to perform an analysis of the company’s enterprise risk management process. During fiscal 2011, based on the Board of Director’s recommendations, we initiated an enterprise risk management program and formed a committee. Enterprise risk is viewed as the threat from an event, action or loss of opportunity that, if it occurs or has occurred, may adversely affect any, or any combination of, our company objectives, business strategies, business model, regulatory compliance, reputation and existence. The committee works with our various departments and committees to manage our enterprise risk management program and reports the results of this work to the Audit Committee of the Board of Directors on a quarterly basis. During fiscal 2012, we used and continue to use consulting services to improve our risk management processes, procedures and reporting.

We manage risk exposure through the involvement of various levels of management. We establish, maintain and regularly monitor maximum securities positions by industry and issuer in both trading and inventory accounts. Current and proposed underwriting, banking and other commitments are subject to due diligence reviews by senior management, as well as professionals in the appropriate business and support units involved. The Bank seeks to reduce the risk of significant adverse effects of market rate fluctuations by minimizing the difference between rate-sensitive assets and liabilities, referred to as “GAP”, and maintaining an interest rate sensitivity position within a particular timeframe. Credit risk related to various financing activities is reduced by the industry practice of obtaining and maintaining collateral. We monitor our exposure to counterparty risk through the use of credit information, the monitoring of collateral values and the establishment of credit limits. We have established various risk management committees that are responsible for reviewing and managing risk related to interest rates, trading positions, margin and other credit risk and risks from capital market transactions.

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Credit Risk

A description of the credit risk for our brokerage and banking segments is as follows:

Brokerage. Credit risk arises from the potential nonperformance by counterparties, customers or debt security issuers. We are exposed to credit risk as a trading counterparty and as a stock loan counterparty to dealers and customers, as a holder of securities and as a member of clearing organizations. We have established credit risk committees to review our credit exposure in our various business units. These committees are composed of senior management of the company. Credit exposure is also associated with customer margin accounts, which are monitored daily. We monitor exposure to individual securities and perform sensitivity analysis on a regular basis in connection with our margin lending activities. We adjust our margin requirements if we believe our risk exposure is not appropriate based on market conditions.

Banking. Credit risk is the possibility that a borrower or counterparty will fail to meet its obligations in accordance with agreed terms and is inherent in all types of lending. The Bank has developed and continues to enhance its policies and procedures to provide a process for managing credit risk. These policies and procedures include underwriting guidelines, credit and collateral tracking and detailed loan approval procedures which include officer and director loan committees. The Bank also maintains a detailed loan review process to monitor the quality of the loan portfolio. The Bank grants loans to customers primarily within Texas and New Mexico. The Bank also purchases mortgage loans which have been originated in other areas of the United States. Although the Bank has a diversified loan portfolio, a substantial portion of its debtors’ ability to honor their contracts is dependent upon the general economic conditions in Texas and New Mexico. Policies and procedures, which are in place to manage credit risk, are designed to be responsive to changes in these economic conditions.

Operational Risk

Operational risk refers generally to risk of loss resulting from our operations, including but not limited to, improper or unauthorized execution and processing of transactions, deficiencies in our operating systems, and inadequacies or breaches in our control processes. We operate in diverse markets and rely on the ability of our employees and systems to process large numbers of transactions. In order to mitigate and control operational risk, we have developed and continue to enhance specific policies and procedures that are designed to identify and manage operational risk at appropriate levels. We also use periodic self-assessments and internal audit examinations as further review of the effectiveness of our controls and procedures in mitigating our operational risk.

Legal Risk

Legal risk includes the risk of non-compliance with applicable legal and regulatory requirements. We are subject to extensive regulation in the various jurisdictions in which we conduct business. We have established procedures based on legal and regulatory requirements that are designed to reasonably ensure compliance with applicable statutory and regulatory requirements. We also have established procedures that are designed to ensure that executive management’s policies relating to conduct, ethics and business practices are followed. In connection with our business, we have various procedures addressing significant issues such as regulatory capital requirements, sales and trading practices, new products, use and safekeeping of customer funds and securities, granting credit, collection activities, money laundering, privacy and record keeping.

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Market Risk

Market risk generally represents the risk of loss that may result from a potential change in value of a financial instrument as a result of fluctuations in interest rates, market prices, investor expectations and changes in credit ratings of the issuer. Our exposure to market risk is directly related to our role as a financial intermediary in customer-related transactions and to our proprietary trading and securities lending activities.

Interest Rate Risk. A description of the interest rate risk for our brokerage and banking segments is as follows:

Brokerage. Interest rate risk is a consequence of maintaining inventory positions, trading in interest rate sensitive financial instruments and maintaining a matched stock loan book. Our fixed income activities also expose us to the risk of loss related to changes in credit spreads. Credit spread risk arises from the potential that changes in an issuer’s credit rating or credit perception could affect the value of financial instruments.

Banking. Our primary emphasis in interest rate risk management for the Bank is the matching of assets and liabilities of similar cash flow and re-pricing time frames. This matching of assets and liabilities reduces exposure to interest rate movements and aids in stabilizing positive interest spreads. We strive to structure our balance sheet as a natural hedge by matching floating rate assets with variable short term funding and by matching fixed rate liabilities with similar longer term fixed rate assets. The Bank has established percentage change limits in both interest margin and net portfolio value. To verify that the Bank is within the limits established for interest margin, the Bank prepares an analysis of net interest margin based on various shifts in interest rates. To verify that the Bank is within the limits established for net portfolio value, the Bank analyzes data using internal modeling data for net portfolio value. These analyses are conducted on a quarterly basis for the Bank’s Board of Directors.

The following table illustrates the estimated change in net interest margin based on shifts in interest rates of positive 300 basis points and negative 100 basis points:

Hypothetical Change in Interest Rates	Projected Change in Net Interest Margin
+300	-8.18%
+200	-6.46%
+100	-3.99%
0	0%
-50	-4.16%
-100	-6.45%

The following GAP analysis table indicates the Bank’s interest rate sensitivity position at September 30, 2012 (in thousands):

	Repricing Opportunities
	0-6 months			7-12 months			1-3 years			3+ years
Earning assets:
Loans-gross	$	702,374		$	23,804		$	44,359		$	46,933
Securities and FHLB stock		3,902			2,250			35,961			337,287
Interest bearing deposits		56,362			—			—			—
Total earning assets		762,638			26,054			80,320			384,220
Interest bearing liabilities:
Transaction accounts and savings		966,362			—			—			—
Certificates of deposit		16,352			8,108			9,903			954
Borrowings		4,204			12,500			20,921			29,693
Total interest bearing liabilities		986,918			20,608			30,824			30,647
GAP	$	(224,280	)	$	5,446		$	49,496		$	353,573
Cumulative GAP	$	(224,280	)	$	(218,834	)	$	(169,338	)	$	184,235

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

The following table categorizes “Securities owned, at fair value” net of “Securities sold, not yet purchased, at fair value,” which are in our securities owned and securities sold, not yet purchased, portfolios and “Securities available for sale” in our available-for-sale portfolio, which are subject to interest rate and market price risk at September 28, 2012 (dollars in thousands):

	Years to Maturity
	1 or less			1 to 5			5 to 10			Over 10			Total
Trading securities, at fair value
Municipal obligations	$	295		$	14,982		$	28,270		$	36,159		$	79,706
Auction rate municipal bonds		—			—			—			20,304			20,304
U.S. government and government agency obligations		1,999			2,866			(12,495	)		(2,952	)		(10,582	)
Corporate obligations		4,083			7,052			11,534			32,074			54,743
Total debt securities		6,377			24,900			27,309			85,585			144,171
Corporate equity securities		—			—			—			1,353			1,353
Other		42,992			—			—			—			42,992
	$	49,369		$	24,900		$	27,309		$	86,938		$	188,516
Restricted cash and cash equivalents	$	30,045		$	—		$	—		$	—		$	30,045
Assets segregated for regulatory purposes	$	—		$	10,062		$	—		$	—		$	10,062
Weighted average yield
Municipal obligations		1.8	%		1.5	%		2.4	%		4.3	%		3.1	%
Auction rate municipal bonds		—			—			—			0.8	%		0.8	%
U.S. government and government agency obligations		0.1	%		0.4	%		1.3	%		3.0	%		1.3	%
Corporate obligations		2.1	%		4.2	%		4.2	%		5.2	%		4.3	%
Assets segregated for regulatory purposes		—			0.2	%		—			—			0.2	%
Available-for-sale securities, at fair value
Securities available for sale	$	7,344		$	48,496		$	40,500		$	260,373		$	356,713

CRITICAL ACCOUNTING POLICIES AND ESTIMATES

Our discussion and analysis of our financial condition and results of operations are based on our consolidated financial statements, which have been prepared in accordance with GAAP. The preparation of these consolidated financial statements requires management to make estimates and assumptions that affect reported amounts of assets, liabilities, revenues, expenses and related disclosures. We review our estimates on an on-going basis. We base our estimates on our experience and on various other assumptions that we believe to be reasonable under the circumstances. Actual results may differ from these estimates under different assumptions or conditions. Our accounting policies and methodology used in establishing estimates have not changed materially since June 29, 2012. See the Fiscal 2012 Form 10-K for a discussion of our critical accounting policies.

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FORWARD-LOOKING STATEMENTS

From time to time, we make statements (including some contained in this report) that predict or forecast future events, depend on future events for their accuracy, or otherwise contain “forward-looking” information and constitute “forward-looking statements” within the meaning of applicable U.S. securities legislation. Such statements are generally identifiable by the terminology used such as “plans,” “expects,” “estimates,” “budgets,” “intends,” “anticipates,” “believes,” “projects,” “indicates,” “targets,” “objective,” “could,” “should,” “may” or other similar words. By their very nature, forward-looking statements require us to make assumptions that may not materialize or that may not be accurate. Readers should not place undue reliance on any forward-looking statement and should recognize that the statements are predictions of future results, which may not occur as anticipated. Actual results may differ materially as a result of various factors, some of which are outside of our control, including:

• the interest rate environment;

• the volume of trading in securities;

• the liquidity in capital markets;

• the volatility and general level of securities prices and interest rates;

• the ability to meet regulatory capital requirements administered by federal agencies, including without limitation, those established by the Order;

• the level of customer margin loan activity and the size of customer account balances;

• the demand for real estate in Texas, New Mexico and the national market;

• the credit-worthiness of our correspondents, counterparties in securities lending transactions and of our banking and margin customers;

• the demand for investment banking services;

• general economic conditions, especially in Texas and New Mexico and investor sentiment and confidence;

• the value of collateral securing the loans we hold;

• competitive conditions in each of our business segments;

• changes in accounting, tax and regulatory compliance requirements;

• changes in federal, state and local tax rates;

• the ability to attract and retain key personnel;

• the availability of credit lines, credit agreements and credit facilities;

• the potential misconduct or errors by our employees or by entities with whom we conduct business;

• the ability of borrowers to meet their contractual obligations and the adequacy of our allowance for loan losses; and

• the potential of litigation and other regulatory liability.

Our future operating results also depend on our operating expenses, which are subject to fluctuation due to:

• variations in the level of compensation expense incurred as a result of changes in the number of total employees, competitive factors, or other market variables;

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• variations in expenses and capital costs, including depreciation, amortization and other non-cash charges incurred to maintain our infrastructure; and

• unanticipated costs which may be incurred from time to time in connection with litigation, regulation and compliance, loan analyses and modifications or other contingencies.

Other factors, risks and uncertainties that could cause actual results to differ materially from our expectations discussed in this report are described in this report under the headings “Overview,” “Risk Management”, “Risk Factors” and “Critical Accounting Policies and Estimates,” in the Fiscal 2012 Form 10-K under the heading Risk Factors and our other reports filed with and available from the SEC. Our forward-looking statements are based on our current beliefs, assumptions and expectations, taking into account information that we reasonably believe to be reliable. All such forward-looking statements that we make speak only as of the date on which they are made, and, except as required by law, we expressly disclaim any obligation or undertaking to disseminate any updates or revisions to any forward-looking statements contained herein to reflect any change in our expectations with regard thereto or any change in events, conditions or circumstances upon which any statement is based.

Item 3. Quantitative and Qualitative Disclosures About Market Risk

The information required by this item is incorporated from “Item 2. Management’s Discussion and Analysis of Financial Condition and Results of Operations” under the caption “Risk Management.”

Item 4. Controls and Procedures

Evaluation of Disclosure Controls and Procedures

Our management, including the principal executive officer and principal financial officer, has evaluated the effectiveness of the design and operation of our disclosure controls and procedures (as defined in Rule 13a-15(e) under to the Exchange Act) as of September 28, 2012. Based on such evaluation, our management, including the principal executive officer and principal financial officer, has concluded that, as of September 28, 2012, our disclosure controls and procedures were effective for the purpose of ensuring that information required to be disclosed by us in the reports that we file or submit under the Exchange Act is recorded, processed, summarized and reported, within the periods specified in the SEC’s rules and forms.

Change in Internal Control Over Financial Reporting

There have not been any changes in our internal control over financial reporting (as defined in Rule 13a-15(f) under to the Exchange Act) during the three-months ended September 28, 2012 that have materially affected, or are reasonably likely to materially affect, our internal control over financial reporting.

PART II. OTHER INFORMATION

Item 1. Legal Proceedings

In the general course of our brokerage business and the business of clearing for other brokerage firms, we have been named as defendants in various pending lawsuits and arbitration and regulatory proceedings. These claims allege violations of various federal and state securities laws, among other matters. The Bank is also involved in certain claims and legal actions arising in the ordinary course of business. We believe that resolution of these claims will not result in a material adverse effect on our business, consolidated financial condition, results of operations or cash flows.

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Item 1A. Risk Factors

There have been no material changes from the risk factors disclosed in the Fiscal 2012 Form 10-K.

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

The following table provides information about our purchases during the quarter ended September 28, 2012 of our equity securities registered pursuant to Section 12 of the Exchange Act:

	Issuer Purchases of Equity Securities
Period	Total Number of Shares Purchased(1)		Average Price Paid  per Share		Total Number of Shares Purchased as Part of Publicly Announced Plans		Maximum Number of Shares that May Yet be Purchased Under the Plans(2)
07/30/12 to 07/27/12		—		—		—		500,000
07/28/12 to 08/31/12		4,647	$	5.78		—		500,000
09/01/12 to 09/24/12		—		—		—		500,000
		4,647	$	5.78		—

⁽¹⁾  All of the 4,647 shares of common stock repurchased during the three-month period ended September 28, 2012 were acquired from grantees in connection with income tax withholding obligations arising from vesting of restricted stock grants. These shares were not part of our publicly announced program to repurchase shares of common stock.

⁽²⁾  On August 24, 2011, the Board of Directors approved and announced a plan authorizing us to repurchase up to 500,000 shares of our common stock from time to time in the open market for an 18-month period ending on February 28, 2013. The company does not currently intend to repurchase any shares of common stock under this plan.

Item 3. Defaults upon Senior Securities

None.

Item 4. Mine Safety Disclosures

Not applicable.

Item 5. Other Information

None.

Item 6. Exhibits

The exhibits required to be furnished pursuant to Item 6 are listed in the Exhibit Index filed herewith, which Exhibit Index is incorporated herein by reference.

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SIGNATURES

Pursuant to the requirements of the Securities Exchange Act of 1934, the registrant has duly caused this report to be signed on its behalf by the undersigned, thereunto duly authorized.

	SWS Group, Inc.
	(Registrant)
November 7, 2012	/S/     James H. Ross
Date	(Signature)
	James H. Ross
	Director, President and Chief Executive Officer
	(Principal Executive Officer)
November 7, 2012	/S/     Stacy M. Hodges
Date	(Signature)
	Stacy M. Hodges
	Chief Financial Officer
	(Principal Financial Officer)
	(Principal Accounting Officer)

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SWS GROUP, INC. AND SUBSIDIARIES

INDEX TO EXHIBITS

Exhibit Number	Description
3.1	Restated Certificate of Incorporation of the Registrant incorporated by reference to Exhibit 3.1 to the Registrant’s Current Report on Form 8-K filed October 15, 2009
3.2	Restated By-laws of the Registrant incorporated by reference to Exhibit 3.2 to the Registrant’s Current Report on Form 8-K filed March 7, 2012
3.3	Certificate of Designations of Non-Voting Perpetual Participating Preferred Stock, Series A of SWS Group, Inc., incorporated by reference to Exhibit 3.1 to the Registrant’s Current Report on Form 8-K filed August 1, 2011
4.1	Warrant to purchase up to 8,695,652 shares of Common Stock, issued on July 29, 2011 to Hilltop Holdings Inc., incorporated by reference to Exhibit 4.1 to the Registrant’s Current Report on Form 8-K filed August 1, 2011
4.2	Warrant to purchase up to 8,419,148 shares of Common Stock, issued on July 29, 2011 to Oak Hill Capital Partners III, L.P., incorporated by reference to Exhibit 4.2 to the Registrant’s Current Report on Form 8-K filed August 1, 2011
4.3	Warrant to purchase up to 276,504 shares of Common Stock, issued on July 29, 2011 to Oak Hill Capital Management Partners III, L.P., incorporated by reference to Exhibit 4.3 to the Registrant’s Current Report on Form 8-K filed August 1, 2011
4.4	Investor Rights Agreement dated as of July 29, 2011 among SWS Group, Inc., Hilltop Holdings Inc., Oak Hill Capital Partners III, L.P. and Oak Hill Capital Management Partners III, L.P., incorporated by reference to Exhibit 4.4 to the Registrant’s Current Report on Form 8-K filed August 1, 2011
31.1*	Chief Executive Officer Certification filed pursuant to Section 302 of the Sarbanes-Oxley Act of 2002
31.2*	Chief Financial Officer Certification filed pursuant to Section 302 of the Sarbanes-Oxley Act of 2002
32.1*	Chief Executive Officer Certification furnished pursuant to Section 906 of the Sarbanes-Oxley Act of 2002
32.2*	Chief Financial Officer Certification furnished pursuant to Section 906 of the Sarbanes-Oxley Act of 2002
101#	The following materials from SWS Group, Inc.’s quarterly report on Form 10-Q for the quarter ended September 28, 2012, formatted in XBRL (Extensible Business Reporting Language): (i) Consolidated Statements of Financial Condition as of September 28, 2012 and June 29, 2012; (ii) Consolidated Statements of Income (Loss) and Comprehensive Income (Loss) for the three-months ended September 28, 2012 and September 30, 2011; (iii) Consolidated Statements of Cash Flows for the three-months ended September 28, 2012 and September 30, 2011 and (iv) Notes to Consolidated Financial Statements

* Filed herewith

^# Pursuant to Rule 406T of Regulation S-T, the XBRL related information in Exhibit 101 to this Quarterly Report on Form 10-Q shall not be deemed to be “filed” for purposes of Section 18 of the Securities Exchange Act of 1934 (the Exchange Act”), or otherwise subject to the liability of that section, and shall not be part of any registration statement or other document filed under the Securities Act of 1933 or the Exchange Act, except as shall be expressly set forth by specific reference in such filing.

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