ITEM 7. MANAGEMENT’S DISCUSSION AND ANALYSIS OF FINANCIAL

CONDITION AND RESULTS OF OPERATIONS

OVERVIEW

  We are engaged in full-service securities brokerage and full-service commercial banking. 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," "Item 1. Business-Competition," "-Regulation" and "Item 1A. Risk Factors."  

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 advisors and institutional firms. In addition to clearing trades, we tailor our services to meet the specific needs of our clearing clients ("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.  

This segment generates revenues 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 proceeds from 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. Generally, we earn net interest income based on the spread between the interest rate on cash or similar collateral we deposit and the interest rate paid on cash or similar collateral we receive. Our public finance and municipal sales and underwriting professionals 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, participate in public offerings of securities with institutional and individual investors, assist clients with raising capital, and provide other consulting and advisory services.  Our fixed income sales and trading group specializes in trading and underwriting U.S. government and 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.                                          -29-

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This segment generates revenues 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 lending, commercial real-estate lending, small business lending and residential construction 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 in newly originated residential loans from various mortgage bankers nationwide. The Bank earns substantially all of its income on the spread between the rates charged to customers on loans and the rates paid to depositors.  The "other" category includes SWS Group, corporate administration and SWS Capital Corporation. SWS Group is a holding company that owns various investments, including common stock of U.S. Home Systems, Inc. ("USHS"). At June 26, 2009, SWS Group also owned NYSE Euronext, Inc. ("NYX") common stock, which was sold in the first quarter of fiscal 2010.  

Business Environment

  Our business is sensitive to financial market conditions, which have been very volatile over the past two years. As of June 25, 2010, equity market indices reflected an average increase from a year ago with the Dow Jones Industrial Average (the "DJIA") up 20%, the Standard & Poor's 500 Index ("S&P 500") up 17% and the NASDAQ Composite Index ("NASDAQ") up 21%. The DJIA closed at 10,143.81 on June 25, 2010 up from 8,438.39 on June 26, 2009 but substantially below the close of 11,346.51 on June 27, 2008. Additionally, the average daily volume on the NYSE declined during our fiscal 2010, decreasing 5% over the same period last fiscal year. Despite the current positive direction in the equity markets, the economic environment is challenging, with the national unemployment rate at approximately 9.5% at the end of June 2010, slightly down from the high of 10% at the end of December 2009. The FRB reduced the federal funds target rate to 0 - 0.25% on December 16, 2008 and has not yet begun increasing rates. Most economists do not expect the federal funds rate to increase significantly during the remainder of calendar 2010.  The disruptions and developments in the general economy and the credit markets over the past two years have resulted in a range of actions by the 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 example, the U.S. government provided capital to rescue the operations of Fannie Mae, Freddie Mac and American International Group, Inc. ("AIG") while allowing Lehman Brothers ("Lehman") to fail. For more details regarding some of the actions taken by U.S. and foreign governments, see the discussion under "Item 1. Business-Regulation."  Investors initially responded to the volatile markets with a flight to quality which, in turn, reduced yields on short-term U.S. treasury securities and produced a dramatic reduction in commercial paper issuance. Investors are slowly moving back to higher yielding investments, but this has been a slow progression.  Unemployment and tight credit markets continue to create an unstable economic environment, and there is no guarantee that conditions will not worsen again. All of these factors have had an impact on our banking and brokerage operations  Brokerage: On the brokerage side of the business, volatility in the credit and mortgage markets, low interest rates and reduced volume in the stock markets continue to have an impact on several aspects of our business primarily related to valuation of securities, liquidity and depressed net interest margins.                                          -30-

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Valuation of Securities

  In order to take advantage of attractive tax-free yields, we began investing in certain auction rate municipal bonds in the spring of 2008. At the end of fiscal 2010 and 2009, we held $22.3 million and $23.9 million, respectively, of auction rate municipal bonds, which represented one security and 17% and 26% of our municipal obligations portfolio at June 25, 2010 and June 26, 2009, respectively. This security is an investment grade credit, was valued at 95.7% of par at June 25, 2010 and was valued at par at June 26, 2009, and yielded less than 1% per year for both periods. While management does not expect any reduction in the cash flow from this bond, the disruption in the credit markets has led to auction failures. We currently have the ability to hold this investment until maturity. While we expect the issuer of this bond to refinance the debt when interest rates rise, there can be no certainty that this refinancing will occur. We believe valuation of this bond at 95.7% of par at June 25, 2010 appropriately reflects a discount for the current lack of liquidity in this investment. See additional discussion under "Critical Accounting Policies-Fair Value."  Our customers own $3.7 million in auction rate bonds as well as approximately $21.5 million in auction rate preferred securities. We did not actively market these securities to our customers or classify them as cash equivalents on our statements to our customers. We do not underwrite auction rate securities or serve as the remarketing agent for any of these securities.  We trade mortgage and asset-backed securities on a regular basis. We monitor our trading limits daily to ensure that these securities are maintained at levels that we consider to be prudent given current market conditions. These securities are priced using a third-party pricing service and we review the price monthly to ensure reasonable valuation. At June 25, 2010, we held mortgage and asset-backed securities of approximately $27.4 million included in securities owned, at market value on the consolidated statements of financial condition.  

Customer margin balances have also been negatively impacted by the volatile equity markets, which reduces the net interest we earn on customer accounts.

  We have one investment in a venture capital investment partnership that we account for using the equity method of accounting, which approximates fair value. This venture capital fund invests in small businesses in various stages of development and that operate in a variety of industries. After several years of losses, during fiscal 2010, we recorded a gain of $1.3 million on this investment. At June 25, 2010, we valued this investment at $2.3 million.  

Liquidity

  Dislocation in the credit markets has led to increased liquidity risk. All but $50 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 reductions in our borrowing capacity, our lenders have taken actions that indicate their concerns regarding liquidity in the marketplace. These actions have included reduced advance rates for certain security types, more stringent requirements for collateral eligibility and higher interest rates. All of these actions have had a negative impact on our liquidity. Should our lenders take additional similar actions, the cost of conducting our business will increase and our volume of business could be limited. To address this liquidity risk, on January 29, 2010, we entered into a $50 million committed credit facility with a national bank, with unsecured borrowing capacity of $15 million. As of June 25, 2010, we have not borrowed under this facility.  The volatility in the U.S. stock markets also impacts our liquidity through increased margin requirements at our clearing houses. These margin requirements are determined through a combination of risk factors including volume of business and volatility in the U.S. stock markets. To the extent we are required to post cash or other collateral to meet these requirements, we will have less borrowing capacity to finance our other businesses.  

Net Interest Margins

  Historically, the profitability of the brokerage business has been 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 is depressed, primarily from the extremely low yields on our assets segregated for regulatory purposes portfolio. Additionally, the spread in our securities lending business has declined. Lastly, because the yield on money market funds have declined significantly, revenue sharing arrangements with our primary money market fund sweep providers have been substantially reduced. We do not expect any significant changes in these dynamics until short-term interest rates begin to rise.                                          -31-

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  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 customers' portfolio and developing new business in our securities lending portfolio. Despite these actions, profits from net interest remain depressed.  Bank: The prolonged depressed economic environment has had a significant impact on our banking business. The impact is focused primarily in two areas: (i) deterioration in the loan portfolio, specifically the commercial real estate portfolio and (ii) heightened regulatory review. The Bank has experienced deterioration in its real estate loan portfolio for the past 24 months. This deterioration was initially limited to the Bank's residential construction portfolio. However, as the recession lengthened, deterioration in credit quality began to appear in the Bank's commercial real estate loan portfolio. This deterioration accelerated in the third quarter of fiscal 2010 as North Texas banks began to experience more significant economic problems from the continuing recession, such as significant declines in property values, reclassification of criticized assets to classified assets, increased charge-offs and continuing declines in banking industry statistics. Criticized assets are assets that reflect developing adverse trends and classified assets are assets that reflect well defined weaknesses. In addition, unemployment, both nationally and in Texas, remains at elevated levels causing continuing economic distress.  Appraisals received in the last half of fiscal 2010 also exhibited more conservative valuation methodologies than in prior periods which adversely affected collateral values. In addition, capitalization rates, defined as net operating income divided by cost or value of the property, increased significantly in a flat interest rate environment, resulting in overall lower collateral valuations. These lower valuations resulted in increased write-downs of our real estate owned ("REO") properties from $1.1 million for the fiscal year ended June 30, 2009 to $5.5 million for the fiscal year ended June 30, 2010.  The deterioration was further evidenced by the progression of criticized assets to classified assets. Classified assets increased significantly during fiscal 2010 from $81.0 million at June 30, 2009 to $191.8 million at June 30, 2010, a 136.8% increase. Total charge-offs for fiscal 2010 were $26.3 million of which 93.1% were real estate related. Non-performing assets increased by $37.6 million from $56.1 million at June 30, 2009 to $93.7 million at June 30, 2010, or 5.3% of total assets.  Banking industry national statistics revealed a decrease in charge-off rates but an increase in delinquency rates which may evidence continued deterioration in the industry. The most recent data published by the Federal Reserve indicated real estate charge-off rates for real estate loans decreased from 2.88% in the fourth calendar quarter of 2009 to 2.20% in the first calendar quarter of 2010. Charge-off rates for total loans decreased from 3.08% in the fourth calendar quarter of 2009 to 2.88% in the first calendar quarter of 2010. Banking industry national delinquency rates increased for real estate loans from 9.69% in the fourth calendar quarter of 2009 to 10.18% in the first calendar quarter of 2010. Total loan delinquencies increased from 7.43% in the fourth calendar quarter of 2009 to 7.49% in the first calendar quarter of 2010.  After consideration of all of these factors, the Bank determined that a $45.1 million loan loss provision was required for fiscal 2010, bringing the Bank's loan loss allowance to $35.1 million or 3.0% of loans held for investment at June 30, 2010. We expect the allowance to be at elevated levels until non-performing assets begin to decline. Stabilization of non-performing assets and loss levels are largely dependent on the North Texas economy and employment levels. Until employment levels improve in North Texas, we do not expect meaningful improvement in the credit quality of our loan portfolio.  To address the deterioration in the Bank's real estate loan portfolio, management has taken actions to reduce the level of problem assets and has established strict limits on new lending, including restrictions on originating certain types of loans. Actions taken include restricting lending for certain loan categories, providing additional experienced staff in the special assets department and expanding the Bank's loan workout and marketing strategies and personnel. Additionally, loan concentration guidelines have been modified to limit the Bank's exposure in commercial real estate, residential construction and lot and land development loans.                                          -32-

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  From a regulatory perspective, the current environment has produced escalating regulatory scrutiny for all financial institutions including the Bank. Effective July 13, 2010, the Bank entered into an informal MOU with the OTS. The MOU provides among other things, that the Bank will (i) maintain a Tier I (core) capital ratio of 8% and a total risk-based capital ratio of 12%; (ii) adopt a classified asset reduction plan; (iii) retain a third-party consulting firm to review loan classifications; (iv) restrict certain lending and (v) not declare or pay dividends from the Bank without OTS approval. The MOU does not contain any monetary assessments or penalties. Management believes that it is instituting the appropriate plans to meet the requirements of the MOU; however, there is no certainty that the Bank can successfully execute on all of these requirements within the time frames noted in the MOU. If the Bank is unable to comply with the MOU or if the economic environment causes additional deterioration in the Bank's operations, the OTS could take additional actions, including initiating formal enforcement actions.  

Events and Transactions

  Several material events and transactions impacted our results of operations in the periods presented. A description of these transactions and the impact on our results of operations is presented below:  Increase in provision for loan losses. The provision for loan loss increased $31.8 million during fiscal 2010, resulting in an allowance for loan loss of $35.1 million at June 30, 2010. See discussion in "Overview-Business Environment-Impact of Credit Markets-Bank."  Sale of 5,000,001 shares of our common stock. On October 16, 2009, we filed a shelf registration statement with the SEC providing for the sale of up to $150.0 million of securities. On December 9, 2009, we closed a public offering of 4,347,827 shares of our common stock at a price of $11.50 per share. On December 16, 2009, the underwriters for the public offering exercised their option to purchase 652,174 additional shares of our common stock to cover over-allotments. We generated net proceeds, after deducting underwriting discounts and commissions, from the offerings of approximately $54.3 million. To date, we have invested $47.5 million of the net proceeds as a $27.5 million capital contribution to the Bank and a $20.0 million capital contribution to Southwest Securities. The remaining funds will be used by us for general corporate purposes.  Write-off of $6.3 million for clearing. In the first quarter of fiscal 2010, we recorded a pre-tax loss of $6.3 million as a result of a clearing correspondent's unauthorized short sale of more than 2 million shares of a stock. The short sale and the subsequent trades to cover the short position resulted in a $6.3 million receivable from the correspondent. We determined that collection of this receivable was doubtful and established an allowance for this receivable. The loss was recorded in "other expenses" on the consolidated statements of income and comprehensive income.  NYSE/Archipelago. We owned 23,721 shares of Archipelago Holdings, LLC ("Archipelago") common stock prior to the merger of Archipelago and the NYSE in March 2006, for which we received 23,721 unrestricted shares of the new entity NYX. As part of the merger, we also surrendered our NYSE seat (carried at a cost of $230,000) in return for $300,000 in cash and 80,177 restricted shares of NYX common stock. In fiscal 2009, we determined that the decline in value of these shares was other than temporary and recorded a $4.3 million realized loss on this investment.  

In the first quarter of fiscal 2010, we sold the 103,898 shares of NYX common stock for $2.9 million. SWS recognized a gain of $16,000 on the sale.

  Write-off of $5.4 million for stock loan. In the first quarter of fiscal 2009, we wrote-off $5.4 million related to a deficit in the collateral securing a counterparty obligation of Lehman. We experienced the counterparty deficit as a result of Lehman declaring bankruptcy on September 19, 2008. Lehman had an obligation to us for stock borrowed of approximately $10.3 million at the time of the bankruptcy filing, which was backed by approximately $9.7 million in collateral. Subsequent sales and revaluation of the remaining collateral resulted in a $5.4 million deficit. This write-off was recorded in other expenses on the consolidated statements of income and comprehensive income.  Acquisition of M.L. Stern. In February 2008, we entered into a definitive agreement to purchase M.L. Stern & Co., LLC and its wholly owned subsidiary Tower Asset Management, LLC (collectively, "M.L. Stern") from a subsidiary of Pacific Life Insurance Company. The acquisition was structured as a purchase of all of the outstanding membership interests of M.L. Stern & Co., LLC. The assets and liabilities acquired as well as the financial results of M.L. Stern were included in our consolidated financial statements after the close of business on March 31, 2008, the acquisition date. Substantially all of the operations of the M.L. Stern broker/dealer were transferred to Southwest Securities in December 2008 and are operating as separate offices in our private client group (references to M.L. Stern include these operations). These operations are included in our retail segment. Effective April 4, 2009, M.L. Stern withdrew its broker/dealer registration with FINRA, the SEC and all states. Tower Asset Management, LLC provided investment advisory services to high net worth individuals or families who required investment expertise and personal services. Tower Asset Management, LLC ceased business operations on June 30, 2009.                                          -33-

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  The aggregate acquisition price for M.L. Stern was approximately $8.7 million, which consisted of cash in the amount of $5.5 million and direct expenses of $3.2 million in finder's fees, legal fees, valuation fees, severance costs and contract cancellation costs.  The cost to acquire M.L. Stern was less than the fair values assigned to the acquired assets and liabilities, and as such, the excess was allocated as a pro-rata reduction of the amounts assigned to the acquired assets bringing all valued intangible assets to an adjusted fair value of zero. Depreciable fixed assets were also reduced to zero through the allocation process. After allocation of the excess, $1.6 million of excess fair value over cost remained. We recognized this amount as an extraordinary gain.  In fiscal 2009, we reduced our initial estimates of the liabilities for severance costs and contract cancellation costs as additional information indicated that the costs would be lower than initially expected. The reduction in the estimate for the severance costs was $290,000 and was due to voluntary employee terminations subsequent to the acquisition date. The reduction in the contract cancellation fee estimate was due to a change in the estimated date of cancellation of the contract, which reduced the fees estimated to be paid to the vendor by $385,000. As a result of these adjustments, we recognized other income of $675,000 on our consolidated statement of income and comprehensive income in fiscal 2009.  Distribution from an Equity Investment. In fiscal 2008, we realized a gain and received a distribution of $639,000 from a limited partnership venture capital fund in which we have an equity investment. This amount was included in other revenue in the consolidated statements of income and comprehensive income. See Note 10 in the Notes to the Consolidated Financial Statements contained in this report.  RESULTS OF OPERATIONS  Consolidated  Net loss for the fiscal year ended June 25, 2010 was $2.9 million, a decrease of $26.5 million from net income for the fiscal year ended June 26, 2009. Net income for the fiscal years ended June 26, 2009 and June 27, 2008 totaled $23.6 million and $31.9 million, respectively, representing a decrease of $8.3 million from fiscal 2008 to 2009. Net income includes income of $17,000 from discontinued operations and an extraordinary gain of $1.1 million for fiscal 2008. Fiscal years 2010, 2009 and 2008 each contained 251 trading days.  

The following is a summary of year-to-year increases (decreases) in categories of net revenues and operating expenses (dollars in thousands):

                                                        Change                         Change                                                Fiscal 2009 to 2010            Fiscal 2008 to 2009                                                 Amount         Percent         Amount         Percent Net revenues: Net revenues from clearing operations        $       (957)       (8)%       $     (2,410)      (17)% Commissions                                       (21,543)      (12)%              67,635        61% Net interest                                       (7,010)       (7)%               2,291         2% Investment banking, advisory and administrative fees                                  (549)       (2)%             (1,135)       (3)% Net gains on principal transactions                  6,530        19%              26,178       303% Other                                                8,879        74%            (12,569)      (51)%                                               $    (14,650)       (4)%       $      79,990        27%                                            -34- 

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  Table of Contents                                                    Change                         Change                                              Fiscal 2009 to 2010            Fiscal 2008 to 2009 Operating expenses:                             Amount      Percent            Amount      Percent Commissions and other employee compensation                               $   (9,592)         (4)%       $    55,173          30% Occupancy, equipment and computer service costs                                    1,283          4 %             5,901          22% Communications                                     122           1%             3,033          30% Floor brokerage and clearing organization charges                               463          13%             1,240          55% Advertising and promotional                      (515)        (11)%               686          18% Provision for loan loss                         31,795         239%             9,777         276% Other                                            4,775          13%            14,860          68%                                                  28,331           8%            90,670          36%  Pretax income                              $  (42,981)       (112)%       $  (10,680)        (22)%    Fiscal 2010 versus 2009  Net revenues decreased $14.7 million from fiscal 2009 to fiscal 2010. The largest components of the decrease were, a $21.5 million decrease in commissions and a $7.0 million decrease in net interest. The decrease in commissions was due to lower commissions in the institutional segment, primarily in the taxable fixed income business, as a result of tighter spreads and reduced market volatility. The decrease in net interest was due to a 64 basis point decrease in the spread in the institutional segment's securities lending business. Additionally, net interest declined due to reduced investment in tax-exempt municipal auction rate bonds in our municipal business. These decreases were partially offset by a $6.5 million increase in net gains on principal transactions and an $8.9 million increase in other revenue. The increase in net gains on principal transactions was primarily from an increase in the number of financings in the institutional segment and an increase in the retail municipal sales trading volume in our municipal business segment in fiscal year 2010 as compared to fiscal year 2009. The increase in other revenue was due primarily to (i) a $2.7 million increase in the sale of insurance products; (ii) a $3.5 million increase in the value of our deferred compensation plan assets and (iii) a gain of $1.3 million related to a limited partnership venture capital fund, as compared to a loss of $2.7 million in the prior fiscal year.  Operating expenses increased $28.3 million for fiscal 2010 as compared to fiscal 2009 due to a $31.8 million increase in the provision for loan loss and a $4.8 million increase in other expense. The increase in the Bank's loan loss provision is discussed in "Overview-Business Environment-Impact of Credit Markets-Bank." The increase in other expenses was due to (i) a $6.3 million loss incurred in the clearing segment in the first quarter of fiscal 2010 from a correspondent's short sale of securities; (ii) an increase in the Bank's write-downs on REO of $4.4 million; (iii) a $2.5 million increase in loan collections and other real estate expense; and (iv) a $734,000 increase in the DIF assessment. Additionally, in last fiscal year's comparable period, other expenses included a $5.4 million write-off related to the Lehman stock loan deficit and a $5.0 million impairment loss for our investments in NYX and USHS common stock. These increases in other expenses and the provision for loan loss were partially offset by a decrease in commission and other employee compensation of $9.6 million driven by a decrease in commission and incentive compensation in our institutional segment as a result of lower revenues. The decrease in commission and other employee compensation in our institutional segment was offset by an increase in salaries to our corporate support and information technology employees and deferred compensation expense related to our Restricted Stock Plan resulting from acceleration in the vesting of restricted stock for retired directors and individuals no longer employed by us.                                          -35- 

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Fiscal 2009 versus 2008

  Net revenues increased $79.9 million from fiscal 2008 to fiscal 2009. The largest components of the increase were in commissions, $67.6 million, net interest, $2.3 million, and net gains on principal transactions, $26.2 million. The increase in commissions is due to a $46.7 million increase in the institutional segment, primarily in the fixed income business, as greater volatility and lack of liquidity resulted in wider spreads that, in turn, led to increased client activity and more transactions. Also contributing to the increase in commissions is the increase in our retail segment of $20.9 million primarily due to the acquisition of M.L. Stern. M.L. Stern recorded commission revenue of $35.2 million for fiscal 2009 up from $9.6 million in fiscal 2008. The commission revenue increases were partially offset by a $2.2 million decrease in commissions for SWS Financial and a $2.4 million decrease in commission for our private client group. The increase in net interest is due primarily to a 23 basis point increase in the spread in the stock loan business as well as an increase in the average loan balance at the Bank of 26%. The increase in net gains on principal transactions is driven by the fixed income business primarily due to the volatility in the market and increased customer activity. These increases were offset by a decrease in other revenue of $12.6 million. This decrease is due to a $2.9 million increase in losses related to our limited partnership venture capital fund, a $1.7 million increase in losses on the deferred compensation plan (with a corresponding decrease in compensation expenses on the deferred compensation plan), a $3.5 million decrease in revenue from the sale of our insurance products, a decrease of $1.9 million in SEC fees collected (with a corresponding decrease in other expenses) and a decrease in miscellaneous income of $650,000, which is primarily made up of the gain recognized on the sale of the Bank's factoring assets in the third quarter of fiscal 2008. There was also a $1.7 million increase in net losses from the sale of REO property at the Bank and a $657,000 decrease in service fee income.  Operating expenses increased $90.7 million for fiscal 2009 as compared to fiscal 2008. The largest increase was in commissions and other employee compensation, $55.2 million, occupancy, equipment and computer service costs, $5.9 million, and other expenses, $24.6 million. The increase in commissions and other employee compensation is due primarily to the acquisition of M.L. Stern. M.L. Stern's commission and other employee expenses were $32.3 million in fiscal 2009 versus $8.6 million in fiscal 2008. The remainder of the increase is due to variable compensation in the institutional segment from fiscal 2008 to fiscal 2009 based on increased profitability. The increase in occupancy, equipment and computer service costs is due primarily to the acquisition of M.L. Stern. The increase in other expenses is primarily due to the $5.4 million write-off of the Lehman counterparty exposure, an increase in the provision for loan loss of $9.8 million, an increase in legal fees of $1.6 million, the losses recognized on our investment in NYX and USHS of $5.0 million and increases in purchase mortgage loan losses, real estate and loan related expenses and DIF assessments of $4.0 million.  Net Interest Income  We generate net interest income from our brokerage segments and our banking segment. 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. For the fiscal years 2010, 2009 and 2008 net interest income from our brokerage operations and banking segment were as follows (in thousands):                                     2010           2009           2008               Brokerage        $   24,769     $   42,631     $   55,607               Bank (1)             76,038         65,186         49,919                Net interest     $  100,807     $  107,817     $  105,526      (1) The net interest reported for the Bank is for the periods ended June 30,     2010, 2009 and 2008.                                           -36- 

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  For the fiscal years ended June 25, 2010, June 26, 2009 and June 27, 2008, net interest income from our brokerage entities accounted for approximately 7%, 11% and 18% of our net revenue, respectively. For fiscal years 2010, 2009 and 2008, average balances of interest-earning assets and interest-bearing liabilities in our brokerage operations were as follows (in thousands):                                                    2010             2009       

2008

 Average interest-earning assets: Customer margin balances                      $  172,690       $  176,321       $  288,667 Assets segregated for regulatory purposes                                         342,431          304,894          336,006 Stock borrowed                                 1,859,000        2,061,000        2,997,000  Average interest-bearing liabilities: Customer funds on deposit, including short credits                                    378,846          409,749          520,523 Stock loaned                                   1,804,000        2,021,000        2,959,000  

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

Income Tax Expense

  For fiscal 2010, income tax benefit (effective rate of 36.4% for the fiscal year ended June 25, 2010) differed from the amount that would otherwise have been calculated by applying the federal corporate tax rate (35%) to loss before income taxes due to state income taxes and other permanently excluded items, such as tax exempt interest, meals and entertainment and increases in the value of company-owned life insurance ("COLI").  For fiscal 2009, income tax expense (effective rate of 38.5% for the year ended June 26, 2009) differed from the amount that would otherwise have been calculated by applying the federal corporate tax rate (35%) to income before income taxes and minority interest in consolidated subsidiaries. The effective rate was higher than the statutory rate because of state income taxes, the increase in net liability for uncertain tax positions and other permanently excluded items, such as meals and entertainment and expense from COLI.  For fiscal 2008, income tax expense (effective rate of 37.2% for the year ended June 27, 2008) differed from the statutory rate. The effective rate was higher than the statutory rate because of state income taxes and the increase in net liability for uncertain tax positions, partially offset by permanently excluded items, such as tax exempt interest.                                          -37-

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Segment Information

The following is a summary of net revenues and pre-tax income (loss) by segment for the fiscal years ended June 25, 2010, June 26, 2009 and June 27, 2008 (dollars in thousands):

                                 June 25,                         June 26,                         June 27,                                 2010           % Change          2009           % Change          2008 Net revenues: Clearing                    $    21,041           (21)%      $    26,565           (28)%      $    37,138 Retail                          110,578            3             107,518           18              91,231 Institutional                   157,977          (16)            187,970           54             121,757 Banking(1)                       76,409           15              66,710           24              53,970 Other                               966          114              (7,142)        (190)             (2,465)  Total                       $   366,971            (4)%      $   381,621             27%      $   301,631   Pre-tax income (loss): Clearing                    $    (5,305)         (201)%      $     5,233           (55)%      $    11,611 Retail                              219          109              (2,425)        (122)             11,037 Institutional                    53,222          (24)             69,714           51              46,158 Banking(1)                      (17,826)        (258)             11,281          (36)             17,701 Other                           (34,862)          23             (45,374)         (21)            (37,398)  Total                       $    (4,552)         (112)%      $    38,429           (22)%      $    49,109    

(1) The net revenues and pre-tax income reported for the banking segment is for the periods ended June 30, 2010, 2009 and 2008.

Clearing. The following is a summary of the results for the clearing segment for fiscal 2010, 2009 and 2008 (dollars in thousands):

                                  June 25,                        June 26,                        June 27,                                 2010          % Change          2009          % Change          2008 Net revenue from clearing                    $    10,582           (8)%      $    11,534          (17)%      $    13,946 Net interest                      6,099           9               5,603         (56)             12,811 Other                             4,360         (54)              9,428          (9)             10,381  Net revenues                     21,041         (21)             26,565         (28)             37,138  Operating expenses               26,346          24              21,332         (16)             25,527 

Pre-tax income (loss) $ (5,305) (201)% $ 5,233

     (55)%      $    11,611   Average customer margin balance              $    99,000           (1)%      $   100,000          (43)%      $   176,000  Average customer funds on deposit                  $   232,000          (15)%      $   273,000     

(24)% $ 358,000

  Customer deposits at the Bank                    $   714,200            17%      $   609,600            21%      $   505,300                                            -38- 

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  The following table reflects the number of client transactions processed for each of the last three fiscal years and the number of correspondents at the end of each fiscal year:                                               Fiscal 2010       Fiscal 2009       Fiscal 2008 Tickets for high-volume trading firms         1,404,848         8,469,552   

30,469,859

 Tickets for general securities broker/dealers                                  937,925           895,329         1,112,514  Total tickets                                 2,342,773         9,364,881        31,582,373  Correspondents(*)                                   174               184               190     

(*) In evaluating correspondent relationships, we determined that certain clearing accounts, while not officially terminated, have become inactive. Consequently, we have revised our definition of correspondent and have excluded these dormant relationships in our correspondent count for all periods presented.

Fiscal 2010 versus 2009

The clearing segment posted a 21% decrease in net revenues and a 201% decrease in pre-tax income for fiscal 2010 as compared to fiscal 2009.

  In fiscal 2010, tickets processed decreased substantially from fiscal year 2009, while clearing fee revenue decreased only 8%. The primary driver of this change was decreased volume from day trading customers. Revenue per ticket was $4.46 for fiscal 2010 up from $1.23 for fiscal 2009 due to a change in the mix of customers from day trading firms to general securities broker/dealers. The fees for services to the day trading firms are discounted substantially from the fees charged to general securities brokers/dealers.  

Net interest revenue in the clearing segment increased $496,000 or 9% in fiscal 2010 as compared to fiscal 2009. Net interest revenue increased due to an increase in the spread we earn on customer deposits.

  Other revenue, which is primarily composed of fees from money market funds, decreased $5.1 million for fiscal 2010 as compared to fiscal 2009. This decrease was due to a 70% decrease in administrative fee income from money market fund providers. This fee income decreased due to a reduction in short-term interest rates, which resulted in reduced revenue sharing with various money market funds.  Operating expenses for fiscal 2010 increased $5.0 million from fiscal 2009 due to a $6.5 million increase in other expenses. This increase was primarily due to a $6.3 million loss incurred on a correspondent's short sale of securities in fiscal 2010 as well as increased legal expenses of $1.4 million. This increase was partially offset by a $1.0 million decrease in information technology and operating expenses and a $1.1 million decrease in commissions and other employee compensation. This decrease in commissions and other employee compensation was due to a decrease in salary expense of $178,000, as well as a $907,000 decrease in incentive compensation, primarily related to reduced headcount.  

Fiscal 2009 versus 2008

The clearing segment posted a decrease in net revenues of 28% and a decrease in pre-tax income of 55% in fiscal 2009 as compared to fiscal 2008.

  Tickets processed decreased substantially over fiscal year 2008 while clearing fee revenue decreased only 17%. Decreased volume from high volume trading customers was the primary driver of this change with an offset from an increase in revenue per ticket to $1.23 for fiscal 2009 from $0.44 for fiscal 2008. The decrease in high volume transactions is due to the departure of one of these firms in early fiscal 2009 and substantially reduced volume from another high volume firm.  Net interest revenue in the clearing segment decreased 56% in fiscal 2009 as compared to fiscal 2008. Net interest decreased primarily due to a 43% decline in margin balances in the clearing segment as well as a 43 basis point drop in the spread we earn on customer deposits.                                          -39-

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  Operating expenses for fiscal 2009 decreased $4.2 million from fiscal 2008 due to decreased commission and employee compensation of $1.0 million and a decrease in other expenses of $2.6 million. The decrease in commission and employee compensation was due to a $327,000 decrease in salary expense and a $671,000 decrease in incentive compensation expense. Fiscal year 2008 included some one time expenses related to the hiring of the new head of clearing. The decrease in incentive compensation is due to reduced compensation accruals because of the smaller pre-tax profit from our clearing operations. The decrease in other expenses is primarily due to a $442,000 decrease in professional services, a $429,000 decrease in licenses and fees and a $1.6 million decrease in the amount of information technology and operating expenses allocated to the clearing segment. The allocations of information technology and operating expenses to the clearing segment are based on ticket count and other metrics, which decreased in fiscal 2009 when compared to fiscal 2008.  

Retail. The following is a summary of the results for the retail segment for fiscal 2010, 2009 and 2008 (dollars in thousands):

                                      June 25,                       June 26,                     June 27,                                      2010          % Change         2009         % Change        2008 Net revenues: Private Client Group ("PCG") Commissions                      $    58,436             2%     $   57,060            68%     $   33,877   Advisory fees                        5,291          (22)           6,756          (3)            6,963   Insurance products                   4,961           21            4,107            5            3,920   Other                                  243          153             (462)       (168)              682   Net interest revenue                 2,315           34            1,732         (38)            2,802                                        71,246            3           69,193           43           48,244  Independent registered representatives (SWS Financial) Commissions                           25,343           14           22,311          (9)           24,506   Advisory fees                        2,444          (24)           3,212         (15)            3,780   Insurance products                   6,034           37            4,403         (43)            7,754   Other                                  841           18              710         (10)              786   Net interest revenue                   819            3              796         (69)            2,529                                        35,481           13           31,432         (20)           39,355   Other Commissions                      $       228            23%    $       185          (24)%     $      242   Advisory fees                        2,253          (59)           5,519          207            1,796   Insurance products                   1,147           22              940         (26)            1,271   Other                                  226            1              223            9              204   Net interest revenue                    (3)        (111)              26         (78)              119                                         3,851          (44)           6,893           90            3,632  Total                            $   110,578            3       $  107,518           18       $   91,231  Operating expenses                   110,359            -          109,943           37           80,194  Pre-tax income (loss)            $       219           109%     $   (2,425)        (122)%     $   11,037   Average customer margin balances                         $    62,000           (2)%     $   63,000          (29)%     $   89,000  Average customer funds on deposit                          $   129,000             5%     $  123,000          (18)%     $  150,000  Customer deposits at the Bank                             $   564,242            16%     $  484,480            32%     $  366,007   PCG representatives                      202          (12)%            230            22%            207  SWS Financial representatives                          307             1%            305           (3)%            315                                            -40- 

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Fiscal 2010 versus 2009

  Net revenues in the retail segment increased 3% in fiscal 2010 as compared to fiscal 2009 driven by (i) a $4.5 million increase in commission revenue, (ii) a $2.7 million increase in insurance product sales and (iii) the elimination of M.L. Stern LLC's deferred compensation plan which produced a loss of $843,000 in the comparable fiscal 2010 period. The insurance product sales increases in fiscal 2010 were due to an increase in volume in both our PCG and SWS Financial businesses. These increases were partially offset by a decrease in advisory fees of $5.5 million. The primary reason for the decrease in advisory fees was due to (i) closing Tower Asset Management, LLC on June 30, 2009, which reduced fees by $3.7 million and (ii) a reduction in money market fee revenue of $3.3 million offset by increased managed and advisory fee income of $1.1 million due to an increase in assets under management from June 26, 2009 to June 25, 2010. Total customer assets were $12.6 billion at June 25, 2010 and $11.5 billion at June 26, 2009. Assets under management were $517.0 million at June 25, 2010 versus $419.0 million at June 26, 2009, excluding Tower Asset Management, LLC.  

Net interest revenue in the retail segment increased 28% in fiscal 2010 as compared to fiscal 2009. Net interest revenue increased due to an increase in the spread we earn on customer deposits.

  Operating expenses increased less than 1% from fiscal 2009 to fiscal 2010. This increase was primarily due to a 2% increase in commission and other employee compensation, which was the primary component of operating expenses in the retail segment, as well as a $1.0 million increase in information and technology expenses. These increases were offset by a $920,000 decrease in communication expense and a $936,000 decrease in occupancy, equipment and computer service costs. These decreases were primarily due to the reorganization of the old M.L. Stern offices.  Fiscal 2009 versus 2008  Net revenues in the retail segment were up 18% in fiscal 2009 as compared to fiscal 2008 driven by commissions, fees and other revenues from the acquisition of M.L. Stern of $41.2 million versus revenue of $11.4 million in fiscal 2008. Total customer assets were $11.5 billion at June 26, 2009 and $11.4 billion at June 27, 2008. Total customer assets for fiscal 2009 and fiscal 2008 include $5.0 billion and $4.4 billion from M.L. Stern, respectively. Assets under management were $419.0 million at June 26, 2009 versus $856.0 million ($463.0 million from Tower Asset Management, LLC) at June 27, 2008. Effective June 30, 2009, Tower Asset Management, LLC ceased operations.  Net interest revenue allocated to the retail segment decreased 50% in fiscal 2009 as compared to fiscal 2008. This decrease is primarily due to a reduction in the spread earned on customer deposits.  Operating expenses increased 37% from fiscal 2008 to fiscal 2009. This increase is primarily due to a 29% increase in commission expense, the primary component of operating expenses in the retail segment, driven by M.L. Stern's commission expense of $32.3 million. In addition, operating expenses increased due to increased rent expense from the addition of new branches, computer services expense, licenses and fees, professional services, legal expense and the information and technology expenses allocated to the segment. M.L. Stern contributed $12.3 million to the increase in other operating expenses.                                          -41-

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Institutional. The following is a summary of the results for the institutional segment for fiscal 2010, 2009 and 2008 (dollars in thousands):

                                   June 25,                          June 26,                          June 27,                                  2010           % Change           2009           % Change           2008 Net revenues: Commissions Taxable fixed income         $    44,751          (37)%        $    71,545           158%        $    27,715 Municipal distribution            15,187          (2)               15,517           60                9,676 Portfolio trading                 13,338           9                12,247          (19)              15,179 Other                                 17          55                    11          (31)                  16                                    73,293         (26)               99,320           89               52,586  Investment banking fees                              26,008          42                18,269          (18)              22,250 Net gains on principal transactions            41,635          20                34,822          315                8,398 Other                              1,013          (6)                1,077           (6)               1,140 Net interest revenue Stock loan                        13,829         (54)               30,064          (13)              34,708 Other                              2,199         (50)                4,418           65                2,675  Total                            157,977         (16)              187,970           54              121,757   Operating expenses               104,755         (11)              118,256           56               75,599  Pre-tax income               $    53,222          (24)%        $    69,714            51%        $    46,158   Taxable fixed income representatives                       32             3%                 31             7%                 29  Municipal distribution representatives                       24             9%                 22            10%                 20    Average balances of interest-earning assets and interest-bearing liabilities for the institutional segment as of June 25, 2010, June 26, 2009 and June 27, 2008 were as follows (in thousands):                                              2010                     2009                     2008 Average interest-earning assets: Stock borrowed                          $   1,859,000            $   2,061,000            $   2,997,000  Average interest-bearing liabilities: Stock loaned                                1,804,000                2,021,000                2,959,000   The following table sets forth the number and aggregate dollar amount of municipal new issue bond underwriting conducted by Southwest Securities, as reported to the Municipal Securities Rulemaking Board for the last three fiscal years:                                                         Aggregate                        Fiscal      Number of         Amount of                         Year        Issues           Offerings                         2010          635         $ 65,012,257,000                         2009          530         $ 45,238,055,000                         2008          568         $ 44,729,320,000                                           -42- 

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Fiscal 2010 versus 2009

  Net revenues from the institutional segment decreased 16% while pre-tax income was down 24% from fiscal 2009 to fiscal 2010. Commissions in the institutional segment were down 26% from fiscal 2009 to fiscal 2010. Volumes in the taxable fixed income area remained at record levels in the first quarter of fiscal 2010; however, tighter spreads and reduced volatility in the last nine months of fiscal 2010 led to decreased commissions in fiscal 2010 in the taxable fixed income area as compared with the prior fiscal year. The decrease in commissions was partially offset by a $7.7 million increase in investment banking fees. The increase in investment banking fees was due to increased unit investment trust underwriting activity in the taxable fixed income business, increased fees generated from competitive underwritings in the municipal bond business as well as increased fees generated from advisory services in the corporate finance business.  Net gains on principal transactions increased 20% in fiscal 2010 as compared to fiscal 2009 due to an increase in the number of financings by the municipal bond business unit of approximately 100 issues and an increase in retail municipal sales trading volume. The municipal bond business unit contributed $8.5 million to this increase. The increase by the municipal bond business unit was offset by a $1.6 million decrease in the taxable fixed income unit due to tighter spreads.  Net interest revenue decreased 54% in fiscal 2010 from fiscal 2009. The institutional segment's net interest is primarily generated from the company's securities lending activity. This decrease was due to a 64 basis point decrease in the spread earned on securities lending caused by low interest rates. The disruption in the markets and changes in our internal risk limits caused average balances in our stock loan business to fall to $1.8 billion at June 25, 2010 from $2.0 billion at June 26, 2009. Net interest revenue also decreased in the municipal business unit due to reduced investments in tax-exempt municipal auction rate bonds.  Operating expenses decreased 11% from fiscal 2009 to fiscal 2010, primarily due to the $5.4 million write-off for the Lehman counterparty exposure in fiscal 2009, as well as a decrease in employee compensation expense in fiscal 2010 as compared to fiscal 2009. The decrease in compensation expense was due primarily to an $8.7 million decrease in commission expense and a $5.6 million decrease in incentive compensation off set by a $1.8 million increase in salaries. The decrease in commission and incentive compensation was due to reduced revenue and profitability in our fixed income and securities lending businesses. The increase in salary expense was due to hiring additional registered representatives in our municipal fixed income business. The decreases in our operating expenses were partially offset by a $1.1 million increase in communication expense, primarily due to an increase in quotations and an $836,000 increase in occupancy expense due to new office locations, insurance and software licenses.  Fiscal 2009 versus 2008  Net revenues from the institutional segment increased 54% while pre-tax income was up 51% from fiscal 2008 to fiscal 2009. The increase in revenues was primarily due to the increase in commissions in the taxable fixed income and municipal businesses as volumes in both areas significantly improved. These increases were partially offset by a decrease in portfolio trading due to a 27% decline in the number of trades processed. Investment banking fees were down 18% driven by a decrease in corporate finance advisory fees of $3.4 million and public finance advisory fees of $2.4 million. The decrease in advisory fees is due to the depressed economic environment and the lack of new municipal issues.  Net gains on principal transactions were up 315% in fiscal 2009 as compared to fiscal 2008 due to an increase in market volatility and wider spreads in the secondary market. Net gains on principal transactions for the municipal business unit increased $10.6 million and the taxable fixed income unit increased $16.0 million.  Net interest revenue decreased 8% in fiscal 2009 from fiscal 2008. The institutional segment's net interest is primarily generated from the company's securities lending activity. This decrease is due to a 32% decrease in average balances despite an increase of 23 basis points in the spread earned on securities lending balances. The disruption in the markets, regulators' limits on short sales and changes in our internal risk limits caused average balances in our stock loan business to fall by $938.0 million.  Operating expenses were up 56% from fiscal 2008 to fiscal 2009 primarily due to increases in commission expense of $34.2 million and other operating expense of $6.5 million. The increase in commission expense is due to the increase in revenue produced by the institutional segment. The increase in other operating expense is due primarily to the $5.4 million write-off for the Lehman counterparty exposure and a $702,000 increase in the amount of information and technology expenses allocated to the institutional segment.                                          -43-

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Banking. The following is a summary of the results for the banking segment for fiscal 2010, 2009 and 2008 (dollars in thousands):

                                 June 30,                            June 30,                            June 30,                                2010          % Change              2009          % Change              2008 Net revenues: Net interest revenue       $   76,038              17 %         $   65,186             31 %         $   49,919 Other                             371             (76 )              1,524            (62 )              4,051  Total net revenues             76,409              15               66,710             24               53,970  Operating expenses             94,235              70               55,429             53               36,269  Pre-Tax income (loss)      $  (17,826)           (258 )%        $   11,281            (36 )%        $   17,701    Fiscal 2010 versus 2009 

The Bank's net revenue increased 15% while pre-tax income decreased 258% from fiscal 2009 to fiscal 2010.

  Net interest revenue generated by the Bank accounted for approximately 20.1% of consolidated net revenue for fiscal 2009. The increase in net interest revenue in fiscal 2010 over fiscal 2009 was due primarily to an 8% increase in loan volume from fiscal 2009 to fiscal 2010 as well as a 10 basis point increase in the net yield from fiscal 2009 to fiscal 2010.  The Bank's operating expenses were up 70% from fiscal 2009 to fiscal 2010. This increase was due primarily to a $31.8 million increase in the Bank's provision for loan loss and a $7.0 million increase in other expense consisting of the following: (i) a $ 4.4 million increase in the Bank's write-downs on REO; (ii) a $2.5 million increase in loan collections, loan related legal fees as well as other real estate expenses; and (iii) a $734,000 increase in the DIF assessment. These increases were partially offset by a $686,000 decrease in expenses related to overdraft charge-offs and write-downs of loans held for sale.  

Fiscal 2009 versus 2008

  The Bank's net revenue increased 24% while pre-tax income decreased 36% from fiscal 2008 to fiscal 2009. Net interest revenue generated by the Bank accounted for approximately 17.1% of consolidated net revenue for fiscal 2009. The increase in net interest revenue in fiscal 2009 over fiscal 2008 is due primarily to a 26% increase in loan balances and an increase in the net yield on interest earning assets from 4.4% in fiscal 2008 to 4.7% in fiscal 2009.  The Bank's operating expenses were up 53% from fiscal 2008 to fiscal 2009. This increase is due to an increase of $9.8 million in the provision for loan losses and an increase in compensation expense of $3.1 million from the five new banking centers established in fiscal 2009, the hiring of a Bank executive in the fourth quarter of fiscal 2008 and the severance paid to employees upon exiting the residential mortgage origination business in the first quarter of fiscal 2009. The Bank also had increased real estate fees of $1.3 million, due to an increase in funding volume of the mortgage purchase division, an increase in the write-downs on REOs of $852,000, due to an increase in REO properties as a result of the deterioration of the real estate market, an increase in DIF assessments of $1.5 million, due to an industry wide 7 basis point increase by the FDIC in the Bank's quarterly assessment as well as the FDIC's special one time assessment, and other loan related expenses of $310,000. See additional discussion on the allowance for loan losses at "-Financial Condition-Loans and Allowance for Probable Loan Losses."                                          -44-

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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 fiscal 2010, 2009 and 2008 (dollars in thousands):                                                            2010                                    2009                                    2008                                                          Interest                                Interest                                Interest                                           Average         Income/      Yield/     Average         Income/      Yield/     Average         Income/      Yield/                                           Balance       Expense (*)     Rate      Balance       Expense (*)     Rate      Balance       Expense (*)     Rate  Assets: Interest-earning assets: Loans: Residential - mortgage                   $   396,580    $     26,687     6.7%    $   378,881    $     27,571     7.3%    $   298,875    $     24,517     8.2% Residential - construction                   113,696           5,920    5.2          168,051           8,762    5.2          209,931          15,608    

7.4

 Commercial - real estate                     615,581          33,906    5.5          478,198          28,907    6.0          298,759          24,581    8.2 Commercial - loans                           164,945           9,742    5.9          119,684           7,758    6.5           86,588           7,115    8.2 Individual                                     4,590             324    7.1            4,755             355    7.5            4,364             351    8.1 Land                                         140,191           6,958    5.0          175,414           9,117    5.2          156,545          12,512    8.0 Money market                                  40,715              56    0.1                -               -      -                -               -      - Federal funds sold                            44,479              55    0.1            9,346             107    1.1           52,866           2,566    4.9 Interest bearing deposits in banks             9,964               2      -           22,412             232    1.0           16,254             478    2.9 Federal reserve funds                         27,150              65    0.2           12,756              85    0.7                -               -      - Investments - other                           42,082           1,088    2.6            8,968             211    2.4            6,830             244    3.6                                           $ 1,599,973          84,803     5.3%    $ 1,378,465          83,105     6.0%    $ 1,131,012          87,972     7.8%  Non interest-earning assets: Cash and due from banks                        7,442                                   9,212                                  29,503 Other assets                                  50,719                                  33,236                                  25,804                                           $ 1,658,134                             $ 1,420,913                             $ 1,186,319   Liabilities and stockholder's equity: Interest-bearing liabilities: Certificates of deposit                  $    70,712           1,279     1.8%    $    81,649           2,465     3.0%    $    85,601           3,831     4.5% Money market accounts                         41,646              63    0.2           45,459             354    0.8           37,377           1,031    2.8 Interest-bearing demand accounts              90,728             160    0.2           75,167             687    0.9           56,631           1,761    3.1 Savings accounts                           1,118,523           1,951    0.2          916,480           8,935    1.0          763,714          27,086    3.6 Federal Home Loan Bank advances              112,798           5,312    4.7          121,761           5,478    4.5           88,851           4,342    4.9 Federal funds purchased                            7               -    0.4               87               -    0.3               63               2    3.4                                             1,434,414           8,765     0.6%      1,240,603          17,919     1.4%      1,032,237          38,053     3.7% Non interest-bearing liabilities: Non interest-bearing demand accounts          64,543                                  53,195                                  47,472 Other liabilities                              6,379                                   6,264                                   7,096                                             1,505,336                               1,300,062                               1,086,805 Stockholder's equity                         152,798                                 120,851                                  99,514                                           $ 1,658,134                             $ 1,420,913                             $ 1,186,319   Net interest income                                     $     76,038                            $     65,186                            $     49,919  Net yield on interest-earning assets                                     4.8%                                    4.7%                                    4.4%     

(*) Loans fees included in interest income for fiscal 2010, 2009 and 2008 were $4,985, $6,802 and $6,237, respectively.

  Interest rate trends, changes in the economy and competition and the scheduled maturities and interest rate sensitivity of the loan portfolios and deposits affect the spreads earned by the Bank.  Net interest margin for the fiscal year ended June 30, 2010 was up slightly from the fiscal year ended June 30, 2009 as the rate paid on interest-bearing liabilities was down 80 basis points. The rate received on loans and investments declined by 70 basis points in fiscal 2010 as compared to fiscal 2009.  Net interest margin for the year ended June 30, 2009 was up by 30 basis points from the year ended June 30, 2008 as the rate paid on interest-bearing liabilities was down 230 basis points. The rate received on loans and investments declined by 180 basis points. The Bank instituted interest rate floors on a large percentage of its loan portfolio leading to the increased net interest margin.                                          -45- 

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  The following table sets forth a summary of the changes in the Bank's interest earned and interest paid resulting from changes in volume and rate (in thousands):                                                                 2009 to 2010                                            2008 to 2009                                            Total                    Attributed to                  Total                     Attributed to                                           Change        Volume         Rate           Mix        Change         Volume         Rate            Mix  Interest income:  Loans: Residential - mortgage                   $   (884 )    $  1,288      $ (2,075 )    $    (97)    $   3,054      $  6,563      $  (2,768 )    $   (741) Residential - construction                 (2,842 )      (2,834 )         (12 )           4        (6,846 )      (3,113 )       (4,663 )         930 Commercial - real estate                    4,999         8,305        (2,568 )        (738)        4,326        14,764         (6,521 )      (3,917) Commercial - loans                          1,984         2,934          (689 )        (261)          643         2,720         (1,503 )        (574) Individual                                    (31 )         (12 )         (20 )           1             4            32            (26 )          (2) Land                                       (2,159 )      (1,831 )        (411 )          83        (3,395 )       1,508         (4,375 )        (528) Money market                                   56             -             -            56             -             -              -             - Federal funds sold                            (52 )         401          

(95 ) (358) (2,459 ) (2,112 ) (1,962 ) 1,615 Interest-bearing deposits in banks

           (230 )        (129 )        (227 )         126          (246 )         181           (310 )        (117) Federal reserve funds                         (20 )          96           (54 )         (62)           85             -              -            85 Investments - other                           877           285           (61 )         653           (33 )          74           (159 )          52                                              1,698         8,503        (6,212 )        (593)       (4,867 )      20,617        (22,287 )      (3,197)  Interest expense:  Certificates of deposit                    (1,186 )        (330 )       

(989 ) 133 (1,366 ) (177 ) (1,247 ) 58 Money market accounts

                        (291 )         (30 )        (285 )          24          (677 )         223           (740 )        

(160)

 Interest-bearing demand accounts             (527 )         142          (554 )        (115)       (1,074 )         576         (1,243 )        (407) Savings accounts                           (6,984 )       1,970       

(7,336 ) (1,618) (18,151 ) 5,418 (19,641 ) (3,928) Federal Home Loan Bank advances

              (166 )          18          (308 )         124         1,136         1,671           (408 )        (127) Federal funds purchased                         -             -             -             -            (2 )           1             (2 )          (1)                                             (9,154 )       1,770        (9,472 )      (1,452)      (20,134 )       7,712        (23,281 )      (4,565)  Net interest income                      $ 10,852      $  6,733      $  3,260      $    859     $  15,267      $ 12,905      $     994      $  1,368    Other. Pre-tax loss from the other category was $34.9 million in fiscal 2010 as compared to $45.4 million in fiscal 2009. The change was primarily due to a $6.6 million increase in other revenue and a $6.2 million decrease in other expenses offset by a $3.2 million increase in commissions and other employee compensation. The increase in other revenue was primarily due to a $2.7 million increase in the value of the investments in our deferred compensation plan and a $ 1.3 million gain in fiscal 2010 related to our investment in a venture capital fund as compared to a $2.7 million loss in fiscal 2009. The decrease in other expenses from fiscal 2009 to fiscal 2010 was due primarily to (i) the $5.0 million impairment loss recognized in fiscal 2009 related to our investments in NYX and USHS common stock and (ii) a $875,000 gain recognized in fiscal 2010 when the cost to cancel M.L. Stern, LLC's back office system contract was less than the amount accrued. The increase in compensation expense was due to (i) a $2.3 million increase in the liability associated with our deferred compensation plan, partially offsetting the other revenue increase above; (ii) a $801,000 increase in salaries for our corporate support and information technology employees and (iii) a $517,000 increase in our deferred compensation expense related to our restricted stock plan, due primarily to accelerated vesting of restricted stock for retired directors and individuals no longer employed by us. The increase in salary expense in fiscal 2010 was partially offset by a decrease in incentive compensation in fiscal 2010.  Pre-tax loss from the other category was $45.4 million in fiscal 2009 compared to $37.4 million in fiscal 2008. The variance is due primarily to a decrease in investment income of $3.0 million related to a limited partnership venture capital fund in which we are an investor and a $5.0 million loss associated with the recognition of accumulated losses for our investments in NYX and USHS upon our impairment review.                                          -46- 

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  Table of Contents  FINANCIAL CONDITION  Investments 

The book value of the Bank's investment portfolio at June 30, 2010, 2009 and 2008 was as follows (in thousands):

                                                          2010                  2009           2008 Government-sponsored enterprises                    $87,685    (1)        $ 7,059         $8,717 States of the U.S. and political subdivisions         6,265                 6,237            267                                                      $93,950               $13,296         $8,984     

(1) In February of fiscal 2010, the Bank's excess liquidity was invested in a portfolio of Government National Mortgage Association ("GNMA") securities.

Loans and Allowance for Probable Loan Losses

  The Bank grants loans to customers primarily within Texas and New Mexico. The Bank also purchases loans in the ordinary course of business, 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 contracts is dependent upon the general economic conditions in Texas and New Mexico. Over 85% of the Bank's loans are collateralized with real estate.  The allowance for probable loan losses is increased by charges to income and decreased by charge-offs (net of recoveries). Management's periodic evaluation of the adequacy of the allowance is based on the Bank's past loan loss experience, known and inherent risks in the portfolio, adverse situations that may affect the borrower's ability to repay, the estimated value of any underlying collateral and current economic conditions. In determining the appropriate allowance at the balance sheet date, management evaluates the Bank's historical loss percentage, concentrations of risk in the portfolio, estimated changes in the value of underlying collateral as well as changes in the volume and growth in the portfolio.  Prior to the third quarter of fiscal 2010, the Bank's provision for loan loss computation used a three year rolling average of historical loan losses by product type to assess losses in the Bank's loan portfolio. Product types include 1-4 family residential loans, 1-4 family residential construction loans, land and land development loans, commercial real estate loans, multi family loans, commercial loans and consumer loans. Due to accelerated deterioration of the Bank's loan portfolio, depressed appraised values for collateral, continued high unemployment rates in Texas and deteriorating banking industry loss statistics, the Bank's management reevaluated its use of historical loan losses in its provision for loan loss computation. As a result of this reevaluation, in the third quarter of fiscal 2010, management reduced the historical loan loss look back period from three years to four quarters. This change resulted in a larger loan loss provision in fiscal 2010.  The historical loss ratios are adjusted by an analysis of real estate market deterioration, derived from industry data related to the markets we serve, as well as information from our bank-specific losses related to real estate transactions. We also revise the historic loss ratios upward for concentrations of capital greater than 100% for the product types defined above. At June 30, 2010, our most significant concentration was in commercial real estate. Lastly, we adjust the loss ratios based on growth in the product types as well as problem loan trends within these product types. Consideration of these factors resulted in an upward adjustment of our historical loss ratios over the past year. Our calculation also includes specific allocations arising from our loan impairment analysis.  Certain types of loans, such as option 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 June 30, 2010, the Bank had $6.6 million in junior lien mortgages. These loans represented less than 1% of total loans at June 30, 2010. At June 30, 2010, the Bank did not have any exposure to sub-prime loans and loans with initial teaser rates. At June 30, 2010, the Bank had $18.5 million of single family interest only loans.                                          -47-

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  At June 30, 2010, the Bank's loan portfolio included a total of $42.0 million in loans with a high loan-to-value ratio. High loan-to-value ratios are defined by OTS regulation and range from 75%-90% depending on the type of loan. At June 30, 2010, approximately 40% 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 June 30, 2010, the Bank had eight loans with high loan-to-value ratios that were deemed impaired. The impairment analysis on these loans resulted in a partial charge-off of $36,000 on three loans and no impairment allocation or loss on the remaining five loans. Regulatory guidelines suggest that high loan-to-value ratio loans should not exceed 100% of total capital. At June 30, 2010, the Bank's high loan-to-value ratio loans represented 24% 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 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 until we sell the property. As discussed above, appraisals obtained in the last half of fiscal 2010 appeared to use more conservative discount rates resulting in lower property valuations.  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.  Loans receivable at June 30, 2010, 2009, 2008, 2007 and 2006 are summarized as follows (in thousands):                                      2010                2009                2008               2007              2006 Residential Mortgage loans held for sale                         $     424,055       $     262,780       $     359,945       $   148,013       $   124,874 Mortgage 1-4 first liens           143,755             118,868              74,327            48,130            48,840 Mortgage 1-4 junior liens                                9,040              10,131              11,469             5,831             4,423                                     576,850             391,779             445,741           201,974           178,137  Construction Residential construction            80,463             143,234             189,379           226,587           200,518 Multi family construction                         7,595              21,264               3,406                __                __ Commercial construction             40,495              86,546              54,398            59,469            51,324                                     128,553             251,044             247,183           286,056           251,842  Lot and land development Residential land                    84,669             120,844             111,297           113,955            93,819 Commercial land                     36,414              38,873              60,004            37,697            31,535                                     121,083             159,717             171,301           151,652           125,354  Commercial real estate             514,930             428,602             290,626           184,540           143,635 Multi family                        75,408              50,340              31,641             5,081             5,588 Commercial loans                   191,745             129,818             101,598            75,407            63,352 Consumer loans                       4,692               4,813               4,549             4,837             4,554                                   1,613,261           1,416,113           1,292,639           909,547           772,462 Allowance for probable loan loss (excluding loans held for sale)                          (35,141)            (14,731)             (6,936)           (5,497)           (5,047)                               $   1,578,120       $   1,401,382       $   1,285,703       $   904,050       $   767,415                                            -48- 

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The following table shows the scheduled maturities of certain loans at June 30, 2010, and segregates those loans with fixed interest rates from those with floating or adjustable rates (in thousands):

                                               1 year            1-5          Over 5                                             or less          years          years           Total  Commercial real estate                     $   100,788    $   304,862    $   184,688      $   590,338 Commercial loans                               108,239         56,400         27,106          191,745 Real estate loans                               85,166         15,854         27,533          128,553  Total                                      $   294,193    $   377,116    $   239,327      $   910,636   Amount of loans based upon: Floating or adjustable interest rates      $   279,016    $   297,339    $   179,731      $   756,086 Fixed interest rates                            15,177         79,777         59,596          154,550  Total                                      $   294,193    $   377,116    $   239,327      $   910,636    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 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 loans with respect to which ultimate full collection is likely. For loans where ultimate collection is not likely, we apply interest payments to the outstanding principal and we recognize income only if full payment is made. Potential problem loans are substandard loans that are not considered non-performing but where information known by management indicates that the borrower may be unable to comply with present terms.                                          -49- 

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Non-performing assets and potential problem loans as of June 30, 2010, 2009, 2008, 2007 and 2006 are as follows (dollars in thousands):

                                      2010              2009              2008              2007              2006 Loans accounted for on a non-accrual basis 1-4 family                      $    6,065        $    3,582        $    1,797        $    1,064        $   1,546 Lot and land development             8,776             8,867             8,741             1,714              109 Multi family                         2,394                 -                 -             4,758                3 Residential construction             3,809             4,342             5,098             5,616              788 Commercial real estate              16,911            10,006             2,340             5,012            1,357 Commercial loans                       462             3,283               674               942              309 Consumer loans                          11                19                12                31                3                                      38,428            30,099            18,662            19,137            4,115   Non-performing loans as a percentage of total loans             2.4%              2.2%              1.5%              2.1%             0.6%  Loans past due 90 days or more, not included above 1-4 family                              29                 -                65                32              332 Residential construction                 -               670                 -                 -                - Commercial loans                         -                 -               268                 -                - Consumer loans                           -                 -                 2                 -                2                                  $       29        $      670        $      335        $       32        $     334   REO: 1-4 family                      $    5,862        $      463        $       82        $       52        $     309 Lot and land development            19,565             8,346             2,304                 -                - Residential construction             7,673             7,947            10,038             1,353              255 Commercial real estate              11,150             8,412             1,758               220            1,221 Commercial loans                       612               133                37               806                -                                  $   44,862        $   25,301        $   14,219        $    2,431        $   1,785 Other repossessed assets ("ORA")                              1,332                 -                 -                 -                - Troubled debt restructuring                        9,009                 -                 -                 -                -  Non-performing assets           $   93,660        $   56,070        $  

33,216 $ 21,600 $ 6,234

   Non-performing assets as a percentage of total assets                                5.3%              3.6%              2.5%              2.0%             0.8%   

Potential problem loans $ 98,096 $ 24,948 $ 8,730 $ 2,903 $ 8,629

    Approximately $1.2 million, $1.3 million and $781,000 of gross interest income would have been recorded in fiscal 2010, 2009 and 2008, 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 fiscal 2010, 2009 and 2008 totaled approximately $842,000, $817,000 and $582,000, respectively.  Bank management is in the process of hiring and allocating additional resources to manage the growth in REO and non-performing assets. Management is preparing an asset-by-asset plan for these asset categories to reduce these loans and properties expeditiously. Reduction of these asset classes may have a material impact on future results of operations.                                          -50-

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The following table presents an analysis of REO for the fiscal years ended June 30, 2010, 2009, 2008, 2007 and 2006 (in thousands):

                                  2010                2009                2008                2007               2006 Balance at beginning of period                   $   25,301          $   14,219          $    2,431          $   1,785          $   2,027  Foreclosures                    55,649              27,839              21,206              3,145              3,999 Sales                          (30,757)            (16,291)             (9,693)            (2,421)            (3,308) Write-downs                     (5,522)             (1,136)               (283)              (101)              (534) Other                              191                 670                 558                 23               (399)  Balance at end of period                      $   44,862          $   25,301          $   14,219          $   2,431          $   1,785   

The following table presents the Bank's non-performing assets as of June 30, 2010 by year of origination (in thousands):

                                       Non-                                              Troubled                                  Performing                                             Debt       Year Originated              Loans              REO              ORA          Restructuring          Total   Fiscal 2006 or prior           $     10,596      $    12,784      $        -      $        4,415      $    27,795   Fiscal 2007                           6,763            6,801           1,219               4,253           19,036   Fiscal 2008                          16,304           20,368               -                  __           36,672   Fiscal 2009                           4,176            4,418             113                 341            9,048   Fiscal 2010                             618              491               -                   -            1,109  Total                            $     38,457      $    44,862      $    1,332      $        9,009      $    93,660    An analysis of the allowance for probable loan losses for the fiscal years ended June 30, 2010, 2009, 2008, 2007 and 2006 is as follows (dollars in thousands):                                             2010                2009                2008              2007              2006 Balance at beginning of year          $   14,731          $    6,936          $   5,497          $ 5,047          $   7,450 Continuing operations: Charge-offs: Construction                               3,788                 635              1,134                -                 45 Lot and land development                   5,841               1,225                337                -                  - Residential mortgage                       2,617                 708                 23                -                 46 Commercial real estate                     9,823               2,116                 27              224                 50 Multi family                               2,391                   -                  -                -                  - Commercial loans                           1,796                 965                619              131                318 Consumer loans                                28                  76                 17               31                  3  Total charge-offs                         26,284               5,725              2,157              386          $     462   Recoveries: Construction                                  15                   -                  -               10                  - Lot and land development                   1,398                 155                  -                8                  - Residential mortgage                         122                   1                  -                -                  - Commercial real estate                         8                   -                  4               11                  - Commercial loans                              30                  41                 47              154                 70 Consumer loans                                 3                   -                  -                2                  -  Total recoveries                           1,576                 197                 51              185                 70   Net charge-offs                          (24,708)             (5,528)            (2,106)            (201)              (392) Additions charged to operations           45,118              13,323              3,545              651              1,624                                            20,410               7,795              1,439              450              1,232                                            -51- 

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  Table of Contents                                      2010                2009                2008               2007               2006 Discontinued operations: Provision for loan losses         $      -            $      -            $     -            $     -            $    5,877 Loans charged to the allowance, net                           -                   -                  -                  -                (5,781) Sale of FSB Financial                    -                   -                  -                  -                (3,731)                                           -                   -                  -                  -                (3,635)  Balance at end of year            $   35,141          $   14,731          $   6,936          $   5,497          $    5,047  Ratio of net charge-offs during the period to average loans outstanding during the period                        1.72%               0.42%              0.20%              0.02%               0.1%    The increase in the allowance for probable loan losses from fiscal year 2009 to fiscal year 2010 is due to several factors, including the continued deterioration in the real estate market in North Texas as well as the continued uncertainty in the U.S. economy. We believe it was appropriate to use the top range of our loan loss calculation to adequately reflect current market conditions. See further discussion regarding the calculation of our provision for loan loss in Note 1(j) in the Notes to the Consolidated Financial Statements contained in this report.  With the continued challenging economic environment and high unemployment, the Bank frequently reviews and updates its processes and procedures surrounding extension of credit, allowance for loan loss computation and internal asset review and classification. 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 classify existing loans as performing loans. The Bank is also updating appraisals more frequently, even on performing loans, and such appraisals serve as an early indicator of loan deterioration. These actions have led to increases in non-performing assets and the loan loss allowance in fiscal 2010 and are likely to continue to lead to increases in non-performing assets and the loan loss allowance during fiscal 2011.  

As a result of the current economic environment, the Bank has significantly limited the growth of its loan portfolio in the first quarter of fiscal 2011 in order to allocate the time, resources and capital necessary to support the existing loan portfolio.

  The allowance for probable loan losses is applicable to the following types of loans as of June 30, 2010, 2009, 2008, 2007 and 2006 (dollars in thousands):                                                 2010                       2009                       2008                      2007                       2006                                                   Percent                    Percent                   Percent                   Percent                   Percent                                                   of loans                   of loans                  of loans                  of loans                  of loans                                                   to total                   to total                  to total                  to total                  to total                                        Amount      loans          Amount      loans         Amount      loans         Amount      loans         Amount      loans  Construction                           $  3,362       8.0  %      $  1,184      17.7  %      $   901      19.1  %      $ 1,131      31.4  %      $ 1,578     32.6 % Lot and land development                  4,808       7.5            1,719      11.3           1,022      13.3           1,293      16.7             959    16.2 Residential mortgage                      3,542      35.8            1,633      27.7             602      34.5             229      22.2             340    23.1 Commercial real estate                   19,733      31.9            8,115      30.3           3,331      22.4           1,845      20.3           1,118    18.6 Multi family                                812       4.6              765       3.5             224       2.4              14       0.6             279     0.7 Commercial loans                          2,853      11.9            1,269       9.2             814       7.9             958       8.3             752     8.2 Consumer loans                               31       0.3               46       0.3              42       0.4              27       0.5              21     0.6                                         $ 35,141     100.0  %      $ 14,731     100.0  %      $ 6,936     100.0  %      $ 5,497     100.0  %      $ 5,047    100.0 %    At June 30, 2010, over half 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 only represented approximately 32% of its total loan portfolio. Because commercial real estate loans tend to be individually larger than residential loans, deterioration in this portfolio leads to more volatility in our earnings.                                          -52- </pre>
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  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 the deposits for fiscal years 2010, 2009 and 2008 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 $34.2 million and $31.4 million certificates of deposit of $100,000 or greater at June 30, 2010 and 2009, respectively. In April 2009, the Bank began classifying the deposits from SWS' brokerage customers as core deposits based on an advisory opinion from the FDIC. The Bank is funded primarily by these deposits. These core deposits provide the Bank with a stable and low cost funding source. The Bank also utilizes short-and long-term FHLB borrowings to match long-term fixed rate loan funding. At June 30, 2010, the Bank had $1,282.2 million in funds on deposit from customers of Southwest Securities, representing approximately 92% of the Bank's total deposits, and $132.8 million of FHLB borrowings. Core deposits have reduced the Bank's reliance on short-term borrowings from the FHLB and brokered certificates of deposit.  
Short Term Borrowings and Advances from Federal Home Loan Bank
This table represents short term borrowings and advances from the FHLB which were due within one year (generally two to seven days) during the 12-month periods ended June 30, 2010, 2009 and 2008 (dollars in thousands):
                                            2010                          2009                         2008                                               Interest                     Interest                     Interest                                   Amount        Rate           Amount        Rate           Amount        Rate   At June 30                       $  33,714       1.55  %      $   5,579       4.95  %      $  71,056       2.33  %  Average during year                  7,871       4.76  %         15,989       1.96  %         12,006       2.75  %  Maximum month-end balance during year                         33,714          -           101,769          -           175,074          -  
LIQUIDITY AND CAPITAL RESOURCES
Secondary Offering
  On October 16, 2009, we filed a shelf registration statement with the SEC providing for the sale of $150.0 million of our securities. On December 9, 2009, the company closed a public offering of 4,347,827 shares of its common stock at a price of $11.50 per share. On December 16, 2009, the underwriters for the public offering exercised their option to purchase 652,174 additional shares of our common stock to cover over-allotments. We generated net proceeds, after deducting underwriting discounts and commissions, of approximately $54.3 million from these offerings. To date, we have invested $47.5 million of the net proceeds as a $27.5 million capital contribution to the Bank and a $20.0 million capital contribution to Southwest Securities.  
Brokerage
  A substantial portion of our assets are highly liquid in nature and consist mainly of cash or assets readily convertible into cash. Our equity capital, short-term bank borrowings, interest bearing and non-interest bearing client credit balances, correspondent deposits and other payables finance these assets. We maintain an allowance for doubtful accounts 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.                                          -53-
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  Short-Term Borrowings. At June 25, 2010, 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 $50.0 million revolving credit facility each of which is described below.  Broker Loan Lines. At June 25, 2010, we had uncommitted broker loan lines of up to $300.0 million. We have not received notification from the banks indicating a change in the amount of our broker loan lines since June 2009. These lines of credit are used primarily to finance securities owned, securities held for correspondent broker/dealer accounts, and receivables in customers' margin accounts. These lines may also be used to release pledged collateral against day loans. These credit arrangements are provided on an "as offered" basis and are not committed lines of credit. These arrangements can be terminated at any time by the lender. Any outstanding balances under these credit arrangements are due on demand and bear interest at rates indexed to the federal funds rate. At June 25, 2010, the amount outstanding under these secured arrangements was $110.0 million, which was collateralized by securities held for firm accounts valued at $167.6 million. Our ability to borrow additional funds is limited by our eligible collateral. See additional discussion under "Item 1A. Risk Factors."  At June 25, 2010, we had $250,000 under unsecured letters of credit, pledged to support our open positions with securities clearing organizations. These letters of credit have a 1% commitment fee and are renewable semi-annually at our option.  At June 25, 2010, we had a $143,000 unsecured letter of credit issued for a sub-lease to the sub-lessee of space previously occupied by a former subsidiary. This letter of credit bears a 1% commitment fee and is renewable annually at our option.  
At June 25, 2010, we had a $500,000 unsecured letter of credit pledged to support our underwriting activities. This letter of credit bears a 1% commitment fee and is renewable annually at our option.
  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 June 25, 2010, there were no amounts outstanding on this line other than the $893,000 under unsecured letters of credit described above. At June 25, 2010, we had $19.1 million available for borrowing under this line of credit.  Letter of Credit Agreement. At June 25, 2010, we have an irrevocable letter of credit agreement aggregating $55.0 million pledged to support our open options positions with an options clearing organization. The letter of credit bears interest at the brokers' call rate (0.5% at June 25, 2010), if drawn, and is renewable semi-annually. This letter of credit is fully collateralized by marketable securities held in client and non-client margin accounts with a value of $80.9 million at June 25, 2010.  Revolving Credit Facility. On January 29, 2010, Southwest Securities entered into an agreement with an unaffiliated bank for a $50.0 million committed revolving credit facility. The facility includes up to $15.0 million in unsecured credit. The commitment fee is 37.5 basis points per annum and, when drawn, the interest rate is equal to the federal funds rate plus 75 basis points. The agreement requires Southwest Securities to maintain tangible net worth of at least $150.0 million. As of June 25, 2010, there were no amounts outstanding under this committed revolving credit facility.  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 the 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 Note 17 in the Notes to the Consolidated Financial Statements contained in this report.  
Banking
  Liquidity is monitored daily to ensure the Bank's ability to support asset growth, meet deposit withdrawals, maintain reserve requirements and otherwise sustain operations. The Bank's liquidity is maintained in the form of readily marketable loans and investment securities, balances with the FHLB, federal funds sold to correspondent banks and vault cash. At June 30, 2010, the Bank had net borrowing capacity from the FHLB of $373.9 million. In addition, at June 30, 2010, the Bank had a $30.0 million federal funds agreement and the ability to borrow up to $96.2 million in funds from the Dallas Federal Reserve Bank, each of which is described below.                                          -54-
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  The Bank has an agreement with an unaffiliated bank for a $30.0 million unsecured line of credit for the purchase of federal funds with a floating interest rate. The unaffiliated bank is not obligated by this agreement to sell federal funds to the Bank. The agreement is used by the Bank to support short-term liquidity needs. At June 30, 2010, there were no amounts outstanding on this line of credit.  In the second quarter of fiscal 2010, the Bank entered into a secured line of credit agreement with the Dallas Federal Reserve Bank. 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 25 basis points over the federal funds target rate. This line is used to support short-term liquidity needs, and at June 30, 2010, the Bank had $96.2 million available for borrowing and no amount outstanding.  
Management believes that the Bank's current assets and available liquidity are adequate to meet its current and future liquidity needs.
  The Bank's asset and liability management policy is intended to manage interest rate risk. The Bank accomplishes this through management of the 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-Banking.") At June 30, 2010, $1,282.2 million of the Bank's deposits were from the brokerage customers of Southwest Securities. Current events in the securities and banking 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 565 and 12 CFR 567) to risk-weighted assets (as defined) and of Tier I (core) capital (as defined) to adjusted assets (as defined). Effective July 31, 2010, the Bank entered into a MOU with the OTS. The MOU provides that the Bank will maintain a Tier I (core) capital ratio of 8% and a total risk based capital ratio of 12%. The OTS may require the Bank to apply another measurement of risk-weight or capital ratio that the OTS deems appropriate.  The Bank has historically met all the capital adequacy requirements to which it is subject and as of June 30, 2010, the Bank was considered "well capitalized" under the regulatory framework for prompt corrective action. To be categorized as "well capitalized," the Bank must maintain minimum total risk-based, Tier I risk-based and Tier I (core) capital ratios. Should the Bank not meet these minimums or should the OTS determine that levels in excess of the minimums are necessary, certain mandatory and discretionary supervisory actions (as defined in 12 CFR 565.6) 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 24 in the Notes to Consolidated Financial Statements contained in this report.                                          -55-
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Contractual Obligations and Contingent Payments
                                                                         Payments Due (in thousands)                                  Less than 1                                 More than                                     Total           year        1-3 years     3-5 years      5 years       Other (6 )  Long-term debt (1)                $    99,107    $         -    $    9,376    $   48,050    $   41,681    $       - Interest on long-term debt (2)         35,812          4,873         8,201         5,018        17,720            - Certificates of deposit                73,097         51,846        12,081         9,170             -            - Uncertain tax positions                 1,121              -             -             -             -        1,121 Other leases (3)                       56,347          9,908        16,068        11,736        18,635            - Investment commitments (4)              2,600          2,600             -             -             -            - Purchase obligations                   14,523          9,735         4,647           141             -            - Deferred compensation (5)               5,257            848         1,462         1,427         1,520            - Scholarship endowment                     700              -             -             -             -          700  Total                             $   288,564    $    79,810    $   51,835    $   75,542    $   79,556    $   1,821     
(1) Long-term debt is comprised of advances from the FHLB with maturities greater than one year.
(2)Amount of interest payable on the advances from the FHLB is based on rates ranging from 0.17% to 6.8%.
(3) Of the $56,347 in lease commitments, approximately $329 has been reserved for impairment.
(4) Of the $2,600 in investment commitments, $600 has been accrued in the financial statements due to a notice of a commitment call to be paid in September 2010.
  (5 ) We have commitments to our employees for deferred compensation in the amount of $5,257 that become payable in future fiscal years as defined by the plan and determined by participants who have formally requested payment of their plan balances. See Note 18 in the Notes to the Consolidated Financial Statements contained in this report.  
(6) Due date cannot be estimated. See Note 1(p) in the Notes to the Consolidated Financial Statements contained in this report.
Cash Flow
  Net cash used in operating activities totaled $259.5 million in fiscal 2010 and $197.7 million in fiscal 2008. In fiscal 2009, net cash provided by operating activities totaled $226.7 million. In fiscal 2010, operating cash flow was primarily used to increase investment in (i) loans held for sale at the Bank, (ii) securities inventories in broker/dealer accounts and (iii) net receivables from clients.  
The largest drivers of the increase in cash provided by operating activities from fiscal 2008 to fiscal 2009 were:
   •   reduced investment in loans held for sale at the Bank in fiscal 2009 versus
       fiscal 2008;       •   reduced inventory of securities owned; and       •   an increase in securities sold not yet purchased.   Net cash used in investing activities was $172.4 million, $253.4 million and $201.1 million in fiscal 2010, 2009 and 2008, respectively. The primary reason for the use of cash in investing activities in fiscal 2010 was a $116.4 million increase in the net amount invested in loans at the Bank and a $83.4 million investment by the Bank in GNMA's. The primary reason for the increase in cash used in investing activities from fiscal 2008 to fiscal 2009 was an increase in the net amount invested in loans at the Bank of $54.2 million in fiscal 2009.                                          -56- 
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  Net cash provided by financing activities totaled $362.9 million, $83.3 million and $309.7 million in fiscal 2010, 2009 and 2008, respectively. The primary reasons for the increase in the cash provided by financing activities in fiscal 2010 was the receipt of funds from our common stock offering, an increase in net short-term borrowings in the brokerage business and a decrease in the net amount paid to the FHLB. In fiscal 2009, the decrease in cash provided by financing activities was primarily due to decreased borrowings from banks and the FHLB.  We expect that cash flows provided by operating activities as well as short-term borrowings will be the primary source of working capital for the next fiscal year.  Treasury Stock  Periodically, we repurchase our shares of common stock under a plan approved by our Board of Directors. In August 2009, the Board of Directors of SWS Group approved a plan authorizing the company to repurchase up to 500,000 shares of its common stock from time to time in the open market for an 18-month time period ending on February 28, 2011. During fiscal 2010, no shares of common stock were repurchased under this program.  On November 27, 2009, the stockholders of SWS Group voted to increase the authorized number of shares of common stock available for issuance under our deferred compensation plan from 375,000 shares to 675,000 shares. 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 by us. During fiscal year 2010, the plan purchased 34,999 shares of common stock at a cost of $472,000, or $13.50 per share. During fiscal 2010, 5,575 shares were sold or distributed pursuant to the plan. See "Item 5. Market for Registrant's Common Equity, Related Stockholder Matters and Issuer Purchases of Equity Securities."  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 fiscal 2010, we repurchased 36,680 shares of common stock with a market value of approximately $513,000, or an average of $13.97 per share, to cover tax liabilities.  
Inflation
  The company's 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. However, changes in inflation do not materially impact our overall net income.  
RISK MANAGEMENT
  We manage risk exposure through the involvement of various levels of management. We establish, maintain and regularly monitor maximum 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.  
Credit Risk
  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 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.                                          -57-
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  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 implemented extensive policies and procedures to provide a robust process for proactively managing credit risk. These policies and procedures include underwriting guidelines, credit and collateral tracking and detailed loan approval procedures which include officer and director loan committees. The Bank also maintains a detailed loan review process to monitor the quality of the loan portfolio. The Bank grants loans to customers primarily within Texas and New Mexico. The Bank also purchases loans, which have been originated in other areas of the United States. Although the Bank has a diversified loan portfolio, a substantial portion of its debtors' ability to honor their contracts is dependent upon the general economic conditions 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 are reliant on the ability of our employees and systems to process large numbers of transactions. In order to mitigate and control operational risk, we have developed and continue to enhance specific policies and procedures that are designed to identify and manage operational risk at appropriate levels. We also use periodic self-assessments and internal audit examinations as further reviews of the effectiveness of our controls and procedures in mitigating our operational risk.  
Legal Risk
  Legal risk includes the risk of non-compliance with applicable legal and regulatory requirements. We are subject to extensive regulation in the different jurisdictions in which we conduct business. We have established procedures based on legal and regulatory requirements that are designed to reasonably ensure compliance with all applicable statutory and regulatory requirements. We also have established procedures that are designed to ensure that executive management's policies relating to conduct, ethics and business practices are followed. In connection with our business, we have various procedures addressing significant issues such as regulatory capital requirements, sales and trading practices, new products, use and safekeeping of customer funds and securities, granting credit, collection activities, money laundering, privacy and record keeping.  Market Risk  Market risk generally represents the risk of loss that may result from the potential change in value of a financial instrument as a result of fluctuations in interest rates, 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 activities and securities lending activities.  
Interest Rate Risk
  Brokerage. Interest rate risk is a consequence of maintaining inventory positions and 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 rate movements and aids in stabilizing positive interest spreads. We strive to structure our balance sheet as a natural hedge by matching floating rate assets with variable short term funding and by matching fixed rate liabilities with similar longer term fixed rate assets. The Bank has established percentage change limits in both interest margin and net portfolio value. To verify that the Bank is within the limits established for interest margin, the Bank prepares an analysis of net interest margin based on various shifts in interest rates. To verify that the Bank is within the limits established for net portfolio value, the Bank analyzes data prepared by the OTS for interest rate sensitivity of the Bank's net portfolio. These analyses are conducted on a quarterly basis for the Bank's Board of Directors.                                          -58- 
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The following table illustrates the estimated change in net interest margin based on shifts in interest rates ranging from positive 300 basis points to negative 100 basis points:
     Hypothetical Change in Interest Rates   Projected Change in Net Interest Margin                  +300                             6.19%                  +200                             3.55%                  +100                             0.89%                    0                                0%                   -50                            -5.36%                  -100                           -10.82%   The following GAP Analysis table indicates the Bank's interest rate sensitivity position at June 30, 2010:                                                               Repricing Opportunities            (in thousands)                 0-6 months        7-12 months      1-3 years        3+ years  Earning assets: Loans-gross                             $   1,381,473      $   31,672       $   51,762     $   148,354 Securities and FHLB stock                       6,810               -                -          87,140 Interest-bearing deposits                       6,532               -                -               -  Total earning assets                        1,394,815          31,672           51,762         235,494   Interest-bearing liabilities: Transaction accounts and savings            1,335,117               -                -               - Certificates of deposit                        33,342          18,505           12,081           9,169 Borrowings                                     27,568           6,146           25,222          73,885 
Total interest-bearing liabilities          1,396,027          24,651      
    37,303          83,054   GAP                                     $     (1,212)      $    7,021       $   14,459     $   152,440  Cumulative GAP                          $     (1,212)      $    5,809       $   20,268     $   172,708   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 market value" net of "Securities sold, not yet purchased, at market 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 June 25, 2010 (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             $      136    $    11,278       $   14,339       $    84,074       $   109,827 Auction rate municipal bonds               -              -                -            22,298            22,298  U.S. government and government agency obligations         10,184        (23,898 )         (7,043 )          (5,051 )         (25,808) Corporate obligations                  5,566         14,064            8,047            22,300            49,977  Total debt securities                 15,886          1,444           15,343           123,621           156,294 Corporate equity                           -              -                -            11,809            11,809                                           -59- 
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  Table of Contents                                                                       Years to Maturity                                        1 or less          1 to 5         5 to 10          Over 10           Total  Other                                        9,890              __              __               __            9,890                                          $   25,776      $    1,444      $   15,343      $   135,430      $   177,993   Assets segregated for regulatory purposes                                $       __      $   62,167      $       __      $        __      $    62,167   Weighted average yield Municipal obligations                         2.02 %          2.22 %          3.63 %           5.83 %            5.17% Auction rate municipal bonds                    __              __              __             0.91 %            0.91% U.S. government and government agency obligations                            0.38 %          1.00 %          2.86 %           4.32 %            1.75% Corporate obligations                         2.74 %          3.49 %          4.70 %           7.34 %            4.82%  Assets segregated for regulatory purposes                                        __            0.81 %            __               __              0.81%  Available-for-sale securities, at fair Value Securities available for sale           $    1,146      $       __      $   
    __      $       242      $       1,338
CRITICAL ACCOUNTING POLICIES AND ESTIMATES
  The preparation of financial statements in accordance with accounting principles generally accepted in the U.S. requires management to make estimates and assumptions that affect reported amounts and disclosures. Actual results may differ from these estimates under different assumptions or conditions. The following policies involve a higher degree of judgment than do our other significant accounting policies detailed in Note 1 in the Notes to the Consolidated Financial Statements contained in this report.  
Fair Value
We adopted the fair value accounting standard of the Financial Accounting Standards Board ("FASB") effective June 28, 2008. Fair value accounting establishes a framework for measuring fair value and expands disclosures about fair value measurements.
  Under fair value accounting, fair value refers to the price that would be received to sell an asset or paid to transfer a liability in an orderly transaction between market participants in the market in which the reporting entity transacts. The standard clarifies the principle that fair value should be based on the assumptions market participants would use when pricing the asset or liability. In support of this principle, the standard establishes a fair value hierarchy that prioritizes the information used to develop those assumptions. The fair value hierarchy gives the highest priority to quoted prices in active markets and the lowest priority to unobservable data. Under the standard, fair value measurements are separately disclosed by level within the fair value hierarchy. The standard describes three levels of inputs that may be used to measure fair value:      •    Level 1 - Quoted prices in an active market for identical assets or        liabilities. Assets and liabilities utilizing Level 1 inputs include the        following: a) our investment in USHS common stock; b) our deferred
       compensation plan's investment in Westwood common stock; c) the company's
       government guaranteed bonds purchased under the TLGP; and d) certain
       inventories held in our securities owned and securities sold, not yet
       purchased portfolio. Valuation of these instruments does not require a high
       degree of judgment as the valuations are based on quoted prices in active
       markets that are readily available.                                           -60- 
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  •    Level 2 - Observable inputs other than Level 1 prices, such as quoted prices
       for similar assets or liabilities; quoted prices in markets that are not        active; or other inputs that are observable or can be corroborated by        observable market data for substantially the full term of the assets or        liabilities. Assets and liabilities utilizing Level 2 inputs certain        inventories held in our securities owned and securities sold, not yet
       purchased portfolio. These financial instruments are valued by quoted prices
       that are less frequent than those in active markets or by models that use
       various assumptions that are derived from or supported by data that is
       generally observable in the marketplace. Valuations in this category are
       inherently less reliable than quoted market prices due to the degree of
       subjectivity involved in determining appropriate methodologies and the
        applicable observable market underlying assumptions.       •    Level 3 - Unobservable inputs that are supported by little or no market
       activity and that are significant to the fair value of the assets and
       liabilities. Assets and liabilities utilizing Level 3 inputs include certain
       inventories held in our securities owned and securities sold, not yet
       purchased portfolio. These financial instruments have significant inputs
       that cannot be validated by readily determinable market data and generally
       involve considerable judgment by management. Our Level 3 assets represented
       8% of our total assets measured at fair value at June 25, 2010. No
       liabilities were categorized within Level 3 at June 25, 2010.
   The availability of observable inputs can vary for different assets. Fair value is a market-based measure; therefore, when market observable inputs are not available, our judgment is applied to reflect those judgments that we believe a market participant would use in valuing the same asset or liability. We use prices and inputs that are current as of the measurement date even in periods of market disruption or illiquidity. Greater judgment in valuation is required when inputs are less observable or unobservable in the marketplace and judgment must be applied in determining the appropriateness of available prices, particularly in assessing whether available data reflects current prices and/or reflects the results of recent market transactions. The valuation of financial instruments classified in Level 3 of the fair value hierarchy involves the greatest amount of management judgment.  Valuation Process for Financial Instruments. Financial instruments are valued at quoted market prices, if available. For financial instruments that do not have readily determinable fair values through quoted market prices, the determination of fair value is based upon consideration of available information including current financial information, fair values of underlying financial instruments and quotations for similar instruments. Certain financial instruments have bid and ask prices that can be observed in the marketplace. For financial instruments whose inputs are based on bid-ask prices, mid-market pricing is applied and adjusted to the point within the bid-ask range that meets our best estimate of fair value.  The valuation process for financial instruments may include the use of valuation models and other techniques. Management makes adjustments to valuations derived from valuation models based on a number of factors, including but not limited to, the size of the position in the financial instrument in a non-active market, the features of the financial instrument such as its complexity, the market in which the financial instrument is traded or if a financial instrument is subject to sales restrictions that would result in a price less than the quoted market price. Adjustments from the price derived from a valuation model reflect management's judgment that other participants in the market for the financial instrument would consider the same factors in valuing the financial instrument.  Management makes assumptions about risk, uncertainties and market conditions in preparing adjustments to prices derived from a valuation model. Results from valuation models and valuation techniques in one period may not be indicative of future period fair value measurements.  Certain financial instruments and other assets trade infrequently and therefore have outdated market prices. As a result, we may use alternative valuation models as methods for determining fair value of these assets. When using alternative valuation techniques or valuation models, the following techniques are applied to different financial instrument classes:    
    •    Municipal auction rate securities are valued using an internal methodology
         based on projected cash flows discounted for lack of liquidity for the          securities; and                                           -61- 
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    •    Non-agency mortgage-backed and other asset-backed securities are valued by
         benchmarking to yields from market prices for comparable securities and
         calibrated based on expected cash flow characteristics of the underlying
         assets;
The following is a description of the valuation methodologies used for instruments measured at fair value on a recurring basis and recognized in the accompanying balance sheet, as well as the general classification of such instruments pursuant to the valuation hierarchy.
  Assets Segregated for Regulatory Purposes. Because quoted market prices are available in an active market, these securities are classified within Level 1 of the valuation hierarchy. These securities include government guaranteed bonds purchased under the TLGP.  Securities Available for Sale. Because quoted market prices are available in an active market, these securities are classified within Level 1 of the valuation hierarchy. These securities include our investments in USHS common stock and our deferred compensation plan's investment in Westwood common stock.  Securities Owned and Securities Sold, Not Yet Purchased Portfolio. Securities classified as Level 1 securities primarily consist of financial instruments whose value is based on quoted market prices such as corporate equity securities and U.S. government obligations.  Securities classified as Level 2 securities include financial instruments that are valued using models or other valuation methodologies. These models are primarily industry standard models that consider various assumptions, including time value, yield curve, volatility factors, current market and contractual prices for the underlying financial instruments, as well as other relevant economic measures. Substantially all of these assumptions are observable in the marketplace, can be derived from observable data or are supported by observable levels at which transactions are executed in the marketplace. Securities in this category include corporate debt, certain U.S. government and government agency obligations and municipal obligations.  Securities classified as Level 3 securities include securities whose fair value is estimated based on internally developed models or methodologies utilizing significant inputs that are generally less readily observable. Included in this category are certain corporate equity securities and municipal auction rate securities.  We had $1.0 million in unrealized losses for these Level 3 securities for the fiscal year ended June 25, 2010. Certain corporate equity securities, valued at $1.8 million, were categorized as Level 3 as these securities were valued based on an inactive market for which there were no observable inputs. These positions were not material to our total portfolio. At June 25, 2010, we had one auction rate bond position categorized as a Level 3 security for which there was not an active trading market. This position was valued at 95.7% of par as of June 25, 2010, which management believes was representative of the price market participants would pay. Management believes that a valuation of this position is indicative of fair market value due to auction failures and the current lack of liquidity in this investment. Also, our internal discounted cash flow valuation methodology supported a valuation at 95.7% of par. At June 25, 2010, this position had a calculated rate of return of 1% per annum. Based on discussions with the issuer of the bonds, it is our understanding that the entity plans to refinance its debt once interest rates rise. However, there can be no certainty that this refinancing will occur. As such, we expect to receive full value on these bonds.                                          -62- 
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Contingencies
  Accounting for contingencies requires the use of judgment and estimates in assessing the magnitude of the exposure and the likely outcome of the situation. In many cases, the outcome will be determined by third parties, which may include governmental or judicial bodies. The provisions made in our consolidated financial statements, as well as the related disclosures, represent management's best estimates of the current status of such matters and their potential outcome based on a review of the facts and, when warranted, in consultation with outside legal counsel. Management evaluates and revises its estimates on a quarterly basis. Adverse legal or arbitration judgments, inability to collect receivables, sudden declines in the market value of securities held in margin accounts or other actions could result in material changes to the estimates recorded in these financial statements. Resolution of these matters in amounts different from what has been accrued in the consolidated financial statements could materially impact our financial position and results of operations.  
Long-Lived Assets, Goodwill and Intangibles
  Our long-lived assets are subject to impairment testing if specific events warrant the review. Our goodwill and intangibles are subject to at least annual impairment testing. The impairment tests are based on determining the fair value of the specified reporting units. Judgment is required in assessing the effects of external factors, including market conditions, and projecting future operating results. These judgments and assumptions could materially change the value of the specified reporting units and, therefore, could materially impact our consolidated financial statements. If actual external conditions and future operating results differ from management's judgments, impairment charges may be necessary to reduce the carrying value of these assets to the appropriate fair value.  
Allowance for Probable Loan Losses
  We provide an allowance for probable loan losses. The allowance for loan losses is established through a charge to earnings. Loan losses are charged against the allowance when management believes the uncollectability of a loan balance is confirmed. Subsequent recoveries, if any, are credited to the allowance. Should actual losses differ from management's estimates, our consolidated financial statements could be materially impacted.  The allowance for loan losses is evaluated on a regular basis by management and is based upon management's periodic review of the collectability of the loans in light of historical experience, the nature and volume of the loan portfolio, adverse situations that may affect the borrower's ability to repay, estimated value of any underlying collateral and prevailing economic conditions. This evaluation is inherently subjective, as it requires estimates that are susceptible to significant revision as more information becomes available.  The Bank's allowance for loan losses consists of three elements: (i) specific valuation allowances established for probable losses on specific loans; (ii) historical valuation allowances calculated based on historical loan loss experience for similar loans with similar characteristics and trends; and (iii) unallocated general valuation allowances determined based on general economic conditions and other qualitative risk factors both internal and external to the Bank.  A loan is considered impaired when, based on current information and events, it is probable that the Bank will be unable to collect the scheduled payments of principal or interest when due according to the contractual terms of the loan agreement. Factors considered by management in determining impairment include payment status, collateral value, and the probability of collecting scheduled principal and interest payments when due. Loans that experience insignificant payment delays and payment shortfalls generally are not classified as impaired. Management determines the significance of payment delays and payment shortfalls on a case-by-case basis, taking into consideration all of the circumstances surrounding the loan and the borrower, including the length of the delay, the reasons for the delay, the borrower's prior payment record, and the amount of the shortfall in relation to the principal and interest owed.                                          -63-
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Income Tax Accrual and Allowance for Deferred and Tax Assets
  We operate in multiple taxing jurisdictions, and as a result, accruals for tax contingencies require us to make estimates and judgments with respect to the ultimate tax liability in any given fiscal year. Actual results could vary from these estimates. Changes in tax laws, new tax rulings, or results of tax audits could cause management's estimates to change. In our opinion, adequate provisions for income taxes have been made for all fiscal years.  Certain deferred tax assets are derived from capital losses, which depend on having sufficient capital gain income within the carryback and carryforward period available under the tax law. We have determined that one or more sources of taxable income of the appropriate character exist for the realization of tax benefits associated with the deferred tax assets derived from capital losses. As a result of our history of taxable income and the nature of the items from which deferred tax assets are derived, we believe that is more likely than not that we will realize the benefit of the deferred tax assets.  
      ITEM 7A. QUANTITATIVE AND QUALITATIVE DISCLOSURES ABOUT MARKET RISK
  The information required by this item is incorporated herein by reference to "Item 7. Management's Discussion and Analysis of Financial Condition and Results of Operations-Market Risk."