Table of Contents

 

 

 

UNITED STATES

SECURITIES AND EXCHANGE COMMISSION

Washington, DC 20549

 

FORM 10-Q

 

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

 

For the quarterly period ended March 31, 2014

 

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

 

Commission File Number: 1-31987

 

Hilltop Holdings Inc.

(Exact name of registrant as specified in its charter)

 

Maryland

 

84-1477939

(State or other jurisdiction of incorporation or

 

(I.R.S. Employer Identification No.)

organization)

 

 

 

 

 

200 Crescent Court, Suite 1330

 

 

Dallas, TX

 

75201

(Address of principal executive offices)

 

(Zip Code)

 

(214) 855-2177

(Registrant’s telephone number, including area code)

 

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

 

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

 

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

 

Large accelerated filer x

 

Accelerated filer o

 

 

 

Non-accelerated filer o
(Do not check if a smaller reporting company)

 

Smaller reporting company o

 

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

 

The number of shares of the registrant’s common stock outstanding at May 2, 2014 was 90,180,699.

 

 

 



Table of Contents

 

HILLTOP HOLDINGS INC.

FORM 10-Q

FOR THE QUARTER ENDED MARCH 31, 2014

 

TABLE OF CONTENTS

 

PART I — FINANCIAL INFORMATION

 

 

 

 

 

Item 1.

Financial Statements

 

 

Consolidated Balance Sheets

3

 

Consolidated Statements of Operations

4

 

Consolidated Statements of Comprehensive Income

5

 

Consolidated Statements of Stockholders’ Equity

6

 

Consolidated Statements of Cash Flows

7

 

Notes to Consolidated Financial Statements

8

 

 

 

Item 2.

Management’s Discussion and Analysis of Financial Condition and Results of Operations

48

 

 

 

Item 3.

Quantitative and Qualitative Disclosures About Market Risk

76

 

 

 

Item 4.

Controls and Procedures

78

 

 

 

 

 

 

PART II — OTHER INFORMATION

 

 

 

Item 1.

Legal Proceedings

78

 

 

 

Item 1A.

Risk Factors

78

 

 

 

Item 2.

Unregistered Sales of Equity Securities and Use of Proceeds

79

 

 

 

Item 6.

Exhibits

79

 

2



Table of Contents

 

HILLTOP HOLDINGS INC. AND SUBSIDIARIES

CONSOLIDATED BALANCE SHEETS

(in thousands, except share and per share data)

 

 

 

March 31,

 

December 31,

 

 

 

2014

 

2013

 

 

 

(Unaudited)

 

 

 

Assets

 

 

 

 

 

Cash and due from banks

 

$

889,950

 

$

713,099

 

Federal funds sold and securities purchased under agreements to resell

 

27,460

 

32,924

 

Securities:

 

 

 

 

 

Trading, at fair value

 

53,350

 

58,846

 

Available for sale, at fair value (amortized cost of $1,270,685 and $1,256,862, respectively)

 

1,245,359

 

1,203,143

 

Held to maturity, at amortized cost (fair value of $30,902)

 

30,981

 

 

 

 

1,329,690

 

1,261,989

 

 

 

 

 

 

 

Loans held for sale

 

887,200

 

1,089,039

 

Non-covered loans, net of unearned income

 

3,646,946

 

3,514,646

 

Allowance for non-covered loan losses

 

(34,645

)

(33,241

)

Non-covered loans, net

 

3,612,301

 

3,481,405

 

 

 

 

 

 

 

Covered loans, net of allowance of $2,665 and $1,061, respectively

 

909,783

 

1,005,308

 

Broker-dealer and clearing organization receivables

 

174,442

 

119,317

 

Insurance premiums receivable

 

26,234

 

25,597

 

Deferred policy acquisition costs

 

21,096

 

20,991

 

Premises and equipment, net

 

202,155

 

200,706

 

FDIC indemnification asset

 

188,736

 

188,291

 

Covered other real estate owned

 

152,310

 

142,833

 

Mortgage servicing rights

 

29,939

 

20,149

 

Other assets

 

262,220

 

279,745

 

Goodwill

 

251,808

 

251,808

 

Other intangible assets, net

 

68,108

 

70,921

 

Total assets

 

$

9,033,432

 

$

8,904,122

 

 

 

 

 

 

 

Liabilities and Stockholders’ Equity

 

 

 

 

 

Deposits:

 

 

 

 

 

Noninterest-bearing

 

$

1,748,391

 

$

1,773,749

 

Interest-bearing

 

4,914,785

 

4,949,169

 

Total deposits

 

6,663,176

 

6,722,918

 

 

 

 

 

 

 

Broker-dealer and clearing organization payables

 

161,888

 

129,678

 

Reserve for losses and loss adjustment expenses

 

28,258

 

27,468

 

Unearned insurance premiums

 

89,646

 

88,422

 

Short-term borrowings

 

491,406

 

342,087

 

Notes payable

 

55,465

 

56,327

 

Junior subordinated debentures

 

67,012

 

67,012

 

Other liabilities

 

121,368

 

158,288

 

Total liabilities

 

7,678,219

 

7,592,200

 

Commitments and contingencies (see Notes 11 and 12)

 

 

 

 

 

Stockholders’ equity:

 

 

 

 

 

Hilltop stockholders’ equity:

 

 

 

 

 

Preferred stock, $0.01 par value, 10,000,000 shares authorized; Series B, liquidation value per share of $1,000; 114,068 shares issued and outstanding

 

114,068

 

114,068

 

Common stock, $0.01 par value, 100,000,000 shares authorized; 90,177,991 and 90,175,688 shares issued and outstanding, respectively

 

902

 

902

 

Additional paid-in capital

 

1,388,002

 

1,388,641

 

Accumulated other comprehensive loss

 

(16,054

)

(34,863

)

Accumulated deficit

 

(132,421

)

(157,607

)

Total Hilltop stockholders’ equity

 

1,354,497

 

1,311,141

 

Noncontrolling interest

 

716

 

781

 

Total stockholders’ equity

 

1,355,213

 

1,311,922

 

Total liabilities and stockholders’ equity

 

$

9,033,432

 

$

8,904,122

 

 

See accompanying notes.

 

3



Table of Contents

 

HILLTOP HOLDINGS INC. AND SUBSIDIARIES

CONSOLIDATED STATEMENTS OF OPERATIONS

(in thousands, except per share data)

(Unaudited)

 

 

 

Three Months Ended March 31,

 

 

 

2014

 

2013

 

Interest income:

 

 

 

 

 

Loans, including fees

 

$

79,744

 

$

64,886

 

Securities:

 

 

 

 

 

Taxable

 

7,588

 

5,912

 

Tax-exempt

 

1,242

 

1,347

 

Federal funds sold and securities purchased under agreements to resell

 

19

 

21

 

Interest-bearing deposits with banks

 

595

 

333

 

Other

 

2,640

 

2,105

 

Total interest income

 

91,828

 

74,604

 

 

 

 

 

 

 

Interest expense:

 

 

 

 

 

Deposits

 

3,759

 

3,450

 

Short-term borrowings

 

395

 

513

 

Notes payable

 

648

 

2,322

 

Junior subordinated debentures

 

584

 

608

 

Other

 

1,021

 

450

 

Total interest expense

 

6,407

 

7,343

 

 

 

 

 

 

 

Net interest income

 

85,421

 

67,261

 

Provision for loan losses

 

3,242

 

13,005

 

Net interest income after provision for loan losses

 

82,179

 

54,256

 

 

 

 

 

 

 

Noninterest income:

 

 

 

 

 

Net gains from sale of loans and other mortgage production income

 

79,111

 

127,596

 

Mortgage loan origination fees

 

12,344

 

18,893

 

Net insurance premiums earned

 

40,319

 

37,473

 

Investment and securities advisory fees and commissions

 

21,335

 

22,009

 

Other

 

16,991

 

7,307

 

Total noninterest income

 

170,100

 

213,278

 

 

 

 

 

 

 

Noninterest expense:

 

 

 

 

 

Employees’ compensation and benefits

 

106,429

 

116,190

 

Loss and loss adjustment expenses

 

18,337

 

21,185

 

Policy acquisition and other underwriting expenses

 

11,687

 

10,803

 

Occupancy and equipment, net

 

26,338

 

19,412

 

Other

 

49,838

 

47,401

 

Total noninterest expense

 

212,629

 

214,991

 

 

 

 

 

 

 

Income before income taxes

 

39,650

 

52,543

 

Income tax expense

 

14,354

 

19,170

 

 

 

 

 

 

 

Net income

 

25,296

 

33,373

 

Less: Net income attributable to noncontrolling interest

 

110

 

300

 

 

 

 

 

 

 

Income attributable to Hilltop

 

25,186

 

33,073

 

Dividends on preferred stock

 

1,426

 

703

 

Income applicable to Hilltop common stockholders

 

$

23,760

 

$

32,370

 

 

 

 

 

 

 

Earnings per common share:

 

 

 

 

 

Basic

 

$

0.26

 

$

0.39

 

Diluted

 

$

0.26

 

$

0.39

 

 

 

 

 

 

 

Weighted average share information:

 

 

 

 

 

Basic

 

89,707

 

83,487

 

Diluted

 

90,585

 

83,743

 

 

See accompanying notes.

 

4



Table of Contents

 

HILLTOP HOLDINGS INC. AND SUBSIDIARIES

CONSOLIDATED STATEMENTS OF COMPREHENSIVE INCOME

(in thousands)

(Unaudited)

 

 

 

Three Months Ended March 31,

 

 

 

2014

 

2013

 

Net income

 

$

25,296

 

$

33,373

 

Other comprehensive income:

 

 

 

 

 

Unrealized gains on securities available for sale, net of tax of $9,583 and $473

 

18,809

 

879

 

Comprehensive income

 

44,105

 

34,252

 

Less: comprehensive income attributable to noncontrolling interest

 

110

 

300

 

 

 

 

 

 

 

Comprehensive income applicable to Hilltop

 

$

43,995

 

$

33,952

 

 

See accompanying notes.

 

5



Table of Contents

 

HILLTOP HOLDINGS INC. AND SUBSIDIARIES

CONSOLIDATED STATEMENTS OF STOCKHOLDERS’ EQUITY

(in thousands)

(Unaudited)

 

 

 

 

 

 

 

 

 

 

 

 

 

Accumulated

 

 

 

Total

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

Additional

 

Other

 

 

 

Hilltop

 

 

 

Total

 

 

 

Preferred Stock

 

Common Stock

 

Paid-in

 

Comprehensive

 

Accumulated

 

Stockholders’

 

Noncontrolling

 

Stockholders’

 

 

 

Shares

 

Amount

 

Shares

 

Amount

 

Capital

 

Income (Loss)

 

Deficit

 

Equity

 

Interest

 

Equity

 

Balance, December 31, 2012

 

114

 

$

114,068

 

83,487

 

$

835

 

$

1,304,448

 

$

8,094

 

$

(282,949

)

$

1,144,496

 

$

2,054

 

$

1,146,550

 

Net income

 

 

 

 

 

 

 

33,073

 

33,073

 

300

 

33,373

 

Other comprehensive income

 

 

 

 

 

 

879

 

 

879

 

 

879

 

Stock-based compensation expense

 

 

 

 

 

64

 

 

 

64

 

 

64

 

Dividends on preferred stock

 

 

 

 

 

(703

)

 

 

(703

)

 

(703

)

Cash distributions to noncontrolling interest

 

 

 

 

 

 

 

 

 

(1,578

)

(1,578

)

Balance, March 31, 2013

 

114

 

$

114,068

 

83,487

 

$

835

 

$

1,303,809

 

$

8,973

 

$

(249,876

)

$

1,177,809

 

$

776

 

$

1,178,585

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

Balance, December 31, 2013

 

114

 

$

114,068

 

90,176

 

$

902

 

$

1,388,641

 

$

(34,863

)

$

(157,607

)

$

1,311,141

 

$

781

 

$

1,311,922

 

Net income

 

 

 

 

 

 

 

25,186

 

25,186

 

110

 

25,296

 

Other comprehensive income

 

 

 

 

 

 

18,809

 

 

18,809

 

 

18,809

 

Stock-based compensation expense

 

 

 

 

 

735

 

 

 

735

 

 

735

 

Common stock issued to board members

 

 

 

2

 

 

52

 

 

 

52

 

 

52

 

Dividends on preferred stock

 

 

 

 

 

(1,426

)

 

 

(1,426

)

 

(1,426

)

Cash distributions to noncontrolling interest

 

 

 

 

 

 

 

 

 

(175

)

(175

)

Balance, March 31, 2014

 

114

 

$

114,068

 

90,178

 

$

902

 

$

1,388,002

 

$

(16,054

)

$

(132,421

)

$

1,354,497

 

$

716

 

$

1,355,213

 

 

See accompanying notes.

 

6



Table of Contents

 

HILLTOP HOLDINGS INC. AND SUBSIDIARIES

CONSOLIDATED STATEMENTS OF CASH FLOWS

(in thousands)

(Unaudited)

 

 

 

Three Months Ended March 31,

 

 

 

2014

 

2013

 

Operating Activities

 

 

 

 

 

Net income

 

$

25,296

 

$

33,373

 

Adjustments to reconcile net income to net cash provided by operating activities

 

 

 

 

 

Provision for loan losses

 

3,242

 

13,005

 

Depreciation, amortization and accretion, net

 

(20,615

)

(9,548

)

Deferred income taxes

 

4,878

 

(7,067

)

Other, net

 

1,435

 

85

 

Net change in securities purchased under resale agreements

 

 

(3,254

)

Net change in trading securities

 

5,496

 

29,344

 

Net change in broker-dealer and clearing organization receivables

 

(88,613

)

(77,077

)

Net change in other assets

 

454

 

47,641

 

Net change in broker-dealer and clearing organization payables

 

62,842

 

34,075

 

Net change in loss and loss adjustment expense reserve

 

790

 

(1,942

)

Net change in unearned insurance premiums

 

1,224

 

1,434

 

Net change in other liabilities

 

(36,773

)

(56,899

)

Net gains from sale of loans

 

(79,111

)

(127,596

)

Loans originated for sale

 

(1,954,133

)

(3,025,709

)

Proceeds from loans sold

 

2,227,917

 

3,310,115

 

Net cash provided by operating activities

 

154,329

 

159,980

 

 

 

 

 

 

 

Investing Activities

 

 

 

 

 

Proceeds from maturities and principal reductions of securities held to maturity

 

351

 

 

Proceeds from sales, maturities and principal reductions of securities available for sale

 

31,845

 

53,759

 

Purchases of securities held to maturity

 

(31,334

)

 

Purchases of securities available for sale

 

(46,024

)

(209,507

)

Net change in loans

 

(256

)

(41,872

)

Purchases of premises and equipment and other assets

 

(8,710

)

(5,041

)

Proceeds from sales of premises and equipment and other real estate owned

 

14,713

 

3,880

 

Net cash received for Federal Home Loan Bank and Federal Reserve Bank stock

 

 

6,702

 

Net cash used in investing activities

 

(39,415

)

(192,079

)

 

 

 

 

 

 

Financing Activities

 

 

 

 

 

Net change in deposits

 

(90,374

)

68,869

 

Net change in short-term borrowings

 

149,319

 

(151,520

)

Payments on notes payable

 

(862

)

(792

)

Dividends paid on preferred stock

 

(1,342

)

 

Net cash distributed to noncontrolling interest

 

(175

)

(1,578

)

Other, net

 

(93

)

(65

)

Net cash provided by (used in) financing activities

 

56,473

 

(85,086

)

 

 

 

 

 

 

Net change in cash and cash equivalents

 

171,387

 

(117,185

)

Cash and cash equivalents, beginning of period

 

746,023

 

726,460

 

Cash and cash equivalents, end of period

 

$

917,410

 

$

609,275

 

 

 

 

 

 

 

Supplemental Disclosures of Cash Flow Information

 

 

 

 

 

Cash paid for interest

 

$

6,934

 

$

8,313

 

Cash paid for income taxes, net of refunds

 

$

(1,845

)

$

2,205

 

Supplemental Schedule of Non-Cash Activities

 

 

 

 

 

Conversion of loans to other real estate owned

 

$

25,588

 

$

284

 

 

See accompanying notes.

 

7



Table of Contents

 

Hilltop Holdings Inc. and Subsidiaries

Notes to Consolidated Financial Statements (continued)

(Unaudited)

 

1. Summary of Significant Accounting and Reporting Policies

 

Nature of Operations

 

Hilltop Holdings Inc. (“Hilltop” and, collectively with its subsidiaries, the “Company”) is a financial holding company registered under the Bank Holding Company Act of 1956, as amended by the Gramm-Leach-Bliley Act of 1999. On November 30, 2012, Hilltop acquired PlainsCapital Corporation pursuant to a plan of merger whereby PlainsCapital Corporation merged with and into a wholly owned subsidiary of Hilltop (the “PlainsCapital Merger”), which continued as the surviving entity under the name “PlainsCapital Corporation” (“PlainsCapital”).

 

The Company has two primary operating business units, PlainsCapital and National Lloyds Corporation (“NLC”). PlainsCapital is a financial holding company, headquartered in Dallas, Texas, that provides, through its subsidiaries, an array of financial products and services. In addition to traditional banking services, PlainsCapital provides residential mortgage lending, investment banking, public finance advisory, wealth and investment management, treasury management, capital equipment leasing, fixed income sales, asset management, and correspondent clearing services. NLC is a property and casualty insurance holding company that provides, through its subsidiaries, fire and homeowners insurance to low value dwellings and manufactured homes primarily in Texas and other areas of the southern United States.

 

On September 13, 2013 (the “Bank Closing Date”), PlainsCapital Bank (the “Bank”) assumed substantially all of the liabilities, including all of the deposits, and acquired substantially all of the assets of Edinburg, Texas-based First National Bank (“FNB”) from the Federal Deposit Insurance Corporation (the “FDIC”), as receiver, and reopened former FNB branches acquired from the FDIC under the “PlainsCapital Bank” name (the “FNB Transaction”). Pursuant to the Purchase and Assumption Agreement (the “P&A Agreement”), the Bank and the FDIC entered into loss-share agreements whereby the FDIC agreed to share in the losses of certain covered loans and covered other real estate owned (“OREO”) that the Bank acquired, as further described in Note 2 to the consolidated financial statements. The fair value of the assets acquired was $2.2 billion, including $1.1 billion in covered loans, $286.2 million in securities, $135.2 million in covered OREO and $42.9 million in non-covered loans. The Bank also assumed $2.2 billion in liabilities, consisting primarily of deposits. The acquisition of FNB’s expansive branch network allowed the Bank to increase its presence in Texas to include the Rio Grande Valley, Houston, Corpus Christi, Laredo and El Paso markets, among others.

 

On March 31, 2014, the Company entered into a definitive merger agreement with SWS Group, Inc. (“SWS”) providing for the merger of SWS with and into a wholly owned subsidiary of Hilltop formed for the purpose of facilitating this transaction. SWS stockholders will receive per share consideration of 0.2496 shares of Hilltop common stock and $1.94 of cash, equating to $7.88 per share based on Hilltop’s closing price on March 31, 2014. The Company intends to fund the cash portion of the consideration through available cash. The merger is subject to customary closing conditions, including regulatory approvals and approval of the stockholders of SWS, and is expected to be completed prior to the end of 2014.

 

Basis of Presentation

 

The accompanying unaudited consolidated financial statements have been prepared in conformity with accounting principles generally accepted in the United States (“GAAP”), and in conformity with the rules and regulations of the Securities and Exchange Commission (the “SEC”). In the opinion of management, these financial statements contain all adjustments necessary for a fair statement of the results of the interim periods presented. Accordingly, the financial statements do not include all of the information and footnotes required by GAAP for complete financial statements and should be read in conjunction with the audited consolidated financial statements and notes thereto included in the Company’s Annual Report on Form 10-K for the year ended December 31, 2013. Results for interim periods are not necessarily indicative of results to be expected for a full year or any future period.

 

The preparation of financial statements in conformity with accounting principles generally accepted in the United States (“GAAP”) requires management to make estimates and assumptions that affect the reported amounts of assets and liabilities, the disclosure of contingent assets and liabilities at the date of the financial statements, and the reported

 

8



Table of Contents

 

Hilltop Holdings Inc. and Subsidiaries

Notes to Consolidated Financial Statements (continued)

(Unaudited)

 

amounts of revenues and expenses during the reporting period. Actual results could differ from those estimates. Estimates regarding the allowance for loan losses, the fair values of financial instruments, the amounts receivable under the loss-share agreements with the FDIC (“FDIC Indemnification Asset”), reserves for losses and loss adjustment expenses, the mortgage loan indemnification liability, and the potential impairment of assets are particularly subject to change. The Company has applied its critical accounting policies and estimation methods consistently in all periods presented in these consolidated financial statements.

 

Certain reclassifications have been made to the prior period consolidated financial statements to conform with the current period presentation. In addition, the Company revised its historical consolidated balance sheets to correct the classification of certain noninterest-bearing deposits. The correction resulted in an increase in noninterest-bearing deposits and a decrease in interest-bearing deposits of $1.3 billion and $1.0 billion at December 31, 2013 and 2012, respectively, and the correction of the deposits note to the consolidated financial statements. Management has evaluated the impact of the correction as immaterial to previously issued financial statements; however, has elected to revise such amounts in the accompanying consolidated financial statements. The Company will similarly revise the consolidated balance sheets and deposits note to the quarterly and annual consolidated financial statements in its future filings.

 

Hilltop owns 100% of the outstanding stock of PlainsCapital. PlainsCapital owns 100% of the outstanding stock of the Bank and 100% of the membership interest in PlainsCapital Equity, LLC. The Bank owns 100% of the outstanding stock of PrimeLending, a PlainsCapital Company (“PrimeLending”) and PCB-ARC, Inc. The Bank has a 100% membership interest in First Southwest Holdings, LLC (“First Southwest”) and PlainsCapital Securities, LLC, as well as a 51% voting interest in PlainsCapital Insurance Services, LLC.

 

Hilltop also owns 100% of NLC, which operates through its wholly owned subsidiaries, National Lloyds Insurance Company (“NLIC”) and American Summit Insurance Company (“ASIC”).

 

PrimeLending owns a 100% membership interest in PrimeLending Ventures Management, LLC, the controlling and sole managing member of PrimeLending Ventures, LLC (“Ventures”).

 

The principal subsidiaries of First Southwest are First Southwest Company (“FSC”), a broker-dealer registered with the SEC and the Financial Industry Regulatory Authority, and First Southwest Asset Management, Inc., a registered investment advisor under the Investment Advisors Act of 1940.

 

The consolidated financial statements include the accounts of the above-named entities. All significant intercompany transactions and balances have been eliminated. Noncontrolling interests have been recorded for minority ownership in entities that are not wholly owned and are presented in compliance with the provisions of Noncontrolling Interest in Subsidiary Subsections of the Financial Accounting Standards Board (“FASB”) Accounting Standards Codification (“ASC”).

 

PlainsCapital also owns 100% of the outstanding common securities of PCC Statutory Trusts I, II, III and IV (the “Trusts”), which are not included in the consolidated financial statements under the requirements of the Variable Interest Entities Subsections of the ASC, because the primary beneficiaries of the Trusts are not within the consolidated group.

 

2. Acquisitions

 

FNB Transaction

 

On the Bank Closing Date, the Bank assumed substantially all of the liabilities, including all of the deposits, and acquired substantially all of the assets of FNB from the FDIC in an FDIC-assisted transaction. As part of the P&A Agreement, the Bank and the FDIC entered into loss-share agreements covering future losses incurred on certain acquired loans and OREO. The Company refers to acquired commercial and single family residential loan portfolios and OREO that are subject to the loss-share agreements as “covered loans” and “covered OREO”, respectively, and these assets are presented as separate line items in the Company’s consolidated balance sheet. Collectively, covered loans and covered OREO are referred to as “covered assets”.

 

9



Table of Contents

 

Hilltop Holdings Inc. and Subsidiaries

Notes to Consolidated Financial Statements (continued)

(Unaudited)

 

In accordance with the loss-share agreements, the Bank may be required to make a “true-up” payment to the FDIC approximately ten years following the Bank Closing Date if the FDIC’s initial estimate of losses on covered assets is greater than the actual realized losses. The “true-up” payment is calculated using a defined formula set forth in the P&A Agreement.

 

The FNB Transaction was accounted for using the purchase method of accounting and, accordingly, purchased assets, including identifiable intangible assets and assumed liabilities, were recorded at their respective fair values as of the Bank Closing Date using significant estimates and assumptions to value certain identifiable assets acquired and liabilities assumed. The amounts are subject to adjustments based upon final settlement with the FDIC. The terms of the P&A Agreement provide for the FDIC to indemnify the Bank against claims with respect to liabilities and assets of FNB or any of its affiliates not assumed or otherwise purchased by the Bank and with respect to certain other claims by third parties.

 

Pro Forma Results of Operations

 

The operations acquired in the FNB Transaction are included in the Company’s operating results beginning September 14, 2013. The purchase of assets and assumption of certain liabilities of FNB from the FDIC, as receiver, was sufficiently significant to require disclosure of historical financial statements and related pro forma financial disclosure. Due to the nature and magnitude of the FNB Transaction, coupled with the federal assistance and protection resulting from the FDIC loss-share agreements, historical financial information of FNB is not relevant to future operations. The Company has omitted certain historical financial information and the related pro forma financial information of FNB pursuant to the guidance provided in Staff Accounting Bulletin Topic 1.K, Financial Statements of Acquired Troubled Financial Institutions (“SAB 1:K”), and a request for relief granted by the SEC. SAB 1:K provides relief from the requirements of Rule 3-05 of Regulation S-X in certain instances, such as the FNB Transaction, where a registrant engages in an acquisition of a significant amount of assets of a troubled financial institution for which audited financial statements are not reasonably available and in which federal assistance is so persuasive as to substantially reduce the relevance of such information to an assessment of future operations.

 

3. Fair Value Measurements

 

Fair Value Measurements and Disclosures

 

The Company determines fair values in compliance with The Fair Value Measurements and Disclosures Topic of the ASC (the “Fair Value Topic”). The Fair Value Topic defines fair value, establishes a framework for measuring fair value in GAAP and expands disclosures about fair value measurements. The Fair Value Topic defines fair value as the price that would be received to sell an asset or paid to transfer a liability in an orderly transaction between market participants. The Fair Value Topic assumes that transactions upon which fair value measurements are based occur in the principal market for the asset or liability being measured. Further, fair value measurements made under the Fair Value Topic exclude transaction costs and are not the result of forced transactions.

 

The Fair Value Topic creates a fair value hierarchy that classifies fair value measurements based upon the inputs used in valuing the assets or liabilities that are the subject of fair value measurements. The fair value hierarchy gives the highest priority to quoted prices in active markets for identical assets or liabilities and the lowest priority to unobservable inputs, as indicated below.

 

·                  Level 1 Inputs: Unadjusted quoted prices in active markets for identical assets or liabilities that the Company can access at the measurement date.

 

·                  Level 2 Inputs: Observable inputs other than Level 1 prices. Level 2 inputs include quoted prices for similar assets or liabilities in active markets, quoted prices for identical or similar assets or liabilities in markets that are not active, inputs other than quoted prices that are observable for the asset or liability (e.g., interest rates, yield curves, prepayment speeds, default rates, credit risks, loss severities, etc.), and inputs that are derived from or corroborated by market data, among others.

 

10



Table of Contents

 

Hilltop Holdings Inc. and Subsidiaries

Notes to Consolidated Financial Statements (continued)

(Unaudited)

 

·                  Level 3 Inputs: Unobservable inputs that reflect an entity’s own assumptions about the assumptions that market participants would use in pricing the assets or liabilities. Level 3 inputs include pricing models and discounted cash flow techniques, among others.

 

Fair Value Option

 

The Company has elected to measure substantially all of PrimeLending’s mortgage loans held for sale and retained mortgage servicing rights (“MSR”) at fair value, and certain time deposits at the Bank under the provisions of the Fair Value Option. The Company elected to apply the provisions of the Fair Value Option to these items so that it would have the opportunity to mitigate volatility in reported earnings caused by measuring related assets and liabilities differently without having to apply complex hedge accounting provisions. The Company determines the fair value of the financial instruments accounted for under the provisions of the Fair Value Option in compliance with the provisions of the Fair Value Topic of the ASC discussed above.

 

At March 31, 2014, the aggregate fair value of PrimeLending’s mortgage loans held for sale accounted for under the Fair Value Option was $886.6 million, and the unpaid principal balance of those loans was $860.5 million. At December 31, 2013, the aggregate fair value of PrimeLending’s mortgage loans held for sale accounted for under the Fair Value Option was $1.09 billion, and the unpaid principal balance of those loans was $1.07 billion. The interest component of fair value is reported as interest income on loans in the accompanying consolidated statements of operations.

 

The Company holds a number of financial instruments that are measured at fair value on a recurring basis, either by the application of the Fair Value Option or other authoritative pronouncements. The fair values of those instruments are determined primarily using Level 2 inputs. Those inputs include quotes from mortgage loan investors and derivatives dealers, data from independent pricing services and rates paid in the brokered certificate of deposit market.

 

The following tables present information regarding financial assets and liabilities measured at fair value on a recurring basis (in thousands).

 

 

 

Level 1

 

Level 2

 

Level 3

 

Total

 

March 31, 2014

 

Inputs

 

Inputs

 

Inputs

 

Fair Value

 

Trading securities

 

$

33

 

$

53,317

 

$

 

$

53,350

 

Available for sale securities

 

24,663

 

1,156,598

 

64,098

 

1,245,359

 

Loans held for sale

 

 

860,374

 

26,826

 

887,200

 

Derivative assets

 

 

23,365

 

 

23,365

 

Mortgage servicing rights asset

 

 

 

29,939

 

29,939

 

Trading liabilities

 

 

48

 

 

48

 

Derivative liabilities

 

 

 

5,950

 

5,950

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

Level 1

 

Level 2

 

Level 3

 

Total

 

December 31, 2013

 

Inputs

 

Inputs

 

Inputs

 

Fair Value

 

Trading securities

 

33

 

58,813

 

$

 

58,846

 

Available for sale securities

 

22,079

 

1,121,011

 

60,053

 

1,203,143

 

Loans held for sale

 

 

1,061,310

 

27,729

 

1,089,039

 

Derivative assets

 

 

23,564

 

 

23,564

 

Mortgage servicing rights asset

 

 

 

20,149

 

20,149

 

Trading liabilities

 

 

46

 

 

46

 

Derivative liabilities

 

 

139

 

5,600

 

5,739

 

 

11



Table of Contents

 

Hilltop Holdings Inc. and Subsidiaries

Notes to Consolidated Financial Statements (continued)

(Unaudited)

 

The following tables include a roll forward for those financial instruments measured at fair value using Level 3 inputs (in thousands).

 

 

 

 

 

 

 

 

 

Total Gains or Losses

 

 

 

 

 

 

 

 

 

 

 

(Realized or Unrealized)

 

 

 

 

 

Balance at

 

 

 

 

 

 

 

Included in Other

 

 

 

 

 

Beginning of

 

Purchases/

 

Sales/

 

Included in

 

Comprehensive

 

Balance at

 

 

 

Period

 

Additions

 

Reductions

 

Net Income

 

Income (Loss)

 

End of Period

 

Three months ended March 31, 2014

 

 

 

 

 

 

 

 

 

 

 

 

 

Available for sale securities

 

$

60,053

 

$

 

$

 

$

593

 

$

3,452

 

$

64,098

 

Loans held for sale

 

27,729

 

4,900

 

(5,594

)

(209

)

 

26,826

 

Mortgage servicing rights asset

 

20,149

 

7,432

 

 

2,358

 

 

29,939

 

Derivative liabilities

 

(5,600

)

 

 

(350

)

 

(5,950

)

Total

 

$

102,331

 

$

12,332

 

$

(5,594

)

$

2,392

 

$

3,452

 

$

114,913

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

Three months ended March 31, 2013

 

 

 

 

 

 

 

 

 

 

 

 

 

Available for sale securities

 

$

56,277

 

$

 

$

 

$

512

 

$

2,012

 

$

58,801

 

Mortgage servicing rights asset

 

2,080

 

2,125

 

 

225

 

 

4,430

 

Derivative liabilities

 

(4,490

)

 

 

(224

)

 

(4,714

)

Total

 

$

53,867

 

$

2,125

 

$

 

$

513

 

$

2,012

 

$

58,517

 

 

All net unrealized gains (losses) in the tables above are reflected in the accompanying consolidated financial statements. The unrealized gains (losses) relate to financial instruments still held at March 31, 2014. The available for sale securities noted in the table above reflect Hilltop’s note receivable and warrant to purchase common stock of SWS as discussed in Note 4 to the consolidated financial statements.

 

Hilltop’s note receivable is valued using a cash flow model that estimates yield based on comparable securities in the market. The interest rate used to discount cash flows is the most significant unobservable input. An increase or decrease in the discount rate would result in a corresponding decrease or increase, respectively, in the fair value measurement of the note receivable.

 

The warrant is valued utilizing a binomial model. The underlying SWS common stock price and its related volatility, an unobservable input, are the most significant inputs into the model, and, therefore, decreases or increases to the SWS common stock price would result in a significant change in the fair value measurement of the warrant.

 

Loans held for sale, including monitored mortgage loans, are valued using commitments on hand from investors or prevailing market prices.

 

The MSR asset is valued by projecting net servicing cash flows, which are then discounted to estimate the fair value. The fair value of the MSR asset is impacted by a variety of factors, including prepayment assumptions, discount rates, delinquency rates, contractually specified servicing fees, servicing costs and underlying portfolio characteristics.

 

Derivative liabilities in the tables above include a derivative option agreement (“Fee Award Option”) entered into by First Southwest and valued using discounted cash flows and probability of exercise.

 

The Company had no transfers between Levels 1 and 2 during the periods presented.

 

The following table presents the changes in fair value for instruments that are reported at fair value under the Fair Value Option (in thousands).

 

 

 

Changes in Fair Value for Assets and Liabilities Reported at Fair Value under Fair Value Option

 

 

 

Three Months Ended March 31, 2014

 

Three Months Ended March 31, 2013

 

 

 

 

 

Other

 

Total

 

 

 

Other

 

Total

 

 

 

Net

 

Noninterest

 

Changes in

 

Net

 

Noninterest

 

Changes in

 

 

 

Gains (Losses)

 

Income

 

Fair Value

 

Gains (Losses)

 

Income

 

Fair Value

 

Loans held for sale

 

$

4,518

 

$

 

$

4,518

 

$

(5,438

)

$

 

$

(5,438

)

Mortgage servicing rights asset

 

2,358

 

 

2,358

 

225

 

 

225

 

Time deposits

 

 

 

 

 

8

 

8

 

 

12



Table of Contents

 

Hilltop Holdings Inc. and Subsidiaries

Notes to Consolidated Financial Statements (continued)

(Unaudited)

 

The Company also determines the fair value of certain assets and liabilities on a non-recurring basis. In addition, facts and circumstances may dictate a fair value measurement when there is evidence of impairment. Assets and liabilities measured on a non-recurring basis include the items discussed below.

 

Impaired Loans — The Company reports impaired loans based on the underlying fair value of the collateral through specific allowances within the allowance for loan losses. Purchased credit impaired (“PCI”) loans with a fair value of $172.9 million and $822.8 million were acquired by the Company upon completion of the PlainsCapital Merger and the FNB Transaction, respectively. Substantially all PCI loans acquired in the FNB Transaction are covered by FDIC loss-share agreements. The fair value of PCI loans was determined using Level 3 inputs, including estimates of expected cash flows that incorporated assumptions regarding default rates, loss severity rates assuming default, prepayment speeds and estimated collateral values.

 

Other Real Estate Owned — The Company reports OREO at fair value less estimated cost to sell. Any excess of recorded investment over fair value, less cost to sell, is charged against the allowance for loan losses when property is initially transferred to OREO. Subsequent to the initial transfer to OREO, downward valuation adjustments are charged against earnings. The Company determines fair value primarily using independent appraisals of OREO properties. The resulting fair value measurements are classified as Level 2 or Level 3 inputs, depending upon the extent to which unobservable inputs determine the fair value measurement. The Company considers a number of factors in determining the extent to which specific fair value measurements utilize unobservable inputs, including, but not limited to, the inherent subjectivity in appraisals, the length of time elapsed since the receipt of independent market price or appraised value, and current market conditions. In the FNB Transaction, the Bank acquired OREO of $135.2 million, all of which is covered by FDIC loss-share agreements. At March 31, 2014 and December 31, 2013, the estimated fair value of covered OREO was $152.3 million and $142.8 million, respectively, and the underlying fair value measurements utilize Level 3 inputs. The fair value of non-covered OREO at March 31, 2014 and December 31, 2013 was $5.8 million and $4.8 million, respectively, and is included in other assets within the consolidated balance sheets. During the reported periods, all fair value measurements for non-covered OREO utilized Level 2 inputs.

 

The following table presents information regarding certain assets and liabilities measured at fair value on a non-recurring basis for which a change in fair value has been recorded during reporting periods subsequent to initial recognition (in thousands).

 

 

 

 

 

 

 

 

 

 

 

Total Gains

 

Total Gains

 

 

 

 

 

 

 

 

 

 

 

(Losses) for the

 

(Losses) for the

 

 

 

 

 

 

 

 

 

 

 

Three Months

 

Three Months

 

 

 

Level 1

 

Level 2

 

Level 3

 

Total

 

Ended

 

Ended

 

March 31, 2014

 

Inputs

 

Inputs

 

Inputs

 

Fair Value

 

March 31, 2014

 

March 31, 2013

 

Non-covered impaired loans

 

$

 

$

 

$

29,043

 

$

29,043

 

$

(215

)

$

(431

)

Covered impaired loans

 

 

 

35,519

 

35,519

 

(1,691

)

 

Non-covered other real estate owned

 

 

18

 

 

18

 

(102

)

(160

)

Covered other real estate owned

 

 

 

34,167

 

34,167

 

(431

)

 

 

The Fair Value of Financial Instruments Subsection of the ASC requires disclosure of the fair value of financial assets and liabilities, including the financial assets and liabilities previously discussed. The methods for determining estimated fair value for financial assets and liabilities is described in detail in Note 3 to the consolidated financial statements included in our Annual Report on Form 10-K for the year ended December 31, 2013.

 

13



Table of Contents

 

Hilltop Holdings Inc. and Subsidiaries

Notes to Consolidated Financial Statements (continued)

(Unaudited)

 

The following tables present the carrying values and estimated fair values of financial instruments not measured at fair value on either a recurring or non-recurring basis (in thousands).

 

 

 

 

 

Estimated Fair Value

 

 

 

Carrying

 

Level 1

 

Level 2

 

Level 3

 

 

 

March 31, 2014

 

Amount

 

Inputs

 

Inputs

 

Inputs

 

Total

 

Financial assets:

 

 

 

 

 

 

 

 

 

 

 

Cash and cash equivalents

 

$

917,410

 

$

917,410

 

$

 

$

 

$

917,410

 

Held to maturity securities

 

30,981

 

 

30,902

 

 

30,902

 

Non-covered loans, net

 

3,612,301

 

 

315,199

 

3,313,626

 

3,628,825

 

Covered loans, net

 

909,783

 

 

 

1,060,417

 

1,060,417

 

Broker-dealer and clearing organization receivables

 

174,442

 

 

174,442

 

 

174,442

 

FDIC indemnification asset

 

188,736

 

 

 

188,736

 

188,736

 

Other assets

 

64,178

 

 

42,233

 

21,945

 

64,178

 

 

 

 

 

 

 

 

 

 

 

 

 

Financial liabilities:

 

 

 

 

 

 

 

 

 

 

 

Deposits

 

6,663,176

 

 

6,667,621

 

 

6,667,621

 

Broker-dealer and clearing organization payables

 

161,888

 

 

161,888

 

 

161,888

 

Short-term borrowings

 

491,406

 

 

491,406

 

 

491,406

 

Debt

 

122,477

 

 

115,777

 

 

115,777

 

Other liabilities

 

2,834

 

 

2,834

 

 

2,834

 

 

 

 

 

 

Estimated Fair Value

 

 

 

Carrying

 

Level 1

 

Level 2

 

Level 3

 

 

 

December 31, 2013

 

Amount

 

Inputs

 

Inputs

 

Inputs

 

Total

 

Financial assets:

 

 

 

 

 

 

 

 

 

 

 

Cash and cash equivalents

 

$

746,023

 

$

746,023

 

$

 

$

 

$

746,023

 

Non-covered loans, net

 

3,481,405

 

 

281,712

 

3,119,319

 

3,401,031

 

Covered loans, net

 

1,005,308

 

 

 

997,371

 

997,371

 

Broker-dealer and clearing organization receivables

 

119,317

 

 

119,317

 

 

119,317

 

FDIC indemnification asset

 

188,291

 

 

 

188,291

 

188,291

 

Other assets

 

66,055

 

 

43,946

 

22,109

 

66,055

 

 

 

 

 

 

 

 

 

 

 

 

 

Financial liabilities:

 

 

 

 

 

 

 

 

 

 

 

Deposits

 

6,722,019

 

 

6,722,909

 

 

6,722,909

 

Broker-dealer and clearing organization payables

 

129,678

 

 

129,678

 

 

129,678

 

Short-term borrowings

 

342,087

 

 

342,087

 

 

342,087

 

Debt

 

123,339

 

 

114,671

 

 

114,671

 

Other liabilities

 

3,362

 

 

3,362

 

 

3,362

 

 

14



Table of Contents

 

Hilltop Holdings Inc. and Subsidiaries

Notes to Consolidated Financial Statements (continued)

(Unaudited)

 

4. Securities

 

The amortized cost and fair value of securities, excluding trading securities, are summarized as follows (in thousands).

 

 

 

Available for Sale

 

 

 

 

 

Gross

 

Gross

 

 

 

 

 

Amortized

 

Unrealized

 

Unrealized

 

 

 

March 31, 2014

 

Cost

 

Gains

 

Losses

 

Fair Value

 

U.S. Treasury securities

 

$

63,684

 

$

80

 

$

(94

)

$

63,670

 

U.S. government agencies:

 

 

 

 

 

 

 

 

 

Bonds

 

704,980

 

1,051

 

(38,903

)

667,128

 

Residential mortgage-backed securities

 

57,781

 

1,269

 

(505

)

58,545

 

Collateralized mortgage obligations

 

117,336

 

296

 

(3,800

)

113,832

 

Corporate debt securities

 

95,422

 

4,955

 

(226

)

100,151

 

States and political subdivisions

 

155,292

 

843

 

(3,550

)

152,585

 

Commercial mortgage-backed securities

 

618

 

69

 

 

687

 

Equity securities

 

20,237

 

4,426

 

 

24,663

 

Note receivable

 

43,267

 

5,315

 

 

48,582

 

Warrant

 

12,068

 

3,448

 

 

15,516

 

Totals

 

$

1,270,685

 

$

21,752

 

$

(47,078

)

$

1,245,359

 

 

 

 

Available for Sale

 

 

 

Amortized

 

Unrealized

 

Unrealized

 

 

 

December 31, 2013

 

Cost

 

Gains

 

Losses

 

Fair Value

 

U.S. Treasury securities

 

$

43,684

 

$

82

 

$

(238

)

$

43,528

 

U.S. government agencies:

 

 

 

 

 

 

 

 

 

Bonds

 

717,909

 

550

 

(55,727

)

662,732

 

Residential mortgage-backed securities

 

59,936

 

735

 

(584

)

60,087

 

Collateralized mortgage obligations

 

124,502

 

349

 

(4,390

)

120,461

 

Corporate debt securities

 

72,376

 

4,610

 

(378

)

76,608

 

States and political subdivisions

 

162,955

 

388

 

(6,508

)

156,835

 

Commercial mortgage-backed securities

 

691

 

69

 

 

760

 

Equity securities

 

20,067

 

2,012

 

 

22,079

 

Note receivable

 

42,674

 

5,235

 

 

47,909

 

Warrant

 

12,068

 

76

 

 

12,144

 

Totals

 

$

1,256,862

 

$

14,106

 

$

(67,825

)

$

1,203,143

 

 

 

 

Held to Maturity

 

 

 

Amortized

 

Unrealized

 

Unrealized

 

 

 

March 31, 2014

 

Cost

 

Gains

 

Losses

 

Fair Value

 

U.S. government agencies:

 

 

 

 

 

 

 

 

 

Residential mortgage-backed securities

 

$

29,582

 

$

 

$

(70

)

$

29,512

 

States and political subdivisions

 

1,399

 

1

 

(10

)

1,390

 

Totals

 

$

30,981

 

$

1

 

$

(80

)

$

30,902

 

 

Available for sale securities includes 1,475,387 shares of SWS common stock, a $50.0 million aggregate principal amount note issued by SWS and a warrant to purchase 8,695,652 shares of SWS common stock. SWS issued the note in July 2011 under a credit agreement pursuant to a senior unsecured loan from Hilltop. The note bears interest at a rate of 8.0% per annum, is prepayable by SWS subject to certain conditions after three years, and has a maturity of five years. The warrant provides for the purchase of 8,695,652 shares of SWS common stock at an exercise price of $5.75 per share, subject to anti-dilution adjustments. If the warrant was fully exercised, Hilltop would beneficially own 24.4% of SWS.

 

15



Table of Contents

 

Hilltop Holdings Inc. and Subsidiaries

Notes to Consolidated Financial Statements (continued)

(Unaudited)

 

Information regarding securities that were in an unrealized loss position is shown in the following tables (dollars in thousands).

 

`

 

March 31, 2014

 

December 31, 2013

 

 

 

 

Number of

 

 

 

Unrealized

 

Number of

 

 

 

Unrealized

 

 

 

 

Securities

 

Fair Value

 

Losses

 

Securities

 

Fair Value

 

Losses

 

 

Available for Sale

 

 

 

 

 

 

 

 

 

 

 

 

 

 

U.S. treasury securities:

 

 

 

 

 

 

 

 

 

 

 

 

 

 

Unrealized loss for less than twelve months

 

6

 

$

13,289

 

$

94

 

6

 

$

12,748

 

$

238

 

 

Unrealized loss for twelve months or longer

 

 

 

 

 

 

 

 

 

 

6

 

13,289

 

94

 

6

 

12,748

 

238

 

 

U.S. government agencies:

 

 

 

 

 

 

 

 

 

 

 

 

 

 

Bonds:

 

 

 

 

 

 

 

 

 

 

 

 

 

 

Unrealized loss for less than twelve months

 

31

 

399,291

 

24,490

 

35

 

526,817

 

45,274

 

 

Unrealized loss for twelve months or longer

 

7

 

160,352

 

14,413

 

5

 

90,931

 

10,453

 

 

 

 

38

 

559,643

 

38,903

 

40

 

617,748

 

55,727

 

 

Residential mortgage-backed securities:

 

 

 

 

 

 

 

 

 

 

 

 

 

 

Unrealized loss for less than twelve months

 

1

 

1,595

 

62

 

2

 

2,194

 

54

 

 

Unrealized loss for twelve months or longer

 

3

 

9,325

 

443

 

3

 

9,309

 

530

 

 

 

 

4

 

10,920

 

505

 

5

 

11,503

 

584

 

 

 

Collateralized mortgage obligations:

 

 

 

 

 

 

 

 

 

 

 

 

 

 

Unrealized loss for less than twelve months

 

6

 

68,200

 

3,740

 

7

 

84,054

 

4,320

 

 

Unrealized loss for twelve months or longer

 

2

 

4,095

 

60

 

2

 

4,995

 

70

 

 

 

 

8

 

72,295

 

3,800

 

9

 

89,049

 

4,390

 

 

 

Corporate debt securities:

 

 

 

 

 

 

 

 

 

 

 

 

 

 

Unrealized loss for less than twelve months

 

7

 

10,732

 

226

 

7

 

10,754

 

378

 

 

Unrealized loss for twelve months or longer

 

 

 

 

 

 

 

 

 

 

7

 

10,732

 

226

 

7

 

10,754

 

378

 

 

 

States and political subdivisions:

 

 

 

 

 

 

 

 

 

 

 

 

 

 

Unrealized loss for less than twelve months

 

29

 

21,753

 

257

 

46

 

30,245

 

669

 

 

Unrealized loss for twelve months or longer

 

140

 

92,954

 

3,293

 

150

 

96,882

 

5,839

 

 

 

 

169

 

114,707

 

3,550

 

196

 

127,127

 

6,508

 

 

 

Total available for sale:

 

 

 

 

 

 

 

 

 

 

 

 

 

 

Unrealized loss for less than twelve months

 

80

 

514,860

 

28,869

 

103

 

666,812

 

50,933

 

 

Unrealized loss for twelve months or longer

 

152

 

266,726

 

18,209

 

160

 

202,117

 

16,892

 

 

 

 

232

 

$

781,586

 

$

47,078

 

263

 

$

868,929

 

$

67,825

 

 

 

 

`

 

March 31, 2014

 

December 31, 2013

 

 

 

Number of

 

 

 

Unrealized

 

Number of

 

 

 

Unrealized

 

 

 

Securities

 

Fair Value

 

Losses

 

Securities

 

Fair Value

 

Losses

 

Held to Maturity

 

 

 

 

 

 

 

 

 

 

 

 

 

U.S. government agencies:

 

 

 

 

 

 

 

 

 

 

 

 

 

Residential mortgage-backed securities:

 

 

 

 

 

 

 

 

 

 

 

 

 

Unrealized loss for less than twelve months

 

3

 

$

29,512

 

$

70

 

$

 

$

 

$

 

Unrealized loss for twelve months or longer

 

 

 

 

 

 

 

 

 

3

 

29,512

 

70

 

 

 

 

States and political subdivisions:

 

 

 

 

 

 

 

 

 

 

 

 

 

Unrealized loss for less than twelve months

 

2

 

1,112

 

10

 

 

 

 

Unrealized loss for twelve months or longer

 

 

 

 

 

 

 

 

 

2

 

1,112

 

10

 

 

 

 

Total held to maturity:

 

 

 

 

 

 

 

 

 

 

 

 

 

Unrealized loss for less than twelve months

 

5

 

30,624

 

80

 

 

 

 

Unrealized loss for twelve months or longer

 

 

 

 

 

 

 

 

 

5

 

$

30,624

 

$

80

 

 

$

 

$

 

 

During the three months ended March 31, 2014 and 2013, the Company did not record any other-than-temporary impairments. While all of the investments are monitored for potential other-than-temporary impairment, the Company’s analysis and experience indicate that these available for sale investments generally do not present a great risk of other-than-temporary-impairment, as fair value should recover over time. Factors considered in the Company’s analysis include the reasons for the unrealized loss position, the severity and duration of the unrealized loss position, credit worthiness, and forecasted performance of the investee. While some of the securities held in the investment portfolio have decreased in value since the date of acquisition, the severity of loss and the duration of the loss position are not believed to be

 

16



Table of Contents

 

Hilltop Holdings Inc. and Subsidiaries

Notes to Consolidated Financial Statements (continued)

(Unaudited)

 

significant enough to warrant other-than-temporary impairment of the securities. The Company does not intend, nor is it likely that the Company will be required, to sell these securities before the recovery of the cost basis. Therefore, management does not believe any other-than-temporary impairments exist at March 31, 2014.

 

Expected maturities may differ from contractual maturities because certain borrowers may have the right to call or prepay obligations with or without penalties. The amortized cost and fair value of securities, excluding trading and available for sale equity securities and the available for sale warrant, at March 31, 2014 are shown by contractual maturity below (in thousands).

 

 

 

Available for Sale

 

Held to Maturity

 

 

 

Amortized

 

 

 

Amortized

 

 

 

 

 

Cost

 

Fair Value

 

Cost

 

Fair Value

 

Due in one year or less

 

$

135,582

 

$

135,741

 

$

 

$

 

Due after one year through five years

 

117,222

 

126,696

 

 

 

Due after five years through ten years

 

85,407

 

86,616

 

 

 

Due after ten years

 

724,434

 

683,063

 

1,399

 

1,390

 

 

 

1,062,645

 

1,032,116

 

1,399

 

1,390

 

 

 

 

 

 

 

 

 

 

 

Residential mortgage-backed securities

 

57,781

 

58,545

 

29,582

 

29,512

 

Collateralized mortgage obligations

 

117,336

 

113,832

 

 

 

Commercial mortgage-backed securities

 

618

 

687

 

 

 

 

 

$

1,238,380

 

$

1,205,180

 

$

30,981

 

$

30,902

 

 

The Company realized a net gain from its trading securities portfolio of $0.6 million during the three months ended March 31, 2014 and a net loss of $1.2 million during the three months ended March 31, 2013, which are recorded as a component of other noninterest income within the consolidated statements of operations.

 

Securities with a carrying amount of $1.1 billion and $1.0 billion (with a fair value of $1.0 billion and $938.1 million) at March 31, 2014 and December 31, 2013, respectively, were pledged to secure public and trust deposits, federal funds purchased and securities sold under agreements to repurchase, and for other purposes as required or permitted by law.

 

Mortgage-backed securities and collateralized mortgage obligations consist principally of Government National Mortgage Association (“GNMA”), Federal National Mortgage Association (“FNMA”) and Federal Home Loan Mortgage Corporation (“FHLMC”) pass-through and participation certificates. GNMA securities are guaranteed by the full faith and credit of the United States, while FNMA and FHLMC securities are fully guaranteed by those respective United States government-sponsored agencies, and conditionally guaranteed by the full faith and credit of the United States.

 

At March 31, 2014 and December 31, 2013, NLC had investments on deposit in custody for various state insurance departments with carrying values of $8.6 million and $9.4 million, respectively.

 

17



Table of Contents

 

Hilltop Holdings Inc. and Subsidiaries

Notes to Consolidated Financial Statements (continued)

(Unaudited)

 

5. Non-Covered Loans and Allowance for Non-Covered Loan Losses

 

Non-covered loans refer to loans not covered by the FDIC loss-share agreements. Covered loans are discussed in Note 6 to the consolidated financial statements. Non-covered loans summarized by portfolio segment are as follows (in thousands).

 

 

 

March 31,

 

December 31,

 

 

 

2014

 

2013

 

Commercial and industrial

 

$

1,670,087

 

$

1,637,266

 

Real estate

 

1,535,361

 

1,457,253

 

Construction and land development

 

387,382

 

364,551

 

Consumer

 

54,116

 

55,576

 

 

 

3,646,946

 

3,514,646

 

Allowance for non-covered loan losses

 

(34,645

)

(33,241

)

Total non-covered loans, net of allowance

 

$

3,612,301

 

$

3,481,405

 

 

The Bank has lending policies in place with the goal of establishing an asset portfolio that will provide a return on stockholders’ equity sufficient to maintain capital to assets ratios that meet or exceed established regulations. Loans are underwritten with careful consideration of the borrower’s financial condition, the specific purpose of the loan, the primary sources of repayment and any collateral pledged to secure the loan.

 

Underwriting procedures address financial components based on the size or complexity of the credit. The financial components include, but are not limited to, current and projected cash flows, shock analysis and/or stress testing, and trends in appropriate balance sheet and statement of operations ratios. Collateral analysis includes a complete description of the collateral, as well as determining values, monitoring requirements, loan to value ratios, concentration risk, appraisal requirements and other information relevant to the collateral being pledged. Guarantor analysis includes liquidity and cash flow analysis based on the significance the guarantors are expected to serve as secondary repayment sources. The Bank’s underwriting standards are governed by adherence to its loan policy. The loan policy provides for specific guidelines by portfolio segment, including commercial and industrial, real estate, construction and land development, and consumer loans. Within each individual portfolio segment, permissible and impermissible loan types are explicitly outlined. Within the loan types, minimum requirements for the underwriting factors listed above are provided.

 

The Bank maintains a loan review department that reviews credit risk in response to both external and internal factors that potentially impact the performance of either individual loans or the overall loan portfolio. The loan review process reviews the creditworthiness of borrowers and determines compliance with the loan policy. The loan review process complements and reinforces the risk identification and assessment decisions made by lenders and credit personnel.  Results of these reviews are presented to management and the Bank’s board of directors.

 

In connection with the PlainsCapital Merger and the FNB Transaction, the Company acquired non-covered loans both with and without evidence of credit quality deterioration since origination. The following table presents the carrying values and the outstanding balances of the non-covered PCI loans (in thousands).

 

 

 

March 31,

 

December 31,

 

 

 

2014

 

2013

 

Carrying amount

 

$

85,396

 

$

100,392

 

Outstanding balance

 

122,881

 

141,983

 

 

18



Table of Contents

 

Hilltop Holdings Inc. and Subsidiaries

Notes to Consolidated Financial Statements (continued)

(Unaudited)

 

Changes in the accretable yield for the non-covered PCI loans were as follows (in thousands).

 

 

 

Three Months Ended March 31,

 

 

 

2014

 

2013

 

Balance, beginning of period

 

$

17,601

 

$

17,553

 

Additions

 

 

 

Increases in expected cash flows

 

3,475

 

11,996

 

Disposals of loans

 

(603

)

(26

)

Accretion

 

(2,760

)

(3,277

)

Balance, end of period

 

$

17,713

 

$

26,246

 

 

Impaired loans exhibit a clear indication that the borrower’s cash flow may not be sufficient to meet principal and interest payments, which is generally when a loan is 90 days past due unless the asset is both well secured and in the process of collection. Non-covered impaired loans include non-accrual loans, troubled debt restructurings (“TDRs”), PCI loans and partially charged-off loans.

 

Non-covered PCI loans are summarized by class in the following tables (in thousands). In addition to the non-covered PCI loans, there were $5.3 million and $4.1 million of additional non-covered impaired loans at March 31, 2014 and December 31, 2013, respectively.

 

 

 

Unpaid

 

Recorded

 

Recorded

 

Total

 

 

 

 

 

Contractual

 

Investment with

 

Investment with

 

Recorded

 

Related

 

March 31, 2014

 

Principal Balance

 

No Allowance

 

Allowance

 

Investment

 

Allowance

 

Commercial and industrial:

 

 

 

 

 

 

 

 

 

 

 

Secured

 

$

57,302

 

$

19,727

 

$

12,894

 

$

32,621

 

$

2,716

 

Unsecured

 

11,421

 

1,225

 

 

1,225

 

 

Real estate:

 

 

 

 

 

 

 

 

 

 

 

Secured by commercial properties

 

41,051

 

12,053

 

17,439

 

29,492

 

450

 

Secured by residential properties

 

4,589

 

1,353

 

1,356

 

2,709

 

79

 

Construction and land development:

 

 

 

 

 

 

 

 

 

 

 

Residential construction loans

 

33

 

 

 

 

 

Commercial construction loans and land development

 

25,535

 

14,912

 

706

 

15,618

 

107

 

Consumer

 

7,516

 

3,731

 

 

3,731

 

 

 

 

$

147,447

 

$

53,001

 

$

32,395

 

$

85,396

 

$

3,352

 

 

 

 

Unpaid

 

Recorded

 

Recorded

 

Total

 

 

 

 

 

Contractual

 

Investment with

 

Investment with

 

Recorded

 

Related

 

December 31, 2013

 

Principal Balance

 

No Allowance

 

Allowance

 

Investment

 

Allowance

 

Commercial and industrial:

 

 

 

 

 

 

 

 

 

 

 

Secured

 

$

60,309

 

$

19,280

 

$

16,092

 

$

35,372

 

$

2,705

 

Unsecured

 

11,772

 

240

 

1,204

 

1,444

 

15

 

Real estate:

 

 

 

 

 

 

 

 

 

 

 

Secured by commercial properties

 

49,306

 

20,185

 

16,070

 

36,255

 

339

 

Secured by residential properties

 

5,013

 

1,347

 

1,648

 

2,995

 

39

 

Construction and land development:

 

 

 

 

 

 

 

 

 

 

 

Residential construction loans

 

33

 

 

 

 

 

Commercial construction loans and land development

 

48,515

 

15,225

 

4,592

 

19,817

 

39

 

Consumer

 

7,946

 

4,509

 

 

4,509

 

 

 

 

$

182,894

 

$

60,786

 

$

39,606

 

$

100,392

 

$

3,137

 

 

19



Table of Contents

 

Hilltop Holdings Inc. and Subsidiaries

Notes to Consolidated Financial Statements (continued)

(Unaudited)

 

Average investment in non-covered PCI loans is summarized by class in the following table (in thousands).

 

 

 

Three Months Ended March 31,

 

 

 

2014

 

2013

 

Commercial and industrial:

 

 

 

 

 

Secured

 

$

33,997

 

$

68,316

 

Unsecured

 

1,335

 

3,107

 

Real estate:

 

 

 

 

 

Secured by commercial properties

 

32,874

 

53,371

 

Secured by residential properties

 

2,852

 

7,413

 

Construction and land development:

 

 

 

 

 

Residential construction loans

 

 

354

 

Commercial construction loans and land development

 

17,718

 

29,266

 

Consumer

 

4,120

 

75

 

 

 

$

92,896

 

$

161,902

 

 

Non-covered non-accrual loans, excluding those classified as held for sale, are summarized by class in the following table (in thousands).

 

 

 

March 31,

 

December 31,

 

 

 

2014

 

2013

 

Commercial and industrial:

 

 

 

 

 

Secured

 

$

14,551

 

$

15,430

 

Unsecured

 

1,024

 

1,300

 

Real estate:

 

 

 

 

 

Secured by commercial properties

 

1,094

 

2,638

 

Secured by residential properties

 

2,371

 

398

 

Construction and land development:

 

 

 

 

 

Residential construction loans

 

 

 

Commercial construction loans and land development

 

142

 

112

 

Consumer

 

 

 

 

 

$

19,182

 

$

19,878

 

 

At March 31, 2014 and December 31, 2013, non-covered non-accrual loans included non-covered PCI loans of $13.9 million and $15.8 million, respectively, for which discount accretion has been suspended because the extent and timing of cash flows from these non-covered PCI loans can no longer be reasonably estimated. In addition to the non-covered non-accrual loans in the table above, $3.7 million and $3.5 million of real estate loans secured by residential properties and classified as held for sale were in non-accrual status at March 31, 2014 and December 31, 2013, respectively.

 

Interest income recorded on accruing impaired loans and on non-accrual loans was $1.4 million for the three months ended March 31, 2014. Interest income recorded on accruing impaired loans and on non-accrual loans for the three months ended March 31, 2013 was nominal.

 

20



Table of Contents

 

Hilltop Holdings Inc. and Subsidiaries

Notes to Consolidated Financial Statements (continued)

(Unaudited)

 

The Bank classifies loan modifications as TDRs when it concludes that it has both granted a concession to a debtor and that the debtor is experiencing financial difficulties. Loan modifications are typically structured to create affordable payments for the debtor and can be achieved in a variety of ways. The Bank modifies loans by reducing interest rates and/or lengthening loan amortization schedules. The Bank also reconfigures a single loan into two or more loans (“A/B Note”). The typical A/B Note restructure results in a “bad” loan which is charged off and a “good” loan or loans the terms of which comply with the Bank’s customary underwriting policies. The debt charged off on the “bad” loan is not forgiven to the debtor.

 

Information regarding TDRs granted is shown in the following tables (in thousands). At March 31, 2014, the Bank had no unadvanced commitments to borrowers whose loans have been restructured in TDRs. At December 31, 2013, the Bank had $0.5 million in such unadvanced commitments.

 

 

 

Recorded Investment in Loans Modified by

 

 

 

 

 

Interest Rate

 

Payment Term

 

Total

 

Three months ended March 31, 2014

 

A/B Note

 

Adjustment

 

Extension

 

Modification

 

Commercial and industrial:

 

 

 

 

 

 

 

 

 

Secured

 

$

 

$

 

$

 

$

 

Unsecured

 

 

 

 

 

Real estate:

 

 

 

 

 

 

 

 

 

Secured by commercial properties

 

 

 

345

 

345

 

Secured by residential properties

 

 

 

258

 

258

 

Construction and land development:

 

 

 

 

 

 

 

 

 

Residential construction loans

 

 

 

 

 

Commercial construction loans and land development

 

 

 

142

 

142

 

Consumer

 

 

 

 

 

 

 

$

 

$

 

$

745

 

$

745

 

 

 

 

Recorded Investment in Loans Modified by

 

 

 

 

 

Interest Rate

 

Payment Term

 

Total

 

Three months ended March 31, 2013

 

A/B Note

 

Adjustment

 

Extension

 

Modification

 

Commercial and industrial:

 

 

 

 

 

 

 

 

 

Secured

 

$

 

$

 

$

28

 

$

28

 

Unsecured

 

 

 

 

 

Real estate:

 

 

 

 

 

 

 

 

 

Secured by commercial properties

 

 

 

1,236

 

1,236

 

Secured by residential properties

 

 

 

262

 

262

 

Construction and land development:

 

 

 

 

 

 

 

 

 

Residential construction loans

 

 

 

 

 

Commercial construction loans and land development

 

 

 

570

 

570

 

Consumer

 

 

 

 

 

 

 

$

 

$

 

$

2,096

 

$

2,096

 

 

21



Table of Contents

 

Hilltop Holdings Inc. and Subsidiaries

Notes to Consolidated Financial Statements (continued)

(Unaudited)

 

An analysis of the aging of the Bank’s non-covered loan portfolio is shown in the following tables (in thousands).

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

Accruing Loans

 

 

 

Loans Past Due

 

Loans Past Due

 

Loans Past Due

 

Total

 

Current

 

PCI

 

Total

 

Past Due

 

March 31, 2014

 

30-59 Days

 

60-89 Days

 

90 Days or More

 

Past Due Loans

 

Loans

 

Loans

 

Loans

 

90 Days or More

 

Commercial and industrial:

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

Secured

 

$

4,492

 

$

4,914

 

$

379

 

$

9,785

 

$

1,528,769

 

$

32,621

 

$

1,571,175

 

$

1

 

Unsecured

 

88

 

1

 

 

89

 

97,598

 

1,225

 

98,912

 

 

Real estate:

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

Secured by commercial properties

 

205

 

 

 

205

 

1,083,444

 

29,492

 

1,113,141

 

 

Secured by residential properties

 

1,976

 

49

 

70

 

2,095

 

417,416

 

2,709

 

422,220

 

 

Construction and land development:

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

Residential construction loans

 

381

 

 

 

381

 

67,540

 

 

67,921

 

 

Commercial construction loans and land development

 

 

3,121

 

 

3,121

 

300,722

 

15,618

 

319,461

 

 

Consumer

 

240

 

10

 

1

 

251

 

50,134

 

3,731

 

54,116

 

1

 

 

 

$

7,382

 

$

8,095

 

$

450

 

$

15,927

 

$

3,545,623

 

$

85,396

 

$

3,646,946

 

$

2

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

Accruing Loans

 

 

 

Loans Past Due

 

Loans Past Due

 

Loans Past Due

 

Total

 

Current

 

PCI

 

Total

 

Past Due

 

December 31, 2013

 

30-59 Days

 

60-89 Days

 

90 Days or More

 

Past Due Loans

 

Loans

 

Loans

 

Loans

 

90 Days or More

 

Commercial and industrial:

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

Secured

 

$

2,171

 

$

277

 

$

1,354

 

$

3,802

 

$

1,492,793

 

$

35,372

 

$

1,531,967

 

$

272

 

Unsecured

 

333

 

9

 

60

 

402

 

103,453

 

1,444

 

105,299

 

59

 

Real estate:

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

Secured by commercial properties

 

192

 

 

132

 

324

 

1,044,437

 

36,255

 

1,081,016

 

 

Secured by residential properties

 

1,045

 

36

 

203

 

1,284

 

371,958

 

2,995

 

376,237

 

203

 

Construction and land development:

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

Residential construction loans

 

415

 

 

 

415

 

64,664

 

 

65,079

 

 

Commercial construction loans and land development

 

41

 

881

 

112

 

1,034

 

278,621

 

19,817

 

299,472

 

 

Consumer

 

201

 

60

 

 

261

 

50,806

 

4,509

 

55,576

 

 

 

 

$

4,398

 

$

1,263

 

$

1,861

 

$

7,522

 

$

3,406,732

 

$

100,392

 

$

3,514,646

 

$

534

 

 

Management tracks credit quality trends on a quarterly basis related to: (i) past due levels, (ii) non-performing asset levels, (iii) classified loan levels, (iv) net charge-offs, and (v) general economic conditions in the state and local markets.

 

The Bank utilizes a risk grading matrix to assign a risk grade to each of the loans in its portfolio. A risk rating is assigned based on an assessment of the borrower’s management, collateral position, financial capacity, and economic factors. The general characteristics of the various risk grades are described below.

 

Pass — “Pass” loans present a range of acceptable risks to the Bank. Loans that would be considered virtually risk-free are rated Pass — low risk.  Loans that exhibit sound standards based on the grading factors above and present a reasonable risk to the Bank are rated Pass — normal risk.  Loans that exhibit a minor weakness in one or more of the grading criteria but still present an acceptable risk to the Bank are rated Pass — high risk.

 

Special Mention — “Special Mention” loans have potential weaknesses that deserve management’s close attention. If left uncorrected, these potential weaknesses may result in a deterioration of the repayment prospects for the loans and weaken the Bank’s credit position at some future date. Special Mention loans are not adversely classified and do not expose the Bank to sufficient risk to require adverse classification.

 

Substandard — “Substandard” loans are inadequately protected by the current sound worth and paying capacity of the obligor or the collateral pledged, if any. Loans so classified must have a well-defined weakness or weaknesses that jeopardize the liquidation of the debt. They are characterized by the distinct possibility that the Bank will sustain some loss if the deficiencies are not corrected. Many substandard loans are considered impaired.

 

PCI — “PCI” loans exhibited evidence of credit deterioration at acquisition that made it probable that all contractually required principal payments would not be collected.

 

22



Table of Contents

 

Hilltop Holdings Inc. and Subsidiaries

Notes to Consolidated Financial Statements (continued)

(Unaudited)

 

The following tables present the internal risk grades of non-covered loans, as previously described, in the portfolio by class (in thousands).

 

March 31, 2014

 

Pass

 

Special Mention

 

Substandard

 

PCI

 

Total

 

Commercial and industrial:

 

 

 

 

 

 

 

 

 

 

 

Secured

 

$

1,474,358

 

$

29,114

 

$

35,082

 

$

32,621

 

$

1,571,175

 

Unsecured

 

97,512

 

8

 

167

 

1,225

 

98,912

 

Real estate:

 

 

 

 

 

 

 

 

 

 

 

Secured by commercial properties

 

1,076,039

 

5,835

 

1,775

 

29,492

 

1,113,141

 

Secured by residential properties

 

413,626

 

 

5,885

 

2,709

 

422,220

 

Construction and land development:

 

 

 

 

 

 

 

 

 

 

 

Residential construction loans

 

67,921

 

 

 

 

67,921

 

Commercial construction loans and land development

 

299,760

 

280

 

3,803

 

15,618

 

319,461

 

Consumer

 

50,348

 

 

37

 

3,731

 

54,116

 

 

 

$

3,479,564

 

$

35,237

 

$

46,749

 

$

85,396

 

$

3,646,946

 

 

December 31, 2013

 

Pass

 

Special Mention

 

Substandard

 

PCI

 

Total

 

Commercial and industrial:

 

 

 

 

 

 

 

 

 

 

 

Secured

 

$

1,450,734

 

$

16,840

 

$

29,021

 

$

35,372

 

$

1,531,967

 

Unsecured

 

103,674

 

12

 

169

 

1,444

 

105,299

 

Real estate:

 

 

 

 

 

 

 

 

 

 

 

Secured by commercial properties

 

1,038,930

 

4,436

 

1,395

 

36,255

 

1,081,016

 

Secured by residential properties

 

367,758

 

 

5,484

 

2,995

 

376,237

 

Construction and land development:

 

 

 

 

 

 

 

 

 

 

 

Residential construction loans

 

65,079

 

 

 

 

65,079

 

Commercial construction loans and land development

 

275,808

 

3,384

 

463

 

19,817

 

299,472

 

Consumer

 

51,052

 

1

 

14

 

4,509

 

55,576

 

 

 

$

3,353,035

 

$

24,673

 

$

36,546

 

$

100,392

 

$

3,514,646

 

 

The allowance for loan losses is a reserve established through a provision for loan losses charged to expense, which represents management’s best estimate of probable losses inherent in the existing portfolio of loans. Management has responsibility for determining the level of the allowance for loan losses, subject to review by the Audit Committee of the Company’s Board of Directors and the Loan Review Committee of the Bank’s board of directors.

 

It is management’s responsibility at the end of each quarter, or more frequently as deemed necessary, to analyze the level of the allowance for loan losses to ensure that it is appropriate for the estimated credit losses in the portfolio consistent with the Interagency Policy Statement on the Allowance for Loan and Lease Losses and the Receivables and Contingencies Topics of the ASC. Estimated credit losses are the probable current amount of loans that the Company will be unable to collect given facts and circumstances as of the evaluation date. When management determines that a loan or portion thereof is uncollectible, the loan, or portion thereof, is charged off against the allowance for loan losses. Any subsequent recovery of charged-off loans is added back to the allowance for loan losses. The Bank’s loan portfolio is designated into two populations: acquired loans and originated loans. The allowance for loan losses is calculated separately for acquired and originated loans.

 

Originated Loans

 

The Company has developed a methodology that seeks to determine an allowance within the scope of the Receivables and Contingencies Topics of the ASC. Each of the loans that has been determined to be impaired is within the scope of the Receivables Topic. Impaired loans that are equal to or greater than $0.5 million are individually evaluated for impairment using one of three impairment measurement methods as of the evaluation date: (1) the present value of expected future discounted cash flows on the loan, (2) the loan’s observable market price, or (3) the fair value of the collateral if the loan is collateral dependent. Specific reserves are provided in the estimate of the allowance based on the measurement of impairment under these three methods, except for collateral dependent loans, which require the fair value method. All non-impaired loans are within the scope of the Contingencies Topic. Estimates of loss for the Contingencies Topic are calculated based on historical loss experience by loan portfolio segment adjusted for changes in trends, conditions, and other relevant factors that affect repayment of loans as of the evaluation date. While historical loss experience provides a

 

23



Table of Contents

 

Hilltop Holdings Inc. and Subsidiaries

Notes to Consolidated Financial Statements (continued)

(Unaudited)

 

reasonable starting point for the analysis, historical losses, or recent trends in losses, are not the sole basis upon which to determine the appropriate level for the allowance for loan losses. Management considers recent qualitative or environmental factors that are likely to cause estimated credit losses associated with the existing portfolio to differ from historical loss experience, including but not limited to: changes in lending policies and procedures; changes in underwriting standards; changes in economic and business conditions and developments that affect the collectability of the portfolio; the condition of various market segments; changes in the nature and volume of the portfolio and in the terms of loans; changes in lending management and staff; changes in the volume and severity of past due loans, the volume of non-accrual loans, and the volume and severity of adversely classified or graded loans; changes in the loan review system; changes in the value of underlying collateral for collateral-dependent loans; and any concentrations of credit and changes in the level of such concentrations.

 

The loan review program is designed to identify and monitor problem loans by maintaining a credit grading process, requiring that timely and appropriate changes be made to reviewed loans and coordinating the delivery of the information necessary to assess the appropriateness of the allowance for loan losses. Loans are evaluated for impaired status when: (i) payments on the loan are delayed, typically by 90 days or more (unless the loan is both well secured and in the process of collection), (ii) the loan becomes classified, (iii) the loan is being reviewed in the normal course of the loan review scope, or (iv) the loan is identified by the servicing officer as a problem.

 

Homogeneous loans, such as consumer installment loans, residential mortgage loans and home equity loans, are not individually reviewed and are generally risk graded at the same levels. The risk grade and reserves are established for each homogeneous pool of loans based on the expected net charge-offs from current trends in delinquencies, losses or historical experience and general economic conditions. At March 31, 2014 and December 31, 2013, there were no material delinquencies in these types of loans.

 

Acquired Loans

 

Loans acquired in a business combination are recorded at their estimated fair value on their purchase date and with no carryover of the related allowance for loan losses. Loans without evidence of credit impairment at acquisition are subsequently evaluated for any required allowance at each reporting date. An allowance for loan losses is calculated using a methodology similar to that described above for originated loans. The allowance as determined for each loan collateral type is compared to the remaining fair value discount for that loan collateral type. If greater, the excess is recognized as an addition to the allowance through a provision for loan losses. If less than the discount, no additional allowance is recorded. Charge-offs and losses first reduce any remaining fair value discount for the loan and once the discount is depleted, losses are applied against the allowance established for that loan.

 

PCI loans acquired in the PlainsCapital Merger are accounted for on an individual loan basis, while PCI loans acquired in the FNB Transaction are accounted for both in pools and at the individual loan level. Cash flows expected to be collected are recast quarterly for each loan or pool. These evaluations require the continued use and updating of key assumptions and estimates such as default rates, loss severity given default and prepayment speed assumptions, similar to those used for the initial fair value estimate. Management judgment must be applied in developing these assumptions. If expected cash flows for a loan or pool decreases, an increase in the allowance for loan losses is made through a charge to the provision for loan losses. If expected cash flows for a loan or pool increase, any previously established allowance for loan losses is reversed and any remaining difference increases the accretable yield which will be taken into income over the remaining life of the loan.

 

The allowance is subject to regulatory examinations and determinations as to appropriateness, which may take into account such factors as the methodology used to calculate the allowance and the size of the allowance.

 

24



Table of Contents

 

Hilltop Holdings Inc. and Subsidiaries

Notes to Consolidated Financial Statements (continued)

(Unaudited)

 

Changes in the allowance for non-covered loan losses, distributed by portfolio segment, are shown below (in thousands).

 

 

 

Commercial and

 

 

 

Construction and

 

 

 

 

 

Three months ended March 31, 2014

 

Industrial

 

Real Estate

 

Land Development

 

Consumer

 

Total

 

Balance, beginning of period

 

$

16,865

 

$

8,331

 

$

7,957

 

$

88

 

$

33,241

 

Provision charged to operations

 

(57

)

1,319

 

17

 

109

 

1,388

 

Loans charged off

 

(807

)

 

 

(74

)

(881

)

Recoveries on charged off loans

 

725

 

32

 

122

 

18

 

897

 

Balance, end of period

 

$

16,726

 

$

9,682

 

$

8,096

 

$

141

 

$

34,645

 

 

 

 

Commercial and

 

 

 

Construction and

 

 

 

 

 

Three months ended March 31, 2013

 

Industrial

 

Real Estate

 

Land Development

 

Consumer

 

Total

 

Balance, beginning of period

 

$

1,845

 

$

977

 

$

582

 

$

5

 

$

3,409

 

Provision charged to operations

 

6,911

 

2,437

 

3,597

 

60

 

13,005

 

Loans charged off

 

(438

)

(31

)

 

(56

)

(525

)

Recoveries on charged off loans

 

494

 

139

 

107

 

8

 

748

 

Balance, end of period

 

$

8,812

 

$

3,522

 

$

4,286

 

$

17

 

$

16,637

 

 

The non-covered loan portfolio was distributed by portfolio segment and impairment methodology as shown below (in thousands).

 

 

 

Commercial and

 

 

 

Construction and

 

 

 

 

 

March 31, 2014

 

Industrial

 

Real Estate

 

Land Development

 

Consumer

 

Total

 

Loans individually evaluated for impairment

 

$

1,930

 

$

2,399

 

$

142

 

$

 

$

4,471

 

Loans collectively evaluated for impairment

 

1,634,311

 

1,500,761

 

371,622

 

50,385

 

3,557,079

 

PCI Loans

 

33,846

 

32,201

 

15,618

 

3,731

 

85,396

 

 

 

$

1,670,087

 

$

1,535,361

 

$

387,382

 

$

54,116

 

$

3,646,946

 

 

 

 

Commercial and

 

 

 

Construction and

 

 

 

 

 

December 31, 2013

 

Industrial

 

Real Estate

 

Land Development

 

Consumer

 

Total

 

Loans individually evaluated for impairment

 

$

2,273

 

$

373

 

$

112

 

$

 

$

2,758

 

Loans collectively evaluated for impairment

 

1,598,177

 

1,417,630

 

344,622

 

51,067

 

3,411,496

 

PCI Loans

 

36,816

 

39,250

 

19,817

 

4,509

 

100,392

 

 

 

$

1,637,266

 

$

1,457,253

 

$

364,551

 

$

55,576

 

$

3,514,646

 

 

The allowance for non-covered loan losses was distributed by portfolio segment and impairment methodology as shown below (in thousands).

 

 

 

Commercial and

 

 

 

Construction and

 

 

 

 

 

March 31, 2014

 

Industrial

 

Real Estate

 

Land Development

 

Consumer

 

Total

 

Loans individually evaluated for impairment

 

$

421

 

$

 

$

 

$

 

$

421

 

Loans collectively evaluated for impairment

 

13,589

 

9,153

 

7,989

 

141

 

30,872

 

PCI Loans

 

2,716

 

529

 

107

 

 

3,352

 

 

 

$

16,726

 

$

9,682

 

$

8,096

 

$

141

 

$

34,645

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

Commercial and

 

 

 

Construction and

 

 

 

 

 

December 31, 2013

 

Industrial

 

Real Estate

 

Land Development

 

Consumer

 

Total

 

Loans individually evaluated for impairment

 

$

421

 

$

 

$

 

$

 

$

421

 

Loans collectively evaluated for impairment

 

13,724

 

7,953

 

7,918

 

88

 

29,683

 

PCI Loans

 

2,720

 

378

 

39

 

 

3,137

 

 

 

$

16,865

 

$

8,331

 

$

7,957

 

$

88

 

$

33,241

 

 

25



Table of Contents

 

Hilltop Holdings Inc. and Subsidiaries

Notes to Consolidated Financial Statements (continued)

(Unaudited)

 

6. Covered Assets and Indemnification Asset

 

As discussed in Note 2 to the consolidated financial statements, the Bank assumed substantially all of the liabilities, including all of the deposits, and acquired substantially all of the assets of FNB in an FDIC-assisted transaction on September 13, 2013. Pursuant to the loss-share agreements, the FDIC has agreed to reimburse the Bank the following amounts with respect to the covered assets: (i) 80% of losses on the first $240.4 million of losses incurred; (ii) 0% of losses in excess of $240.4 million up to and including $365.7 million of losses incurred; and (iii) 80% of losses in excess of $365.7 million of losses incurred. The Bank has also agreed to reimburse the FDIC for any subsequent recoveries. The loss-share agreements for commercial and single family residential loans are in effect for 5 years and 10 years, respectively, from the Bank Closing Date, and the loss recovery provisions to the FDIC are in effect for 8 years and 10 years, respectively, from the Bank Closing Date. The asset arising from the loss-share agreements, which we refer to as the “FDIC Indemnification Asset,” is measured separately from the covered loan portfolio because the agreements are not contractually embedded in the covered loans and are not transferable should the Bank choose to dispose of the covered loans.

 

In accordance with the loss-share agreements, the Bank may be required to make a “true-up” payment to the FDIC approximately ten years following the Bank Closing Date if the FDIC’s initial estimate of losses on covered assets is greater than the actual realized losses. The “true-up” payment is calculated using a defined formula set forth in the P&A Agreement.

 

Covered Loans and Allowance for Covered Loan Losses

 

Loans acquired in a FDIC-assisted acquisition that are subject to a loss-share agreement are referred to as “covered loans” and reported separately in the consolidated balance sheets. Covered loans are reported exclusive of the cash flow reimbursements that may be received from the FDIC.

 

The Bank’s portfolio of acquired covered loans had a fair value of $1.1 billion as of the Bank Closing Date, with no carryover of any allowance for loan losses. Acquired covered loans were preliminarily segregated between those considered to be PCI loans and those without credit impairment at acquisition.

 

In connection with the FNB Transaction, the Bank acquired loans both with and without evidence of credit quality deterioration since origination. The Company’s accounting policies for acquired covered loans, including covered PCI loans, are consistent with that of acquired non-covered loans, as described in Note 5 to the consolidated financial statements. The Company has established under its PCI accounting policy a framework to aggregate certain acquired covered loans into various loan pools based on a minimum of two layers of common risk characteristics for the purpose of determining their respective fair values as of their acquisition dates, and for applying the subsequent recognition and measurement provisions for income accretion and impairment testing.

 

The following table presents the carrying value of the covered loans summarized by portfolio segment (in thousands).

 

 

 

March 31,

 

December 31,

 

 

 

2014

 

2013

 

Commercial and industrial

 

$

52,363

 

$

66,943

 

Real estate

 

746,454

 

787,982

 

Construction and land development

 

113,631

 

151,444

 

Consumer

 

 

 

Total covered loans

 

912,448

 

1,006,369

 

Allowance for covered loans

 

(2,665

)

(1,061

)

Total covered loans, net of allowance

 

$

909,783

 

$

1,005,308

 

 

26



Table of Contents

 

Hilltop Holdings Inc. and Subsidiaries

Notes to Consolidated Financial Statements (continued)

(Unaudited)

 

The following table presents the carrying value and the outstanding contractual balance of the covered PCI loans (in thousands).

 

 

 

March 31,

 

December 31,

 

 

 

2014

 

2013

 

Carrying amount

 

$

651,927

 

$

729,156

 

Outstanding balance

 

940,972

 

1,022,514

 

 

Changes in the accretable yield for the covered PCI loans for the three months ended March 31, 2014 were as follows (in thousands).

 

Balance, beginning of period

 

$

156,548

 

Additions

 

 

Increases in expected cash flows

 

30,710

 

Transfer of loans to covered OREO

 

5,261

 

Accretion

 

(16,050

)

Balance, end of period

 

$

176,469

 

 

Covered PCI loans are summarized by class in the following tables (in thousands). In addition to the covered PCI loans, there were $2.7 million and $0.9 million of additional covered impaired loans at March 31, 2014 and December 31, 2013, respectively.

 

 

 

Unpaid

 

Recorded

 

Recorded

 

Total

 

 

 

 

 

Contractual

 

Investment with

 

Investment with

 

Recorded

 

Related

 

March 31, 2014

 

Principal Balance

 

No Allowance

 

Allowance

 

Investment

 

Allowance

 

 

 

 

 

 

 

 

 

 

 

 

 

Commercial and industrial:

 

 

 

 

 

 

 

 

 

 

 

Secured

 

$

36,395

 

$

22,110

 

$

132

 

$

22,242

 

$

 

Unsecured

 

16,577

 

8,065

 

903

 

8,968

 

883

 

Real estate:

 

 

 

 

 

 

 

 

 

 

 

Secured by commercial properties

 

505,438

 

312,576

 

26,786

 

339,362

 

142

 

Secured by residential properties

 

280,825

 

177,719

 

10,271

 

187,990

 

1,548

 

Construction and land development:

 

 

 

 

 

 

 

 

 

 

 

Residential construction loans

 

5,029

 

2,363

 

 

2,363

 

 

Commercial construction loans and land development

 

151,091

 

91,002

 

 

91,002

 

 

Consumer

 

 

 

 

 

 

 

 

$

995,355

 

$

613,835

 

$

38,092

 

$

651,927

 

$

2,573

 

 

 

 

Unpaid

 

Recorded

 

Recorded

 

Total

 

 

 

 

 

Contractual

 

Investment with

 

Investment with

 

Recorded

 

Related

 

December 31, 2013

 

Principal Balance

 

No Allowance

 

Allowance

 

Investment

 

Allowance

 

 

 

 

 

 

 

 

 

 

 

 

 

Commercial and industrial:

 

 

 

 

 

 

 

 

 

 

 

Secured

 

$

43,867

 

$

28,520

 

$

 

$

28,520

 

$

 

Unsecured

 

16,280

 

9,008

 

882

 

9,890

 

882

 

Real estate:

 

 

 

 

 

 

 

 

 

 

 

Secured by commercial properties

 

528,785

 

365,306

 

 

365,306

 

 

Secured by residential properties

 

288,859

 

199,372

 

 

199,372

 

 

Construction and land development:

 

 

 

 

 

 

 

 

 

 

 

Residential construction loans

 

8,341

 

4,705

 

 

4,705

 

 

Commercial construction loans and land development

 

183,117

 

121,363

 

 

121,363

 

 

Consumer

 

 

 

 

 

 

 

 

$

1,069,249

 

$

728,274

 

$

882

 

$

729,156

 

$

882

 

 

27



Table of Contents

 

Hilltop Holdings Inc. and Subsidiaries

Notes to Consolidated Financial Statements (continued)

(Unaudited)

 

Average investment in covered PCI loans for the three months ended March 31, 2014 is summarized by class in the following table (in thousands).

 

Commercial and industrial:

 

 

 

Secured

 

$

25,381

 

Unsecured

 

9,429

 

Real estate:

 

 

 

Secured by commercial properties

 

352,334

 

Secured by residential properties

 

193,681

 

Construction and land development:

 

 

 

Residential construction loans

 

3,534

 

Commercial construction loans and land development

 

106,183

 

Consumer

 

 

 

 

$

690,542

 

 

Covered non-accrual loans, excluding those classified as held for sale, are summarized by class in the following table (in thousands).

 

`

 

March 31,

 

December 31,

 

 

 

2014

 

2013

 

Commercial and industrial:

 

 

 

 

 

Secured

 

$

 

$

91

 

Unsecured

 

882

 

882

 

Real estate:

 

 

 

 

 

Secured by commercial properties

 

10,607

 

40

 

Secured by residential properties

 

670

 

209

 

Construction and land development:

 

 

 

 

 

Residential construction loans

 

1,898

 

575

 

Commercial construction loans and land development

 

15

 

 

Consumer

 

 

 

 

 

$

14,072

 

$

1,797

 

 

At March 31, 2014, covered non-accrual loans included covered PCI loans of $11.4 million for which discount accretion has been suspended because the extent and timing of cash flows from these covered PCI loans can no longer be reasonably estimated.

 

Interest income recorded on accruing impaired loans and on non-accrual loans for the three months ended March 31, 2014 was nominal. Except as noted above, covered PCI loans are considered to be performing due to the application of the accretion method. Additionally, no acquired covered performing loans have been modified in a TDR.

 

28



Table of Contents

 

Hilltop Holdings Inc. and Subsidiaries

Notes to Consolidated Financial Statements (continued)

(Unaudited)

 

An analysis of the aging of the Bank’s covered loan portfolio is shown in the following tables (in thousands).

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

Accruing Loans

 

 

 

Loans Past Due

 

Loans Past Due

 

Loans Past Due

 

Total

 

Current

 

PCI

 

Total

 

Past Due

 

March 31, 2014

 

30-59 Days

 

60-89 Days

 

90 Days or More

 

Past Due Loans

 

Loans

 

Loans

 

Loans

 

90 Days or More

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

Commercial and industrial:

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

Secured

 

$

218

 

$

56

 

$

168

 

$

442

 

$

13,045

 

$

22,242

 

$

35,729

 

$

168

 

Unsecured

 

98

 

71

 

 

169

 

7,497

 

8,968

 

16,634

 

 

Real estate:

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

Secured by commercial properties

 

356

 

 

455

 

811

 

62,282

 

339,362

 

402,455

 

379

 

Secured by residential properties

 

2,190

 

584

 

995

 

3,769

 

152,240

 

187,990

 

343,999

 

419

 

Construction and land development:

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

Residential construction loans

 

730

 

858

 

1,399

 

2,987

 

1,850

 

2,363

 

7,200

 

85

 

Commercial construction loans and land development

 

43

 

66

 

 

109

 

15,320

 

91,002

 

106,431

 

 

Consumer

 

 

 

 

 

 

 

 

 

 

 

$

3,635

 

$

1,635

 

$

3,017

 

$

8,287

 

$

252,234

 

$

651,927

 

$

912,448

 

$

1,051

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

Accruing Loans

 

 

 

Loans Past Due

 

Loans Past Due

 

Loans Past Due

 

Total

 

Current

 

PCI

 

Total

 

Past Due

 

December 31, 2013

 

30-59 Days

 

60-89 Days

 

90 Days or More

 

Past Due Loans

 

Loans

 

Loans

 

Loans

 

90 Days or More

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

Commercial and industrial:

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

Secured

 

$

3,904

 

$

10

 

$

81

 

$

3,995

 

$

20,918

 

$

28,520

 

$

53,433

 

$

 

Unsecured

 

10

 

259

 

 

269

 

3,351

 

9,890

 

13,510

 

 

Real estate:

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

Secured by commercial properties

 

999

 

 

40

 

1,039

 

63,780

 

365,306

 

430,125

 

 

Secured by residential properties

 

1,679

 

678

 

209

 

2,566

 

155,919

 

199,372

 

357,857

 

 

Construction and land development:

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

Residential construction loans

 

1,861

 

 

576

 

2,437

 

5,026

 

4,705

 

12,168

 

 

Commercial construction loans and land development

 

244

 

20

 

 

264

 

17,649

 

121,363

 

139,276

 

 

Consumer

 

 

 

 

 

 

 

 

 

 

 

$

8,697

 

$

967

 

$

906

 

$

10,570

 

$

266,643

 

$

729,156

 

$

1,006,369

 

$

 

 

The Bank assigns a risk grade to each of its covered loans in a manner consistent with the existing loan review program and risk grading matrix used for non-covered loans, as described in Note 5 to the consolidated financial statements. The following tables present the internal risk grades of covered loans in the portfolio by class (in thousands).

 

March 31, 2014

 

Pass

 

Special Mention

 

Substandard

 

PCI

 

Total

 

 

 

 

 

 

 

 

 

 

 

 

 

Commercial and industrial:

 

 

 

 

 

 

 

 

 

 

 

Secured

 

$

13,187

 

$

 

$

300

 

$

22,242

 

$

35,729

 

Unsecured

 

7,350

 

 

316

 

8,968

 

16,634

 

Real estate:

 

 

 

 

 

 

 

 

 

 

 

Secured by commercial properties

 

52,598

 

1,702

 

8,793

 

339,362

 

402,455

 

Secured by residential properties

 

150,862

 

 

5,147

 

187,990

 

343,999

 

Construction and land development:

 

 

 

 

 

 

 

 

 

 

 

Residential construction loans

 

2,853

 

 

1,984

 

2,363

 

7,200

 

Commercial construction loans and land development

 

14,926

 

 

503

 

91,002

 

106,431

 

Consumer

 

 

 

 

 

 

 

 

$

241,776

 

$

1,702

 

$

17,043

 

$

651,927

 

$

912,448

 

 

December 31, 2013

 

Pass

 

Special Mention

 

Substandard

 

PCI

 

Total

 

 

 

 

 

 

 

 

 

 

 

 

 

Commercial and industrial:

 

 

 

 

 

 

 

 

 

 

 

Secured

 

$

 

24,152

 

$

 

$

761

 

$

28,520

 

$

53,433

 

Unsecured

 

3,040

 

 

580

 

9,890

 

13,510

 

Real estate:

 

 

 

 

 

 

 

 

 

 

 

Secured by commercial properties

 

59,343

 

3,310

 

2,166

 

365,306

 

430,125

 

Secured by residential properties

 

155,439

 

 

3,046

 

199,372

 

357,857

 

Construction and land development:

 

 

 

 

 

 

 

 

 

 

 

Residential construction loans

 

6,087

 

 

1,376

 

4,705

 

12,168

 

Commercial construction loans and land development

 

17,806

 

 

107

 

121,363

 

139,276

 

Consumer

 

 

 

 

 

 

 

 

$

 

265,867

 

$

3,310

 

$

8,036

 

$

729,156

 

$

1,006,369

 

 

The Bank’s impairment methodology for the covered loans is consistent with that of non-covered loans as discussed in Note 5 to the consolidated financial statements. To the extent there is experienced or projected credit deterioration on the acquired covered loan pools subsequent to amounts estimated at the previous quarterly recast date and expected cash flows for a loan or pool decreases, an increase in the allowance for loan losses is made through a charge to the provision for loan losses. If expected cash flows for a loan or pool increase, any previously established allowance for loan losses is

 

29



Table of Contents

 

Hilltop Holdings Inc. and Subsidiaries

Notes to Consolidated Financial Statements (continued)

(Unaudited)

 

reversed and any remaining difference increases the accretable yield which will be taken into income over the remaining life of the loan. Additionally, provision for credit losses will be recorded on advances on covered loans subsequent to the acquisition date in a manner consistent with the allowance for non-covered loan losses. These provisions will be partially offset by an increase to the FDIC Indemnification Asset in an amount equal to the FDIC’s loss sharing percentage under the loss-share agreements, which is recognized in noninterest income within the consolidated statement of operations.

 

Changes in the allowance for covered loan losses for the three months ended March 31, 2014, distributed by portfolio segment, are shown below (in thousands).

 

 

 

Commercial and

 

 

 

Construction and

 

 

 

 

 

 

 

Industrial

 

Real Estate

 

Land Development

 

Consumer

 

Total

 

Balance, beginning of period

 

$

1,053

 

$

8

 

$

 

$

 

$

1,061

 

Provision charged to operations

 

(30

)

1,732

 

152

 

 

1,854

 

Loans charged off

 

(91

)

(44

)

(115

)

 

(250

)

Recoveries on charged off loans

 

 

 

 

 

 

Balance, end of period

 

$

932

 

$

1,696

 

$

37

 

$

 

$

2,665

 

 

The covered loan portfolio was distributed by portfolio segment and impairment methodology as shown below (in thousands).

 

 

 

Commercial and

 

 

 

Construction and

 

 

 

 

 

March 31, 2014

 

Industrial

 

Real Estate

 

Land Development

 

Consumer

 

Total

 

Loans individually evaluated for impairment

 

$

 

$

 

$

1,385

 

$

 

$

1,385

 

Loans collectively evaluated for impairment

 

21,153

 

219,102

 

18,881

 

 

259,136

 

PCI Loans

 

31,210

 

527,352

 

93,365

 

 

651,927

 

 

 

$

52,363

 

$

746,454

 

$

113,631

 

$

 

$

912,448

 

 

 

 

Commercial and

 

 

 

Construction and

 

 

 

 

 

December 31, 2013

 

Industrial

 

Real Estate

 

Land Development

 

Consumer

 

Total

 

Loans individually evaluated for impairment

 

$

 

$

 

$

 

$

 

$

 

Loans collectively evaluated for impairment

 

28,533

 

223,304

 

25,376

 

 

277,213

 

PCI Loans

 

38,410

 

564,678

 

126,068

 

 

729,156

 

 

 

$

66,943

 

$

787,982

 

$

151,444

 

$

 

$

1,006,369

 

 

The allowance for covered loan losses was distributed by portfolio segment and impairment methodology as shown below (in thousands).

 

 

 

Commercial and

 

 

 

Construction and

 

 

 

 

 

March 31, 2014

 

Industrial

 

Real Estate

 

Land Development

 

Consumer

 

Total

 

Loans individually evaluated for impairment

 

$

 

$

 

$

 

$

 

$

 

Loans collectively evaluated for impairment

 

49

 

6

 

37

 

 

92

 

PCI Loans

 

883

 

1,690

 

 

 

2,573

 

 

 

$

932

 

$

1,696

 

$

37

 

$

 

$

2,665

 

 

 

 

Commercial and

 

 

 

Construction and

 

 

 

 

 

December 31, 2013

 

Industrial

 

Real Estate

 

Land Development

 

Consumer

 

Total

 

Loans individually evaluated for impairment

 

$

 

$

 

$

 

$

 

$

 

Loans collectively evaluated for impairment

 

171

 

8

 

 

 

179

 

PCI Loans

 

882

 

 

 

 

882

 

 

 

$

1,053

 

$

8

 

$

 

$

 

$

1,061

 

 

30



Table of Contents

 

Hilltop Holdings Inc. and Subsidiaries

Notes to Consolidated Financial Statements (continued)

(Unaudited)

 

Covered Other Real Estate Owned

 

A summary of the activity in covered OREO for the three months ended March 31, 2014 is as follows (in thousands).

 

Balance, beginning of period

 

$

142,833

 

Additions to covered OREO

 

23,190

 

Dispositions of covered OREO

 

(13,282

)

Valuation adjustments in the period

 

(431

)

Balance, end of period

 

$

152,310

 

 

FDIC Indemnification Asset

 

A summary of the activity in the FDIC Indemnification Asset for the three months ended March 31, 2014 is as follows (in thousands).

 

Balance, beginning of period

 

$

188,291

 

FDIC Indemnification Asset accretion (amortization)

 

1,357

 

Transfers to due from FDIC and other

 

(912

)

Balance, end of period

 

$

188,736

 

 

7. Mortgage Servicing Rights

 

The following table presents the change in fair value of the Company’s MSR (dollars in thousands).

 

 

 

Three Months Ended March 31,

 

 

 

2014

 

2013

 

Balance, beginning of period

 

$

20,149

 

$

2,080

 

Additions

 

7,432

 

2,125

 

Changes in fair value:

 

 

 

 

 

Due to changes in model inputs or assumptions (1)

 

2,764

 

300

 

Due to customer payments

 

(406

)

(75

)

Balance, end of period

 

$

29,939

 

$

4,430

 

 

 

 

 

 

 

Mortgage loans serviced for others

 

$

2,692,730

 

$

602,771

 

MSR as a percentage of serviced mortgage loans

 

1.11

%

0.73

%


(1)

Primarily represents changes in discount rates and prepayment speed assumptions, which are primarily affected by changes in interest rates and the refinement of other MSR model assumptions.

 

The key assumptions used in measuring the fair value of the Company’s MSR were as follows.

 

 

 

Three Months Ended March 31,

 

 

 

2014

 

2013

 

Weighted average constant prepayment rate

 

9.92

%

12.53

%

Weighted average discount rate

 

11.58

%

20.27

%

Weighted average life (in years)

 

7.4

 

6.6

 

 

31



Table of Contents

 

Hilltop Holdings Inc. and Subsidiaries

Notes to Consolidated Financial Statements (continued)

(Unaudited)

 

A sensitivity analysis of the fair value of the Company’s MSR to certain key assumptions is presented in the following table (in thousands).

 

 

 

March 31,

 

December 31,

 

 

 

2014

 

2013

 

Constant prepayment rate:

 

 

 

 

 

Impact of 10% adverse change

 

$

(678

)

$

(601

)

Impact of 20% adverse change

 

(1,313

)

(1,170

)

Discount rate:

 

 

 

 

 

Impact of 100 basis point adverse change

 

(792

)

(631

)

Impact of 200 basis point adverse change

 

(1,520

)

(1,236

)

 

This sensitivity analysis presents the effect of hypothetical changes in key assumptions on the fair value of the MSR. The effect of such hypothetical change in assumptions generally cannot be extrapolated because the relationship of the change in one key assumption to the change in the fair value of the MSR is not linear. In addition, in the analysis, the impact of an adverse change in one key assumption is calculated independent of any impact on other assumptions. In reality, changes in one assumption may change another assumption.

 

During the three months ended March 31, 2014 and 2013, contractually specified servicing fees, late fees and ancillary fees earned of $2.2 million and $0.3 million, respectively, were included in other noninterest income within the consolidated statements of operations.

 

8. Deposits

 

Deposits are summarized as follows (in thousands).

 

 

 

March 31,

 

December 31,

 

 

 

2014

 

2013

 

Noninterest-bearing demand

 

$

1,748,391

 

$

1,773,749

 

Interest-bearing:

 

 

 

 

 

NOW accounts

 

1,226,645

 

1,083,596

 

Money market

 

932,417

 

878,578

 

Brokered - money market

 

279,733

 

276,760

 

Demand

 

48,703

 

47,636

 

Savings

 

298,082

 

357,325

 

Time

 

1,968,938

 

2,110,947

 

Brokered - time

 

160,267

 

194,327

 

 

 

$

6,663,176

 

$

6,722,918

 

 

32



Table of Contents

 

Hilltop Holdings Inc. and Subsidiaries

Notes to Consolidated Financial Statements (continued)

(Unaudited)

 

9. Short-term Borrowings

 

Short-term borrowings are summarized as follows (in thousands).

 

 

 

March 31,

 

December 31,

 

 

 

2014

 

2013

 

Federal funds purchased

 

$

193,275

 

$

137,225

 

Securities sold under agreements to repurchase

 

158,931

 

107,462

 

Federal Home Loan Bank notes

 

 

 

Short-term bank loans

 

139,200

 

97,400

 

 

 

$

491,406

 

$

342,087

 

 

Federal funds purchased and securities sold under agreements to repurchase generally mature daily, on demand, or on some other short-term basis. The Bank and FSC execute transactions to sell securities under agreements to repurchase with both customers and broker-dealers. Securities involved in these transactions are held by the Bank, FSC or the dealer.

 

Information concerning federal funds purchased and securities sold under agreements to repurchase is shown in the following tables (dollars in thousands).

 

 

 

Three Months Ended March 31,

 

 

 

2014

 

2013

 

Average balance during the period

 

$

343,233

 

$

328,521

 

Average interest rate during the period

 

0.18

%

0.21

%

 

 

 

March 31,

 

December 31,

 

 

 

2014

 

2013

 

Average interest rate at end of period

 

0.16

%

0.16

%

Securities underlying the agreements at end of period

 

 

 

 

 

Carrying value

 

$

166,472

 

$

144,991

 

Estimated fair value

 

$

162,932

 

$

138,719

 

 

Federal Home Loan Bank (“FHLB”) notes mature over terms not exceeding 365 days and are collateralized by FHLB Dallas stock, nonspecified real estate loans and certain specific commercial real estate loans. Other information regarding FHLB notes is shown in the following tables (dollars in thousands).

 

 

 

Three Months Ended March 31,

 

 

 

2014

 

2013

 

Average balance during the period

 

$

8

 

$

34,174

 

Average interest rate during the period

 

0.13

%

0.09

%

 

 

 

March 31,

 

December 31,

 

 

 

2014

 

2013

 

Average interest rate at end of period

 

 

 

 

FSC uses short-term bank loans periodically to finance securities owned, customers’ margin accounts and underwriting activities. Interest on the borrowings varies with the federal funds rate. The weighted average interest rate on the borrowings at March 31, 2014 and December 31, 2013 was 1.13% and 1.15%, respectively.

 

33



Table of Contents

 

Hilltop Holdings Inc. and Subsidiaries

Notes to Consolidated Financial Statements (continued)

(Unaudited)

 

10. Income Taxes

 

The Company applies an estimated annual effective rate to interim period pre-tax income to calculate the income tax provision for the quarter in accordance with the principal method prescribed by the accounting guidance established for computing income taxes in interim periods. The Company’s effective rate was 36.2% and 36.5% for the three months ended March 31, 2014 and 2013, respectively.

 

GAAP requires the measurement of uncertain tax positions. Uncertain tax positions are the difference between a tax position taken, or expected to be taken in a tax return, and the benefit recognized for accounting purposes. There were no uncertain tax positions at March 31, 2014 and December 31, 2013.

 

The Company files income tax returns in U.S. federal and several U.S. state jurisdictions. The Company is subject to tax audits in numerous jurisdictions in the U.S. until the applicable statute of limitations expires. Excluding those entities acquired as a part of the PlainsCapital Merger, the Company has been examined by U.S. tax authorities for U.S. federal income tax years prior to 2010, and is under no federal or state tax audits at March 31, 2014. PlainsCapital has been examined by U.S. tax authorities for U.S. federal income tax years prior to 2011, and is under no federal or state tax audits at March 31, 2014.

 

For the majority of tax jurisdictions, the Company is no longer subject to federal, state or local income tax examinations by tax authorities for years prior to 2010.

 

11. Commitments and Contingencies

 

Legal Matters

 

The Company is subject to loss contingencies related to litigation, claims, investigations and legal and administrative cases and proceedings arising in the ordinary course of business. The Company evaluates these contingencies based on information currently available, including advice of counsel. The Company establishes accruals for those matters when a loss contingency is considered probable and the related amount is reasonably estimable. Any accruals are periodically reviewed and may be adjusted as circumstances change. Some of the Company’s exposure with respect to loss contingencies may be offset by applicable insurance coverage. In determining the amounts of any accruals or estimates of possible loss contingencies however, the Company does not take into account the availability of insurance coverage. When it is practicable, the Company estimates loss contingencies for possible litigation and claims, whether or not there is an accrued probable loss. When the Company is able to estimate such possible losses, and when it estimates that it is reasonably possible it could incur losses, in excess of amounts accrued, the Company is required to make a disclosure of the aggregate estimation. However, as available information changes, the matters for which the Company is able to estimate, as well as the estimates themselves will be adjusted, accordingly.

 

Assessments of litigation and claims exposures are difficult due to many factors that involve inherent unpredictability. Those factors include the following: the varying stages of the proceedings, particularly in the early stages; unspecified, unsupported, or uncertain damages; damages other than compensatory, such as punitive damages; a matter presenting meaningful legal uncertainties, including novel issues of law; multiple defendants and jurisdictions; whether discovery has begun or not or discovery is not complete; meaningful settlement discussions have not commenced; and whether the claim involves a class action and if so, how the class is defined. As a result of some of these factors, the Company may be unable to estimate reasonably possible losses with respect to some or all of the pending and threatened litigation and claims asserted against the Company. The aggregated estimated amount provided above therefore may not include an estimate for every such matter.

 

The Company is involved in information-gathering requests and investigations (both formal and informal), as well as reviews, examinations and proceedings (collectively, “Inquiries”) by various governmental regulatory agencies, law enforcement authorities and self-regulatory bodies regarding its business, business practices and policies, as well as the conduct of persons with whom it does business. Additional Inquiries will arise from time to time. In connection with those

 

34



Table of Contents

 

Hilltop Holdings Inc. and Subsidiaries

Notes to Consolidated Financial Statements (continued)

(Unaudited)

 

Inquiries, the Company receives document requests, subpoenas and other requests for information. The Inquiries, including those described below, could develop into administrative, civil or criminal proceedings or enforcement actions that could result in consequences that have a material effect on the Company’s consolidated financial position, results of operations or cash flows as a whole. Such consequences could include adverse judgments, findings, settlements, penalties, fines, orders, injunctions, restitution, or alterations in the Company’s business practices, and could result in additional expenses and collateral costs, including reputational damage.

 

Hilltop, Peruna LLC (wholly owned subsidiary of Hilltop), SWS and the individual members of the board of directors of SWS, including Gerald J. Ford, have been named as defendants in two purported shareholder class action lawsuits arising out of the proposed acquisition of SWS by Hilltop, which acquisition was announced on April 1, 2014. Both lawsuits were filed in Delaware Chancery Court (Joseph Arceri v. SWS Group, Inc. et al and Chaile Steinberg v. SWS Group, Inc. et al filed April 8, 2014 and April 11, 2014, respectively). The lawsuits allege claims for breach of fiduciary duty by the individual directors of SWS, and claims against Hilltop for aiding and abetting that breach of fiduciary duty. Both actions seek to enjoin the proposed acquisition. Hilltop believes that the claims are without merit and intends to vigorously defend against these actions.

 

As a part of an industry-wide inquiry, PrimeLending has received a subpoena from the Office of Inspector General of the U.S. Department of Housing and Urban Development regarding mortgage-related practices, including those relating to origination practices for loans insured by the Federal Housing Administration. PrimeLending is cooperating with this Inquiry.

 

While the final outcome of litigation and claims exposures or of any Inquiries is inherently unpredictable, management is currently of the opinion that the outcome of pending and threatened litigation and Inquiries will not have a material effect on the Company’s business, consolidated financial position, results of operations or cash flows as a whole. However, in the event of unexpected future developments, it is reasonably possible that an adverse outcome in any of the matters discussed above could be material to the Company’s business, consolidated financial position, results of operations or cash flows for any particular reporting period of occurrence.

 

Other Contingencies

 

The mortgage origination segment may be responsible for errors or omissions relating to its representations and warranties that each loan sold meets certain requirements, including representations as to underwriting standards and the validity of certain borrower representations in connection with the loan. If determined to be at fault, the mortgage origination segment either repurchases the affected loan from the investor or reimburses the investor’s losses. The mortgage origination segment has established an indemnification liability reserve for such probable losses.

 

Generally, the mortgage origination segment first becomes aware that an investor believes a loss has been incurred on a sold loan when it receives a written request from the investor to repurchase the loan or reimburse the investor’s losses. Upon completing its review of the investor’s request, the mortgage origination segment establishes a specific claims reserve for the loan if it concludes its obligation to the investor is both probable and reasonably estimable.

 

An additional reserve has been established for probable investor losses that may have been incurred, but not yet reported to the mortgage origination segment based upon a reasonable estimate of such losses. Factors considered in the calculation of this reserve include, but are not limited to, the total volume of loans sold exclusive of specific investor requests, actual investor claim settlements and the severity of estimated losses resulting from future claims, and the mortgage origination segment’s history of successfully curing defects identified in investor claim requests. While the mortgage origination segment’s sales contracts typically include borrower early payment default repurchase provisions, these provisions have not been a primary driver of investor claims to date, and therefore, are not a primary factor considered in the calculation of this reserve.

 

At March 31, 2014 and December 31, 2013, the mortgage origination segment’s indemnification liability reserve totaled $21.0 million and $21.1 million, respectively. The provision for indemnification losses was $0.6 million and $1.0 million during the three months ended March 31, 2014 and 2013, respectively.

 

35



Table of Contents

 

Hilltop Holdings Inc. and Subsidiaries

Notes to Consolidated Financial Statements (continued)

(Unaudited)

 

The following tables provide for a roll-forward of claims activity for loans put-back to the mortgage origination segment based upon an alleged breach of a representation or warranty with respect to a loan sold and related indemnification liability reserve activity (in thousands).

 

 

 

Representation and Warranty Specific Claims
Activity - Origination Loan Balance

 

 

 

Three Months Ended March 31,

 

 

 

2014

 

2013

 

Balance, beginning of period

 

$

51,912

 

$

39,693

 

Claims made

 

10,044

 

11,620

 

Claims resolved with no payment

 

(4,458

)

(7,820

)

Repurchases

 

(4,878

)

(1,651

)

Indemnification payments

 

(691

)

(612

)

Balance, end of period

 

$

51,929

 

$

41,230

 

 

 

 

Indemnification Liability Reserve Activity

 

 

 

Three Months Ended March 31,

 

 

 

2014

 

2013

 

Balance, beginning of period

 

$

21,121

 

$

18,964

 

Additions for new sales

 

560

 

956

 

Repurchases

 

(504

)

(41

)

Early payment defaults

 

(21

)

(95

)

Indemnification payments

 

(181

)

(219

)

Change in estimate

 

 

136

 

Balance, end of period

 

$

20,975

 

$

19,701

 

 

 

 

 

 

 

Reserve for Indemnification Liability:

 

 

 

 

 

Specific claims

 

$

12,482

 

 

 

Incurred but not reported claims

 

8,493

 

 

 

Total

 

$

20,975

 

 

 

 

Although management considers the total indemnification liability reserve to be appropriate, there may be changes in the reserve over time to address incurred losses, due to unanticipated adverse changes in the economy and historical loss patterns, discrete events adversely affecting specific borrowers or industries, and/or actions taken by institutions or investors. The impact of such matters is considered in the reserving process when probable and estimable.

 

In connection with the FNB Transaction, the Bank entered into two loss-share agreements with the FDIC that collectively cover $1.2 billion of loans and OREO acquired in the FNB Transaction. Pursuant to the loss-share agreements, the FDIC has agreed to reimburse the Bank the following amounts with respect to the covered assets: (i) 80% of losses on the first $240.4 million of losses incurred; (ii) 0% of losses in excess of $240.4 million up to and including $365.7 million of losses incurred; and (iii) 80% of losses in excess of $365.7 million of losses incurred. The Bank has also agreed to reimburse the FDIC for any subsequent recoveries. The loss-share agreements for commercial and single family residential loans are in effect for 5 years and 10 years, respectively, from the Bank Closing Date and the loss recovery provisions to the FDIC are in effect for 8 years and 10 years, respectively, from the Bank Closing Date. In accordance with the loss-share agreements, the Bank may be required to make a “true-up” payment to the FDIC approximately ten years following the Bank Closing Date if the FDIC’s initial estimate of losses on covered assets is greater than the actual realized losses. The “true-up” payment is calculated using a defined formula set forth in the P&A Agreement.

 

36



Table of Contents

 

Hilltop Holdings Inc. and Subsidiaries

Notes to Consolidated Financial Statements (continued)

(Unaudited)

 

12. Financial Instruments with Off-Balance Sheet Risk

 

The Bank is party to financial instruments with off-balance sheet risk in the normal course of business to meet the financing needs of its customers. These financial instruments include commitments to extend credit and standby letters of credit that involve varying degrees of credit and interest rate risk in excess of the amount recognized in the consolidated financial statements. Such financial instruments are recorded in the consolidated financial statements when they are funded or related fees are incurred or received. The contract amounts of those instruments reflect the extent of involvement (and therefore the exposure to credit loss) the Bank has in particular classes of financial instruments.

 

Commitments to extend credit are agreements to lend to a customer provided that the terms established in the contract are met. Commitments generally have fixed expiration dates and may require payment of fees. Because some commitments are expected to expire without being drawn upon, the total commitment amounts do not necessarily represent future cash requirements. Standby letters of credit are conditional commitments issued to guarantee the performance of a customer to a third party. These letters of credit are primarily issued to support public and private borrowing arrangements. The credit risk involved in issuing letters of credit is essentially the same as that involved in extending loan commitments to customers.

 

In the aggregate, the Bank had outstanding unused commitments to extend credit of $1.2 billion at March 31, 2014 and outstanding financial and performance standby letters of credit of $42.9 million at March 31, 2014.

 

The Bank uses the same credit policies in making commitments and standby letters of credit as it does for on-balance sheet instruments. The amount of collateral obtained, if deemed necessary, in these transactions is based on management’s credit evaluation of the borrower. Collateral held varies but may include real estate, accounts receivable, marketable securities, interest-bearing deposit accounts, inventory, and property, plant and equipment.

 

In the normal course of business, FSC executes, settles, and finances various securities transactions that may expose FSC to off-balance sheet risk in the event that a customer or counterparty does not fulfill its contractual obligations. Examples of such transactions include the sale of securities not yet purchased by customers or for the account of FSC, clearing agreements between FSC and various clearinghouses and broker-dealers, secured financing arrangements that involve pledged securities, and when-issued underwriting and purchase commitments.

 

13. Stock-Based Compensation

 

Pursuant to the Hilltop Holdings 2012 Equity Incentive Plan (the “2012 Plan”), the Company may grant nonqualified stock options, stock appreciation rights, restricted stock, restricted stock units, performance awards, dividend equivalent rights and other awards to employees of the Company, its subsidiaries and outside directors of the Company. Upon the approval by stockholders and effectiveness of the 2012 Plan in September 2012, no additional awards were permissible under the 2003 Equity Incentive Plan (the “2003 Plan”). In the aggregate, 4,000,000 shares of common stock may be delivered pursuant to awards granted under the 2012 Plan. At March 31, 2014, 3,361,277 shares of common stock remain available for issuance pursuant to the 2012 Plan.

 

During January 2014 and February 2014, the Compensation Committee of the Board of Directors of the Company awarded certain executives and key employees an aggregate of 156,077 restricted stock units (“RSUs”) pursuant to the 2012 Plan. A total of 86,040 of these RSUs are subject to time-based vesting conditions and generally cliff vest on the third anniversary of the grant date, and the remaining RSUs vest based upon the achievement of certain performance goals over a three-year period. These RSUs are subject to service conditions set forth in the award agreements, with associated costs recognized on a straight-line basis over the respective vesting periods. The weighted average grant date fair value related to these RSUs was $23.76 per share. At March 31, 2014, unrecognized compensation expense related to these RSUs was $3.6 million, which will be amortized through February 2017. The RSUs are not transferable, and the shares of common stock issuable upon conversion of vested RSUs are generally subject to transfer restrictions for a period of one year following conversion, subject to certain exceptions. In addition, the applicable RSU award agreements provide for accelerated vesting under certain conditions.

 

37



Table of Contents

 

Hilltop Holdings Inc. and Subsidiaries

Notes to Consolidated Financial Statements (continued)

(Unaudited)

 

During 2013, the Compensation Committee of the Board of Directors of the Company awarded certain executives and key employees a total of 471,000 restricted shares of common stock (“Restricted Stock Awards”) pursuant to the 2012 Plan. These Restricted Stock Awards generally cliff vest on the third anniversary of the grant date and are subject to service conditions set forth in the award agreements, with associated costs recognized on a straight-line basis over the respective vesting periods. The weighted average grant date fair value related to these Restricted Stock Awards was $13.32 per share. At March 31, 2014, unrecognized compensation expense related to these Restricted Stock Awards was $4.3 million, which will be amortized through September 2016. The award agreements governing these Restricted Stock Awards provide for accelerated vesting under certain conditions.

 

During the three months ended March 31, 2014, Hilltop granted 2,303 shares of common stock to independent members of the Company’s Board of Directors for service rendered to the Company during the respective periods. There were no shares of common stock granted to independent members of the Company’s Board of Directors during the three months ended March 31, 2013.

 

Stock options granted on November 2, 2011 to two senior executives pursuant to the 2003 Plan to purchase an aggregate of 600,000 shares of the Company’s common stock (the “Stock Option Awards”) at an exercise price of $7.70 per share were outstanding at March 31, 2014. These Stock Option Awards vest in five equal installments beginning on the grant date, with the remainder vesting on each grant date anniversary through 2015. At March 31, 2014, unrecognized compensation expense related to these Stock Option Awards was $0.1 million, which will be amortized on a straight-line basis through October 2015. Additionally, these Stock Option Awards expire on November 2, 2016.

 

Compensation expense related to the plans was $0.7 million and $0.1 million for the three months ended March 31, 2014 and 2013, respectively.

 

14. Regulatory Matters

 

Bank

 

The Bank and Hilltop are subject to various regulatory capital requirements administered by the federal banking agencies. Failure to meet minimum capital requirements can initiate certain mandatory — and possibly additional discretionary — actions by regulators that, if undertaken, could have a direct, material effect on the consolidated financial statements. The regulations require us to meet specific capital adequacy guidelines that involve quantitative measures of assets, liabilities and certain off-balance sheet items as calculated under regulatory accounting practices. The capital classifications are also subject to qualitative judgments by the regulators about components, risk weightings and other factors.

 

Quantitative measures established by regulation to ensure capital adequacy require the companies to maintain minimum amounts and ratios (set forth in the following table) of Tier 1 capital (as defined in the regulations) to total average assets (as defined), and minimum ratios of Tier 1 and total capital (as defined) to risk-weighted assets (as defined).

 

38



Table of Contents

 

Hilltop Holdings Inc. and Subsidiaries

Notes to Consolidated Financial Statements (continued)

(Unaudited)

 

The following table shows the Bank’s and Hilltop’s consolidated actual capital amounts and ratios compared to the regulatory minimum capital requirements and the Bank’s regulatory minimum capital requirements needed to qualify as a “well-capitalized” institution (dollars in thousands), without giving effect to the final Basel III capital rules adopted by the Federal Reserve Board on July 2, 2013.

 

 

 

 

 

 

 

 

 

 

 

To Be Well Capitalized

 

 

 

 

 

 

 

Minimum Capital

 

Minimum Capital

 

 

 

Actual

 

Requirements

 

Requirements

 

 

 

Amount

 

Ratio

 

Amount

 

Ratio

 

Amount

 

Ratio

 

March 31, 2014

 

 

 

 

 

 

 

 

 

 

 

 

 

Tier 1 capital (to average assets):

 

 

 

 

 

 

 

 

 

 

 

 

 

Bank

 

$

780,226

 

9.53

%

$

327,545

 

4

%

$

409,431

 

5

%

Hilltop

 

1,137,727

 

13.12

%

346,871

 

4

%

N/A

 

N/A

 

Tier 1 capital (to risk-weighted assets):

 

 

 

 

 

 

 

 

 

 

 

 

 

Bank

 

780,226

 

13.47

%

231,644

 

4

%

347,466

 

6

%

Hilltop

 

1,137,727

 

18.66

%

243,951

 

4

%

N/A

 

N/A

 

Total capital (to risk-weighted assets):

 

 

 

 

 

 

 

 

 

 

 

 

 

Bank

 

818,760

 

14.14

%

463,288

 

8

%

579,110

 

10

%

Hilltop

 

1,178,253

 

19.32

%

487,901

 

8

%

N/A

 

N/A

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

December 31, 2013

 

 

 

 

 

 

 

 

 

 

 

 

 

Tier 1 capital (to average assets):

 

 

 

 

 

 

 

 

 

 

 

 

 

Bank

 

$

762,364

 

9.29

%

$

328,275

 

4

%

$

410,344

 

5

%

Hilltop

 

1,112,424

 

12.81

%

347,480

 

4

%

N/A

 

N/A

 

Tier 1 capital (to risk-weighted assets):

 

 

 

 

 

 

 

 

 

 

 

 

 

Bank

 

762,364

 

13.38

%

227,984

 

4

%

341,976

 

6

%

Hilltop

 

1,112,424

 

18.53

%

240,159

 

4

%

N/A

 

N/A

 

Total capital (to risk-weighted assets):

 

 

 

 

 

 

 

 

 

 

 

 

 

Bank

 

797,771

 

14.00

%

455,968

 

8

%

569,960

 

10

%

Hilltop

 

1,148,736

 

19.13

%

480,318

 

8

%

N/A

 

N/A

 

 

To be considered “adequately capitalized” (as defined) under regulatory requirements, the Bank must maintain minimum Tier 1 capital to total average assets and Tier 1 capital to risk-weighted assets ratios of 4%, and a total capital to risk-weighted assets ratio of 8%. Based on the actual capital amounts and ratios shown in the previous table, the Bank’s ratios place it in the “well capitalized” (as defined) capital category under regulatory requirements.

 

Management continues to evaluate the final Basel III capital rules and their impact, which would apply to reporting periods beginning after January 1, 2015.

 

Financial Advisory

 

Pursuant to the net capital requirements of the Securities Exchange Act of 1934, as amended (the “Exchange Act”), FSC has elected to determine its net capital requirements using the alternative method. Accordingly, FSC is required to maintain minimum net capital, as defined in Rule 15c3-1 promulgated under the Exchange Act, equal to the greater of $250,000 or 2% of aggregate debit balances, as defined in Rule 15c3-3 promulgated under the Exchange Act. At March 31, 2014, FSC had net capital of $71.5 million (the minimum net capital requirement was $4.8 million), net capital maintained by FSC was 29.8% of aggregate debits, and net capital in excess of the minimum requirement was $66.7 million.

 

Under certain conditions, FSC may be required to segregate cash and securities in a special reserve account for the benefit of customers under Rule 15c3-3 promulgated under the Exchange Act. Assets segregated under the provisions of the Exchange Act are not available for general corporate purposes. At March 31, 2014 and December 31, 2013, FSC was not required to segregate cash and securities.

 

39



Table of Contents

 

Hilltop Holdings Inc. and Subsidiaries

Notes to Consolidated Financial Statements (continued)

(Unaudited)

 

FSC was not required to segregate cash or securities in a special reserve account for the benefit of proprietary accounts of introducing broker-dealers at March 31, 2014 and December 31, 2013.

 

Mortgage Origination

 

As a mortgage originator, PrimeLending is subject to minimum net worth requirements established by the United States Department of Housing and Urban Development (“HUD”) and the GNMA. On an annual basis, PrimeLending submits audited financial statements to HUD and GNMA documenting PrimeLending’s compliance with its minimum net worth requirements. In addition, PrimeLending monitors compliance on an ongoing basis and, as of March 31, 2014, PrimeLending’s net worth exceeded the amounts required by both HUD and GNMA.

 

Insurance

 

The statutory financial statements of the Company’s insurance subsidiaries, which are domiciled in the State of Texas, are presented on the basis of accounting practices prescribed or permitted by the Texas Department of Insurance. Texas has adopted the National Association of Insurance Commissioners’ (“NAIC”) statutory accounting practices as the basis of its statutory accounting practices with certain differences that are not significant to the insurance company subsidiaries’ statutory equity.

 

A summary of statutory capital and surplus and statutory net income of each insurance subsidiary is as follows (in thousands).

 

 

 

March 31,

 

December 31,

 

 

 

2014

 

2013

 

Capital and surplus:

 

 

 

 

 

National Lloyds Insurance Company

 

$

104,599

 

$

98,602

 

American Summit Insurance Company

 

27,687

 

26,452

 

 

 

 

Three Months Ended March 31,

 

 

 

2014

 

2013

 

Statutory net income:

 

 

 

 

 

National Lloyds Insurance Company

 

$

5,986

 

$

3,391

 

American Summit Insurance Company

 

1,131

 

251

 

 

Regulations of the Texas Department of Insurance require insurance companies to maintain minimum levels of statutory surplus to ensure their ability to meet their obligations to policyholders. At March 31, 2014, the Company’s insurance subsidiaries had statutory surplus in excess of the minimum required.

 

The NAIC has adopted a risk based capital (“RBC”) formula for insurance companies that establishes minimum capital requirements indicating various levels of available regulatory action on an annual basis relating to insurance risk, asset credit risk, interest rate risk and business risk. The RBC formula is used by the NAIC and certain state insurance regulators as an early warning tool to identify companies that require additional scrutiny or regulatory action. At December 31, 2013, the most recent date for which the RBC calculation was performed, the Company’s insurance subsidiaries’ RBC ratio exceeded the level at which regulatory action would be required. As of March 31, 2014, management was not aware of any changes in financial condition or structure that would cause the Company’s insurance subsidiaries to not be in compliance with the required RBC ratio.

 

40



Table of Contents

 

Hilltop Holdings Inc. and Subsidiaries

Notes to Consolidated Financial Statements (continued)

(Unaudited)

 

15. Derivative Financial Instruments

 

The Company uses various derivative financial instruments to mitigate interest rate risk. The Bank’s interest rate risk management strategy involves effectively modifying the re-pricing characteristics of certain assets and liabilities so that changes in interest rates do not adversely affect the net interest margin. PrimeLending has interest rate risk relative to interest rate lock commitments (“IRLCs”) and its inventory of mortgage loans held for sale. PrimeLending is exposed to such rate risk from the time an IRLC is made to an applicant to the time the related mortgage loan is sold. To mitigate interest rate risk, PrimeLending executes forward commitments to sell mortgage-backed securities (“MBSs”). FSC uses forward commitments to both purchase and sell MBSs to facilitate customer transactions and as a means to hedge related exposure to interest rate risk in certain inventory positions.

 

Non-Hedging Derivative Instruments and the Fair Value Option

 

As discussed in Note 3 to the consolidated financial statements, the Company has elected to measure substantially all mortgage loans held for sale at fair value under the provisions of the Fair Value Option. The election provides the opportunity to mitigate volatility in reported earnings caused by measuring related assets and liabilities differently without applying complex hedge accounting provisions. The fair values of PrimeLending’s IRLCs and forward commitments are recorded in other assets or other liabilities, as appropriate, and changes in the fair values of these derivative instruments produced a net loss of $1.6 million for the three months ended March 31, 2014 and a net gain of $1.9 million for the three months ended March 31, 2013, which were recorded as a component of net gains from sale of loans and other mortgage production income. Changes in fair value are attributable to changes in the volume of IRLCs, mortgage loans held for sale, commitments to purchase and sell MBSs and changes in market interest rates. Changes in market interest rates also conversely affect the value of PrimeLending’s mortgage loans held for sale, which are measured at fair value under the Fair Value Option. The effect of the change in market interest rates on PrimeLending’s loans held for sale is discussed in Note 3 to the consolidated financial statements. The fair values of FSC’s derivative instruments are recorded in other assets or other liabilities, as appropriate, and changes in the fair values of FSC’s derivatives produced net gains of $2.8 million and $1.8 million for the three months ended March 31, 2014 and 2013, respectively, which were recorded as a component of other noninterest income.

 

Derivative positions are presented in the following table (in thousands).

 

 

 

March 31, 2014

 

December 31, 2013

 

 

 

Notional

 

Estimated

 

Notional

 

Estimated

 

 

 

Amount

 

Fair Value

 

Amount

 

Fair Value

 

Derivative instruments:

 

 

 

 

 

 

 

 

 

IRLCs

 

$

797,934

 

$

19,244

 

$

602,467

 

$

12,151

 

Commitments to purchase MBSs

 

258,015

 

1,768

 

236,305

 

(109

)

Commitments to sell MBSs

 

1,686,208

 

2,353

 

1,645,332

 

11,383

 

Fee Award Option

 

20,432

 

(5,950

)

20,432

 

(5,600

)

 

41



Table of Contents

 

Hilltop Holdings Inc. and Subsidiaries

Notes to Consolidated Financial Statements (continued)

(Unaudited)

 

16. Balance Sheet Offsetting

 

Certain financial instruments, including resale and repurchase agreements, securities lending arrangements and derivatives, may be eligible for offset in the consolidated balance sheets and/or subject to master netting arrangements or similar agreements. The following tables present the assets and liabilities subject to enforceable master netting arrangements, repurchase agreements, or similar agreements with offsetting rights (in thousands).

 

 

 

 

 

 

 

 

 

Gross Amounts Not Offset in

 

 

 

 

 

 

 

 

 

Net Amounts

 

the Balance Sheet

 

 

 

 

 

Gross Amounts

 

Gross Amounts

 

of Assets

 

 

 

Cash

 

 

 

 

 

of Recognized

 

Offset in the

 

Presented in the

 

Financial

 

Collateral

 

Net

 

 

 

Assets

 

Balance Sheet

 

Balance Sheet

 

Instruments

 

Pledged

 

Amount

 

March 31, 2014

 

 

 

 

 

 

 

 

 

 

 

 

 

Securities borrowed:

 

 

 

 

 

 

 

 

 

 

 

 

 

Institutional counterparties

 

$

144,936

 

$

 

$

144,936

 

$

(144,936

)

$

 

$

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

Forward MBS sale derivatives:

 

 

 

 

 

 

 

 

 

 

 

 

 

Institutional counterparties

 

3,111

 

(758

)

2,353

 

 

13,517

 

15,870

 

 

 

$

148,047

 

$

(758

)

$

147,289

 

$

(144,936

)

$

13,517

 

$

15,870

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

December 31, 2013

 

 

 

 

 

 

 

 

 

 

 

 

 

Securities borrowed:

 

 

 

 

 

 

 

 

 

 

 

 

 

Institutional counterparties

 

$

107,365

 

$

 

$

107,365

 

$

(107,365

)

$

 

$

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

Forward MBS sale derivatives:

 

 

 

 

 

 

 

 

 

 

 

 

 

Institutional counterparties

 

11,489

 

(76

)

11,413

 

 

(286

)

11,127

 

 

 

$

118,854

 

$

(76

)

$

118,778

 

$

(107,365

)

$

(286

)

$

11,127

 

 

 

 

 

 

 

 

 

 

Gross Amounts Not Offset in

 

 

 

 

 

 

 

 

 

Net Amounts

 

the Balance Sheet

 

 

 

 

 

Gross Amounts

 

Gross Amounts

 

of Liabilities

 

 

 

Cash

 

 

 

 

 

of Recognized

 

Offset in the

 

Presented in the

 

Financial

 

Collateral

 

Net

 

 

 

Liabities

 

Balance Sheet

 

Balance Sheet

 

Instruments

 

Pledged

 

Amount

 

March 31, 2014

 

 

 

 

 

 

 

 

 

 

 

 

 

Securities Loaned:

 

 

 

 

 

 

 

 

 

 

 

 

 

Institutional counterparties

 

$

91,879

 

$

 

$

91,879

 

$

(91,879

)

$

 

$

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

Repurchase Agreements:

 

 

 

 

 

 

 

 

 

 

 

 

 

Customer counterparties

 

151,945

 

 

151,945

 

(151,945

)

 

 

Institutional counterparties

 

6,986

 

 

6,986

 

(6,986

)

 

 

 

 

$

250,810

 

$

 

$

250,810

 

$

(250,810

)

$

 

$

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

December 31, 2013

 

 

 

 

 

 

 

 

 

 

 

 

 

Securities Loaned:

 

 

 

 

 

 

 

 

 

 

 

 

 

Institutional counterparties

 

$

74,913

 

$

 

$

74,913

 

$

(74,913

)

$

 

$

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

Repurchase Agreements:

 

 

 

 

 

 

 

 

 

 

 

 

 

Customer counterparties

 

107,462

 

 

107,462

 

(107,462

)

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

Forward MBS Sale Derivatives:

 

 

 

 

 

 

 

 

 

 

 

 

 

Institutional counterparties

 

30

 

 

30

 

 

(17

)

13

 

 

 

$

182,405

 

$

 

$

182,405

 

$

(182,375

)

$

(17

)

$

13

 

 

42



Table of Contents

 

Hilltop Holdings Inc. and Subsidiaries

Notes to Consolidated Financial Statements (continued)

(Unaudited)

 

17. Broker-Dealer and Clearing Organization Receivables and Payables

 

Broker-dealer and clearing organization receivables and payables consisted of the following (in thousands). 

 

 

 

March 31,

 

December 31,

 

 

 

2014

 

2013

 

Receivables:

 

 

 

 

 

Securities borrowed

 

$

144,936

 

$

107,365

 

Securities failed to deliver

 

19,232

 

7,160

 

Clearing organizations

 

10,108

 

4,698

 

Due from dealers

 

166

 

94

 

 

 

$

174,442

 

$

119,317

 

 

 

 

 

 

 

Payables:

 

 

 

 

 

Securities loaned

 

$

91,879

 

$

74,913

 

Correspondents

 

50,268

 

44,852

 

Securities failed to receive

 

17,601

 

5,523

 

Clearing organizations

 

2,140

 

4,390

 

 

 

$

161,888

 

$

129,678

 

 

18. Reserves for Unpaid Losses and Loss Adjustment Expenses

 

Information regarding the reserve for unpaid losses and losses and loss adjustment expenses (“LAE”) are as follows (in thousands).

 

 

 

Three Months Ended March 31,

 

 

 

2014

 

2013

 

 

 

 

 

 

 

Balance, beginning of period

 

$

27,468

 

$

34,012

 

Less reinsurance recoverables

 

(4,508

)

(10,385

)

Net balance, beginning of period

 

22,960

 

23,627

 

 

 

 

 

 

 

Incurred related to:

 

 

 

 

 

Current period

 

16,087

 

21,531

 

Prior periods

 

2,250

 

(346

)

Total incurred

 

18,337

 

21,185

 

 

 

 

 

 

 

Payments related to:

 

 

 

 

 

Current period

 

(8,337

)

(9,734

)

Prior periods

 

(7,788

)

(9,024

)

Total payments

 

(16,125

)

(18,758

)

 

 

 

 

 

 

Net balance, end of period

 

25,172

 

26,054

 

Plus reinsurance recoverables

 

3,086

 

6,016

 

Balance, end of period

 

$

28,258

 

$

32,070

 

 

The decrease in the reserves at March 31, 2014 as compared to March 31, 2013 of $3.8 million is primarily due to recovery of reinsurance recoverables outstanding at March 31, 2013. Prior period adverse development of $2.3 million during the three months ended March 31, 2014 was primarily related to a series of hail storms within the 2012 accident year.

 

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Hilltop Holdings Inc. and Subsidiaries

Notes to Consolidated Financial Statements (continued)

(Unaudited)

 

19. Reinsurance Activity

 

NLC limits the maximum net loss that can arise from large risks or risks in concentrated areas of exposure by reinsuring (ceding) certain levels of risk. Substantial amounts of business are ceded, and these reinsurance contracts do not relieve NLC from its obligations to policyholders. Such reinsurance includes quota share, excess of loss, catastrophe, and other forms of reinsurance on essentially all property and casualty lines of insurance. Net insurance premiums earned, losses and LAE and policy acquisition and other underwriting expenses are reported net of the amounts related to reinsurance ceded to other companies. Amounts recoverable from reinsurers related to the portions of the liability for losses and LAE and unearned insurance premiums ceded to them are reported as assets. Failure of reinsurers to honor their obligations could result in losses to NLC; consequently, allowances are established for amounts deemed uncollectible as NLC evaluates the financial condition of its reinsurers and monitors concentrations of credit risk arising from similar geographic regions, activities, or economic characteristics of the reinsurers to minimize its exposure to significant losses from reinsurer insolvencies. At March 31, 2014, reinsurance receivables have a carrying value of $4.0 million, which is included in other assets within the consolidated balance sheet. There was no allowance for uncollectible accounts at March 31, 2014, based on NLC’s quality requirements.

 

The effects of reinsurance on premiums written and earned are summarized as follows (in thousands).

 

 

 

Three Months Ended March 31,

 

 

 

2014

 

2013

 

 

 

Written

 

Earned

 

Written

 

Earned

 

Premiums from direct business

 

$

43,770

 

$

42,759

 

$

41,857

 

$

40,546

 

Reinsurance assumed

 

2,233

 

2,020

 

1,754

 

1,630

 

Reinsurance ceded

 

(4,186

)

(4,460

)

(4,555

)

(4,703

)

Net premiums

 

$

41,817

 

$

40,319

 

$

39,056

 

$

37,473

 

 

The effects of reinsurance on incurred losses are as follows (in thousands).

 

 

 

Three Months Ended March 31,

 

 

 

2014

 

2013

 

Loss and LAE incurred

 

$

17,752

 

$

21,412

 

Reinsurance recoverables

 

585

 

(227

)

Net loss and LAE incurred

 

$

18,337

 

$

21,185

 

 

 

Multi-line excess of loss coverage

 

In addition to the catastrophe reinsurance noted below, both NLIC and ASIC participate in an excess of loss program placed with various reinsurers. This program is limited to each risk with respect to property and liability in the amount of $500,000 for each of NLIC and ASIC. Each of NLIC and ASIC retain $500,000 in this program.

 

Catastrophic coverage

 

At March 31, 2014, NLC had catastrophic excess of loss reinsurance coverage of losses per event in excess of $8 million retention by NLIC and $1.5 million retention by ASIC. ASIC maintained an underlying layer of coverage, providing $6.5 million in excess of its $1.5 million retention to bridge to the primary program. The reinsurance in excess of $8 million is comprised of four layers of protection: $17 million in excess of $8 million retention; $25 million in excess of $25 million loss; $50 million in excess of $50 million loss and $40 million in excess of $100 million loss. NLIC and ASIC retain no participation in any of the layers, beyond the first $8 million and $1.5 million, respectively. At March 31, 2014, total retention for any one catastrophe that affects both NLIC and ASIC was limited to $8 million in the aggregate.

 

Additionally, NLC purchased an underlying excess of loss contract that provides $10 million aggregate coverage for sub-catastrophic events. NLC retains a 34% participation in this coverage.

 

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Hilltop Holdings Inc. and Subsidiaries

Notes to Consolidated Financial Statements (continued)

(Unaudited)

 

20. Segment and Related Information

 

The Company currently has four reportable business segments that are organized primarily by the core products offered to the segments’ respective customers. These segments reflect the manner in which operations are managed and the criteria used by the Company’s chief operating decision maker function to evaluate segment performance, develop strategy and allocate resources. The chief operating decision maker function consists of the President and Chief Executive Officer of the Company and the Chief Executive Officer of PlainsCapital. During the fourth quarter of 2013, we began presenting certain amounts previously allocated to the four reportable business segments under the heading Corporate to better reflect our internal organizational structure. This change had no impact on the Company’s consolidated results of operations. The Company’s historical segment disclosures have been revised to conform to the current presentation.

 

The banking segment includes the operations of the Bank, which, since September 14, 2013, includes the operations acquired in the FNB Transaction. The mortgage origination segment is composed of PrimeLending. The insurance segment is composed of NLC. The financial advisory segment is composed of First Southwest.

 

Corporate includes certain activities not allocated to specific business segments. These activities include holding company financing and investing activities, and management and administrative services to support the overall operations of the Company including, but not limited to, certain executive management, corporate relations, legal, finance, and acquisition costs not allocated to business segments.

 

Balance sheet amounts for remaining subsidiaries not discussed previously and the elimination of intercompany transactions are included in “All Other and Eliminations.” The following tables present certain information about reportable segment revenues, operating results, goodwill and assets (in thousands).

 

 

 

 

 

Mortgage

 

 

 

Financial

 

 

 

All Other and

 

Hilltop

 

Three Months Ended March 31, 2014

 

Banking

 

Origination

 

Insurance

 

Advisory

 

Corporate

 

Eliminations

 

Consolidated

 

Net interest income (expense)

 

$

79,572

 

$

(4,139

)

$

980

 

$

2,629

 

$

1,692

 

$

4,687

 

$

85,421

 

Provision for loan losses

 

3,228

 

 

 

14

 

 

 

3,242

 

Noninterest income

 

16,228

 

91,763

 

42,773

 

24,597

 

 

(5,261

)

170,100

 

Noninterest expense

 

60,677

 

90,632

 

32,341

 

27,365

 

2,188

 

(574

)

212,629

 

Income (loss) before income taxes

 

$

31,895

 

$

(3,008

)

$

11,412

 

$

(153

)

$

(496

)

$

 

$

39,650

 

 

 

 

 

 

Mortgage

 

 

 

Financial

 

 

 

All Other and

 

Hilltop

 

Three Months Ended March 31, 2013

 

Banking

 

Origination

 

Insurance

 

Advisory

 

Corporate

 

Eliminations

 

Consolidated

 

Net interest income (expense)

 

$

67,624

 

$

(12,003

)

$

1,059

 

$

3,244

 

$

(131

)

$

7,468

 

$

67,261

 

Provision for loan losses

 

12,966

 

 

 

39

 

 

 

13,005

 

Noninterest income

 

12,253

 

146,529

 

39,376

 

22,778

 

 

(7,658

)

213,278

 

Noninterest expense

 

30,679

 

122,272

 

34,267

 

25,727

 

2,236

 

(190

)

214,991

 

Income (loss) before income taxes

 

$

36,232

 

$

12,254

 

$

6,168

 

$

256

 

$

(2,367

)

$

 

$

52,543

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

March 31, 2014

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

Goodwill

 

$

207,741

 

$

13,071

 

$

23,988

 

$

7,008

 

$

 

$

 

$

251,808

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

Total assets

 

$

8,018,568

 

$

1,045,935

 

$

315,531

 

$

616,743

 

$

1,364,208

 

$

(2,327,553

)

$

9,033,432

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

December 31, 2013

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

Goodwill

 

$

207,741

 

$

13,071

 

$

23,988

 

$

7,008

 

$

 

$

 

$

251,808

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

Total assets

 

$

7,981,517

 

$

1,249,091

 

$

308,160

 

$

520,412

 

$

1,316,398

 

$

(2,471,456

)

$

8,904,122

 

 

45



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Hilltop Holdings Inc. and Subsidiaries

Notes to Consolidated Financial Statements (continued)

(Unaudited)

 

21. Earnings per Common Share

 

Nonvested share-based payment awards that contain nonforfeitable rights to dividends or dividend equivalents are participating securities and are included in the computation of earnings per share pursuant to the two-class method prescribed by the Earnings Per Share Topic of the ASC. The two-class method is an earnings allocation formula that determines earnings per share for each class of common stock and participating security according to dividends declared (or accumulated) and participation rights in undistributed earnings. In May 2013, as discussed in Note 13 to the consolidated financial statements, Hilltop issued restricted stock awards which qualify as participating securities.

 

Net earnings, less any preferred dividends accumulated for the period (whether or not declared), is allocated between the common stock and participating securities pursuant to the two-class method. Basic earnings per common share is computed by dividing net earnings available to common stockholders by the weighted average number of common shares outstanding during the period, excluding participating nonvested restricted shares.

 

Diluted earnings per common share is computed in a similar manner, except that first the denominator is increased to include the number of additional common shares that would have been outstanding if potentially dilutive common shares, excluding the participating securities, were issued using the treasury stock method. For the three months ended March 31, 2014, stock options and RSUs are the only potentially dilutive non-participating instruments issued by Hilltop, while potentially dilutive non-participating instruments for the three months ended March 31, 2013 were limited to stock options and the 7.50% Senior Exchangeable Notes due 2025 (the “Notes”), which were called for redemption during the fourth quarter of 2013. Next, we determine and include in the diluted earnings per common share calculation the more dilutive effect of the participating securities using the treasury stock method or the two-class method. Undistributed losses are not allocated to the nonvested share-based payment awards (the participating securities) under the two-class method as the holders are not contractually obligated to share in the losses of the Company.

 

The following table presents the computation of basic and diluted earnings per common share (in thousands, except per share data).

 

 

 

Three Months Ended March 31,

 

 

 

2014

 

2013

 

Basic earnings per share:

 

 

 

 

 

Income applicable to Hilltop common stockholders

 

$

23,760

 

$

32,370

 

Less: income applicable to participating shares

 

(124

)

 

Net earnings available to Hilltop common stockholders

 

$

23,636

 

$

32,370

 

 

 

 

 

 

 

Weighted average shares outstanding - basic

 

89,707

 

83,487

 

 

 

 

 

 

 

Basic earnings per common share

 

$

0.26

 

$

0.39

 

 

 

 

 

 

 

Diluted earnings per share:

 

 

 

 

 

Income applicable to Hilltop common stockholders

 

$

23,760

 

$

32,370

 

Add: interest expense on senior exchangeable notes (net of tax)

 

 

 

Net earnings available to Hilltop common stockholders

 

$

23,760

 

$

32,370

 

 

 

 

 

 

 

Weighted average shares outstanding - basic

 

89,707

 

83,487

 

Effect of potentially dilutive securities

 

878

 

256

 

Weighted average shares outstanding - diluted

 

90,585

 

83,743

 

 

 

 

 

 

 

Diluted earnings per common share

 

$

0.26

 

$

0.39

 

 

For the three months ended March 31, 2013, the computation of diluted net earnings per common share did not include 6,208,000 equivalent shares issuable upon conversion of the Notes as the equivalent exchange rate per share was in excess of the average stock price for the noted period.

 

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Hilltop Holdings Inc. and Subsidiaries

Notes to Consolidated Financial Statements (continued)

(Unaudited)

 

22. Recently Issued Accounting Standards

 

In January 2014, the FASB issued ASU No. 2014-04 to clarify that an in substance repossession or foreclosure occurs upon either the creditor obtaining legal title to the residential real estate property upon completion of a foreclosure or the borrower conveying all interest in the residential real estate property to the creditor to satisfy that loan through completion of a deed in lieu of foreclosure or through a similar legal agreement. Additionally, the amendments require interim and annual disclosure of both the amount of foreclosed residential real estate property held by the creditor and the recorded investment in consumer mortgage loans collateralized by residential real estate property that are in the process of foreclosure according to local requirements of the applicable jurisdiction. The amendments are effective for annual periods, and interim reporting periods within those annual periods, beginning after December 15, 2014 and may be adopted using either a modified retrospective transition method or a prospective transition method. Early adoption is permitted. The Company is currently evaluating this guidance, but adoption of the amendments is not expected to have a significant effect on its future consolidated financial statements.

 

In July 2013, the FASB issued ASU No. 2013-11 to require an entity to present an unrecognized tax benefit, or portion thereof, in the financial statements as a reduction to a deferred tax asset for a net operating loss carryforward, a similar tax loss, or a tax credit carryforward. However, to the extent a net operating loss carryforward, a similar tax loss, or a tax credit carryforward is not available at the reporting date under the tax law of the applicable jurisdiction to settle any additional income taxes that would result from the disallowance of a tax position, or the tax law of the applicable jurisdiction does not require the entity to use, and the entity does not intend to use, the deferred tax asset for such purpose, the unrecognized tax benefit should be presented in the financial statements as a liability and should not be combined with deferred tax assets. The amendment became effective for the Company on January 1, 2014, and its adoption did not have any effect on the Company’s consolidated financial statements as the amendment is to be applied prospectively to all unrecognized tax benefits that exist at the balance sheet date.

 

23. Subsequent Events

 

On April 1, 2014, the Company awarded certain executives and key employees a total of 190,641 RSUs pursuant to the 2012 Plan. These RSUs generally cliff vest on the third anniversary of the grant date and are subject to service conditions set forth in the award agreements, with associated costs recognized on a straight-line basis over the vesting period. The grant date fair value related to these RSUs was $24.06 per share. Total compensation expense related to these RSUs was $4.6 million, which will be amortized through March 2017. The RSUs are not transferable, and the shares of common stock issuable upon conversion of vested RSUs are subject to transfer restrictions for a period of one year following conversion, subject to certain exceptions. In addition, the applicable RSU award agreements provide for accelerated vesting under certain conditions.

 

On April 1, 2014, Hilltop filed Articles of Amendment to Hilltop’s charter, as approved by the Board of Directors, increasing the number of authorized shares of common stock from 100,000,000 to 125,000,000.

 

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Table of Contents

 

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

 

The following discussion should be read in conjunction with the consolidated historical financial statements and notes appearing elsewhere in this Quarterly Report on Form 10-Q (this “Quarterly Report”) and the financial information set forth in the tables herein.

 

Unless the context otherwise indicates, all references in this Quarterly Report, references to the “Company,” “we,” “us,” “our” or “ours” or similar words are to Hilltop Holdings Inc. and its direct and indirect wholly owned subsidiaries, references to “Hilltop” refer solely to Hilltop Holdings Inc., references to “PlainsCapital” refer to PlainsCapital Corporation (a wholly owned subsidiary of Hilltop), references to the “Bank” refer to PlainsCapital Bank (a wholly owned subsidiary of PlainsCapital), references to “FNB” refer to First National Bank, references to “First Southwest” refer to First Southwest Holdings, LLC (a wholly owned subsidiary of the Bank) and its subsidiaries as a whole, references to “FSC” refer to First Southwest Company (a wholly owned subsidiary of First Southwest), references to “PrimeLending” refer to PrimeLending, a PlainsCapital Company (a wholly owned subsidiary of the Bank) and its subsidiaries as a whole and references to “NLC” refer to National Lloyds Corporation (a wholly owned subsidiary of Hilltop) and its subsidiaries as a whole.

 

FORWARD-LOOKING STATEMENTS

 

This Quarterly Report and the documents incorporated by reference into this report include “forward-looking statements” within the meaning of Section 27A of the Securities Act of 1933, as amended, and Section 21E of the Securities Exchange Act of 1934, or the Exchange Act, as amended by the Private Securities Litigation Reform Act of 1995. All statements, other than statements of historical fact, included in this Quarterly Report that address results or developments that we expect or anticipate will or may occur in the future, and statements that are preceded by, followed by or include, words such as “anticipates,” “believes,” “could,” “estimates,” “expects,” “forecasts,” “goal,” “intends,” “may,” “might,” “probable,” “projects,” “seeks,” “should,” “target,” “view” or “would” or the negative of these words and phrases or similar words or phrases, including such things as our business strategy, our financial condition, our litigation, our efforts to make strategic acquisitions, our pending acquisition of SWS Group, Inc. (“SWS”), our revenue, our liquidity and sources of funding, market trends, operations and business, expectations concerning mortgage loan origination volume, anticipated changes in our revenues or earnings, the effects of government regulation applicable to our operations, the appropriateness of our allowance for loan losses and provision for loan losses, and the collectability of loans are forward-looking statements.

 

These forward-looking statements are based on our beliefs, assumptions and expectations of our future performance taking into account all information currently available to us. These beliefs, assumptions and expectations are subject to risks and uncertainties and can change as a result of many possible events or factors, not all of which are known to us. If an event occurs, our business, business plan, financial condition, liquidity and results of operations may vary materially from those expressed in our forward-looking statements. Certain factors that could cause actual results to differ include, among others:

 

·                  risks related to our pending acquisition of SWS;

 

·                  risks associated with merger and acquisition integration;

 

·                  our ability to estimate loan losses;

 

·                  changes in the default rate of our loans;

 

·                  risks associated with concentration in real estate related loans;

 

·                  our ability to obtain reimbursements for losses on acquired loans under loss-share agreements with the Federal Deposit Insurance Corporation (the “FDIC”);

 

·                  changes in general economic, market and business conditions in areas or markets where we compete;

 

·                  severe catastrophic events in our geographic area;

 

·                  changes in the interest rate environment;

 

·                  cost and availability of capital;

 

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Table of Contents

 

·                  changes in state and federal laws, regulations or policies affecting one or more of our business segments, including changes in regulatory fees, deposit insurance premiums, capital requirements and the Dodd-Frank Wall Street Reform and Consumer Protection Act (the “Dodd-Frank Act”);

 

·                  our ability to use net operating loss carry forwards to reduce future tax payments;

 

·                  approval of new, or changes in, accounting policies and practices;

 

·                  changes in key management;

 

·                  competition in our banking, mortgage origination, financial advisory and insurance segments from other banks and financial institutions as well as insurance companies, mortgage bankers, investment banking and financial advisory firms, asset-based non-bank lenders and government agencies;

 

·                  failure of our insurance segment reinsurers to pay obligations under reinsurance contracts;

 

·                  our ability to use excess cash in an effective manner, including the execution of successful acquisitions; and

 

·                  our participation in governmental programs, including the Small Business Lending Fund (“SBLF”).

 

For a more detailed discussion of these and other factors that may affect our business and that could cause the actual results to differ materially from those anticipated in these forward-looking statements, please refer to “Risk Factors” in Part I, Item 1A of our Annual Report on Form 10-K, which was filed with the Securities and Exchange Commission (the “SEC”) on March 3, 2014, this Item 2, “Management’s Discussion and Analysis of Financial Condition and Results of Operations,” Part II, Item 1A, “Risk Factors” herein and other filings we have made with the SEC. We caution that the foregoing list of factors is not exhaustive, and new factors may emerge, or changes to the foregoing factors may occur, that could impact our business. All subsequent written and oral forward-looking statements concerning our business attributable to us or any person acting on our behalf are expressly qualified in their entirety by the cautionary statements above. We do not undertake any obligation to update any forward-looking statement, whether written or oral, relating to the matters discussed in this Quarterly Report except to the extent required by federal securities laws.

 

OVERVIEW

 

We are a financial holding company registered under the Bank Holding Company Act of 1956, as amended by the Gramm-Leach-Bliley Act of 1999. Our primary line of business is to provide business and consumer banking services from offices located throughout Texas. We also provide an array of financial products and services such as mortgage origination, insurance and financial advisory services.

 

On September 13, 2013 (the “Bank Closing Date”), the Bank assumed substantially all of the liabilities, including all of the deposits, and acquired substantially all of the assets of Edinburg, Texas-based FNB from the Federal Deposit Insurance Corporation (the “FDIC”), as receiver, and reopened former branches of FNB acquired from the FDIC under the “PlainsCapital Bank” name (the “FNB Transaction”). Pursuant to the Purchase and Assumption Agreement by and among the FDIC as receiver for FNB, the FDIC and the Bank (the “P&A Agreement”), the Bank and the FDIC entered into loss-share agreements whereby the FDIC agreed to share in the losses of certain covered loans and covered other real estate owned (“OREO”) that the Bank acquired in the FNB Transaction. The fair value of the assets acquired was $2.2 billion, including $1.1 billion in covered loans, $286.2 million in securities, $135.2 million in covered OREO and $42.9 million in non-covered loans. The Bank also assumed $2.2 billion in liabilities, consisting primarily of deposits.

 

On March 31, 2014, we entered into a definitive merger agreement with SWS providing for the merger of SWS with and into a subsidiary of Hilltop formed for the purpose of facilitating this transaction. Under the terms of the merger agreement, SWS stockholders will receive per share consideration of 0.2496 shares of Hilltop common stock and $1.94 of cash, equating to $7.88 per share based on Hilltop’s closing price on March 31, 2014. We intend to fund the cash portion of the consideration through available cash. The merger is subject to customary closing conditions, including regulatory approvals and approval of the stockholders of SWS, and is expected to be completed prior to the end of 2014.

 

At March 31, 2014, on a consolidated basis, we had total assets of $9.0 billion, total deposits of $6.7 billion, total loans, including loans held for sale, of $5.4 billion and stockholders’ equity of $1.4 billion. Our banking operations include the operations acquired in the FNB Transaction since September 14, 2013.

 

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Table of Contents

 

Segment Information

 

We have two primary operating business units, PlainsCapital (financial services and products) and NLC (insurance). Within the PlainsCapital unit are three primary wholly owned operating subsidiaries: the Bank, PrimeLending and First Southwest. Under accounting principles generally accepted in the United States (“GAAP”), our business units are comprised of four reportable business segments organized primarily by the core products offered to the segments’ respective customers: banking, mortgage origination, insurance and financial advisory. During the fourth quarter of 2013, we began presenting certain amounts previously allocated to the four reportable business segments under the heading Corporate to better reflect our internal organizational structure. This change had no impact on our consolidated results of operations. Our historical segment disclosures and MD&A have been revised to conform to the current presentation. Consistent with the segment operating results during 2013, we anticipate that future revenues will be driven primarily from the banking and mortgage origination segments, with the remainder being generated by our insurance and financial advisory segments. Based on historical results of PlainsCapital Corporation, which we acquired on November 30, 2012, the relative share of total revenue provided by our banking and mortgage origination segments fluctuates depending on market conditions, and operating results for the mortgage origination segment tend to be more volatile than operating results for the banking segment.

 

The banking segment includes the operations of the Bank and, since September 14, 2013, the operations acquired in the FNB Transaction. The banking segment primarily provides business and consumer banking products and services from offices located throughout Texas and generates revenue from its portfolio of earning assets. The Bank’s results of operations are primarily dependent on net interest income, while also deriving revenue from other sources, including service charges on customer deposit accounts and trust fees.

 

The mortgage origination segment includes the operations of PrimeLending, which offers a variety of loan products from offices in 42 states and generates revenue predominantly from fees charged on the origination of loans and from selling these loans in the secondary market.

 

The insurance segment includes the operations of NLC, which operates through its wholly owned subsidiaries, National Lloyds Insurance Company (“NLIC”) and American Summit Insurance Company (“ASIC”). Insurance segment income is primarily generated from revenue earned on net insurance premiums less loss and loss adjustment expenses (“LAE”) and policy acquisition and other underwriting expenses in Texas and other areas of the southern United States.

 

The financial advisory segment generates a majority of its revenues from fees and commissions earned from investment advisory and securities brokerage services at First Southwest. The principal subsidiaries of First Southwest are FSC, a broker-dealer registered with the SEC and Financial Industry Regulatory Authority, and First Southwest Asset Management, Inc., a registered investment advisor under the Investment Advisors Act of 1940. FSC holds trading securities to support sales, underwriting and other customer activities. These securities are marked to market through other noninterest income. FSC uses derivatives to support mortgage origination programs of certain non-profit housing organization clients. FSC hedges its related exposure to interest rate risk from these programs with U.S. Agency to-be-announced, or TBA, mortgage-backed securities. These derivatives are marked to market through other noninterest income.

 

Corporate includes certain activities not allocated to specific business segments. These activities include holding company financing and investing activities, and management and administrative services to support the overall operations of the Company including, but not limited to, certain executive management, corporate relations, legal, finance, and acquisition costs not allocated to business segments. Balance sheet amounts for remaining subsidiaries not discussed previously and the elimination of intercompany transactions are included in “All Other and Eliminations.”

 

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Additional information concerning our reportable segments is presented in Note 20, Segment and Related Information, in the notes to our consolidated financial statements. The following tables present certain information about the operating results of our reportable segments (in thousands).

 

 

 

 

 

Mortgage

 

 

 

Financial

 

 

 

All Other and

 

Hilltop

 

Three Months Ended March 31, 2014

 

Banking

 

Origination

 

Insurance

 

Advisory

 

Corporate

 

Eliminations

 

Consolidated

 

Net interest income (expense)

 

$

79,572

 

$

(4,139

)

$

980

 

$

2,629

 

$

1,692

 

$

4,687

 

$

85,421

 

Provision for loan losses

 

3,228

 

 

 

14

 

 

 

3,242

 

Noninterest income

 

16,228

 

91,763

 

42,773

 

24,597

 

 

(5,261

)

170,100

 

Noninterest expense

 

60,677

 

90,632

 

32,341

 

27,365

 

2,188

 

(574

)

212,629

 

Income (loss) before income taxes

 

$

31,895

 

$

(3,008

)

$

11,412

 

$

(153

)

$

(496

)

$

 

$

39,650

 

 

 

 

 

 

Mortgage

 

 

 

Financial

 

 

 

All Other and

 

Hilltop

 

Three Months Ended March 31, 2013

 

Banking

 

Origination

 

Insurance

 

Advisory

 

Corporate

 

Eliminations

 

Consolidated

 

Net interest income (expense)

 

$

67,624

 

$

(12,003

)

$

1,059

 

$

3,244

 

$

(131

)

$

7,468

 

$

67,261

 

Provision for loan losses

 

12,966

 

 

 

39

 

 

 

13,005

 

Noninterest income

 

12,253

 

146,529

 

39,376

 

22,778

 

 

(7,658

)

213,278

 

Noninterest expense

 

30,679

 

122,272

 

34,267

 

25,727

 

2,236

 

(190

)

214,991

 

Income (loss) before income taxes

 

$

36,232

 

$

12,254

 

$

6,168

 

$

256

 

$

(2,367

)

$

 

$

52,543

 

 

How We Generate Revenue

 

We generate revenue from net interest income and from noninterest income. Net interest income represents the difference between the income earned on our assets, including our loans and investment securities, and our cost of funds, including the interest paid on the deposits and borrowings that are used to support our assets. Net interest income is a significant contributor to our operating results. Fluctuations in interest rates, as well as the amounts and types of interest-earning assets and interest-bearing liabilities we hold, affect net interest income. We generated $85.4 million in net interest income during the three months ended March 31, 2014, compared with net interest income of $67.2 million during the same period in 2013. The year-over-year increase in net interest income was primarily due to the inclusion of those operations acquired as a part of the FNB Transaction within our banking segment.

 

The other component of our revenue is noninterest income, which is primarily comprised of the following:

 

(i)                                     Income from mortgage operations. Through our wholly owned subsidiary, PrimeLending, we generate noninterest income by originating and selling mortgage loans. During the three months ended March 31, 2014 and 2013, we generated $91.5 million and $146.5 million, respectively, in net gains from the sale of loans, other mortgage production income (including income associated with retained mortgage servicing rights), and mortgage loan origination fees.

 

(ii)                                  Net insurance premiums earned.  Through our wholly owned insurance subsidiary, NLC, we provide fire and limited homeowners insurance for low value dwellings and manufactured homes. We generated $40.3 million in net insurance premiums earned during the three months ended March 31, 2014, compared with $37.5 million during the same period in the prior year.

 

(iii)                               Investment advisory fees and commissions and securities brokerage fees and commissions.  Through our wholly owned subsidiary, First Southwest, we provide public finance advisory and various investment banking and brokerage services. We generated $21.3 million and $22.0 million in investment advisory fees and commissions and securities brokerage fees and commissions during the three months ended March 31, 2014 and 2013, respectively.

 

In the aggregate, we generated $170.1 million and $213.3 million in noninterest income during the three months ended March 31, 2014 and 2013, respectively. The significant year-over-year decrease in noninterest income was primarily due to the decrease in loan origination volume within our mortgage origination segment.

 

We also incur noninterest expenses in the operation of our businesses. Our businesses engage in labor intensive activities and, consequently, employees’ compensation and benefits represent the majority of our noninterest expenses.

 

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Table of Contents

 

Consolidated Operating Results

 

Net income applicable to common stockholders for the three months ended March 31, 2014 was $23.8 million, or $0.26 per diluted share, compared to net income applicable to common stockholders of $32.4 million, or $0.39 per diluted share, for the three months ended March 31, 2013.

 

Certain items included in net income for 2013 and 2014 resulted from purchase accounting associated with the merger of PlainsCapital Corporation with and into a wholly owned subsidiary of Hilltop on November 30, 2012 (the “PlainsCapital Merger”) and the FNB Transaction. Income before taxes for the three months ended March 31, 2014 includes net accretion of $10.0 million and $9.5 million on earning assets and liabilities acquired in the PlainsCapital Merger and FNB Transaction, respectively, offset by amortization of identifiable intangibles of $2.3 million and $0.3 million, respectively. During the three months ended March 31, 2013, income before taxes includes net accretion of $16.1 million on earning assets and liabilities acquired in the PlainsCapital Merger, offset by amortization of identifiable intangibles of $2.5 million.

 

We consider the ratios shown in the table below to be key indicators of our performance.

 

 

 

Three Months Ended March 31,

 

Year Ended

 

 

 

2014

 

2013

 

December 31, 2013

 

Performance Ratios:

 

 

 

 

 

 

 

Return on average stockholders’ equity

 

7.65

%

11.46

%

10.48

%

Return on average assets

 

1.14

%

1.87

%

1.66

%

Net interest margin (taxable equivalent) (1)

 

4.62

%

4.35

%

4.47

%

 


(1) Taxable equivalent net interest income divided by average interest-earning assets.

 

During the three months ended March 31, 2014, the consolidated taxable equivalent net interest margin of 4.62% was impacted by PlainsCapital Merger related accretion of discount on loans of $10.8 million, amortization of premium on acquired securities of $1.0 million and amortization of premium on acquired time deposits of $0.2 million. Additionally, FNB Transaction related accretion of discount on loans of $7.2 million and amortization of premium on acquired time deposits of $2.3 million also impacted the consolidated taxable equivalent net interest margin during the three months ended March 31, 2014. These items increased the consolidated taxable equivalent net interest margin by 95 basis points for the three months ended March 31, 2014. The consolidated taxable equivalent net interest margin was 4.35% for the three months ended March 31, 2013. The taxable equivalent net interest margin for the first quarter of 2013 was impacted by PlainsCapital Merger related accretion of discount on loans of $16.9 million, amortization of premium on acquired securities of $1.9 million and amortization of premium on acquired time deposits of $1.1 million. These items increased the consolidated taxable equivalent interest margin by 95 basis points for the three months ended March 31, 2013.

 

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The table below provides additional details regarding our consolidated net interest income (dollars in thousands).

 

 

 

Three Months Ended March 31,

 

 

 

2014

 

2013

 

 

 

Average

 

Interest

 

Annualized

 

Average

 

Interest

 

Annualized

 

 

 

Outstanding

 

Earned or

 

Yield or

 

Outstanding

 

Earned or

 

Yield or

 

 

 

Balance

 

Paid

 

Rate

 

Balance

 

Paid

 

Rate

 

Assets

 

 

 

 

 

 

 

 

 

 

 

 

 

Interest-earning assets Loans, gross (1) 

 

$

5,068,892

 

$

79,744

 

6.29

%

$

4,207,871

 

$

64,886

 

6.17

%

Investment securities - taxable

 

1,122,241

 

7,588

 

2.71

%

900,422

 

5,863

 

2.64

%

Investment securities - non-taxable (2) 

 

183,143

 

1,861

 

4.06

%

218,343

 

2,024

 

3.71

%

Federal funds sold and securities purchased under agreements to resell

 

26,336

 

19

 

0.29

%

10,195

 

21

 

0.84

%

Interest-bearing deposits in other financial institutions

 

966,921

 

595

 

0.25

%

747,242

 

333

 

0.25

%

Other

 

188,276

 

2,640

 

5.67

%

154,560

 

2,105

 

5.52

%

Interest-earning assets, gross

 

7,555,809

 

92,447

 

4.90

%

6,238,633

 

75,232

 

4.84

%

Allowance for loan losses

 

(36,861

)

 

 

 

 

(6,776

)

 

 

 

 

Interest-earning assets, net

 

7,518,948

 

 

 

 

 

6,231,857

 

 

 

 

 

Noninterest-earning assets

 

1,432,519

 

 

 

 

 

882,998

 

 

 

 

 

Total assets

 

$

8,951,467

 

 

 

 

 

$

7,114,855

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

Liabilities and Stockholders’ Equity

 

 

 

 

 

 

 

 

 

 

 

 

 

Interest-bearing liabilities

 

 

 

 

 

 

 

 

 

 

 

 

 

Interest-bearing deposits

 

$

4,949,212

 

$

3,759

 

0.31

%

$

3,558,091

 

$

3,450

 

0.39

%

Notes payable and other borrowings

 

664,072

 

2,648

 

1.60

%

850,418

 

3,893

 

1.85

%

Total interest-bearing liabilities

 

5,613,284

 

6,407

 

0.46

%

4,408,509

 

7,343

 

0.67

%

Noninterest-bearing liabilities

 

 

 

 

 

 

 

 

 

 

 

 

 

Noninterest-bearing deposits

 

1,721,403

 

 

 

 

 

1,190,779

 

 

 

 

 

Other liabilities

 

285,121

 

 

 

 

 

356,538

 

 

 

 

 

Total liabilities

 

7,619,808

 

 

 

 

 

5,955,826

 

 

 

 

 

Stockholders’ equity

 

1,331,243

 

 

 

 

 

1,158,292

 

 

 

 

 

Noncontrolling interest

 

416

 

 

 

 

 

737

 

 

 

 

 

Total liabilities and stockholders’ equity

 

$

8,951,467

 

 

 

 

 

$

7,114,855

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

Net interest income (2)

 

 

 

$

86,040

 

 

 

 

 

$

67,889

 

 

 

Net interest spread (2)

 

 

 

 

 

4.44

%

 

 

 

 

4.17

%

Net interest margin (2)

 

 

 

 

 

4.62

%

 

 

 

 

4.35

%

 


(1) Average balance includes non-accrual loans.

(2) Annualized taxable equivalent adjustments are based on a 35% tax rate. The adjustment to interest income was $0.6 million and $0.7 million for the three months ended March 31, 2014 and 2013, respectively.

 

On a consolidated basis, net interest income increased $18.2 million during the three months ended March 31, 2014, compared with the same period in 2013. This increase was primarily due to the inclusion of those operations acquired as a part of the FNB Transaction within our banking segment.

 

The provision for loan losses is determined by management as the amount to be added to the allowance for loan losses after net charge-offs have been deducted to bring the allowance to a level which, in management’s best estimate, is necessary to absorb probable losses within the existing loan portfolio. The consolidated provision for loan losses, primarily in the banking segment, was $3.2 million and $13.0 million during the three months ended March 31, 2014 and 2013, respectively. During the three months ended March 31, 2014 and 2013, the provision for loan losses was comprised of charges relating to newly originated loans and acquired loans without credit impairment at acquisition of $1.3 million and $12.6 million, respectively, and purchased credit impaired (“PCI”) loans of $1.9 million and $0.4 million, respectively.

 

Consolidated noninterest income decreased $43.2 million during the three months ended March 31, 2014, compared with the same period in 2013. This decrease was primarily related to the reduction in net gains from sale of loans, other mortgage production income and mortgage loan origination fees within our mortgage origination segment of $55.0 million, slightly offset by increases in noninterest income in our banking, insurance and financial advisory segments.

 

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Table of Contents

 

Our consolidated noninterest expense during the three months ended March 31, 2014 decreased $2.4 million, compared with the same period in 2013. This year-over-year decrease included a significant decrease in noninterest expenses within our mortgage origination segment of $31.6 million primarily due to variable compensation tied to mortgage loan originations, which was offset by a significant increase in noninterest expenses within our banking segment of $30.0 million primarily due to the inclusion of those operations acquired as part of the FNB Transaction. Changes between periods within the major components of noninterest expense included decreases of $9.8 million in employees’ compensation and benefits and $2.8 million in loss and loss adjustment expenses, significantly offset by increases of $6.9 million in occupancy and equipment and $2.4 million in other expenses.

 

Consolidated income tax expense during the three months ended March 31, 2014 and 2013 was $14.4 million and $19.2 million, respectively, reflecting effective rates of 36.2% and 36.5%, respectively. The year-over-year decrease in income tax expense was primarily due to the reduction in operating income generated by our mortgage origination segment.

 

Segment Results

 

Banking Segment

 

Income before income taxes in our banking segment for the three months ended March 31, 2014 and 2013 was $31.9 million and $36.2 million, respectively, and was primarily driven by net interest income of $79.6 million and $67.6 million, respectively, offset by noninterest expenses of $60.7 million and $30.7 million, respectively.

 

At March 31, 2014, the Bank exceeded all regulatory capital requirements with a total capital to risk weighted assets ratio of 14.14%, Tier 1 capital to risk weighted assets ratio of 13.47% and a Tier 1 capital to average assets, or leverage, ratio of 9.53%. At March 31, 2014, the Bank was also considered to be “well-capitalized” under regulatory requirements without giving effect to the final Basel III capital rules adopted by the Federal Reserve Board on July 2, 2013.

 

We consider the ratios shown in the table below to be key indicators of the performance of our banking segment.

 

 

 

Three Months Ended March 31,

 

Year Ended

 

 

 

2014

 

2013

 

December 31, 2013

 

Performance Ratios:

 

 

 

 

 

 

 

Efficiency ratio (1)

 

63.34

%

38.41

%

42.58

%

Return on average assets

 

1.04

%

1.60

%

1.78

%

Net interest margin (taxable equivalent) (2)

 

4.80

%

5.30

%

5.17

%

 


(1) Noninterest expenses divided by the sum of total noninterest income and net interest income for the period.

 

(2) Taxable equivalent net interest income divided by average interest-earning assets.

 

During the three months ended March 31, 2014, the banking segment’s taxable equivalent net interest margin of 4.80% was impacted by PlainsCapital Merger related accretion of discount on loans of $10.8 million, amortization of premium on acquired securities of $1.0 million and amortization of premium on acquired time deposits of $0.2 million. Additionally, FNB Transaction related accretion of discount on loans of $7.2 million and amortization of premium on acquired time deposits of $2.3 million also impacted the banking segment’s taxable equivalent net interest margin during the three months ended March 31, 2014. These items increased the banking segment’s taxable equivalent net interest margin by 106 basis points for the three months ended March 31, 2014. The banking segment’s taxable equivalent net interest margin for the three months ended March 31, 2013 of 5.30% was impacted by PlainsCapital Merger related accretion of discount on loans of $16.9 million, amortization of premium on acquired securities of $1.9 million and amortization of premium on acquired time deposits of $1.1 million. These items increased the banking segment’s taxable equivalent interest margin by 124 basis points for three months ended March 31, 2013.

 

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Table of Contents

 

The table below provides additional details regarding our banking segment’s net interest income (dollars in thousands).

 

 

 

Three Months Ended March 31,

 

 

 

2014

 

2013

 

 

 

Average

 

Interest

 

Annualized

 

Average

 

Interest

 

Annualized

 

 

 

Outstanding

 

Earned or

 

Yield or

 

Outstanding

 

Earned or

 

Yield or

 

 

 

Balance

 

Paid

 

Rate

 

Balance

 

Paid

 

Rate

 

Assets

 

 

 

 

 

 

 

 

 

 

 

 

 

Interest-earning assets Loans, gross (1) 

 

$

4,246,133

 

$

70,721

 

6.66

%

$

2,899,961

 

$

53,809

 

7.42

%

Subsidiary warehouse lines of credit

 

636,700

 

6,932

 

4.35

%

981,524

 

13,887

 

5.66

%

Investment securities - taxable

 

896,669

 

4,395

 

1.96

%

686,942

 

2,717

 

1.58

%

Investment securities - non-taxable (2) 

 

154,064

 

1,496

 

3.88

%

166,552

 

1,429

 

3.43

%

Federal funds sold and securities purchased under agreements to resell

 

26,336

 

19

 

0.29

%

8,566

 

6

 

0.28

%

Interest-bearing deposits in other financial institutions

 

797,304

 

513

 

0.26

%

485,292

 

312

 

0.26

%

Other

 

29,085

 

400

 

5.50

%

20,112

 

165

 

3.28

%

Interest-earning assets, gross

 

6,786,291

 

84,476

 

4.98

%

5,248,949

 

72,325

 

5.51

%

Allowance for loan losses

 

(36,710

)

 

 

 

 

(6,639

)

 

 

 

 

Interest-earning assets, net

 

6,749,581

 

 

 

 

 

5,242,310

 

 

 

 

 

Noninterest-earning assets

 

1,270,934

 

 

 

 

 

814,106

 

 

 

 

 

Total assets

 

$

8,020,515

 

 

 

 

 

$

6,056,416

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

Liabilities and Stockholders’ Equity

 

 

 

 

 

 

 

 

 

 

 

 

 

Interest-bearing liabilities

 

 

 

 

 

 

 

 

 

 

 

 

 

Interest-bearing deposits

 

$

4,949,973

 

$

3,785

 

0.31

%

$

3,497,258

 

$

3,434

 

0.40

%

Notes payable and other borrowings

 

350,248

 

326

 

0.37

%

366,315

 

353

 

0.39

%

Total interest-bearing liabilities (3)

 

5,300,221

 

4,111

 

0.31

%

3,863,573

 

3,787

 

0.40

%

Noninterest-bearing liabilities

 

 

 

 

 

 

 

 

 

 

 

 

 

Noninterest-bearing deposits

 

1,699,817

 

 

 

 

 

1,263,716

 

 

 

 

 

Other liabilities

 

18,518

 

 

 

 

 

82,613

 

 

 

 

 

Total liabilities

 

7,018,556

 

 

 

 

 

5,209,902

 

 

 

 

 

Stockholders’ equity

 

1,001,959

 

 

 

 

 

846,514

 

 

 

 

 

Total liabilities and stockholders’ equity

 

$

8,020,515

 

 

 

 

 

$

6,056,416

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

Net interest income (2)

 

 

 

$

80,365

 

 

 

 

 

$

68,538

 

 

 

Net interest spread (2)

 

 

 

 

 

4.67

%

 

 

 

 

5.11

%

Net interest margin (2)

 

 

 

 

 

4.80

%

 

 

 

 

5.30

%

 


(1) Average balance includes non-accrual loans.

(2) Annualized taxable equivalent adjustments are based on a 35% tax rate. The adjustment to interest income was $0.5 million for each of the three months ended March 31, 2014 and 2013,.

(3) Excludes the allocation of interest expense on PlainsCapital debt of $0.3 million for each of the three months ended March 31, 2014 and 2013.

 

The banking segment’s net interest margin shown above exceeds our consolidated net interest margin. Our consolidated net interest margin includes the yields and costs associated with certain items within interest-earning assets and interest-bearing liabilities in the financial advisory segment, as well as the borrowing costs of Hilltop and PlainsCapital, both of which reduce our consolidated net interest margin. In addition, the banking segment’s interest earning assets include lines of credit extended to subsidiaries, the yields on which increase the banking segment’s net interest margin. Such yields and costs are eliminated from the consolidated financial statements.

 

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Table of Contents

 

The following table summarizes the changes in the banking segment’s net interest income for the periods indicated below, including the component changes in the volume of average interest-earning assets and interest-bearing liabilities and changes in the rates earned or paid on those items (in thousands).

 

 

 

Three Months Ended March 31,

 

 

 

2014 v. 2013

 

 

 

Change Due To (1)

 

 

 

 

 

Volume

 

Yield/Rate

 

Change

 

Interest income

 

 

 

 

 

 

 

Loans, gross

 

$

24,982

 

$

(8,070

)

$

16,912

 

Subsidiary warehouse lines of credit

 

(4,879

)

(2,076

)

(6,955

)

Investment securities - taxable

 

830

 

848

 

1,678

 

Investment securities - non-taxable (2) 

 

(107

)

174

 

67

 

Federal funds sold and securities purchased under agreements to resell

 

13

 

 

13

 

Interest-bearing deposits in other financial institutions

 

203

 

(2

)

201

 

Other

 

74

 

161

 

235

 

Total interest income (2)

 

21,116

 

(8,965

)

12,151

 

 

 

 

 

 

 

 

 

Interest expense

 

 

 

 

 

 

 

Deposits

 

$

1,446

 

$

(1,095

)

$

351

 

Notes payable and other borrowings

 

(16

)

(11

)

(27

)

Total interest expense

 

1,430

 

(1,106

)

324

 

 

 

 

 

 

 

 

 

Net interest income (2)

 

$

19,686

 

$

(7,859

)

$

11,827

 

 


(1) Changes attributable to both volume and yield/rate are included in yield/rate column.

 

(2) Annualized taxable equivalent.

 

Taxable equivalent net interest income increased $11.8 million during the three months ended March 31, 2014, compared with the same period in 2013. Increases in the volume of interest-earning assets, primarily loans acquired in the FNB Transaction, increased taxable equivalent net interest income by $21.1 million, while increases in the volume of interest-bearing liabilities, primarily deposits assumed in the FNB Transaction, reduced taxable equivalent interest income by $1.4 million. Changes in the yields earned on interest-earning assets decreased taxable equivalent net interest income by $9.0 million, primarily due to lower yields on the loan portfolio and the subsidiary warehouse lines of credit. Changes in rates paid on interest-bearing liabilities increased taxable equivalent interest income by $1.1 million, primarily due to the acquisition of savings deposits in the FNB Transaction that carry lower average rates than the average rate on the Bank’s savings deposits prior to the FNB Transaction, and the amortization of premiums on time deposits acquired in the FNB Transaction.

 

The banking segment’s noninterest income was $16.2 million and $12.3 million during the three months ended March 31, 2014 and 2013, respectively. This year-over-year increase in noninterest income was primarily due to the accretion on the amounts receivable under the loss-share agreements with the FDIC (“FDIC Indemnification Asset”) associated with the FNB Transaction. Noninterest income was also negatively affected by changes in intercompany financing charges associated with the lending commitment on the PrimeLending warehouse line of credit.

 

The banking segment’s noninterest expenses were $60.7 million and $30.7 million during the three months ended March 31, 2014 and 2013, respectively, and were primarily comprised of employees’ compensation and benefits, and occupancy expenses. The significant year-over-year increase in noninterest expenses was primarily due to the inclusion of the operations acquired in the FNB Transaction.

 

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Mortgage Origination Segment

 

Loss before income taxes in our mortgage origination segment for the three months ended March 31, 2014 was $3.0 million, compared with income before income taxes of $12.3 million during the three months ended March 31, 2013. During the three months ended March 31, 2014 and 2013, operating results for the mortgage origination segment were primarily driven by noninterest income of $91.8 million and $146.5 million, respectively, offset by noninterest expense of $90.6 million and $122.3 million, respectively. Additionally, net interest expense of $4.1 million and $12.0 million during the three months ended March 31, 2014 and 2013, respectively, resulted from interest incurred on a warehouse line of credit held at the Bank as well as related intercompany financing costs, partially offset by interest income earned on loans held for sale.

 

The mortgage origination segment originates all of its mortgage loans through a retail channel. The following table provides certain details regarding our mortgage loan originations (dollars in thousands).

 

 

 

Three Months Ended

 

% of

 

Three Months Ended

 

% of

 

 

 

March 31, 2014

 

Total

 

March 31, 2013

 

Total

 

Mortgage Loan Originations - units

 

9,152

 

 

 

14,446

 

 

 

 

 

 

 

 

 

 

 

 

 

Mortgage Loan Originations - volume

 

$

1,866,153

 

 

 

$

3,046,263

 

 

 

 

 

 

 

 

 

 

 

 

 

Mortgage Loan Originations:

 

 

 

 

 

 

 

 

 

Conventional

 

$

1,194,137

 

63.99

%

$

1,924,771

 

63.18

%

Government

 

552,328

 

29.60

%

923,719

 

30.32

%

Jumbo

 

116,734

 

6.25

%

185,388

 

6.09

%

Other

 

2,954

 

0.16

%

12,385

 

0.41

%

 

 

$

1,866,153

 

100.00

%

$

3,046,263

 

100.00

%

 

 

 

 

 

 

 

 

 

 

Home purchases

 

$

1,468,710

 

78.70

%

$

1,609,861

 

52.85

%

Refinancings

 

397,443

 

21.30

%

1,436,402

 

47.15

%

 

 

$

1,866,153

 

100.00

%

$

3,046,263

 

100.00

%

 

 

 

 

 

 

 

 

 

 

Texas

 

$

430,154

 

23.05

%

$

657,262

 

21.58

%

California

 

291,571

 

15.62

%

551,819

 

18.11

%

Florida

 

93,374

 

5.00

%

110,173

 

3.62

%

North Carolina

 

91,733

 

4.92

%

174,841

 

5.74

%

Arizona

 

79,485

 

4.26

%

107,261

 

3.52

%

Ohio

 

67,080

 

3.60

%

85,615

 

2.81

%

Washington

 

58,259

 

3.12

%

88,672

 

2.91

%

Missouri

 

52,246

 

2.80

%

45,615

 

1.50

%

Virginia

 

50,879

 

2.73

%

132,486

 

4.35

%

All other states

 

651,372

 

34.90

%

1,092,519

 

35.86

%

 

 

$

1,866,153

 

100.00

%

$

3,046,263

 

100.00

%

 

The mortgage lending business is subject to variables that can impact loan origination volume, including seasonal and interest rate fluctuations. Historically, we have typically experienced increased loan origination volume from purchases of homes during the spring and summer, when more people tend to move and buy or sell homes. An increase in mortgage interest rates tends to result in decreased loan origination volume from refinancings, while a decrease in mortgage interest rates tends to result in increased refinancings. Changes in interest rates have historically had a lesser impact on home purchases volume than on refinancing volume.

 

Beginning in May 2013 and continuing through the fourth quarter of 2013, mortgage interest rates increased at a pace that, along with other factors, resulted in a 38.7% decrease in the mortgage origination segment’s total loan origination volume during the three months ended March 31, 2014 when compared to the same period in 2013. Home purchases volume during the three months ended March 31, 2014 and 2013 was $1.5 billion and $1.6 billion, respectively, an 8.8% decrease, while refinancing volume decreased from $1.4 billion (47.2% of total loan origination volume) to $397.4 million (21.3% of total loan origination volume) between the same periods. We anticipate that the decrease in refinancing volume as a percentage of total loan origination volume during the three months ended March 31, 2014 compared to the same period in 2013 will continue throughout 2014 and therefore anticipate our mortgage loan origination volumes in 2014 will more closely follow seasonal trends historically experienced by the mortgage origination segment.

 

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While the mortgage origination segment’s total loan origination volume decreased 38.7% during the three months ended March 31, 2014, compared to the same period in 2013, income before income taxes decreased 124.5% between the same periods ($3.0 million loss compared to $12.3 million income). Income before income taxes decreased at a greater rate primarily because segment operating costs included in noninterest expenses, such as employee related (salaries and benefits), occupancy, and administrative expenses, decreased at a lesser rate, approximately 13%, than loan origination volume decreased between the two periods. To address negative trends in loan origination volume resulting from changes in interest rates that began in May 2013, the mortgage origination segment reduced its non-origination employee headcount approximately 22% during the third and fourth quarters of 2013. Salaries and benefits expenses decreased approximately 15% between the first quarters of 2014 and 2013, as the benefits of the headcount reductions in the third and fourth quarters of 2013 were realized. We also engaged in other initiatives to reduce segment operating costs during the third and fourth quarters of 2013 that were primarily responsible for the decrease of approximately 10% in non-employee related expenses between the first quarters of 2014 and 2013. The benefits of the employee reductions and other cost savings initiatives include a decrease in recurring quarterly operating costs of approximately $8 million since the third quarter of 2013. Also impacting the trend in income before taxes, to a lesser extent, was a decrease in loan revenue margins resulting from increased pricing competition.

 

The mortgage origination segment sells substantially all mortgage loans it originates to various investors in the secondary market, the majority servicing released. During the first quarter of 2013, the mortgage origination segment retained servicing on approximately 8% of loans sold. This rate was increased to approximately 22% during the third and fourth quarters of 2013, and approximately 37% during the first quarter of 2014. The related mortgage servicing rights (“MSR”) asset was valued at $29.9 million on $2.7 billion of serviced loan volume at March 31, 2014, compared to a value of $20.1 million on $2.0 billion of serviced loan volume at December 31, 2013. All income related to retained servicing, including changes in the value of the MSR asset, is included in noninterest income. The mortgage origination segment’s determination on whether to retain or release servicing on mortgage loans it sells is impacted by changes in mortgage interest rates, and refinancing and market activity. We may, from time to time, manage our MSR asset through different strategies, including varying the percentage of mortgage loans sold servicing released and opportunistically selling MSR assets.

 

Noninterest income of $91.8 million and $146.5 million for the three months ended March 31, 2014 and 2013, respectively, was comprised of net gains on the sale of loans and other mortgage production income, and mortgage origination fees. Noninterest income decreased 37.4% during the three months ended March 31, 2014 when compared to the same period in 2013, which approximated the 38.7% decrease in loan origination volume experienced during the same periods. Noninterest income included $3.4 million of net gains and $3.5 million of net losses during the three months ended March 31, 2014 and 2013, respectively, resulting from changes in the fair value of the mortgage origination segment’s interest rate lock commitments (“IRLCs”) and loans held for sale, and the related activity associated with forward commitments used by the mortgage origination segment to mitigate interest rate risk associated with its IRLCs and mortgage loans held for sale. Since the total volume of IRLCs and mortgage loans held for sale was relatively unchanged between December 31, 2013 and March 31, 2014, the gain during the three months ended March 31, 2014 was primarily the result of an increase in the average value of individual IRLCs and mortgage loans held for sale since December 31, 2013.

 

Noninterest expenses were $90.6 million and $122.3 million for the three months ended March 31, 2014 and 2013, respectively. Employees’ compensation and benefits accounted for the majority of the noninterest expenses incurred. Compensation that varies with the volume of mortgage loan originations and overall segment profitability decreased $16.2 million during the three months ended March 31, 2014, as compared to the same period in 2013, and comprised approximately 52% and 58% of the total employees’ compensation and benefits expenses during the three months ended March 31, 2014 and 2013, respectively. In addition, employee salaries and benefits decreased $5.1 million during the three months ended March 31, 2014, as compared to the same period in 2013, primarily as a result of headcount reductions in the third and fourth quarters of 2013. The mortgage origination segment records unreimbursed closing costs when it pays a customer’s closing costs in return for the customer choosing to accept a higher interest rate on the customer’s mortgage loan. Unreimbursed closing costs during the three months ended March 31, 2014 and 2013 were $5.2 million and $10.4 million, respectively.

 

Between January 1, 2005, and March 31, 2014, the mortgage origination segment sold mortgage loans totaling $58.3 billion. These loans were sold under sales contracts that generally include provisions which hold the mortgage origination segment responsible for errors or omissions relating to its representations and warranties that loans sold meet certain requirements, including representations as to underwriting standards and the validity of certain borrower representations in connection with the loan. In addition, the sales contracts typically require the refund of purchased servicing rights plus certain investor

 

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servicing costs if a loan experiences an early payment default. While the mortgage origination segment sold loans prior to 2005, it has not experienced, nor does it anticipate experiencing, significant losses on loans originated prior to 2005 as a result of investor claims under these provisions of its sales contracts.

 

When an investor claim for indemnification of a loan sold is made, we evaluate the claim and determine if the claim can be satisfied through additional documentation or other deliverables. If the claim cannot be satisfied in that matter, we negotiate with the investor to reach a settlement of the claim. Settlements typically result in either the repurchase of a loan or reimbursement to the investor for losses incurred on the loan. Following is a summary of the mortgage origination segment’s claims resolution activity relating to loans sold between January 1, 2005, and March 31, 2014 (dollars in thousands).

 

 

 

Original Loan Balance

 

Loss Recognized

 

 

 

 

 

% of

 

 

 

% of

 

 

 

 

 

Loans

 

 

 

Loans

 

 

 

Amount

 

Sold

 

Amount

 

Sold

 

Claims resolved with no payment

 

$

133,843

 

0.23

%

$

 

0.00

%

 

 

 

 

 

 

 

 

 

 

Claims resolved as a result of a loan repurchase or payment to an investor for losses incurred (1)

 

178,137

 

0.31

%

22,880

 

0.04

%

 

 

$

311,980

 

0.54

%

$

22,880

 

0.04

%

 


(1) Losses incurred include refunded purchased servicing rights.

 

At March 31, 2014 and December 31, 2013, the mortgage origination segment’s indemnification liability reserve totaled $21.0 million and $21.1 million, respectively. The related provision for indemnification losses was $0.6 million and $1.0 million for the three months ended March 31, 2014 and 2013, respectively.

 

Insurance Segment

 

Income before income taxes in our insurance segment was $11.4 million during the three months ended March 31, 2014, compared with income before income taxes of $6.2 million during the three months ended March 31, 2013. The insurance segment is subject to claims arising out of severe weather, the incidence and severity of which are inherently unpredictable. Generally, the insurance segment’s insured risks exhibit higher losses in the second and third calendar quarters due to a seasonal concentration of weather-related events in its primary geographic markets. Although weather-related losses (including hail, high winds, tornadoes and hurricanes) can occur in any calendar quarter, the second calendar quarter, historically, has experienced the highest frequency of losses associated with these events. Hurricanes, however, are more likely to occur in the third calendar quarter of the year.

 

The insurance segment’s results during the three months ended March 31, 2014 and 2013 resulted in combined ratios of 77.5% and 88.7%, respectively. The year-over-year improvement in the combined ratio was primarily driven by the increase in earned premiums and improvement in our claims loss experience. The combined ratio is a measure of overall insurance underwriting profitability, and represents the sum of the loss and LAE ratio and the underwriting expense ratio, which are discussed in more detail below.

 

Noninterest income of $42.8 million and $39.4 million during the three months ended March 31, 2014 and 2013, respectively, included net insurance premiums earned of $40.3 million and $37.5 million, respectively. The increase in earned premiums is primarily attributable to volume and, to a lesser extent, rate increases in homeowners and mobile home products.

 

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Direct insurance premiums written by major product line are presented in the table below (in thousands).

 

 

 

Three Months Ended March 31,

 

Variance

 

 

 

2014

 

2013

 

2014 vs 2013

 

Direct Insurance Premiums Written:

 

 

 

 

 

 

Homeowners

 

$

18,583

 

$

18,543

 

$

40

 

Fire

 

13,835

 

13,052

 

783

 

Mobile Home

 

10,219

 

9,083

 

1,136

 

Commercial

 

1,087

 

1,135

 

(48

)

Other

 

46

 

44

 

2

 

 

 

$

43,770

 

$

41,857

 

$

1,913

 

 

Total direct insurance premiums written for our three largest insurance product lines increased by $2.0 million during the three months ended March 31, 2014, compared to the same period in 2013. These increases were due to growth in our core insurance products.

 

Net insurance premiums earned by major product line are presented in the table below (in thousands).

 

 

 

Three Months Ended March 31,

 

Variance

 

 

 

2014

 

2013

 

2014 vs 2013

 

Net Insurance Premiums Earned:

 

 

 

 

 

 

 

Homeowners

 

$

17,118

 

$

16,601

 

$

517

 

Fire

 

12,745

 

11,685

 

1,060

 

Mobile Home

 

9,413

 

8,132

 

1,281

 

Commercial

 

1,001

 

1,016

 

(15

)

Other

 

42

 

39

 

3

 

 

 

$

40,319

 

$

37,473

 

$

2,846

 

 

Net insurance premiums earned during the three months ended March 31, 2014 increased compared to the same period in 2013, primarily due to the increases in direct insurance premiums written of $1.9 million and premiums assumed of $0.5 million, while also improving due to a decrease in ceded insurance premiums during the same periods.

 

Noninterest expenses of $32.3 million and $34.3 million during the three months ended March 31, 2014 and 2013, respectively, include both loss and LAE expenses and policy acquisition and other underwriting expenses, as well as other noninterest expenses. Loss and LAE are recognized based on formula and case basis estimates for losses reported with respect to direct business, estimates of unreported losses based on past experience and deduction of amounts for reinsurance placed with reinsurers. Loss and LAE during the three months ended March 31, 2014 was $18.3 million, compared to $21.2 million during the same period in 2013. As a result, the loss and LAE ratio during the three months ended March 31, 2014 and 2013 was 45.5% and 56.5%, respectively. The year-over-year ratio improvement was primarily a result of growth of earned premium and improved claims loss experience.

 

Policy acquisition and other underwriting expenses encompass all expenses incurred relative to NLC operations, and include elements of multiple categories of expense otherwise reported as noninterest expense in the consolidated statements of operations.

 

Policy acquisition and other underwriting expenses were as follows (dollars in thousands).

 

 

 

Three Months Ended March 31,

 

Variance

 

 

 

2014

 

2013

 

2014 vs 2013

 

Amortization of deferred policy acquisition costs

 

$

10,197

 

$

9,614

 

$

583

 

Other underwriting expenses

 

3,380

 

3,025

 

355

 

Total

 

13,577

 

12,639

 

938

 

Agency expenses

 

(690

)

(569

)

(121

)

Total less agency expenses

 

$

12,887

 

$

12,070

 

$

817

 

Net insurance premiums earned

 

$

40,319

 

$

37,473

 

$

2,846

 

Expense ratio

 

32.0

%

32.2

%

-0.2

%

 

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Table of Contents

 

During 2013, the insurance segment initiated a review of the pricing of its primary products in each state of operation utilizing a consulting actuarial firm to supplement normal review processes. Rate filings have been made for certain products in several states for increases effective in 2014, and the process will continue through the remainder of the insurance segment’s products and states in which it operates. Concurrently, business concentrations were reviewed and actions initiated, including cancellation of agents, non-renewal of policies and cessation of new business writing on certain products in problematic geographic areas. We expect that these actions will reduce the rate of premium growth for 2014 when compared with the patterns exhibited in prior years. However, we expect the reduced exposure to volatile weather to improve our loss experience during 2014.

 

Financial Advisory Segment

 

Loss before income taxes in our financial advisory segment for the three months ended March 31, 2014 was $0.2 million, compared with income before income taxes of $0.3 million during the three months ended March 31, 2013. Higher interest rates along with increased volatility in fixed income markets have resulted in reduced sales of fixed income securities to institutional customers.

 

The financial advisory segment had net interest income of $2.6 million and $3.2 million during the three months ended March 31, 2014 and 2013, respectively, consisting of securities lending activity, customer margin loan balances and investment securities used to support sales, underwriting and other customer activities.

 

The majority of the financial advisory segment’s noninterest income for the three months ended March 31, 2014 and 2013 of $24.6 million and $22.8 million, respectively, was generated from fees and commissions earned from investment advisory and securities brokerage activities of $21.3 million and $22.0 million, respectively. The financial advisory segment participates in programs in which it issues forward purchase commitments of mortgage-backed securities to certain clients and sells TBAs. Changes in the fair values of these derivative instruments during the three months ended March 31, 2014 and 2013 produced net gains of $2.8 million and $1.8 million, respectively. Changes in the fair value of the financial advisory segment’s trading portfolio, which is used to support sales, underwriting and other customer activities, produced gains of $0.4 million during the three months ended March 31, 2014 and losses of $1.0 million during the three months ended March 31, 2013.

 

Noninterest expenses were $27.4 million and $25.7 million for the three months ended March 31, 2014 and 2013, respectively. Employees’ compensation and benefits accounted for the majority of the increase in noninterest expenses primarily due to increases in compensation costs that vary with noninterest income.

 

Corporate

 

Corporate includes certain activities not allocated to specific business segments. These activities include holding company financing and investing activities, and management and administrative services to support the overall operations of the Company including, but not limited to, certain executive management, corporate relations, legal, finance, and acquisition costs not allocated to business segments.

 

As a holding company, Hilltop’s primary investment objectives are to preserve capital and have available cash resources to utilize in making acquisitions. Investment and interest income earned, primarily from available cash and available-for-sale securities, including our note receivable from SWS, was $1.7 million and $1.6 million during the three months ended March 31, 2014 and 2013, respectively.

 

Interest expense of $1.7 million during the three months ended March 31, 2013 was due to interest costs associated with the 7.50% Senior Exchangeable Notes due 2025 of HTH Operating Partnership LP, a wholly owned subsidiary of Hilltop, which were called for redemption during the fourth quarter of 2013.

 

Noninterest expenses of $2.2 million during each of the three months ended March 31, 2014 and 2013 primarily include compensation and benefits and professional fees.

 

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Table of Contents

 

Financial Condition

 

The following discussion contains a more detailed analysis of our financial condition at March 31, 2014 as compared to December 31, 2013.

 

Securities Portfolio

 

At March 31, 2014, investment securities consisted of securities of the U.S. Treasury, U.S. government and its agencies, obligations of municipalities and other political subdivisions, primarily in the State of Texas, mortgage-backed, corporate debt, and equity securities, a note receivable and a warrant. We have the ability to categorize investments as trading, available for sale, and held to maturity.

 

Our securities portfolio consists of two major components: trading securities and securities available for sale. Trading securities are bought and held principally for the purpose of selling them in the near term and are carried at fair value, marked to market through operations and held at the Bank and First Southwest. Securities that may be sold in response to changes in market interest rates, changes in securities’ prepayment risk, increases in loan demand, general liquidity needs and other similar factors are classified as available for sale and are carried at estimated fair value, with unrealized gains and losses recorded in accumulated other comprehensive income (loss). Securities are classified as held to maturity based on the intent and ability of our management, at the time of purchase, to hold such securities to maturity. These securities are carried at amortized cost.

 

The table below summarizes our securities portfolio (in thousands).

 

 

 

March 31,

 

December 31,

 

 

 

2014

 

2013

 

Trading securities, at fair value

 

$

53,350

 

$

58,846

 

 

 

 

 

 

 

Securities available for sale, at fair value

 

 

 

 

 

U.S. Treasury securities

 

63,670

 

43,528

 

U.S. government agencies:

 

 

 

 

 

Bonds

 

667,128

 

662,732

 

Residential mortgage-backed securities

 

58,545

 

60,087

 

Collateralized mortgage obligations

 

113,832

 

120,461

 

Corporate debt securities

 

100,151

 

76,608

 

States and political subdivisions

 

152,585

 

156,835

 

Commercial mortgage-backed securities

 

687

 

760

 

Equity securities

 

24,663

 

22,079

 

Note receivable

 

48,582

 

47,909

 

Warrant

 

15,516

 

12,144

 

 

 

1,245,359

 

1,203,143

 

Securities held to maturity, at amortized cost

 

 

 

 

 

U.S. government agencies:

 

 

 

 

 

Residential mortgage-backed securities

 

29,582

 

 

States and political subdivisions

 

1,399

 

 

 

 

30,981

 

 

Total securities portfolio

 

$

1,329,690

 

$

1,261,989

 

 

We had net unrealized losses of $25.3 million and $53.7 million related to the available for sale investment portfolio at March 31, 2014 and December 31, 2013, respectively. The significant decrease in the net unrealized loss position of our available for sale investment portfolio during the first quarter of 2014 was due to the effects of a decrease in market interest rates since December 31, 2013 that resulted in an increase in the fair value of our debt securities.

 

The market value of securities held to maturity at March 31, 2014 approximated book value.

 

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Table of Contents

 

Banking Segment

 

The banking segment’s securities portfolio plays a role in the management of our interest rate sensitivity and generates additional interest income. In addition, the securities portfolio is used to meet collateral requirements for public and trust deposits, securities sold under agreements to repurchase and other purposes. The available for sale securities portfolio serves as a source of liquidity. Historically, the Bank’s policy has been to invest primarily in securities of the U.S. government and its agencies, obligations of municipalities in the State of Texas and other high grade fixed income securities to minimize credit risk. At March 31, 2014, the banking segment’s securities portfolio of $1.1 billion was comprised of trading securities of $20.9 million, available for sale securities of $1.1 billion and held to maturity securities of $31.0 million.

 

Insurance Segment

 

Our insurance segment’s primary investment objective is to preserve capital and manage for a total rate of return. NLC’s strategy is to purchase securities in sectors that represent the most attractive relative value. Our insurance segment invests the premiums it receives from policyholders until they are needed to pay policyholder claims or other expenses. At March 31, 2014, the insurance segment’s securities portfolio was comprised of $151.8 million in available for sale securities and $5.5 million of other investments included in other assets within the consolidated balance sheet.

 

Financial Advisory Segment

 

Our financial advisory segment holds securities to support sales, underwriting and other customer activities. Because FSC is a broker-dealer, it is required to carry its securities at fair value and record changes in the fair value of the portfolio in operations. Accordingly, FSC classifies its securities portfolio of $32.4 million at March 31, 2014 as trading.

 

Corporate

 

Available for sale securities of Hilltop at March 31, 2014 include the note receivable from, and warrant to purchase shares of SWS, of $64.1 million, and equity securities of $11.0 million representing those shares of SWS common stock held by Hilltop.

 

Non-Covered Loan Portfolio

 

Consolidated non-covered loans held for investment are detailed in the table below, classified by portfolio segment and segregated between those considered to be PCI loans and all other originated or acquired loans (in thousands). PCI loans showed evidence of credit deterioration that makes it probable that all contractually required principal and interest payments will not be collected.

 

 

 

 

 

Loans, excluding

 

PCI

 

Total

 

March 31, 2014

 

PCI Loans

 

Loans

 

Loans

 

Commercial and industrial

 

$

1,636,241

 

$

33,846

 

$

1,670,087

 

Real estate

 

1,503,160

 

32,201

 

1,535,361

 

Construction and land development

 

371,764

 

15,618

 

387,382

 

Consumer

 

50,385

 

3,731

 

54,116

 

Non-covered loans, gross

 

3,561,550

 

85,396

 

3,646,946

 

Allowance for loan losses

 

(31,293

)

(3,352

)

(34,645

)

Non-covered loans, net of allowance

 

$

3,530,257

 

$

82,044

 

$

3,612,301

 

 

 

 

Loans, excluding

 

PCI

 

Total

 

December 31, 2013

 

PCI Loans

 

Loans

 

Loans

 

Commercial and industrial

 

$

1,600,450

 

$

36,816

 

$

1,637,266

 

Real estate

 

1,418,003

 

39,250

 

1,457,253

 

Construction and land development

 

344,734

 

19,817

 

364,551

 

Consumer

 

51,067

 

4,509

 

55,576

 

Non-covered loans, gross

 

3,414,254

 

100,392

 

3,514,646

 

Allowance for loan losses

 

(30,104

)

(3,137

)

(33,241

)

Non-covered loans, net of allowance

 

$

3,384,150

 

$

97,255

 

$

3,481,405

 

 

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Banking Segment

 

The loan portfolio constitutes the major earning asset of the banking segment and typically offers the best alternative for obtaining the maximum interest spread above the banking segment’s cost of funds. The overall economic strength of the banking segment generally parallels the quality and yield of its loan portfolio. The banking segment’s loan portfolio is presented below in two sections, “— Non-Covered Loan Portfolio” and “— Covered Loan Portfolio.” The “Covered Loan Portfolio” consists of loans acquired in the FNB Transaction that are subject to loss-share agreements with the FDIC and is discussed below. The “Non-Covered Loan Portfolio” includes all other loans held by the Bank, which we refer to as “non-covered loans,” and is discussed herein.

 

The banking segment’s total non-covered loans, net of the allowance for non-covered loan losses, were $4.1 billion and $4.3 billion at March 31, 2014 and December 31, 2013, respectively. The banking segment’s non-covered loan portfolio includes a $1.3 billion warehouse line of credit extended to PrimeLending, of which $0.8 billion and $1.0 billion was drawn at March 31, 2014 and December 31, 2013, respectively, as well as term loans to First Southwest that had an outstanding balance of $23.0 million at March 31, 2014 and December 31, 2013. Amounts advanced against the warehouse line of credit and the First Southwest term loans are eliminated from net loans on our consolidated balance sheets. The decrease in the non-covered loan portfolio is primarily due to the decrease in the amount drawn under PrimeLending’s warehouse line of credit.

 

The banking segment does not generally participate in syndicated loan transactions and has no foreign loans in its portfolio. At March 31, 2014, the banking segment’s only non-covered loan concentration (loans to borrowers engaged in similar activities) that exceeded 10% of its total non-covered loans was non-construction commercial real estate loans within the non-covered real estate portfolio. At March 31, 2014, non-construction commercial real estate loans were 28.75% of the banking segment’s total non-covered loans. The banking segment’s non-covered loan concentrations were within regulatory requirements at March 31, 2014.

 

Mortgage Origination Segment

 

The loan portfolio of the mortgage origination segment consists of loans held for sale, primarily single-family residential mortgages funded through PrimeLending, and pipeline loans, which are loans in various stages of the application process, but not yet closed and funded. Pipeline loans may not close if potential borrowers elect in their sole discretion not to proceed with the loan application. Total loans held for sale were $0.9 billion and $1.1 billion at March 31, 2014 and December 31, 2013, respectively.

 

The components of the mortgage origination segment’s loans held for sale and pipeline loans are as follows (in thousands).

 

 

 

March 31,

 

December 31,

 

 

 

2014

 

2013

 

Loans held for sale:

 

 

 

 

 

Unpaid principal balance

 

$

860,527

 

$

1,066,850

 

Fair value adjustment

 

26,073

 

21,555

 

 

 

$

886,600

 

$

1,088,405

 

 

 

 

 

 

 

Pipeline loans:

 

 

 

 

 

Unpaid principal balance

 

$

797,934

 

$

602,467

 

Fair value adjustment

 

19,244

 

12,151

 

 

 

$

817,178

 

$

614,618

 

 

Financial Advisory Segment

 

The loan portfolio of the financial advisory segment consists primarily of margin loans to customers and correspondents.  These loans are collateralized by the securities purchased or by other securities owned by the clients and, because of collateral coverage ratios, are believed to present minimal collectability exposure. Additionally, these loans are subject to a number of regulatory requirements as well as FSC’s internal policies. The financial advisory segment’s total non-covered loans, net of the allowance for non-covered loan losses, were $315.0 million and $281.6 million at March 31, 2014 and December 31, 2013, respectively. This increase was primarily attributable to increased borrowings in margin accounts held by FSC customers and correspondents.

 

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Covered Loan Portfolio

 

Banking Segment

 

Loans acquired in the FNB Transaction that are subject to loss-share agreements with the FDIC are referred to as “covered loans” and reported separately in our consolidated balance sheets. Under the terms of the loss-share agreements, the FDIC has agreed to reimburse the Bank the following amounts with respect to the covered assets (including covered loans): (i) 80% of losses on the first $240.4 million of losses incurred; (ii) 0% of losses in excess of $240.4 million up to and including $365.7 million of losses incurred; and (iii) 80% of losses in excess of $365.7 million of losses incurred. The Bank has also agreed to reimburse the FDIC for any subsequent recoveries. The loss-share agreements for commercial and single family residential loans are in effect for 5 years and 10 years, respectively, and the loss recovery provisions to the FDIC are in effect for 8 years and 10 years, respectively, from the Bank Closing Date. In accordance with the loss-share agreements, the Bank may be required to make a “true-up” payment to the FDIC approximately ten years following the Bank Closing Date if the FDIC’s initial estimate of losses on covered assets is greater than the actual realized losses. The “true-up” payment is calculated using a defined formula set forth in the P&A Agreement.

 

In connection with the FNB Transaction, the Bank acquired loans both with and without evidence of credit quality deterioration since origination. The banking segment’s portfolio of acquired covered loans had a fair value of $1.1 billion as of the Bank Closing Date, with no carryover of any allowance for loan losses.

 

Covered loans held for investment are detailed in the table below and classified by portfolio segment (in thousands).

 

 

 

 

Loans, excluding

 

PCI

 

Total

 

March 31, 2014

 

PCI Loans

 

Loans

 

Loans

 

Commercial and industrial

 

$

21,153

 

$

31,210

 

$

52,363

 

Real estate

 

219,102

 

527,352

 

746,454

 

Construction and land development

 

20,266

 

93,365

 

113,631

 

Consumer

 

 

 

 

Covered loans, gross

 

260,521

 

651,927

 

912,448

 

Allowance for loan losses

 

(92

)

(2,573

)

(2,665

)

Covered loans, net of allowance

 

$

260,429

 

$

649,354

 

$

909,783

 

 

 

 

Loans, excluding

 

PCI

 

Total

 

December 31, 2013

 

PCI Loans

 

Loans

 

Loans

 

Commercial and industrial

 

$

28,533

 

$

38,410

 

$

66,943

 

Real estate

 

223,304

 

564,678

 

787,982

 

Construction and land development

 

25,376

 

126,068

 

151,444

 

Consumer

 

 

 

 

Covered loans, gross

 

277,213

 

729,156

 

1,006,369

 

Allowance for loan losses

 

(179

)

(882

)

(1,061

)

Covered loans, net of allowance

 

$

277,034

 

$

728,274

 

$

1,005,308

 

 

At March 31, 2014, the banking segment had covered loan concentrations (loans to borrowers engaged in similar activities) that exceeded 10% of total covered loans in its real estate portfolio. The areas of concentration within our covered real estate portfolio were construction and land development loans, non-construction residential real estate loans, and non-construction commercial real estate loans. At March 31, 2014, construction and land development loans, non-construction residential real estate loans, and non-construction commercial real estate loans were 12.45%, 31.58% and 38.88%, respectively, of the banking segment’s total covered loans. The banking segment’s covered loan concentrations were within regulatory requirements at March 31, 2014.

 

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Allowance for Loan Losses

 

The allowance for loan losses is a reserve established through a provision for loan losses charged to expense, which represents management’s best estimate of probable losses inherent in our existing non-covered and covered loan portfolios. Our management has responsibility for determining the level of the allowance for loan losses, subject to review by the Audit Committee of our Board of Directors and the Loan Review Committee of the Bank’s board of directors.

 

It is our management’s responsibility at the end of each quarter, or more frequently as deemed necessary, to analyze the level of the allowance for loan losses to ensure that it is appropriate for the estimated credit losses in the portfolio consistent with the Interagency Policy Statement on the Allowance for Loan and Lease Losses and the Receivables and Contingencies Topics of the Financial Accounting Standards Board (“FASB”) Accounting Standards Codification (“ASC”). Estimated credit losses are the probable current amount of loans that we will be unable to collect given facts and circumstances as of the evaluation date. When management determines that a loan, or portion thereof, is uncollectible, the loan, or portion thereof, is charged-off against the allowance for loan losses, or for acquired loans accounted for in pools, charged against the pool discount. Recoveries on charge-offs that occurred prior to the PlainsCapital Merger represent contractual cash flows not expected to be collected and are recorded as accretion income. Recoveries on loans charged-off subsequent to the PlainsCapital Merger are credited to the allowance for loan loss, except for recoveries on loans accounted for in pools, which are credited to the pool discount.

 

We have developed a methodology that seeks to determine an allowance within the scope of the Receivables and Contingencies Topics of the ASC. Each of the loans that has been determined to be impaired is within the scope of the Receivables Topic. Impaired loans that are equal to or greater than $0.5 million are individually evaluated for impairment using one of three impairment measurement methods as of the evaluation date: (1) the present value of expected future discounted cash flows on the loan, (2) the loan’s observable market price, or (3) the fair value of the collateral if the loan is collateral dependent. Specific reserves are provided in our estimate of the allowance based on the measurement of impairment under these three methods, except for collateral dependent loans, which require the fair value method. All non-impaired loans are within the scope of the Contingencies Topic. Estimates of loss for the Contingencies Topic are calculated based on historical loss experience by collateral type adjusted for changes in trends, conditions, and other relevant factors that affect repayment of loans as of the evaluation date. While historical loss experience provides a reasonable starting point for the analysis, historical losses, or recent trends in losses, are not the sole basis upon which to determine the appropriate level for the allowance for loan losses. Management considers recent qualitative or environmental factors that are likely to cause estimated credit losses associated with the existing portfolio to differ from historical loss experience, including but not limited to: changes in lending policies and procedures; changes in underwriting standards; changes in economic and business conditions and developments that affect the collectability of the portfolio; the condition of various market segments; changes in the nature and volume of the portfolio and in the terms of loans; changes in lending management and staff; changes in the volume and severity of past due loans, the volume of non-accrual loans, and the volume and severity of adversely classified or graded loans; changes in the loan review system; changes in the value of underlying collateral for collateral-dependent loans; and any concentrations of credit and changes in the level of such concentrations.

 

We design our loan review program to identify and monitor problem loans by maintaining a credit grading process, requiring that timely and appropriate changes are made to reviewed loans and coordinating the delivery of the information necessary to assess the appropriateness of the allowance for loan losses. Loans are evaluated for impaired status when: (i) payments on the loan are delayed, typically by 90 days or more (unless the loan is both well secured and in the process of collection), (ii) the loan becomes classified, (iii) the loan is being reviewed in the normal course of the loan review scope, or (iv) the loan is identified by the servicing officer as a problem. We review on an individual basis all loan relationships over $0.5 million that exhibit probable or observed credit weaknesses, the top 25 loan relationships by dollar amount in each market we serve, and additional relationships necessary to achieve adequate coverage of our various lending markets.

 

Homogeneous loans, such as consumer installment loans, residential mortgage loans and home equity loans, are not individually reviewed and are generally risk graded at the same levels. The risk grade and reserves are established for each homogeneous pool of loans based on the expected net charge-offs from current trends in delinquencies, losses or historical experience and general economic conditions. At March 31, 2014, we had no material delinquencies in these types of loans.

 

The allowance is subject to regulatory examination and determination as to adequacy, which may take into account such factors as the methodology used to calculate the allowance and the size of the allowance. While we believe we have an appropriate allowance for our existing non-covered and covered portfolios at March 31, 2014, additional provisions for

 

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losses on existing loans may be necessary in the future. Within our non-covered portfolio, we recorded net recoveries of $16 thousand and $0.2 million for the three months ended March 31, 2014 and 2013, respectively. Our allowance for non-covered loan losses totaled $34.6 million and $33.2 million at March 31, 2014 and December 31, 2013, respectively. The ratio of the allowance for non-covered loan losses to total non-covered loans held for investment at both March 31, 2014 and December 31, 2013 was 0.95%.

 

In connection with the PlainsCapital Merger and the FNB Transaction, we acquired loans both with and without evidence of credit quality deterioration since origination. PCI loans acquired in the PlainsCapital Merger are accounted for on an individual loan basis, while PCI loans acquired in the FNB Transaction are accounted for in pools as well as on an individual loan basis. We have established under our PCI accounting policy a framework to aggregate certain acquired loans into various loan pools based on a minimum of two layers of common risk characteristics for the purpose of determining their respective fair values as of their acquisition dates, and for applying the subsequent recognition and measurement provisions for income accretion and impairment testing. The common risk characteristics used for the pooling of the FNB PCI loans are risk grade and loan collateral type. The acquired loans were initially recorded at fair value with no carryover of any allowance for loan losses. Within our covered portfolio, we recorded net charge-offs of $0.3 million for the three months ended March 31, 2014. Our allowance for covered loan losses totaled $2.7 million and $1.1 million at March 31, 2014 and December 31, 2013, respectively. The ratio of the allowance for covered loan losses to total covered loans held for investment at March 31, 2014 and December 31, 2013 was 0.29% and 0.11%, respectively.

 

Provisions for loan losses are charged to operations to record the total allowance for loan losses at a level deemed appropriate by the banking segment’s management based on such factors as the volume and type of lending it conducted, the amount of non-performing loans and related collateral security, the present level of the allowance for loan losses, the results of recent regulatory examinations, generally accepted accounting principles, general economic conditions and other factors related to the ability to collect loans in its portfolio. The provision for loan losses, primarily in the banking segment, within our non-covered and covered portfolios was $3.2 million and $13.0 million for the three months ended March 31, 2014 and 2013, respectively.

 

The following tables present the activity in our allowance for loan losses within our non-covered and covered loan portfolios for the periods presented (in thousands). Substantially all of the activity shown below occurred within the banking segment.

 

 

 

Three Months Ended March 31,

 

Non-Covered Portfolio

 

2014

 

2013

 

Balance, beginning of period

 

$

33,241

 

$

3,409

 

Provisions charged to operating expenses

 

1,388

 

13,005

 

Recoveries of non-covered loans previously charged off:

 

 

 

 

 

Commercial and industrial

 

725

 

494

 

Real estate

 

32

 

139

 

Construction and land development

 

122

 

107

 

Consumer

 

18

 

8

 

Total recoveries

 

897

 

748

 

Non-covered loans charged off:

 

 

 

 

 

Commercial and industrial

 

807

 

438

 

Real estate

 

 

31

 

Construction and land development

 

 

 

Consumer

 

74

 

56

 

Total charge-offs

 

881

 

525

 

Net recoveries

 

16

 

223

 

Balance, end of period

 

$

34,645

 

$

16,637

 

 

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Three Months Ended

 

Covered Portfolio

 

March 31, 2014

 

Balance, beginning of period

 

$

1,061

 

Provisions charged to operating expenses

 

1,854

 

Recoveries of covered loans previously charged off:

 

 

 

Commercial and industrial

 

 

Real estate

 

 

Construction and land development

 

 

Consumer

 

 

Total recoveries

 

 

Covered loans charged off:

 

 

 

Commercial and industrial

 

91

 

Real estate

 

159

 

Construction and land development

 

 

Consumer

 

 

Total charge-offs

 

250

 

Net charge-offs

 

(250

)

Balance, end of period

 

$

2,665

 

 

The distribution of the allowance for loan losses among loan types and the percentage of the loans for that type to gross loans, excluding unearned income, within our non-covered and covered loan portfolios are presented in the tables below (dollars in thousands).

 

 

 

March 31, 2014

 

December 31, 2013

 

 

 

 

 

% of

 

 

 

% of

 

 

 

 

 

Gross

 

 

 

Gross

 

 

 

 

 

Non-Covered

 

 

 

Non-Covered

 

Non-Covered Portfolio 

 

Reserve

 

Loans

 

Reserve

 

Loans

 

Commercial and industrial

 

$

16,726

 

45.80

%

$

16,865

 

46.58

%

Real estate (including construction and land development)

 

17,778

 

52.72

%

16,288

 

51.84

%

Consumer

 

141

 

1.48

%

88

 

1.58

%

Total

 

$

34,645

 

100.00

%

$

33,241

 

100.00

%

 

 

 

March 31, 2014

 

December 31, 2013

 

 

 

 

 

% of

 

 

 

% of

 

 

 

 

 

Gross

 

 

 

Gross

 

 

 

 

 

Covered

 

 

 

Covered

 

Covered Portfolio 

 

Reserve

 

Loans

 

Reserve

 

Loans

 

Commercial and industrial

 

$

932

 

5.74

%

$

1,053

 

6.65

%

Real estate (including construction and land development)

 

1,733

 

94.26

%

8

 

93.35

%

Consumer

 

 

0.00

%

 

0.00

%

Total

 

$

2,665

 

100.00

%

$

1,061

 

100.00

%

 

Potential Problem Loans

 

Potential problem loans consist of loans that are performing in accordance with contractual terms but for which management has concerns about the ability of an obligor to continue to comply with repayment terms because of the obligor’s potential operating or financial difficulties. Management monitors these loans and reviews their performance on a regular basis. Potential problem loans contain potential weaknesses that could improve, persist or further deteriorate. If such potential weaknesses persist without improving, the loan is subject to downgrade, typically to substandard, in three to six months. Within our non-covered loan portfolio at March 31, 2014, we had 12 credit relationships totaling $35.2 million of potential problem loans, which are assigned a grade of special mention within our risk grading matrix. At December 31, 2013, we had ten credit relationships totaling $24.7 million of non-covered potential problem loans. Within our covered loan portfolio at March 31, 2014, we had one credit relationship totaling $1.7 million of potential problem loans assigned a grade of special mention within our risk grading matrix, compared with two credit relationships totaling $3.3 million at December 31, 2013.

 

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Non-Performing Assets

 

The following table presents our components of non-covered non-performing assets (dollars in thousands).

 

 

 

March 31,

 

December 31,

 

 

 

2014

 

2013

 

Non-covered loans accounted for on a non-accrual basis:

 

 

 

 

 

Commercial and industrial

 

$

15,575

 

$

16,730

 

Real estate

 

7,213

 

6,511

 

Construction and land development

 

142

 

112

 

Consumer

 

 

 

 

 

$

22,930

 

$

23,353

 

 

 

 

 

 

 

Non-covered non-performing loans as a percentage of total non-covered loans

 

0.51

%

0.51

%

 

 

 

 

 

 

Non-covered other real estate owned

 

$

5,774

 

$

4,805

 

 

 

 

 

 

 

Other repossessed assets

 

$

250

 

$

13

 

 

 

 

 

 

 

Non-covered non-performing assets

 

$

28,954

 

$

28,171

 

 

 

 

 

 

 

Non-covered non-performing assets as a percentage of total assets

 

0.32

%

0.32

%

 

 

 

 

 

 

Non-covered loans past due 90 days or more and still accruing

 

$

2

 

$

534

 

 

 

 

 

 

 

Troubled debt restructurings included in accruing non-covered loans

 

$

776

 

$

1,055

 

 

At March 31, 2014, total non-covered non-performing assets increased $0.8 million to $29.0 million, compared with $28.2 million at December 31, 2013, primarily due to an increase in non-covered OREO of $1.0 million. Non-covered non-performing loans totaled $22.9 million at March 31, 2014 and $23.4 million at December 31, 2013. At March 31, 2014, non-covered non-accrual loans included four commercial and industrial relationships with loans totaling $12.1 million secured by accounts receivable, inventory, oil and gas properties, aircraft and life insurance, and a total of $1.3 million in lease financing receivables. Non-covered non-accrual loans at March 31, 2014 also included $7.2 million characterized as real estate loans, including three commercial real estate loan relationships totaling $3.0 million and loans secured by residential real estate totaling $3.7 million, substantially all of which were classified as loans held for sale, as well as construction and land development loans of $0.1 million. At December 31, 2013, non-covered non-accrual loans included five commercial and industrial relationships with loans totaling $14.0 million secured by accounts receivable, inventory, aircraft and life insurance, and a total of $1.0 million in lease financing receivables. Non-covered non-accrual loans at December 31, 2013 also included $6.5 million characterized as real estate loans, including three commercial real estate loan relationships totaling $2.5 million and loans secured by residential real estate totaling $3.5 million, substantially all of which were classified as loans held for sale, as well as construction and land development loans of $0.1 million.

 

Non-covered OREO increased $1.0 million to $5.8 million at March 31, 2014, compared with $4.8 million at December 31, 2013. The increase was primarily due to the addition of two properties totaling $2.0 million, partially offset by the disposal of three properties totaling $0.7 million. At March 31, 2014, non-covered OREO included commercial properties of $1.8 million, commercial real estate property consisting of parcels of unimproved land of $2.1 million and residential lots under development of $1.9 million. At December 31, 2013, non-covered OREO included commercial properties of $4.2 million, commercial real estate property consisting of parcels of unimproved land of $0.5 million and residential lots under development of $0.1 million.

 

At March 31, 2014, troubled debt restructurings (“TDRs”) granted on non-covered loans totaled $11.2 million, of which $0.8 million relate to non-covered PCI loans that are considered to be performing due to the application of the accretion method and non-covered non-performing loans of $10.4 million for which discount accretion has been suspended. At December 31, 2013, TDRs granted on non-covered loans totaled $11.4 million. These TDRs were comprised of $1.1 million of non-covered PCI loans that are considered to be performing due to the application of the accretion method and non-covered non-performing loans of $10.3 million for which discount accretion has been suspended.

 

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Non-covered loans past due 90 days or more and still accruing totaled $2 thousand at March 31, 2014 and included a secured commercial and industrial loan and consumer loans, compared to a total of $0.5 million at December 31, 2013 that included secured commercial and industrial loans, and a real estate loan.

 

The following table presents components of our covered non-performing assets (dollars in thousands).

 

 

 

March 31,

 

December 31,

 

 

 

2014

 

2013

 

Covered loans accounted for on a non-accrual basis:

 

 

 

 

 

Commercial and industrial

 

$

882

 

$

973

 

Real estate

 

11,277

 

249

 

Construction and land development

 

1,913

 

575

 

Consumer

 

 

 

 

 

$

14,072

 

$

1,797

 

 

 

 

 

 

 

Covered non-performing loans as a percentage of total covered loans

 

1.54

%

0.18

%

 

 

 

 

 

 

Covered other real estate owned

 

$

152,310

 

$

142,833

 

 

 

 

 

 

 

Other repossessed assets

 

$

 

$

 

 

 

 

 

 

 

Covered non-performing assets

 

$

166,382

 

$

144,630

 

 

 

 

 

 

 

Covered non-performing assets as a percentage of total assets

 

1.84

%

1.62

%

 

 

 

 

 

 

Covered loans past due 90 days or more and still accruing

 

$

1,051

 

$

 

 

 

 

 

 

 

Troubled debt restructurings included in accruing covered loans

 

$

 

$

 

 

At March 31, 2014, covered non-performing assets increased by $21.8 million to $166.4 million, compared with $144.6 million at December 31, 2013, due to increases in covered non-accrual loans of $12.3 million and covered OREO of $9.5 million. Covered non-performing loans totaled $14.1 million at March 31, 2014 and $1.8 million at December 31, 2013. At March 31, 2014, covered non-performing loans included one commercial and industrial relationship with loans totaling $0.9 million secured by accounts receivable and inventory, two commercial real estate loan relationships totaling $11.3 million, as well as construction and land development loans of $1.9 million. At December 31, 2013, covered non-performing loans of $1.8 million included one commercial and industrial relationship with loans totaling $1.0 million secured by accounts receivable, inventory and equipment. Covered non-accrual loans at December 31, 2013 also included one commercial real estate loan relationship totaling $0.2 million, as well as construction and land development loans of $0.6 million.

 

OREO acquired in the FNB Transaction that is subject to the FDIC loss-share agreements is referred to as “covered OREO” and reported separately in our consolidated balance sheets. Covered OREO increased $9.5 million to $152.3 million at March 31, 2014, compared with $142.8 million at December 31, 2013. The increase was primarily due to the addition of 41 properties totaling $23.2 million, partially offset by the disposal of 70 properties totaling $13.4 million. At March 31, 2014, covered OREO included commercial properties of $103.1 million, commercial real estate property consisting of parcels of unimproved land of $24.5 million and residential lots under development of $24.7 million. At December 31, 2013, covered OREO included commercial properties of $90.5 million, commercial real estate property consisting of parcels of unimproved land of $21.4 million and residential lots under development of $30.9 million.

 

Covered loans past due 90 days or more and still accruing totaled $1.1 million at March 31, 2014 and included secured commercial and industrial loans, a construction and land development loan, and commercial and residential real estate loans.

 

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Insurance Losses and Loss Adjustment Expenses

 

At March 31, 2014 and December 31, 2013, our reserves for unpaid losses and LAE were $28.3 million and $27.5 million, respectively. The liability for insurance losses and LAE represents estimates of the ultimate unpaid cost of all losses incurred, including losses for claims that have not yet been reported. Separately for each of NLIC and ASIC and each line of business, our actuaries estimate the liability for unpaid losses and LAE by first estimating ultimate losses and LAE amounts for each year, prior to recognizing the impact of reinsurance.

 

Insured losses for a given accident year change in value over time as additional information on claims is received, as claim conditions change and as new claims are reported. This process is commonly referred to as loss development. To project ultimate losses and LAE, our actuaries examine the paid and reported losses and LAE for each accident year and multiply these values by a loss development factor. The selected loss development factors are based upon a review of the loss development patterns indicated in the companies’ historical loss triangles and applicable insurance industry loss development factors.

 

The reserve analysis performed by our actuaries provides preliminary central estimates of the unpaid losses and LAE. At each quarter-end, the results of the reserve analysis are summarized and discussed with our senior management. The senior management group considers many factors in determining the amount of reserves to record for financial statement purposes. These factors include the extent and timing of any recent catastrophic events, historical pattern and volatility of the actuarial indications, the sensitivity of the actuarial indications to changes in paid and reported loss patterns, the consistency of claims handling processes, the consistency of case reserving practices, changes in our pricing and underwriting, and overall pricing and underwriting trends in the insurance market.

 

Deposits

 

The banking segment’s major source of funds and liquidity is its deposit base. Deposits provide funding for its investment in loans and securities. Interest paid for deposits must be managed carefully to control the level of interest expense and overall net interest margin. The composition of the deposit base (time deposits versus interest-bearing demand deposits and savings) is constantly changing due to the banking segment’s needs and market conditions. Overall, average deposits totaled $6.7 billion for the three months ended March 31, 2014, an increase from average deposits of $4.7 billion for the three months ended March 31, 2013. The significant year-over-year increase in average deposits was primarily due to those deposits assumed as a part of the FNB Transaction. The table below presents the average balance of deposits and the average rate paid on those deposits (dollars in thousands).

 

 

 

Three Months Ended March 31,

 

Year Ended

 

 

 

2014

 

2013

 

December 31, 2013

 

 

 

Average

 

Average

 

Average

 

Average

 

Average

 

Average

 

 

 

Balance

 

Rate Paid

 

Balance

 

Rate Paid

 

Balance

 

Rate Paid

 

Noninterest-bearing demand deposits

 

$

1,721,403

 

0.00

%

$

1,190,779

 

0.00

%

$

1,370,029

 

0.00

%

Interest-bearing demand deposits

 

2,355,333

 

0.22

%

1,831,554

 

0.25

%

1,930,622

 

0.24

%

Savings deposits

 

312,675

 

0.25

%

178,770

 

0.37

%

247,789

 

0.32

%

Certificates of deposit

 

2,281,205

 

0.40

%

1,547,766

 

0.56

%

1,745,483

 

0.54

%

 

 

$

6,670,616

 

0.23

%

$

4,748,869

 

0.29

%

$

5,293,923

 

0.28

%

 

Borrowings

 

Our borrowings are shown in the table below (dollars in thousands).

 

 

 

March 31, 2014

 

December 31, 2013

 

 

 

 

 

Average

 

 

 

Average

 

 

 

Balance

 

Rate Paid

 

Balance

 

Rate Paid

 

Short-term borrowings

 

$

491,406

 

0.36

%

$

342,087

 

0.36

%

Notes payable

 

55,465

 

4.68

%

56,327

 

6.33

%

Junior subordinated debentures

 

67,012

 

3.53

%

67,012

 

3.59

%

 

 

$

613,883

 

1.16

%

$

465,426

 

2.10

%

 

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Short-term borrowings consist of federal funds purchased, securities sold under agreements to repurchase and short-term bank loans. The $149.3 million increase in short-term borrowings at March 31, 2014 compared with December 31, 2013 included increases of $56.1 million in federal funds purchased, $51.5 million in securities sold under agreements to repurchase and $41.8 million in short-term bank loans. These increases were primarily the result of increases in customer borrowings and the cyclical nature of certain other short-term borrowing components. Notes payable at March 31, 2014 of $55.5 million is comprised of insurance segment term notes and nonrecourse notes owed by First Southwest.

 

Liquidity and Capital Resources

 

Hilltop is a financial holding company whose assets primarily consist of the stock of its subsidiaries and invested assets. Hilltop’s primary investment objectives, as a holding company, are to preserve capital and have available cash resources to utilize in making acquisitions. At March 31, 2014, Hilltop had approximately $157 million in freely available cash and cash equivalents. If necessary or appropriate, we may also finance acquisitions with the proceeds from equity or debt issuances. The current short-term liquidity needs of Hilltop include operating expenses and dividends on preferred stock.

 

Recent Event

 

On March 31, 2014, we entered into a definitive merger agreement with SWS providing for the merger of SWS with and into a subsidiary of Hilltop formed for the purpose of facilitating this transaction. Under the terms of the merger agreement, SWS stockholders will receive per share consideration of 0.2496 shares of Hilltop common stock and $1.94 of cash, equating to $7.88 per share based on Hilltop’s closing price on March 31, 2014. We intend to fund the cash portion of the consideration, currently estimated at approximately $78 million in the aggregate, through available cash. The merger is subject to customary closing conditions, including regulatory approvals and approval of the stockholders of SWS, and is expected to be completed prior to the end of 2014.

 

Series B Preferred Stock

 

As a result of the PlainsCapital Merger, the outstanding shares of PlainsCapital Corporation’s Non-Cumulative Perpetual Preferred Stock, Series C, all of which were held by the U.S. Treasury, were converted on a one-for-one basis into shares of Hilltop Series B Preferred Stock. The terms of our Series B Preferred Stock provide for the payment of non-cumulative dividends on a quarterly basis. The dividend rate, as a percentage of the liquidation amount, fluctuated until December 31, 2013 based upon changes in the level of “qualified small business lending” (“QSBL”) by the Bank. The shares of Hilltop Series B Preferred Stock are senior to shares of our common stock with respect to dividends and liquidation preference, and qualify as Tier 1 Capital for regulatory purposes. At both March 31, 2014 and December 31, 2013, $114.1 million of our Series B Preferred Stock was outstanding. During the three months ended March 31, 2014, we accrued dividends of $1.4 million on the Hilltop Series B Preferred Stock.

 

The dividend rate on the Hilltop Series B Preferred Stock is fixed at 5.0% from January 1, 2014 until March 26, 2016, based upon our level of QSBL at September 30, 2013. Beginning March 27, 2016, the dividend rate on any outstanding shares of Hilltop Series B Preferred Stock will be fixed at nine percent (9%) per annum.

 

Loss-Share Agreements

 

In connection with the FNB Transaction, the Bank entered into two loss-share agreements with the FDIC that collectively cover $1.2 billion of loans and OREO acquired in the FNB Transaction, which we refer to as “covered assets”. Pursuant to the loss-share agreements, the FDIC has agreed to reimburse the Bank the following amounts with respect to the covered assets: (i) 80% of losses on the first $240.4 million of losses incurred; (ii) 0% of losses in excess of $240.4 million up to and including $365.7 million of losses incurred; and (iii) 80% of losses in excess of $365.7 million of losses incurred. The Bank has also agreed to reimburse the FDIC for any subsequent recoveries. The loss-share agreements for commercial and single family residential loans are in effect for 5 years and 10 years, respectively, from the Bank Closing Date and the loss recovery provisions to the FDIC are in effect for 8 years and 10 years, respectively, from the Bank Closing Date. In accordance with the loss-share agreements, the Bank may be required to make a “true-up” payment to the FDIC approximately ten years following the Bank Closing Date if the FDIC’s initial estimate of losses on covered assets is greater than the actual realized losses. The “true-up” payment is calculated using a defined formula set forth in the P&A Agreement.

 

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Regulatory Capital

 

We are subject to various regulatory capital requirements administered by the federal banking agencies. Failure to meet minimum capital requirements may prompt certain actions by regulators that, if undertaken, could have a direct material adverse effect on our financial condition and results of operations. Under capital adequacy and regulatory requirements, we must meet specific capital guidelines that involve quantitative measures of our assets, liabilities, and certain off-balance sheet items as calculated under regulatory accounting practices. Our capital amounts and classification are also subject to qualitative judgments by the regulators about components, risk weightings and other factors.

 

At March 31, 2014, Hilltop exceeded all regulatory capital requirements with a total capital to risk weighted assets ratio of 19.32%, Tier 1 capital to risk weighted assets ratio of 18.66% and a Tier 1 capital to average assets, or leverage, ratio of 13.12%. At March 31, 2014, the Bank was also considered to be “well-capitalized” under regulatory requirements. We discuss regulatory capital requirements in more detail in Note 14 to our consolidated financial statements.

 

Cash Flow Activities

 

Cash and cash equivalents (consisting of cash and due from banks and federal funds sold), totaled $917.4 million at March 31, 2014, an increase of $171.4 million from $746.0 million at December 31, 2013. Deposit flows, calls of investment securities and borrowed funds, and prepayments of loans and mortgage-backed securities are strongly influenced by interest rates, general and local economic conditions and competition in the marketplace. These factors reduce the predictability of the timing of these sources of funds.

 

Cash provided by operations during the three months ended March 31, 2014 was $154.3 million, a decrease in cash flow of $5.7 million compared with the same period in 2013. Cash provided by operations decreased primarily due to reductions in cash provided by our mortgage loan origination activities.

 

Cash used in our investment activities during the three months ended March 31, 2014 was $39.4 million, primarily including net purchases of securities in our investment portfolio of $45.2 million and net purchases of premises and equipment and other assets of $8.7 million, partially offset by $14.7 million from sales of premises and equipment and other real estate owned. Cash used in our investment activities during the three months ended March 31, 2013 of $192.1 million primarily included net purchases of securities for investment of $155.7 million, $41.9 million for the origination of loans held for investment and net purchases of premises and equipment and other assets of $5.0 million. The decrease in cash used in investing activities during the three months ended March 31, 2014, compared to the same period in 2013, was primarily due to reduced net purchases of securities driven by market conditions.

 

Cash used in financing activities during the three months ended March 31, 2014 was $56.5 million, an increase in cash provided of $141.6 million compared with the same period in 2013. The increase in cash provided was due primarily to an increase in short-term borrowings during the first quarter of 2014, partially offset by a decrease in deposits during the three months ended March 31, 2014 compared with a decrease in short-term borrowings partially offset by an increase in deposits during the same period in 2013.

 

Banking Segment

 

Within our banking segment, liquidity refers to the measure of our ability to meet our customers’ short-term and long-term deposit withdrawals and anticipated and unanticipated increases in loan demand without penalizing earnings. Interest rate sensitivity involves the relationships between rate-sensitive assets and liabilities and is an indication of the probable effects of interest rate fluctuations on our net interest income.

 

Our asset and liability group is responsible for continuously monitoring our liquidity position to ensure that assets and liabilities are managed in a manner that will meet our short-term and long-term cash requirements. Funds invested in short-term marketable instruments, the continuous maturing of other interest-earning assets, cash flows from self-liquidating investments such as mortgage-backed securities and collateralized mortgage obligations, the possible sale of available for sale securities, and the ability to securitize certain types of loans provide sources of liquidity from an asset perspective. The liability base provides sources of liquidity through deposits and the maturity structure of short-term borrowed funds. For short-term liquidity needs, we utilize federal fund lines of credit with correspondent banks, securities sold under agreements to repurchase, borrowings from the Federal Reserve and borrowings under lines of credit with

 

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other financial institutions.  For intermediate liquidity needs, we utilize advances from the FHLB. To supply liquidity over the longer term, we have access to brokered certificates of deposit, term loans at the FHLB and borrowings under lines of credit with other financial institutions.

 

We had deposits of $6.7 billion at both March 31, 2014 and December 31, 2013. Deposit flows are affected by the level of market interest rates, the interest rates and products offered by competitors, the volatility of equity markets and other factors. At March 31, 2014, money market deposits, including brokered deposits, were $1.2 billion; time deposits, including brokered deposits, were $2.1 billion; and noninterest bearing demand deposits were $1.7 billion. Money market deposits, including brokered deposits, increased by $56.8 million from $1.2 billion and time deposits, including brokered deposits, decreased $176.1 million from $2.3 billion at December 31, 2013.

 

The Bank’s 15 largest depositors, excluding Hilltop and First Southwest, accounted for 17.48% of the Bank’s total deposits, and the Bank’s five largest depositors, excluding First Southwest, accounted for 10.89% of the Bank’s total deposits at March 31, 2014. The loss of one or more of our largest Bank customers, or a significant decline in our deposit balances due to ordinary course fluctuations related to these customers’ businesses, could adversely affect our liquidity and might require us to raise deposit rates to attract new deposits, purchase federal funds or borrow funds on a short-term basis to replace such deposits. We have not experienced any liquidity issues to date with respect to brokered deposits or our other large balance deposits, and we believe alternative sources of funding are available to more than compensate for the loss of one or more of these customers.

 

Mortgage Origination Segment

 

PrimeLending funds the mortgage loans it originates through a warehouse line of credit of up to $1.3 billion maintained with the Bank. At March 31, 2014, PrimeLending had outstanding borrowings of $0.8 billion against the warehouse line of credit. PrimeLending sells substantially all mortgage loans it originates to various investors in the secondary market, the majority with servicing released. As these mortgage loans are sold in the secondary market, PrimeLending pays down its warehouse line of credit with the Bank. In addition, PrimeLending has an available line of credit with JPMorgan Chase Bank, NA (“JPMorgan Chase”) of up to $1.0 million. At March 31, 2014, PrimeLending had no borrowings under the JPMorgan Chase line of credit.

 

Insurance Segment

 

Our insurance operating subsidiary’s primary investment objectives is to preserve capital and manage for a total rate of return. NLC’s strategy is to purchase securities in sectors that represent the most attractive relative value. Bonds, cash and short-term investments of $205.3 million, or 91.5%, equity investments of $13.6 million and other investments of $5.5 million comprised NLC’s $224.4 million in total cash and investments at March 31, 2014. NLC does not currently have any significant concentration in both direct and indirect guarantor exposure or any investments in subprime mortgages. NLC has custodial agreements with Wells Fargo and an investment management agreement with DTF Holdings, LLC.

 

Financial Advisory Segment

 

FSC relies on its equity capital, short-term bank borrowings, interest-bearing and non-interest-bearing client credit balances, correspondent deposits, securities lending arrangements, repurchase agreement financings and other payables to finance its assets and operations. FSC has credit arrangements with three unaffiliated banks of up to $255.0 million, which are used to finance securities owned, securities held for correspondent accounts, receivables in customer margin accounts and underwriting activities. These credit arrangements are provided on an “as offered” basis and are not committed lines of credit. At March 31, 2014, FSC had borrowed $139.2 million under these credit arrangements.

 

Impact of Inflation and Changing Prices

 

Our consolidated financial statements included herein have been prepared in accordance with GAAP, which presently require us to measure financial position and operating results primarily in terms of historic dollars. Changes in the relative value of money due to inflation or recession are generally not considered. The primary effect of inflation on our operations is reflected in increased operating costs. In management’s opinion, changes in interest rates affect the financial condition of a financial institution to a far greater degree than changes in the inflation rate. While interest rates are greatly influenced by changes in the inflation rate, they do not necessarily change at the same rate or in the same magnitude as the

 

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inflation rate. Interest rates are highly sensitive to many factors that are beyond our control, including changes in the expected rate of inflation, the influence of general and local economic conditions and the monetary and fiscal policies of the U.S. government, its agencies and various other governmental regulatory authorities.

 

Off-Balance Sheet Arrangements; Commitments; Guarantees

 

In the normal course of business, we enter into various transactions, which, in accordance with GAAP, are not included in our consolidated balance sheets. We enter into these transactions to meet the financing needs of our customers. These transactions include commitments to extend credit and standby letters of credit, which involve, to varying degrees, elements of credit risk and interest rate risk in excess of the amounts recognized in our consolidated balance sheets.

 

We enter into contractual loan commitments to extend credit, normally with fixed expiration dates or termination clauses, at specified rates and for specific purposes. Substantially all of our commitments to extend credit are contingent upon customers maintaining specific credit standards until the time of loan funding. We minimize our exposure to loss under these commitments by subjecting them to credit approval and monitoring procedures. We assess the credit risk associated with certain commitments to extend credit and have recorded a liability related to such credit risk in our consolidated financial statements.

 

Standby letters of credit are written conditional commitments issued by us to guarantee the performance of a customer to a third party. In the event the customer does not perform in accordance with the terms of the agreement with the third party, we would be required to fund the commitment. The maximum potential amount of future payments we could be required to make is represented by the contractual amount of the commitment. If the commitment is funded, we would be entitled to seek recovery from the customer. Our policies generally require that standby letter of credit arrangements contain security and debt covenants similar to those contained in loan agreements.

 

In the aggregate, the Bank had outstanding unused commitments to extend credit of $1.2 billion at March 31, 2014 and outstanding financial and performance standby letters of credit of $42.9 million at March 31, 2014.

 

In the normal course of business, FSC executes, settles and finances various securities transactions that may expose FSC to off-balance sheet risk in the event that a customer or counterparty does not fulfill its contractual obligations. Examples of such transactions include the sale of securities not yet purchased by customers or for the account of FSC, clearing agreements between FSC and various clearinghouses and broker-dealers, secured financing arrangements that involve pledged securities, and when-issued underwriting and purchase commitments.

 

Critical Accounting Policies and Estimates

 

Our accounting policies are fundamental to understanding our management’s discussion and analysis of our results of operations and financial condition. We have identified certain significant accounting policies which involve a higher degree of judgment and complexity in making certain estimates and assumptions that affect amounts reported in our consolidated financial statements. The significant accounting policies which we believe to be the most critical in preparing our consolidated financial statements relate to Allowance for Loan Losses, FDIC Indemnification Asset, Reserve for Losses and Loss Adjustment Expenses, Goodwill and Identifiable Intangible Assets, Loan Indemnification Liability, Mortgage Servicing Rights and Acquisition Accounting. Since December 31, 2013, there have been no changes in critical accounting policies as further described under “Critical Accounting Policies and Estimates” and Note 1 to the Consolidated Financial Statements in our Annual Report on Form 10-K for the year ended December 31, 2013.

 

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Item 3. Quantitative and Qualitative Disclosures About Market Risk.

 

Our assessment of market risk as of March 31, 2014 indicates there are no material changes in the quantitative and qualitative disclosures from those previously reported in our Annual Report on Form 10-K for the year ended December 31, 2013, except as discussed below.

 

The primary objective of the following information is to provide forward-looking quantitative and qualitative information about our potential exposure to market risks. Market risk represents the risk of loss that may result from changes in value of a financial instrument as a result of changes in interest rates, market prices and the credit perception of an issuer. The disclosure is not meant to be a precise indicator of expected future losses, but rather an indicator of reasonably possible losses, and therefore our actual results may differ from any of the following projections. This forward-looking information provides an indicator of how we view and manage our ongoing market risk exposures.

 

Banking Segment

 

The banking segment is engaged primarily in the business of investing funds obtained from deposits and borrowings in interest-earning loans and investments, and our primary component of market risk is sensitivity to changes in interest rates. Consequently, our earnings depend to a significant extent on our net interest income, which is the difference between interest income on loans and investments and our interest expense on deposits and borrowings. To the extent that our interest-bearing liabilities do not reprice or mature at the same time as our interest-bearing assets, we are subject to interest rate risk and corresponding fluctuations in net interest income.

 

There are several common sources of interest rate risk that must be effectively managed if there is to be minimal impact on our earnings and capital. Repricing risk arises largely from timing differences in the pricing of assets and liabilities.  Reinvestment risk refers to the reinvestment of cash flows from interest payments and maturing assets at lower or higher rates. Basis risk exists when different yield curves or pricing indices do not change at precisely the same time or in the same magnitude such that assets and liabilities with the same maturity are not all affected equally. Yield curve risk refers to unequal movements in interest rates across a full range of maturities.

 

We have employed asset/liability management policies that attempt to manage our interest-earning assets and interest-bearing liabilities, thereby attempting to control the volatility of net interest income, without having to incur unacceptable levels of risk. We employ procedures which include interest rate shock analysis, repricing gap analysis and balance sheet decomposition techniques to help mitigate interest rate risk in the ordinary course of business. In addition, the asset/liability management policies permit the use of various derivative instruments to manage interest rate risk or hedge specified assets and liabilities.

 

An interest rate sensitive asset or liability is one that, within a defined time period, either matures or experiences an interest rate change in line with general market interest rates. The management of interest rate risk is performed by analyzing the maturity and repricing relationships between interest-earning assets and interest-bearing liabilities at specific points in time (“GAP”) and by analyzing the effects of interest rate changes on net interest income over specific periods of time by projecting the performance of the mix of assets and liabilities in varied interest rate environments. Interest rate sensitivity reflects the potential effect on net interest income resulting from a movement in interest rates. A company is considered to be asset sensitive, or have a positive GAP, when the amount of its interest-earning assets maturing or repricing within a given period exceeds the amount of its interest-bearing liabilities also maturing or repricing within that time period. Conversely, a company is considered to be liability sensitive, or have a negative GAP, when the amount of its interest-bearing liabilities maturing or repricing within a given period exceeds the amount of its interest-earning assets also maturing or repricing within that time period. During a period of rising interest rates, a negative GAP would tend to affect net interest income adversely, while a positive GAP would tend to result in an increase in net interest income. During a period of falling interest rates, a negative GAP would tend to result in an increase in net interest income, while a positive GAP would tend to affect net interest income adversely. However, it is our intent to remain relatively balanced so that changes in rates do not have a significant impact on earnings.

 

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As illustrated in the table below, the banking segment is asset sensitive overall. Loans that adjust daily or monthly to the Wall Street Journal Prime rate comprise a large percentage of interest sensitive assets and are the primary cause of the banking segment’s asset sensitivity. To help neutralize interest rate sensitivity, the banking segment has kept the terms of most of its borrowings under one year as shown in the following table (dollars in thousands).

 

 

 

March 31, 2014

 

 

 

3 Months or

 

> 3 Months to

 

> 1 Year to

 

> 3 Years to

 

 

 

 

 

 

 

Less

 

1 Year

 

3 Years

 

5 Years

 

> 5 Years

 

Total

 

Interest sensitive assets:

 

 

 

 

 

 

 

 

 

 

 

 

 

Loans

 

$

2,814,586

 

$

619,010

 

$

689,354

 

$

286,085

 

$

663,953

 

$

5,072,988

 

Securities

 

200,426

 

386,373

 

220,841

 

70,862

 

191,774

 

1,070,276

 

Federal funds sold and securities purchased under agreements to resell

 

27,460

 

 

 

 

 

27,460

 

Other interest sensitive assets

 

551,496

 

 

 

 

 

551,496

 

Total interest sensitive assets

 

3,593,968

 

1,005,383

 

910,195

 

356,947

 

855,727

 

6,722,220

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

Interest sensitive liabilities:

 

 

 

 

 

 

 

 

 

 

 

 

 

Interest bearing checking

 

$

2,480,977

 

$

 

$

 

$

 

$

 

$

2,480,977

 

Savings

 

298,082

 

 

 

 

 

298,082

 

Time deposits

 

627,598

 

1,074,976

 

257,901

 

140,942

 

27,788

 

2,129,205

 

Notes payable & other borrowings

 

345,380

 

494

 

1,405

 

754

 

5,352

 

353,385

 

Total interest sensitive liabilities

 

3,752,037

 

1,075,470

 

259,306

 

141,696

 

33,140

 

5,261,649

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

Interest sensitivity gap

 

$

(158,069

)

$

(70,087

)

$

650,889

 

$

215,251

 

$

822,587

 

$

1,460,571

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

Cumulative interest sensitivity gap

 

$

(158,069

)

$

(228,156

)

$

422,733

 

$

637,984

 

$

1,460,571

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

Percentage of cumulative gap to total interest sensitive assets

 

-2.35

%

-3.39

%

6.29

%

9.49

%

21.73

%

 

 

 

The positive GAP in the interest rate analysis indicates that banking segment net interest income would generally rise if rates increase. Because of inherent limitations in interest rate GAP analysis, the banking segment uses multiple interest rate risk measurement techniques. Simulation analysis is used to subject the current repricing conditions to rising and falling interest rates in increments and decrements of 1%, 2% and 3% to determine the effect on net interest income changes for the next twelve months. The banking segment also measures the effects of changes in interest rates on market value of equity by discounting projected cash flows of deposits and loans. Market value changes in the investment portfolio are estimated by discounting future cash flows and using duration analysis. Investment security prepayments are estimated using current market information. We believe the simulation analysis presents a more accurate picture than the GAP analysis. Simulation analysis recognizes that deposit products may not react to changes in interest rates as quickly or with the same magnitude as earning assets contractually tied to a market rate index. The sensitivity to changes in market rates varies across deposit products. Also, unlike GAP analysis, simulation analysis takes into account the effect of embedded options in the securities and loan portfolios as well as any off-balance-sheet derivatives.

 

The table below shows the estimated impact of increases of 1%, 2% and 3% and a decrease of 0.5% in interest rates on net interest income and on economic value of equity for the banking segment at March 31, 2014 (dollars in thousands).

 

Change in

 

Changes in

 

Changes in

 

Interest Rates

 

Net Interest Income

 

Economic Value of Equity

 

(basis points)

 

Amount

 

Percent

 

Amount

 

Percent

 

+300

 

$

4,782

 

1.91

%

$

(76,551

)

-6.35

%

+200

 

$

(4,798

)

-1.92

%

$

(64,630

)

-5.36

%

+100

 

$

(10,492

)

-4.20

%

$

(40,132

)

-3.33

%

-50

 

$

2,543

 

1.02

%

$

15,699

 

1.30

%

 

The projected changes in net interest income and market value of equity to changes in interest rates at March 31, 2014 were in compliance with established internal policy guidelines. These projected changes are based on numerous assumptions of growth and changes in the mix of assets or liabilities.

 

The historically low level of interest rates, combined with the existence of rate floors that are in effect for a significant portion of the loan portfolio, are projected to cause yields on our earning assets to rise more slowly than increases in market

 

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interest rates. As a result, in a rising interest rate environment, our interest rate margins are projected to compress until the rise in market interest rates is sufficient to allow our loan portfolio to reprice above applicable rate floors.

 

Item 4. Controls and Procedures

 

Evaluation of Disclosure Controls and Procedures

 

Our management, with the supervision and participation of our Principal Executive Officer and Principal Financial Officer, has evaluated the effectiveness of the design and operation of our disclosure controls and procedures (as defined in Rules 13a-15(e) and 15d-15(e) under the Exchange Act) as of the end of the period covered by this report.

 

Based upon that evaluation, our Principal Executive Officer and Principal Financial Officer concluded that, as of the end of such period, our disclosure controls and procedures were effective in recording, processing, summarizing and reporting, on a timely basis, information required to be disclosed by us in the reports that we file or submit under the Exchange Act and are effective in ensuring that information required to be disclosed by us in the reports that we file or submit under the Exchange Act is accumulated and communicated to the Company’s management, including our Principal Executive Officer and Principal Financial Officer, as appropriate to allow timely decisions regarding required disclosure.

 

Changes in Internal Control over Financial Reporting

 

There were no changes in our internal control over financial reporting (as defined in Rules 13a-15(f) and 15d-15(f) under the Exchange Act) during the quarter covered by this report that have materially affected, or are reasonably likely to materially affect, our internal control over financial reporting.

 

PART II. OTHER INFORMATION

 

Item 1. Legal Proceedings.

 

For a description of material pending legal proceedings, see the discussion set forth under the heading “Legal Matters” in Note 11 to our Consolidated Financial Statements, which is incorporated by reference herein.

 

Item 1A. Risk Factors.

 

The pending merger with SWS Group, Inc. is subject to closing conditions, the failure of any of which could result in our inability to consummate the transaction.

 

On March 31, 2014, we entered into an Agreement and Plan of Merger with SWS. The closing of the transaction is subject to the satisfaction of certain conditions, including the receipt of all necessary or advisable regulatory approvals and the approval of SWS’s stockholders. No assurance can be given as to when or whether these approvals will be received.

 

Furthermore, the merger agreement contains certain termination rights for Hilltop and SWS, as the case may be, applicable upon, among other events, (i) final, non-appealable denial of a required regulatory approval, (ii) the Closing having not been completed on or prior to the first anniversary of the date of the Merger Agreement, (iii) a material breach of the Merger Agreement by the other party that cannot be cured within 30 days’ notice and would cause the closing conditions not to be satisfied, (iv) if SWS stockholders fail to approve the Merger, or (v) by Hilltop if the SWS board of directors withdraws its recommendation of the Merger to the SWS stockholders or if a governmental entity imposes a materially burdensome regulatory condition. The Merger Agreement further provides that, in connection with the termination of the Merger Agreement under specified circumstances, including if the SWS board of directors withdraws its recommendation in favor of the Merger, SWS will be required to pay Hilltop a termination fee of $8,000,000.

 

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We may fail to realize all of the anticipated benefits of our pending acquisition of SWS.

 

The success of our pending acquisition of SWS will depend on, among other things, the ability to achieve certain operating results at SWS. If the financial condition or result of operations of SWS is materially different than those that we forecasted, the anticipated benefits of the acquisition may not be realized fully, or at all, or may take longer to realize than expected.

 

Hilltop and SWS have operated and, until the completion of the merger, will continue to operate, independently. The companies may have difficulty addressing possible differences in corporate cultures and management philosophies. It is also possible that clients, customers, depositors and counterparties of SWS could choose to discontinue their relationships with the company post-merger, which would adversely affect our future performance.

 

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

 

On January 17, 2014, we issued an aggregate of 2,303 shares of common stock under the Hilltop Holdings 2012 Equity Incentive Plan to certain non-employee directors as compensation for their service on our Board of Directors during the fourth quarter of 2013. The shares were issued pursuant to the exemption from registration under Section 4(2) of the Securities Act.

 

Item 6. Exhibits

 

A list of exhibits filed herewith is contained in the Exhibit Index that immediately precedes such exhibits and is incorporated by reference herein.

 

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SIGNATURES

 

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

 

 

HILLTOP HOLDINGS INC.

 

 

 

Date:  May 5, 2014

By:

/s/ Darren Parmenter

 

 

Darren Parmenter

 

 

Executive Vice President — Principal Financial Officer

(Principal Financial and Accounting Officer and duly authorized officer)

 



Table of Contents

 

EXHIBIT INDEX

 

Exhibit
Number

 

Description of Exhibit

2.1

 

Agreement and Plan of Merger by and among SWS Group, Inc., Hilltop Holdings Inc. and Peruna LLC, dated as of March 31, 2014 (filed as Exhibit 2.1 to the Registrant’s Current Report on Form 8-K filed on April 1, 2014 (File No. 001-31987) and incorporated herein by reference).

 

 

 

3.1

 

Articles of Amendment, dated March 31, 2014 (filed as Exhibit 3.1 to the Registrant’s Current Report on Form 8-K filed on April 1, 2014 (File No. 001-31987) and incorporated herein by reference).

 

 

 

10.1

 

Form of Restricted Stock Unit Award Agreement (Time-Based Vesting) (filed as Exhibit 10.1 to the Registrant’s Current Report on Form 8-K filed on February 28, 2014 (File No. 001-31987) and incorporated herein by reference).

 

 

 

10.2

 

Form of Restricted Stock Unit Award Agreement (Performance-Based Vesting) (filed as Exhibit 10.2 to the Registrant’s Current Report on Form 8-K filed on February 28, 2014 (File No. 001-31987) and incorporated herein by reference).

 

 

 

10.3

 

Compensation Arrangement with Jeremy B. Ford (filed as Exhibit 10.3 to the Registrant’s Current Report on Form 8-K filed on February 28, 2014 (File No. 001-31987) and incorporated herein by reference).

 

 

 

10.4

 

Compensation Arrangement with Darren Parmenter (filed as Exhibit 10.4 to the Registrant’s Current Report on Form 8-K filed on February 28, 2014 (File No. 001-31987) and incorporated herein by reference).

 

 

 

31.1*

 

Certification of Principal Executive Officer pursuant to Rule 13a-14(a) of the Securities Exchange Act of 1934, as amended.

 

 

 

31.2*

 

Certification of Principal Financial Officer pursuant to Rule 13a-14(a) of the Securities Exchange Act of 1934, as amended.

 

 

 

32.1*

 

Certification of Principal Executive Officer and Principal Financial Officer pursuant to 18 U.S.C. Section 1350, as adopted pursuant to Section 906 of the Sarbanes-Oxley Act of 2002.

 

 

 

101.INS

 

XBRL Instance Document

 

 

 

101.SCH

 

XBRL Taxonomy Extension Schema

 

 

 

101.CAL

 

XBRL Taxonomy Extension Calculation Linkbase

 

 

 

101.DEF

 

XBRL Taxonomy Extension Definition Linkbase

 

 

 

101.LAB

 

XBRL Taxonomy Extension Label Linkbase

 

 

 

101.PRE

 

XBRL Taxonomy Extension Presentation Linkbase

 


*Filed herewith.