Table of Contents

 

 

 

UNITED STATES

SECURITIES AND EXCHANGE COMMISSION

Washington, D.C. 20549

 

FORM 10-K

 

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

 

For the fiscal year ended: December 31, 2014

 

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

 

For the transition period from            to          

 

Commission file number: 1-31987

 

Hilltop Holdings Inc.

(Exact name of registrant as specified in its charter)

 

Maryland

 

84-1477939

(State or other jurisdiction of
incorporation or organization)

 

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

 

 

 

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)

 

Securities registered pursuant to Section 12(b) of the Act:

 

Title of each class

 

Name of each exchange on which registered

Common Stock, par value $0.01 per share

 

New York Stock Exchange

 

Securities registered pursuant to Section 12(g) of the Act: None

 

Indicate by check mark if the registrant is a well-known seasoned issuer, as defined in Rule 405 of the Securities Act. x Yes o No

 

Indicate by check mark if the registrant is not required to file reports pursuant to Section 13 or Section 15(d) of the Act. o Yes x No

 

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. x Yes o No

 

Indicate by check mark whether the registrant has submitted electronically and posted on its corporate Website, 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). x Yes o No

 

Indicate by check mark if disclosure of delinquent filers pursuant to Item 405 of Regulation S-K (§229.405 of this chapter) is not contained herein, and will not be contained, to the best of registrant’s knowledge, in definitive proxy or information statements incorporated by reference in Part III of this Form 10-K or any amendment to this Form 10-K. x

 

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

 

Large accelerated filer

x

 

Accelerated filer

£

Non-accelerated filer

o (Do not check if a smaller reporting company)

 

Smaller reporting company

£

 

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

 

Aggregate market value of the voting and non-voting common equity held by non-affiliates, computed by reference to the price at which the common stock was last sold on the New York Stock Exchange on June 30, 2014, was approximately $1.4 billion. For the purposes of this computation, all officers, directors and 10% stockholders are considered affiliates. The number of shares of the registrant’s common stock outstanding at February 26, 2015 was 100,296,330.

 

DOCUMENTS INCORPORATED BY REFERENCE

 

The Registrant’s definitive Proxy Statement pertaining to the 2015 Annual Meeting of Stockholders, filed or to be filed not later than 120 days after the end of the fiscal year pursuant to Regulation 14A, is incorporated herein by reference into Part III.

 

 

 



Table of Contents

 

TABLE OF CONTENTS

 

MARKET AND INDUSTRY DATA AND FORECASTS

 

FORWARD-LOOKING STATEMENTS

 

PART I

 

 

Item 1.

Business

5

Item 1A.

Risk Factors

33

Item 1B.

Unresolved Staff Comments

51

Item 2.

Properties

51

Item 3.

Legal Proceedings

52

Item 4.

Mine Safety Disclosures

52

PART II

 

 

Item 5.

Market for Registrant’s Common Equity, Related Stockholder Matters and Issuer Purchases of Equity Securities

53

Item 6.

Selected Financial Data

55

Item 7.

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

57

Item 7A.

Quantitative and Qualitative Disclosures About Market Risk

92

Item 8.

Financial Statements and Supplementary Data

95

Item 9.

Changes in and Disagreements With Accountants on Accounting and Financial Disclosure

95

Item 9A.

Controls and Procedures

96

Item 9B.

Other Information

96

PART III

 

 

Item 10.

Directors, Executive Officers and Corporate Governance

97

Item 11.

Executive Compensation

97

Item 12.

Security Ownership of Certain Beneficial Owners and Management and Related Stockholder Matters

97

Item 13.

Certain Relationships and Related Transactions, and Director Independence

97

Item 14.

Principal Accounting Fees and Services

97

PART IV

 

 

Item 15.

Exhibits, Financial Statement Schedules

98

 

MARKET AND INDUSTRY DATA AND FORECASTS

 

Market and industry data and other statistical information and forecasts used throughout this Annual Report on Form 10-K (this “Annual Report”) are based on independent industry publications, government publications and reports by market research firms or other published independent sources. We have not sought or obtained the approval or endorsement of the use of this third-party information. Some data also is based on our good faith estimates, which are derived from our review of internal surveys, as well as independent sources. Forecasts are particularly likely to be inaccurate, especially over long periods of time.

 

2



Table of Contents

 

Unless the context otherwise indicates, all references in this Annual Report 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 “Hilltop Securities” refer to Hilltop Securities Holdings LLC (a wholly owned subsidiary of Hilltop), references to “Southwest Securities” refer to Southwest Securities, Inc. (a wholly owned subsidiary of Hilltop Securities), references to “SWS Financial” refer to SWS Financial Services, Inc. (a wholly owned subsidiary of Hilltop Securities), 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 Hilltop Securities) and its subsidiaries as a whole, references to “FSC” refer to First Southwest Company, LLC (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 Annual 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 (the “Securities Act”), and Section 21E of the Securities Exchange Act of 1934 (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 Annual 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,” “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 recent acquisition of SWS Group, Inc. (“SWS”) and integration thereof, 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 associated with merger and acquisition integration, including the diversion of management time on acquisition-related issues and our ability to promptly and effectively integrate our businesses with those of FNB and SWS and achieve the synergies and value creation contemplated by the acquisitions;

 

·                  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;

 

·                  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;

 

3



Table of Contents

 

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

 

·                  changes in key management;

 

·                  competition in our banking, broker-dealer (formerly financial advisory), mortgage origination 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; and

 

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

 

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, see Item 1A, “Risk Factors,” and Item 7, “Management’s Discussion and Analysis of Financial Condition and Results of Operations,” herein. 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 Annual Report except to the extent required by federal securities laws.

 

4



Table of Contents

 

PART I

 

Item 1. Business.

 

General

 

Hilltop Holdings Inc., headquartered in Dallas, Texas, 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”.

 

Following the PlainsCapital Merger, our primary line of business has been to provide business and consumer banking services from offices located throughout Texas through the Bank. We also provide an array of financial products and services through our broker-dealer (formerly financial advisory), mortgage origination and insurance segments. The Company currently delivers its financial products and services through the following primary operating business units.

 

PlainsCapital.  PlainsCapital is a financial holding company, headquartered in Dallas, Texas, that provides, through its subsidiaries, traditional banking services, residential mortgage lending, wealth and investment management and treasury management primarily in Texas.

 

Hilltop Securities.  Hilltop Securities is a holding company, headquartered in Dallas, Texas, that provides, through its subsidiaries, investment banking and other related financial services, including municipal advisory, sales, trading and underwriting of taxable and tax-exempt fixed income securities, equity trading, clearing, securities lending, structured finance and retail brokerage services throughout the United States.

 

NLC.  NLC is a property and casualty insurance holding company, headquartered in Waco, Texas, 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.

 

At December 31, 2014, on a consolidated basis, we had total assets of $9.2 billion, total deposits of $6.4 billion, total loans, including loans held for sale, of $5.8 billion and stockholders’ equity of $1.5 billion. Our operating results beginning December 1, 2012 include the banking, mortgage origination and broker-dealer operations acquired in the PlainsCapital Merger. The operations acquired in the FNB Transaction (defined hereinafter) are included in the results of our banking operations beginning September 14, 2013.

 

Our common stock is listed on the New York Stock Exchange (“NYSE”) under the symbol “HTH.”

 

Our principal office is located at 200 Crescent Court, Suite 1330, Dallas, Texas 75201, and our telephone number at that location is (214) 855-2177. Our internet address is www.hilltop-holdings.com. Our Annual Reports on Form 10-K, Quarterly Reports on Form 10-Q, Current Reports on Form 8-K and amendments to those reports filed or furnished pursuant to Section 13(a) or 15(d) of the Exchange Act are available on our website at http://ir.hilltop-holdings.com/ under the tab “SEC Filings” as soon as reasonably practicable after we electronically file such reports with, or furnish them to, the Securities and Exchange Commission (the “SEC”). The references to our website in this Annual Report are inactive textual references only. The information on our website is not incorporated by reference into this Annual Report.

 

Company Background

 

In January 2007, we acquired NLC, a property and casualty insurance holding company. As a result, our subsequent primary operations through November 2012 were limited to providing fire and homeowners insurance to low value dwellings and manufactured homes primarily in Texas and other areas of the southern United States through NLC’s wholly owned subsidiaries, National Lloyds Insurance Company (“NLIC”) and American Summit Insurance Company (“ASIC”).

 

On November 30, 2012, we acquired PlainsCapital Corporation through the PlainsCapital Merger. Concurrent with the consummation of the PlainsCapital Merger, we became a financial holding company registered under the Bank Holding Company Act of 1956 (the “Bank Holding Company Act”), as amended by the Gramm-Leach-Bliley Act of 1999 (the “Gramm-Leach-Bliley Act”).

 

5



Table of Contents

 

On September 13, 2013, the Bank assumed substantially all of the liabilities, incl uding all of the deposits, and acquired substantially all of the assets, of FNB from the FDIC, as receiver, and reopened former FNB branches acquired from the FDIC under the “PlainsCapital Bank” name (the “FNB Transaction”).

 

On January 1, 2015, we completed our acquisition of SWS in a stock and cash transaction, whereby SWS merged with and into Hilltop Securities, formerly Peruna LLC, a wholly owned subsidiary of Hilltop formed for the purpose of facilitating this transaction (the “SWS Merger”). Following the SWS Merger, our broker-dealer segment operations include Southwest Securities, a clearing broker-dealer subsidiary registered with the SEC and Financial Industry Regulatory Authority (“FINRA”) and SWS Financial, an introducing broker-dealer subsidiary that is also registered with the SEC and FINRA. SWS’s banking subsidiary, Southwest Securities, FSB (“SWS FSB”), was merged into the Bank, an indirect wholly owned subsidiary of Hilltop. As a result, our results of operations will include those acquired in the SWS Merger beginning January 1, 2015.

 

We intend to make acquisitions with available cash, excess liquidity and, if necessary or appropriate, from additional equity or debt financing sources.

 

Organizational Structure

 

Our organizational structure is comprised of three primary operating business units, PlainsCapital (banking and mortgage origination), Hilltop Securities (broker-dealer) and NLC (insurance). Within the PlainsCapital unit are two primary wholly owned operating subsidiaries: the Bank and PrimeLending. The Hilltop Securities unit includes three primary wholly owned operating subsidiaries: First Southwest (transferred from the PlainsCapital unit effective January 1, 2015), Southwest Securities and SWS Financial (both acquired on January 1, 2015). The following provides additional details regarding our current organizational structure.

 

 

Geographic Dispersion of our Businesses

 

The Bank provides traditional banking services, residential mortgage lending, wealth and investment management, and treasury management. Substantially all of our banking operations are in Texas, and as a result of the FNB Transaction, the Bank has a presence in every major market in Texas. Immediately following the SWS Merger on January 1, 2015, the operations of the former SWS FSB were merged into the Bank.

 

Through December 31, 2014, our broker-dealer services were provided through FSC, a diversified investment banking firm and a registered broker-dealer, which competes for business nationwide. Public finance financial advisory revenues, of which 70% during 2014 were from entities located in Texas, represent a significant portion of total segment revenues. Effective January 1, 2015, the broker-dealer segment’s operations will include those provided by the broker-dealer subsidiaries acquired as a result of the SWS Merger. The retail brokerage service operations acquired in the SWS Merger, which represent a significant portion of the historical revenues of SWS, are concentrated in Texas, California and Oklahoma.

 

PrimeLending provides residential mortgage origination products and services from over 250 locations in 42 states. For the year ended December 31, 2014, 61.0% of PrimeLending’s origination volume was concentrated in eight states (none of the other states in which PrimeLending operated during 2014 had origination volume of 3% or more).

 

6



Table of Contents

 

The following table is a summary of the origination volume by state for the periods shown (dollars in thousands).

 

 

 

Year Ended December 31,

 

 

 

 

 

% of

 

 

 

% of

 

 

 

2014

 

Total

 

2013

 

Total

 

Texas

 

$

2,453,705

 

23.7

%

$

2,660,810

 

22.6

%

California

 

1,552,372

 

15.0

%

2,082,184

 

17.7

%

Florida

 

505,507

 

4.9

%

456,643

 

3.9

%

North Carolina

 

423,164

 

4.1

%

618,802

 

5.3

%

Ohio

 

401,379

 

3.9

%

383,518

 

3.2

%

Arizona

 

339,830

 

3.3

%

392,006

 

3.3

%

Virginia

 

322,134

 

3.1

%

466,531

 

4.0

%

South Carolina

 

307,832

 

3.0

%

318,109

 

2.7

%

All other states

 

4,057,925

 

39.0

%

4,413,959

 

37.3

%

 

 

$

10,363,848

 

100.0

%

$

11,792,562

 

100.0

%

 

Our insurance products are distributed through a broad network of independent agents and a select number of managing general agents, referred to as MGAs, which are concentrated in five states (none of the other states in which we operated during 2014 had gross written premiums of 3% or more). The following table sets forth our total gross written premiums by state for the periods shown (dollars in thousands).

 

 

 

Year Ended December 31,

 

 

 

 

 

% of

 

 

 

% of

 

 

 

% of

 

 

 

2014

 

Total

 

2013

 

Total

 

2012

 

Total

 

Texas

 

$

126,273

 

69.3

%

$

125,696

 

69.1

%

$

118,361

 

69.5

%

Arizona

 

16,775

 

9.2

%

15,904

 

8.7

%

13,914

 

8.2

%

Oklahoma

 

14,122

 

7.7

%

16,494

 

9.1

%

15,398

 

9.1

%

Tennessee

 

10,903

 

6.0

%

10,589

 

5.8

%

10,527

 

6.2

%

Georgia

 

7,031

 

3.9

%

6,393

 

3.5

%

5,454

 

3.2

%

All other states

 

7,105

 

3.9

%

6,892

 

3.8

%

6,547

 

3.8

%

Total

 

$

182,209

 

100.0

%

$

181,968

 

100.0

%

$

170,201

 

100.0

%

 

Business Segments

 

Under U.S. generally accepted accounting principles (“GAAP”), our three business units are comprised of four reportable business segments organized primarily by the core products offered to the segments’ respective customers: banking, broker-dealer, mortgage origination and insurance. The SWS Merger has not resulted in changes to our four reportable business segments. These segments reflect the manner in which operations are managed and the criteria used by our chief operating decision maker function to evaluate segment performance, develop strategy and allocate resources. Our chief operating decision maker function consists of the President and Chief Executive Officer of Hilltop and the Chief Executive Officer of PlainsCapital.

 

For more financial information about each of our business segments, see Item 7, “Management’s Discussion and Analysis of Financial Condition and Results of Operations,” herein. See also Note 30 in the notes to our consolidated financial statements included under Item 8, “Financial Statements and Supplementary Data.”

 

Banking

 

The banking segment includes the operations of the Bank and, since September 14, 2013, the banking operations acquired in the FNB Transaction. At December 31, 2014, our banking segment had $8.0 billion in assets and total deposits of $6.2 billion. The primary sources of our deposits are residents and businesses located in Texas. Immediately following the SWS Merger on January 1, 2015, SWS’s banking subsidiary, SWS FSB, was merged into the Bank. The Bank expects the integration of the back office operations of the former SWS FSB into the Bank to be substantially complete by April 2015.

 

Business Banking.  Our business banking customers primarily consist of agribusiness, energy, health care, institutions of higher education, real estate (including construction and land development) and wholesale/retail trade companies. We provide these customers with extensive banking services, such as Internet banking, business check cards and other add-on

 

7



Table of Contents

 

services as determined on a customer-by-customer basis. Our treasury management services, which are designed to reduce the time, burden and expense of collecting, transferring, disbursing and reporting cash, are also available to our business customers. We offer these business customers lines of credit, equipment loans and leases, letters of credit, agricultural loans, commercial real estate loans and other loan products.

 

The table below sets forth a distribution of the banking segment’s non-covered and covered loans, classified by portfolio segment and segregated between those considered to be purchased credit impaired (“PCI”) loans and all other originated or acquired loans at December 31, 2014 (dollars 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. The banking segment’s loan portfolio includes “covered loans” acquired in the FNB Transaction that are subject to loss-share agreements with the FDIC, while all other loans held by the Bank are referred to as “non-covered loans.” The commercial and industrial non-covered loans category includes a $1.5 billion warehouse line of credit extended to PrimeLending, of which $1.2 billion was drawn at December 31, 2014. Amounts advanced against the warehouse line are included in the table below, but are eliminated from net loans on our consolidated balance sheets.

 

 

 

 

 

 

 

 

 

% of Total

 

 

 

Loans, excluding

 

PCI

 

Total

 

Non-Covered

 

Non-covered loans

 

PCI Loans

 

Loans

 

Loans

 

Loans

 

Commercial and industrial:

 

 

 

 

 

 

 

 

 

Secured

 

$

2,450,541

 

$

13,374

 

$

2,463,915

 

52.0

%

Unsecured

 

110,350

 

68

 

110,418

 

2.3

%

Real estate:

 

 

 

 

 

 

 

 

 

Secured by commercial properties

 

1,175,838

 

22,341

 

1,198,179

 

25.3

%

Secured by residential properties

 

497,113

 

1,810

 

498,923

 

10.5

%

Construction and land development:

 

 

 

 

 

 

 

 

 

Residential construction loans

 

65,046

 

 

65,046

 

1.4

%

Commercial construction loans and land development

 

339,419

 

9,178

 

348,597

 

7.4

%

Consumer

 

51,009

 

2,138

 

53,147

 

1.1

%

Total non-covered loans

 

$

4,689,316

 

$

48,909

 

$

4,738,225

 

100.0

%

 

 

 

 

 

 

 

 

 

% of Total

 

 

 

Loans, excluding

 

PCI

 

Total

 

Covered

 

Covered loans

 

PCI Loans

 

Loans

 

Loans

 

Loans

 

Commercial and industrial:

 

 

 

 

 

 

 

 

 

Secured

 

$

9,135

 

$

13,630

 

$

22,765

 

3.5

%

Unsecured

 

1,210

 

6,805

 

8,015

 

1.2

%

Real estate:

 

 

 

 

 

 

 

 

 

Secured by commercial properties

 

42,557

 

227,772

 

270,329

 

42.1

%

Secured by residential properties

 

141,329

 

141,192

 

282,521

 

44.0

%

Construction and land development:

 

 

 

 

 

 

 

 

 

Residential construction loans

 

1,286

 

354

 

1,640

 

0.3

%

Commercial construction loans and land development

 

11,735

 

45,635

 

57,370

 

8.9

%

Consumer

 

 

 

 

0.0

%

Total covered loans

 

$

207,252

 

$

435,388

 

$

642,640

 

100.0

%

 

Our lending policies seek to achieve 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. In support of that goal, we have designed our underwriting standards to determine:

 

·                  That our borrowers possess sound ethics and competently manage their affairs;

 

·                  That we know the source of the funds the borrower will use to repay the loan;

 

·                  That the purpose of the loan makes economic sense; and

 

·                  That we identify relevant risks of the loan and determine that the risks are acceptable.

 

We implement our underwriting standards according to the facts and circumstances of each particular loan request, as discussed below.

 

Commercial and industrial loans are primarily made within Texas and are underwritten on the basis of the borrower’s ability to service the debt from cash flow from an operating business. In general, commercial and industrial loans involve more

 

8



Table of Contents

 

credit risk than residential and commercial mortgage loans and, therefore, usually yield a higher return. The increased risk in commercial and industrial loans results primarily from the type of collateral securing these loans, which typically includes commercial real estate, accounts receivable, equipment and inventory. Additionally, increased risk arises from the expectation that commercial and industrial loans generally will be serviced principally from operating cash flow of the business, and such cash flows are dependent upon successful business operations. Historical trends have shown these types of loans to have higher delinquencies than mortgage loans. As a result of the additional risk and complexity associated with commercial and industrial loans, such loans require more thorough underwriting and servicing than loans to individuals. To manage these risks, our policy is to attempt to secure commercial and industrial loans with both the assets of the borrowing business and other additional collateral and guarantees that may be available. In addition, depending on the size of the credit, we actively monitor the financial condition of the borrower by analyzing the borrower’s financial statements and assessing certain financial measures, including cash flow, collateral value and other appropriate credit factors. We also have processes in place to analyze and evaluate on a regular basis our exposure to industries, products, market changes and economic trends.

 

The Bank also offers term financing on commercial real estate properties that include retail, office, multi-family, industrial, warehouse and non-owner occupied single family residences. Commercial mortgage lending can involve high principal loan amounts, and the repayment of these loans is dependent, in large part, on a borrower’s on-going business operations or on income generated from the properties that are leased to third parties. Accordingly, we apply the measures described above for commercial and industrial loans to our commercial real estate lending, with increased emphasis on analysis of collateral values. As a general practice, the Bank requires its commercial mortgage loans to (i) be secured with first lien positions on the underlying property, (ii) generate adequate equity margins, (iii) be serviced by businesses operated by an established management team and (iv) be guaranteed by the principals of the borrower. The Bank seeks lending opportunities where cash flow from the collateral provides adequate debt service coverage and/or the guarantor’s net worth is comprised of assets other than the project being financed.

 

The Bank offers construction financing for (i) commercial, retail, office, industrial, warehouse and multi-family developments, (ii) residential developments and (iii) single family residential properties. Construction loans involve additional risks because loan funds are advanced upon the security of a project under construction, and the project is of uncertain value prior to its completion. If the Bank is forced to foreclose on a project prior to completion, it may not be able to recover the entire unpaid portion of the loan. Additionally, it may be required to fund additional amounts to complete a project and may have to hold the property for an indeterminate period of time. Because of uncertainties inherent in estimating construction costs, the market value of the completed project and the effects of governmental regulation on real property, it can be difficult to accurately evaluate the total funds required to complete a project and the related loan-to-value ratio. As a result of these uncertainties, construction lending often involves the disbursement of substantial funds with repayment dependent, in part, on the success of the ultimate project rather than the ability of a borrower or guarantor to repay the loan. We generally require that the subject property of a construction loan for commercial real estate be pre-leased, since cash flows from the completed project provide the most reliable source of repayment for the loan. Loans to finance these transactions are generally secured by first liens on the underlying real property. The Bank conducts periodic completion inspections, either directly or through an agent, prior to approval of periodic draws on these loans.

 

In addition to the real estate lending activities described above, a portion of the Bank’s real estate portfolio consists of single family residential mortgage loans typically collateralized by owner occupied properties located in its market areas. These residential mortgage loans are generally secured by a first lien on the underlying property and have maturities up to thirty years. At December 31, 2014, the Bank had $641.8 million in one-to-four family residential loans, which represented 11.9% of its total loans held for investment.

 

Personal Banking.  We offer a broad range of personal banking products and services for individuals. Similar to our business banking operations, we also provide our personal banking customers with a variety of add-on features such as check cards, safe deposit boxes, Internet banking, bill pay, overdraft privilege services, gift cards and access to automated teller machine (ATM) facilities throughout the United States. We offer a variety of deposit accounts to our personal banking customers including savings, checking, interest-bearing checking, money market and certificates of deposit.

 

We loan to individuals for personal, family and household purposes, including lines of credit, home improvement loans, home equity loans, credit cards and loans for purchasing and carrying securities. At December 31, 2014, we had $53.1 million of loans for these purposes, which are shown in the non-covered loans table above as “Consumer.”

 

Wealth and Investment Management.  Our private banking team personally assists high net worth individuals and their families with their banking needs, including depository, credit, asset management, and trust and estate services. We offer trust and asset management services in order to assist these customers in managing, and ultimately transferring, their wealth.

 

9



Table of Contents

 

Our wealth management services provide personal trust, investment management and employee benefit plan administration services, including estate planning, management and administration, investment portfolio management, employee benefit accounts and individual retirement accounts.

 

Broker-Dealer

 

Through December 31, 2014, our broker-dealer segment’s operations were comprised of First Southwest. FSC, a wholly owned subsidiary of First Southwest, is a diversified investment banking firm and a registered broker-dealer with the SEC and FINRA. First Southwest’s primary focus is on providing public finance services. At December 31, 2014, First Southwest employed approximately 400 people and maintained 25 locations nationwide, nine of which are in Texas. At December 31, 2014, First Southwest had consolidated assets of $758.6 million, maintained $123.7 million in equity capital and had more than 1,600 public sector clients.

 

Following the SWS Merger, our broker-dealer segment operations include Southwest Securities, a clearing broker-dealer subsidiary registered with the SEC and FINRA and a member of the NYSE, and SWS Financial, an introducing broker-dealer subsidiary that is also registered with the SEC and FINRA. Southwest Securities and SWS Financial are both registered with the Commodity Futures Trading Commission (“CFTC”) as non-guaranteed introducing brokers and as members of the National Futures Association (“NFA”). First Southwest, Southwest Securities and SWS Financial are continuing to operate as separate broker-dealers, under coordinated leadership, until such time as the necessary regulatory approvals are obtained and systems integrations are complete. At December 31, 2014, Southwest Securities employed approximately 700 people and maintained 35 locations nationwide, 11 of which are in Texas. At December 31, 2014, Southwest Securities had consolidated assets of $2.1 billion and net capital of approximately $170.6 million, which is approximately $164.6 million in excess of its minimum net capital requirement of approximately $6.0 million.

 

As of January 1, 2015, our broker-dealer segment has six primary lines of business: (i) public finance, (ii) capital markets, (iii) retail, (iv) structured finance, (v) clearing, and (vi) securities lending activities.

 

Public Finance.  The First Southwest public finance group, along with a similar group within Southwest Securities, assists public bodies in originating, syndicating and distributing securities of municipalities and political subdivisions. Our broker-dealer segment advises cities, counties, school districts, utility districts, tax increment zones, special districts, state agencies and other governmental entities nationwide. In addition, the group provides specialized advisory and investment banking services for airports, convention centers, healthcare institutions, institutions of higher education, housing, industrial development agencies, toll road authorities, and public power and utility providers.

 

Additionally, First Southwest Asset Management, LLC and Southwest Securities are investment advisors registered under the Investment Advisers Act of 1940 providing state and local governments with advice and assistance with respect to arbitrage rebate compliance, portfolio management and local government investment pool administration.

 

Capital Markets.  Through its capital markets group, First Southwest trades fixed income securities to support sales and other customer activities, underwrites tax-exempt and taxable fixed income securities and trades equities and option orders on an agency basis on behalf of its retail and institutional clients. In addition, First Southwest provides asset and liability management advisory services to community banks.

 

Similarly, Southwest Securities specializes in trading and underwriting U.S. government and government agency bonds, corporate bonds, municipal bonds, mortgage-backed, asset-backed and commercial mortgage-backed securities and structured products. The clients of its fixed income group include corporations, insurance companies, banks, mutual funds, money managers and other institutions. Southwest Securities’ equity trading department focuses on executing equity and option orders on an agency basis for clients. Southwest Securities’ syndicate department, housed within its fixed income sales group, coordinates the distribution of managed and co-managed corporate equity underwritings, accepts invitations to participate in competitive or negotiated underwritings managed by other investment banking firms and allocates and markets Southwest Securities selling allotments to institutional clients and to other broker-dealers.

 

Retail.  Prior to the SWS Merger, the broker-dealer segment did not have substantial retail brokerage service operations. The retail group we acquired in the SWS Merger acts as a securities broker for retail investors in the purchase and sale of securities, options, commodities and futures contracts that are traded on various exchanges or in the over-the-counter market through SWS employee registered representatives or independent contractor arrangements. As a securities broker, we extend margin credit on a secured basis to our retail customers in order to facilitate securities transactions. Through our insurance subsidiaries, we hold insurance licenses to facilitate the sale of insurance and annuity products by SWS Financial advisors to retail clients. We retain no underwriting risk related to these insurance and annuity products. In addition, through the

 

10



Table of Contents

 

Investment Management Group of Southwest Securities, the retail group provides a number of advisory programs that offer advisors a wide array of products and services for their advisory business. In most cases, we charge commissions to our clients in accordance with an established commission schedule, subject to certain discounts based upon the client’s level of business, the trade size and other relevant factors. Some registered representatives also maintain licenses to sell certain insurance products. Southwest Securities is also a fully disclosed client of two of the largest futures commission merchants in the United States. At December 31, 2014, Southwest Securities employed 144 registered representatives in 16 retail brokerage offices and SWS Financial had contracts with 259 independent retail representatives for the administration of their securities business.

 

Structured Finance.  Through its structured finance group, First Southwest provides structured asset and liability services and commodity hedging advisory services to facilitate balance sheet management primarily to its public finance clients. In addition, the structured finance group within First Southwest participates in programs in which it issues forward purchase commitments of mortgage-backed securities to certain non-profit housing clients and sells U.S. Agency to-be-announced, or TBA, mortgage-backed securities.

 

Clearing.  The First Southwest clearing group, along with a similar group within Southwest Securities, offers fully disclosed clearing services to FINRA and SEC registered member firms for trade executing, clearing and back office services such as record keeping, trade reporting, accounting, general back-office support, securities and margin lending, reorganization assistance and custody of securities. At December 31, 2014, First Southwest provided services to approximately 80 correspondent firms, including discount and full-service brokerage firms, registered investment advisors and institutional firms, while Southwest Securities provided services to approximately 140 financial service organizations, including correspondent broker-dealers and registered investment advisors.

 

Securities Lending Activities.  The securities lending groups of both First Southwest and Southwest Securities perform activities that include borrowing and lending securities for other broker-dealers, lending institutions and internal clearing and retail operations. These activities involve borrowing securities to cover short sales and to complete transactions in which clients have failed to deliver securities by the required settlement date and lending securities to other broker-dealers for similar purposes.

 

Mortgage Origination

 

Our mortgage origination segment operates through a wholly owned subsidiary of the Bank, PrimeLending. Founded in 1986, PrimeLending is a residential mortgage banker licensed to originate and close loans in all 50 states and the District of Columbia. At December 31, 2014, our mortgage origination segment operated from over 250 locations in 42 states, originating 23.7% of its mortgages from its Texas locations and 15.0% of its mortgages from locations in California. The mortgage lending business is subject to variables that can impact loan origination volume, including seasonal and interest rate fluctuations. Historically, the mortgage origination segment has 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.

 

PrimeLending handles loan processing, underwriting and closings in-house. Mortgage loans originated by PrimeLending are funded through a warehouse line of credit maintained with the Bank. PrimeLending sells substantially all mortgage loans it originates to various investors in the secondary market, the majority servicing released. PrimeLending’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. PrimeLending may, from time to time, manage its mortgage servicing rights (“MSR”) asset through different strategies, including varying the percentage of mortgage loans sold servicing released and opportunistically selling MSR assets. As mortgage loans are sold in the secondary market, PrimeLending pays down its warehouse line of credit with the Bank. Loans sold are subject to certain standard indemnification provisions with investors, including the repurchase of loans sold and the repayment of sales proceeds to investors under certain conditions.

 

Our mortgage lending underwriting strategy, driven in large measure by secondary market investor standards, seeks primarily to originate conforming loans. Our underwriting practices include:

 

·                  granting loans on a sound and collectible basis;

 

·                  obtaining a balance between maximum yield and minimum risk;

 

11



Table of Contents

 

·                  ensuring that primary and secondary sources of repayment are adequate in relation to the amount of the loan; and

 

·                  ensuring that each loan is properly documented and, if appropriate, adequately insured.

 

Since its inception, PrimeLending has grown from a staff of 20 individuals producing approximately $80 million in annual closed mortgage loan volume to a staff of approximately 2,500 producing $10.4 billion in 2014, of which 80% related to home purchases volume. PrimeLending offers a variety of loan products catering to the specific needs of borrowers seeking purchase or refinancing options, including 30-year and 15-year fixed rate conventional mortgages, adjustable rate mortgages, jumbo loans, and Federal Housing Administration (“FHA”) and Veteran Affairs (“VA”) loans. Mortgage loans originated by PrimeLending are secured by a first lien on the underlying property. PrimeLending does not currently originate subprime loans (which it defines to be loans to borrowers having a Fair Isaac Corporation (FICO) score lower than 620 on conventional mortgages and VA loans or 600 on FHA loans or loans that do not comply with applicable agency or investor-specific underwriting guidelines).

 

Insurance

 

The operations of NLC comprise our insurance segment. NLC specializes in providing fire and limited homeowners insurance for low value dwellings and manufactured homes primarily in Texas and other areas of the south, southeastern and southwestern United States. NLC’s product lines also include enhanced homeowners products offering higher coverage limits with distribution restricted to select agents. NLC targets underserved markets through a broad network of independent agents currently operating in 23 states and a select number of MGAs, which require underwriting expertise that many larger carriers have been unwilling to develop given the relatively small volume of premiums produced by local agents.

 

Ratings.  Many insurance buyers, agents and brokers use the ratings assigned by A.M. Best and other rating agencies to assist them in assessing the financial strength and overall quality of the companies from which they purchase insurance. The financial strength ratings for NLIC and ASIC of “A” (Excellent) were affirmed by A.M. Best in April 2014. An “A” rating is the third highest of 16 rating categories used by A.M. Best. In evaluating a company’s financial and operating performance, A.M. Best reviews a company’s profitability, leverage and liquidity, as well as its book of business, the adequacy and soundness of its reinsurance, the quality and estimated market value of its assets, the adequacy of its liabilities for losses and loss adjustment expenses (“LAE”), the adequacy of its surplus, its capital structure, the experience and competence of its management and its market presence. This rating assignment is subject to the ability to meet A.M. Best’s expectations as to performance and capitalization on an ongoing basis, and is subject to revocation or revision at any time at the sole discretion of A.M. Best. NLC cannot ensure that NLIC and ASIC will maintain their present ratings.

 

Product Lines.  NLC’s business is conducted in two product lines: personal lines and commercial lines. The personal lines include homeowners, dwelling fire, manufactured home, flood and vacant policies. The commercial lines include commercial multi-peril, builders risk, builders risk renovation, sports liability and inland marine policies.

 

The NLC companies specialize in writing fire and homeowners insurance coverage for low value dwellings and manufactured homes. The vast majority of NLC’s property coverage is written on policies that provide actual cash value payments, as opposed to replacement cost. Under actual cash value policies, the insured is entitled to receive only the cost of replacing or repairing damaged or destroyed property with comparable new property, less depreciation. Replacement cost coverage does not include such a deduction for depreciation; however it does include limited water coverage. These products have been marketed and sold primarily in Texas. Rate increases and exposure management since 2013 have reduced the proportionate premium provided by these products.

 

Underwriting and Pricing.  NLC applies its regional expertise, underwriting discipline and a risk-adjusted, return-on-equity-based approach to capital allocation to primarily offer short-tail insurance products in its target markets. NLC’s underwriting process involves securing an adequate level of underwriting information from its independent agents, identifying and evaluating risk exposures and then pricing the risks it chooses to accept. Management reviews pricing on an ongoing basis to monitor any emerging issues on a specific coverage or geographic territory.

 

Catastrophe Exposure.  NLC maintains a comprehensive risk management strategy, which includes actively monitoring its catastrophe prone territories by zip code to ensure a diversified book of risks. NLC utilizes software and risk support from its reinsurance brokers to analyze its portfolio and catastrophe exposure. Biannually, NLC has its entire portfolio analyzed by its reinsurance broker who utilizes hurricane and severe storm models to predict risk.

 

Reinsurance.  NLC purchases reinsurance to reduce its exposure to liability on individual risks and claims and to protect against catastrophe losses. NLC’s management believes that less volatile, yet reasonable returns are in the long-term interest of NLC.

 

12



Table of Contents

 

Reinsurance involves an insurance company transferring, or ceding, a portion of its risk to another insurer, the reinsurer.  The reinsurer assumes the exposure in return for a portion of the premium. The ceding of risk to a reinsurer does not legally discharge the primary insurer from its liability for the full amount of the policies on which it obtains reinsurance.  Accordingly, the primary insurer remains liable for the entire loss if the reinsurer fails to meet its obligations under the reinsurance agreement, and as a result, the primary insurer is exposed to the risk of non-payment by its reinsurers. In formulating its reinsurance programs, NLC believes that it is selective in its choice of reinsurers and considers numerous factors, the most important of which are the financial stability of the reinsurer, its history of responding to claims and its overall reputation.

 

NLC purchases catastrophe excess of loss reinsurance to a limit that exceeds the Hurricane 200-year return time as modeled by RMS Risk Link v.13.1 and exceeds the Hurricane 500-year return time as modeled by AIR Touchstone v.2. Additionally, NLC purchased an underlying excess of loss contract that provides $10 million aggregate coverage for sub-catastrophic events. As of January 1, 2015, NLC retains a 9% participation in this coverage, down from 34% participation during 2014.

 

Competition

 

We face significant competition with respect to the business segments in which we operate and the geographic markets we serve. Many of our competitors have substantially greater financial resources, lending limits and larger branch networks than we do, and offer a broader range of products and services.

 

Our banking segment primarily competes with national, regional and community banks within the various markets where the Bank operates. The Bank also faces competition from many other types of financial institutions, including savings and loan associations, credit unions, finance companies, pension trusts, mutual funds, insurance companies, brokerage and investment banking firms, asset-based non-bank lenders, government agencies and certain other non-financial institutions. The ability to attract and retain skilled lending professionals is critical to our banking business. Competition for deposits and in providing lending products and services to consumers and businesses in our market area is intense and pricing is important. Other factors encountered in competing for savings deposits are convenient office locations, interest rates and fee structures of products offered. Direct competition for savings deposits also comes from other commercial bank and thrift institutions, money market mutual funds and corporate and government securities that may offer more attractive rates than insured depository institutions are willing to pay. Competition for loans includes such additional factors as interest rates, loan origination fees and the range of services offered by the provider. We seek to distinguish ourselves from our competitors through our commitment to personalized customer service and responsiveness to customer needs while providing a range of competitive loan and deposit products and other services.

 

Within our broker-dealer segment we face significant competition based on a number of factors, including price, perceived expertise, quality of advice, reputation, range of services and products, technology, innovation and local presence. Competition for successful securities traders, stock loan professionals and investment bankers among securities firms and other competitors is intense. Our broker-dealer business competes directly with numerous other financial advisory and investment banking firms, broker-dealers and banks, including large national and major regional firms and smaller niche companies, some of whom are not broker-dealers and, therefore, are not subject to the broker-dealer regulatory framework. Further, our broker-dealer segment competes with discount brokerage firms that do not offer equivalent services but offer discounted prices.

 

Our competitors in the mortgage origination business include large financial institutions as well as independent mortgage banking companies, commercial banks, savings banks and savings and loan associations. Our mortgage origination segment competes on a number of factors including customer service, quality and range of products and services offered, price, reputation, interest rates and loan origination fees. The ability to attract and retain skilled mortgage origination professionals is critical to our mortgage origination business. We seek to distinguish ourselves from our competitors through our commitment to personalized customer service and responsiveness to customer needs while providing a range of competitive mortgage loan products and services.

 

Our insurance business competes with a large number of other companies in its selected lines of business, including major U.S. and non-U.S. insurers, regional companies, mutual companies, specialty insurance companies, underwriting agencies and diversified financial services companies. The personal lines market in Texas is dominated by a few large carriers and their subsidiaries and affiliates. We seek to distinguish ourselves from our competitors by targeting underserved market segments that provide us with the best opportunity to obtain favorable policy terms, conditions and pricing.

 

13



Table of Contents

 

Employees

 

At December 31, 2014, we employed approximately 4,400 people, substantially all of which are full-time. None of our employees are represented by any collective bargaining unit or a party to any collective bargaining agreement. After giving effect to the SWS Merger on January 1, 2015, we employed approximately 5,300 people.

 

Government Supervision and Regulation

 

General

 

We are subject to extensive regulation under federal and state laws. The regulatory framework is intended primarily for the protection of customers and clients, and not for the protection of our stockholders or creditors. In many cases, the applicable regulatory authorities have broad enforcement power over bank holding companies, banks and their subsidiaries, including the power to impose substantial fines and other penalties for violations of laws and regulations. The following discussion describes the material elements of the regulatory framework that applies to us and our subsidiaries. References in this Annual Report to applicable statutes and regulations are brief summaries thereof, do not purport to be complete, and are qualified in their entirety by reference to such statutes and regulations.

 

Recent Regulatory Developments. New regulations and statutes are regularly proposed and/or adopted that contain wide-ranging proposals for altering the structures, regulations and competitive relationships of financial institutions operating and doing business in the United States. Certain of these recent proposals and changes are described below.

 

On July 21, 2010, President Obama signed into law the Dodd-Frank Act. The Dodd-Frank Act aims to restore responsibility and accountability to the financial system by significantly altering the regulation of financial institutions and the financial services industry. Most of the provisions contained in the Dodd-Frank Act have delayed effective dates. Full implementation of the Dodd-Frank Act will require many new rules to be issued by federal regulatory agencies over the next several years, which will profoundly affect how financial institutions will be regulated in the future. The ultimate effect of the Dodd-Frank Act and its implementing regulations on the financial services industry in general, and on us in particular, is uncertain at this time.

 

The Dodd-Frank Act, among other things:

 

·                  Established the Consumer Financial Protection Bureau (the “CFPB”), an independent organization within the Federal Reserve which has the authority to promulgate consumer protection regulations applicable to all entities offering consumer financial products or services, including banks and mortgage originators. The CFPB has broad rule-making authority for a wide range of consumer protection laws, including the authority to prohibit “unfair, deceptive or abusive” acts and practices. The CFPB has exclusive examination authority and primary enforcement authority with respect to financial institutions with total assets of more than $10.0 billion and their affiliates for purposes of federal consumer protection laws. After June 30, 2011, a financial institution becomes subject to the CFPB’s exclusive examination authority and primary enforcement authority after it has reported total assets of greater than $10.0 billion in its quarterly call reports for four consecutive quarters.

 

·                  Established the Financial Stability Oversight Council, tasked with the authority to identify and monitor institutions and systems which pose a systemic risk to the financial system, and to impose standards regarding capital, leverage, liquidity, risk management, and other requirements for financial firms.

 

·                  Changed the base for FDIC insurance assessments.

 

·                  Increased the minimum reserve ratio for the Deposit Insurance Fund from 1.15% to 1.35% (the FDIC subsequently increased it by regulation to 2.00%).

 

·                  Permanently increased the deposit insurance coverage amount from $100,000 to $250,000.

 

·                  Directed the Federal Reserve to establish interchange fees for debit cards pursuant to a restrictive “reasonable and proportional cost” per transaction standard.

 

·                  Limits the ability of banking organizations to sponsor or invest in private equity and hedge funds and to engage in proprietary trading in a provision known as the “Volcker Rule”.

 

·                  Grants the U.S. government authority to liquidate or take emergency measures with respect to troubled nonbank financial companies that fall outside the existing resolution authority of the FDIC, including the establishment of an orderly liquidation fund.

 

14



Table of Contents

 

·                  Increases regulation of asset-backed securities, including a requirement that issuers of asset-backed securities retain at least 5% of the risk of the asset-backed securities.

 

·                  Increases regulation of consumer protections regarding mortgage originations, including banker compensation, minimum repayment standards, and prepayment consideration.

 

·                  Establishes new disclosure and other requirements relating to executive compensation and corporate governance.

 

On June 21, 2010, the Federal Reserve Board, the Office of the Comptroller of the Currency, the Office of Thrift Supervision and the FDIC jointly issued comprehensive final guidance on incentive compensation policies (the “Incentive Compensation Guidance”) intended to ensure that the incentive compensation policies of banking organizations do not undermine the safety and soundness of such organizations by encouraging excessive risk-taking. The Incentive Compensation Guidance sets expectations for banking organizations concerning their incentive compensation arrangements and related risk-management, control and governance processes. The Incentive Compensation Guidance, which covers all employees that have the ability to materially affect the risk profile of an organization, either individually or as part of a group, is based upon three primary principles: (i) balanced risk-taking incentives, (ii) compatibility with effective controls and risk management, and (iii) strong corporate governance. Any deficiencies in compensation practices that are identified may be incorporated into the organization’s supervisory ratings, which can affect its ability to make acquisitions or perform other actions. In addition, under the Incentive Compensation Guidance, a banking organization’s federal supervisor may initiate enforcement action if the organization’s incentive compensation arrangements pose a risk to the safety and soundness of the organization.

 

On April 14, 2011, the Federal Reserve Board and various other federal agencies published a notice of proposed rulemaking implementing provisions of the Dodd-Frank Act that would require reporting of incentive-based compensation arrangements by a covered financial institution and prohibit incentive-based compensation arrangements at a covered financial institution that provide excessive compensation or that could expose the institution to inappropriate risks that could lead to material financial loss. The Dodd-Frank Act defines “covered financial institution” to include, among other entities, a depository institution or depository institution holding company that has $1 billion or more in assets. There are enhanced requirements for institutions with more than $50 billion in assets. The proposed rule states that it is consistent with the Incentive Compensation Guidance.

 

On January 10, 2013, the CFPB issued a final rule to implement the “qualified mortgage”, or “QM” provisions of the Dodd-Frank Act requiring mortgage lenders to consider consumers’ ability to repay home loans before extending them credit. The final rule describes certain minimum requirements for creditors making ability-to-repay determinations, but does not dictate that they follow particular underwriting models. Lenders will be presumed to have complied with the ability-to-repay rule if they issue “qualified mortgages”, which are generally defined as mortgage loans prohibiting or limiting certain risky features. Loans that do not meet the ability-to-repay standard can be challenged in court by borrowers who default and the absence of ability-to-repay status can be used against a creditor in foreclosure proceedings. The CFPB’s QM rule took effect on January 10, 2014.

 

We cannot predict whether or in what form any proposed regulation or statute will be adopted or the extent to which our business may be affected by any new regulation or statute.

 

Corporate

 

Hilltop is a legal entity separate and distinct from PlainsCapital and its other subsidiaries. On November 30, 2012, concurrent with the consummation of the PlainsCapital Merger, Hilltop became a financial holding company registered under the Bank Holding Company Act, as amended by the Gramm-Leach-Bliley Act. Accordingly, it is subject to supervision, regulation and examination by the Federal Reserve Board. The Dodd-Frank Act, Gramm-Leach-Bliley Act, the Bank Holding Company Act and other federal laws subject financial and bank holding companies to particular restrictions on the types of activities in which they may engage and to a range of supervisory requirements and activities, including regulatory enforcement actions for violations of laws and regulations.

 

Changes of Control.  Federal and state laws impose additional notice, approval and ongoing regulatory requirements on any investor that seeks to acquire direct or indirect “control” of a regulated holding company, such as Hilltop. These laws include the Bank Holding Company Act, the Change in Bank Control Act and the Texas Insurance Code. Among other things, these laws require regulatory filings by an investor that seeks to acquire direct or indirect “control” of a regulated holding company. The determination whether an investor “controls” a regulated holding company is based on all of the facts and circumstances surrounding the investment. As a general matter, an investor is deemed to control a depository institution or other company if the investor owns or controls 25% or more of any class of voting stock. Subject to rebuttal, an investor

 

15



Table of Contents

 

may be presumed to control the regulated holding company if the investor owns or controls 10% or more of any class of voting stock. Accordingly, these laws would apply to a person acquiring 10% or more of Hilltop’s common stock.  Furthermore, these laws may discourage potential acquisition proposals and may delay, deter or prevent change of control transactions, including those that some or all of our stockholders might consider to be desirable.

 

Regulatory Restrictions on Dividends; Source of Strength. It is the policy of the Federal Reserve Board that bank holding companies should pay cash dividends on common stock only out of income available over the past year and only if prospective earnings retention is consistent with the organization’s expected future needs and financial condition. The policy provides that bank holding companies should not maintain a level of cash dividends that undermines the bank holding company’s ability to serve as a source of strength to its banking subsidiaries. The Dodd-Frank Act requires the regulatory agencies to issue regulations requiring that all bank and savings and loan holding companies serve as a source of financial and managerial strength to their subsidiary depository institutions by providing capital, liquidity and other support in times of financial stress; however, no such proposals have yet been published.

 

Under Federal Reserve Board policy, a bank holding company is expected to act as a source of financial strength to each of its banking subsidiaries and commit resources to their support. Such support may be required at times when, absent this Federal Reserve Board policy, a holding company may not be inclined to provide it. As discussed herein, a bank holding company, in certain circumstances, could be required to guarantee the capital plan of an undercapitalized banking subsidiary.

 

Scope of Permissible Activities. Under the Bank Holding Company Act, Hilltop and PlainsCapital generally may not acquire a direct or indirect interest in, or control of more than 5% of, the voting shares of any company that is not a bank or bank holding company. Additionally, the Bank Holding Company Act may prohibit Hilltop from engaging in activities other than those of banking, managing or controlling banks or furnishing services to, or performing services for, its subsidiaries, except that it may engage in, directly or indirectly, certain activities that the Federal Reserve Board has determined to be closely related to banking or managing and controlling banks as to be a proper incident thereto. In approving acquisitions or the addition of activities, the Federal Reserve Board considers, among other things, whether the acquisition or the additional activities can reasonably be expected to produce benefits to the public, such as greater convenience, increased competition, or gains in efficiency, that outweigh such possible adverse effects as undue concentration of resources, decreased or unfair competition, conflicts of interest or unsound banking practices.

 

Notwithstanding the foregoing, the Gramm-Leach-Bliley Act, effective March 11, 2000, eliminated the barriers to affiliations among banks, securities firms, insurance companies and other financial service providers and permits bank holding companies to become financial holding companies and thereby affiliate with securities firms and insurance companies and engage in other activities that are financial in nature. The Gramm-Leach-Bliley Act defines “financial in nature” to include: securities underwriting; dealing and market making; sponsoring mutual funds and investment companies; insurance underwriting and agency; merchant banking activities; and activities that the Federal Reserve Board has determined to be closely related to banking. Prior to enactment of the Dodd-Frank Act, regulatory approval was not required for a financial holding company to acquire a company, other than a bank or savings association, engaged in activities that were financial in nature or incidental to activities that were financial in nature, as determined by the Federal Reserve Board.

 

Under the Gramm-Leach-Bliley Act, a bank holding company may become a financial holding company by filing a declaration with the Federal Reserve Board if each of its subsidiary banks is “well capitalized” under the Federal Deposit Insurance Corporation Improvement Act prompt corrective action provisions, is “well managed”, and has at least a “satisfactory” rating under the Community Reinvestment Act of 1977 (the “CRA”). The Dodd-Frank Act underscores the criteria for becoming a financial holding company by amending the Bank Holding Company Act to require that bank holding companies be “well capitalized” and “well managed” in order to become financial holding companies. Hilltop became a financial holding company on December 1, 2012.

 

Safe and Sound Banking Practices. Bank holding companies are not permitted to engage in unsafe and unsound banking practices. The Federal Reserve Board’s Regulation Y, for example, generally requires a holding company to give the Federal Reserve Board prior notice of any redemption or repurchase of its equity securities, if the consideration to be paid, together with the consideration paid for any repurchases or redemptions in the preceding year, is equal to 10% or more of the company’s consolidated net worth. In addition, bank holding companies are required to consult with the Federal Reserve Board prior to making any redemption or repurchase, even within the foregoing parameters. The Federal Reserve Board may oppose the transaction if it believes that the transaction would constitute an unsafe or unsound practice or would violate any law or regulation. Depending upon the circumstances, the Federal Reserve Board could take the position that paying a dividend would constitute an unsafe or unsound banking practice.

 

16



Table of Contents

 

The Federal Reserve Board has broad authority to prohibit activities of bank holding companies and their nonbanking subsidiaries that represent unsafe and unsound banking practices or that constitute violations of laws or regulations, and can assess civil money penalties for certain activities conducted on a knowing and reckless basis, if those activities caused a substantial loss to a depository institution. The penalties can be as high as $1.425 million for each day the activity continues. In addition, the Dodd-Frank Act authorizes the Federal Reserve Board to require reports from and examine bank holding companies and their subsidiaries, and to regulate functionally regulated subsidiaries of bank holding companies.

 

Anti-tying Restrictions. Subject to various exceptions, bank holding companies and their affiliates are generally prohibited from tying the provision of certain services, such as extensions of credit, to certain other services offered by a bank holding company or its affiliates.

 

Capital Adequacy Requirements. The Federal Reserve Board has adopted a system using risk-based capital guidelines to evaluate the capital adequacy of bank holding companies. Under the guidelines in effect as of December 31, 2014, a risk weight factor of 0% to 100% is assigned to each category of assets based generally on the perceived credit risk of the asset class. The risk weights are then multiplied by the corresponding asset balances to determine a “risk-weighted” asset base. At least half of the risk-based capital must consist of core (Tier 1) capital, which is comprised of:

 

·                  common stockholders’ equity (includes common stock and any related surplus, undivided profits, disclosed capital reserves that represent a segregation of undivided profits and foreign currency translation adjustments, excluding changes in other comprehensive income (loss));

 

·                  certain noncumulative perpetual preferred stock and related surplus; and

 

·                  minority interests in the equity capital accounts of consolidated subsidiaries (excludes goodwill and various intangible assets).

 

The remainder, supplementary (Tier 2) capital, may consist of:

 

·                  allowance for loan losses, up to a maximum of 1.25% of risk-weighted assets;

 

·                  certain perpetual preferred stock and related surplus;

 

·                  hybrid capital instruments;

 

·                  perpetual debt;

 

·                  mandatory convertible debt securities;

 

·                  term subordinated debt;

 

·                  intermediate term preferred stock; and

 

·                  certain unrealized holding gains on equity securities.

 

Total capital is the sum of Tier 1 and Tier 2 capital. The guidelines require a minimum ratio of total capital to total risk-weighted assets of 8.0% (of which at least 4.0% is required to consist of Tier 1 capital elements). At December 31, 2014, our ratio of Tier 1 capital to total risk-weighted assets was 19.02% and our ratio of total capital to total risk-weighted assets was 19.69%.

 

In addition to the risk-based capital guidelines, the Federal Reserve Board uses a leverage ratio as an additional tool to evaluate the capital adequacy of bank holding companies. The leverage ratio is a company’s Tier 1 capital divided by its average total consolidated assets. We are required to maintain a leverage ratio of 4.0%, and, at December 31, 2014, our leverage ratio was 14.17%.

 

The federal banking agencies’ risk-based and leverage ratios are minimum supervisory ratios generally applicable to banking organizations that meet certain specified criteria, assuming that they have the highest regulatory rating. Banking organizations not meeting these criteria are expected to operate with capital positions well above the minimum ratios. The federal bank regulatory agencies may set capital requirements for a particular banking organization that are higher than the minimum ratios when circumstances warrant. Federal Reserve Board guidelines also provide that banking organizations experiencing internal growth or making acquisitions will be expected to maintain strong capital positions substantially above the minimum supervisory levels, without significant reliance on intangible assets.

 

17



Table of Contents

 

The Dodd-Frank Act directs federal banking agencies to establish minimum leverage capital requirements and minimum risk-based capital requirements for insured depository institutions, depository institution holding companies, and nonbank financial companies supervised by the Federal Reserve Board. These minimum capital requirements may not be less than the “generally applicable leverage and risk-based capital requirements” applicable to insured depository institutions, in effect applying the same leverage and risk-based capital requirements that apply to insured depository institutions to most bank holding companies. The Dodd-Frank Act, for the first time, embeds in the law a leverage capital requirement as opposed to leaving it to the regulators to use a risk-based capital requirement. However, it is left to the discretion of the agencies to set the leverage ratio requirement through the rulemaking process.

 

BASEL III.  In December 2010, the Basel Committee on Banking Supervision (the “Basel Committee”) released revised final frameworks for the regulation of capital and liquidity of internationally active banking organizations. These frameworks are generally referred to as “Basel III.” On July 2, 2013, the Federal Reserve, the FDIC, and the Office of the Comptroller of the Currency released three final rules that substantially amend the regulatory risk-based capital rules applicable to the Company and the Bank. These final rules implement the Basel III regulatory capital reforms and changes required by the Dodd-Frank Act. Hilltop, PlainsCapital and the Bank began transitioning to the final rules on January 1, 2015 when the minimum capital requirements, as set forth in the table below, became effective. However, the capital conservation buffer and certain deductions from common equity Tier 1 capital phase in over a time period from 2015 through 2019.

 

The following table summarizes the Basel III transition schedule for the ratios and capital definitions beginning January 1, 2015.

 

Year (as of January 1)

 

2015

 

2016

 

2017

 

2018

 

2019

 

Minimum common equity Tier 1 capital ratio

 

4.5

%

4.5

%

4.5

%

4.5

%

4.5

%

Common equity Tier 1 capital conservation buffer

 

N/A

 

0.625

%

1.25

%

1.875

%

2.5

%

Minimum common equity Tier 1 capital ratio plus capital conservation buffer

 

4.5

%

5.125

%

5.75

%

6.375

%

7.0

%

Phase-in of most deductions from common equity Tier 1 (including 10 percent & 15 percent common equity Tier 1 threshold deduction items that are over the limits)(1)

 

40.0

%

60.0

%

80.0

%

100.0

%

100.0

%

Minimum Tier 1 capital ratio

 

6.0

%

6.0

%

6.0

%

6.0

%

6.0

%

Minimum Tier 1 capital ratio plus capital conservation buffer

 

N/A

 

6.625

%

7.25

%

7.875

%

8.5

%

Minimum total capital ratio

 

8.0

%

8.0

%

8.0

%

8.0

%

8.0

%

Minimum total capital ratio plus conservation buffer

 

N/A

 

8.625

%

9.25

%

9.875

%

10.5

%

 


*            N/A means not applicable.

 

(1)             Deductions from common equity Tier 1 capital include goodwill and other intangibles, deferred tax assets that arise from net operating loss and tax credit carryforwards (above certain levels), gains-on-sale in connection with a securitization, any defined benefit pension fund net asset (for banking organizations that are not insured depository institutions), investments in a banking organization’s own capital instruments, mortgage servicing assets (above certain levels) and investments in the capital of unconsolidated financial institutions (above certain levels).

 

The final Basel III rules take important steps toward improving the quality and increasing the quantity of capital for all banking organizations as well as setting higher standards for large, internationally active banking organizations. The regulatory agencies believe that the new rules will result in capital requirements that better reflect banking organizations’ risk profiles, thereby improving the overall resilience of the banking system. The regulatory agencies carefully considered the potential impacts on all banking organizations, including community and regional banking organizations such as Hilltop and the Bank, and sought to minimize the potential burden of these changes where consistent with applicable law and the agencies’ goals of establishing a robust and comprehensive capital framework.

 

The final Basel III rules treatment of one- to four-family residential mortgage exposures remains the same as under current general risk-based capital rules. This includes a 50 percent risk weight for prudently underwritten first lien mortgage loans that are not past due, reported as nonaccrual, or restructured, and a 100 percent risk weight for all other residential mortgages. Also in the new rules, non-advanced approaches banking organizations, such as Hilltop and the Bank, are given a one-time option to filter certain Accumulated Other Comprehensive Income (“AOCI”) components, comparable to the

 

18



Table of Contents

 

treatment under the current general risk-based capital rule. The AOCI opt-out election must be made on the institution’s first regulatory filing after January 1, 2015.

 

The final Basel III rules also make certain major changes from the current general risk-based capital rules, including, but not limited to the following:

 

·                  Implementing higher minimum capital requirements, including a new common equity Tier 1 capital requirement, and establishes criteria that instruments must meet in order to be considered common equity Tier 1 capital, additional Tier 1 capital or Tier 2 capital. The new minimum capital to risk-weighted assets requirements are a common equity Tier 1 capital ratio of 4.5 percent and a Tier 1 capital ratio of 6.0 percent (an increase from 4.0 percent), and a total capital ratio that remains at 8.0 percent.  The minimum leverage ratio (Tier 1 capital to total assets) is 4.0 percent. The new rules maintain the general structure of the current prompt corrective action framework (described below) while incorporating these increased minimum requirements starting January 1, 2015.

 

·                  Changing the definition of capital by incorporating stricter eligibility criteria for regulatory capital instruments that disallow the inclusion of instruments such as newly issued and, in certain circumstances, existing trust preferred securities in Tier 1 capital going forward, and new constraints on the inclusion of minority interests, mortgage-servicing rights, deferred tax assets, and other certain investments in the capital of unconsolidated financial institutions. In addition, the new rules require that most regulatory capital deductions be made from common equity Tier 1 capital.

 

·                  The Dodd-Frank Act prohibits references to, and reliance on, external credit ratings in the banking regulations and directs the agencies to use alternative standards of creditworthiness. The new rules replace the ratings-based approach with a simplified supervisory formula approach in order to determine the appropriate risk-weights of securitization exposures. Alternatively, banking organizations may use the existing gross-up approach to assign securitization exposures to a risk weight category or choose to assign such exposures a 1,250 percent risk weight.

 

·                  Mortgage servicing assets and deferred tax assets are subject to stricter individual and aggregate limitations as a percentage of common equity Tier 1 capital than those applicable under the current general risk-based capital rules.

 

·                  Increasing the risk-weights for past-due loans, certain commercial real estate loans, and some equity exposures, and makes selected other changes in risk-weights and credit conversion factors.

 

·                  In order to avoid limitations on capital distributions, including dividend payments, stock repurchases and certain discretionary bonus payments to executive officers, a banking organization must hold a capital conservation buffer composed of common equity Tier 1 capital above its minimum risk-based capital requirements. This buffer will help to ensure that banking organizations conserve capital when it is most needed, allowing them to better weather periods of economic stress. The buffer is measured relative to risk-weighted assets. Phase-in of the capital conservation buffer requirements will begin on January 1, 2016.

 

The following table summarizes how much a banking organization can pay out in the form of distributions or discretionary bonus payments in a quarter based on its capital conservation buffer. A banking organization with a buffer greater than 2.5 percent would not be subject to limits on capital distributions or discretionary bonus payments; however, a banking organization with a buffer of less than 2.5 percent would be subject to increasingly stringent limitations as the buffer approaches zero.

 

Capital Conservation Buffer

 

Maximum Payout

(as a percentage of risk-weighted assets)

 

(as a percentage of eligible retained income)

Greater than 2.5 percent

 

No payout limitation applies

Less than or equal to 2.5 percent and greater than 1.875 percent

 

60 percent

Less than or equal to 1.875 percent and greater than 1.25 percent

 

40 percent

Less than or equal to 1.25 percent and greater than 0.625 percent

 

20 percent

Less than or equal to 0.625 percent

 

0 percent

 

19



Table of Contents

 

The new rules also prohibit a banking organization from making distributions or discretionary bonus payments during any quarter if its eligible retained income is negative in that quarter and its capital conservation buffer ratio was less than 2.5 percent at the beginning of the quarter. The eligible retained income of a banking organization is defined as its net income for the four calendar quarters preceding the current calendar quarter, based on the organization’s quarterly regulatory reports, net of any distributions and associated tax effects not already reflected in net income. When the new rules are fully phased-in in 2019, the minimum capital requirements plus the capital conservation buffer will exceed the prompt corrective action well-capitalized thresholds.

 

Imposition of Liability for Undercapitalized Subsidiaries. Bank regulators are required to take “prompt corrective action” to resolve problems associated with insured depository institutions whose capital declines below certain levels. In the event an institution becomes “undercapitalized,” it must submit a capital restoration plan. The capital restoration plan will not be accepted by the regulators unless each company having control of the undercapitalized institution guarantees the subsidiary’s compliance with the capital restoration plan up to a certain specified amount. Any such guarantee from a depository institution’s holding company is entitled to a priority of payment in bankruptcy.

 

The aggregate liability of the holding company of an undercapitalized bank is limited to the lesser of 5% of the institution’s assets at the time it became undercapitalized or the amount necessary to cause the institution to be “adequately capitalized.” The bank regulators have greater power in situations where an institution becomes “significantly” or “critically” undercapitalized or fails to submit a capital restoration plan. For example, a bank holding company controlling such an institution can be required to obtain prior Federal Reserve Board approval of proposed dividends, or might be required to consent to a consolidation or to divest the troubled institution or other affiliates.

 

Acquisitions by Bank Holding Companies. The Bank Holding Company Act requires every bank holding company to obtain the prior approval of the Federal Reserve Board before it may acquire all or substantially all of the assets of any bank, or ownership or control of any voting shares of any bank, if after such acquisition it would own or control, directly or indirectly, more than 5% of the voting shares of such bank. In approving bank acquisitions by bank holding companies, the Federal Reserve Board is required to consider, among other things, the financial and managerial resources and future prospects of the bank holding company and the banks concerned, the convenience and needs of the communities to be served, and various competitive factors. In addition, the Dodd-Frank Act requires the Federal Reserve Board to consider “the risk to the stability of the U.S. banking or financial system” when evaluating acquisitions of banks and nonbanks under the Bank Holding Company Act. With respect to interstate acquisitions, the Dodd-Frank Act amends the Bank Holding Company Act by raising the standard by which interstate bank acquisitions are permitted from a standard that the acquiring bank holding company be “adequately capitalized” and “adequately managed”, to the higher standard of being “well capitalized” and “well managed”.

 

Control Acquisitions. The Change in Bank Control Act prohibits a person or group of persons from acquiring “control” of a bank holding company unless the Federal Reserve Board has been notified and has not objected to the transaction. Under a rebuttable presumption established by the Federal Reserve Board, the acquisition of 10% or more of a class of voting stock of a bank holding company with a class of securities registered under Section 12 of the Exchange Act, would, under the circumstances set forth in the presumption, constitute acquisition of control of such company.

 

Emergency Economic Stabilization Act of 2008 and the Small Business Jobs Act of 2010. The U.S. Congress, the U.S. Department of the Treasury (“U.S. Treasury”) and the federal banking regulators took broad action beginning in early September 2008 to address volatility in the U.S. banking system. The Emergency Economic Stabilization Act of 2008 authorized the U.S. Treasury to purchase from financial institutions and their holding companies certain mortgage loans, mortgage-backed securities and certain other financial instruments, including debt and equity securities issued by financial institutions and their holding companies in the Troubled Asset Relief Program (“TARP”) Capital Purchase Program.

 

On December 19, 2008, PlainsCapital sold 87,631 shares of its Fixed Rate Cumulative Perpetual Stock, Series A and a warrant to purchase, upon net exercise, 4,382 shares of its Fixed Rate Cumulative Perpetual Stock, Series B to the U.S. Treasury for $87.6 million pursuant to the TARP Capital Purchase Program. The U.S. Treasury immediately exercised its warrant on December 19, 2008, and PlainsCapital issued the underlying shares of its Series B Preferred Stock to the U.S. Treasury. On September 27, 2011, PlainsCapital entered into a Securities Purchase Agreement with the Secretary of the Treasury (the “Purchase Agreement”) pursuant to which PlainsCapital issued 114,068 shares of its newly designated Non-Cumulative Perpetual Preferred Stock, Series C for a total purchase price of $114,068,000. The proceeds from the sale of PlainsCapital’s Series C Preferred Stock were used to redeem and repurchase PlainsCapital’s Series A and Series B Preferred Stock. PlainsCapital’s Series C Preferred Stock was issued pursuant to the Small Business Lending Fund program, a $30 billion fund established under the Small Business Jobs Act of 2010 that was created to encourage lending to small businesses by providing capital to qualified community banks with assets of less than $10 billion. In connection with the

 

20



Table of Contents

 

PlainsCapital Merger, Hilltop assumed PlainsCapital’s obligations under the Purchase Agreement and redeemed PlainsCapital’s outstanding Series C Preferred Stock in exchange for the Non-Cumulative Perpetual Preferred Stock, Series B of Hilltop (the “Hilltop Series B Preferred Stock”).

 

On November 29, 2012, Hilltop filed with the State Department of Assessments and Taxation of the State of Maryland articles supplementary for the Hilltop Series B Preferred Stock, setting forth its terms. Holders of the Hilltop Series B Preferred Stock are entitled to noncumulative cash dividends at a fluctuating dividend rate based on the Bank’s level of qualified small business lending (“QSBL”). The Hilltop Series B Preferred Stock is non-voting, except in limited circumstances, and ranks senior to Hilltop’s common stock with respect to the payment of dividends and distribution of assets upon any liquidation, dissolution or winding up of Hilltop.

 

The terms of the Hilltop Series B Preferred Stock restrict Hilltop’s ability to pay dividends on, make distributions with respect to, or redeem, purchase or acquire, or make a liquidation payment on its common stock and other Hilltop capital stock ranking junior to the Hilltop Series B Preferred Stock, and on other preferred stock and other stock ranking on a parity with the Hilltop Series B Preferred Stock, in the event that Hilltop does not declare dividends on the Hilltop Series B Preferred Stock during any dividend period.

 

The Hilltop Series B Preferred Stock qualifies as Tier 1 capital and is entitled to receive non-cumulative dividends, payable quarterly, on each January 1, April 1, July 1 and October 1. Until December 31, 2013, the dividend rate, as a percentage of the liquidation amount, fluctuated based upon changes in the level of QSBL by the Bank. From January 1, 2014 until March 26, 2016, the dividend rate is fixed at 5.0% based upon the Bank’s 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.

 

Except as noted in the next sentence, the Hilltop Series B Preferred Stock may be redeemed at any time at the Company’s option, at a redemption price of 100 percent of the liquidation amount plus accrued but unpaid dividends to the date of redemption for the current period, subject to approval of the Federal Reserve Board. In the agreement and plan of merger with PlainsCapital Corporation, the Company agreed not to redeem or otherwise acquire the Hilltop Series B Preferred Stock prior to the second anniversary of the closing date of the PlainsCapital Merger, or November 30, 2014. For more information, see “Risk Factors — The Treasury’s investment in us imposes restrictions and obligations upon us that could adversely affect the rights of our common stockholders.”

 

Governmental Monetary Policies. Our earnings are affected by domestic economic conditions and the monetary and fiscal policies of the U.S. government and its agencies. The monetary policies of the Federal Reserve Board have had, and are likely to continue to have, an important impact on the operating results of commercial banks through its power to implement national monetary policy in order, among other things, to curb inflation or combat a recession. The monetary policies of the Federal Reserve Board affect the levels of bank loans, investments and deposits through its influence over the issuance of U.S. government securities, its regulation of the discount rate applicable to member banks and its influence over reserve requirements to which member banks are subject. We cannot predict the nature or impact of future changes in monetary and fiscal policies.

 

Banking

 

The Bank is subject to various requirements and restrictions under the laws of the United States, and to regulation, supervision and regular examination by the Texas Department of Banking. The Bank, as a state member bank, is also subject to regulation and examination by the Federal Reserve Board. As a bank with less than $10 billion in assets, the Bank became subject to the regulations issued by the CFPB on July 21, 2011, although the Federal Reserve Board continued to examine the Bank for compliance with federal consumer protection laws. As of December 31, 2014, the Bank’s total assets were $8.0 billion. If the Bank’s total assets were to increase, either organically or through an acquisition, merger or combination, to over $10.0 billion (as measured on four consecutive quarterly call reports of the Bank and any institutions it acquires), the Bank would become subject to the CFPB’s supervisory and enforcement authority with respect to federal consumer financial laws beginning in the following quarter. SWS FSB, which was merged with the Bank on January 1, 2015, was formerly regulated by the Office of the Comptroller of the Currency. The Bank is also an insured depository institution and, therefore, subject to regulation by the FDIC, although the Federal Reserve Board is the Bank’s primary federal regulator. The Federal Reserve Board, the Texas Department of Banking, the CFPB and the FDIC have the power to enforce compliance with applicable banking statutes and regulations. Such requirements and restrictions include requirements to maintain reserves against deposits, restrictions on the nature and amount of loans that may be made and the interest that may be charged thereon and restrictions relating to investments and other activities of the Bank. In July 2010, the FDIC voted to revise its agreement with the primary federal regulators to enhance the FDIC’s existing backup authorities over insured depository

 

21



Table of Contents

 

institutions that the FDIC does not directly supervise. As a result, the Bank may be subject to increased supervision by the FDIC.

 

Restrictions on Transactions with Affiliates. Transactions between the Bank and its nonbanking affiliates, including Hilltop and PlainsCapital, are subject to Section 23A of the Federal Reserve Act. In general, Section 23A imposes limits on the amount of such transactions, and also requires certain levels of collateral for loans to affiliated parties. It also limits the amount of advances to third parties that are collateralized by the securities or obligations of Hilltop or its subsidiaries. Among other changes, the Dodd-Frank Act expands the definition of “covered transactions” and clarifies the amount of time that the collateral requirements must be satisfied for covered transactions, and amends the definition of “affiliate” in Section 23A to include “any investment fund with respect to which a member bank or an affiliate thereof is an investment advisor.”

 

Affiliate transactions are also subject to Section 23B of the Federal Reserve Act, which generally requires that certain transactions between the Bank and its affiliates be on terms substantially the same, or at least as favorable to the Bank, as those prevailing at the time for comparable transactions with or involving other nonaffiliated persons. The Federal Reserve has also issued Regulation W, which codifies prior regulations under Sections 23A and 23B of the Federal Reserve Act and interpretive guidance with respect to affiliate transactions.

 

Loans to Insiders. The restrictions on loans to directors, executive officers, principal stockholders and their related interests (collectively referred to herein as “insiders”) contained in the Federal Reserve Act and Regulation O apply to all insured institutions and their subsidiaries and holding companies. These restrictions include limits on loans to one borrower and conditions that must be met before such a loan can be made. There is also an aggregate limitation on all loans to insiders and their related interests. These loans cannot exceed the institution’s total unimpaired capital and surplus, and the Federal Reserve Board may determine that a lesser amount is appropriate. Insiders are subject to enforcement actions for knowingly accepting loans in violation of applicable restrictions. The Dodd-Frank Act amends the statutes placing limitations on loans to insiders by including credit exposures to the person arising from a derivatives transaction, repurchase agreement, reverse repurchase agreement, securities lending transaction, or securities borrowing transaction between the member bank and the person within the definition of an extension of credit.

 

Restrictions on Distribution of Subsidiary Bank Dividends and Assets. Dividends paid by the Bank have provided a substantial part of PlainsCapital’s operating funds and for the foreseeable future it is anticipated that dividends paid by the Bank to PlainsCapital will continue to be PlainsCapital’s and Hilltop’s principal source of operating funds. Capital adequacy requirements serve to limit the amount of dividends that may be paid by the Bank. Pursuant to the Texas Finance Code, a Texas banking association may not pay a dividend that would reduce its outstanding capital and surplus unless it obtains the prior approval of the Texas Banking Commissioner. Additionally, the FDIC and the Federal Reserve Board have the authority to prohibit Texas state banks from paying a dividend when they determine the dividend would be an unsafe or unsound banking practice. As a member of the Federal Reserve System, the Bank must also comply with the dividend restrictions with which a national bank would be required to comply. Those provisions are generally similar to those imposed by the state of Texas. Among other things, the federal restrictions require that if losses have at any time been sustained by a bank equal to or exceeding its undivided profits then on hand, no dividend may be paid.

 

In the event of a liquidation or other resolution of an insured depository institution, the claims of depositors and other general or subordinated creditors are entitled to a priority of payment over the claims of holders of any obligation of the institution to its stockholders, including any depository institution holding company (such as PlainsCapital and Hilltop) or any stockholder or creditor thereof.

 

Branching. The establishment of a branch must be approved by the Texas Department of Banking and the Federal Reserve Board, which consider a number of factors, including financial history, capital adequacy, earnings prospects, character of management, needs of the community and consistency with corporate powers. The regulators will also consider the applicant’s CRA record.

 

Interstate Branching. Effective June 1, 1997, the Riegle-Neal Interstate Banking and Branching Efficiency Act of 1994 (the “Riegle-Neal Act”) amended the Federal Deposit Insurance Act and certain other statutes to permit state and national banks with different home states to merge across state lines, with approval of the appropriate federal banking agency, unless the home state of a participating bank had passed legislation prior to May 31, 1997 expressly prohibiting interstate mergers. Under the Dodd-Frank Act, de novo interstate branching by banks is permitted if, under the laws of the state where the branch is to be located, a state bank chartered in that state would be permitted to establish a branch.

 

Prompt Corrective Action. The Federal Deposit Insurance Corporation Improvement Act of 1991 establishes a system of prompt corrective action to resolve the problems of undercapitalized financial institutions. Under this system, the federal

 

22



Table of Contents

 

banking regulators have established five capital categories (“well capitalized,” “adequately capitalized,” “undercapitalized,” “significantly undercapitalized” and “critically undercapitalized”) in which all institutions are placed. Federal banking regulators are required to take various mandatory supervisory actions and are authorized to take other discretionary actions with respect to institutions in the three undercapitalized categories. The severity of the action depends upon the capital category in which the institution is placed. Generally, subject to a narrow exception, the banking regulator must appoint a receiver or conservator for an institution that is critically undercapitalized. The federal banking agencies have specified by regulation the relevant capital level for each category.

 

An institution that is categorized as “undercapitalized”, “significantly undercapitalized” or “critically undercapitalized” is required to submit an acceptable capital restoration plan to its appropriate federal banking agency. A bank holding company must guarantee that a subsidiary depository institution meets its capital restoration plan, subject to various limitations. The controlling holding company’s obligation to fund a capital restoration plan is limited to the lesser of 5% of an undercapitalized subsidiary’s assets at the time it became undercapitalized or the amount required to meet regulatory capital requirements. An undercapitalized institution is also generally prohibited from increasing its average total assets, making acquisitions, establishing any branches or engaging in any new line of business, except under an accepted capital restoration plan or with FDIC approval. The regulations also establish procedures for downgrading an institution to a lower capital category based on supervisory factors other than capital. The Bank was classified as “well capitalized” at December 31, 2014.

 

In addition, if a bank is classified as “undercapitalized,” the bank is required to submit a capital restoration plan to the federal banking regulators. Pursuant to FDICIA, an “undercapitalized” bank is prohibited from increasing its assets, engaging in a new line of business, acquiring any interest in any company or insured depository institution, or opening or acquiring a new branch office, except under certain circumstances, including the acceptance by the federal banking regulators of a capital restoration plan for the bank.

 

Furthermore, if a bank is classified as “undercapitalized,” the federal banking regulators may take certain actions to correct the capital position of the bank; if a bank is classified as “significantly undercapitalized” or “critically undercapitalized,” the federal banking regulators would be required to take one or more prompt corrective actions. These actions would include, among other things, requiring: sales of new securities to bolster capital, improvements in management, limits on interest rates paid, prohibitions on transactions with affiliates, termination of certain risky activities and restrictions on compensation paid to executive officers. If a bank is classified as “critically undercapitalized,” FDICIA requires the bank to be placed into conservatorship or receivership within 90 days, unless the federal banking regulators determines that other action would better achieve the purposes of FDICIA regarding prompt corrective action with respect to undercapitalized banks.

 

The capital classification of a bank affects the frequency of examinations of the bank and impacts the ability of the bank to engage in certain activities and affects the deposit insurance premiums paid by such bank. Under FDICIA, the federal banking regulators are required to conduct a full-scope, on-site examination of every bank at least once every 12 months. An exception to this rule is made, however, that provides that banks (i) with assets of less than $100 million, (ii) that are categorized as “well capitalized,” (iii) that were found to be well managed and composite rating was outstanding and (iv) have not been subject to a change in control during the last 12 months, need only be examined once every 18 months.

 

FDIC Insurance Assessments. The FDIC has adopted a risk-based assessment system for insured depository institutions that takes into account the risks attributable to different categories and concentrations of assets and liabilities. The system assigns an institution to one of three capital categories: (1) “well capitalized;” (2) “adequately capitalized;” or (3) “undercapitalized.” These three categories are substantially similar to the prompt corrective action categories described above, with the “undercapitalized” category including institutions that are undercapitalized, significantly undercapitalized and critically undercapitalized for prompt corrective action purposes. The FDIC also assigns an institution to one of three supervisory subgroups based on a supervisory evaluation that the institution’s primary federal regulator provides to the FDIC and information that the FDIC determines to be relevant to the institution’s financial condition and the risk posed to the deposit insurance funds. The FDIC may terminate its insurance of deposits if it finds that the institution has engaged in unsafe and unsound practices, is in an unsafe or unsound condition to continue operations, or has violated any applicable law, regulation, rule, order or condition imposed by the FDIC.

 

On February 7, 2011, the FDIC issued a final rule implementing revisions to the assessment system mandated by the Dodd-Frank Act. The new regulation was effective April 1, 2011 and was reflected in the June 30, 2011 FDIC deposit insurance fund (“DIF”) balance and the invoices for assessments due September 30, 2011. Accruals for DIF assessments were $1.0 million for the year ended December 31, 2014.

 

23



Table of Contents

 

The FDIC is required to maintain a designated reserve ratio of the DIF to insured deposits in the United States. The Dodd-Frank Act requires the FDIC to assess insured depository institutions to achieve a DIF ratio of at least 1.35 percent by September 30, 2020. Pursuant to its authority in the Dodd-Frank Act, the FDIC on December 20, 2010, published a final rule establishing a higher long-term target DIF ratio of greater than 2%. Deposit insurance assessment rates are subject to change by the FDIC and will be impacted by the overall economy and the stability of the banking industry as a whole. The FDIC will notify the Bank concerning an assessment rate that we will be charged for the assessment period. As a result of the new regulations, we expect to incur higher annual deposit insurance assessments, which could have a significant adverse impact on our financial condition and results of operations.

 

The Dodd-Frank Act permanently increased the standard maximum deposit insurance amount from $100,000 to $250,000. The FDIC insurance coverage limit applies per depositor, per insured depository institution for each account ownership category.

 

Community Reinvestment Act. The CRA requires, in connection with examinations of financial institutions, that federal banking regulators (in the Bank’s case, the Federal Reserve Board) evaluate the record of each financial institution in meeting the credit needs of its local community, including low and moderate-income neighborhoods. These facts are also considered in evaluating mergers, acquisitions and applications to open a branch or facility. Failure to adequately meet these criteria could impose additional requirements and limitations on the Bank. Additionally, the Bank must publicly disclose the terms of various CRA-related agreements.

 

During the second quarter of 2013, the Bank received a “satisfactory” CRA rating in connection with its most recent CRA performance evaluation. A CRA rating of less than “satisfactory” adversely affects a bank’s ability to establish new branches and impairs a bank’s ability to commence new activities that are “financial in nature” or acquire companies engaged in these activities. See “Risk factors — We are subject to extensive supervision and regulation that could restrict our activities and impose financial requirements or limitations on the conduct of our business and limit our ability to generate income.”

 

Privacy. Under the Gramm-Leach-Bliley Act, financial institutions are required to disclose their policies for collecting and protecting confidential information. Customers generally may prevent financial institutions from sharing nonpublic personal financial information with nonaffiliated third parties except under narrow circumstances, such as the processing of transactions requested by the consumer or when the financial institution is jointly sponsoring a product or service with a nonaffiliated third party. Additionally, financial institutions generally may not disclose consumer account numbers to any nonaffiliated third party for use in telemarketing, direct mail marketing or other marketing to consumers. The Bank and all of its subsidiaries have established policies and procedures to comply with the privacy provisions of the Gramm-Leach-Bliley Act.

 

Federal Laws Applicable to Credit Transactions. The loan operations of the Bank are also subject to federal laws and implementing regulations applicable to credit transactions, such as the:

 

·                  Truth-In-Lending Act, governing disclosures of credit terms to consumer borrowers;

 

·                  Home Mortgage Disclosure Act of 1975, requiring financial institutions to provide information to enable the public and public officials to determine whether a financial institution is fulfilling its obligation to help meet the housing needs of the community it serves;

 

·                  Equal Credit Opportunity Act, prohibiting discrimination on the basis of race, creed or other prohibited factors in extending credit;

 

·                  Fair Credit Reporting Act of 1978, governing the use and provision of information to credit reporting agencies and preventing identity theft;

 

·                  Fair Debt Collection Practices Act, governing the manner in which consumer debts may be collected by collection agencies;

 

·                  Service Members Civil Relief Act, which amended the Soldiers’ and Sailors’ Civil Relief Act of 1940, governing the repayment terms of, and property rights underlying, secured obligations of persons in military service;

 

·                  The Dodd-Frank Act, which establishes the CFPB, an independent entity within the Federal Reserve, dedicated to promulgating and enforcing consumer protection laws applicable to all entities offering consumer financial services or products; and

 

·                  The rules and regulations of the various federal agencies charged with the responsibility of implementing these federal laws.

 

24



Table of Contents

 

Interest and other charges collected or contracted for by the Bank are subject to state usury laws and federal laws concerning interest rates.

 

Federal Laws Applicable to Deposit Operations. The deposit operations of the Bank are subject to:

 

·                  Right to Financial Privacy Act, which imposes a duty to maintain confidentiality of consumer financial records and prescribes procedures for complying with administrative subpoenas of financial records;

 

·                  Truth in Savings Act, which requires the Bank to disclose the terms and conditions on which interest is paid and fees are assessed in connection with deposit accounts; and

 

·                  Electronic Funds Transfer Act and Regulation E issued by the Federal Reserve Board and the CFPB to implement that act, which govern automatic deposits to and withdrawals from deposit accounts and customers’ rights and liabilities arising from the use of ATMs and other electronic banking services. The Dodd-Frank Act amends the Electronic Funds Transfer Act to, among other things, give the Federal Reserve Board the authority to establish rules regarding interchange fees charged for electronic debit transactions by payment card issuers having assets over $10 billion and to enforce a new statutory requirement that such fees be reasonable and proportional to the actual cost of a transaction to the issuer.

 

Capital Requirements. The Federal Reserve Board and the Texas Department of Banking monitor the capital adequacy of the Bank by using a combination of risk-based guidelines and leverage ratios. The agencies consider the Bank’s capital levels when taking action on various types of applications and when conducting supervisory activities related to the safety and soundness of individual banks and the banking system.

 

Under the regulatory capital guidelines (without giving effect to Basel III discussed below), the Bank must maintain a total risk-based capital to risk-weighted assets ratio of at least 8.0%, a Tier 1 capital to risk-weighted assets ratio of at least 4.0%, and a Tier 1 capital to average total assets ratio of at least 4.0% (3.0% for banks receiving the highest examination rating) to be considered “adequately capitalized.” See the discussion herein under “The FDIC Improvement Act.” At December 31, 2014, the Bank’s ratio of total risk-based capital to risk-weighted assets was 14.45%, the Bank’s ratio of Tier 1 capital to risk-weighted assets was 13.74% and the Bank’s ratio of Tier 1 capital to average total assets was 10.31%.

 

On January 1, 2015, the Bank began transitioning to the final rules that substantially amend the regulatory risk-based capital rules to implement the Basel III regulatory capital reforms. For additional discussion of Basel III, see the section entitled “Government Supervision and Regulation — Corporate — Basel III” earlier in this Item 1.

 

FIRREA. The Financial Institutions Reform, Recovery and Enforcement Act of 1989 (“FIRREA”) includes various provisions that affect or may affect the Bank. Among other matters, FIRREA generally permits bank holding companies to acquire healthy thrifts as well as failed or failing thrifts. FIRREA removed certain cross marketing prohibitions previously applicable to thrift and bank subsidiaries of a common holding company. Furthermore, a multi-bank holding company may now be required to indemnify the DIF against losses it incurs with respect to such company’s affiliated banks, which in effect makes a bank holding company’s equity investments in healthy bank subsidiaries available to the FDIC to assist such company’s failing or failed bank subsidiaries.

 

In addition, pursuant to FIRREA, any depository institution that has been chartered less than two years, is not in compliance with the minimum capital requirements of its primary federal banking regulator, or is otherwise in a troubled condition must notify its primary federal banking regulator of the proposed addition of any person to its board of directors or the employment of any person as a senior executive officer of the institution at least 30 days before such addition or employment becomes effective. During such 30 day period, the applicable federal banking regulatory agency may disapprove of the addition of or employment of such director or officer. The Bank is not subject to any such requirements. FIRREA also expanded and increased civil and criminal penalties available for use by the appropriate regulatory agency against certain “institution affiliated parties” primarily including: (i) management, employees and agents of a financial institution; (ii) independent contractors such as attorneys and accountants and others who participate in the conduct of the financial institution’s affairs and who caused or are likely to cause more than minimum financial loss to or a significant adverse effect on the institution, who knowingly or recklessly violate a law or regulation, breach a fiduciary duty or engage in unsafe or unsound practices. Such practices can include the failure of an institution to timely file required reports or the submission of inaccurate reports. Furthermore, FIRREA authorizes the appropriate banking agency to issue cease and desist orders that may, among other things, require affirmative action to correct any harm resulting from a violation or practice, including restitution, reimbursement, indemnifications or guarantees against loss. A financial

 

25



Table of Contents

 

institution may also be ordered to restrict its growth, dispose of certain assets or take other action as determined by the ordering agency to be appropriate.

 

The FDIC Improvement Act. The Federal Deposit Insurance Corporation Improvement Act of 1991 (“FDICIA”) made a number of reforms addressing the safety and soundness of the deposit insurance system, supervision of domestic and foreign depository institutions, and improvement of accounting standards. This statute also limited deposit insurance coverage, implemented changes in consumer protection laws and provided for least-cost resolution and prompt regulatory action with regard to troubled institutions.

 

FDICIA requires every bank with total assets in excess of $500 million to have an annual independent audit made of the bank’s financial statements by a certified public accountant to verify that the financial statements of the bank are presented in accordance with GAAP and comply with such other disclosure requirements as prescribed by the FDIC.

 

Brokered Deposits. Under FDICIA, banks may be restricted in their ability to accept brokered deposits, depending on their capital classification. “Well capitalized” banks are permitted to accept brokered deposits, but banks that are not “well capitalized” are not permitted to accept such deposits. The FDIC may, on a case-by-case basis, permit banks that are “adequately capitalized” to accept brokered deposits if the FDIC determines that acceptance of such deposits would not constitute an unsafe or unsound banking practice with respect to the bank. At December 31, 2014, the Bank was “well capitalized” and therefore not subject to any limitations with respect to its brokered deposits. Brokered deposits are the subject of a study under the Dodd-Frank Act.

 

Federal limitations on activities and investments. The equity investments and activities, as a principle of FDIC-insured state-chartered banks, are generally limited to those that are permissible for national banks. Under regulations dealing with equity investments, an insured state bank generally may not directly or indirectly acquire or retain any equity investment of a type, or in an amount, that is not permissible for a national bank.

 

Check Clearing for the 21st Century Act. The Check Clearing for the 21st Century Act gives “substitute checks,” such as a digital image of a check and copies made from that image, the same legal standing as the original paper check.

 

Federal Home Loan Bank System. The Federal Home Loan Bank (“FHLB”) system, of which the Bank is a member, consists of 12 regional FHLBs governed and regulated by the Federal Housing Finance Board. The FHLBs serve as reserve or credit facilities for member institutions within their assigned regions. The reserves are funded primarily from proceeds derived from the sale of consolidated obligations of the FHLB system. The FHLBs make loans (i.e., advances) to members in accordance with policies and procedures established by the FHLB and the boards of directors of each regional FHLB.

 

As a system member, according to currently existing policies and procedures, the Bank is entitled to borrow from the FHLB of its respective region and is required to own a certain amount of capital stock in the FHLB. The Bank is in compliance with the stock ownership rules with respect to such advances, commitments and letters of credit and home mortgage loans and similar obligations. All loans, advances and other extensions of credit made by the FHLB to the Bank are secured by a portion of the respective mortgage loan portfolio, certain other investments and the capital stock of the FHLB held by the Bank.

 

Anti-terrorism and Money Laundering Legislation. The Bank is subject to the Uniting and Strengthening America by Providing Appropriate Tools Required to Intercept and Obstruct Terrorism of 2001 (the “USA PATRIOT Act”), the Bank Secrecy Act and rules and regulations of the Office of Foreign Assets Control. These statutes and related rules and regulations impose requirements and limitations on specific financial transactions and account relationships intended to guard against money laundering and terrorism financing. The Bank has established a customer identification program pursuant to Section 326 of the USA PATRIOT Act and the Bank Secrecy Act, and otherwise has implemented policies and procedures intended to comply with the foregoing rules.

 

26



Table of Contents

 

Broker-Dealer

 

FSC, Southwest Securities and SWS Financial (collectively, the “Hilltop Broker-Dealers”) are broker-dealers registered with the SEC, FINRA, all 50 U.S. states and the District of Columbia. FSC and Southwest Securities are also registered in Puerto Rico and the U.S. Virgin Islands. Much of the regulation of broker-dealers, however, has been delegated to self-regulatory organizations, principally FINRA, the Municipal Securities Rulemaking Board and national securities exchanges. These self-regulatory organizations adopt rules (which are subject to approval by the SEC) for governing its members and the industry. Broker-dealers are also subject to the laws and rules of the states in which a broker-dealer conducts business. The Hilltop Broker-Dealers are members of, and are primarily subject to regulation, supervision and regular examination by, FINRA.

 

The regulations to which broker-dealers are subject cover all aspects of the securities business, including, but not limited to, sales and trade practices, net capital requirements, record keeping and reporting procedures, relationships and conflicts with customers, the handling of cash and margin accounts, experience and training requirements for certain employees, the conduct of investment banking and research activities and the conduct of registered persons, directors, officers and employees. Broker-dealers are also subject to the privacy and anti-money laundering laws and regulations discussed herein. Additional legislation, changes in rules promulgated by the SEC and by self-regulatory organizations or changes in the interpretation or enforcement of existing laws and rules often directly affects the method of operation and profitability of broker-dealers. The SEC, the self-regulatory organizations and states may conduct administrative and enforcement proceedings that can result in censure, fine, suspension or expulsion of our broker-dealers, their registered persons, officers or employees. The principal purpose of regulation and discipline of broker-dealers is the protection of customers and the securities markets rather than protection of creditors and stockholders of broker-dealers.

 

Limitation on Businesses. The businesses that the Hilltop Broker-Dealers may conduct are limited by its agreements with, and its oversight by, FINRA, other regulatory authorities and federal and state law. Participation in new business lines, including trading of new products or participation on new exchanges or in new countries often requires governmental and/or exchange approvals, which may take significant time and resources. In addition, the Hilltop-Broker Dealers are operating subsidiaries of Hilltop, which means its activities are further limited by those that are permissible for subsidiaries of financial holding companies, and as a result, may be prevented from entering new businesses that may be profitable in a timely manner, if at all.

 

Net Capital Requirements. The SEC, FINRA and various other regulatory authorities have stringent rules and regulations with respect to the maintenance of specific levels of net capital by regulated entities. Rule 15c3-1 of the Exchange Act (the “Net Capital Rule”) requires that a broker-dealer maintain minimum net capital. Generally, a broker-dealer’s net capital is net worth plus qualified subordinated debt less deductions for non-allowable (or non-liquid) assets and other adjustments and operational charges. At December 31, 2014, the Hilltop Broker-Dealers were in compliance with applicable net capital requirements.

 

The SEC, CFTC, FINRA and other regulatory organizations impose rules that require notification when net capital falls below certain predefined thresholds. These rules also dictate the ratio of debt-to-equity in the regulatory capital composition of a broker-dealer, and constrain the ability of a broker-dealer to expand its business under certain circumstances. If a broker-dealer fails to maintain the required net capital, it may be subject to suspension or revocation of registration by the SEC or applicable regulatory authorities, and suspension or expulsion by these regulators could ultimately lead to the broker-dealer’s liquidation. Additionally, the Net Capital Rule and certain FINRA rules impose requirements that may have the effect of prohibiting a broker-dealer from distributing or withdrawing capital and requiring prior notice to, and approval from, the SEC and FINRA for certain capital withdrawals.

 

Compliance with the net capital requirements may limit our operations, requiring the intensive use of capital. Such rules require that a certain percentage of our assets be maintained in relatively liquid form and therefore act to restrict our ability to withdraw capital from our broker-dealer entities, which in turn may limit our ability to pay dividends, repay debt or redeem or purchase shares of our outstanding common stock.  Any change in such rules or the imposition of new rules affecting the scope, coverage, calculation or amount of capital requirements, or a significant operating loss or any unusually large charge against capital, could adversely affect our ability to pay dividends, repay debt, meet our debt covenant requirements or to expand or maintain our operations. In addition, such rules may require us to make substantial capital contributions into one or more of the Hilltop Broker-Dealers in order for such subsidiaries to comply with such rules, either in the form of cash or subordinated loans made in accordance with the requirements of all applicable net capital rules.

 

27



Table of Contents

 

Customer Protection Rule.  The Hilltop Broker-Dealers that hold customers’ funds and securities are subject to the SEC’s customer protection rule (Rule 15c3-3 under the Exchange Act), which generally provides that such broker-dealers maintain physical possession or control of all fully-paid securities and excess margin securities carried for the account of customers and maintain certain reserves of cash or qualified securities.

 

Securities Investor Protection Corporation (“SIPC”). The Hilltop Broker-Dealers are subject to the Securities Investor Protection Act and belong to SIPC, whose primary function is to provide financial protection for the customers of failing brokerage firms. SIPC provides protection for customers up to $500,000, of which a maximum of $250,000 may be in cash.

 

Anti-Money Laundering. The Hilltop Broker-Dealers must also comply with the USA PATRIOT Act of 2001, as amended, (the “Patriot Act”), and other rules and regulations designed to fight international money laundering and to block terrorist access to the U.S. financial system. We are required to have systems and procedures to ensure compliance with such laws and regulations.

 

CFTC Oversight.  Southwest Securities and SWS Financial are registered as introducing brokers with the CFTC and NFA. The CFTC also has net capital regulations (CFTC Rule 1.17) that must be satisfied. Our futures business is also regulated by the NFA, a registered futures association. FSC is registered with the CFTC as a commodity trading advisor. Violation of the rules of the CFTC, the NFA or the commodity exchanges could result in remedial actions including fines, registration restrictions or terminations, trading prohibitions or revocations of commodity exchange memberships.

 

Investment Advisory Activity.  First Southwest Asset Management, LLC, Southwest Securities and SWS Financial are registered with, and subject to oversight and inspection by, the SEC as investment advisers under the Investment Advisers Act of 1940, as amended. The investment advisory business of our subsidiaries is subject to significant federal regulation, including with respect to wrap fee programs, the management of client accounts, the safeguarding of client assets, client fees and disclosures, transactions among affiliates and recordkeeping and reporting procedures. Legislation and changes in regulations promulgated by the SEC or changes in the interpretation or enforcement of existing laws and regulations often directly affect the method of operation and profitability of investment advisers. The SEC may conduct administrative and enforcement proceedings that can result in censure, fine, suspension, revocation or expulsion of the investment advisory business of our subsidiaries, our officers or employees.

 

Volcker Rule.  Provisions of the Volcker Rule and the final rules implementing the Volcker Rule restrict certain activities provided by Hilltop Broker-Dealers, including proprietary trading. For purposes of the Volcker Rule, purchases or sales of financial instruments such as securities, derivatives, contracts of sale of commodities for future delivery or options on the foregoing for the purpose of short-term gain are deemed to be proprietary trading (with financial instruments held for less than 60 days presumed to be for proprietary trading unless an alternative purpose can be demonstrated), unless certain exemptions apply. Exempted activities include, among others, the following: 1) underwriting; 2) market making; 3) risk mitigating hedging; 4) trading in certain government securities; 5) employee compensation plans and 6) transactions entered into on behalf of and for the account of clients as agent, broker, custodian or in a trustee or fiduciary capacity. While management continues to assess compliance with the Volcker Rule, we have reviewed our processes and procedures in regard to proprietary trading and we believe we are currently complying with the provisions of the Volcker Rule regarding proprietary trading. However, it remains uncertain how the scope of applicable restrictions and exceptions will be interpreted and administered by the relevant regulators. Absent further regulatory guidance, we are required to make certain assumptions as to the degree to which our activities, processes and procedures in these areas comply with the requirements of the Volcker Rule. If these assumptions are not accurate or if our implementation of compliance processes and procedures is not consistent with regulatory expectations, we may be required to make certain changes to our business activities, processes or procedures, which could further increase our compliance and regulatory risks and costs.

 

Changing Regulatory Environment. The regulatory environment in which the Hilltop Broker-Dealers operate is subject to frequent change. Our business, financial condition and operating results may be adversely affected as a result of new or revised legislation or regulations imposed by the U.S. Congress, the SEC, FINRA or other U.S. and state governmental regulatory authorities. The business, financial condition and operating results of the Hilltop Broker-Dealers also may be adversely affected by changes in the interpretation and enforcement of existing laws and rules by these governmental and regulatory authorities. In the current era of heightened regulation of financial institutions, the Hilltop Broker-Dealers can expect to incur increasing compliance costs, along with the industry as a whole.

 

28



Table of Contents

 

Mortgage Origination

 

PrimeLending and the Bank are subject to the rules and regulations of the CFPB, FHA, VA, the Federal National Mortgage Association, the Federal Home Loan Mortgage Corporation and Government National Mortgage Association with respect to originating, processing, selling and servicing mortgage loans and the issuance and sale of mortgage-backed securities. Those rules and regulations, among other things, prohibit discrimination and establish underwriting guidelines which include provisions for inspections and appraisals, require credit reports on prospective borrowers and fix maximum loan amounts, and, with respect to VA loans, fix maximum interest rates. Mortgage origination activities are subject to, among others, the Equal Credit Opportunity Act, Federal Truth-in-Lending Act, Secure and Fair Enforcement of Mortgage Licensing Act, Home Mortgage Disclosure Act, Fair Credit Reporting Act and the Real Estate Settlement Procedures Act and the regulations promulgated thereunder which, among other things, prohibit discrimination and require the disclosure of certain basic information to borrowers concerning credit terms and settlement costs. PrimeLending and the Bank are also subject to regulation by the Texas Department of Banking with respect to, among other things, the establishment of maximum origination fees on certain types of mortgage loan products. PrimeLending and the Bank are also subject to the provisions of the Dodd-Frank Act. Among other things, the Dodd-Frank Act established the CFPB and provides mortgage reform provisions regarding a customer’s ability to repay, restrictions on variable-rate lending, loan officers’ compensation, risk retention, and new disclosure requirements. The Dodd-Frank Act also clarifies that applicable state laws, rules and regulations related to the origination, processing, selling and servicing of mortgage loans continue to apply to PrimeLending. The additional regulatory requirements affecting our mortgage origination operations will result in increased compliance costs and may impact revenue.

 

On August 16, 2010, the Federal Reserve Board published a final rule on loan broker compensation, pursuant to the Dodd-Frank Act, which prohibits certain compensation payments to loan brokers and the practice of steering consumers to loans not in their interest when it will result in greater compensation for a loan broker. This final rule became effective on April 1, 2011, however, the Federal Reserve Board noted in the final rule that the CFPB may clarify the rule in the future pursuant to the CFPB’s authority granted under the Dodd-Frank Act. The CFPB’s final rule addressing mortgage loan originator compensation is discussed in more detail below.

 

In addition, the Dodd-Frank Act directed the Federal Reserve Board to promulgate regulations requiring lenders and securitizers to retain an economic interest in the credit risk relating to loans the lender sells and other asset-backed securities that the securitizer issues if the loans have not complied with the ability to repay standards spelled out in the Dodd-Frank Act and its implementing regulations.

 

On March 2, 2011, the Federal Reserve Board published a final rule implementing a provision in the Dodd-Frank Act that provides a separate, higher rate threshold for determining when the escrow requirements apply to higher-priced mortgage loans that exceed the maximum principal obligation eligible for purchase by Freddie Mac.

 

In January 2013, the CFPB published final rules that will impact mortgage origination and servicing. Had these final rules not been published, many of the statutory requirements in Title XIV of the Dodd-Frank Act would have become effective on January 21, 2013 without any implementing regulations. Unless noted below, these final rules became effective in January 2014.

 

On October 22, 2014 the Federal Reserve Board, the SEC and several other agencies collectively issued a final rule that implements the credit risk retention provisions under Section 941 of the Dodd-Frank Act.

 

The final rules concerning mortgage origination and servicing address the following topics:

 

Ability to Repay.  This final rule implements the Dodd-Frank Act provisions requiring that for residential mortgages, creditors must make a reasonable and good faith determination based on verified and documented information that the consumer has a reasonable ability to repay the loan according to its terms. The final rule also establishes a presumption of compliance with the ability to repay determination for a certain category of mortgages called “qualified mortgages” meeting a series of detailed requirements. The final rule also provides a rebuttable presumption for higher-priced mortgage loans.

 

High-Cost Mortgage.  This final rule strengthens consumer protections for high-cost mortgages (generally bans balloon payments and prepayment penalties, subject to exceptions and bans or limits certain fees and practices) and requires consumers to receive information about homeownership counseling prior to taking out a high-cost mortgage.

 

Appraisals for High-Risk Mortgages.  The final rule permits a creditor to extend a higher-priced (subprime) mortgage loan (“HPML”) only if the following conditions are met (subject to exceptions):  (i) the creditor obtains a written appraisal; (ii) 

 

29



Table of Contents

 

the appraisal is performed by a certified or licensed appraiser; and (iii) the appraiser conducts a physical property visit of the interior of the property. The rule also requires that during the application process, the applicant receives a notice regarding the appraisal process and their right to receive a free copy of the appraisal.

 

Copies of Appraisals.  This final rule amends Regulation B that implements the Equal Credit Opportunity Act. It requires a creditor to provide a free copy of appraisal or valuation reports prepared in connection with any closed-end loan secured by a first lien on a dwelling. The final rule requires notice to applicants of the right to receive copies of any appraisal or valuation reports and creditors must send copies of the reports whether or not the loan transaction is consummated.  Creditors must provide the copies of the appraisal or evaluation reports for free, however, the creditors may charge reasonable fees for the cost of the appraisal or valuation unless applicable law provides otherwise.

 

Escrow Requirements.  This final rule implements Dodd-Frank Act changes that generally extend the required duration of an escrow account on certain higher-priced mortgage loans from a minimum of one year to a minimum of five years, subject to certain exemptions for loans made by certain creditors that operate predominantly in rural or underserved areas, as long as certain other criteria are met. This final rule became effective on June 1, 2013.

 

Servicing.  Two final rules were published to implement laws to protect consumers from detrimental actions by mortgage servicers and to provide consumers with better tools and information when dealing with mortgage servicers. One final rule amends Regulation Z, which implements the Truth in Lending Act, and a second final rule amends Regulation X, which implements the Real Estate Settlement Procedures Act. The rules cover nine major topics implementing the Dodd-Frank Act provisions related to mortgage servicing. The final rules include a number of exemptions and other adjustments for small servicers, defined as servicers that service 5,000 or fewer mortgage loans and service only mortgage loans that they or an affiliate originated or own.

 

Mortgage Loan Originator Compensation.  This final rule implements Dodd-Frank Act requirements, as well as revises and clarifies existing regulations and commentary on loan originator compensation. The rule also prohibits, among other things: (i) certain arbitration agreements; (ii) financing certain credit insurance in connection with a mortgage loan; (iii) compensation based on a term of a transaction or a proxy for a term of a transaction; and (iv) dual compensation from a consumer and another person in connection with the transaction. The final rule also imposes a duty on individual loan officers, mortgage brokers and creditors to be “qualified” and, when applicable, registered or licensed to the extent required under applicable State and Federal law.

 

Risk Retention.  This final rule implements the requirements of the Dodd-Frank Act that at least one sponsor of each securitization retains at least 5% of the credit risk of the assets collateralizing asset-backed securities. Sponsors are prohibited from hedging or transferring this credit risk, and the rule applies in both public and private transactions. Securitizations backed by “qualified residential mortgages” or “servicing assets” are exempt from the rule, and the definition of “qualified residential mortgages” is subject to review of the joint regulators every five years. The rule becomes effective on December 24, 2015 with respect to asset-backed securities collateralized by residential mortgages and December 24, 2016 with respect to all other classes of asset-backed securities.

 

Additional rules and regulations are expected. Any additional regulatory requirements affecting PrimeLending mortgage origination operations will result in increased compliance costs and may impact revenue.

 

Insurance

 

NLC’s insurance subsidiaries, NLIC and ASIC, are subject to regulation and supervision in each state where they are licensed to do business. This regulation and supervision is vested in state agencies having broad administrative power over the various aspects of the business of NLIC and ASIC.

 

State insurance holding company regulation.  NLC controls two operating insurance companies, NLIC and ASIC, and is subject to the insurance holding company laws of Texas, the state in which those insurance companies are domiciled. These laws generally require NLC to register with the Texas Department of Insurance and periodically to furnish financial and other information about the operations of companies within its holding company structure. Generally under these laws, all transactions between an insurer and an affiliated company in its holding company structure, including sales, loans, reinsurance agreements and service agreements, must be fair and reasonable and, if satisfying a specified threshold amount or of a specified category, require prior notice and approval or non-objection by the Texas Department of Insurance.

 

National Association of Insurance Commissioners.  The National Association of Insurance Commissioners (“NAIC”) is a group consisting of state insurance commissioners that discuss issues and formulate policy with respect to regulation,

 

30



Table of Contents

 

reporting and accounting for insurance companies. Although the NAIC has no legislative authority and insurance companies are at all times subject to the laws of their respective domiciliary states and, to a lesser extent, other states in which they conduct business, the NAIC is influential in determining the form in which such laws are enacted. Certain Model Insurance Laws, Regulations and Guidelines, or Model Laws, have been promulgated by the NAIC as a minimum standard by which state regulatory systems and regulations are measured. Adoption of state laws that provide for substantially similar regulations to those described in the Model Laws is a requirement for accreditation by the NAIC.

 

The NAIC provides authoritative guidance to insurance regulators on current statutory accounting issues by promulgating and updating a codified set of statutory accounting practices in its Accounting Practices and Procedures Manual. The Texas Department of Insurance has generally adopted these codified statutory accounting practices.

 

Texas also has adopted laws substantially similar to the NAIC’s risk based capital (“RBC”) laws, which require insurers to maintain minimum levels of capital based on their investments and operations. Domestic property and casualty insurers are required to report their RBC based on a formula that attempts to measure statutory capital and surplus needs based on the risks in the insurer’s mix of products and investment portfolio. The formula is designed to allow the Texas Department of Insurance to identify potential inadequately capitalized companies. Under the formula, a company determines its RBC by taking into account certain risks related to its assets (including risks related to its investment portfolio and ceded reinsurance) and its liabilities (including underwriting risks related to the nature and experience of its insurance business). Among other requirements, an insurance company must maintain capital and surplus of at least 200% of the RBC computed by the NAIC’s RBC model (known as the “Authorized Control Level” of RBC). At December 31, 2014, NLIC and ASIC capital and surplus levels exceeded the minimum RBC requirements that would trigger regulatory attention. In their 2014 statutory financial statements, both NLIC and ASIC complied with the NAIC’s RBC reporting requirements.

 

The NAIC’s Insurance Regulatory Information System (“IRIS”) was developed to assist state insurance departments in executing their statutory mandates to oversee the financial condition of insurance companies. IRIS identifies twelve industry ratios and specifies a range of “usual values” for each ratio. Departure from the usual values on four or more of these ratios can lead to inquiries from state insurance commissioners as to certain aspects of an insurer’s business. For 2014, all ratios for both NLIC and ASIC were within the usual values with two exceptions. Both companies fell below the indicated minimum investment yield range of 3%, with NLIC at 1.9% and ASIC at 1.5%, due to the concentration in cash at each company. We expect improvement in the yields at both companies as appropriate investment opportunities are identified.

 

The NAIC adopted an amendment to its “Model Audit Rule” in response to the passage of the Sarbanes-Oxley Act of 2002 (“SOX”). The amendment is effective for financial statements for accounting periods after January 1, 2010. This amendment addresses auditor independence, corporate governance and, most notably, the application of certain provisions of Section 404 of SOX regarding internal control reporting. The rules relating to internal controls apply to insurers with gross direct and assumed written premiums of $500 million or more, measured at the legal entity level (rather than at the insurance holding company level), and to insurers that the domiciliary commissioner selects from among those identified as in hazardous condition, but exempts SOX compliant entities. Neither NLIC nor ASIC currently has direct and assumed written premiums of at least $500 million, but it is conceivable that this may change in the future;  however, NLC must be SOX compliant because it is wholly owned by Hilltop, a public company subject to SOX compliance.

 

Legislative changes.  From time to time, various regulatory and legislative changes have been, or are, proposed that would adversely affect the insurance industry. Among the proposals that have been, or are being, considered are the possible introduction of Federal regulation in addition to, or in lieu of, the current system of state regulation of insurers and proposals in various state legislatures (some of which proposals have been enacted) to conform portions of their insurance laws and regulations to various Model Laws adopted by the NAIC. NLC is unable to predict whether any of these laws and regulations will be adopted, the form in which any such laws and regulations would be adopted, or the effect, if any, these developments would have on its financial condition or results of operations.

 

In November 2002, in response to the tightening supply in certain insurance and reinsurance markets resulting from, among other things, the September 11, 2001 terrorist attacks, the Terrorism Risk Insurance Act (“TRIA”) was enacted. TRIA was modified and extended by the Terrorism Risk Insurance Extension Act of 2005 and extended again by the Terrorism Risk Insurance Program Reauthorization Act of 2007. These Acts created a Federal Program designed to ensure the availability of commercial insurance coverage for terrorist acts in the United States. This Program helped the commercial property and casualty insurance industry cover claims related to terrorism-related losses and requires such companies to offer coverage for certain acts of terrorism. As a result, NLC is prohibited from adding certain terrorism exclusions to the policies written by its insurance company subsidiaries. The 2005 Act extended the Program through 2007, but eliminated commercial auto, farm-owners and certain other commercial coverages from its scope. The Terrorism Risk Insurance Program Reauthorization Act of 2015 further extended the Program through December 31, 2020 and set the reimbursement

 

31



Table of Contents

 

percentage at 85%, subject to a decrease of one percentage point per calendar year until it equals 80%, and the deductible at 20%. Although NLC is protected by federally funded terrorism reinsurance as provided for in the TRIA, there is a substantial deductible that must be met, the payment of which could have an adverse effect on its financial condition and results of operations. NLC’s deductible under the Program was $1.2 million for 2014 and is estimated to be $0.8 million in 2015. Potential future changes to the TRIA could also adversely affect NLC by causing its reinsurers to increase prices or withdraw from certain markets where terrorism coverage is required. NLC had no terrorism-related losses in 2014.

 

State insurance regulations.  State insurance authorities have broad powers to regulate U.S. insurance companies. The primary purposes of these powers are to promote insurer solvency and to protect individual policyholders. The extent of regulation varies, but generally has its source in statutes that delegate regulatory, supervisory and administrative power to state insurance departments. These powers relate to, among other things, licensing to transact business, accreditation of reinsurers, admittance of assets to statutory surplus, regulating unfair trade and claims practices, establishing actuarial requirements and solvency standards, regulating investments and dividends, and regulating policy forms, related materials and premium rates. State insurance laws and regulations require insurance companies to file financial statements prepared in accordance with accounting principles prescribed by insurance departments in states in which they conduct insurance business, and their operations are subject to examination by those departments.

 

As part of the broad authority that state insurance commissioners hold, they may impose periodic rules or regulations related to local issues or events. An example is the State of Oklahoma’s prohibition on the cancellation of policies for nonpayment of premium in the wake of severe tornadic activity. Due to the extent of damage and displacement of people, inability of mail to reach policyholders and inaccessibility of entire neighborhoods, the State of Oklahoma prohibited insurance companies from canceling or non-renewing policies for a period of time following the specific event.

 

Periodic financial and market conduct examinations.  The insurance departments in every state in which NLC’s insurance companies do business may conduct on-site visits and examinations of its insurance companies at any time to review the insurance companies’ financial condition, market conduct and relationships and transactions with affiliates. In addition, the Texas Department of Insurance will conduct comprehensive examinations of insurance companies domiciled in Texas every three to five years. Examinations are generally carried out in cooperation with the insurance departments of other licensing states under guidelines promulgated by the NAIC.

 

The Texas Department of Insurance completed their last examinations of NLIC and ASIC through December 31, 2010 in an examination report dated May 12, 2012. This examination report contained no information of any significant compliance issues and there is no indication of any significant changes to our financial statements as a result of the examination by the domiciliary state.

 

State dividend limitations.  The Texas Department of Insurance must approve any dividend declared or paid by an insurance company domiciled in the state if the dividend, together with all dividends declared or distributed by that insurance company during the preceding twelve months, exceeds the greater of (1) 10% of its policyholders’ surplus as of December 31 of the preceding year or (2) 100% of its net income for the preceding calendar year. The greater number is known as the insurer’s extraordinary dividend limit. At December 31, 2014, the extraordinary dividend limit for NLIC and ASIC was $14.9 million and $2.9 million, respectively. In addition, NLC’s insurance companies may only pay dividends out of their earned surplus.

 

Statutory accounting principles.  Statutory accounting principles (“SAP”) are a comprehensive basis of accounting developed to assist insurance regulators in monitoring and regulating the solvency of insurance companies. SAP rules are different from GAAP, and are intended to reflect a more conservative view of the insurer. SAP is primarily concerned with measuring an insurer’s surplus to policyholders. Accordingly, SAP focuses on valuing assets and liabilities of insurers at financial reporting dates in accordance with insurance laws and regulatory provisions applicable in each insurer’s domiciliary state.

 

While GAAP is concerned with a company’s solvency, it also stresses other financial measurements, such as income and cash flows. Accordingly, GAAP gives more consideration to appropriate matching of revenues and expenses and accounting for management’s stewardship of assets than does SAP. As a direct result, different amounts of assets and liabilities will be reflected in financial statements prepared in accordance with GAAP as opposed to SAP. SAP, as established by the NAIC and adopted by Texas regulators, determines the statutory surplus and statutory net income of the NLC insurance companies and, thus, determines the amount they have available to pay dividends.

 

Guaranty associations.  In Texas, and in all of the jurisdictions in which NLIC and ASIC are, or in the future may be, licensed to transact business, there is a requirement that property and casualty insurers doing business within the jurisdiction must participate in guaranty associations, which are organized to pay limited covered benefits owed pursuant to insurance

 

32



Table of Contents

 

policies issued by impaired, insolvent or failed insurers. These associations levy assessments, up to prescribed limits, on all member insurers in a particular state on the basis of the proportionate share of the premiums written by member insurers in the lines of business in which the impaired, insolvent or failed insurer was engaged. States generally permit member insurers to recover assessments paid through full or partial premium tax offsets.

 

NLC did not incur any levies in 2014, 2013 or 2012. Property and casualty insurance company insolvencies or failures may, however, result in additional guaranty fund assessments at some future date. At this time NLC is unable to determine the impact, if any, that these assessments may have on its financial condition or results of operations. NLC has established liabilities for guaranty fund assessments with respect to insurers that are currently subject to insolvency proceedings.

 

National Flood Insurance Program.  NLC’s insurance subsidiaries voluntarily participate as Write Your Own carriers in the National Flood Insurance Program (“NFIP”). The NFIP is administered and regulated by the Federal Emergency Management Agency (“FEMA”). NLIC and ASIC operates as a fiscal agent of the Federal government in the selling and administering of the Standard Flood Insurance Policy. This involves writing the policy, the collection of premiums and the paying of covered claims. All pricing is set by FEMA and all collections are made by NLIC and ASIC.

 

NLIC and ASIC cede 100% of the policies written by NLIC and ASIC on the Standard Flood Insurance Policy to FEMA; however, if FEMA were unable to perform, NLIC and ASIC would have a legal obligation to the policyholders. The terms of the reinsurance agreement are standard terms, which require NLIC and ASIC to maintain its rating criteria, determine policyholder eligibility, issue policies on NLIC and ASIC’s paper, endorse and cancel policies, collect from insureds and process claims. NLIC and ASIC receive ceding commissions from NFIP for underwriting administration, claims management, commission and adjuster fees.

 

Participation in involuntary risk plans.  NLC’s insurance companies are required to participate in residual market or involuntary risk plans in various states where they are licensed that provide insurance to individuals or entities that otherwise would be unable to purchase coverage from private insurers. If these plans experience losses in excess of their capitalization, they may assess participating insurers for proportionate shares of their financial deficit. These plans include the Georgia Underwriting Association, Texas FAIR Plan Association, Texas Windstorm Insurance Agency, the Louisiana Citizens Property Insurance Corporation, the Mississippi Residential Property Insurance Underwriting Association and the Mississippi Windstorm Underwriting Association.  For example in 2005, following Hurricanes Katrina and Rita, the above plans levied collective assessments totaling $10.4 million on NLC’s insurance subsidiaries. Additional assessments, including emergency assessments, may follow. In some of these instances, NLC’s insurance companies should be able to recover these assessments through policyholder surcharges, higher rates or reinsurance. The ultimate impact hurricanes have on the Texas and Louisiana facilities is currently uncertain and future assessments can occur whenever the involuntary facilities experience financial deficits.

 

Other.  Insurance activities are subject to state insurance laws and regulations as determined by the particular insurance commissioner for each state in accordance with the McCarran-Ferguson Act, as well as subject to the Gramm-Leach-Bliley Act and the privacy regulations promulgated by the Federal Trade Commission.

 

Changes in any of the laws governing our conduct could have an adverse impact on our ability to conduct our business or could materially affect our financial position, operating income, expense or cash flow.

 

Item 1A. Risk Factors.

 

The following discussion sets forth what management currently believes could be the most significant regulatory, market and economic, liquidity, legal and business and operational risks and uncertainties that could impact our business, results of operations and financial condition. Other risks and uncertainties, including those not currently known to us, could also negatively impact our businesses, results of operations and financial condition. Thus, the following should not be considered a complete discussion of all of the risks and uncertainties we may face and the order of their respective significance may change.

 

Risks Related to our Business

 

We may fail to realize all of the anticipated benefits of the FNB Transaction or the SWS Merger.

 

Achieving the anticipated cost savings and financial benefits of the FNB Transaction, the SWS Merger and any other acquisitions we may complete will depend, in part, on our ability to successfully integrate the operations of the respective companies with our own in an efficient and effective manner. It is possible that the integration process could result in the loss of key employees, the disruption of ongoing business or inconsistencies in standards, controls, procedures and policies

 

33



Table of Contents

 

that adversely affect our ability to maintain relationships with clients, customers, depositors and employees. In addition, the integration of certain operations will require the dedication of significant management resources, which may temporarily distract management’s attention from our day-to-day business. Any inability to realize the full extent, or any, of the anticipated cost savings and financial benefits of the FNB Transaction or the SWS Merger, as well as any delays encountered in the integration process, could have an adverse effect on our business and results of operations, which could adversely affect our financial condition and cause a decrease in our earnings per share or decrease or delay the expected accretive effect of the acquisitions and contribute to a decrease in the price of our common stock.

 

If our allowance for loan losses is insufficient to cover actual loan losses, our banking segment earnings will be adversely affected.

 

As a lender, we are exposed to the risk that we could sustain losses because our borrowers may not repay their loans in accordance with the terms of their loans. We have historically accounted for this risk by maintaining an allowance for loan losses in an amount intended to cover Bank management’s estimate of losses inherent in the loan portfolio. Under the acquisition method of accounting requirements, we were required to estimate the fair value of the loan portfolios acquired in each of the PlainsCapital Merger, the FNB Transaction and the SWS Merger as of the applicable acquisition date and write-down the recorded value of such acquired portfolio to that estimate. For most loans, this process was accomplished by computing the net present value of estimated cash flows to be received from borrowers of these loans. The allowance for loan losses that had been maintained by PlainsCapital Corporation, FNB or SWS, as applicable, prior to the transaction was eliminated in this accounting process. A new allowance for loan losses has been established for loans made by the Bank subsequent to consummation of the PlainsCapital Merger and for any decrease from that originally estimated as of the acquisition date in the estimate of cash flows to be received from the loans acquired in the PlainsCapital Merger and the FNB Transaction. We anticipate that we will establish a new allowance for loan losses for any decrease from that originally estimated as of the acquisition date in the estimate of cash flows to be received from the loans acquired in the SWS Merger.

 

The estimates of fair value as of the consummation of the PlainsCapital Merger, the FNB Transaction and the SWS Merger were based on economic conditions at such time and on Bank management’s projections concerning both future economic conditions and the ability of the borrowers to continue to repay their loans. If management’s assumptions and projections prove to be incorrect, however, the estimate of fair value may be higher than the actual fair value and we may suffer losses in excess of those estimated. Further, the allowance for loan losses established for new loans or for revised estimates may prove to be inadequate to cover actual losses, especially if economic conditions worsen.

 

While management will endeavor to estimate the allowance to cover anticipated losses, no underwriting and credit monitoring policies and procedures that we could adopt to address credit risk could provide complete assurance that we will not incur unexpected losses. These losses could have a material adverse effect on our business, financial condition, results of operations and cash flows. In addition, federal regulators periodically evaluate the adequacy of the allowance for loan losses and may require us to increase our provision for loan losses or recognize further loan charge-offs based on judgments different from those of our Bank management. As a result, any such increase in our provision for loan losses or additional loan charge-offs could have a material adverse effect on our results of operations and financial condition.

 

An adverse change in real estate market values may result in losses in our banking segment and otherwise adversely affect our profitability.

 

At December 31, 2014, 42% of the loan portfolio of our banking segment was comprised of loans with real estate as the primary component of collateral. The real estate collateral in each case provides a source of repayment in the event of default by the borrower and may deteriorate in value during the time the credit is extended. A decline in real estate values generally, and in Texas or California specifically, could impair the value of our collateral and our ability to sell the collateral upon any foreclosure. In the event of a default with respect to any of these loans, the amounts we receive upon sale of the collateral may be insufficient to recover the outstanding principal and interest on the loan. As a result, our results of operations and financial condition may be materially adversely affected by a decrease in real estate market values.

 

Loans acquired in the FNB Transaction may not be covered by the loss-share agreements if the FDIC determines that we have not adequately managed these loans.

 

Under the terms of the loss-share agreements we entered into with the FDIC in connection with the FNB Transaction, the FDIC is obligated to reimburse us for the following losses on 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 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

 

34



Table of Contents

 

effect for 8 years and 10 years, respectively, from September 13, 2013 (the “Bank Closing Date”). Although the FDIC has agreed to reimburse us for the substantial portion of losses on covered loans, the FDIC has the right to refuse or delay payment for loan losses if we do not manage covered loans in accordance with the loss-share agreements. In addition, reimbursable losses are based on the book value of the relevant loans as determined by the FDIC as of the effective dates of the transactions. The amount that we realize on these loans could differ materially from the carrying value that will be reflected in our consolidated financial statements, based upon the timing and amount of collections on the covered loans in future periods. Any losses we experience in the assets acquired in the FNB Transaction that are not covered under the loss-share agreements could have an adverse effect on our results of operations and financial condition.

 

In addition, 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 purchase and assumption agreement we entered into with the FDIC in connection with the FNB Transaction.

 

Our business and results of operations may be adversely affected by unpredictable economic, market and business conditions.

 

Our business and results of operations are affected by general economic, market and business conditions. The credit quality of our loan portfolio necessarily reflects, among other things, the general economic conditions in the areas in which we conduct our business. Our continued financial success depends to a degree on factors beyond our control, including:

 

·                  national and local economic conditions, such as the level and volatility of short-term and long-term interest rates, inflation, home prices, unemployment and under-employment levels, energy prices, bankruptcies, household income and consumer spending;

 

·                  general economic consequences of international conditions, such as weakness in the European and Asian economies and emerging markets and the impact of that weakness on the U.S. and global economies;

 

·                  the availability and cost of capital and credit;

 

·                  incidence of customer fraud; and

 

·                  federal, state and local laws affecting these matters.

 

The deterioration of any of these conditions, as we have experienced with past economic downturns, could adversely affect our consumer and commercial businesses and securities portfolios, our level of charge-offs and provision for credit losses, the carrying value of our deferred tax assets, the investment portfolio of our insurance segment, our capital levels and liquidity, and our results of operations.

 

Although the United States has recently seen improvement in certain economic indicators, including improvement in the housing market, increasing consumer confidence, continued growth in private sector employment, and improved credit availability, these improvements are relatively recent and may not be sustainable. Several factors could pose risks to the financial services industry, including political gridlock in Washington, D.C., regulatory uncertainty, continued infrastructure deterioration, and international political unrest. In addition, the current environment of heightened scrutiny of financial institutions has resulted in increased public awareness of and sensitivity to banking fees and practices. Each of these factors may adversely affect our fees and costs.

 

Our geographic concentration may magnify the adverse effects and consequences of any regional or local economic downturn.

 

We conduct our banking operations primarily in Texas. At December 31, 2014, substantially all of the real estate loans in our loan portfolio were secured by properties located in our three largest markets within Texas, with 34.8%, 26.0% and 18.6% secured by properties located in the Dallas/Fort Worth, Austin/San Antonio and Rio Grande Valley/South Texas markets, respectively. Substantially all of the real estate loans in our loan portfolio are made to borrowers who live and conduct business in Texas. Accordingly, economic conditions in Texas have a significant impact on the ability of the Bank’s customers to repay loans, the value of the collateral securing loans and the stability of the Bank’s deposit funding sources. Further, recent declines in crude oil prices may have a more profound effect on the economy of energy-dominant states such as Texas. At December 31, 2014, energy loans comprised 6.5% of the Bank’s loan portfolio, and the Bank also has loans extended to businesses that depend on the energy industry. If crude oil prices remain at low levels for an extended period, the Bank could experience weaker energy loan demand and increased losses within its energy and Texas-related loan portfolios.

 

35



Table of Contents

 

In addition, mortgage origination fee income and insurance premium volume are both dependent to a significant degree on economic conditions in Texas and California. During 2014, 23.7% and 15.0% by dollar volume of our mortgage loans originated were collateralized by properties located in Texas and California, respectively. Further, Texas insureds accounted for 69.3% of our insurance segment’s gross premiums written in 2014 and 2013, respectively. Any regional or local economic downturn that affects Texas or, to a lesser extent, California, whether caused by recession, inflation, unemployment, changing oil prices or other factors, may affect us and our profitability more significantly and more adversely than our competitors that are less geographically concentrated and could have a material adverse effect on our results of operations and financial condition.

 

Our geographic concentration may also exacerbate the adverse effects on our insurance segment of inherently unpredictable catastrophic events.

 

Our insurance segment expects to have large aggregate exposures to inherently unpredictable natural and man-made disasters of great severity, such as hurricanes, hail, tornados, windstorms, wildfires and acts of terrorism. Hurricanes Ike, Katrina and Rita highlighted the challenges inherent in predicting the impact of catastrophic events. The catastrophe models utilized by our insurance segment to assess its probable maximum insurance losses generally failed to adequately project the financial impact of these hurricanes. Although our insurance segment may attempt to exclude certain losses, such as terrorism and other similar risks, from some coverage that our insurance segment writes, it may be prohibited from, or may not be successful in, doing so. The occurrence of losses from catastrophic events may have a material adverse effect on our insurance segment’s ability to write new business and on its financial condition and results of operations. Increases in the values and geographic concentrations of policyholder property and the effects of inflation have resulted in increased severity of industry losses in recent years, and our insurance segment expects that these factors will increase the severity of losses in the future. Factors that may influence our insurance segment’s exposure to losses from these types of events, in addition to the routine adjustment of losses, include, among others:

 

·                  exhaustion of reinsurance coverage;

 

·                  increases in reinsurance rates;

 

·                  unanticipated litigation expenses;

 

·                  unrecoverability of ceded losses;

 

·                  impact on independent agent operations and future premium income in areas affected by catastrophic events;

 

·                  unanticipated expansion of policy coverage or reduction of premium due to regulatory, legislative and/or judicial action following a catastrophic event; and

 

·                  unanticipated demand surge related to other recent catastrophic events.

 

Our insurance segment writes insurance primarily in the states of Texas, Oklahoma, Arizona, Tennessee, Georgia and Louisiana. In 2014, Texas accounted for 69.3%, Arizona accounted for 9.2%, Oklahoma accounted for 7.7%, Tennessee accounted for 6.0% and Georgia accounted for 3.9% of our premiums. As a result, a single catastrophe, destructive weather pattern, wildfire, terrorist attack, regulatory development or other condition or general economic trend affecting these regions or significant portions of these regions could adversely affect our insurance segment’s financial condition and results of operations more significantly than other insurance companies that conduct business across a broader geographic area. Although our insurance segment purchases catastrophe reinsurance to limit its exposure to these types of catastrophes, in the event of one or more major catastrophes resulting in losses to it in excess of $140.0 million, our insurance segment’s losses would exceed the limits of its reinsurance coverage.

 

Our risk management processes may not fully identify and mitigate exposure to the various risks that we face, including interest rate, credit, liquidity and market risk.

 

We continue to refine our risk management techniques, strategies and assessment methods on an ongoing basis. However, risk management techniques and strategies, both ours and those available to the market generally, may not be fully effective in mitigating our risk exposure in all economic market environments or against all types of risk. For example, we might fail to identify or anticipate particular risks, or the systems that we use, and that are used within our business segments generally, may not be capable of identifying certain risks. Certain of our strategies for managing risk are based upon our use of observed historical market behavior. We apply statistical and other tools to these observations to quantify our risk exposure. Any failures in our risk management techniques and strategies to accurately identify and quantify our risk exposure could limit our ability to manage risks. In addition, any risk management failures could cause our losses to be significantly greater

 

36



Table of Contents

 

than the historical measures indicate. Further, our quantified modeling does not take all risks into account. As a result, we also take a qualitative approach in reducing our risk. Our qualitative approach to managing those risks could also prove insufficient, exposing us to material unanticipated losses.

 

Our business is subject to interest rate risk, and fluctuations in interest rates may adversely affect our earnings, capital levels and overall results.

 

The majority of our assets are monetary in nature and, as a result, we are subject to significant risk from changes in interest rates. Changes in interest rates may impact our net interest income in our banking segment as well as the valuation of our assets and liabilities in each of our segments. Earnings in our banking segment are significantly dependent on our net interest income, which is the difference between interest income on interest-earning assets, such as loans and securities, and interest expense on interest-bearing liabilities, such as deposits and borrowings. We expect to periodically experience “gaps” in the interest rate sensitivities of our banking segment’s assets and liabilities, meaning that either our interest-bearing liabilities will be more sensitive to changes in market interest rates than our interest-earning assets, or vice versa. In either event, if market interest rates should move contrary to our position, this “gap” may work against us, and our results of operations and financial condition may be adversely affected.

 

An increase in the general level of interest rates may also, among other things, adversely affect the demand for loans and our ability to originate loans. In particular, if mortgage interest rates increase, the demand for residential mortgage loans and the refinancing of residential mortgage loans will likely decrease, which will have an adverse effect on our income generated from mortgage origination activities. Conversely, a decrease in the general level of interest rates, among other things, may lead to prepayments on our loan and mortgage-backed securities portfolios and increased competition for deposits. Accordingly, changes in the general level of market interest rates may adversely affect our net yield on interest-earning assets, loan origination volume and our overall results.

 

Our broker-dealer segment holds securities, principally fixed-income municipal bonds, to support sales, underwriting and other customer activities. If interest rates increase, the value of debt securities held in the broker-dealer segment’s inventory would decrease. Rapid or significant changes in interest rates could adversely affect the segment’s bond sales, underwriting activities and broker-dealer businesses. Further, the profitability of our margin and stock lending businesses depends to a great extent on the difference between interest income earned on loans and investments of customer cash balances and the interest expense paid on customer cash balances and borrowings.

 

Our insurance segment invested over 87% of its invested assets in fixed maturity assets such as bonds and mortgage-backed securities at December 31, 2014. Because bond trading prices decrease as interest rates rise, a significant increase in interest rates could have a material adverse effect on our insurance segment’s financial condition and results of operations. On the other hand, decreases in interest rates could have an adverse effect on our insurance segment’s investment income and results of operations. For example, if interest rates decline, investment of new premiums received and funds reinvested will earn less. Additionally, mortgage-backed securities typically are prepaid more quickly when interest rates fall and the holder must reinvest the proceeds at lower interest rates. In periods of increasing interest rates, mortgage-backed securities typically are prepaid more slowly, which may require our insurance segment to receive interest payments that are below the then prevailing interest rates for longer time periods than expected. The volatility of our insurance segment’s claims may force it to liquidate securities, which may cause it to incur capital losses. If our insurance segment’s investment portfolio is not appropriately matched with its insurance liabilities, it may be forced to liquidate investments prior to maturity at a significant loss to cover these liabilities. In addition, if we experience market disruption and volatility, such as that experienced in 2009 and 2010, we may experience additional losses on our investments and reductions in our earnings. Investment losses could significantly decrease the asset base and statutory surplus of our insurance segment, thereby adversely affecting its ability to conduct business and potentially its A.M. Best financial strength rating.

 

In addition, we hold 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, which may fluctuate with changes in market interest rates. The effects of an increase in market interest rates may result in a decrease in the value of our available for sale investment portfolio.

 

Market interest rates are affected by many factors outside of our control, including inflation, recession, unemployment, money supply, international disorder and instability in domestic and foreign financial markets. We may not be able to accurately predict the likelihood, nature and magnitude of such changes or how and to what extent such changes may affect our business. We also may not be able to adequately prepare for, or compensate for, the consequences of such changes. Any failure to predict and prepare for changes in interest rates, or adjust for the consequences of these changes, may adversely affect our earnings and capital levels and overall results of operations and financial condition.

 

37



Table of Contents

 

Our bank lending, margin lending, stock lending, securities trading and execution and mortgage purchase businesses are all subject to credit risk.

 

We are exposed to credit risk in all areas of our business. The Bank is exposed to the risk that its loan customers may not repay their loans in accordance with their terms, the collateral securing the loans may be insufficient, or its loan loss reserve may be inadequate to fully compensate the Bank for the outstanding balance of the loan plus the costs to dispose of the collateral. Our mortgage warehousing activities subject us to credit risk during the period between funding by the Bank and when the mortgage company sells the loan to a secondary investor.

 

Our broker-dealer business is subject to credit risk if securities prices decline rapidly because the value of our collateral could fall below the amount of the indebtedness it secures. In rapidly appreciating markets, credit risk increases due to short positions. Our securities lending business as well as our securities trading and execution businesses subject us to credit risk if a counterparty fails to perform or if collateral securing its obligations is insufficient. In securities transactions, we are subject to credit risk during the period between the execution of a trade and the settlement by the customer.

 

Significant failures by our customers, including correspondents, or clients to honor their obligations, together with insufficient collateral and reserves, could have a material adverse effect on our business, financial condition, results of operations or cash flows.

 

Our banking segment is subject to funding risks associated with its high deposit concentration and its potential reliance on brokered deposits.

 

At December 31, 2014, the Bank’s fifteen largest depositors, excluding Hilltop and First Southwest, accounted for 13.24% of the Bank’s total deposits, and the Bank’s five largest depositors, excluding First Southwest, accounted for 7.77% of the Bank’s total deposits. Brokered deposits at December 31, 2014 accounted for 2.8% of the Bank’s total deposits, and we may increase our reliance on brokered deposits in the future. The loss of one or more of our largest Bank customers, a significant decline in our deposit balances due to ordinary course fluctuations related to these customers’ businesses, or, if we increase our reliance on brokered deposits, the loss of a significant amount of our brokered deposits could adversely affect our liquidity. Additionally, such circumstances could require us to raise deposit rates in an attempt to attract new deposits, or purchase federal funds or borrow funds on a short-term basis at higher rates, which would adversely affect our results of operations. Under applicable regulations, if the Bank were no longer “well capitalized,” the Bank would not be able to accept brokered deposits without the approval of the FDIC.

 

We are heavily dependent on dividends from our subsidiaries.

 

We are a financial holding company engaged in the business of managing, controlling and operating our subsidiaries, including the Bank and its subsidiary, PrimeLending, NLC and its two insurance company subsidiaries, NLIC and ASIC, and our Hilltop Securities subsidiaries. We conduct no material business or other activity other than activities incidental to holding stock in the Bank, NLC and the Hilltop Securities subsidiaries. As a result, we rely substantially on the profitability of, and dividends from, these subsidiaries to pay our operating expenses, to satisfy our obligations and to pay dividends on our preferred stock. Each of the Bank, NLC and the Hilltop Securities subsidiaries is subject to significant regulatory restrictions limiting their ability to declare and pay dividends to us. Accordingly, if the Bank, NLC or the Hilltop Securities subsidiaries are unable to make cash distributions to us, then we may be unable to satisfy our obligations or make distributions on our preferred stock.

 

NLIC and ASIC are also subject to limitations under debt agreements limiting their ability to declare and pay dividends, including the indenture governing NLC’s London Interbank Offered Rate (“LIBOR”) plus 3.40% notes due 2035 and the surplus indentures governing NLIC’s two LIBOR plus 4.10% and 4.05% notes due 2033 and ASIC’s LIBOR plus 4.05% notes due 2034.

 

We are subject to extensive supervision and regulation that could restrict our activities and impose financial requirements or limitations on the conduct of our business and limit our ability to generate income.

 

We are subject to extensive federal and state regulation and supervision, including that of the Federal Reserve Board, the Texas Department of Banking, the Texas Department of Insurance, the FDIC, the CFPB, the SEC and FINRA. Banking regulations are primarily intended to protect depositors’ funds, federal deposit insurance funds and the banking system as a whole, not stockholders or other debt holders. Insurance regulations promulgated by state insurance departments are primarily intended to protect policyholders rather than stockholders or other debt holders. Likewise, regulations promulgated

 

38



Table of Contents

 

by FINRA are primarily intended to protect customers of broker-dealer businesses rather than stockholders or other debt holders.

 

These regulations affect our lending practices, capital structure, capital requirements, investment practices, brokerage and investment advisory activities, dividend policy and growth, among other things. Failure to comply with laws, regulations or policies could result in money damages, civil money penalties or reputational damage, as well as sanctions and supervisory actions by regulatory agencies that could subject us to significant restrictions or suspensions on our business and our ability to expand through acquisitions or branching. Further, our clearing contracts generally include automatic termination provisions that are triggered in the event we are suspended from any of the national exchanges of which we are a member for failure to comply with the rules or regulations thereof. While we have implemented policies and procedures designed to prevent any such violations of laws and regulations, such violations may occur from time to time, which could have a material adverse effect on our financial condition and results of operations.

 

The U.S. Congress and federal regulatory agencies frequently revise banking and securities laws, regulations and policies. On July 21, 2010, President Obama signed into law the Dodd-Frank Act, which significantly alters the regulation of financial institutions and the financial services industry. The Dodd-Frank Act established the CFPB and requires the CFPB and other federal agencies to implement many provisions of the Dodd-Frank Act. We expect that several aspects of the Dodd-Frank Act may affect our business, including, without limitation, increased capital requirements, increased mortgage regulation, restrictions on proprietary trading in securities, restrictions on investments in hedge funds and private equity funds, executive compensation restrictions and disclosure and reporting requirements. At this time, it is difficult to predict the extent to which the Dodd-Frank Act or the resulting rules and regulations will affect our business. Compliance with these new laws and regulations likely will result in additional costs, which could be significant and may adversely impact our results of operations, financial condition, and liquidity.

 

During the second quarter of 2013, the Bank received a “satisfactory” CRA rating in connection with its most recent CRA performance evaluation. A CRA rating of less than “satisfactory” adversely affects a bank’s ability to establish new branches and impairs a bank’s ability to commence new activities that are “financial in nature” or acquire companies engaged in these activities. Other regulatory exam ratings or findings also may adversely impact our ability to branch, commence new activities or make acquisitions.

 

We cannot predict whether or in what form any other proposed regulations or statutes will be adopted or the extent to which our business may be affected by any new regulation or statute. Such changes could subject our business to additional costs, limit the types of financial services and products we may offer and increase the ability of non-banks to offer competing financial services and products, among other things.

 

The impact of the changing regulatory capital requirements and new capital rules are uncertain.

 

In July 2013, the Federal Reserve Board approved a final rule that substantially amends the risk-based capital rules applicable to Hilltop and the Bank. The final rule implements the Basel III regulatory capital reforms and changes required by the Dodd-Frank Act. The final rule includes new minimum risk-based capital and leverage ratios, which became effective on a phase-in basis for Hilltop and the Bank on January 1, 2015, and refines the definition of what constitutes “capital” for purposes of calculating these ratios. The new minimum capital requirements are: (i) a new common equity Tier 1 capital ratio of 4.5%; (ii) a Tier 1 to risk-based assets capital ratio of 6% (increased from 4%); (iii) a total capital ratio of 8% (unchanged from current rules); and (iv) a Tier 1 leverage ratio of 4%. The final rule also establishes a “capital conservation buffer” of 2.5% above the new regulatory minimum capital ratios and results in the following minimum ratios: (i) a common equity Tier 1 capital ratio of 7.0%; (ii) a Tier 1 to risk-based assets capital ratio of 8.5%; and (iii) a total capital ratio of 10.5%. The new capital conservation buffer requirement will be phased in beginning in January 2016 at 0.625% of risk-weighted assets and will increase each year until fully implemented in January 2019. An institution will be subject to limitations on paying dividends, engaging in share repurchases, and paying discretionary bonuses if its capital level falls below the buffer amount. These limitations will establish a maximum percentage of eligible retained income that can be utilized for such actions. The application of more stringent capital requirements for Hilltop and the Bank could, among other things, adversely affect our results of operations and growth, require the raising of additional capital, restrict our ability to pay dividends or repurchase shares and result in regulatory actions if we were to be unable to comply with such requirements.

 

In addition, the Federal Reserve Board adopted a final rule in February 2014 that clarifies how companies should incorporate the Basel III regulatory capital reforms into their capital and business projections during the 2014 and subsequent cycles of capital plan submissions and stress tests required under the Dodd-Frank Act. For companies and their subsidiary banks with between $10.0 billion and $50.0 billion in total consolidated assets, the initial stress testing cycle

 

39



Table of Contents

 

began on October 1, 2013 and the initial nine-quarter planning horizon for stress capital projections continues through the fourth quarter of 2015, which overlaps with the implementation of the Basel III capital reforms beginning on January 1, 2015. At December 31, 2014, Hilltop and the Bank had $9.2 billion and $8.0 billion, respectively, in total consolidated assets and their average of total consolidated assets for the four most recent consecutive quarters was $9.2 billion and $8.1 billion, respectively. Accordingly, Hilltop and the Bank are not currently subject to capital planning and stress testing requirements. However, as a result of the SWS Merger, Hilltop has more than $10.0 billion in assets. If such asset level is maintained, we will become subject to the stress testing requirements, which will increase our cost of regulatory compliance. Management continues to study the implementation of Basel III regulatory capital reforms and stress testing requirements.

 

In July 2013 the SEC also adopted various amendments to Rules 15c3-1 and 15c3-3 under the Exchange Act related to, among other things, securities lending, certain new deductions from net capital, proprietary accounts of broker-dealer customers, certain broker-dealer insolvency events and corresponding related amendments to books and records rules.

 

The CFPB has issued “ability-to-repay” and “qualified mortgage” rules that may have a negative impact on our loan origination process and foreclosure proceedings, which could adversely affect our business, operating results, and financial condition.

 

On January 10, 2013, the CFPB issued a final rule to implement the “qualified mortgage” provisions of the Dodd-Frank Act requiring mortgage lenders to consider consumers’ ability to repay home loans before extending them credit. The CFPB’s “qualified mortgage” rule took effect on January 10, 2014. The final rule describes certain minimum requirements for lenders making ability-to-repay determinations, but does not dictate that they follow particular underwriting models. Lenders will be presumed to have complied with the ability-to-repay rule if they issue “qualified mortgages,” which are generally defined as mortgage loans prohibiting or limiting certain risky features. Loans that do not meet the ability-to-repay standard can be challenged in court by borrowers who default and the absence of ability-to-repay status can be used against a lender in foreclosure proceedings. Any loans that we make outside of the “qualified mortgage” criteria could expose us to an increased risk of liability and reduce or delay our ability to foreclose on the underlying property. The CFPB’s “qualified mortgage” rule could limit our ability or desire to make certain types of loans or loans to certain borrowers, or could make it more expensive or time consuming to make these loans. Any decreases in loan origination volume or increases in compliance and foreclosure costs caused by the rule could negatively affect our business, operating results and financial condition.

 

Our broker-dealer business is subject to various risks associated with the securities industry, particularly those impacting the public finance industry.

 

Our broker-dealer business is subject to uncertainties that are common in the securities industry. These uncertainties include:

 

·                  intense competition in the public finance and other sectors of the securities industry;

 

·                  the volatility of domestic and international financial, bond and stock markets;

 

·                  extensive governmental regulation;

 

·                  litigation; and

 

·                  substantial fluctuations in the volume and price level of securities.

 

As a result, the revenues and operating results of our broker-dealer segment may vary significantly from quarter to quarter and from year to year. Unfavorable financial or economic conditions could reduce the number and size of transactions in which we provide financial advisory, underwriting and other services. Disruptions in fixed income and equity markets could lead to a decline in the volume of transactions executed for customers and, therefore, to declines in revenues from commissions and clearing services. Our broker-dealer business is much smaller and has much less capital than many competitors in the securities industry. In addition, FSC, Southwest Securities and SWS Financial are operating subsidiaries of Hilltop, which means that their activities are limited to those that are permissible for subsidiaries of a financial holding company.

 

Market fluctuations could adversely impact our broker-dealer business.

 

Our broker-dealer segment is subject to risks as a result of fluctuations in the securities markets. Our securities trading, market-making and underwriting activities involve the purchase and sale of securities as a principal, which subjects our capital to significant risks. Market conditions could limit our ability to sell securities purchased or to purchase securities sold

 

40



Table of Contents

 

in such transactions. If price levels for equity securities decline generally, the market value of equity securities that we hold in our inventory could decrease and trading volumes could decline. In addition, if interest rates increase, the value of debt securities we hold in our inventory would decrease. Rapid or significant market fluctuations could adversely affect our business, financial condition, results of operations and cash flow.

 

In addition, during periods of market disruption, it may be difficult to value certain assets if comparable sales become less frequent or market data becomes less observable.  Certain classes of assets or loan collateral that were in active markets with significant observable data may become illiquid due to the current financial environment.  In such cases, asset valuations may require more estimation and subjective judgment.

 

Our investment advisory business may be affected if our investment products perform poorly.

 

Poor investment returns and declines in client assets in our investment advisory business, due to either general market conditions or underperformance (relative to our competitors or to benchmarks) by investment products, affects our ability to retain existing assets, prevent clients from transferring their assets out of products or their accounts, or inhibit our ability to attract new clients or additional assets from existing clients. Any such poor performance could adversely affect our investment advisory business and the advisory fees that we earn on client assets.

 

Our portfolio trading business is highly price competitive and serves a very limited market.

 

Our portfolio trading business serves one small component of the capital markets group with a small customer base and a high service model, charging competitive commission rates. Consequently, growing or maintaining market share is very price sensitive. We rely upon a high level of customer service and product customization to maintain our market share; however, should prevailing market prices fall, or the size of our market segment or customer base decline, our profitability would be adversely impacted.  In addition, in our portfolio trading business, we purchase securities as principal, which subjects our capital to significant risks.

 

Our existing correspondents may choose to perform their own clearing services, move their clearing business to one of our competitors or exit the business.

 

As our correspondents’ operations grow, they often consider the option of performing clearing functions themselves, in a process referred to as “self-clearing.” The option to convert to self-clearing operations may be attractive due to the fact that as the transaction volume of a broker-dealer grows, the cost of implementing the necessary infrastructure for self-clearing may eventually be offset by the elimination of per transaction processing fees that would otherwise be paid to a clearing firm. Additionally, performing their own clearing services allows self-clearing broker-dealers to retain their customers’ margin balances, free credit balances and securities for use in margin lending activities. Furthermore, our correspondents may decide to use the clearing services of one of our competitors or exit the business. Any significant loss of correspondents due to self-clearing or because of their use of a competitor’s clearing service or their exiting the business could have a material adverse effect on our business, financial condition, results of operations or cash flows.

 

Several of our broker-dealer segment’s product lines rely on favorable tax treatment and changes in federal tax law could impact the attractiveness of these products to our customers.

 

We offer a variety of services and products, such as individual retirement accounts and municipal bonds, that rely on favorable federal income tax treatment to be attractive to our customers. Should favorable tax treatment of these products be eliminated or reduced, sales of these products could be materially impacted, which could have a material adverse effect on our business, financial condition, results of operations or cash flows.

 

Our mortgage origination segment is subject to investment risk on loans that it originates.

 

We intend to sell, and not hold for investment, substantially all residential mortgage loans that we originate through PrimeLending. At times, however, we may originate a loan or execute an interest rate lock commitment (“IRLC”) with a customer pursuant to which we agree to originate a mortgage loan on a future date at an agreed-upon interest rate without having identified a purchaser for such loan. An identified purchaser may also decline to purchase a loan for a variety of reasons. In these instances, we will bear interest rate risk on an IRLC until, and unless, we are able to find a buyer for the loan underlying such IRLC and the risk of investment on a loan until, and unless, we are able to find a buyer for such loan. In addition, if a customer defaults on a mortgage payment shortly after the loan is originated, the purchaser of the loan may have a put right, whereby the purchaser can require us to repurchase the loan at the full amount that it paid. During periods of market downturn, we have at times chosen to hold mortgage loans when the identified purchasers have declined to

 

41



Table of Contents

 

purchase such loans because we could not obtain an acceptable substitute bid price for such loan. The failure of mortgage loans that we hold on our books to perform adequately could have a material adverse effect on our financial condition, liquidity and results of operations.

 

Changes in interest rates may change the value of our mortgage servicing rights portfolio which may increase the volatility of our earnings.

 

We have recently expanded, and may continue to expand, our residential mortgage servicing operations within our mortgage origination segment. As a result of our mortgage servicing business, we have a portfolio of MSR assets. A MSR is the right to service a mortgage loan-collect principal, interest and escrow amounts-for a fee. We measure and carry all of our residential MSR assets using the fair value measurement method. Fair value is determined as the present value of estimated future net servicing income, calculated based on a number of variables, including assumptions about the likelihood of prepayment by borrowers.

 

One of the principal risks associated with MSR assets is that in a declining interest rate environment, they will likely lose a substantial portion of their value as a result of higher than anticipated prepayments. Moreover, if prepayments are greater than expected, the cash we receive over the life of the mortgage loans would be reduced. During the three months ended September 30, 2014, the mortgage origination segment began using derivative financial instruments, including interest rate swaps and swaptions, as a means to mitigate market risk associated with MSR assets. However, no hedging strategy can protect us completely, and hedging strategies may fail because they are improperly designed, improperly executed and documented or based on inaccurate assumptions and, as a result, could actually increase our risks and losses. The increasing size of our MSR portfolio may increase our interest rate risk and correspondingly, the volatility of our earnings, especially if we cannot adequately hedge the interest rate risk relating to our MSR assets.

 

At December 31, 2014, the mortgage origination segment’s MSR asset had a fair value of $37.4 million. All income related to retained servicing, including changes in the value of the MSR asset, is included in noninterest income. Depending on the interest rate environment, it is possible that the fair value of our MSR asset may be reduced in the future. If such changes in fair value significantly reduce the carrying value of our MSR asset, our financial condition and results of operations would be negatively affected.

 

Income that we recognize in connection with the purchase discount of the credit-impaired loans acquired in the PlainsCapital Merger, the FNB Transaction and the SWS Merger and accounted for under Accounting Standards Codification 310-30 could be volatile in nature and have significant effects on reported net income.

 

In connection with the PlainsCapital Merger and the FNB Transaction, we acquired loans at a discount of $146.6 million and $343.1 million, respectively, and we anticipate that we will record a discount on loans acquired in the SWS Merger. The PlainsCapital Merger, the FNB Transaction and the SWS Merger have each been accounted for under the acquisition method of accounting. Accordingly, these discounts are amortized and accreted to interest income on a monthly basis. The effective yield and related discount accretion on credit-impaired loans is initially determined at the acquisition date based upon estimates of the timing and amount of future cash flows as well as the amount of credit losses that will be incurred. These estimates are updated quarterly. In future periods, if actual historical results combined with future projections of these factors (amount, timing, or credit losses) differ from the initial projections, the effective yield and the amount of discount recognized will change. Volatility may increase as the variance of actual results from initial projections increases. As the acquired loans are removed from our books, the related discount will no longer be available for accretion into income. Accretion of $37.4 million and $43.7 million on loans purchased at a discount in the PlainsCapital Merger and FNB Transaction, respectively, were recorded as interest income during the year ended December 31, 2014. As of December 31, 2014, the balance of our discount on loans in the aggregate was $308.9 million, and we anticipate that we will record an additional discount on loans after accounting for the loans acquired in the SWS Merger.

 

We ultimately may write-off goodwill and other intangible assets resulting from business combinations.

 

As a result of purchase accounting in connection with our acquisition of NLC, the PlainsCapital Merger and the FNB Transaction, our consolidated balance sheet at December 31, 2014, contained goodwill of $251.8 million and other intangible assets of $59.8 million. The SWS Merger will result in additional intangible assets being recorded based on the determination of fair values of identifiable assets acquired. On an ongoing basis, we evaluate whether facts and circumstances indicate any impairment of value of intangible assets. As circumstances change, the value of these intangible assets may not be realized by us. If we determine that a material impairment has occurred, we will be required to write-off the impaired portion of intangible assets, which could have a material adverse effect on our results of operations in the period in which the write-off occurs.

 

42



Table of Contents

 

The accuracy of our financial statements and related disclosures could be affected if we are exposed to actual conditions different from the judgments, assumptions or estimates used in our critical accounting policies.

 

The preparation of financial statements and related disclosure in conformity with GAAP requires us to make judgments, assumptions and estimates that affect the amounts reported in our consolidated financial statements and accompanying notes. Our critical accounting policies, which are included in this Annual Report, describe those significant accounting policies and methods used in the preparation of our consolidated financial statements that are considered “critical” by us because they require judgments, assumptions and estimates that materially impact our consolidated financial statements and related disclosures. As a result, if future events differ significantly from the judgments, assumptions and estimates in our critical accounting policies, such events or assumptions could have a material impact on our audited consolidated financial statements and related disclosures.

 

We are dependent on our management team, and the loss of our senior executive officers or other key employees could impair our relationship with customers and adversely affect our business and financial results.

 

Our success is dependent, to a large degree, upon the continued service and skills of our existing management team and other key employees with long-term customer relationships. Our business and growth strategies are built primarily upon our ability to retain employees with experience and business relationships within their respective segments. The loss of one or more of these key personnel could have an adverse impact on our business because of their skills, knowledge of the market, years of industry experience and the difficulty of finding qualified replacement personnel. In addition, we currently do not have non-competition agreements with certain members of management and other key employees. If any of these personnel were to leave and compete with us, our business, financial condition, results of operations and growth could suffer.

 

A decline in the market for municipal advisory services could adversely affect our business and results of operations.

 

Our broker-dealer segment has historically earned a significant portion of its revenues from advisory fees paid to it by its clients, in large part upon the successful completion of the client’s transaction. Revenues from the public finance group of First Southwest represented the largest component of our broker-dealer segment’s net revenues for the year ended December 31, 2014. Unlike other investment banks, First Southwest earns most of its revenues from its advisory fees and, to a lesser extent, from other business activities such as commissions and underwriting. New issuances in the municipal market by cities, counties, school districts, state and other governmental agencies, airports, healthcare institutions, institutions of higher education and other clients that First Southwest’s public finance group serves can be subject to significant fluctuations based on by factors such as changes in interest rates, property tax bases, budget pressures on certain issuers caused by uncertain economic times and other factors. We expect that the reliance of our broker-dealer segment on advisory fees will continue for the foreseeable future, and a decline in public finance advisory engagements or the market for advisory services generally would have an adverse effect on our business and results of operations.

 

The soundness of other financial institutions could adversely affect our business.

 

Our ability to engage in routine funding transactions could be adversely affected by the actions and commercial soundness of other financial institutions. Financial services institutions are interrelated as a result of trading, clearing, counterparty or other relationships. We have exposure to many different counterparties and we routinely execute transactions with counterparties in the financial services industry, including brokers and dealers, commercial banks, credit unions, investment banks, mutual and hedge funds, and other institutional clients. As a result, defaults by, or even negative speculation about, one or more financial services institutions, or the financial services industry in general, have led to market-wide liquidity problems and could lead to losses or defaults by us or by other institutions. Many of these transactions expose us to credit risk in the event of default of our counterparty or client. In addition, our credit risk may be exacerbated when the collateral held by us cannot be realized or is liquidated at prices not sufficient to recover the full amount of the receivable due us. Any such losses could be material and could materially and adversely affect our business, financial condition, results of operations or cash flows.

 

We depend on our computer and communications systems and an interruption in service would negatively affect our business.

 

Our businesses rely on electronic data processing and communications systems. The effective use of technology allows us to better serve customers and clients, increases efficiency and reduces costs. Our continued success will depend, in part, upon our ability to successfully maintain, secure and upgrade the capability of our systems, our ability to address the needs of our clients by using technology to provide products and services that satisfy their demands and our ability to retain skilled information technology employees. Significant malfunctions or failures of our computer systems, computer security,

 

43



Table of Contents

 

software or any other systems in the trading process (e.g., record retention and data processing functions performed by third parties, and third party software, such as Internet browsers) could cause delays in customer trading activity. Such delays could cause substantial losses for customers and could subject us to claims from customers for losses, including litigation claiming fraud or negligence. In addition, if our computer and communications systems fail to operate properly, regulations would restrict our ability to conduct business. Any such failure could prevent us from collecting funds relating to customer and client transactions, which would materially impact our cash flows. Any computer or communications system failure or decrease in computer system performance that causes interruptions in our operations could have a material adverse effect on our business, financial condition, results of operations or cash flows.

 

The financial services industry is continually undergoing rapid technological change with frequent introductions of new technology-driven products and services. Many of our competitors have substantially greater resources to invest in technological improvements. We may not be able to effectively or timely implement new technology-driven products and services or be successful in marketing these products and services to our customers and clients. Failure to successfully keep pace with technological change affecting the financial services industry could have a material adverse impact on our business, financial condition, results of operations or cash flows.

 

Negative publicity regarding us, or financial institutions in general, could damage our reputation and adversely impact our business and results of operations.

 

Our ability to attract and retain customers and conduct our business could be adversely affected to the extent our reputation is damaged. Reputational risk, or the risk to our business, earnings and capital from negative public opinion regarding our company, or financial institutions in general, is inherent in our business. Adverse perceptions concerning our reputation could lead to difficulties in generating and maintaining accounts as well as in financing them. In particular, negative perceptions concerning our reputation could lead to decreases in the level of deposits that consumer and commercial customers and potential customers choose to maintain with us. Negative public opinion could result from actual or alleged conduct in any number of activities or circumstances, including lending or foreclosure practices; sales practices; corporate governance and potential conflicts of interest; ethical failures or fraud, including alleged deceptive or unfair lending or pricing practices; regulatory compliance; protection of customer information; cyber-attacks, whether actual, threatened, or perceived; negative news about us or the financial institutions industry generally; general company performance; or from actions taken by government regulators and community organizations in response to such activities or circumstances. Furthermore, our failure to address, or the perception that we have failed to address, these issues appropriately could impact our ability to keep and attract customers and/or employees and could expose us to litigation and/or regulatory action, which could have an adverse effect on our business and results of operations.

 

Our operational systems and networks have been, and will continue to be, subject to an increasing risk of continually evolving cybersecurity or other technological risks, which could result in a loss of customer business, financial liability, regulatory penalties, damage to our reputation or the disclosure of confidential information.

 

We rely heavily on communications and information systems to conduct our business and maintain the security of confidential information and complex transactions, which subjects us to an increasing risk of cyber incidents from these activities due to a combination of new technologies and the increasing use of the Internet to conduct financial transactions, as well as a potential failure of interruption or breach in the security of these systems, including those that could result from attacks or planned changes, upgrades and maintenance of these systems. Such cyber incidents could result in failures or disruptions in our customer relationship management, securities trading, general ledger, deposits, computer systems, electronic underwriting servicing or loan origination systems. Third parties with which we do business may also be sources of cybersecurity or other technological risks.

 

Although we devote significant resources to maintain and regularly upgrade our systems and networks with measures such as intrusion detection and prevention systems and monitoring firewalls to safeguard critical business applications, there is no guarantee that these measures or any other measures can provide absolute security. Our computer systems, software and networks may be adversely affected by cyber incidents such as unauthorized access; loss or destruction of data (including confidential client information); account takeovers; unavailability of service; computer viruses or other malicious code; cyber-attacks; and other events. These threats may derive from human error, fraud or malice on the part of employees or third parties, or may result from accidental technological failure. Additional challenges are posed by external extremist parties, including foreign state actors, in some circumstances, as a means to promote political ends. If one or more of these events occurs, it could result in the disclosure of confidential client information, damage to our reputation with our clients and the market, customer dissatisfaction, additional costs such as repairing systems or adding new personnel or protection technologies, regulatory penalties, exposure to litigation and other financial losses to both us and our clients and customers. Such events could also cause interruptions or malfunctions in our operations.

 

44



Table of Contents

 

We have been the subject of “denial of services” attacks from external sources that have limited or interrupted the availability of our online banking services. Although to date we are not aware of any material losses relating to cyber-attacks or other information security breaches, we may suffer such losses in the future. We have taken steps to improve and upgrade the security of our systems in response to such threats, but such incidents could occur again, more frequently or on a more significant scale.

 

In February 2014, FINRA released a report identifying principles and effective practices it expects firms to consider as they develop or enhance their cybersecurity programs. We intend to evaluate our cybersecurity program in light of the guidance in this recent report and will consider incorporating new practices as necessary to meet FINRA’s expectations.

 

We face strong competition from other financial institutions and financial service and insurance companies, which may adversely affect our operations and financial condition.

 

Our banking and mortgage origination businesses face vigorous competition from banks and other financial institutions, including savings and loan associations, savings banks, finance companies and credit unions. A number of these banks and other financial institutions have substantially greater resources and lending limits, larger branch systems and a wider array of banking services than we do. We also compete with other providers of financial services, such as money market mutual funds, brokerage firms, consumer finance companies, insurance companies and governmental organizations, each of which may offer more favorable financing than we are able to provide. In addition, some of our non-bank competitors are not subject to the same extensive regulations that govern us. The banking business in Texas has become increasingly competitive over the past several years, and we expect the level of competition we face to further increase. Our profitability depends on our ability to compete effectively in these markets. This competition may reduce or limit our margins on banking services, reduce our market share and adversely affect our results of operations and financial condition.

 

The financial advisory and investment banking industries also are intensely competitive industries and will likely remain competitive. Our broker-dealer business competes directly with numerous other financial advisory and investment banking firms, broker-dealers and banks, including large national and major regional firms and smaller niche companies, some of whom are not broker-dealers and, therefore, not subject to the broker-dealer regulatory framework. In addition to competition from firms currently in the industry, there has been increasing competition from others offering financial services, including automated trading and other services based on technological innovations. Our broker-dealer business competes on the basis of a number of factors, including the quality of advice and service, technology, product selection, innovation, reputation client relationships and price. Many of our broker-dealer segment’s competitors in the investment banking industry have a greater range of products and services, greater financial and marketing resources, larger customer bases, greater name recognition, more managing directors to serve their clients’ needs, greater global reach and more established relationships with their customers than our broker-dealer business. Additionally, certain competitors of our financial advisory business have reorganized or plan to reorganize from investment banks into bank holding companies which may provide them with a competitive advantage. These larger and better capitalized competitors may be more capable of responding to changes in the investment banking market, to compete for skilled professionals, to finance acquisitions, to fund internal growth and to compete for market share generally. Increased pressure created by any current or future competitors, or by competitors of our broker-dealer business collectively, could materially and adversely affect our business and results of operations. Increased competition may result in reduced revenue and loss of market share. Further, as a strategic response to changes in the competitive environment, our broker-dealer business may from time to time make certain pricing, service or marketing decisions that also could materially and adversely affect our business and results of operations.

 

The insurance industry also is highly competitive and has, historically, been characterized by periods of significant price competition, alternating with periods of greater pricing discipline during which competitors focus on other factors, including service, experience, the strength of agent and policyholder relationships, reputation, speed and accuracy of claims payment, perceived financial strength, ratings, scope of business, commissions paid and policy and contract terms and conditions. Our insurance business competes with many other insurers, including large national companies which have greater financial, marketing and management resources than our insurance segment. Many of these competitors also have better ratings and market recognition than our insurance business.

 

In addition, a number of new, proposed or potential industry developments also could increase competition in our insurance segment’s industry. These developments include changes in practices and other effects caused by the Internet (including direct marketing campaigns by our insurance segment’s competitors in established and new geographic markets), which have led to greater competition in the insurance business and increased expectations for customer service. These developments could prevent our insurance business from expanding its book of business. Our insurance business also faces competition from new entrants into the insurance market. New entrants do not have historic claims or losses to address and,

 

45



Table of Contents

 

therefore, may be able to price policies on a basis that is not favorable to our insurance business. New competition could reduce the demand for our insurance segment’s insurance products, which could have a material adverse effect on our financial condition and results of operations.

 

Our mortgage origination and insurance businesses are subject to seasonal fluctuations and, as a result, our results of operations for any given quarter may not be indicative of the results that may be achieved for the full fiscal year.

 

Our mortgage origination business is subject to several variables that can impact loan origination volume, including seasonal and interest rate fluctuations. We typically experience increased loan origination volume from purchases of homes during the second and third calendar quarters, when more people tend to move and buy or sell homes. In addition, an increase in the general level of interest rates may, among other things, adversely affect the demand for mortgage loans and our ability to originate mortgage loans. In particular, if mortgage interest rates increase, the demand for residential mortgage loans and the refinancing of residential mortgage loans will likely decrease, which will have an adverse effect on our mortgage origination activities. Conversely, a decrease in the general level of interest rates, among other things, may lead to increased competition for mortgage loan origination business. As a result of these variables, our results of operations for any single quarter are not necessarily indicative of the results that may be achieved for a full fiscal year.

 

Generally, our 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.

 

If the actual losses and loss adjustment expenses of our insurance segment exceed its loss and expense estimates, its financial condition and results of operations could be materially adversely affected.

 

The financial condition and results of operations of our insurance segment depend upon its ability to assess accurately the potential losses associated with the risks that it insures. Our insurance segment establishes reserve liabilities to cover the payment of all losses and loss adjustment expenses incurred under the policies that it writes. These liability estimates include case estimates, which are established for specific claims that have been reported to our insurance segment, and liabilities for claims that have been incurred but not reported (“IBNR”). Loss adjustment expenses represent expenses incurred to investigate and settle claims. To the extent that losses and loss adjustment expenses exceed estimates, NLIC and ASIC will be required to increase their reserve liabilities and reduce their income in the period in which the deficiency is identified. In addition, increasing reserves causes a reduction in policyholders’ surplus and could cause a downgrade in the ratings of NLIC and ASIC. This, in turn, could diminish our ability to sell insurance policies.

 

The liability estimation process for our insurance segment’s casualty insurance coverage possesses characteristics that make case and IBNR reserving inherently less susceptible to accurate actuarial estimation than is the case with property coverages. Unlike property losses, casualty losses are claims made by third-parties of which the policyholder may not be aware and, therefore, may be reported a significant time after the occurrence, including sometimes years later. As casualty claims most often involve claims of bodily injury, assessment of the proper case estimates is a far more subjective process than claims involving property damage. In addition, in determining the case estimate for a casualty claim, information develops slowly over the life of the claim and can subject the case estimation to substantial modification well after the claim was first reported. Numerous factors impact the casualty case reserving process, such as venue, the amount of monetary damage, legislative activity, the permanence of the injury and the age of the claimant.

The effects of inflation could cause the severity of claims from catastrophes or other events to rise in the future. Increases in the values and geographic concentrations of policyholder property and the effects of inflation have resulted in increased severity of industry losses in recent years, and our insurance segment expects that these factors will increase the severity of losses in the future. As NLC observed in 2008, the severity of some catastrophic weather events, including the scope and extent of damage and the inability to gain access to damaged properties, and the ensuing shortages of labor and materials and resulting demand surge, provide additional challenges to estimating ultimate losses. Our insurance segment’s liabilities for losses and loss adjustment expenses include assumptions about future payments for settlement of claims and claims handling expenses, such as medical treatments and litigation costs. To the extent inflation causes these costs to increase above liabilities established for these costs, our insurance segment expects to be required to increase its liabilities, together with a corresponding reduction in its net income in the period in which the deficiency is identified.

 

Estimating an appropriate level of liabilities for losses and loss adjustment expense is an inherently uncertain process. Accordingly, actual loss and loss adjustment expenses paid will likely deviate, perhaps substantially, from the liability estimates reflected in our insurance segment’s consolidated financial statements. Claims could exceed our insurance

 

46



Table of Contents

 

segment’s estimate for liabilities for losses and loss adjustment expenses, which could have a material adverse effect on its financial condition and results of operations.

 

If our insurance segment cannot obtain adequate reinsurance protection for the risks it underwrites or its reinsurers do not pay losses in a timely fashion, or at all, our insurance segment will suffer greater losses from these risks or may reduce the amount of business it underwrites, which may materially adversely affect its financial condition and results of operations.

 

Our insurance segment purchases reinsurance to protect itself from certain risks and to share certain risks it underwrites. During 2014 and 2013, our insurance segment’s personal lines ceded 10.2% and 10.2%, respectively, of its direct insurance premiums written (primarily through excess of loss, quota share and catastrophe reinsurance treaties) and its commercial lines ceded 4.6% and 4.6%, respectively, of its direct insurance premiums written (primarily through excess of loss and catastrophe reinsurance treaties). The total cost of reinsurance, inclusive of per risk excess and catastrophe, decreased 4.1% in the year ended December 31, 2014, which is partially attributable to reduced limits, lower rates and lower reinstatement premiums in 2014 of $0.1 million. Reinsurance cost generally fluctuates as a result of storm costs or any changes in capacity within the reinsurance market.

 

From time to time, market conditions have limited, and in some cases have prevented, insurers from obtaining the types and amounts of reinsurance that they have considered adequate for their business needs. Accordingly, our insurance segment may not be able to obtain desired amounts of reinsurance. Even if our insurance segment is able to obtain adequate reinsurance, it may not be able to obtain it from entities with satisfactory creditworthiness or negotiate terms that it deems appropriate or acceptable. Although the cost of reinsurance is, in some cases, reflected in our insurance segment’s premium rates, our insurance segment may have guaranteed certain premium rates to its policyholders. Under these circumstances, if the cost of reinsurance were to increase with respect to policies for which our insurance segment guaranteed the rates, our insurance segment would be adversely affected. In addition, if our insurance segment cannot obtain adequate reinsurance protection for the risks it underwrites, it may be exposed to greater losses from these risks or it may be forced to reduce the amount of business that it underwrites for such risks, which will reduce our insurance segment’s revenue and may have a material adverse effect on its results of operations and financial condition.

 

At December 31, 2014, our insurance segment had $4.9 million in reinsurance recoverables, including ceded paid loss recoverables, ceded losses and loss adjustment expense recoverables and ceded unearned insurance premiums. Our insurance segment expects to continue to purchase substantial reinsurance coverage in the foreseeable future. Because our insurance segment remains primarily liable to its policyholders for the payment of their claims, regardless of the reinsurance it has purchased relating to those claims, in the event that one of its reinsurers becomes insolvent or otherwise refuses to reimburse our insurance segment for losses paid, or delays in reimbursing our insurance segment for losses paid, its liability for these claims could materially and adversely affect its financial condition and results of operations.

 

We are subject to legal claims and litigation, including potential securities law liabilities, any of which could have a material adverse effect on our business.

 

We face significant legal risks in each of the business segments in which we operate, and the volume of legal claims and amount of damages and penalties claimed in litigation and regulatory proceedings against financial service companies remains high. These risks often are difficult to assess or quantify, and their existence and magnitude often remain unknown for substantial periods of time. Substantial legal liability or significant regulatory action against us or any of our subsidiaries could have a material adverse effect on our results of operations or cause significant reputational harm to us, which could seriously harm our business and prospects. Further, regulatory inquiries and subpoenas, other requests for information, or testimony in connection with litigation may require incurrence of significant expenses, including fees for legal representation and fees associated with document production. These costs may be incurred even if we are not a target of the inquiry or a party to the litigation. Any financial liability or reputational damage could have a material adverse effect on our business, which, in turn, could have a material adverse effect on our financial condition and results of operations.

 

Further, in the normal course of business, our broker-dealer segment has been subject to claims by customers and clients alleging unauthorized trading, churning, mismanagement, suitability of investments, breach of fiduciary duty or other alleged misconduct by our employees or brokers. We are sometimes brought into lawsuits based on allegations concerning our correspondents. As underwriters, we are subject to substantial potential liability for material misstatements and omissions in prospectuses and other communications with respect to underwritten offerings of securities.  Prolonged litigation producing significant legal expenses or a substantial settlement or adverse judgment could have a material adverse effect on our business, financial condition, results of operations or cash flows.

 

47



Table of Contents

 

We may be subject to environmental liabilities in connection with the foreclosure on real estate assets securing the loan portfolio of our banking segment.

 

Hazardous or toxic substances or other environmental hazards may be located on the real estate that secures our loans. If we acquire such properties as a result of foreclosure, or otherwise, we could become subject to various environmental liabilities. For example, we could be held liable for the cost of cleaning up or otherwise addressing contamination at or from these properties. We could also be held liable to a governmental entity or third party for property damage, personal injury or other claims relating to any environmental contamination at or from these properties. In addition, we could be held liable for costs relating to environmental contamination at or from our current or former properties. We may not detect all environmental hazards associated with these properties. If we ever became subject to significant environmental liabilities, our business, financial condition, liquidity and results of operations could be harmed.

 

If we fail to maintain an effective system of internal controls over financial reporting, the accuracy and timing of our financial reporting may be adversely affected.

 

Effective internal controls are necessary for us to provide timely and reliable financial reports and effectively prevent fraud. Any inability to provide reliable financial reports or prevent fraud could harm our business. If we fail to maintain the adequacy of our internal controls, our financial statements may not accurately reflect our financial condition. Inadequate internal controls over financial reporting could impact the reliability and timeliness of our financial reports and could cause investors to lose confidence in our reported financial information, which could have a negative effect on our business and the value of our securities.

 

The debt agreements of our insurance segment and its controlled affiliates contain financial covenants and impose restrictions on its business.

 

The indenture governing NLC’s LIBOR plus 3.40% notes due 2035 contains restrictions on its ability to, among other things, declare and pay dividends and merge or consolidate. In addition, this indenture contains a change of control provision, which provides that (i) if a person or group becomes the beneficial owner, directly or indirectly, of 50% or more of NLC’s equity securities and (ii) if NLC’s ratings are downgraded by a nationally recognized statistical rating organization (as defined in the Exchange Act), then each holder of the notes governed by such indenture has the right to require that NLC purchase such holder’s notes, in whole or in part, at a price equal to 100% of the then outstanding principal amount. Likewise, the surplus indentures governing NLIC’s two LIBOR plus 4.10% and 4.05% notes due 2033 and ASIC’s LIBOR plus 4.05% notes due 2034 contain restrictions on dividends and mergers and consolidations. In addition, NLC has other credit arrangements with its affiliates and other third-parties.

 

NLC’s ability to comply with these covenants may be affected by events beyond its control, including prevailing economic, financial and industry conditions. The breach of any of these restrictions could result in a default under the loan agreements or indentures governing the notes or under its other debt agreements. An event of default under its debt agreements would permit some of its lenders to declare all amounts borrowed from them to be due and payable, together with accrued and unpaid interest. If NLC were unable to repay debt to its secured lenders, these lenders could proceed against the collateral securing that debt. In addition, acceleration of its other indebtedness may cause NLC to be unable to make interest payments on the notes. Other agreements that NLC or its insurance company subsidiaries may enter into in the future may contain covenants imposing significant restrictions on their respective businesses that are similar to, or in addition to, the covenants under their respective existing agreements. These restrictions may affect NLC’s ability to operate its business and may limit its ability to take advantage of potential business opportunities as they arise.

 

Risks Related to our Substantial Cash Position and Related Strategies for its Use

 

Because we intend to use a substantial portion of our remaining available cash to make acquisitions or effect a business combination, we may become subject to risks inherent in pursuing and completing any such acquisitions or business combination.

 

We are endeavoring to make acquisitions or effect business combinations with a substantial portion of our remaining available cash. We may not, however, be able to identify suitable targets, consummate acquisitions or effect a combination on commercially acceptable terms or, if consummated, successfully integrate personnel and operations.

 

The success of any acquisition or business combination will depend upon, among other things, the ability of management and our employees to integrate personnel, operations, products and technologies effectively, to retain and motivate key personnel and to retain customers and clients of targets. In addition, any acquisition or business combination we undertake may consume available cash resources, result in potentially dilutive issuances of equity securities and divert management’s

 

48



Table of Contents

 

attention from other business concerns. Even if we conduct extensive due diligence on a target business that we acquire or with which we merge, our diligence may not surface all material issues that may adversely affect a particular target business, and we may be forced to later write-down or write-off assets, restructure our operations or incur impairment or other charges that could result in our reporting losses. Consequently, we also may need to make further investments to support the acquired or combined company and may have difficulty identifying and acquiring the appropriate resources.

 

We may enter, through acquisitions or a business combination, into new lines of business or initiate new service offerings subject to the restrictions imposed upon us as a regulated financial holding company. Accordingly, there is no basis for you to evaluate the possible merits or risks of the particular target business with which we may combine or that we may ultimately acquire.

 

Existing circumstances may result in several of our directors having interests that may conflict with our interests.

 

A director who has a conflict of interest with respect to an issue presented to our board will have no inherent legal obligation to abstain from voting upon that issue. We do not have provisions in our bylaws or charter that require an interested director to abstain from voting upon an issue, and we do not expect to add provisions in our charter and bylaws to this effect. Although each director has a duty to act in good faith and in a manner he or she reasonably believes to be in our best interests, there is a risk that, should interested directors vote upon an issue in which they or one of their affiliates has an interest, their vote may reflect a bias that could be contrary to our best interests. In addition, even if an interested director abstains from voting, the director’s participation in the meeting and discussion of an issue in which they have, or companies with which they are associated have, an interest could influence the votes of other directors regarding the issue.

 

Difficult market conditions have adversely affected the yield on our available cash.

 

Our primary objective is to preserve and maintain the liquidity of our available cash, while at the same time maximizing yields without significantly increasing risk. The capital and credit markets have been experiencing volatility and disruption for a prolonged period. This volatility and disruption reached unprecedented levels, resulting in dramatic declines in interest rates and other yields relative to risk. This downward pressure has negatively affected the yields we receive on our available cash. If current levels of market disruption and volatility continue or worsen, there can be no assurance that we will receive any significant yield on our available cash. Further, given current market conditions, no assurance can be given that we will be able to preserve our available cash.

 

Risks Related to Our Common Stock

 

We may issue shares of preferred stock or additional shares of common stock to complete an acquisition or effect a combination or under an employee incentive plan after consummation of an acquisition or combination, which would dilute the interests of our stockholders and likely present other risks.

 

The issuance of shares of preferred stock or additional shares of common stock:

 

·                  may significantly dilute the equity interest of our stockholders;

 

·                  may subordinate the rights of holders of common stock if preferred stock is issued with rights senior to those afforded our common stock;

 

·                  could cause a change in control if a substantial number of shares of common stock are issued, which may affect, among other things, our ability to use our net operating loss carry forwards; and

 

·                  may adversely affect prevailing market prices for our common stock.

 

Our authorized capital stock includes ten million shares of preferred stock, and we currently have 114,068 shares of Series B Preferred Stock issued and outstanding, liquidation preference $1,000 per share, to the Secretary of the Treasury pursuant to the Small Business Lending Fund (“SBLF”). Our board of directors, in its sole discretion, may designate and issue one or more additional series of preferred stock from the authorized and unissued shares of preferred stock. Subject to limitations imposed by law or our articles of incorporation, our board of directors is empowered to determine the designation and number of shares constituting each series of preferred stock, as well as any designations, qualifications, privileges, limitations, restrictions or special or relative rights of additional series. The rights of preferred stockholders may supersede the rights of common stockholders. Preferred stock could be issued with voting and conversion rights that could adversely affect the voting power of the shares of our common stock. The issuance of preferred stock could also result in a series of securities outstanding that would have preferences over the common stock with respect to dividends and in liquidation.

 

49



Table of Contents

 

Our common stock price may experience substantial volatility, which may affect your ability to sell our common stock at an advantageous price.

 

Price volatility of our common stock may affect your ability to sell our common stock at an advantageous price. Market price fluctuations in our common stock may arise due to acquisitions, dispositions or other material public announcements, including those regarding dividends or changes in management, along with a variety of additional factors, including, without limitation, other risks identified in “Forward-looking Statements” and these “Risk Factors.” In addition, the stock markets in general, including the NYSE, have experienced extreme price and trading fluctuations. These fluctuations have resulted in volatility in the market prices of securities that often have been unrelated or disproportionate to changes in operating performance. These broad market fluctuations may adversely affect the market price of our common stock.

 

Our rights and the rights of our stockholders to take action against our directors and officers are limited.

 

We are organized under Maryland law, which provides that a director or officer has no liability in that capacity if he or she performs his or her duties in good faith, in a manner he or she reasonably believes to be in our best interests and with the care that an ordinarily prudent person in a like position would use under similar circumstances. In addition, our charter eliminates our directors’ and officers’ liability to us and our stockholders for money damages, except for liability resulting from actual receipt of an improper benefit or profit in money, property or services or active and deliberate dishonesty established by a final judgment and that is material to the cause of action. Our bylaws require us to indemnify our directors and officers for liability resulting from actions taken by them in those capacities to the maximum extent permitted by Maryland law. As a result, our stockholders and we may have more limited rights against our directors and officers than might otherwise exist under common law. In addition, we may be obligated to fund the defense costs incurred by our directors and officers.

 

The Treasury’s investment in us imposes restrictions and obligations upon us that could adversely affect the rights of our common stockholders.

 

We have sold 114,068 shares of our Series B Preferred Stock, liquidation preference $1,000 per share, for $114.1 million, to the Secretary of the Treasury pursuant to the SBLF. The shares of Series B Preferred Stock are senior to shares of our common stock with respect to dividends and liquidation preference. The terms of the Series B Preferred Stock provided for the payment of non-cumulative dividends on a quarterly basis. As long as shares of Series B Preferred Stock remain outstanding, we may not pay dividends to our common stockholders (nor may we repurchase or redeem any shares of our common stock) during any quarter in which we fail to declare and pay dividends on the Series B Preferred Stock and for the next three quarters following such failure. In addition, under the terms of the Series B Preferred Stock, we may only declare and pay dividends on our common stock (or repurchase shares of our common stock), if, after payment of such dividend, the dollar amount of our Tier 1 capital would be at least ninety percent (90%) of Tier 1 capital as of September 27, 2011, excluding any charge-offs and redemptions of the Series B Preferred Stock.

 

Our charter and laws contain provisions that could discourage acquisition bids or merger proposals, which may adversely affect the market price of our common stock.

 

Authority to Issue Additional Shares. Under our charter, our board of directors may issue up to an aggregate of ten million shares of preferred stock without stockholder action. The preferred stock may be issued, in one or more series, with the preferences and other terms designated by our board of directors that may delay or prevent a change in control of us, even if the change is in the best interests of stockholders. At December 31, 2014, 114,068 shares of preferred stock were designated or outstanding.

 

Banking Laws. Any change in control of our company is subject to prior regulatory approval under the Bank Holding Company Act or the Change in Bank Control Act, which may delay, discourage or prevent an attempted acquisition or change in control of us.

 

Insurance Laws. NLIC and ASIC are domiciled in the State of Texas. Before a person can acquire control of an insurance company domiciled in Texas, prior written approval must be obtained from the Texas Department of Insurance. Acquisition of control would be presumed on the acquisition, directly or indirectly, of ten percent or more of our outstanding voting stock, unless the regulators determine otherwise. Prior to granting approval of an application to acquire control of a domestic insurer, the Texas Department of Insurance will consider several factors, such as:

 

·                  the financial strength of the acquirer;

 

50



Table of Contents

 

·                  the integrity and management experience of the acquirer’s board of directors and executive officers;

 

·                  the acquirer’s plans for the management of the insurer;

 

·                  the acquirer’s plans to declare dividends, sell assets or incur debt;

 

·                  the acquirer’s plans for the future operations of the domestic insurer;

 

·                  the impact of the acquisition on continued licensure of the domestic insurer;

 

·                  the impact on the interests of Texas policyholders; and

 

·                  any anti-competitive results that may arise from the consummation of the acquisition of control.

 

These laws may discourage potential acquisition proposals for us and may delay, deter or prevent a change of control of us, including transactions that some or all of our stockholders might consider desirable.

 

FINRA. Any change in control of any of the Hilltop Broker-Dealers, including through acquisition, is subject to prior regulatory approval by FINRA which may delay, discourage or prevent an attempted acquisition or other change in control of such broker-dealers.

 

Restrictions on Calling Special Meeting, Cumulative Voting and Director Removal. Our bylaws includes a provision prohibiting the holders of less than a majority of the voting power represented by all of our shares issued, outstanding and entitled to be voted at a proposed meeting, from calling a special meeting of stockholders. Our charter does not provide for the cumulative voting in the election of directors. In addition, our charter provides that our directors may only be removed for cause and then only by an affirmative vote of at least two-thirds of the votes entitled to be cast in the election of directors. Any amendment to our charter relating to the removal of directors requires the affirmative vote of two-thirds of all of the votes entitled to be cast on the matter. These provisions of our bylaws and charter may delay, discourage or prevent an attempted acquisition or change in control of us.

 

An investment in our common stock is not an insured deposit.

 

An investment in our common stock is not a bank deposit and is not insured or guaranteed by the FDIC, SIPC, the Texas Department of Insurance or any other government agency. Accordingly, you should be capable of affording the loss of any investment in our common stock.

 

Item 1B. Unresolved Staff Comments.

 

None.

 

Item 2. Properties.

 

We lease office space for our principal executive offices in Dallas, Texas. In addition to our principal office, our various business segments conduct business at various locations.

 

Banking.  At December 31, 2014, our banking segment conducted business at 87 locations throughout Texas, including seven support facilities. Our banking segment’s principal executive offices are located in Dallas, Texas, in space leased by PlainsCapital. We lease 32 banking locations including our principal offices and we own the remaining 55 banking locations. We have options to renew leases at most locations.

 

Broker-dealer.  Our broker-dealer segment is headquartered in Dallas, Texas and at December 31, 2014 conducted business at 25 locations in 14 states. Each of these offices is leased by First Southwest.

 

Mortgage Origination.  Our mortgage origination segment is headquartered in Dallas, Texas and at December 31, 2014 conducted business from over 250 locations in 42 states. Each of these locations is leased by PrimeLending.

 

Insurance.  At December 31, 2014, our insurance segment leases office space in Waco, Texas for all corporate, claims, customer service and data center operations.

 

After giving effect to the SWS Merger on January 1, 2015, we had leased or owned an aggregate of approximately 450 locations in 44 states.

 

51



Table of Contents

 

Item 3. Legal Proceedings.

 

For a description of material pending legal proceedings, see the discussion set forth under the heading “Legal Matters” in Note 18 to our Consolidated Financial Statements, which is incorporated by reference herein.

 

Item 4. Mine Safety Disclosures.

 

Not applicable.

 

52



Table of Contents

 

PART II

 

Item 5. Market for Registrant’s Common Equity, Related Stockholder Matters and Issuer Purchases of Equity Securities.

 

Securities, Stockholder and Dividend Information

 

Our common stock is listed on the New York Stock Exchange under the symbol “HTH”.  Our common stock has no public trading history prior to February 12, 2004. Our common stock closed at $19.33 on February 25, 2015. At February 26, 2015, there were 100,296,330 shares of our common stock outstanding with 540 stockholders of record.

 

In connection with the PlainsCapital Merger, on November 29, 2012, we filed with the State Department of Assessments and Taxation of the State of Maryland articles supplementary for the Series B Preferred Stock, setting forth its terms. Holders of the Series B Preferred Stock are entitled to noncumulative cash dividends at a fluctuating dividend rate based on the Bank’s level of qualified small business lending. The Series B Preferred Stock is non-voting, except in limited circumstances, and ranks senior to our common stock with respect to the payment of dividends and distribution of assets upon any liquidation, dissolution or winding up of Hilltop.

 

Subject to the restrictions discussed below, our stockholders are entitled to receive dividends when, as, and if declared by our board of directors out of funds legally available for that purpose. Our board of directors exercises discretion with respect to whether we will pay dividends and the amount of such dividend, if any. Factors that affect our ability to pay dividends on our common stock in the future include, without limitation, our earnings and financial condition, liquidity and capital resources, the general economic and regulatory climate, our ability to service any equity or debt obligations senior to our common stock and other factors deemed relevant by our board of directors. We have not declared or paid any dividends over the past two completed fiscal years.

 

As a holding company, we are ultimately dependent upon our subsidiaries to provide funding for our operating expenses, debt service and dividends. Various laws limit the payment of dividends and other distributions by our subsidiaries to us, and may therefore limit our ability to pay dividends on our common stock. In addition, as long as shares of Series B Preferred Stock remain outstanding, we may not pay dividends to our common stockholders (nor may we repurchase or redeem any shares of our common stock) during any quarter in which we fail to declare and pay dividends on the Series B Preferred Stock and for the next three quarters following such failure. In addition, under the terms of the Series B Preferred Stock, we may only declare and pay dividends on our common stock (or repurchase shares of our common stock), if, after payment of such dividend, the dollar amount of our Tier 1 capital would be at least ninety percent (90%) of Tier 1 capital as of September 27, 2011, excluding any charge-offs and redemptions of the Series B Preferred Stock.

 

If required payments on our outstanding junior subordinated debentures held by our unconsolidated subsidiary trusts are not made or suspended, we may be prohibited from paying dividends on our common stock. Regulatory authorities could impose administratively stricter limitations on the ability of our subsidiaries to pay dividends to us if such limits were deemed appropriate to preserve certain capital adequacy requirements. See Item 7, “Management’s Discussion and Analysis of Financial Condition and Results of Operations — Liquidity and Capital Resources — Restrictions on Dividends and Distributions.”

 

The following table discloses the high and low sales prices per quarter for our common stock during 2014 and 2013. Quotations reflect inter-dealer prices, without retail mark-up, mark-down or commission and may not represent actual transactions.

 

 

 

Price Range

 

 

 

High

 

Low

 

Year Ended December 31, 2014

 

 

 

 

 

First Quarter

 

$

25.61

 

$

22.42

 

Second Quarter

 

$

25.08

 

$

19.72

 

Third Quarter

 

$

22.39

 

$

19.32

 

Fourth Quarter

 

$

22.20

 

$

19.27

 

 

 

 

 

 

 

Year Ended December 31, 2013

 

 

 

 

 

First Quarter

 

$

14.21

 

$

12.34

 

Second Quarter

 

$

16.94

 

$

12.59

 

Third Quarter

 

$

18.71

 

$

15.46

 

Fourth Quarter

 

$

24.05

 

$

17.09

 

 

53



Table of Contents

 

Securities Authorized for Issuance under Equity Compensation Plans

 

The following table sets forth information at December 31, 2014 with respect to compensation plans under which shares of our common stock may be issued. Additional information concerning our stock-based compensation plans is presented in Note 20, Stock-Based Compensation, in the notes to our consolidated financial statements.

 

Equity Compensation Plan Information

 

Plan Category

 

Number of securities
to be issued upon
exercise of
outstanding options,
warrants and rights

 

Weighted-average
exercise price of
outstanding options,
warrants and rights

 

Number of securities
remaining available for
future issuance under
equity compensation plans
(excluding securities
reflected in first column)

 

Equity compensation plans approved by security holders*

 

600,000

 

$

7.70

 

3,078,374

 

 

 

 

 

 

 

 

 

Total

 

600,000

 

$

7.70

 

3,078,374

 

 


*Excludes shares of restricted stock granted under the 2003 equity incentive plan (the “2003 Plan”), as all such shares are vested. No exercise price is required to be paid upon the vesting of the restricted shares of common stock granted. In September 2012, our stockholders approved the Hilltop Holdings Inc. 2012 Equity Incentive Plan (the “2012 Plan”), which allows for the granting of nonqualified stock options, stock appreciation rights, restricted stock, restricted stock units, performance awards, dividend equivalent rights and other awards to employees of Hilltop, its subsidiaries and outside directors of Hilltop. Upon the effectiveness of the 2012 Plan, no additional awards are permissible under 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 December 31, 2014, 933,004 awards had been granted pursuant to the 2012 Plan, while 11,378 awards were forfeited and are eligible for reissuance. All shares outstanding under the 2003 Plan and the 2012 Plan, whether vested or unvested, are entitled to receive dividends and to vote, unless forfeited. No participant in our 2012 Plan may be granted awards in any fiscal year covering more than 1,250,000 shares of our common stock. Excludes 62,994 shares of Hilltop common stock that are issuable pursuant to awards assumed in the SWS Merger, as these awards were not assumed until January 1, 2015.

 

Issuer Repurchases of Equity Securities

 

There were no repurchases of shares of common stock during the three months ended December 31, 2014.

 

Recent Sales of Unregistered Securities

 

On October 15, 2014, we issued an aggregate of 2,292 shares of common stock under the 2012 Plan to certain non-employee directors as compensation for their service on our Board of Directors during the third quarter of 2014. The shares were issued pursuant to the exemption from registration under Section 4(a)(2) of the Securities Act.

 

54



Table of Contents

 

Item 6. Selected Financial Data.

 

Our historical consolidated balance sheet data at December 31, 2014 and 2013 and our consolidated statements of operations data for the years ended December 31, 2014, 2013 and 2012 have been derived from our audited historical consolidated financial statements included elsewhere in this Annual Report. The following table shows our selected historical financial data for the periods indicated. You should read our selected historical financial data, together with the notes thereto, in conjunction with the more detailed information contained in our consolidated financial statements and related notes and “Management’s Discussion and Analysis of Financial Condition and Results of Operations” included in this Annual Report. Our operating results for 2012 include the results from the operations acquired in the PlainsCapital Merger for the month of December 2012 and the operations acquired in the FNB Transaction are included in our operating results beginning September 14, 2013 (dollars in thousands, except per share data and weighted average shares outstanding).

 

 

 

2014

 

2013

 

2012

 

2011

 

2010

 

Statement of Operations Data:

 

 

 

 

 

 

 

 

 

 

 

Total interest income

 

$

388,769

 

$

329,075

 

$

39,038

 

$

11,049

 

$

8,154

 

Total interest expense

 

27,628

 

32,874

 

10,196

 

8,985

 

8,971

 

Net interest income (loss)

 

361,141

 

296,201

 

28,842

 

2,064

 

(817

)

Provision for loan losses

 

16,933

 

37,158

 

3,800

 

 

 

Net interest income (loss) after provision for loan losses

 

344,208

 

259,043

 

25,042

 

2,064

 

(817

)

Total noninterest income

 

799,311

 

850,085

 

224,232

 

141,650

 

124,073

 

Total noninterest expense

 

965,353

 

911,735

 

255,517

 

155,254

 

124,811

 

Income (loss) before income taxes

 

178,166

 

197,393

 

(6,243

)

(11,540

)

(1,555

)

Income tax expense (benefit)

 

65,608

 

70,684

 

(1,145

)

(5,009

)

(1,007

)

Net income (loss)

 

112,558

 

126,709

 

(5,098

)

(6,531

)

(548

)

Less: Net income attributable to noncontrolling interest

 

908

 

1,367

 

494

 

 

 

Income (loss) attributable to Hilltop

 

111,650

 

125,342

 

(5,592

)

(6,531

)

(548

)

Dividends on preferred stock and other (1)

 

5,703

 

4,327

 

259

 

 

12,939

 

Income (loss) applicable to Hilltop common stockholders

 

$

105,947

 

$

121,015

 

$

(5,851

)

$

(6,531

)

$

(13,487

)

 

 

 

 

 

 

 

 

 

 

 

 

Per Share Data:

 

 

 

 

 

 

 

 

 

 

 

Net income (loss) - basic

 

$

1.18

 

$

1.43

 

$

(0.10

)

$

(0.12

)

$

(0.24

)

Weighted average shares outstanding - basic

 

89,710

 

84,382

 

58,754

 

56,499

 

56,492

 

Net income (loss) - diluted

 

$

1.17

 

$

1.40

 

$

(0.10

)

$

(0.12

)

$

(0.24

)

Weighted average shares outstanding - diluted

 

90,573

 

90,331

 

58,754

 

56,499

 

56,492

 

Book value per common share

 

$

14.93

 

$

13.27

 

$

12.34

 

$

11.60

 

$

11.56

 

Tangible book value per common share

 

$

11.47

 

$

9.70

 

$

8.37

 

$

11.01

 

$

10.95

 

 

 

 

 

 

 

 

 

 

 

 

 

Balance Sheet Data:

 

 

 

 

 

 

 

 

 

 

 

Total assets

 

$

9,242,416

 

$

8,904,122

 

$

7,286,865

 

$

925,425

 

$

939,641

 

Cash and due from banks

 

782,473

 

713,099

 

722,039

 

578,520

 

649,439

 

Securities

 

1,109,461

 

1,261,989

 

1,081,066

 

224,200

 

148,965

 

Investment in SWS common stock (2)

 

70,282

 

 

 

 

 

Loans held for sale

 

1,309,693

 

1,089,039

 

1,401,507

 

 

 

Non-covered loans, net of unearned income

 

3,920,476

 

3,514,646

 

3,152,396

 

 

 

Covered loans

 

642,640

 

1,006,369

 

 

 

 

Allowance for loan losses

 

(41,652

)

(34,302

)

(3,409

)

 

 

Goodwill and other intangible assets, net

 

311,591

 

322,729

 

331,508

 

33,062

 

34,587

 

Total deposits

 

6,369,892

 

6,722,918

 

4,700,461

 

 

 

Notes payable

 

56,684

 

56,327

 

141,539

 

131,450

 

138,350

 

Junior subordinated debentures

 

67,012

 

67,012

 

67,012

 

 

 

Total stockholders’ equity

 

1,461,239

 

1,311,922

 

1,146,550

 

655,383

 

653,055

 

 

 

 

 

 

 

 

 

 

 

 

 

Performance Ratios (3):

 

 

 

 

 

 

 

 

 

 

 

Return on average stockholders’ equity

 

8.01

%

10.48

%

-0.62

%

 

 

 

 

Return on average assets

 

1.26

%

1.66

%

-0.08

%

 

 

 

 

Net interest margin (taxable equivalent) (4)

 

4.74

%

4.47

%

4.64

%

 

 

 

 

Efficiency ratio (5)(6)(7)

 

61.17

%

42.58

%

NM

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

Asset Quality Ratios (3):

 

 

 

 

 

 

 

 

 

 

 

Total nonperforming assets to total loans and other real estate (6)

 

4.14

%

3.70

%

NM

 

 

 

 

 

Allowance for loan losses to nonperforming loans (6)

 

74.01

%

136.39

%

NM

 

 

 

 

 

Allowance for loan losses to total loans (6)

 

0.91

%

0.76

%

NM

 

 

 

 

 

Net charge-offs to average loans outstanding (6)

 

0.21

%

0.18

%

NM

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

Capital Ratios:

 

 

 

 

 

 

 

 

 

 

 

Equity to assets ratio

 

15.80

%

14.73

%

15.71

%

70.82

%

69.50

%

Tangible common equity to tangible assets

 

11.59

%

10.19

%

10.05

%

69.74

%

68.33

%

 

55



Table of Contents

 

 

 

2014

 

2013

 

2012

 

2011

 

2010

 

Regulatory Capital Ratios (3):

 

 

 

 

 

 

 

 

 

 

 

Hilltop - Leverage ratio (8)

 

14.17

%

12.81

%

13.08

%

 

 

 

 

Hilltop - Tier 1 risk-based capital ratio

 

19.02

%

18.53

%

17.72

%

 

 

 

 

Hilltop - Total risk-based capital ratio

 

19.69

%

19.13

%

17.81

%

 

 

 

 

Bank - Leverage ratio (8)

 

10.31

%

9.29

%

8.84

%

 

 

 

 

Bank - Tier 1 risk-based capital ratio

 

13.74

%

13.38

%

11.83

%

 

 

 

 

Bank - Total risk-based capital ratio

 

14.45

%

14.00

%

11.93

%

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

Other Data (9):

 

 

 

 

 

 

 

 

 

 

 

Net loss and LAE ratio

 

57.4

%

70.3

%

74.4

%

72.2

%

60.5

%

Expense ratio

 

31.9

%

32.3

%

34.4

%

34.0

%

36.0

%

GAAP combined ratio

 

89.3

%

102.6

%

108.8

%

106.2

%

96.5

%

Statutory surplus (10)

 

$

141,989

 

$

125,054

 

$

120,319

 

$

118,708

 

$

119,297

 

Statutory premiums to surplus ratio

 

115.8

%

130.7

%

125.0

%

119.4

%

102.0

%

 


(1) Series A preferred stock was redeemed in September 2010.

(2) For periods prior to 2014, Hilltop’s investment in SWS common stock was accounted for and included within its available for sale securities portfolio.

(3) Noted measures are typically used for measuring the performance of banking and financial institutions. Our operations prior to the PlainsCapital Merger are limited to our insurance operations. Therefore, noted measures for periods prior to 2012 are not a useful measure and have been excluded.

(4) Taxable equivalent net interest income divided by average interest-earning assets. Our operations prior to the PlainsCapital Merger are limited to our insurance operations. Therefore, noted measure for 2012 reflects the ratio for the month ended December 31, 2012.

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

(6) Noted measures are typically used for measuring the performance of banking and financial institutions. Our operations prior to the PlainsCapital Merger are limited to our insurance operations. Additionally, noted measure is not meaningful (“NM”) in 2012.

(7) Only considers operations of banking segment.

(8) Ratio for 2012 was calculated using the average assets for the month of December.

(9) Only considers operations of insurance segment.

(10) Statutory surplus includes combined surplus of NLIC and ASIC.

 

GAAP Reconciliation and Management’s Explanation of Non-GAAP Financial Measures

 

We present two measures in our selected financial data that are not measures of financial performance recognized by GAAP. “Tangible book value per common share” is defined as our total stockholders’ equity, excluding preferred stock, reduced by goodwill and other intangible assets, divided by total common shares outstanding. “Tangible common equity to tangible assets” is defined as our total stockholders’ equity, excluding preferred stock, reduced by goodwill and other intangible assets divided by total assets reduced by goodwill and other intangible assets. These measures are important to investors interested in changes from period to period in tangible common equity per share exclusive of changes in intangible assets. For companies such as ours that have engaged in business combinations, purchase accounting can result in the recording of significant amounts of goodwill and other intangible assets related to those transactions.

 

You should not view this disclosure as a substitute for results determined in accordance with GAAP, and our disclosure is not necessarily comparable to that of other companies that use non-GAAP measures. The following table reconciles these non-GAAP financial measures to the most comparable GAAP financial measures, “book value per common share” and “Hilltop stockholders’ equity to total assets” (dollars in thousands, except per share data).

 

 

 

December 31,

 

 

 

2014

 

2013

 

2012

 

2011

 

2010

 

 

 

 

 

 

 

 

 

 

 

 

 

Book value per common share

 

$

14.93

 

$

13.27

 

$

12.34

 

$

11.60

 

$

11.56

 

Effect of goodwill and intangible assets per share

 

$

(3.46

)

$

(3.57

)

$

(3.97

)

$

(0.59

)

$

(0.61

)

Tangible book value per common share

 

$

11.47

 

$

9.70

 

$

8.37

 

$

11.01

 

$

10.95

 

 

 

 

 

 

 

 

 

 

 

 

 

Hilltop stockholders’ equity

 

$

1,460,452

 

$

1,311,141

 

$

1,144,496

 

$

655,383

 

$

653,055

 

Less: preferred stock

 

114,068

 

114,068

 

114,068

 

 

 

Less: goodwill and intangible assets, net

 

311,591

 

322,729

 

331,508

 

33,062

 

34,587

 

Tangible common equity

 

1,034,793

 

874,344

 

698,920

 

622,321

 

618,468

 

 

 

 

 

 

 

 

 

 

 

 

 

Total assets

 

9,242,416

 

8,904,122

 

7,286,865

 

925,425

 

939,641

 

Less: goodwill and intangible assets, net

 

311,591

 

322,729

 

331,508

 

33,062

 

34,587

 

Tangible assets

 

8,930,825

 

8,581,393

 

6,955,357

 

892,363

 

905,054

 

 

 

 

 

 

 

 

 

 

 

 

 

Equity to assets

 

15.80

%

14.73

%

15.71

%

70.82

%

69.50

%

Tangible common equity to tangible assets

 

11.59

%

10.19

%

10.05

%

69.74

%

68.33

%

 

56



Table of Contents

 

Item 7. Management’s Discussion and Analysis of Financial Condition and Results of Operations.

 

The following discussion is intended to help the reader understand our results of operations and financial condition and is provided as a supplement to, and should be read in conjunction with, our audited consolidated financial statements and the accompanying notes thereto commencing on page F-1. In addition to historical financial information, the following discussion and analysis contains forward-looking statements that involve risks, uncertainties and assumptions. Our results and the timing of selected events may differ materially from those anticipated in these forward-looking statements as a result of many factors, including those discussed under “Item 1A. Risk Factors” and elsewhere in this Annual Report. See “Forward-Looking Statements.” All dollar amounts in the following discussion are in thousands, except per share amounts.

 

Unless the context otherwise indicates, all references in this Management’s Discussion and Analysis of Financial Condition and Results of Operations, or MD&A, 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 “Hilltop Securities” refer to Hilltop Securities Holdings LLC (a wholly owned subsidiary of Hilltop), references to “Southwest Securities” refer to Southwest Securities, Inc. (a wholly owned subsidiary of Hilltop Securities), references to “SWS Financial” refer to SWS Financial Services, Inc. (a wholly owned subsidiary of Hilltop Securities), 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 Hilltop Securities) and its subsidiaries as a whole, references to “FSC” refer to First Southwest Company, LLC (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.

 

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 through the Bank. We also provide an array of financial products and services through our broker-dealer, mortgage origination and insurance segments.

 

Through December 31, 2014, the Company delivered these financial products and services through the following primary operating business units.

 

PlainsCapital.  PlainsCapital is a financial holding company, headquartered in Dallas, Texas, that provides, through its subsidiaries, traditional banking services, residential mortgage lending, investment banking, public finance advisory, wealth and investment management, treasury management, fixed income sales, asset management, and correspondent clearing services.

 

NLC.  NLC is a property and casualty insurance holding company, headquartered in Waco, Texas, 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.

 

At December 31, 2014, on a consolidated basis, we had total assets of $9.2 billion, total deposits of $6.4 billion, total loans, including loans held for sale, of $5.8 billion and stockholders’ equity of $1.5 billion. Our operating results beginning December 1, 2012 include the banking, mortgage origination and broker-dealer (formerly financial advisory) operations acquired in the PlainsCapital Merger (defined hereafter). Accordingly, our operating results and financial condition for the years ended December 31, 2014 and 2013 are not comparable to prior years. The operations acquired in the FNB Transaction (defined hereafter) are included in the results of our banking operations beginning September 14, 2013.

 

Effective January 1, 2015, in connection with our acquisition of SWS Group, Inc. (“SWS”), we modified our organizational structure into three primary operating business units, PlainsCapital (banking and mortgage origination), Hilltop Securities (broker-dealer) and NLC (insurance). The PlainsCapital unit continues to include the Bank and PrimeLending, while the new Hilltop Securities unit includes First Southwest (transferred from the PlainsCapital unit effective January 1, 2015), Southwest Securities and SWS Financial (both acquired on January 1, 2015).

 

57



Table of Contents

 

Company Background

 

In January 2007, we acquired NLC, a property and casualty insurance holding company. As a result, our subsequent primary operations through November 2012 were limited to providing fire and homeowners insurance to low value dwellings and manufactured homes primarily in Texas and other areas of the southern United States through NLC’s wholly owned subsidiaries, National Lloyds Insurance Company (“NLIC”) and American Summit Insurance Company (“ASIC”).

 

On November 30, 2012, we acquired PlainsCapital Corporation in a stock and cash transaction, whereby PlainsCapital Corporation merged with and into our wholly owned subsidiary, which continued as the surviving entity under the name “PlainsCapital Corporation” (the “PlainsCapital Merger”). Based on Hilltop’s closing stock price on November 30, 2012, the total purchase price was $813.5 million, consisting of 27.1 million shares of common stock, $311.8 million in cash and the issuance of 114,068 shares of Hilltop Non-Cumulative Perpetual Preferred Stock, Series B (“Hilltop Series B Preferred Stock”). The fair value of assets acquired, excluding goodwill, totaled $6.5 billion, including $3.2 billion of loans, $730.8 million of investment securities and $70.7 million of identifiable intangibles. The fair value of the liabilities assumed was $5.9 billion, including $4.5 billion of deposits.

 

Concurrent with the consummation of the PlainsCapital Merger, Hilltop became a financial holding company registered under the Bank Holding Company Act of 1956, as amended by the Gramm-Leach-Bliley Act of 1999.

 

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 January 1, 2015, we completed our acquisition of SWS in a stock and cash transaction, whereby SWS merged with and into Hilltop Securities, formerly Peruna LLC, a wholly owned subsidiary of Hilltop formed for the purpose of facilitating this transaction (the “SWS Merger”). SWS’s broker-dealer subsidiaries, Southwest Securities and SWS Financial, became subsidiaries of Hilltop Securities. Immediately following the SWS Merger, SWS’s banking subsidiary, Southwest Securities, FSB (“SWS FSB”), was merged into the Bank, an indirect wholly owned subsidiary of Hilltop. As a result of the SWS Merger, each outstanding share of SWS common stock was converted into the right to receive 0.2496 shares of Hilltop common stock and $1.94 in cash, equating to $6.92 per share based on Hilltop’s closing price on December 31, 2014 and resulting in an aggregate purchase price of $349.0 million, consisting of 10.0 million shares of common stock, $78.2 million in cash and $70.3 million associated with our existing investment in SWS common stock. Additionally, due to appraisal rights proceedings filed in connection with the SWS Merger, the merger consideration is subject to change, and therefore, preliminary at this time. The SWS Merger will be accounted for using the acquisition method of accounting, and accordingly, purchased assets, including identifiable intangible assets and assumed liabilities will be recorded at their respective acquisition date fair values using significant estimates and assumptions to value certain identifiable assets acquired and liabilities assumed.

 

Segment Information

 

Through December 31, 2014, we had two primary operating business units, PlainsCapital (financial services and products) and NLC (insurance). Within the PlainsCapital unit were 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 were comprised of four reportable business segments organized primarily by the core products offered to the segments’ respective customers: banking, broker-dealer, mortgage origination and insurance. The SWS Merger has not resulted in changes to our four reportable business segments. Consistent with the segment operating results during 2013 and 2014, we anticipate that future revenues will be driven primarily from the banking segment, with the remainder being generated by our broker-dealer, mortgage origination and insurance 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.

 

58



Table of Contents

 

The banking segment includes the operations of the Bank and, since September 14, 2013, the operations acquired in the FNB Transaction. Beginning January 1, 2015, the banking segment will also include the operations of the former SWS FSB. 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 broker-dealer segment has historically generated 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 Securities and Exchange Commission (the “SEC”) and Financial Industry Regulatory Authority, and First Southwest Asset Management, LLC, 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 (“TBA”) mortgage-backed securities. These derivatives are marked to market through other noninterest income. Beginning January 1, 2015, the broker-dealer segment will also include the operations of Southwest Securities and SWS Financial.

 

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, NLIC and 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.

 

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.”

 

Additional information concerning our reportable segments is presented in Note 30, 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

 

 

 

 

 

All Other and

 

Hilltop

 

Year Ended December 31, 2014

 

Banking

 

Broker-Dealer

 

Origination

 

Insurance

 

Corporate

 

Eliminations

 

Consolidated

 

Net interest income (expense)

 

$

334,377

 

$

12,144

 

$

(12,591

)

$

3,672

 

$

5,219

 

$

18,320

 

$

361,141

 

Provision for loan losses

 

16,916

 

17

 

 

 

 

 

16,933

 

Noninterest income

 

67,438

 

119,451

 

456,776

 

173,577

 

5,985

 

(23,916

)

799,311

 

Noninterest expense

 

245,790

 

124,715

 

431,820

 

151,541

 

13,878

 

(2,391

)

965,353

 

Income (loss) before income taxes

 

$

139,109

 

$

6,863

 

$

12,365

 

$

25,708

 

$

(2,674

)

$

(3,205

)

$

178,166

 

 

 

 

 

 

 

 

Mortgage

 

 

 

 

 

All Other and

 

Hilltop

 

Year Ended December 31, 2013

 

Banking

 

Broker-Dealer

 

Origination

 

Insurance

 

Corporate

 

Eliminations

 

Consolidated

 

Net interest income (expense)

 

$

293,254

 

$

12,064

 

$

(37,840

)

$

7,442

 

$

(1,597

)

$

22,878

 

$

296,201

 

Provision for loan losses

 

37,140

 

18

 

 

 

 

 

37,158

 

Noninterest income

 

71,045

 

102,714

 

537,497

 

166,163

 

 

(27,334

)

850,085

 

Noninterest expense

 

155,102

 

112,360

 

472,284

 

166,006

 

10,439

 

(4,456

)

911,735

 

Income (loss) before income taxes

 

$

172,057

 

$

2,400

 

$

27,373

 

$

7,599

 

$

(12,036

)

$

 

$

197,393

 

 

 

 

 

 

 

 

Mortgage

 

 

 

 

 

All Other and

 

Hilltop

 

Year Ended December 31, 2012

 

Banking

 

Broker-Dealer

 

Origination

 

Insurance

 

Corporate

 

Eliminations

 

Consolidated

 

Net interest income (expense)

 

$

24,885

 

$

1,191

 

$

(4,987

)

$

4,730

 

$

39

 

$

2,984

 

$

28,842

 

Provision for loan losses

 

3,670

 

130

 

 

 

 

 

3,800

 

Noninterest income

 

4,601

 

10,909

 

57,618

 

154,147

 

 

(3,043

)

224,232

 

Noninterest expense

 

16,130

 

11,078

 

50,296

 

163,585

 

14,487

 

(59

)

255,517

 

Income (loss) before income taxes

 

$

9,686

 

$

892

 

$

2,335

 

$

(4,708

)

$

(14,448

)

$

 

$

(6,243

)

 

59



Table of Contents

 

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 $361.1 million in net interest income during the year ended December 31, 2014, compared with net interest income of $296.2 million in 2013 and net interest income of $28.8 million in 2012. The year-over-year increases in net interest income were primarily due to the inclusion of those operations acquired as a part of the PlainsCapital Merger and FNB Transaction within our banking segment.

 

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

 

(i)                                     Investment and securities advisory fees and commissions.  Through our wholly owned subsidiary, First Southwest, we provide public finance advisory and various investment banking and brokerage services. We generated $101.9 million, $93.1 million and $11.2 million in investment advisory fees and commissions and securities brokerage fees and commissions during the years ended December 31, 2014 and 2013 and the month ended December 31, 2012, respectively.

 

(ii)                                  Income from mortgage operations. Through our wholly owned subsidiary, PrimeLending, we generate noninterest income by originating and selling mortgage loans. During the years ended December 31, 2014 and 2013 and the month ended December 31, 2012, we generated $453.4 million, $537.3 and $57.6 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.

 

(iii)                               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 $164.5 million, $157.5 million and $146.7 million in net insurance premiums earned during 2014, 2013 and 2012, respectively.

 

In the aggregate, we generated $799.3 million, $850.1 million and $224.2 million in noninterest income during 2014, 2013 and 2012, respectively. The significant year-over-year decrease in noninterest income in 2014 compared to 2013 was primarily due to the decrease in loan origination volume within our mortgage origination segment and, to a lesser extent, the recognition of a pre-tax bargain purchase gain related to the FNB Transaction of $12.6 million during 2013 within our banking segment, partially offset by increases in noninterest income in our banking, insurance and broker-dealer segments. The significant year-over-year increase in noninterest income during 2013 was primarily due to the inclusion of the mortgage origination and broker-dealer operations that we acquired as a part of the PlainsCapital Merger.

 

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.

 

Consolidated Operating Results

 

Net income applicable to common stockholders for the year ended December 31, 2014 was $105.9 million, or $1.17 per diluted share, compared with net income applicable to common stockholders of $121.0 million, or $1.40 per diluted share, for the year ended December 31, 2013, and net loss applicable to common stockholders of $5.9 million, or $0.10 per diluted share for the year ended December 31, 2012. The consolidated operating results for 2013 include the recognition of a bargain purchase gain related to the FNB Transaction of $12.6 million, before income taxes of $4.5 million.

 

As a result of the PlainsCapital Merger, the net income of PlainsCapital is included in our operating results for the years ended December 31, 2014 and 2013 and the month ended December 31, 2012. The operations acquired in the FNB Transaction are included in our operating results beginning September 14, 2013, and are therefore not fully reflected in our consolidated statement of operations for the year ended December 31, 2013. We expect the operations acquired in the FNB Transaction to have a significant effect on the Bank’s operating results in future periods. The operations, assets and liabilities acquired in the SWS Merger will be included in our balance sheet and operating results beginning January 1, 2015, and we expect them to have a significant effect on our broker-dealer segment in future periods.

 

Certain items included in net income for 2014, 2013 and 2012 resulted from purchase accounting associated with the PlainsCapital Merger and FNB Transaction. Income before taxes for 2014 includes net accretion of $33.9 million and $49.2

 

60



Table of Contents

 

million on earning assets and liabilities acquired in the PlainsCapital Merger and FNB Transaction, respectively, offset by amortization of identifiable intangibles of $9.2 million and $1.0 million, respectively, compared with net accretion of $58.5 million and $10.2 million on earning assets and liabilities acquired in the PlainsCapital Merger and FNB Transaction, respectively, offset by amortization of identifiable intangibles of $9.8 million and $0.3 million, respectively, during 2013. Loss before taxes for 2012 includes net accretion of $5.9 million on earning assets and liabilities acquired in the PlainsCapital Merger and amortization of identifiable intangibles of $0.8 million.

 

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

 

 

 

Year Ended December 31,

 

Month Ended

 

 

 

2014

 

2013

 

December 31, 2012

 

Performance Ratios:

 

 

 

 

 

 

 

Return on average stockholders’ equity (1)

 

8.01

%

10.48

%

-0.62

%

Return on average assets (1)

 

1.26

%

1.66

%

-0.08

%

Net interest margin (taxable equivalent) (2)

 

4.74

%

4.47

%

4.64

%

 


(1) Noted measure is typically used for measuring the performance of banking and financial institutions. Our operations prior to the acquisition of PlainsCapital are limited to our insurance operations. Therefore, noted measure for 2012 is not comparable to subsequent periods.

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

 

During the year ended December 31, 2014, the consolidated taxable equivalent net interest margin of 4.74% was impacted by PlainsCapital Merger related accretion of discount on loans of $37.4 million, amortization of premium on acquired securities of $4.1 million and amortization of premium on acquired time deposits of $0.6 million. Additionally, FNB Transaction related accretion of discount on loans of $43.6 million and amortization of premium on acquired time deposits of $5.5 million also impacted the consolidated taxable equivalent net interest margin during the year ended December 31, 2014. These items increased the consolidated taxable equivalent net interest margin by 125 basis points for the year ended December 31, 2014. During the year ended December 31, 2013, the consolidated taxable equivalent net interest margin of 4.47% was impacted by PlainsCapital Merger related accretion of discount on loans of $61.8 million, amortization of premium on acquired securities of $5.7 million and amortization of premium on acquired time deposits of $2.4 million. Additionally, FNB Transaction related accretion of discount on loans of $7.5 million and amortization of premium on acquired time deposits of $2.7 million also impacted the consolidated taxable equivalent net interest margin during the year ended December 31, 2013. These items increased the consolidated taxable equivalent net interest margin by 103 basis points for the year ended December 31, 2013. The consolidated taxable equivalent net interest margin was 4.64% for the month ended December 31, 2012. The taxable equivalent net interest margin was impacted by PlainsCapital Merger related accretion of discount on loans of $6.3 million, amortization of premium on acquired securities of $0.7 million and amortization of premium on acquired time deposits of $0.4 million. These items increased the consolidated taxable equivalent interest margin by 110 basis points for the month ended December 31, 2012.

 

61



Table of Contents

 

The table below provides additional details regarding our consolidated net interest income (dollars in thousands). Our operations prior to the PlainsCapital Merger were limited to our insurance operations. Therefore, the consolidated net interest income for 2012 reflects details for the month ended December 31, 2012.

 

 

 

Year Ended December 31,

 

Month Ended December 31,

 

 

 

2014

 

2013

 

2012

 

 

 

Average

 

Interest

 

Annualized

 

Average

 

Interest

 

Annualized

 

Average

 

Interest

 

Annualized

 

 

 

Outstanding

 

Earned or

 

Yield or

 

Outstanding

 

Earned or

 

Yield or

 

Outstanding

 

Earned or

 

Yield or

 

 

 

Balance

 

Paid

 

Rate

 

Balance

 

Paid

 

Rate

 

Balance

 

Paid

 

Rate

 

Assets

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

Interest-earning assets

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

Loans, gross (1) 

 

$

5,461,611

 

$

341,458

 

6.21

%

$

4,584,079

 

$

284,782

 

6.15

%

$

4,513,214

 

$

23,900

 

6.15

%

Investment securities - taxable

 

1,072,564

 

29,206

 

2.72

%

947,844

 

27,078

 

2.85

%

675,631

 

1,604

 

2.81

%

Investment securities - non-taxable (2) 

 

182,881

 

7,028

 

3.84

%

192,933

 

7,158

 

3.71

%

230,733

 

698

 

2.51

%

Federal funds sold and securities purchased under agreements to resell

 

18,120

 

52

 

0.29

%

27,996

 

113

 

0.40

%

54,017

 

106

 

2.35

%

Interest-bearing deposits in other financial institutions

 

698,638

 

1,602

 

0.23

%

727,284

 

1,848

 

0.25

%

574,913

 

121

 

0.25

%

Other

 

229,461

 

11,770

 

5.16

%

160,320

 

10,479

 

6.58

%

159,181

 

651

 

4.84

%

Interest-earning assets, gross

 

7,663,275

 

391,116

 

5.08

%

6,640,456

 

331,458

 

4.96

%

6,207,689

 

27,080

 

5.04

%

Allowance for loan losses

 

(40,516

)

 

 

 

 

(22,906

)

 

 

 

 

(159

)

 

 

 

 

Interest-earning assets, net

 

7,622,759

 

 

 

 

 

6,617,550

 

 

 

 

 

6,207,530

 

 

 

 

 

Noninterest-earning assets

 

1,343,070

 

 

 

 

 

996,327

 

 

 

 

 

782,958

 

 

 

 

 

Total assets

 

$

8,965,829

 

 

 

 

 

$

7,613,877

 

 

 

 

 

$

6,990,488

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

Liabilities and Stockholders' Equity

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

Interest-bearing liabilities

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

Interest-bearing deposits

 

$

4,490,748

 

$

15,742

 

0.35

%

$

3,923,895

 

$

14,877

 

0.38

%

$

3,233,503

 

$

1,013

 

0.37

%

Notes payable and other borrowings

 

934,031

 

11,886

 

1.27

%

823,478

 

17,997

 

2.19

%

1,048,113

 

1,351

 

1.51

%

Total interest-bearing liabilities

 

5,424,779

 

27,628

 

0.51

%

4,747,373

 

32,874

 

0.69

%

4,281,616

 

2,364

 

0.65

%

Noninterest-bearing liabilities

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

Noninterest-bearing deposits

 

1,862,277

 

 

 

 

 

1,370,029

 

 

 

 

 

1,322,023

 

 

 

 

 

Other liabilities

 

283,922

 

 

 

 

 

299,871

 

 

 

 

 

488,759

 

 

 

 

 

Total liabilities

 

7,570,978

 

 

 

 

 

6,417,273

 

 

 

 

 

6,092,398

 

 

 

 

 

Stockholders’ equity

 

1,394,351

 

 

 

 

 

1,195,960

 

 

 

 

 

896,567

 

 

 

 

 

Noncontrolling interest

 

500

 

 

 

 

 

644

 

 

 

 

 

1,523

 

 

 

 

 

Total liabilities and stockholders' equity

 

$

8,965,829

 

 

 

 

 

$

7,613,877

 

 

 

 

 

$

6,990,488

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

Net interest income (2)

 

 

 

$

363,488

 

 

 

 

 

$

298,584

 

 

 

 

 

$

24,716

 

 

 

Net interest spread (2)

 

 

 

 

 

4.57

%

 

 

 

 

4.27

%

 

 

 

 

4.39

%

Net interest margin (2)

 

 

 

 

 

4.74

%

 

 

 

 

4.47

%

 

 

 

 

4.64

%

 


(1) Average balance includes non-accrual loans.

(2) Taxable equivalent adjustments are based on a 35% tax rate. The adjustment to interest income was $2.3 million, $2.4 million and $0.2 million for the years ended December 31, 2014 and 2013 and the month ended December 31, 2012, respectively.

 

On a consolidated basis, net interest income increased $64.9 million during 2014, compared with 2013, while net interest income increased $267.4 million during 2013, compared with 2012. These increases were primarily due to the inclusion of those operations acquired as a part of the PlainsCapital Merger and FNB Transaction within our banking segment. Net interest income prior to December 2012 was limited to interest income on securities and interest expense on notes payable of the insurance 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 $16.9 million and $37.2 million during 2014 and 2013, respectively. During 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 $6.1 million and $33.1 million, respectively, and purchased credit impaired (“PCI”) loans of $10.8 million and $4.1 million, respectively.

 

Consolidated noninterest income decreased $50.8 million during 2014, compared with 2013, while consolidated noninterest income increased $625.9 million during 2013, compared with 2012. These year-over-year changes included the recognition of a pre-tax bargain purchase gain related to the FNB Transaction of $12.6 million during 2013. The remaining changes in noninterest income between 2014 and 2013 included the reduction in net gains from sale of loans, other mortgage production income and mortgage loan origination fees within our mortgage origination segment of $83.9 million, slightly offset by increases in noninterest income in our insurance and broker-dealer segments of $7.4 million and $16.7 million, respectively. The remaining changes between 2013 and 2012 were primarily due to the inclusion of noninterest income generated from the operations of the mortgage origination and broker-dealer segments acquired in the PlainsCapital Merger. Consolidated noninterest income during 2013 also included an increase in net insurance premiums earned of $10.8 million, compared with 2012.

 

62



Table of Contents

 

Our consolidated noninterest expense during 2014 increased $53.6 million, compared with 2013, while consolidated noninterest expense during 2013 increased $656.2 million, compared with 2012. The year-over-year changes between 2014 and 2013 included significant increases in noninterest expenses within our banking segment of $90.7 million, primarily due to the inclusion of those operations acquired as part of the FNB Transaction and within our broker-dealer segment of $12.4 million due to increases in professional fees and compensation costs that vary with noninterest income. These increases were partially offset by significant decreases in noninterest expenses within our mortgage origination segment of $40.5 million, primarily due to reductions in variable compensation tied to mortgage loan originations and initiatives to decrease segment operating costs, and within our insurance segment of $14.5 million due to improved claims loss experience associated with the significant decline in the severity of severe weather-related events during 2014. Changes between 2014 and 2013 within the major components of noninterest expense included increases of $10.2 million in employees’ compensation and benefits, $15.4 million in occupancy and equipment and $43.6 million in other expenses partially offset by decreases of $16.3 million in loss and loss adjustment expenses. The year-over-year changes between 2013 and 2012 primarily resulted from the inclusion of employees’ compensation and benefits, occupancy and equipment and other expenses specifically attributable to those segments acquired as a part of the PlainsCapital Merger. Included in employee’s compensation and benefits expense during 2012 is an $8.9 million expense related to the separate retention agreements between Hilltop and two executive officers of PlainsCapital entered into in connection with the PlainsCapital Merger. Other noninterest expenses during 2012 include PlainsCapital Merger related expenses of $6.6 million. The balance of increases in our consolidated noninterest expenses between 2013 and 2012 were primarily related to loss and LAE and policy acquisition and other underwriting expenses specific to our insurance segment.

 

Consolidated income tax expense during 2014 and 2013 were $65.6 million and $70.7 million, respectively, reflecting effective rates of 36.8% and 35.8%, respectively. During 2012, we recorded an income tax benefit, due to losses from operations, of $1.1 million, reflecting an effective rate of 18.3%. The effective income tax rate for 2012 is not indicative of future effective income tax rates due to the inclusion of those operations acquired as a part of the PlainsCapital Merger beginning December 1, 2012.

 

Segment Results

 

Banking Segment

 

Income before income taxes in our banking segment for the years ended December 31, 2014 and 2013 and the month ended December 31, 2012 was $139.1 million, $172.1 million and $9.7 million, respectively. These year-over-year changes included the recognition of a pre-tax bargain purchase gain related to the FNB Transaction of $12.6 million during the year ended December 31, 2013. The remaining changes in income before income taxes during the year ended December 31, 2014, compared with the year ended December 31, 2013, were primarily due to an increase in noninterest expense, partially offset by an increase in net interest income and a decrease in the provision for loan losses. The operations acquired as a part of the FNB Transaction had a significant effect on each of the components of income before income taxes during the year ended December 31, 2014, compared with the year ended December 31, 2013. The remaining changes in income before income taxes, and each of its components, are not comparable between the 2013 and 2012 periods since the operations of our banking segment was acquired as a part of the PlainsCapital Merger.

 

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

 

 

 

Year Ended December 31,

 

Month Ended

 

 

 

2014

 

2013

 

December 31, 2012

 

Performance Ratios:

 

 

 

 

 

 

 

Efficiency ratio (1)(2)

 

61.17

%

42.58

%

NM

 

Return on average assets (1)

 

1.20

%

1.78

%

NM

 

Net interest margin (taxable equivalent) (3)

 

5.00

%

5.17

%

5.83

%

 


(1) The banking segment was acquired on November 30, 2012. Therefore, noted measure for periods prior to 2013 is not meaningful.

 

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

 

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

 

During the year ended December 31, 2014, the banking segment’s taxable equivalent net interest margin of 5.00% was impacted by PlainsCapital Merger related accretion of discount on loans of $37.4 million, amortization of premium on acquired securities of $4.1 million and amortization of premium on acquired time deposits of $0.6 million. Additionally,

 

63



Table of Contents

 

FNB Transaction related accretion of discount on loans of $43.6 million and amortization of premium on acquired time deposits of $5.5 million also impacted the banking segment’s taxable equivalent net interest margin during the year ended December 31, 2014. These items increased the banking segment’s taxable equivalent net interest margin by 143 basis points for the year ended December 31, 2014. During the year ended December 31, 2013, the banking segment’s taxable equivalent net interest margin of 5.17% was impacted by PlainsCapital Merger related accretion of discount on loans of $61.8 million, amortization of premium on acquired securities of $5.7 million and amortization of premium on acquired time deposits of $2.4 million. Additionally, FNB Transaction related accretion of discount on loans of $7.5 million and amortization of premium on acquired time deposits of $2.7 million also impacted the banking segment’s taxable equivalent net interest margin during the year ended December 31, 2013. These items increased the banking segment’s taxable equivalent net interest margin by 120 basis points for the year ended December 31, 2013. The banking segment’s taxable equivalent net interest margin for the month ended December 31, 2012 of 5.83% was impacted by PlainsCapital Merger related accretion of discount on loans of $6.3 million, amortization of premium on acquired securities of $0.7 million and amortization of premium on acquired time deposits of $0.4 million. These items increased the banking segment’s taxable equivalent interest margin by 140 basis points for the month ended December 31, 2012.

 

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

 

 

 

Year Ended December 31,

 

Month Ended December 31,

 

 

 

2014

 

2013

 

2012

 

 

 

Average

 

Interest

 

Annualized

 

Average

 

Interest

 

Annualized

 

Average

 

Interest

 

Annualized

 

 

 

Outstanding

 

Earned or

 

Yield or

 

Outstanding

 

Earned or

 

Yield or

 

Outstanding

 

Earned or

 

Yield or

 

 

 

Balance

 

Paid

 

Rate

 

Balance

 

Paid

 

Rate

 

Balance

 

Paid

 

Rate

 

Assets

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

Interest-earning assets

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

Loans, gross (1) 

 

$

4,189,895

 

$

292,859

 

6.99

%

$

3,279,228

 

$

238,314

 

7.27

%

$

2,886,549

 

$

19,228

 

7.77

%

Subsidiary warehouse lines of credit

 

912,652

 

34,598

 

3.79

%

947,064

 

51,114

 

5.40

%

1,261,768

 

5,984

 

5.51

%

Investment securities - taxable

 

886,168

 

17,956

 

2.03

%

792,860

 

14,625

 

1.84

%

494,285

 

444

 

1.08

%

Investment securities - non-taxable (2) 

 

149,656

 

5,800

 

3.88

%

158,739

 

5,734

 

3.61

%

175,850

 

481

 

2.24

%

Federal funds sold and securities purchased under agreements to resell

 

18,120

 

52

 

0.29

%

26,373

 

75

 

0.28

%

33,180

 

48

 

1.75

%

Interest-bearing deposits in other financial institutions

 

527,678

 

1,362

 

0.26

%

494,220

 

1,319

 

0.27

%

310,747

 

68

 

0.26

%

Other

 

45,225

 

1,717

 

3.80

%

31,794

 

1,311

 

4.12

%

33,594

 

57

 

2.03

%

Interest-earning assets, gross

 

6,729,394

 

354,344

 

5.27

%

5,730,278

 

312,492

 

5.45

%

5,195,973

 

26,310

 

5.87

%

Allowance for loan losses

 

(40,352

)

 

 

 

 

(22,752

)

 

 

 

 

248

 

 

 

 

 

Interest-earning assets, net

 

6,689,042

 

 

 

 

 

5,707,526

 

 

 

 

 

5,196,221

 

 

 

 

 

Noninterest-earning assets

 

1,245,722

 

 

 

 

 

940,880

 

 

 

 

 

804,190

 

 

 

 

 

Total assets

 

$

7,934,764

 

 

 

 

 

$

6,648,406

 

 

 

 

 

$

6,000,411

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

Liabilities and Stockholders’ Equity

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

Interest-bearing liabilities

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

Interest-bearing deposits

 

$

4,451,191

 

$

15,801

 

0.35

%

$

3,900,867

 

$

14,889

 

0.38

%

$

3,161,312

 

$

1,009

 

0.38

%

Notes payable and other borrowings

 

587,921

 

1,780

 

0.30

%

391,111

 

1,340

 

0.34

%

560,572

 

123

 

0.26

%

Total interest-bearing liabilities (3)

 

5,039,112

 

17,581

 

0.35

%

4,291,978

 

16,229

 

0.38

%

3,721,884

 

1,132

 

0.36

%

Noninterest-bearing liabilities

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

Noninterest-bearing deposits

 

1,808,225

 

 

 

 

 

1,419,594

 

 

 

 

 

1,397,308

 

 

 

 

 

Other liabilities

 

35,755

 

 

 

 

 

39,028

 

 

 

 

 

58,491

 

 

 

 

 

Total liabilities

 

6,883,092

 

 

 

 

 

5,750,600

 

 

 

 

 

5,177,683

 

 

 

 

 

Stockholders’ equity

 

1,051,672

 

 

 

 

 

897,806

 

 

 

 

 

822,728

 

 

 

 

 

Total liabilities and stockholders’ equity

 

$

7,934,764

 

 

 

 

 

$

6,648,406

 

 

 

 

 

$

6,000,411

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

Net interest income (2)

 

 

 

$

336,763

 

 

 

 

 

$

296,263

 

 

 

 

 

$

25,178

 

 

 

Net interest spread (2)

 

 

 

 

 

4.92

%

 

 

 

 

5.07

%

 

 

 

 

5.51

%

Net interest margin (2)

 

 

 

 

 

5.00

%

 

 

 

 

5.17

%

 

 

 

 

5.65

%

 


(1) Average balance includes non-accrual loans.

(2) Taxable equivalent adjustments are based on a 35% tax rate. The adjustment to interest income was $2.0 million, $2.0 million and $0.2 million for the years ended December 31, 2014 and 2013 and the month ended December 31, 2012, respectively.

(3) Excludes the allocation of interest expense on PlainsCapital debt of $1.1 million, $1.0 million and $0.1 million for the years ended December 31, 2014 and 2013 and the month ended December 31, 2012, respectively.

 

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 broker-dealer 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. Such yields and costs are eliminated from the consolidated financial statements.

 

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). Because the operations of the banking segment acquired in the PlainsCapital Merger are not included in our results of operations for the full fiscal year ended December 31, 2012, the table

 

64



Table of Contents

 

summarizing the changes in our net interest income between the year ended December 31, 2013 and the month ended December 31, 2012 due to variances in the volume of our interest-earning assets and interest-bearing liabilities would not be meaningful and has therefore been omitted.

 

 

 

Year Ended December 31,

 

 

 

2014 v. 2013

 

 

 

Change Due To (1)

 

 

 

 

 

Volume

 

Yield/Rate

 

Change

 

Interest income

 

 

 

 

 

 

 

Loans, gross

 

$

66,182

 

$

(11,637

)

$

54,545

 

Subsidiary warehouse lines of credit

 

(1,857

)

(14,659

)

(16,516

)

Investment securities - taxable

 

1,721

 

1,610

 

3,331

 

Investment securities - non-taxable (2) 

 

(328

)

394

 

66

 

Federal funds sold and securities purchased under agreements to resell

 

(23

)

 

(23

)

Interest-bearing deposits in other financial institutions

 

89

 

(46

)

43

 

Other

 

554

 

(148

)

406

 

Total interest income (2)

 

66,338

 

(24,486

)

41,852

 

 

 

 

 

 

 

 

 

Interest expense

 

 

 

 

 

 

 

Deposits

 

$

2,101

 

$

(1,189

)

$

912

 

Notes payable and other borrowings

 

674

 

(234

)

440

 

Total interest expense

 

2,775

 

(1,423

)

1,352

 

 

 

 

 

 

 

 

 

Net interest income (2)

 

$

63,563

 

$

(23,063

)

$

40,500

 

 


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

 

(2) Taxable equivalent.

 

Taxable equivalent net interest income increased $40.5 million during the year ended December 31, 2014, compared with the year ended December 31, 2013. Increases in the volume of interest-earning assets, primarily loans acquired in the FNB Transaction, increased taxable equivalent net interest income by $66.4 million during the year ended December 31, 2014, compared with the year ended December 31, 2013, while increases in the volume of interest-bearing liabilities, primarily deposits assumed in the FNB Transaction, reduced taxable equivalent interest income by $2.8 million during this same period. Changes in the yields earned on interest-earning assets decreased taxable equivalent net interest income by $24.5 million during the year ended December 31, 2014, compared with the year ended December 31, 2013, primarily due to the net effects of lower yields on the loan portfolio and subsidiary warehouse lines of credit, partially offset by increased yields on the investment portfolio. Changes in rates paid on interest-bearing liabilities increased taxable equivalent interest income by $1.4 million during the year ended December 31, 2014, compared with the year ended December 31, 2013, primarily due to the amortization of premiums on time deposits acquired in the FNB Transaction.

 

The banking segment’s noninterest income was $67.4 million, $71.0 million and $4.6 million during the years ended December 31, 2014 and 2013 and the month ended December 31, 2012, respectively. These year-over-year changes included the recognition of a pre-tax bargain purchase gain related to the FNB Transaction of $12.6 million during the year ended December 31, 2013. The remaining changes in noninterest income between the years ended December 31, 2014 and 2013 were primarily due to increases in service charges and fees on deposits assumed in the FNB Transaction, partially offset by a reduction in intercompany financing fees charged to the mortgage origination segment which are eliminated from the consolidated financial statements.

 

The banking segment’s noninterest expenses were $245.8 million, $155.1 million and $16.1 million during the years ended December 31, 2014 and 2013 and the month ended December 31, 2012, respectively. Noninterest expenses were primarily comprised of employees’ compensation and benefits, and occupancy expenses. The significant increase in noninterest expenses between the years ended December 31, 2014 and 2013 was primarily due to the inclusion of the operations acquired in the FNB Transaction and write downs of $19.7 million associated with covered OREO assets during the year ended December 31, 2014. The write downs to fair value of the covered OREO reflect new appraisals on certain OREO acquired in the FNB Transaction and OREO acquired from the foreclosure on certain FNB loans acquired in the FNB Transaction. Although the Bank recorded a fair value discount on the acquired assets upon acquisition, in some cases additional downward valuations were required.

 

These additional downward valuation adjustments reflect changes to the assumptions regarding the fair value of the OREO, including in some cases the intended use of the OREO due to the availability of more information as well as the passage of

 

65



Table of Contents

 

time. The process of determining fair value is subjective in nature and requires the use of significant estimates and assumptions. Although the Bank makes market-based assumptions when valuing acquired assets, new information may come to light that causes estimates to increase or decrease. When the Bank determines, based on subsequent information, that its estimates require adjustment, the Bank records the adjustment. The accounting for such adjustments requires that the decreases to fair value be recorded at the time such new information is received, while increases to fair value are recorded when the asset is subsequently sold. All of the impairments recorded during 2014 related to covered assets subject to the loss-share agreements with the FDIC.

 

On October 24, 2014, the Bank notified its federal and state banking regulators and affected customers that, effective January 30, 2015, it would be closing certain branch locations acquired in the FNB Transaction. Eleven of the branches closed were located in the Texas Rio Grande Valley, and the remaining two branches were located in Houston and Laredo, Texas. The Bank previously notified its federal and state banking regulators and affected customers of the November 7, 2014 closure of two other branches acquired in the FNB Transaction in the Houston market. It is anticipated that the closure of these branches will improve the operational efficiencies of the Bank. In an effort to mitigate potential deposit runoff associated with these branch closures, the Bank will continue to offer banking services to its customers through other branches operating in these markets.

 

Broker-Dealer Segment

 

Income before income taxes in our broker-dealer segment during the years ended December 31, 2014 and 2013 and the month ended December 31, 2012 were $6.9 million, $2.4 million and $0.9 million, respectively. Most of the improvement during 2014, compared with 2013, was in fees earned from advising its public finance clients on an increased volume of debt offerings due to lower interest rates and an improving economy. However, continuing uncertainty in fixed income markets as a result of increased regulations, uncertainty in the direction of future interest rates and a lack of liquidity in the market have continued to suppress sales of fixed income securities to institutional customers. Income before income taxes, and each of its components, are not comparable between the 2013 and 2012 periods since our broker-dealer segment was acquired as a part of the PlainsCapital Merger.

 

The broker-dealer segment had net interest income of $12.1 million, $12.1 million and $1.2 million during the years ended December 31, 2014 and 2013 and the month ended December 31, 2012, respectively, consisting of securities lending activity, customer margin loan balances and investment securities used to support sales, underwriting and other customer activities.

 

Noninterest income was $119.5 million, $102.7 million and $10.9 million during the years ended December 31, 2014 and 2013 and the month ended December 31, 2012, respectively. The majority of the broker-dealer segment’s noninterest income was generated from fees and commissions earned from investment advisory and securities brokerage activities of $101.9 million, $93.1 million and $11.2 million during the years ended December 31, 2014 and 2013 and the month ended December 31, 2012, respectively. As discussed above, the increase during 2014, compared with 2013, was primarily from fees earned on advising public finance clients on an increased volume of debt offerings. The broker-dealer segment participates in programs in which it issues forward purchase commitments of mortgage-backed securities to certain non-profit housing clients and sells TBAs. The fair values of these derivative instruments increased $16.2 million, $11.4 million and $0.2 million during the years ended December 31, 2014 and 2013 and the month ended December 31, 2012, respectively. The fair value of the broker-dealer segment’s trading portfolio, which is used to support sales, underwriting and other customer activities, increased $1.3 million during the year ended December 31, 2014 and decreased $1.8 million and $0.6 million during the year ended December 31, 2013 and the month ended December 31, 2012, respectively.

 

Noninterest expenses were $124.7 million, $112.4 million and $11.1 million for the years ended December 31, 2014 and 2013 and the month ended December 31, 2012, respectively. The increase in noninterest expenses of $12.3 million during 2014, compared to 2013, was primarily due to increases of $10.2 million in employees’ compensation and benefits costs, and $2.3 million in litigation defense costs associated with a lawsuit pending in the state of Rhode Island. Compensation that varies with noninterest income accounted for $6.8 million of the noted increase in compensation costs. Employees’ compensation and benefits and occupancy and equipment accounted for the majority of the costs incurred during all periods.

 

Mortgage Origination Segment

 

Income before income taxes in our mortgage origination segment for the years ended December 31, 2014 and 2013 and the month ended December 31, 2012 was $12.4 million, $27.4 million and $2.3 million, respectively. The decrease in income before income taxes between the years ended December 31, 2014 and 2013 was primarily due to a decrease in noninterest income, partially offset by decreases in noninterest expense and net interest expense. Income before income taxes, and each of its components, are not comparable between the 2013 and 2012 periods since the operations of our mortgage origination

 

66



Table of Contents

 

segment was acquired as a part of the PlainsCapital Merger. Net interest expense of $12.6 million, $37.8 million and $5.0 million during the years ended December 31, 2014 and 2013 and the month ended December 31, 2012, respectively, resulted from interest incurred on a warehouse line of credit held with 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 for the periods indicated below (dollars in thousands). Because the operations of the mortgage origination segment acquired in the PlainsCapital Merger are not included in our results of operations for the full fiscal year ended December 31, 2012, the details regarding the month ended December 31, 2012 would not be meaningful and have therefore been omitted.

 

 

 

Year Ended December 31,

 

 

 

 

 

% of

 

 

 

% of

 

 

 

2014

 

Total

 

2013

 

Total

 

Mortgage Loan Originations - units

 

48,655

 

 

 

55,781

 

 

 

 

 

 

 

 

 

 

 

 

 

Mortgage Loan Originations - volume

 

$

10,363,848

 

 

 

$

11,792,562

 

 

 

 

 

 

 

 

 

 

 

 

 

Mortgage Loan Originations:

 

 

 

 

 

 

 

 

 

Conventional

 

$

6,487,825

 

62.60

%

$

7,505,437

 

63.65

%

Government

 

2,737,415

 

26.41

%

3,465,078

 

29.38

%

Jumbo

 

863,770

 

8.34

%

780,604

 

6.62

%

Other

 

274,838

 

2.65

%

41,443

 

0.35

%

 

 

$

10,363,848

 

100.00

%

$

11,792,562

 

100.00

%

 

 

 

 

 

 

 

 

 

 

Home purchases

 

$

8,295,994

 

80.05

%

$

8,178,970

 

69.36

%

Refinancings

 

2,067,854

 

19.95

%

3,613,592

 

30.64

%

 

 

$

10,363,848

 

100.00

%

$

11,792,562

 

100.00

%

 

 

 

 

 

 

 

 

 

 

Texas

 

$

2,453,705

 

23.68

%

$

2,660,810

 

22.56

%

California

 

1,552,372

 

14.98

%

2,082,184

 

17.66

%

Florida

 

505,507

 

4.88

%

456,643

 

3.87

%

North Carolina

 

423,164

 

4.08

%

618,802

 

5.25

%

Ohio

 

401,379

 

3.87

%

383,518

 

3.25

%

Arizona

 

339,830

 

3.28

%

392,006

 

3.32

%

Virginia

 

322,134

 

3.11

%

466,531

 

3.96

%

South Carolina

 

307,832

 

2.97

%

318,109

 

2.70

%

Washington

 

298,845

 

2.88

%

360,100

 

3.05

%

Maryland

 

298,577

 

2.88

%

385,215

 

3.27

%

All other states

 

3,460,503

 

33.39

%

3,668,644

 

31.11

%

 

 

$

10,363,848

 

100.00

%

$

11,792,562

 

100.00

%

 

The mortgage lending business is subject to variables that can impact loan origination volume, including seasonal and interest rate fluctuations. Historically, the mortgage origination segment has 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 decrease in the mortgage origination segment’s refinancings during the last six months of 2013. Refinancing volume totaled $2.6 billion and $1.0 billion (40% and 19%, respectively, of total loan origination volume) during the first and second six months of 2013, respectively. During the first three quarters of 2014, refinancing volumes as a percentage of total loan origination volume were consistent with the last six months of 2013, ranging between 16% and 21%. During the fourth quarter 2014, refinancing volume increased to 25% of total origination volume, as interest rates decreased during that time. While total refinancing volumes decreased between 2013 and 2014 ($3.6 billion and $2.1 billion, respectively), home purchases volume of $8.3 billion during the year ended December 31, 2014 was virtually unchanged from the year ended December 31, 2013. Due to additional declines in mortgage interest rates subsequent to December 31, 2014, we anticipate refinancing as a percentage of total loan origination volume to continue to increase through the first quarter of 2015.

 

67



Table of Contents

 

While the mortgage origination segment’s total loan origination volume decreased 12.1% between the years ended December 31, 2014 and 2013, income before income taxes decreased 54.8% between the same periods (from $27.4 million income in 2013 to $12.4 million income in 2014), primarily due to a reduction in noninterest income, partially offset by decreases in noninterest expense and net interest expense. 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 for the year ended December 31, 2014 decreased 11% as compared with the year ended December 31, 2013, as the benefits of the headcount reductions made in the third and fourth quarters of 2013 were realized in 2014. The mortgage origination segment 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 6% in non-employee related expenses, including occupancy and administrative costs, during the year ended December 31, 2014, as compared with the year ended December 31, 2013.

 

The mortgage origination segment sells substantially all mortgage loans it originates to various investors in the secondary market, the majority servicing released. During the six months ended June 30, 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 31% during 2014. The related mortgage servicing rights (“MSR”) asset was valued at $37.4 million on $3.8 billion of serviced loan volume at December 31, 2014, compared with a value of $20.1 million on $2.0 billion of serviced loan volume at December 31, 2013. The mortgage origination segment has also retained servicing on certain loans sold to the banking segment. The MSR value associated with these loans at December 31, 2014 was $1.2 million on $145.9 million of serviced loan volume. Gains and losses associated with this sale to the banking segment and the related MSR are eliminated in consolidation. 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. The mortgage origination segment may, from time to time, manage its MSR asset through different strategies, including varying the percentage of mortgage loans sold servicing released and opportunistically selling MSR assets. During the third quarter of 2014, the mortgage origination segment began using derivative financial instruments, including interest rate swaps, swaptions and forward commitments to sell mortgage-backed securities (“MBSs”), as a means to mitigate market risk associated with MSR assets. Changes in the net value of the MSR and the related derivatives resulted in a loss of $4.3 million during the year ended December 31, 2014. No similar gains or losses were recorded during the year ended December 31, 2013. In July 2014, the mortgage origination segment sold MSR assets of $11.4 million, which represented $1.0 billion of its serviced loan volume at that time.

 

Noninterest income was $456.8 million, $537.5 million and $57.6 million for the years ended December 31, 2014 and 2013 and the month ended December 31, 2012, respectively. Noninterest income was comprised of net gains on the sale of loans and other mortgage production income, and mortgage origination fees. Noninterest income decreased 15.0% during 2014 when compared with 2013 primarily as a result of a decrease of 12.1% in loan origination volume and a decrease in average loan origination margins resulting from increased pricing competition. Average loan origination margins began to decrease during the fourth quarter of 2013 and continued to decrease through the second quarter of 2014. While these average margins increased during the last six months of 2014, surpassing average margins recognized during the fourth quarter of 2013, average loan origination margins have not returned to levels recognized during the first three quarters of 2013.

 

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, are included in noninterest income. The related net fair value increased $14.3 million during the year ended December 31, 2014, compared with decreases in net fair value of $11.1 million and $8.8 million during the year ended December 31, 2013 and the month ended December 31, 2012, respectively. During the year ended December 31, 2014, the increase in net fair value was primarily a result of an increase in the volume of IRLCs and mortgage loans held during this period and an increase in the average value of individual IRLCs and mortgage loans. During both the year ended December 31, 2013 and the month ended December 31, 2012, the decrease in net fair value was primarily the result of a decrease in the volume of IRLCs and mortgage loans held during these respective periods, partially offset by an increase in the average value of individual IRLCs and mortgage loans.

 

Noninterest expenses were $431.8 million, $472.3 million and $50.3 million for the years ended December 31, 2014 and 2013 and the month ended December 31, 2012, 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 $20.9 million during the year ended December 31, 2014, compared with the year ended December 31, 2013, and comprised approximately 58% and 59% of the total employees’ compensation and benefits expenses during the years ended December 31, 2014 and 2013, respectively. In addition, employee salaries and benefits decreased $14.5 million during

 

68



Table of Contents

 

the year ended December 31, 2014, as compared with the year ended December 31, 2013, primarily as a result of headcount reductions in the third and fourth quarters of 2013. The mortgage origination segment records unreimbursed closing costs as noninterest expense 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 years ended December 31, 2014 and 2013 and the month ended December 31, 2012 were $32.7 million, $30.1 million and $5.9 million, respectively.

 

Between January 1, 2005 and December 31, 2014, the mortgage origination segment sold mortgage loans totaling $65.6 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 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, the mortgage origination segment evaluates the claim and determines if the claim can be satisfied through additional documentation or other deliverables. If the claim cannot be satisfied in that matter, the mortgage origination segment negotiates 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 December 31, 2014 (dollars in thousands).

 

 

 

Original Loan Balance

 

Loss Recognized

 

 

 

 

 

% of

 

 

 

% of

 

 

 

 

 

Loans

 

 

 

Loans

 

 

 

Amount

 

Sold

 

Amount

 

Sold

 

Claims resolved with no payment

 

$

168,442

 

0.26

%

$

 

0.00

%

 

 

 

 

 

 

 

 

 

 

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

 

193,758

 

0.30

%

25,439

 

0.04

%

 

 

$

362,200

 

0.56

%

$

25,439

 

0.04

%

 


(1) Losses incurred include refunded purchased servicing rights.

 

At December 31, 2014 and 2013, the mortgage origination segment’s indemnification liability reserve totaled $17.6 million and $21.1 million, respectively. The related provision for indemnification losses was $3.1 million, $3.5 million and $0.4 million for the years ended December 31, 2014 and 2013 and the month ended December 31, 2012, respectively.

 

Insurance Segment

 

Income before income taxes in our insurance segment was $25.7 million and $7.6 million during 2014 and 2013, respectively, compared with a loss before income taxes of $4.7 million during 2012. Included within noninterest income of the insurance segment during 2013 is the recognition of a non-recurring gain of $3.7 million. This non-recurring gain, which is eliminated upon consolidation, is due to our redemption during the fourth quarter of 2013 of $6.9 million in aggregate principal amount of 7.50% Senior Exchangeable Notes due 2025 (the “Notes”) of HTH Operating Partnership LP, a wholly owned subsidiary of Hilltop, which were held by our insurance subsidiaries. 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 significant improvement in operating results in our insurance segment during 2014, compared with 2013, was primarily a result of growth in earned premium and improved claims loss experience associated with the significant decline in the general severity of severe weather-related events during 2014. Based on our estimates of the ultimate losses, claims associated with these storms totaled $21.7 million through December 31, 2014, with a net loss, after reinsurance, of $19.9 million during 2014. The insurance segment had positive results during 2013, despite experiencing three tornado, wind and hail storms during the second quarter of 2013. Based on estimates of the ultimate cost, two of these storms are considered catastrophic losses as

 

69



Table of Contents

 

they exceeded our $8 million reinsurance retention during the third quarter of 2013. The estimate of ultimate losses from these storms totaled $26.5 million through December 31, 2013 with a net loss, after reinsurance, of $22.1 million.

 

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. Based on this review, the insurance segment increased rates on certain products in several states in 2014. A state-by-state review of the insurance segment’s products and pricing continues and has resulted in additional rate filings. 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. These actions have both reduced the rate of premium growth for 2014 when compared with the patterns exhibited in prior years and reduced the insurance segment’s exposure to volatile weather through a lower number of insureds in these areas to improve its loss experience during 2014. The insurance segment aims to manage and diversify its business concentrations and products to minimize the effects of future weather-related events.

 

The insurance segment’s operations resulted in combined ratios of 89.3% during 2014, compared with 102.6% and 108.8% during 2013 and 2012, respectively. The year-over-year improvement in the combined ratios was primarily driven by the increase in net 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 $173.6 million, $166.2 million and $154.1 million during 2014, 2013 and 2012, respectively, included net insurance premiums earned of $164.5 million, $157.5 million and $146.7 million, respectively. The increases in earned premiums were primarily attributable to rate and volume increases in homeowners and mobile home products.

 

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

 

 

 

Year Ended December 31,

 

Variance

 

 

 

2014

 

2013

 

2012

 

2014 vs 2013

 

2013 vs 2012

 

Direct Insurance Premiums Written:

 

 

 

 

 

 

 

 

 

 

 

Homeowners

 

$

76,250

 

$

79,711

 

$

73,943

 

$

(3,461

)

$

5,768

 

Fire

 

54,375

 

54,566

 

51,345

 

(191

)

3,221

 

Mobile Home

 

37,611

 

34,940

 

30,123

 

2,671

 

4,817

 

Commercial

 

3,973

 

4,489

 

8,043

 

(516

)

(3,554

)

Other

 

255

 

276

 

326

 

(21

)

(50

)

 

 

$

172,464

 

$

173,982

 

$

163,780

 

$

(1,518

)

$

10,202

 

 

The total direct insurance premiums written for our three largest insurance product lines decreased by $1.0 million during 2014, compared with 2013, due to efforts to reduce concentrations both geographically and within specific product lines. During 2013, total direct insurance premiums written for our three largest insurance product lines increased by $13.8 million compared to 2012. This increase was due to growth in our core insurance products, partially offset by decreases of $3.5 million and $0.3 million in 2013 and 2012, respectively, related to a commercial product line that was non-renewed.

 

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

 

 

 

Year Ended December 31,

 

Variance

 

 

 

2014

 

2013

 

2012

 

2014 vs 2013

 

2013 vs 2012

 

Net Insurance Premiums Earned:

 

 

 

 

 

 

 

 

 

 

 

Homeowners

 

$

72,739

 

$

72,175

 

$

66,233

 

$

564

 

$

5,942

 

Fire

 

51,871

 

49,407

 

45,990

 

2,464

 

3,417

 

Mobile Home

 

35,880

 

31,636

 

26,982

 

4,244

 

4,654

 

Commercial

 

3,790

 

4,065

 

7,204

 

(275

)

(3,139

)

Other

 

244

 

250

 

292

 

(6

)

(42

)

 

 

$

164,524

 

$

157,533

 

$

146,701

 

$

6,991

 

$

10,832

 

 

Net insurance premiums earned during 2014 and 2013 increased compared to 2013 and 2012, respectively, primarily due to the increases in net insurance premiums written of $0.9 million and $13.0 million in 2014 and 2013, respectively. During the fourth quarter of 2014, compared with the same period in 2013, net insurance premiums earned were relatively flat. This reduction in the rate of premium growth when compared with the patterns exhibited in prior quarters and years was consistent

 

70



Table of Contents

 

with the insurance segment’s previously discussed efforts to manage and diversify its business concentrations and products to minimize the effects of future weather-related events.

 

Noninterest expenses of $151.5 million, $166.0 million and $163.6 million during 2014, 2013 and 2012, 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 2014 was $94.4 million, compared to $110.8 million and $109.2 million during 2013 and 2012, respectively. As a result, the loss and LAE ratio during 2014, 2013 and 2012 was 57.4%, 70.3% and 74.4%, respectively. These year-over-year ratio improvements were primarily a result of growth in earned premium and improved claims loss experience associated with the significant decline in the severity of severe weather-related events during 2014 and the improved containment of expected losses during 2013 from the prior year weather events.

 

The insurance segment seeks to generate underwriting profitability. Management evaluates NLC’s loss and LAE ratio by bifurcating the losses to derive catastrophic and non-catastrophic loss ratios. The non-catastrophic loss ratio excludes Property Claims Services events that exceed $1.0 million of losses to NLC. Catastrophic events, including those that do not exceed our reinsurance retention, affect insurance segment loss ratios. During 2014, catastrophic events that did not exceed reinsurance retention accounted for $19.9 million of the total loss and loss adjustment expense, as compared to $22.3 million and $23.3 million during 2013 and 2012, respectively. The inclusion of catastrophic events increased insurance segment combined ratios by 14.1%, 14.3% and 15.8% during 2014, 2013 and 2012, respectively.

 

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. The expense ratio during 2012 included other underwriting expenses of $1.7 million related to the write down of a policy administration system NLC was unable to successfully implement. This charge increased the expense ratio during 2012 by 1.1%.

 

The following table details the calculation of the underwriting expense ratio for the periods presented (dollars in thousands).

 

 

 

Year Ended December 31,

 

Variance

 

 

 

2014

 

2013

 

2012

 

2014 vs 2013

 

2013 vs 2012

 

Amortization of deferred policy acquisition costs

 

$

41,609

 

$

40,592

 

$

38,757

 

$

1,017

 

$

1,835

 

Other underwriting expenses

 

13,823

 

12,859

 

13,829

 

964

 

(970

)

Total

 

55,432

 

53,451

 

52,586

 

1,981

 

865

 

Agency expenses

 

(3,023

)

(2,571

)

(2,073

)

(452

)

(498

)

Total less agency expenses

 

$

52,409

 

$

50,880

 

$

50,513

 

$

1,529

 

$

367

 

Net insurance premiums earned

 

$

164,524

 

$

157,533

 

$

146,701

 

$

6,991

 

$

10,832

 

Expense ratio

 

31.9

%

32.3

%

34.4

%

-0.4

%

-2.1

%

 

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 $5.2 million, $6.6 million and $7.0 million during 2014, 2013 and 2012, respectively. On October 2, 2014, Hilltop exercised its warrant to purchase 8,695,652 shares of SWS common stock at an exercise price of $5.75 per share (the “SWS Warrant”). The aggregate exercise price was paid by the automatic elimination of the $50.0 million aggregate principal amount note receivable from SWS. Consequently, recurring quarterly investment and interest income of $1.6 million were no longer recognized beginning in the fourth calendar quarter of 2014. This transaction is discussed in more detail within the section entitled “Liquidity and Capital Resources — SWS” below.

 

Interest expense of $8.2 million and $7.0 million during 2013 and 2012, respectively, 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. During 2013, interest expense included the recognition of a non-recurring charge of $2.1 million due to the write-off

 

71



Table of Contents

 

of remaining unamortized loan origination fees associated with the Notes being called for redemption during the fourth quarter of 2013.

 

Following the exercise of the SWS Warrant, Hilltop owned approximately 21% of the outstanding shares of SWS common stock as of October 2, 2014. Contemporaneous with the exercise of the SWS Warrant, Hilltop changed the accounting method for its investment in SWS common stock and elected to account for its investment in accordance with the provisions of the Fair Value Option Subsections of the Accounting Standards Codification (“ASC”) (“Fair Value Option”) as permitted by GAAP. Hilltop had previously accounted for its investment in SWS common stock as an available for sale security. Under the Fair Value Option, Hilltop’s investment in SWS common stock is recorded at fair value effective October 2, 2014, with changes in fair value being recorded in other noninterest income within the consolidated statement of operations rather than as a component of other comprehensive income. Hilltop’s election to apply the provisions of the Fair Value Option resulted in Hilltop recording those unrealized gains previously associated with its investment in SWS common stock of $7.2 million. For the period from October 3, 2014 through December 31, 2014, the change in fair value of Hilltop’s investment in SWS common stock resulted in a loss of $1.2 million. In the aggregate, Hilltop recorded a $6.0 million net gain in other noninterest income during 2014.

 

Noninterest expenses of $13.9 million, $10.4 million and $14.5 million during 2014, 2013 and 2012, respectively, were primarily comprised of employees’ compensation and benefits, professional fees and transaction costs associated with acquisition efforts. During 2014, noninterest expenses included year-over-year increases in professional fees, including corporate governance, legal and transaction costs, and headcount and related costs. During 2013, noninterest expenses included the recognition of a non-recurring loss of $3.7 million associated with the Notes held by our insurance segment being called for redemption during the fourth quarter of 2013. This loss was eliminated in consolidation. In addition, noninterest expenses included $1.4 million, $0.1 million and $6.4 million of transaction costs associated with acquisition efforts during 2014, 2013 and 2012, respectively. We expect to incur additional estimated SWS Merger-related transaction costs of $4.9 million during 2015.

 

Financial Condition

 

The following discussion contains a more detailed analysis of our financial condition at December 31, 2014 as compared to December 31, 2013 and 2012.

 

Securities Portfolio

 

At December 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. We have the ability to categorize investments as trading, available for sale, and held to maturity.

 

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.

 

72



Table of Contents

 

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

 

 

 

December 31,

 

 

 

2014

 

2013

 

2012

 

Trading securities, at fair value

 

$

65,717

 

$

58,846

 

$

90,113

 

 

 

 

 

 

 

 

 

Securities available for sale, at fair value

 

 

 

 

 

 

 

U.S. Treasury securities

 

19,613

 

43,528

 

7,185

 

U.S. government agencies:

 

 

 

 

 

 

 

Bonds

 

516,241

 

662,732

 

526,237

 

Residential mortgage-backed securities

 

52,898

 

60,087

 

18,893

 

Collateralized mortgage obligations

 

87,124

 

120,461

 

97,924

 

Corporate debt securities

 

98,472

 

76,608

 

87,177

 

States and political subdivisions

 

136,785

 

156,835

 

175,759

 

Commercial mortgage-backed securities

 

640

 

760

 

1,073

 

Equity securities

 

13,762

 

22,079

 

20,428

 

Note receivable

 

 

47,909

 

44,160

 

Warrant

 

 

12,144

 

12,117

 

 

 

925,535

 

1,203,143

 

990,953

 

 

 

 

 

 

 

 

 

Securities held to maturity, at amortized cost

 

 

 

 

 

 

 

U.S. Treasury securities

 

25,008

 

 

 

U.S. government agencies:

 

 

 

 

 

 

 

Residential mortgage-backed securities

 

29,782

 

 

 

Collateralized mortgage obligations

 

57,328

 

 

 

States and political subdivisions

 

6,091

 

 

 

 

 

118,209

 

 

 

Total securities portfolio

 

$

1,109,461

 

$

1,261,989

 

$

1,081,066

 

 

We had net unrealized gains of $0.8 million and $12.5 million related to the available for sale investment portfolio at December 31, 2014 and 2012, respectively, compared with a net unrealized loss of $53.7 million at December 31, 2013. The significant changes in the net unrealized gain (loss) position of our available for sale investment portfolio during 2013 and 2014 were due to the effects of increases in market interest rates beginning May 2013 that resulted in a decrease in the fair value of our debt securities until January 2014 when the effects of decreases in market interest rates resulted in an increase in the fair value of our debt securities. As previously discussed, Hilltop’s election to apply the provisions of the Fair Value Option for its investment in SWS common stock effective October 2, 2014, resulted in Hilltop recording an unrealized net gain of $7.2 million associated with its investment in SWS common stock. Therefore, Hilltop’s securities portfolio included its $70.3 million investment in SWS common stock in other assets within the consolidated balance sheet at December 31, 2014. This transaction is discussed in more detail within the section entitled “Liquidity and Capital Resources — SWS” below.

 

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

 

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 December 31, 2014, the banking segment’s securities portfolio of $916.5 million was comprised of trading securities of $20.8 million, available for sale securities of $777.5 million and held to maturity securities of $118.2 million.

 

73



Table of Contents

 

Broker-Dealer Segment

 

Our broker-dealer 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 $44.9 million at December 31, 2014 as trading.

 

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 December 31, 2014, the insurance segment’s securities portfolio was comprised of $148.0 million in available for sale securities and $6.2 million of other investments included in other assets within the consolidated balance sheet.

 

Corporate

 

At December 31, 2014, Hilltop’s portfolio was comprised of its $70.3 million investment in SWS common stock included in other assets within the consolidated balance sheet. On January 1, 2015, Hilltop completed its acquisition of SWS in a stock and cash transaction. This transaction is discussed in more detail within the section entitled “Liquidity and Capital Resources — SWS” below.

 

The following table sets forth the estimated maturities of debt securities, excluding trading securities. Contractual maturities may be different (dollars in thousands, yields are tax-equivalent).

 

 

 

December 31, 2014

 

 

 

One Year

 

One Year to

 

Five Years to

 

Greater Than

 

 

 

 

 

Or Less

 

Five Years

 

Ten Years

 

Ten Years

 

Total

 

U.S. Treasury securities:

 

 

 

 

 

 

 

 

 

 

 

Amortized cost

 

$

29,361

 

$

10,086

 

$

4,943

 

$

 

$

44,390

 

Fair value

 

29,356

 

10,102

 

5,157

 

 

44,615

 

Weighted average yield

 

0.22

%

1.12

%

2.65

%

 

0.70

%

U.S. government agencies:

 

 

 

 

 

 

 

 

 

 

 

Bonds:

 

 

 

 

 

 

 

 

 

 

 

Amortized cost

 

6,469

 

5,743

 

16,668

 

493,128

 

522,008

 

Fair value

 

6,591

 

5,822

 

18,144

 

485,684

 

516,241

 

Weighted average yield

 

3.63

%

1.60

%

3.57

%

2.14

%

2.20

%

Residential mortgage-backed securities:

 

 

 

 

 

 

 

 

 

 

 

Amortized cost

 

2,018

 

1,033

 

3,438

 

74,656

 

81,145

 

Fair value

 

2,008

 

1,051

 

3,494

 

76,655

 

83,208

 

Weighted average yield

 

2.08

%

2.23

%

3.14

%

3.21

%

3.17

%

Collateralized mortgage obligations:

 

 

 

 

 

 

 

 

 

 

 

Amortized cost

 

 

1,034

 

2,682

 

142,903

 

146,619

 

Fair value

 

 

1,046

 

2,712

 

140,264

 

144,022

 

Weighted average yield

 

 

1.93

%

1.98

%

1.99

%

1.98

%

Corporate debt securities:

 

 

 

 

 

 

 

 

 

 

 

Amortized cost

 

10,624

 

46,732

 

35,133

 

917

 

93,406

 

Fair value

 

10,728

 

50,033

 

36,747

 

964

 

98,472

 

Weighted average yield

 

3.77

%

4.34

%

3.39

%

6.25

%

3.94

%

States and political subdivisions:

 

 

 

 

 

 

 

 

 

 

 

Amortized cost

 

365

 

4,762

 

11,126

 

125,257

 

141,510

 

Fair value

 

366

 

4,772

 

11,191

 

126,591

 

142,920

 

Weighted average yield

 

4.93

%

1.72

%

2.34

%

2.56

%

2.52

%

Commercial mortgage-backed securities:

 

 

 

 

 

 

 

 

 

 

 

Amortized cost

 

 

 

 

593

 

593

 

Fair value

 

 

 

 

640

 

640

 

Weighted average yield

 

 

 

 

6.24

%

6.24

%

Total securities portfolio:

 

 

 

 

 

 

 

 

 

 

 

Amortized cost

 

48,837

 

69,390

 

73,990

 

837,454

 

1,029,671

 

Fair value

 

49,049

 

72,826

 

77,445

 

830,798

 

1,030,118

 

Weighted average yield

 

1.56

%

3.40

%

3.16

%

2.28

%

2.38

%

 

74



Table of Contents

 

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

 

December 31, 2014

 

PCI Loans

 

Loans

 

Loans

 

Commercial and industrial

 

$

1,745,409

 

$

13,442

 

$

1,758,851

 

Real estate

 

1,670,684

 

24,151

 

1,694,835

 

Construction and land development

 

404,465

 

9,178

 

413,643

 

Consumer

 

51,009

 

2,138

 

53,147

 

Non-covered loans, gross

 

3,871,567

 

48,909

 

3,920,476

 

Allowance for loan losses

 

(31,722

)

(5,319

)

(37,041

)

Non-covered loans, net of allowance

 

$

3,839,845

 

$

43,590

 

$

3,883,435

 

 

 

 

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

 

 

 

 

Loans, excluding

 

PCI

 

Total

 

December 31, 2012

 

PCI Loans

 

Loans

 

Loans

 

Commercial and industrial

 

$

1,588,907

 

$

71,386

 

$

1,660,293

 

Real estate

 

1,122,667

 

62,247

 

1,184,914

 

Construction and land development

 

247,413

 

33,070

 

280,483

 

Consumer

 

26,629

 

77

 

26,706

 

Non-covered loans, gross

 

2,985,616

 

166,780

 

3,152,396

 

Allowance for loan losses

 

(3,409

)

 

(3,409

)

Non-covered loans, net of allowance

 

$

2,982,207

 

$

166,780

 

$

3,148,987

 

 

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 $4.7 billion, $4.2 billion and $4.1 million at December 31, 2014, 2013 and 2012, respectively. The banking segment’s non-covered loan portfolio includes a $1.5 billion warehouse line of credit extended to PrimeLending, of which $1.2 billion was drawn at December 31, 2014. At December 31, 2013 and 2012, the banking segment’s non-covered loan portfolio included $1.0 billion and $1.3 billion, respectively, drawn against the PrimeLending warehouse line of credit, as well as term loans to First Southwest that had outstanding balances of $23.0 million and $4.0 million, respectively. Amounts advanced against the warehouse line of credit and the First Southwest term loans are eliminated from net loans on our consolidated balance sheets.

 

75



Table of Contents

 

The banking segment does not generally participate in syndicated loan transactions and has no foreign loans in its portfolio. The areas of concentration within our non-covered real estate portfolio were construction and land development loans, non-construction residential real estate loans and non-construction commercial real estate loans. At December 31, 2014, the banking segment’s non-covered loan concentrations (loans to borrowers engaged in similar activities) that exceeded 10% of its total non-covered loans included non-construction commercial real estate loans within the non-covered real estate portfolio. At December 31, 2014, non-construction commercial real estate loans were 23.32% of the banking segment’s total non-covered loans. The banking segment’s non-covered loan concentrations were within regulatory guidelines at December 31, 2014.

 

Broker-Dealer Segment

 

The loan portfolio of the broker-dealer 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 broker-dealer segment’s total non-covered loans, net of the allowance for non-covered loan losses, were $378.3 million, $281.6 million and $277.0 million at December 31, 2014, 2013 and 2012, respectively. These increases were primarily attributable to increased borrowings in margin accounts held by FSC customers and correspondents.

 

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 IRLCs with a customer pursuant to which we agree to originate a mortgage loan on a future date at an agreed-upon interest rate. The components of the mortgage origination segment’s loans held for sale and IRLCs are as follows (in thousands).

 

 

 

December 31,

 

 

 

2014

 

2013

 

2012

 

Loans held for sale:

 

 

 

 

 

 

 

Unpaid principal balance

 

$

1,218,792

 

$

1,037,528

 

$

1,359,829

 

Fair value adjustment

 

53,360

 

21,555

 

40,908

 

 

 

$

1,272,152

 

$

1,059,083

 

$

1,400,737

 

 

 

 

 

 

 

 

 

IRLCs:

 

 

 

 

 

 

 

Unpaid principal balance

 

$

621,216

 

$

602,467

 

$

968,083

 

Fair value adjustment

 

17,057

 

12,151

 

15,150

 

 

 

$

638,273

 

$

614,618

 

$

983,233

 

 

The mortgage origination segment uses forward commitments to mitigate interest rate risk associated with its loans held for sale and IRLCs. The notional amounts of these forward commitments at December 31, 2014, 2013 and 2012, were $1.5 billion, $1.4 billion and $1.4 billion, respectively, while the related estimated fair values were $(11.1) million, $10.5 million and $0.7 million, respectively.

 

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. As of December 31, 2014, the Bank estimated that

 

76



Table of Contents

 

covered losses and reimbursable expenses exceed $240.4 million, but do not exceed $365.7 million. Unless the estimates of covered losses and reimbursable expenses exceed $365.7 million, the Bank will not record additional reimbursement receivable from the FDIC. As of December 31, 2014, the Bank had billed $75.5 million of covered net losses to the FDIC, of which 80%, or $60.4 million, are reimbursable under the loss-share agreements. As of December 31, 2014, the Bank had received aggregate reimbursements of $38.5 million from the FDIC.

 

In connection with the FNB Transaction, the Bank acquired loans both with and without evidence of credit quality deterioration since origination. Based on purchase date valuations, 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

 

December 31, 2014

 

PCI Loans

 

Loans

 

Loans

 

Commercial and industrial

 

$

10,345

 

$

20,435

 

$

30,780

 

Real estate

 

183,886

 

368,964

 

552,850

 

Construction and land development

 

13,021

 

45,989

 

59,010

 

Consumer

 

 

 

 

Covered loans, gross

 

207,252

 

435,388

 

642,640

 

Allowance for loan losses

 

(77

)

(4,534

)

(4,611

)

Covered loans, net of allowance

 

$

207,175

 

$

430,854

 

$

638,029

 

 

 

 

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 December 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 December 31, 2014, non-construction residential real estate loans and non-construction commercial real estate loans were 38.30% and 41.10%, respectively, of the banking segment’s total covered loans. The banking segment’s covered loan concentrations were within regulatory guidelines at December 31, 2014.

 

Loan Portfolio Maturities

 

Banking Segment

 

The following table provides information regarding the maturities of the banking segment’s non-covered and covered commercial and real estate loans held for investment, net of unearned income (in thousands).

 

 

 

December 31, 2014

 

 

 

Due Within

 

Due From One

 

Due After

 

 

 

 

 

One Year

 

To Five Years

 

Five Years

 

Total

 

Commercial and industrial

 

$

1,992,858

 

$

509,995

 

$

102,260

 

$

2,605,113

 

Real estate (including construction and land development)

 

313,160

 

974,476

 

1,434,969

 

2,722,605

 

Total

 

$

2,306,018

 

$

1,484,471

 

$

1,537,229

 

$

5,327,718

 

 

 

 

 

 

 

 

 

 

 

Fixed rate loans

 

$

2,162,921

 

$

1,435,589

 

$

1,535,952

 

$

5,134,462

 

Floating rate loans

 

143,097

 

48,882

 

1,277

 

193,256

 

Total

 

$

2,306,018

 

$

1,484,471

 

$

1,537,229

 

$

5,327,718

 

 

77



Table of Contents

 

In the table above, floating rate loans that have reached their applicable rate floor or ceiling are classified as fixed rate loans rather than floating rate loans. The majority of floating rate loans carry an interest rate tied to The Wall Street Journal Prime Rate, as published in The Wall Street Journal.

 

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. 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 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”) 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 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, adjusted for qualitative or environmental factors. The Bank uses a rolling three year average net loss rate to calculate historical loss factors. The analysis is conducted by call report category, and further disaggregates commercial and industrial loans by collateral type. The analysis considers charge-offs and recoveries in determining the loss rate; therefore net charge-off experience is used. The historical loss calculation for the quarter is calculated by dividing the current quarter net charge-offs for each loan category by the quarter ended loan category balance. The Bank utilizes a weighted average loss rate to better represent recent trends. The Bank weights the most recent four quarter average at 120% versus the oldest four quarters at 80%.

 

While historical loss experience provides a reasonable starting point for the analysis, historical losses are not the sole basis upon which we 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 the volume and severity of past due, nonaccrual and classified loans;

·                  changes in the nature, volume and terms of loans in the portfolio;

·                  changes in lending policies and procedures;

·                  changes in economic and business conditions and developments that affect the collectability of the portfolio;

·                  changes in lending management and staff;

·                  changes in the loan review system and the degree of oversight by the Bank’s board of directors; and

·                  any concentrations of credit and changes in the level of such concentrations.

 

Changes in the volume and severity of past due, nonaccrual and classified loans, as well as changes in the nature, volume and terms of loans in the portfolio are key indicators of changes that could indicate a necessary adjustment to the historical loss factors.  The magnitude of the impact of these factors on our qualitative assessment of the allowance for loan loss changes from quarter to quarter.

 

78



Table of Contents

 

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 equal to or greater than $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.

 

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 December 31, 2014, additional provisions for losses on existing loans may be necessary in the future. Within our non-covered portfolio, we recorded net charge-offs of $3.9 million, $6.3 million and $0.4 million for the years ended December 31, 2014 and 2013 and the month ended December 31, 2012, respectively. Our allowance for non-covered loan losses totaled $37.0 million, $33.2 million and $3.4 million at December 31, 2014, 2013 and 2012, respectively. The ratio of the allowance for non-covered loan losses to total non-covered loans held for investment at December 31, 2014, 2013 and 2012 was 0.94%, 0.95% and 0.11%, respectively.

 

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 $5.6 million for the year ended December 31, 2014. Our allowance for covered loan losses totaled $4.6 million and $1.1 million at December 31, 2014 and 2013, respectively. The ratio of the allowance for covered loan losses to total covered loans held for investment at December 31, 2014 and 2013 was 0.72% 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, was $16.9 million, $37.2 million and $3.8 million for the years ended December 31, 2014 and 2013 and the month ended December 31, 2012, respectively. The increase in our provision for loan losses during 2013 and 2014, compared with 2012, was related to the accumulation of a reserve on the non-covered and covered loan portfolios subsequent to the PlainsCapital Merger and the FNB Transaction, respectively, at which time the respective acquired loan portfolios were recorded at estimated fair value with no carryover of the related allowance for loan loss. The decrease in the provision for loan losses during 2014, compared with 2013, was attributable to lower charge-offs related to the pooling of PCI loans acquired in the FNB Transaction, lower originations and lower historical losses used in the calculation of the required reserve.

 

79



Table of Contents

 

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. With respect to the covered portfolio, the year ended December 31, 2013 below refers to the period from September 14, 2013 through December 31, 2013.

 

 

 

Year Ended December 31,

 

Month Ended

 

Non-Covered Portfolio

 

2014

 

2013

 

December 31, 2012

 

Balance, beginning of period

 

$

33,241

 

$

3,409

 

$

 

Provisions charged to operating expenses

 

7,747

 

36,093

 

3,800

 

Recoveries of non-covered loans previously charged off:

 

 

 

 

 

 

 

Commercial and industrial

 

2,944

 

3,439

 

 

Real estate

 

218

 

282

 

 

Construction and land development

 

185

 

265

 

 

Consumer

 

105

 

61

 

 

Total recoveries

 

3,452

 

4,047

 

 

Non-covered loans charged off:

 

 

 

 

 

 

 

Commercial and industrial

 

6,926

 

9,359

 

391

 

Real estate

 

114

 

209

 

 

Construction and land development

 

 

524

 

 

Consumer

 

359

 

216

 

 

Total charge-offs

 

7,399

 

10,308

 

391

 

Net charge-offs

 

(3,947

)

(6,261

)

(391

)

Balance, end of period

 

$

37,041

 

$

33,241

 

$

3,409

 

 

 

 

Year Ended December 31,

 

 

 

Covered Portfolio

 

2014

 

2013

 

 

 

Balance, beginning of year

 

$

1,061

 

$

 

 

 

Provisions charged to operating expenses

 

9,186

 

1,065

 

 

 

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

 

90

 

4

 

 

 

Real estate

 

5,399

 

 

 

 

Construction and land development

 

147

 

 

 

 

Consumer

 

 

 

 

 

Total charge-offs

 

5,636

 

4

 

 

 

Net charge-offs

 

(5,636

)

(4

)

 

 

Balance, end of year

 

$

4,611

 

$

1,061

 

 

 

 

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 table below (dollars in thousands).

 

 

December 31,

 

 

 

2014

 

2013

 

2012

 

 

 

 

 

% of

 

 

 

% of

 

 

 

% of

 

 

 

 

 

Gross

 

 

 

Gross

 

 

 

Gross

 

 

 

 

 

Non-Covered

 

 

 

Non-Covered

 

 

 

Non-Covered

 

Non-Covered Portfolio

 

Reserve

 

Loans

 

Reserve

 

Loans

 

Reserve

 

Loans

 

Commercial and industrial

 

$

18,999

 

44.86

%

$

16,865

 

46.58

%

$

1,845

 

52.67

%

Real estate (including construction and land development)

 

17,581

 

53.78

%

16,288

 

51.84

%

1,559

 

46.48

%

Consumer

 

461

 

1.36

%

88

 

1.58

%

5

 

0.85

%

Total

 

$

37,041

 

100.00

%

$

33,241

 

100.00

%

$

3,409

 

100.00

%

 

80



Table of Contents

 

 

 

December 31,

 

 

 

2014

 

2013

 

 

 

 

 

% of

 

 

 

% of

 

 

 

 

 

Gross

 

 

 

Gross

 

 

 

 

 

Covered

 

 

 

Covered

 

Covered Portfolio

 

Reserve

 

loans

 

Reserve

 

Loans

 

Commercial and industrial

 

$

1,193

 

4.79

%

$

1,053

 

6.65

%

Real estate (including construction and land development)

 

3,418

 

95.21

%

8

 

93.35

%

Consumer

 

 

0.00

%

 

0.00

%

Total

 

$

4,611

 

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 December 31, 2014, we had three credit relationships totaling $1.8 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 December 31, 2014, we had no credit relationships with 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.

 

Non-Performing Assets

 

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

 

 

 

December 31,

 

 

 

2014

 

2013

 

2012

 

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

 

 

 

 

 

 

 

Commercial and industrial

 

$

16,648

 

$

16,730

 

$

 

Real estate

 

4,707

 

6,511

 

1,756

 

Construction and land development

 

703

 

112

 

 

Consumer

 

 

 

 

 

 

$

22,058

 

$

23,353

 

$

1,756

 

 

 

 

 

 

 

 

 

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

 

0.42

%

0.51

%

0.04

%

 

 

 

 

 

 

 

 

Non-covered other real estate owned

 

$

808

 

$

4,805

 

$

11,098

 

 

 

 

 

 

 

 

 

Other repossessed assets

 

$

361

 

$

13

 

$

557

 

 

 

 

 

 

 

 

 

Non-covered non-performing assets

 

$

23,227

 

$

28,171

 

$

13,411

 

 

 

 

 

 

 

 

 

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

 

0.25

%

0.32

%

0.18

%

 

 

 

 

 

 

 

 

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

 

$

19,237

 

$

7,301

 

$

3,563

 

 

 

 

 

 

 

 

 

Troubled debt restructurings included in accruing non-covered loans

 

$

2,901

 

$

1,055

 

$

 

 

At December 31, 2014, total non-covered non-performing assets decreased $5.0 million to $23.2 million, compared with $28.2 million at December 31, 2013. Non-covered non-performing loans totaled $22.1 million at December 31, 2014 and $23.4 million at December 31, 2013. At December 31, 2014, non-covered non-accrual loans included twelve commercial and industrial relationships with loans of $15.0 million secured by accounts receivable, inventory, equipment, life insurance, and a total of $1.6 million in lease financing receivables. Non-covered non-accrual loans at December 31, 2014 also included $4.7 million characterized as real estate loans, including two commercial real estate loan relationships of $0.4 million and loans secured by residential real estate of $1.3 million, $3.0 million of which were classified as loans held for sale, as well as construction and land development loans of $0.7 million. Total non-covered non-performing assets increased $14.8 million to $28.2 million at December 31, 2013, compared with $13.4 million at December 31, 2012, primarily due to an increase in non-covered non-accrual PCI loans of $15.8 million. At December 31, 2013, non-covered non-accrual loans included five commercial and industrial relationships with loans of $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

 

81



Table of Contents

 

included $6.5 million characterized as real estate loans, including three commercial real estate loan relationships of $2.5 million and loans secured by residential real estate of $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 decreased $4.0 million to $0.8 million at December 31, 2014, compared with $4.8 million at December 31, 2013. Changes in non-covered OREO included the disposal of twelve properties totaling $5.8 million and the addition of seven properties totaling $2.6 million. At December 31, 2014, non-covered OREO included commercial properties of $0.4 million and commercial real estate property consisting of parcels of unimproved land of $0.4 million. Non-covered OREO decreased $6.3 million to $4.8 million at December 31, 2013, compared with $11.1 million at December 31, 2012. The decrease was primarily due to the disposal of two properties totaling $5.7 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.

 

Non-covered loans past due 90 days or more and still accruing were $19.2 million, $7.3 million and $3.6 million at December 31, 2014, 2013 and 2012, respectively, Included in those amounts were $19.2 million, $6.8 million and $1.6 million, respectively, of loans held for sale that are subject to repurchase by PrimeLending, all of which are guaranteed by U.S. Government agencies. The remaining amounts of loans past due and still accruing at December 31, 2013 and 2012 included secured commercial and industrial loans, and a real estate loan.

 

At December 31, 2014, troubled debt restructurings (“TDRs”) on non-covered loans totaled $10.3 million, of which $2.9 million relate to non-covered loans that are considered to be performing and non-covered non-performing loans of $7.4 million reported in non-accrual loans. At December 31, 2013, TDRs on non-covered loans totaled $11.4 million. These TDRs were comprised of $1.1 million of non-covered loans that are considered to be performing and non-covered non-performing loans of $10.3 million reported in non-accrual loans.

 

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

 

 

 

December 31,

 

 

 

2014

 

2013

 

Covered loans accounted for on a non-accrual basis:

 

 

 

 

 

Commercial and industrial

 

$

1,325

 

$

973

 

Real estate

 

31,869

 

249

 

Construction and land development

 

1,029

 

575

 

Consumer

 

 

 

 

 

$

34,223

 

$

1,797

 

 

 

 

 

 

 

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

 

5.33

%

0.18

%

 

 

 

 

 

 

Covered other real estate owned:

 

 

 

 

 

Real estate - residential

 

$

15,711

 

$

11,634

 

Real estate - commercial

 

40,889

 

51,897

 

Construction and land development - residential

 

21,719

 

36,866

 

Construction and land development - commercial

 

58,626

 

42,436

 

 

 

$

136,945

 

$

142,833

 

 

 

 

 

 

 

Other repossessed assets

 

$

 

$

 

 

 

 

 

 

 

Covered non-performing assets

 

$

171,168

 

$

144,630

 

 

 

 

 

 

 

Covered non-performing assets as a percentage of total assets

 

1.85

%

1.62

%

 

 

 

 

 

 

Covered loans past due 90 days or more and still accruing

 

$

67

 

$

 

 

 

 

 

 

 

Troubled debt restructurings included in accruing covered loans

 

$

326

 

$

 

 

At December 31, 2014, covered non-performing assets increased by $26.6 million to $171.2 million, compared with $144.6 million at December 31, 2013, primarily due to an increase in covered non-accrual loans of $32.4 million. Covered non-performing loans totaled $34.2 million at December 31, 2014 and $1.8 million at December 31, 2013. At December 31, 2014, covered non-performing loans included two commercial and industrial relationships with loans of $2.1 million secured by accounts receivable and inventory, four commercial real estate loan relationships of $30.8 million, nine residential real estate loan relationships of $1.1 million, as well as construction and land development loans of $1.0 million. At December 31, 2013, covered non-performing loans of $1.8 million included one commercial and industrial relationship with loans of $1.0 million

 

82



Table of Contents

 

secured by accounts receivable, inventory and equipment. Covered non-accrual loans at December 31, 2013 also included one commercial real estate loan relationship of $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 decreased $5.9 million to $136.9 million at December 31, 2014, compared with $142.8 million at December 31, 2013. The decrease was primarily due to the disposal of 252 properties totaling $55.1 million and fair value valuation decreases of $19.7 million, partially offset by the addition of 210 properties totaling $64.9 million.

 

Covered loans past due 90 days or more and still accruing totaled $0.1 million at December 31, 2014 and included a secured commercial and industrial loan, a construction and land development loan, and a residential real estate loan. There were no covered loans past due 90 days or more and still accruing at December 31, 2013.

 

At December 31, 2014, TDRs on covered loans totaled $0.7 million, of which $0.3 million relate to covered loans that are considered to be performing and covered non-performing loans of $0.4 million included in non-accrual loans.

 

Insurance Losses and Loss Adjustment Expenses

 

At December 31, 2014 and 2013, our reserves for unpaid losses and LAE were $25.4 million and $23.0 million, respectively, net of estimated recoveries from reinsurance of $4.3 million and $4.5 million, respectively. The increase in the net reserve for unpaid losses and LAE was primarily due to increased reserves attributable to prior period adverse development associated with litigation emerging from a series of hail storms within the 2012 accident year. 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, less a reduction for reinsurance recoverables related to those liabilities. 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. The amount of liabilities for reported claims is based primarily on a claim-by-claim evaluation of coverage, liability, injury severity or scope of property damage, and any other information considered relevant to estimating exposure presented by the claim.

 

The methods that our actuaries utilize to estimate ultimate loss and LAE amounts are the paid and reported loss development method and the paid and reported Bornhuetter-Ferguson method (the “BF method”). Significant periods of time can elapse between the occurrence of an insured loss, the reporting of the loss to the insurer and the insurer’s payment of that loss. NLC’s liabilities for unpaid losses represent the best estimate at a given point in time of what it expects to pay claimants, based on facts, circumstances and historical trends then known. During the loss settlement period, additional facts regarding individual claims may become known and, consequently, it often becomes necessary to refine and adjust the estimates of liability. 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 (which utilize historical trends, adjusted for changes in loss costs, underwriting standards, policy provisions, product mix and other factors) and applicable insurance industry loss development factors. Estimating the liability for unpaid losses and LAE is inherently judgmental and is influenced by factors that are subject to significant variation. Liabilities for LAE are intended to cover the ultimate cost of settling claims, including investigation and defense of lawsuits resulting from such claims.

 

The BF method is a procedure that weights an expected ultimate loss and LAE amount, and the result of the loss development method. This method is useful when loss data is immature or sparse because it is not as sensitive as the loss development method to unusual variations in the paid or reported amounts. The BF method requires an initial estimate of expected ultimate losses and LAE. For each year, the expected ultimate losses and LAE is based on a review of the ultimate loss ratios indicated in the companies’ historical data and applicable insurance industry ultimate loss ratios. Each loss development factor, paid or reported, implies a certain percent of the ultimate losses and LAE is still unpaid or unreported. The amounts of unpaid or unreported losses and LAE by year are estimated as the percentage unpaid or unreported, times the expected ultimate loss and LAE amounts. To project ultimate losses and LAE, the actual paid or reported losses and LAE to date are added to the estimated unpaid or unreported amounts. The results of each actuarial method performed by year are reviewed to select an ultimate loss and LAE amount for each accident year. In general, more weight is given to the loss development projections for more mature accident periods and more weight is given to the BF methods for less mature accident periods.

 

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

 

83



Table of Contents

 

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. We would consider reasonably likely changes in the key assumptions to have an impact on our best estimate by plus or minus 10%. At December 31, 2014, this equates to approximately plus or minus $2.5 million, or 1.76% of insurance segment equity, and 2.7% of calendar year 2014 insurance losses.

 

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), as discussed in more detail within the section entitled “Liquidity and Capital Resources — Banking Segment” below, is constantly changing due to the banking segment’s needs and market conditions. Overall, average deposits totaled $6.4 billion for the year ended December 31, 2014, an increase from average deposits of $5.3 billion for the year ended December 31, 2013 and $4.6 billion for the month ended December 31, 2012. The significant year-over-year increases in average deposits were primarily due to those deposits assumed as a part of the FNB Transaction. For the periods presented below, the average rates paid associated with certificates of deposits include the effects of amortization of the deposit premiums booked as a part of the PlainsCapital Merger and the FNB Transaction.

 

The table below presents the average balance of, and rate paid on, consolidated deposits (dollars in thousands).

 

 

 

Year Ended December 31,

 

Month Ended

 

 

 

2014

 

2013

 

December 31, 2012

 

 

 

Average

 

Average

 

Average

 

Average

 

Average

 

Average

 

 

 

Balance

 

Rate Paid

 

Balance

 

Rate Paid

 

Balance

 

Rate Paid

 

Noninterest-bearing demand deposits

 

$

 1,862,277

 

0.00

%

$

 1,370,029

 

0.00

%

$

 1,322,023

 

0.00

%

Interest-bearing demand deposits

 

2,249,527

 

0.22

%

1,930,622

 

0.24

%

1,700,265

 

0.25

%

Savings deposits

 

304,774

 

0.19

%

247,789

 

0.32

%

177,803

 

0.32

%

Certificates of deposit

 

1,936,447

 

0.53

%

1,745,483

 

0.54

%

1,355,435

 

0.53

%

 

 

$

 6,353,025

 

0.25

%

$

 5,293,923

 

0.28

%

$

 4,555,526

 

0.26

%

 

The maturity of consolidated interest-bearing time deposits of $100,000 or more at December 31, 2014 is set forth in the table below (in thousands).

 

Months to maturity:

 

 

 

3 months or less

 

$

279,056

 

3 months to 6 months

 

161,787

 

6 months to 12 months

 

299,525

 

Over 12 months

 

469,459

 

 

 

$

1,209,827

 

 

The banking segment experienced a decline of $464.6 million in interest-bearing time deposits of $100,000 or more at December 31, 2014 compared with December 31, 2013, primarily due to our strategic decisions to both not renew any “listing service” time deposits and offer lower renewal rates on certain time deposits acquired in the FNB Transaction to conform to the legacy Bank interest rate structure. Interest-bearing time deposits of $100,000 or more at December 31, 2013, compared with December 31, 2012 increased by $693.1 million primarily due to those deposits assumed as a part of the FNB Transaction. At December 31, 2014, there were $1.1 billion in interest-bearing time deposits scheduled to mature within one year.

 

84



Table of Contents

 

Borrowings

 

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

 

 

December 31,

 

 

 

2014

 

2013

 

2012

 

 

 

 

 

Average

 

 

 

Average

 

 

 

Average

 

 

 

Balance

 

Rate Paid

 

Balance

 

Rate Paid

 

Balance

 

Rate Paid

 

Short-term borrowings

 

$

762,696

 

0.32

%

$

342,087

 

0.36

%

$

728,250

 

0.33

%

Notes payable

 

56,684

 

4.27

%

56,327

 

6.33

%

141,539

 

5.89

%

Junior subordinated debentures

 

67,012

 

3.52

%

67,012

 

3.59

%

67,012

 

3.53

%

 

 

$

886,392

 

0.88

%

$

465,426

 

2.10

%

$

936,801

 

1.40

%

 

Short-term borrowings consisted of federal funds purchased, securities sold under agreements to repurchase, borrowings at the Federal Home Loan Bank (“FHLB”) and short-term bank loans. The $420.6 million increase in short-term borrowings at December 31, 2014 compared with December 31, 2013 was primarily due to an increase of $375.0 million in borrowings at the FHLB that had an original maturity of one year. This increase was the result of a strategic decision to lengthen the weighted-average duration of the Bank’s funding in an effort to manage interest rate risk, higher funding requirements associated with the increase in our mortgage origination segment’s balance on its warehouse line of credit with the Bank and a decrease in deposits acquired in the FNB Transaction. The $386.2 million decrease in short-term borrowings at December 31, 2013 compared with December 31, 2012 was primarily the result of lower funding requirements due to a reduction in our mortgage origination segment’s balance on it warehouse line of credit with the Bank. Notes payable at December 31, 2014 of $56.7 million was comprised of insurance segment term notes and nonrecourse notes owed by First Southwest. The $85.2 million decrease in notes payable at December 31, 2013 compared to December 31, 2012 was primarily due to the Notes of HTH Operating Partnership LP, a wholly owned subsidiary of Hilltop, being called for redemption during the fourth quarter of 2013. The First Southwest nonrecourse notes of $4.2 million at December 31, 2014 were paid off in January 2015.

 

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 December 31, 2014, Hilltop had $146.0 million in freely available cash and cash equivalents, a decrease of $17.9 million from $163.9 million at December 31, 2013. As a result of the SWS Merger, Hilltop used $78.2 million of this available cash to settle the cash portion of the merger consideration. If necessary or appropriate, we may also finance acquisitions with the proceeds from equity or debt issuances. Subject to regulatory restrictions, Hilltop may also receive dividends from its subsidiaries. The current short-term liquidity needs of Hilltop include operating expenses and dividends on preferred stock.

 

SWS

 

On October 2, 2014, Hilltop exercised its SWS Warrant in full, acquiring 8,695,652 shares of SWS common stock at an exercise price of $5.75 per share. Pursuant to the terms of the warrant and a credit agreement with SWS, the aggregate exercise price was paid by the automatic elimination of the $50.0 million aggregate principal amount note due to Hilltop under the credit agreement. Following the exercise of the SWS Warrant, Hilltop (i) owned 10,171,039 shares of SWS common stock, representing approximately 21% of the outstanding shares of SWS common stock and (ii) was no longer a lender under the credit agreement. Contemporaneous with the exercise of the SWS Warrant, Hilltop changed the accounting method for its investment in SWS common stock and elected to account for its investment in accordance with the provisions of the Fair Value Option as permitted by GAAP. Hilltop had previously accounted for its investment in SWS common stock as an available for sale security. Under the Fair Value Option, Hilltop’s investment in SWS common stock is recorded at fair value effective October 2, 2014, with changes in fair value being recorded in other noninterest income within the consolidated statement of operations rather than as a component of other comprehensive income. Hilltop’s election to apply the provisions of the Fair Value Option resulted in Hilltop recording those unrealized gains previously associated with its investment in SWS common stock of $7.2 million. For the period from October 3, 2014 through December 31, 2014, the change in fair value of Hilltop’s investment in SWS common stock resulted in a loss of $1.2 million. In the aggregate, Hilltop recorded a $6.0 million net gain in other noninterest income during 2014. At December 31, 2014, Hilltop’s investment in SWS common stock is included in other assets within the consolidated balance sheet and is recorded at a fair value of $70.3 million.

 

85



Table of Contents

 

On January 1, 2015, we completed our acquisition of SWS in a stock and cash transaction, whereby SWS merged with and into Hilltop Securities, a wholly owned subsidiary of Hilltop formed for the purpose of facilitating this transaction. SWS’s broker-dealer subsidiaries, Southwest Securities and SWS Financial, became subsidiaries of Hilltop Securities. Immediately following the SWS Merger, SWS’s banking subsidiary, SWS FSB, was merged into the Bank. As a result of the SWS Merger, each outstanding share of SWS common stock was converted into the right to receive 0.2496 shares of Hilltop common stock and $1.94 in cash, equating to $6.92 per share based on Hilltop’s closing price on December 31, 2014 and resulting in an aggregate purchase price of $349.0 million, consisting of 10.0 million shares of common stock, $78.2 million in cash and $70.3 million associated with our existing investment in SWS common stock. Additionally, due to appraisal rights proceedings filed in connection with the SWS Merger, the merger consideration is subject to change, and therefore, preliminary at this time.

 

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 September 30, 2014 and December 31, 2013, $114.1 million of our Series B Preferred Stock was outstanding. During the three months ended December 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% per annum 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.

 

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.

 

In July 2013, federal banking regulators released final rules for the regulation of capital and liquidity for U.S. banking organizations (“Basel III”), a new comprehensive capital framework for U.S. banking organizations that will become effective for reporting periods beginning after January 1, 2015 (subject to a phase-in period through January 2019).

 

In addition, under the final rules, bank holding companies with less than $15 billion in assets as of December 31, 2009 are allowed to continue to include junior subordinated debentures in Tier 1 capital, subject to certain restrictions. However, if an institution grows to above $15 billion in assets as a result of an acquisition, or organically grows to above $15 billion in assets and then makes an acquisition, the combined trust preferred issuances must be phased out of Tier 1 and into Tier 2 capital (75% in 2015 and 100% in 2016). All of the debentures issued to PCC Statutory Trusts I, II, III and IV (the “Trusts”),

 

86



Table of Contents

 

less the common stock of the Trusts, qualified as Tier 1 capital as of December 31, 2014, under guidance issued by the Board of Governors of the Federal Reserve System. We anticipate that 100% of the Trusts, less the common stock of the Trusts, will qualify as Tier 1 Capital.

 

The final rules also provide for a number of adjustments to and deductions from the new common equity Tier 1 capital ratio, as well as changes to the calculation of risk weighted assets which is expected to increase the absolute level. Under current capital standards, the effects of accumulated other comprehensive items included in capital are excluded for the purposes of determining regulatory capital ratios. Under Basel III, the effects of certain accumulated other comprehensive items are not excluded; however, non-advanced approaches banking organizations, including Hilltop and the Bank, may make a one-time permanent election to continue to exclude these items. Hilltop and Bank expect to make this election in order to avoid significant variations in the level of capital depending upon the impact of interest rate fluctuations on the fair value of our securities portfolio. In addition, deductions include, for example, the requirement that mortgage servicing rights, deferred tax assets dependent upon future taxable income and significant investments in non-consolidated financial entities be deducted from the common equity Tier 1 capital ratio to the extent that any one such category exceeds 10% of the common equity Tier 1 capital ratio or all such categories in the aggregate exceed 15% of the common equity Tier 1 capital ratio. Further, deferred tax assets which are related to operating losses and tax credit carry forward are excluded from the common equity Tier 1 capital ratio.

 

At December 31, 2014, Hilltop exceeded all regulatory capital requirements with a total capital to risk weighted assets ratio of 19.69%, Tier 1 capital to risk weighted assets ratio of 19.02% and a Tier 1 capital to average assets, or leverage, ratio of 14.17%. The Bank’s consolidated actual capital amounts and ratios at December 31, 2014 resulted in it being considered “well-capitalized” under regulatory requirements, without giving effect to Basel III, and included a total capital to risk weighted assets ratio of 14.45%, Tier 1 capital to risk weighted assets ratio of 13.74% and a Tier 1 capital to average assets, or leverage, ratio of 10.31%. Management believes that, as of December 31, 2014, Hilltop and the Bank would meet all applicable capital adequacy requirements under the Basel III capital rules for banks with less than $15 billion in assets on a fully phased-in basis as if such requirements were currently in effect. We discuss regulatory capital requirements in more detail in Note 21 to our consolidated financial statements, as well as under the caption “Government Supervision and Regulation — Banking — BASEL III” set forth in Part I, Item I. of our Annual Report on Form 10-K.

 

Cash Flow Activities

 

Cash and cash equivalents (consisting of cash and due from banks and federal funds sold), totaled $813.1 million at December 31, 2014, an increase of $67.1 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 used in operations during 2014 was $91.4 million, a decrease in cash flow of $488.1 million compared with 2013. Cash used in operations increased primarily due to reductions in cash provided by our mortgage loan origination activities. Cash provided by operations during 2013 was $396.7 million, an increase in cash flow of $281.5 million compared with 2012. Cash provided by operations increased primarily due to those operating activities acquired as a part of the PlainsCapital Merger for the year ended December 31, 2013 compared with the month ended December 31, 2012.

 

Cash provided by our investing activities during 2014 was $259.8 million, including net proceeds from securities in our investment portfolio of $147.7 million, net changes in loans of $103.0 million, and net sales of premises and equipment and other real estate owned of $26.2 million. Cash provided by our investment activities during 2013 was $223.9 million, including $362.7 million in net cash from the FNB Transaction and net proceeds from securities in our investment portfolio of $8.9 million, partially offset by $140.4 million for the origination of loans held for investment and net purchases of premises and equipment and other assets of $11.8 million. During 2012, cash provided by our investment activities was $12.9 million and primarily included $165.7 million in net cash from the PlainsCapital Merger, offset by $147.4 million in net purchases of securities in our investment portfolio.

 

Cash used in financing activities during 2014 was $101.4 million, a decrease in cash used of $499.7 million compared with 2013. The decrease in cash used in financing activities was primarily due to an increase in short-term borrowings during 2014, offset by a greater decrease in deposits, primarily due to our strategic decisions to both not renew any “listing service” time deposits and offer lower renewal rates on certain time deposits acquired in the FNB Transaction, during 2014, compared with 2013. Cash used in financing activities during 2013 increased by $620.9 million compared with 2012. The increase in cash used was primarily due to those financing activities of the banking segment acquired as a part of the PlainsCapital Merger for the year ended December 31, 2013 compared with the month ended December 31, 2012.

 

87



Table of Contents

 

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 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 $6.4 billion at December 31, 2014, a decrease of $353.0 million from $6.7 billion at December 31, 2013. This decrease is primarily due to our strategic decisions to both not renew any “listing service” time deposits and offer lower renewal rates on certain time deposits acquired in the FNB Transaction to conform to the legacy PlainsCapital Bank interest rate structure. 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 December 31, 2014, money market deposits, including brokered deposits, were $941.8 million; time deposits, including brokered deposits, were $1.7 billion; and noninterest bearing demand deposits were $2.1 billion. Money market deposits, including brokered deposits, decreased by $213.6 million from $1.2 billion and time deposits, including brokered deposits, decreased $631.6 million from $2.3 billion at December 31, 2013.

 

The Bank’s 15 largest depositors, excluding Hilltop and First Southwest, accounted for 13.24% of the Bank’s total deposits, and the Bank’s five largest depositors, excluding First Southwest, accounted for 7.77% of the Bank’s total deposits at December 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.

 

Broker-Dealer 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 four unaffiliated banks of up to $305.0 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 December 31, 2014, FSC had borrowed $123.2 million under these credit arrangements.

 

Mortgage Origination Segment

 

PrimeLending funds the mortgage loans it originates through a warehouse line of credit of up to $1.5 billion maintained with the Bank. At December 31, 2014, PrimeLending had outstanding borrowings of $1.2 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 December 31, 2014, PrimeLending had no borrowings under the JPMorgan Chase line of credit.

 

88



Table of Contents

 

Insurance Segment

 

Our insurance operating subsidiary’s primary investment objectives are 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 $214.6 million, or 91.5%, equity investments of $13.8 million and other investments of $6.2 million comprised NLC’s $234.5 million in total cash and investments at December 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 Bank, N.A. and an investment management agreement with DTF Holdings, LLC.

 

Contractual Obligations

 

The following table presents information regarding our contractual obligations at December 31, 2014 (in thousands). Our reserve for losses and loss adjustment expenses does not have a contractual maturity date. However, based on historical payment patterns, the amounts presented are management’s estimate of the expected timing of these payments. The timing of payments is subject to significant uncertainty. NLC maintains a portfolio of investments with varying maturities to provide adequate cash flows for such payments. Payments related to leases are based on actual payments specified in the underlying contracts. Payments related to short-term borrowings and long-term debt obligations include the estimated contractual interest payments under the respective agreements. The following table reflects First Southwest’s payoff of its $4.2 million nonrecourse notes contractually due January 2035 in January 2015. The contractual obligations assumed as a part of the SWS Merger, effective January 1, 2015, are not included in the following table.

 

 

 

Payments Due by Period

 

 

 

 

 

More than 1

 

3 Years or

 

 

 

 

 

 

 

1 year

 

Year but Less

 

More but Less

 

5 Years

 

 

 

 

 

or Less

 

than 3 Years

 

than 5 Years

 

or More

 

Total

 

Reserve for losses and loss adjustment expenses

 

$

20,059

 

$

7,904

 

$

1,605

 

$

148

 

$

29,716

 

Short-term borrowings

 

764,403

 

 

 

 

764,403

 

Long-term debt obligations

 

13,932

 

9,556

 

9,917

 

198,433

 

231,838

 

Capital lease obligations

 

1,090

 

2,232

 

2,354

 

10,348

 

16,024

 

Operating lease obligations

 

24,588

 

34,238

 

19,776

 

28,169

 

106,771

 

Cash portion of SWS merger consideration

 

78,216

 

 

 

 

78,216

 

Total

 

$

902,288

 

$

53,930

 

$

33,652

 

$

237,098

 

$

1,226,968

 

 

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 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,

 

89



Table of Contents

 

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 $1.4 billion at December 31, 2014 and outstanding financial and performance standby letters of credit of $45.1 million at December 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, use of derivatives to support certain non-profit housing organization clients, 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. Our significant accounting policies are presented in Note 1 to our consolidated financial statements, which are included in this Annual Report. 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, amounts receivable under the loss-share agreements with the FDIC (“FDIC Indemnification Asset”), reserve for losses and loss adjustment expenses, goodwill and identifiable intangible assets, loan indemnification liability, mortgage servicing rights and acquisition accounting.

 

Allowance for Loan Losses

 

The allowance for loan losses is a valuation allowance for probable losses inherent in the loan portfolio. Loans are charged to the allowance when the loss is confirmed or when a determination is made that a probable loss has occurred on a specific loan. Recoveries are credited to the allowance at the time of recovery. Throughout the year, management estimates the probable level of losses to determine whether the allowance for credit losses is appropriate to absorb losses in the existing portfolio. Based on these estimates, an amount is charged to the provision for loan losses and credited to the allowance for loan losses in order to adjust the allowance to a level determined to be appropriate to absorb losses. Management’s judgment regarding the appropriateness of the allowance for loan losses involves the consideration of current economic conditions and their estimated effects on specific borrowers; an evaluation of the existing relationships among loans, potential loan losses and the present level of the allowance; results of examinations of the loan portfolio by regulatory agencies; and management’s internal review of the loan portfolio. In determining the ability to collect certain loans, management also considers the fair value of any underlying collateral. The amount ultimately realized may differ from the carrying value of these assets because of economic, operating or other conditions beyond our control. For additional discussion of allowance for loan losses and provisions for loan losses, see the section entitled “Allowance for Loan Losses” earlier in this Item 7.

 

FDIC Indemnification Asset

 

We have elected to account for the FDIC Indemnification Asset in accordance with FASB ASC 805. The FDIC Indemnification Asset is initially recorded at fair value, based on the discounted value of expected future cash flows under the loss-share agreements. The difference between the present value and the undiscounted cash flows we expect to collect from the FDIC will be accreted into noninterest income within the consolidated statements of operations over the life of the FDIC Indemnification Asset. The FDIC Indemnification Asset is reviewed quarterly and adjusted for any changes in expected cash flows based on recent performance and expectations for future performance of the covered portfolio. These adjustments are measured on the same basis as the related covered loans and covered OREO. Any increases in cash flow of the covered assets over those expected will reduce the FDIC Indemnification Asset, and any decreases in cash flow of the covered assets under those expected will increase the FDIC Indemnification Asset. Any amortization of changes in value is limited to the contractual terms of the loss-share agreements. Increases and decreases to the FDIC Indemnification Asset are recorded as adjustments to noninterest income within the consolidated statements of operations over the life of the loss-share agreements.

 

90



Table of Contents

 

Reserve for Losses and Loss Adjustment Expenses

 

The reserve for losses and loss adjustment expenses represents our best estimate of our ultimate liability for losses and loss adjustment expenses relating to events that occurred prior to the end of any given accounting period but have not been paid, less a reduction for reinsurance recoverables related to those liabilities. Months and potentially years may elapse between the occurrence of a loss covered by one of our insurance policies, the reporting of the loss and the payment of the claim. We record a liability for estimates of losses that will be paid for claims that have been reported, which is referred to as case reserves. As claims are not always reported when they occur, we estimate liabilities for claims that have occurred but have not been reported (“IBNR”).

 

Each of our insurance company subsidiaries establishes a reserve for all of its unpaid losses, including case reserves and IBNR reserves, and estimates for the cost to settle the claims. We estimate our IBNR reserves by estimating our ultimate liability for loss and loss adjustment expense reserves first, and then reducing that amount by the amount of cumulative paid claims and by the amount of our case reserves. 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. As experience develops or new information becomes known, we increase or decrease the level of our reserves in the period in which changes to the estimates are determined. Accordingly, the actual losses and loss adjustment expenses may differ materially from the estimates we have recorded. See “Insurance Losses and Loss Adjustment Expenses” earlier in this Item 7 for additional discussion.

 

Goodwill and Identifiable Intangible Assets

 

Goodwill and other identifiable intangible assets were initially recorded at their estimated fair values at the date of acquisition. Goodwill and other intangible assets having an indefinite useful life are not amortized for financial statement purposes. In the event that facts and circumstances indicate that the goodwill and other identifiable intangible assets may be impaired, an interim impairment test would be required. Intangible assets with finite lives have been fully amortized over their useful lives. We perform required annual impairment tests of our goodwill and other intangible assets as of October 1st for our reporting units.

 

The goodwill impairment test is a two-step process that requires us to make judgments in determining what assumptions to use in the calculation. The first step of the process consists of estimating the fair value of each reporting unit based on valuation techniques, including a discounted cash flow model using revenue and profit forecasts and recent industry transaction and trading multiples of our peers, and comparing those estimated fair values with the carrying values of the assets and liabilities of the reporting unit, which includes the allocated goodwill. If the estimated fair value is less than the carrying value, a second step is performed to compute the amount of the impairment, if any, by determining an “implied fair value” of goodwill. The determination of the “implied fair value” of goodwill of a reporting unit requires us to allocate the estimated fair value of the reporting unit to the assets and liabilities of the reporting unit. Any unallocated fair value represents the “implied fair value” of goodwill, which is compared to its corresponding carrying value.

 

Our evaluation includes multiple assumptions, including estimated discounted cash flows and other estimates that may change over time. If future discounted cash flows become less than those projected by us, future impairment charges may become necessary that could have a materially adverse impact on our results of operations and financial condition in the period in which the write-off occurs.

 

Loan Indemnification Liability

 

The mortgage origination segment may be responsible for errors or omissions relating to its representations and warranties that the loans sold meet 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 loans from the investors or reimburses the investors’ losses (a “make-whole” payment). The mortgage origination segment has established an indemnification liability for such probable losses based upon, among other things, the level of current unresolved repurchase requests, the volume of estimated probable future repurchase requests, our ability to cure the defects identified in the repurchase requests, and the severity of the estimated loss upon repurchase. Although we consider this reserve to be appropriate, there can be no assurance that the reserve will prove to be appropriate overtime to cover ultimate losses, due to unanticipated adverse changes in the economy and historical loss patterns, discrete events adversely affecting

 

91



Table of Contents

 

specific borrowers or industries, and/or actions taken by institutions or investors. The impact of such matters will be considered in the reserving process when known.

 

Mortgage Servicing Rights

 

The Company measures its residential mortgage servicing assets using the fair value method. Under the fair value method, the retained MSR are carried in the balance sheet at fair value and the changes in fair value are reported in earnings within other noninterest income in the period in which the change occurs. Retained MSR are measured at fair value as of the date of sale of the related mortgage loan. Subsequent fair value measurements are determined using a discounted cash flow model. In order to determine the fair value of the MSR, the present value of expected future cash flows is estimated. Assumptions used include market discount rates, anticipated prepayment speeds, delinquency and foreclosure rates, and ancillary fee income.

 

The model assumptions and the MSR fair value estimates are compared to observable trades of similar portfolios as well as to MSR broker valuations and industry surveys, as available. The expected life of the loan can vary from management’s estimates due to prepayments by borrowers, especially when rates fall. Prepayments in excess of management’s estimates would negatively impact the recorded value of the MSR. The value of the MSR is also dependent upon the discount rate used in the model, which is based on current market rates. Management reviews this rate on an ongoing basis based on current market rates. A significant increase in the discount rate would reduce the value of the MSR.

 

Acquisition Accounting

 

We account for business combinations using the acquisition method, which requires an allocation of the purchase price of an acquired entity to the assets acquired, including identifiable intangibles, and liabilities assumed based on their estimated fair values at the date of acquisition. Management applies various valuation methodologies to these acquired assets and assumed liabilities which often involve a significant degree of judgment, particularly when liquid markets do not exist for the particular item being valued. Examples of such items include loans, deposits, identifiable intangible assets and certain other assets and liabilities acquired or assumed in business combinations. Management uses significant estimates and assumptions to value such items, including, among others, projected cash flows, prepayment and default assumptions, discount rates, and realizable collateral values. Purchase date valuations, which are subject to change for up to one year after the acquisition date, determine the amount of goodwill or bargain purchase gain recognized in connection with the business combination. Certain assumptions and estimates must be updated regularly in connection with the ongoing accounting for purchased loans. Valuation assumptions and estimates may also have to be revisited in connection with periodic assessments of possible value impairment, including impairment of goodwill, intangible assets and certain other long-lived assets. The use of different assumptions could produce significantly different valuation results, which could have material positive or negative effects on the Company’s results of operations.

 

Item 7A. Quantitative and Qualitative Disclosures About Market Risk.

 

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.

 

At December 31, 2014, total notes payable outstanding on our consolidated balance sheet was $56.7 million, and was comprised entirely of indebtedness subject to variable interest rates. If LIBOR and the prime rate were to increase by one eighth of one percent (0.125%), the increase in interest expense on the variable rate debt would not have a significant impact on our future consolidated earnings or cash flows.

 

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.

 

92



Table of Contents

 

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.

 

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).

 

 

 

December 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

 

$

3,079,529

 

$

614,022

 

$

739,362

 

$

293,244

 

$

654,707

 

$

5,380,864

 

Securities

 

24,144

 

75,537

 

278,873

 

215,786

 

322,150

 

916,490

 

Federal funds sold and securities purchased under agreements to resell

 

30,602

 

 

 

 

 

30,602

 

Other interest sensitive assets

 

448,544

 

 

 

 

 

448,544

 

Total interest sensitive assets

 

3,582,819

 

689,559

 

1,018,235

 

509,030

 

976,857

 

6,776,500

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

Interest sensitive liabilities:

 

 

 

 

 

 

 

 

 

 

 

 

 

Interest bearing checking

 

$

2,268,982

 

$

 

$

 

$

 

$

 

$

2,268,982

 

Savings

 

299,051

 

 

 

 

 

299,051

 

Time deposits

 

495,527

 

639,870

 

496,333

 

35,926

 

6,016

 

1,673,672

 

Notes payable & other borrowings

 

414,652

 

225,476

 

1,355

 

727

 

5,163

 

647,373

 

Total interest sensitive liabilities

 

3,478,212

 

865,346

 

497,688

 

36,653

 

11,179

 

4,889,078

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

Interest sensitivity gap

 

$

104,607

 

$

(175,787

)

$

520,547

 

$

472,377

 

$

965,678

 

$

1,887,422

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

Cumulative interest sensitivity gap

 

$

104,607

 

$

(71,180

)

$

449,367

 

$

921,744

 

$

1,887,422

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

Percentage of cumulative gap to total interest sensitive assets

 

1.54

%

-1.05

%

6.63

%

13.60

%

27.85

%

 

 

 

 

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

 

93



Table of Contents

 

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 economic value of equity by discounting projected cash flows of deposits and loans. Economic 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 December 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

 

$

15,201

 

6.16

%

$

68,676

 

5.36

%

+200

 

$

4,087

 

1.65

%

$

43,831

 

3.42

%

+100

 

$

(2,762

)

-1.12

%

$

21,591

 

1.68

%

-50

 

$

414

 

0.17

%

$

(17,823

)

-1.39

%

 

The projected changes in net interest income and economic value of equity to changes in interest rates at December 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 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.

 

Broker-Dealer Segment

 

Our broker-dealer segment is exposed to market risk primarily due to its role as a financial intermediary in customer transactions, which may include purchases and sales of securities, use of derivatives and securities lending activities, and in our trading activities, which are used to support sales, underwriting and other customer activities. We are subject to the risk of loss that may result from the potential change in value of a financial instrument as a result of fluctuations in interest rates, market prices, investor expectations and changes in credit ratings of the issuer.

 

Our broker-dealer segment is exposed to interest rate risk as a result of maintaining inventories of interest rate sensitive financial instruments and other interest earning assets including customer and correspondent margin loans and securities borrowing activities. Our exposure to interest rate risk is also from our funding sources including customer and correspondent cash balances, bank borrowings, repurchase agreements and securities lending activities. Interest rates on customer and correspondent balances and securities produce a positive spread with rates generally fluctuating in parallel.

 

With respect to securities held, our interest rate risk is managed by setting and monitoring limits on the size and duration of positions and on the length of time securities can be held. Much of the interest rates on customer and correspondent margin loans are indexed and can vary daily. Our funding sources are generally short term with interest rates that can vary daily.

 

Derivatives are used to support certain customer programs and hedge our related exposure to interest rate risks.

 

Our broker-dealer segment is engaged in various brokerage and trading activities that expose us to credit risk arising from potential non-performance from counterparties, customers or issuers of securities. This risk is managed by setting and monitoring position limits for each counterparty, conducting periodic credit reviews of counterparties, reviewing concentrations of securities and conducting business through central clearing organizations.

 

Collateral underlying margin loans to customers and correspondents and with respect to securities lending activities is marked to market daily and additional collateral is required as necessary.

 

94



Table of Contents

 

Mortgage Origination Segment

 

Within our mortgage origination segment, our principal market exposure is to interest rate risk due to the impact on our mortgage-related assets and commitments, including mortgage loans held for sale, IRLCs and MSR. Changes in interest rates could also materially and adversely affect our volume of mortgage loan originations.

 

IRLCs represent an agreement to extend credit to a mortgage loan applicant, whereby the interest rate on the loan is set prior to funding. Our mortgage loans held for sale, which we hold in inventory while awaiting sale into the secondary market, and our IRLCs are subject to the effects of changes in mortgage interest rates from the date of the commitment through the sale of the loan into the secondary market. As a result, we are exposed to interest rate risk and related price risk during the period from the date of the lock commitment until (i) the lock commitment cancellation or expiration date or (ii) the date of sale into the secondary mortgage market. Loan commitments generally range from 20 to 60 days, and our average holding period of the mortgage loan from funding to sale is approximately 30 days. An integral component of our interest rate risk management strategy is our execution of forward commitments to sell MBSs to minimize the impact on earnings resulting from significant fluctuations in the fair value of mortgage loans held for sale and IRLCs caused by changes in interest rates.

 

We have recently expanded, and may continue to expand, our residential mortgage servicing operations within our mortgage origination segment. As a result of our mortgage servicing business, we have a portfolio of retained MSR. One of the principal risks associated with MSR is that in a declining interest rate environment, they will likely lose a substantial portion of their value as a result of higher than anticipated prepayments. Moreover, if prepayments are greater than expected, the cash we receive over the life of the mortgage loans would be reduced. The mortgage origination segment uses derivative financial instruments, including interest rate swaps, swaptions, and forward MBS commitments, as a means to mitigate market risk associated with MSR assets. No hedging strategy can protect us completely, and hedging strategies may fail because they are improperly designed, improperly executed and documented or based on inaccurate assumptions and, as a result, could actually increase our risks and losses. The increasing size of our MSR portfolio may increase our interest rate risk and correspondingly, the volatility of our earnings, especially if we cannot adequately hedge the interest rate risk relating to our MSR.

 

The goal of our interest rate risk management strategy within our mortgage origination segment is not to eliminate interest rate risk, but to manage it within appropriate limits. To mitigate the risk of loss, we have established policies and procedures, which include guidelines on the amount of exposure to interest rate changes we are willing to accept.

 

Insurance Segment

 

Within our insurance segment, our exposures to market risk relate primarily to our investment portfolio, which is exposed primarily to interest rate risk and credit risk. The fair value of our investment portfolio is directly impacted by changes in market interest rates; generally, the fair value of fixed-income investments moves inversely with movements in market interest rates. Our fixed maturity portfolio is comprised of substantially all fixed rate investments with primarily short-term and intermediate-term maturities. This portfolio composition allows flexibility in reacting to fluctuations of interest rates. The portfolios of our insurance company subsidiaries are managed to achieve an adequate risk-adjusted return while maintaining sufficient liquidity to meet policyholder obligations. Additionally, the fair values of interest rate sensitive instruments may be affected by the creditworthiness of the issuer, prepayment options, relative values of alternative investments, the liquidity of the instrument and other general market conditions.

 

Item 8. Financial Statements and Supplementary Data.

 

Our financial statements required by this item are submitted as a separate section of this Annual Report. See “Financial Statements,” commencing on page F-1 hereof.

 

Item 9. Changes in and Disagreements With Accountants on Accounting and Financial Disclosure.

 

None.

 

95



Table of Contents

 

Item 9A. Controls and Procedures.

 

Conclusion Regarding the Effectiveness 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 Annual 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 during the fiscal quarter ended December 31, 2014 in our internal control over financial reporting that have materially affected, or are reasonably likely to materially affect, our internal control over financial reporting, other than as it relates to the inclusion within our control environment of new or updated controls and processes associated with covered loans, FDIC Indemnification Asset and covered OREO acquired in the FNB Transaction.

 

Management’s Report on Internal Control Over Financial Reporting

 

Our management is responsible for establishing and maintaining adequate internal control over financial reporting. Internal control over financial reporting is defined in Rules 13a-15(f) and 15d-15(f) under the Exchange Act, as a process designed by, or under the supervision of, our Principal Executive Officer and Principal Financial Officer and effected by our board of directors, management and other personnel to provide reasonable assurance regarding the reliability of financial reporting and the preparation of financial statements for external purposes in accordance with generally accepted accounting principles and includes those policies and procedures that:

 

·                        pertain to the maintenance of records that in reasonable detail accurately and fairly reflect the transactions and dispositions of our assets;

·                        provide reasonable assurance that transactions are recorded as necessary to permit preparation of financial statements in accordance with generally accepted accounting principles, and that our receipts and expenditures are being made only in accordance with authorization of our management and directors; and

·                        provide reasonable assurance regarding prevention or timely detection of unauthorized acquisition, use or disposition of our assets that could have a material effect on the financial statements.

 

Because of its inherent limitations, internal control over financial reporting may not prevent or detect misstatements.  Projections of any evaluation of effectiveness to future periods are subject to the risks that controls may become inadequate because of changes in conditions, or that the degree of compliance with the policies or procedures may deteriorate.

 

Management assessed the effectiveness of our internal control over financial reporting at December 31, 2014. In making this assessment, management used the criteria set forth in Internal Control—Integrated Framework (2013) issued by the Committee of Sponsoring Organizations of the Treadway Commission, or COSO. Based on our assessment, management concluded that, at December 31, 2014, our internal control over financial reporting is effective.

 

Item 9B. Other Information.

 

None.

 

96



Table of Contents

 

PART III

 

Item 10. Directors, Executive Officers and Corporate Governance.

 

The information called for by this Item is contained in our definitive Proxy Statement for our 2015 Annual Meeting of Stockholders, and is incorporated herein by reference.

 

Item 11. Executive Compensation.

 

The information called for by this Item is contained in our definitive Proxy Statement for our 2015 Annual Meeting of Stockholders, and is incorporated herein by reference.

 

Item 12. Security Ownership of Certain Beneficial Owners and Management and Related Stockholder Matters.

 

The information called for by this Item is contained in our definitive Proxy Statement for our 2015 Annual Meeting of Stockholders, or in Item 5 of this Annual Report for the year ended December 31, 2014, and is incorporated herein by reference.

 

Item 13. Certain Relationships and Related Transactions, and Director Independence.

 

The information called for by this Item is contained in our definitive Proxy Statement for our 2015 Annual Meeting of Stockholders, and is incorporated herein by reference.

 

Item 14. Principal Accounting Fees and Services.

 

The information called for by this Item is contained in our definitive Proxy Statement for our 2015 Annual Meeting of Stockholders, and is incorporated herein by reference.

 

97



Table of Contents

 

PART IV

 

Item 15. Exhibits, Financial Statement Schedules.

 

(a)          The following documents are filed herewith as part of this Form 10-K.

 

 

 

 

 

Page

1.

 

Financial Statements.

 

 

 

 

 

 

 

 

 

Hilltop Holdings Inc.

 

 

 

 

Report of Independent Registered Public Accounting Firm (PricewaterhouseCoopers LLP) for Hilltop Holdings Inc.

 

F-2

 

 

Report of Independent Registered Public Accounting Firm (Ernst & Young LLP) for PrimeLending

 

F-3

 

 

Report of Independent Registered Public Accounting Firm (Ernst & Young LLP) for First Southwest Company

 

F-4

 

 

Consolidated Balance Sheets

 

F-5

 

 

Consolidated Statements of Operations

 

F-6

 

 

Consolidated Statements of Comprehensive Income (Loss)

 

F-7

 

 

Consolidated Statements of Stockholders’ Equity

 

F-8

 

 

Consolidated Statements of Cash Flows

 

F-9

 

 

Notes to Consolidated Financial Statements

 

F-10

 

 

 

 

 

2.

 

Financial Statement Schedules.

 

 

 

 

 

 

 

 

 

The financial statements as of June 30, 2014 and 2013 and for each of the three years in the period ended June 30, 2014 of SWS Group, Inc., are filed as Exhibit 99.1 to this Annual Report on Form 10-K and are incorporated by reference herein.

 

 

 

 

 

 

 

All other financial statement schedules have been omitted because they are not required, not applicable or the information has been included in our consolidated financial statements.

 

 

 

 

 

3.

 

Exhibits. See the Exhibit Index following the signature page hereto.

 

 

 

98



Table of Contents

 

SIGNATURES

 

Pursuant to the requirements of Section 13 or 15(d) 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: February 26, 2015

By:

/s/ Jeremy B. Ford

 

 

Jeremy B. Ford

 

 

President and Chief Executive Officer

 

 

(Principal Executive Officer and duly authorized officer)

 

Pursuant to the requirements of the Securities Exchange Act of 1934, this report has been signed below by the following persons on behalf of the registrant and in the capacities and on the dates indicated.

 

Signature

 

Capacity in which Signed

 

Date

 

 

 

 

 

/s/ Jeremy B. Ford

 

President, Chief Executive Officer and Director

 

February 26, 2015

Jeremy B. Ford

 

(Principal Executive Officer)

 

 

 

 

 

 

 

/s/ Darren Parmenter

 

Executive Vice President — Principal Financial Officer

 

February 26, 2015

Darren Parmenter

 

(Principal Financial and Accounting Officer)

 

 

 

 

 

 

 

/s/ Charlotte Jones Anderson

 

Director

 

February 26, 2015

Charlotte Jones Anderson

 

 

 

 

 

 

 

 

 

/s/ Rhodes Bobbitt

 

Director

 

February 26, 2015

Rhodes Bobbitt

 

 

 

 

 

 

 

 

 

/s/ Tracy A. Bolt

 

Director and Audit Committee Member

 

February 26, 2015

Tracy A. Bolt

 

 

 

 

 

 

 

 

 

/s/ W. Joris Brinkerhoff

 

Director

 

February 26, 2015

W. Joris Brinkerhoff

 

 

 

 

 

 

 

 

 

/s/ Charles R. Cummings

 

Director and Chairman of Audit Committee

 

February 26, 2015

Charles R. Cummings

 

 

 

 

 

 

 

 

 

/s/ Hill A. Feinberg

 

Director

 

February 26, 2015

Hill A. Feinberg

 

 

 

 

 

 

 

 

 

/s/ Gerald J. Ford

 

Director

 

February 26, 2015

Gerald J. Ford

 

 

 

 

 

 

 

 

 

/s/ J. Markham Green

 

Director and Audit Committee Member

 

February 26, 2015

J. Markham Green

 

 

 

 

 

 

 

 

 

 

 

Director

 

 

Jess T. Hay

 

 

 

 

 

 

 

 

 

/s/ William T. Hill, Jr.

 

Director

 

February 26, 2015

William T. Hill, Jr.

 

 

 

 

 

 

 

 

 

/s/ James R. Huffines

 

Director

 

February 26, 2015

James R. Huffines

 

 

 

 

 

 

 

 

 

/s/ Lee Lewis

 

Director

 

February 26, 2015

Lee Lewis

 

 

 

 

 

 

 

 

 

 

 

Director

 

 

Andrew J. Littlefair

 

 

 

 

 

99



 

Table of Contents

 

Signature

 

Capacity in which Signed

 

Date

 

 

 

 

 

/s/ W. Robert Nichols, III

 

Director

 

February 26, 2015

W. Robert Nichols, III

 

 

 

 

 

 

 

 

 

/s/ C. Clifton Robinson

 

Director

 

February 26, 2015

C. Clifton Robinson

 

 

 

 

 

 

 

 

 

/s/ Kenneth D. Russell

 

Director

 

February 26, 2015

Kenneth D. Russell

 

 

 

 

 

 

 

 

 

/s/ A. Haag Sherman

 

Director

 

February 26, 2015

A. Haag Sherman

 

 

 

 

 

 

 

 

 

/s/ Robert Taylor, Jr.

 

Director

 

February 26, 2015

Robert Taylor, Jr.

 

 

 

 

 

 

 

 

 

/s/ Carl B. Webb

 

Director

 

February 26, 2015

Carl B. Webb

 

 

 

 

 

 

 

 

 

/s/ Alan B. White

 

Director

 

February 26, 2015

Alan B. White

 

 

 

 

 

100



Table of Contents

 

Exhibit
Number

 

Description of Exhibit

 

 

 

2.1

 

Agreement and Plan of Merger, dated May 8, 2012, by and among Hilltop Holdings Inc., Meadow Corporation and PlainsCapital Corporation (filed as Exhibit 2.1 to the Registrant’s Current Report on Form 8-K filed on May 11, 2012 (File No. 001-31987) and incorporated herein by reference).

 

 

 

2.2

 

Purchase and Assumption Agreement — Whole Bank, All Deposits, dated as of September 13, 2013, by and among the Federal Deposit Insurance Corporation, receiver of First National Bank, Edinburg, Texas, PlainsCapital Bank and the Federal Deposit Insurance Corporation (filed as Exhibit 2.1 to the Registrant’s Current Report on Form 8-K filed on September 19, 2013 (File No. 001-31987) and incorporated herein by reference).

 

 

 

2.3

 

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 and Restatement of Affordable Residential Communities Inc., dated February 16, 2004, as amended or supplemented by: Articles Supplementary, dated February 16, 2004; Corporate Charter Certificate of Notice, dated June 6, 2005; Articles of Amendment, dated January 23, 2007; Articles of Amendment, dated July 31, 2007; Corporate Charter Certificate of Notice, dated September 23, 2008; Articles Supplementary, dated December 15, 2010; Articles Supplementary, dated as of November 29, 2012 relating to Subtitle 8 election; Articles Supplementary, dated November 29, 2012 relating to Non-Cumulative Perpetual Preferred Stock, Series B, of Hilltop Holdings Inc.; and Articles of Amendment, dated March 31, 2014 (filed as Exhibit 3.1 to the Quarterly Report on Form 10-Q for the quarter ended June 30, 2014 (File No. 001-31987) and incorporated herein by reference).

 

 

 

3.2

 

Second Amended and Restated Bylaws of Hilltop Holdings Inc. (filed as Exhibit 3.2 to the Registrant’s Current Report on Form 8-K filed on March 16, 2009 (File No. 001-31987) and incorporated herein by reference).

 

 

 

4.1

 

Form of Certificate of Common Stock of Hilltop Holdings Inc. (filed as Exhibit 4.1 to the Registrant’s Annual Report on Form 10-K for the year ended December 31, 2007 (File No. 001-31987) and incorporated herein by reference).

 

 

 

4.2

 

Form of Certificate of Non-Cumulative Perpetual Preferred Stock, Series B, of Hilltop Holdings Inc. (filed as Exhibit 4.2 to the Registrant’s Annual Report on Form 10-K for the year ended December 31, 2012 filed on March 15, 2013 (File No. 001-31987) and incorporated herein by reference).

 

 

 

4.3

 

Corporate Charter Certificate of Notice, dated June 6, 2005 (filed as Exhibit 3.2 to the Registrant’s Registration Statement on Form S-3 (File No. 333-125854) and incorporated herein by reference).

 

 

 

4.4.1

 

Amended and Restated Declaration of Trust, dated as of July 31, 2001, by and among U.S. Bank National Association (successor in interest to State Street Bank and Trust Company of Connecticut, National Association), as Institutional Trustee, PlainsCapital Corporation (successor by merger to Plains Capital Corporation), and Alan B. White, George McCleskey, and Jeff Isom, as Administrators (filed as Exhibit 4.2 to the Registration Statement on Form 10 filed by PlainsCapital Corporation on April 17, 2009 (File No. 000-53629) and incorporated herein by reference).

 

101



Table of Contents

 

4.4.2

 

First Amendment to Amended and Restated Declaration of Trust, dated as of August 7, 2006, by and between PlainsCapital Corporation (successor by merger to Plains Capital Corporation) and U.S. Bank National Association, as Institutional Trustee (filed as Exhibit 4.3 to the Registration Statement on Form 10 filed by PlainsCapital Corporation on April 17, 2009 (File No. 000-53629) and incorporated herein by reference).

 

 

 

4.4.3

 

Indenture, dated as of July 31, 2001, by and between PlainsCapital Corporation (successor by merger to Plains Capital Corporation) and U.S. Bank National Association (successor in interest to State Street Bank and Trust Company of Connecticut, National Association), as Trustee (filed as Exhibit 4.4 to the Registration Statement on Form 10 filed by PlainsCapital Corporation on April 17, 2009 (File No. 000-53629) and incorporated herein by reference).

 

 

 

4.4.4

 

First Supplemental Indenture, dated as of August 7, 2006, by and between PlainsCapital Corporation (successor by merger to Plains Capital Corporation) and U.S. Bank National Association, as Trustee (filed as Exhibit 4.5 to the Registration Statement on Form 10 filed by PlainsCapital Corporation on April 17, 2009 (File No. 000-53629) and incorporated herein by reference).

 

 

 

4.4.5

 

Second Supplemental Indenture, dated as of November 30, 2012, by and among U.S. Bank National Association, as Trustee, PlainsCapital Corporation (f/k/a Meadow Corporation) and PlainsCapital Corporation (filed as Exhibit 4.5.5 to the Registrant’s Annual Report on Form 10-K for the year ended December 31, 2012 filed on March 15, 2013 (File No. 001-31987) and incorporated herein by reference).

 

 

 

4.4.6

 

Amended and Restated Floating Rate Junior Subordinated Deferrable Interest Debenture of Plains Capital Corporation, dated as of August 7, 2006, by PlainsCapital Corporation (successor by merger to Plains Capital Corporation) in favor of U.S. Bank National Association, as Institutional Trustee for PCC Statutory Trust I (filed as Exhibit 4.6 to the Registration Statement on Form 10 filed by PlainsCapital Corporation on April 17, 2009 (File No. 000-53629) and incorporated herein by reference).

 

 

 

4.4.7

 

Guarantee Agreement, dated as of July 31, 2001, by and between PlainsCapital Corporation (successor by merger to Plains Capital Corporation) and U.S. Bank National Association (successor in interest to State Street Bank and Trust Company of Connecticut, National Association), as Trustee (filed as Exhibit 4.7 to the Registration Statement on Form 10 filed by PlainsCapital Corporation on April 17, 2009 (File No. 000-53629) and incorporated herein by reference).

 

 

 

4.4.8

 

First Amendment to Guarantee Agreement, dated as of August 7, 2006, by and between PlainsCapital Corporation (successor by merger to Plains Capital Corporation) and U.S. Bank National Association, as Guarantee Trustee (filed as Exhibit 4.8 to the Registration Statement on Form 10 filed by PlainsCapital Corporation on April 17, 2009 (File No. 000-53629) and incorporated herein by reference).

 

 

 

4.5.1

 

Amended and Restated Declaration of Trust, dated as of March 26, 2003, by and among U.S. Bank National Association, as Institutional Trustee, PlainsCapital Corporation (successor by merger to Plains Capital Corporation), and Alan B. White, George McCleskey, and Jeff Isom, as Administrators (filed as Exhibit 4.9 to the Registration Statement on Form 10 filed by PlainsCapital Corporation on April 17, 2009 (File No. 000-53629) and incorporated herein by reference).

 

 

 

4.5.2

 

Indenture, dated as of March 26, 2003, by and between PlainsCapital Corporation (successor by merger to Plains Capital Corporation) and U.S. Bank National Association, as Trustee (filed as Exhibit 4.10 to the Registration Statement on Form 10 filed by PlainsCapital Corporation on April 17, 2009 (File No. 000-53629) and incorporated herein by reference).

 

102



Table of Contents

 

4.5.3

 

First Supplemental Indenture, dated as of November 30, 2012, by and among U.S. Bank National Association, as Trustee, PlainsCapital Corporation (f/k/a Meadow Corporation) and PlainsCapital Corporation (filed as Exhibit 4.6.3 to the Registrant’s Annual Report on Form 10-K for the year ended December 31, 2012 filed on March 15, 2013 (File No. 001-31987) and incorporated herein by reference).

 

 

 

4.5.4

 

Floating Rate Junior Subordinated Deferrable Interest Debenture of Plains Capital Corporation, dated as of March 26, 2003, by PlainsCapital Corporation (successor by merger to Plains Capital Corporation) in favor of U.S. Bank National Association, as Institutional Trustee for PCC Statutory Trust II (filed as Exhibit 4.11 to the Registration Statement on Form 10 filed by PlainsCapital Corporation on April 17, 2009 (File No. 000-53629) and incorporated herein by reference).

 

 

 

4.5.5

 

Guarantee Agreement, dated as of March 26, 2003, by and between PlainsCapital Corporation (successor by merger to Plains Capital Corporation) and U.S. Bank National Association, as Guarantee Trustee (filed as Exhibit 4.12 to the Registration Statement on Form 10 filed by PlainsCapital Corporation on April 17, 2009 (File No. 000-53629) and incorporated herein by reference).

 

 

 

4.6.1

 

Amended and Restated Declaration of Trust, dated as of September 17, 2003, by and among U.S. Bank National Association, as Institutional Trustee, PlainsCapital Corporation (successor by merger to Plains Capital Corporation), and Alan B. White, George McCleskey, and Jeff Isom, as Administrators (filed as Exhibit 4.13 to the Registration Statement on Form 10 filed by PlainsCapital Corporation on April 17, 2009 (File No. 000-53629) and incorporated herein by reference).

 

 

 

4.6.2

 

Indenture, dated as of September 17, 2003, by and between PlainsCapital Corporation (successor by merger to Plains Capital Corporation) and U.S. Bank National Association, as Trustee (filed as Exhibit 4.14 to the Registration Statement on Form 10 filed by PlainsCapital Corporation on April 17, 2009 (File No. 000-53629) and incorporated herein by reference).

 

 

 

4.6.3

 

First Supplemental Indenture, dated as of November 30, 2012, by and among U.S. Bank National Association, as Trustee, PlainsCapital Corporation (f/k/a Meadow Corporation) and PlainsCapital Corporation. (filed as Exhibit 4.7.3 to the Registrant’s Annual Report on Form 10-K for the year ended December 31, 2012 filed on March 15, 2013 (File No. 001-31987) and incorporated herein by reference).

 

 

 

4.6.4

 

Floating Rate Junior Subordinated Deferrable Interest Debenture of Plains Capital Corporation, dated as of September 17, 2003, by PlainsCapital Corporation (successor by merger to Plains Capital Corporation) in favor of U.S. Bank National Association, as Institutional Trustee for PCC Statutory Trust III (filed as Exhibit 4.15 to the Registration Statement on Form 10 filed by PlainsCapital Corporation on April 17, 2009 (File No. 000-53629) and incorporated herein by reference).

 

 

 

4.6.5

 

Guarantee Agreement, dated as of September 17, 2003, by and between PlainsCapital Corporation (successor by merger to Plains Capital Corporation) and U.S. Bank National Association, as Guarantee Trustee (filed as Exhibit 4.16 to the Registration Statement on Form 10 filed by PlainsCapital Corporation on April 17, 2009 (File No. 000-53629) and incorporated herein by reference).

 

 

 

4.7.1

 

Amended and Restated Trust Agreement, dated as of February 22, 2008, by and among PlainsCapital Corporation (successor by merger to Plains Capital Corporation), Wells Fargo Bank, N.A., as Property Trustee, Wells Fargo Delaware Trust Company, as Delaware Trustee, and Alan B. White, DeWayne Pierce, and Jeff Isom, as Administrative Trustees (filed as Exhibit 4.17 to the Registration Statement on Form 10 filed by PlainsCapital Corporation on April 17, 2009 (File No. 000-53629) and incorporated herein by reference).

 

103



Table of Contents

 

4.7.2

 

Junior Subordinated Indenture, dated as of February 22, 2008, by and between PlainsCapital Corporation (successor by merger to Plains Capital Corporation) and Wells Fargo Bank, N.A., as Trustee (filed as Exhibit 4.18 to the Registration Statement on Form 10 filed by PlainsCapital Corporation on April 17, 2009 (File No. 000-53629) and incorporated herein by reference).

 

 

 

4.7.3

 

First Supplemental Indenture, dated as of November 30, 2012, by and between PlainsCapital Corporation and Wells Fargo Bank, National Association, as Trustee. (filed as Exhibit 4.8.3 to the Registrant’s Annual Report on Form 10-K for the year ended December 31, 2012 filed on March 15, 2013 (File No. 001-31987) and incorporated herein by reference).

 

 

 

4.7.4

 

Plains Capital Corporation Floating Rate Junior Subordinated Note due 2038, dated as of February 22, 2008, by PlainsCapital Corporation (successor by merger to Plains Capital Corporation) in favor of Wells Fargo Bank, N.A., as Property Trustee of PCC Statutory Trust IV (filed as Exhibit 4.19 to the Registration Statement on Form 10 filed by PlainsCapital Corporation on April 17, 2009 (File No. 000-53629) and incorporated herein by reference).

 

 

 

4.7.5

 

Guarantee Agreement, dated as of February 22, 2008, by and between PlainsCapital Corporation (successor by merger to Plains Capital Corporation) and Wells Fargo Bank, N.A., as Guarantee Trustee (filed as Exhibit 4.20 to the Registration Statement on Form 10 filed by PlainsCapital Corporation on April 17, 2009 (File No. 000-53629) and incorporated herein by reference).

 

 

 

10.1.1

 

First Amended and Restated Agreement of Limited Partnership of Affordable Residential Communities LP, dated February 11, 2004 (filed as Exhibit 10.1.1 to the Registrant’s Annual Report on Form 10-K for the year ended December 31, 2007 (File No. 001-31987) and incorporated herein by reference).

 

 

 

10.1.2

 

Amendment to the First Amended and Restated Agreement of Limited Partnership of Affordable Residential Communities LP, dated July 3, 2007 (filed as Exhibit 10.1 to the Registrant’s Current Report on Form 8-K filed on July 6, 2007 (File No. 001-31987) and incorporated herein by reference).

 

 

 

10.2.1†

 

Affordable Residential Communities Inc. 2003 Equity Incentive Plan (filed as Exhibit 10.5 to the Registrant’s Registration Statement on Form S-11 (File No. 333-109816) and incorporated herein by reference).

 

 

 

10.2.2†

 

Form of Affordable Residential Communities Inc. 2003 Equity Incentive Plan Non-Qualified Stock Option Agreement (filed as Exhibit 10.2.3 to the Registrant’s Annual Report on Form 10-K for the year ended December 31, 2010 (File No. 001-31987) and incorporated herein by reference).

 

 

 

10.3

 

Registration Rights Agreement, dated January 31, 2007, by and between Affordable Residential Communities Inc. and C. Clifton Robinson. (filed as Exhibit 10.1 to the Registrant’s Current Report on Form 8-K filed on February 5, 2007 (File No. 001-31987) and incorporated herein by reference).

 

 

 

10.4†

 

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).

 

 

 

10.5†

 

Retention Agreement, dated May 8, 2012, but effective as of November 30, 2012, by and among Alan B. White, Hilltop Holdings Inc. and PlainsCapital Corporation (f/k/a Meadow Corporation) (filed as Exhibit 10.1 to the Registrant’s Current Report on Form 8-K filed on May 11, 2012 (File No. 001-31987) and incorporated herein by reference).

 

104



Table of Contents

 

10.6†

 

Retention Agreement, dated May 8, 2012, but effective as of November 30, 2012, by and among Jerry L. Schaffner, Hilltop Holdings Inc. and PlainsCapital Corporation (f/k/a Meadow Corporation) (filed as Exhibit 10.2 to the Registrant’s Current Report on Form 8-K filed on May 11, 2012 (File No. 001-31987) and incorporated herein by reference).

 

 

 

10.7†

 

Employment Agreement, dated as of December 4, 2014, by and between James R. Huffines and Hilltop Holdings Inc. (filed as Exhibit 10.1 to the Current Report on Form 8-K filed by the Registrant on December 9, 2014 (File No. 001-31987) and incorporated herein by reference).

 

 

 

10.8†*

 

Employment Agreement, dated as of December 4, 2014, by and between Todd Salmans and Hilltop Holdings Inc.

 

 

 

10.9†*

 

Compensation arrangement with Hill A. Feinberg.

 

 

 

10.10†

 

Hilltop Holdings Inc. 2012 Equity Incentive Plan, effective September 20, 2012 (filed as Exhibit 10.18 to the Registrant’s Annual Report on Form 10-K for the year ended December 31, 2012 filed on March 15, 2013 (File No. 001-31987) and incorporated herein by reference).

 

 

 

10.11†

 

Hilltop Holdings Inc. Annual Incentive Plan, effective September 20, 2012 (filed as Exhibit 10.19 to the Registrant’s Annual Report on Form 10-K for the year ended December 31, 2012 filed on March 15, 2013 (File No. 001-31987) and incorporated herein by reference).

 

 

 

10.12

 

Securities Purchase Agreement, dated as of September 27, 2011, by and between PlainsCapital Corporation (successor by merger to PlainsCapital Corporation) and the Secretary of the Treasury (filed as Exhibit 10.1 to the Current Report on Form 8-K filed by PlainsCapital Corporation on September 28, 2011 (File No. 000-53629) and incorporated herein by reference).

 

 

 

10.13

 

Repurchase Letter, dated as of September 27, 2011, by and between PlainsCapital Corporation (successor by merger to PlainsCapital Corporation) and the United Stated Department of the Treasury (filed as Exhibit 10.2 to the Current Report on Form 8-K filed by PlainsCapital Corporation on September 28, 2011 (File No. 000-53629) and incorporated herein by reference).

 

 

 

10.14†

 

Form of Restricted Stock Award Agreement (filed as Exhibit 10.1 to the Registrant’s Quarterly Report on Form 10-Q for the quarter ended March 31, 2013 filed on May 6, 2013 (File No. 001-31987) and incorporated herein by reference).

 

 

 

10.15†

 

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).

 

 

 

10.16†

 

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).

 

 

 

10.17†

 

Compensation arrangement of 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).

 

 

 

10.18†

 

Sublease, dated December 1, 2012, by and between Hunter’s Glen/Ford, LTD and Hilltop Holdings Inc. (filed as Exhibit 10.19 to the Registrant’s Report on Form 10-K for the year ended December 31, 2013 filed on March 3, 2014 (File No. 001-31987) and incorporated herein by reference).

 

105



Table of Contents

 

10.19†

 

First Amendment to Sublease, dated February 28, 2014, by and between Hunter’s Glen/Ford, LTD and Hilltop Holdings Inc. (filed as Exhibit 10.20 to the Registrant’s Report on Form 10-K for the year ended December 31, 2013 filed on March 3, 2014 (File No. 001-31987) and incorporated herein by reference).

 

 

 

21.1*

 

List of subsidiaries of the Registrant.

 

 

 

23.1*

 

Consent of PricewaterhouseCoopers LLP.

 

 

 

23.2*

 

Consent of Ernst & Young LLP.

 

 

 

23.3*

 

Consent of Grant Thornton LLP.

 

 

 

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.

 

 

 

99.1*

 

Audited consolidated financial statements of SWS Group, Inc. as of June 30, 2014 and 2013 and for each of the three years in the period ended June 30, 2014.

 

 

 

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.

†    Exhibit is a management contract or compensatory plan.

 

106



Table of Contents

 

Index to Consolidated Financial Statements

 

Hilltop Holdings Inc.

 

 

 

Report of Independent Registered Public Accounting Firm (PricewaterhouseCoopers LLP) for Hilltop Holdings Inc.

F-2

Report of Independent Registered Public Accounting Firm (Ernst & Young LLP) for PrimeLending

F-3

Report of Independent Registered Public Accounting Firm (Ernst & Young LLP) for First Southwest Company

F-4

 

 

Audited Consolidated Financial Statements, Years Ended December 31, 2014, 2013 and 2012

 

 

 

Consolidated Balance Sheets

F-5

Consolidated Statements of Operations

F-6

Consolidated Statements of Comprehensive Income (Loss)

F-7

Consolidated Statements of Stockholders’ Equity

F-8

Consolidated Statements of Cash Flows

F-9

Notes to Consolidated Financial Statements

F-10

 

F-1



Table of Contents

 

Report of Independent Registered Public Accounting Firm

 

To The Board of Directors and Stockholders of Hilltop Holdings Inc.

 

In our opinion, based on our audits and the reports of other auditors, the consolidated financial statements listed in the accompanying index appearing under Item 15(a)(1) present fairly, in all material respects, the financial position of Hilltop Holdings Inc. and its subsidiaries (the “Company”) at December 31, 2014 and 2013, and the results of their operations and their cash flows for each of the three years in the period ended December 31, 2014 in conformity with accounting principles generally accepted in the United States of America. Also in our opinion, the Company maintained, in all material respects, effective internal control over financial reporting as of December 31, 2014, based on criteria established in Internal Control - Integrated Framework (2013) issued by the Committee of Sponsoring Organizations of the Treadway Commission (COSO). The Company’s management is responsible for these financial statements, for maintaining effective internal control over financial reporting and for its assessment of the effectiveness of internal control over financial reporting, included in Management’s Report on Internal Control over Financial Reporting appearing under Item 9A. Our responsibility is to express opinions on these financial statements and on the Company’s internal control over financial reporting based on our integrated audits. We did not audit the financial statements of PrimeLending and First Southwest Company for the year ended December 31, 2012, both wholly owned subsidiaries of the Company, which statements reflect total assets of approximately $1.5 billion and $0.5 billion, respectively, of the related consolidated total as of December 31, 2012 and total net income before tax of approximately $5.7 million and $1.6 million, respectively, of the related consolidated total for the year ended December 31, 2012. The 2012 financial statements of PrimeLending and First Southwest Company were audited by other auditors whose reports thereon have been furnished to us, and our opinion on the financial statements expressed herein, insofar as it relates to the amounts included for PrimeLending and First Southwest Company, is based solely on the reports of the other auditors. We conducted our audits in accordance with the standards of the Public Company Accounting Oversight Board (United States). Those standards require that we plan and perform the audits to obtain reasonable assurance about whether the financial statements are free of material misstatement and whether effective internal control over financial reporting was maintained in all material respects. Our audits of the financial statements included examining, on a test basis, evidence supporting the amounts and disclosures in the financial statements, assessing the accounting principles used and significant estimates made by management, and evaluating the overall financial statement presentation. Our audit of internal control over financial reporting included obtaining an understanding of internal control over financial reporting, assessing the risk that a material weakness exists, and testing and evaluating the design and operating effectiveness of internal control based on the assessed risk. Our audits also included performing such other procedures as we considered necessary in the circumstances. We believe that our audits and the reports of other auditors provide a reasonable basis for our opinions.

 

A company’s internal control over financial reporting is a process designed to provide reasonable assurance regarding the reliability of financial reporting and the preparation of financial statements for external purposes in accordance with generally accepted accounting principles. A company’s internal control over financial reporting includes those policies and procedures that (i) pertain to the maintenance of records that, in reasonable detail, accurately and fairly reflect the transactions and dispositions of the assets of the company; (ii) provide reasonable assurance that transactions are recorded as necessary to permit preparation of financial statements in accordance with generally accepted accounting principles, and that receipts and expenditures of the company are being made only in accordance with authorizations of management and directors of the company; and (iii) provide reasonable assurance regarding prevention or timely detection of unauthorized acquisition, use, or disposition of the company’s assets that could have a material effect on the financial statements.

 

Because of its inherent limitations, internal control over financial reporting may not prevent or detect misstatements. Also, projections of any evaluation of effectiveness to future periods are subject to the risk that controls may become inadequate because of changes in conditions, or that the degree of compliance with the policies or procedures may deteriorate.

 

 

/s/ PricewaterhouseCoopers LLP

 

Dallas, Texas

February 26, 2015

 

F-2



Table of Contents

 

Report of Independent Registered Public Accounting Firm

 

The Board of Directors and Stockholder

PrimeLending, a PlainsCapital Company

 

We have audited the consolidated financial statements of PrimeLending, a PlainsCapital Company (the Company), which comprise the consolidated balance sheet as of December 31, 2012, and the related consolidated statement of income, stockholder’s equity, and cash flows for the period from December 1, 2012 through December 31, 2012, and the related consolidated notes to the financial statements (not presented separately herein).

 

Management’s Responsibility for the Financial Statements

 

Management is responsible for the preparation and fair presentation of these consolidated financial statements in conformity with U.S. generally accepted accounting principles; this includes the design, implementation, and maintenance of internal control relevant to the preparation and fair presentation of consolidated financial statements that are free of material misstatement, whether due to fraud or error.

 

Auditor’s Responsibility

 

Our responsibility is to express an opinion on these consolidated financial statements based on our audit. We conducted our audit in accordance with auditing standards generally accepted in the United States and in accordance with the standards of the Public Company Accounting Oversight Board (United States). Those standards require that we plan and perform the audit to obtain reasonable assurance about whether the consolidated financial statements are free of material misstatement.

 

An audit involves performing procedures to obtain audit evidence about the amounts and disclosures in the consolidated financial statements. The procedures selected depend on the auditor’s judgment, including the assessment of the risks of material misstatement of the consolidated financial statements, whether due to fraud or error. In making those risk assessments, the auditor considers internal control relevant to the entity’s preparation and fair presentation of the consolidated financial statements in order to design audit procedures that are appropriate in the circumstances, but not for the purpose of expressing an opinion on the effectiveness of the entity’s internal control. Accordingly, we express no such opinion. An audit also includes evaluating the appropriateness of accounting policies used and the reasonableness of significant accounting estimates made by management, as well as evaluating the overall presentation of the consolidated financial statements.

 

We believe that the audit evidence we have obtained is sufficient and appropriate to provide a basis for our audit opinion.

 

Opinion

 

In our opinion, the consolidated financial statements referred to above present fairly, in all material respects, the financial position of PrimeLending, a PlainsCapital Company at December 31, 2012, and the results of its operations and its cash flows for the period from December 1, 2012 through December 31, 2012 in conformity with U.S. generally accepted accounting principles.

 

 

/s/ Ernst & Young LLP

 

Dallas, Texas

March 15, 2013

 

F-3



Table of Contents

 

Report of Independent Registered Public Accounting Firm

 

Board of Directors

First Southwest Company

 

We have audited the financial statements of First Southwest Company (the Company), which comprise the statement of financial condition as of December 31, 2012, and the related statements of income, changes in stockholder’s equity, and cash flows for the period from December 1, 2012 through December 31, 2012 that are filed pursuant to Rule 17a-5 under the Securities Exchange Act of 1934, and the related notes to the financial statements (not presented separately herein).

 

Management’s Responsibility for the Financial Statements

 

Management is responsible for the preparation and fair presentation of these financial statements in conformity with U.S. generally accepted accounting principles; this includes the design, implementation, and maintenance of internal control relevant to the preparation and fair presentation of financial statements that are free from material misstatement, whether due to fraud or error.

 

Auditor’s Responsibility

 

Our responsibility is to express an opinion on these financial statements based on our audit. We conducted our audit in accordance with auditing standards generally accepted in the United States and in accordance with the standards of the Public Company Accounting Oversight Board (United States). Those standards require that we plan and perform the audit to obtain reasonable assurance about whether the financial statements are free of material misstatement.

 

An audit involves performing procedures to obtain audit evidence about the amounts and disclosures in the financial statements. The procedures selected depend on the auditor’s judgment, including the assessment of the risks of material misstatement of the financial statements, whether due to fraud or error. In making those risk assessments, the auditor considers internal control relevant to the Company’s preparation and fair presentation of the financial statements in order to design audit procedures that are appropriate in the circumstances, but not for the purpose of expressing an opinion on the effectiveness of the Company’s internal control. Accordingly, we express no such opinion. An audit also includes evaluating the appropriateness of accounting policies used and the reasonableness of significant accounting estimates made by management, as well as evaluating the overall presentation of the financial statements.

 

We believe that the audit evidence we have obtained is sufficient and appropriate to provide a basis for our audit opinion.

 

Opinion

 

In our opinion, the financial statements referred to above present fairly, in all material respects, the financial position of First Southwest Company as of December 31, 2012, and the results of its operations and its cash flows for the period from December 1, 2012 through December 31, 2012, in conformity with U.S. generally accepted accounting principles.

 

 

/s/ Ernst & Young LLP

 

Dallas, Texas

February 28, 2013

 

F-4



Table of Contents

 

HILLTOP HOLDINGS INC. AND SUBSIDIARIES

CONSOLIDATED BALANCE SHEETS

(in thousands, except share and per share data)

 

 

 

December 31,

 

 

 

2014

 

2013

 

Assets

 

 

 

 

 

Cash and due from banks

 

$

782,473

 

$

713,099

 

Federal funds sold and securities purchased under agreements to resell

 

30,602

 

32,924

 

Securities:

 

 

 

 

 

Trading, at fair value

 

65,717

 

58,846

 

Available for sale, at fair value (amortized cost of $924,755 and $1,256,862, respectively)

 

925,535

 

1,203,143

 

Held to maturity, at amortized cost (fair value of $118,345)

 

118,209

 

 

 

 

1,109,461

 

1,261,989

 

 

 

 

 

 

 

Loans held for sale

 

1,309,693

 

1,089,039

 

Non-covered loans, net of unearned income

 

3,920,476

 

3,514,646

 

Allowance for non-covered loan losses

 

(37,041

)

(33,241

)

Non-covered loans, net

 

3,883,435

 

3,481,405

 

 

 

 

 

 

 

Covered loans, net of allowance of $4,611 and $1,061, respectively

 

638,029

 

1,005,308

 

Broker-dealer and clearing organization receivables

 

167,884

 

119,317

 

Insurance premiums receivable

 

25,066

 

25,597

 

Deferred policy acquisition costs

 

20,416

 

20,991

 

Premises and equipment, net

 

206,991

 

200,706

 

FDIC indemnification asset

 

130,437

 

188,291

 

Covered other real estate owned

 

136,945

 

142,833

 

Mortgage servicing rights

 

36,155

 

20,149

 

Other assets

 

453,238

 

279,745

 

Goodwill

 

251,808

 

251,808

 

Other intangible assets, net

 

59,783

 

70,921

 

Total assets

 

$

9,242,416

 

$

8,904,122

 

 

 

 

 

 

 

Liabilities and Stockholders’ Equity

 

 

 

 

 

Deposits:

 

 

 

 

 

Noninterest-bearing

 

$

2,076,385

 

$

1,773,749

 

Interest-bearing

 

4,293,507

 

4,949,169

 

Total deposits

 

6,369,892

 

6,722,918

 

 

 

 

 

 

 

Broker-dealer and clearing organization payables

 

179,042

 

129,678

 

Reserve for losses and loss adjustment expenses

 

29,716

 

27,468

 

Unearned insurance premiums

 

88,176

 

88,422

 

Short-term borrowings

 

762,696

 

342,087

 

Notes payable

 

56,684

 

56,327

 

Junior subordinated debentures

 

67,012

 

67,012

 

Other liabilities

 

227,959

 

158,288

 

Total liabilities

 

7,781,177

 

7,592,200

 

Commitments and contingencies (see Notes 18 and 19)

 

 

 

 

 

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, 125,000,000 and 100,000,000 shares authorized; 90,181,888 and 90,175,688 shares issued and outstanding, respectively

 

902

 

902

 

Additional paid-in capital

 

1,390,788

 

1,388,641

 

Accumulated other comprehensive income (loss)

 

651

 

(34,863

)

Accumulated deficit

 

(45,957

)

(157,607

)

Total Hilltop stockholders’ equity

 

1,460,452

 

1,311,141

 

Noncontrolling interests

 

787

 

781

 

Total stockholders’ equity

 

1,461,239

 

1,311,922

 

Total liabilities and stockholders’ equity

 

$

9,242,416

 

$

8,904,122

 

 

See accompanying notes.

 

F-5



Table of Contents

 

HILLTOP HOLDINGS INC. AND SUBSIDIARIES

CONSOLIDATED STATEMENTS OF OPERATIONS

(in thousands, except per share data)

 

 

 

Year Ended December 31,

 

 

 

2014

 

2013

 

2012

 

Interest income:

 

 

 

 

 

 

 

Loans, including fees

 

$

341,458

 

$

284,782

 

$

23,900

 

Securities:

 

 

 

 

 

 

 

Taxable

 

29,206

 

27,078

 

13,116

 

Tax-exempt

 

4,681

 

4,775

 

464

 

Federal funds sold and securities purchased under agreements to resell

 

52

 

113

 

106

 

Interest-bearing deposits with banks

 

1,602

 

1,848

 

801

 

Other

 

11,770

 

10,479

 

651

 

Total interest income

 

388,769

 

329,075

 

39,038

 

 

 

 

 

 

 

 

 

Interest expense:

 

 

 

 

 

 

 

Deposits

 

15,742

 

14,877

 

1,013

 

Short-term borrowings

 

2,205

 

1,814

 

215

 

Notes payable

 

2,532

 

10,512

 

8,613

 

Junior subordinated debentures

 

2,360

 

2,409

 

212

 

Other

 

4,789

 

3,262

 

143

 

Total interest expense

 

27,628

 

32,874

 

10,196

 

 

 

 

 

 

 

 

 

Net interest income

 

361,141

 

296,201

 

28,842

 

Provision for loan losses

 

16,933

 

37,158

 

3,800

 

Net interest income after provision for loan losses

 

344,208

 

259,043

 

25,042

 

 

 

 

 

 

 

 

 

Noninterest income:

 

 

 

 

 

 

 

Net realized gains on securities

 

 

4,937

 

112

 

Net gains from sale of loans and other mortgage production income

 

390,361

 

457,531

 

50,384

 

Mortgage loan origination fees

 

63,011

 

79,736

 

7,224

 

Net insurance premiums earned

 

164,524

 

157,533

 

146,701

 

Investment and securities advisory fees and commissions

 

101,874

 

93,093

 

11,238

 

Bargain purchase gain

 

 

12,585

 

 

Other

 

79,541

 

44,670

 

8,573

 

Total noninterest income

 

799,311

 

850,085

 

224,232

 

 

 

 

 

 

 

 

 

Noninterest expense:

 

 

 

 

 

 

 

Employees’ compensation and benefits

 

490,706

 

480,496

 

60,972

 

Loss and loss adjustment expenses

 

94,429

 

110,755

 

109,159

 

Policy acquisition and other underwriting expenses

 

46,942

 

46,289

 

43,658

 

Occupancy and equipment, net

 

101,697

 

86,248

 

7,360

 

Other

 

231,579

 

187,947

 

34,368

 

Total noninterest expense

 

965,353

 

911,735

 

255,517

 

 

 

 

 

 

 

 

 

Income (loss) before income taxes

 

178,166

 

197,393

 

(6,243

)

Income tax expense (benefit)

 

65,608

 

70,684

 

(1,145

)

 

 

 

 

 

 

 

 

Net income (loss)

 

112,558

 

126,709

 

(5,098

)

Less: Net income attributable to noncontrolling interest

 

908

 

1,367

 

494

 

 

 

 

 

 

 

 

 

Income (loss) attributable to Hilltop

 

111,650

 

125,342

 

(5,592

)

Dividends on preferred stock

 

5,703

 

4,327

 

259

 

Income (loss) applicable to Hilltop common stockholders

 

$

105,947

 

$

121,015

 

$

(5,851

)

 

 

 

 

 

 

 

 

Earnings (loss) per common share:

 

 

 

 

 

 

 

Basic

 

$

1.18

 

$

1.43

 

$

(0.10

)

Diluted

 

$

1.17

 

$

1.40

 

$

(0.10

)

 

 

 

 

 

 

 

 

Weighted average share information:

 

 

 

 

 

 

 

Basic

 

89,710

 

84,382

 

58,754

 

Diluted

 

90,573

 

90,331

 

58,754

 

 

See accompanying notes.

 

F-6



Table of Contents

 

HILLTOP HOLDINGS INC. AND SUBSIDIARIES

CONSOLIDATED STATEMENTS OF COMPREHENSIVE INCOME (LOSS)

(in thousands)

 

 

 

Year Ended December 31,

 

 

 

2014

 

2013

 

2012

 

Net income (loss)

 

$

112,558

 

$

126,709

 

$

(5,098

)

Other comprehensive income (loss):

 

 

 

 

 

 

 

Unrealized gains (losses) on securities available for sale, net of tax of $22,268, $(21,972) and $(3,172), respectively

 

40,090

 

(39,709

)

(5,889

)

Reclassification adjustment for gains included in net income, net of tax of $(2,582) $(1,793) and $0, and other

 

(4,576

)

(3,248

)

 

Comprehensive income (loss)

 

148,072

 

83,752

 

(10,987

)

Less: comprehensive income attributable to noncontrolling interest

 

908

 

1,367

 

494

 

 

 

 

 

 

 

 

 

Comprehensive income (loss) applicable to Hilltop

 

$

147,164

 

$

82,385

 

$

(11,481

)

 

See accompanying notes.

 

F-7



Table of Contents

 

HILLTOP HOLDINGS INC. AND SUBSIDIARIES

CONSOLIDATED STATEMENTS OF STOCKHOLDERS’ EQUITY

(in thousands)

 

 

 

 

 

 

 

 

 

 

 

 

 

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, 2011

 

 

$

 

56,501

 

$

565

 

$

918,192

 

$

13,983

 

$

(277,357

)

$

655,383

 

$

 

$

655,383

 

Net loss

 

 

 

 

 

 

 

(5,592

)

(5,592

)

494

 

(5,098

)

Other comprehensive loss

 

 

 

 

 

 

(5,889

)

 

(5,889

)

 

(5,889

)

Issuance of preferred stock

 

114

 

114,068

 

 

 

 

 

 

114,068

 

 

114,068

 

Issuance of common stock

 

 

 

27,123

 

271

 

387,312

 

 

 

387,583

 

 

387,583

 

Stock-based compensation expense

 

 

 

 

 

450

 

 

 

450

 

 

450

 

Common stock issued to board members

 

 

 

4

 

 

50

 

 

 

50

 

 

50

 

Repurchase and retirement of common stock

 

 

 

(141

)

(1

)

(1,297

)

 

 

(1,298

)

 

(1,298

)

Dividends on preferred stock

 

 

 

 

 

(259

)

 

 

(259

)

 

(259

)

Acquired noncontrolling interest

 

 

 

 

 

 

 

 

 

1,789

 

1,789

 

Cash distributions to noncontrolling interest

 

 

 

 

 

 

 

 

 

(229

)

(229

)

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

 

 

 

 

 

 

 

125,342

 

125,342

 

1,367

 

126,709

 

Other comprehensive loss

 

 

 

 

 

 

(42,957

)

 

(42,957

)

 

(42,957

)

Issuance of common stock

 

 

 

6,208

 

62

 

86,705

 

 

 

86,767

 

 

86,767

 

Stock-based compensation expense

 

 

 

 

 

1,671

 

 

 

1,671

 

 

1,671

 

Common stock issued to board members

 

 

 

10

 

 

149

 

 

 

149

 

 

149

 

Issuance of restricted common stock

 

 

 

471

 

5

 

(5

)

 

 

 

 

 

Dividends on preferred stock

 

 

 

 

 

(4,327

)

 

 

(4,327

)

 

(4,327

)

Cash distributions to noncontrolling interest

 

 

 

 

 

 

 

 

 

(2,640

)

(2,640

)

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

 

 

 

 

 

 

 

111,650

 

111,650

 

908

 

112,558

 

Other comprehensive income

 

 

 

 

 

 

35,514

 

 

35,514

 

 

35,514

 

Stock-based compensation expense

 

 

 

 

 

4,653

 

 

 

4,653

 

 

4,653

 

Common stock issued to board members

 

 

 

9

 

 

208

 

 

 

208

 

 

208

 

Forfeiture of restricted common stock awards

 

 

 

(3

)

 

(12

)

 

 

(12

)

 

(12

)

Dividends on preferred stock

 

 

 

 

 

(5,703

)

 

 

(5,703

)

 

(5,703

)

Issuance of common stock

 

 

 

 

 

3,001

 

 

 

3,001

 

 

3,001

 

Cash distributions to noncontrolling interest

 

 

 

 

 

 

 

 

 

(902

)

(902

)

Balance, December 31, 2014

 

114

 

$

114,068

 

90,182

 

$

902

 

$

1,390,788

 

$

651

 

$

(45,957

)

$

1,460,452

 

$

787

 

$

1,461,239

 

 

See accompanying notes.

 

F-8



Table of Contents

 

HILLTOP HOLDINGS INC. AND SUBSIDIARIES

CONSOLIDATED STATEMENTS OF CASH FLOWS

(in thousands)

 

 

 

Year Ended December 31,

 

 

 

2014

 

2013

 

2012

 

Operating Activities

 

 

 

 

 

 

 

Net income (loss)

 

$

112,558

 

$

126,709

 

$

(5,098

)

Adjustments to reconcile net income (loss) to net cash provided by (used in) operating activities:

 

 

 

 

 

 

 

Provision for loan losses

 

16,933

 

37,158

 

3,800

 

Depreciation, amortization and accretion, net

 

(83,279

)

(53,794

)

(2,533

)

Net realized gains on securities

 

 

(4,937

)

(112

)

Bargain purchase gain

 

 

(12,585

)

 

Net gain on investment in SWS common stock

 

(5,985

)

 

 

Deferred income taxes

 

(22,782

)

15,829

 

(6,426

)

Other, net

 

19,000

 

6,249

 

612

 

Net change in trading securities

 

(6,871

)

31,267

 

12,900

 

Net change in broker-dealer and clearing organization receivables

 

(145,283

)

21,219

 

43,309

 

Net change in other assets

 

(36,167

)

7,465

 

(541

)

Net change in broker-dealer and clearing organization payables

 

214,755

 

(55,247

)

(46,509

)

Net change in loss and loss adjustment expense reserve

 

2,248

 

(6,544

)

(10,823

)

Net change in unearned insurance premiums

 

(246

)

5,824

 

1,937

 

Net change in other liabilities

 

57,329

 

(34,540

)

9,025

 

Net gains from sale of loans

 

(390,361

)

(457,531

)

(50,384

)

Loans originated for sale

 

(10,839,905

)

(11,752,800

)

(1,344,577

)

Proceeds from loans sold

 

11,016,636

 

12,522,963

 

1,510,639

 

Net cash provided by (used in) operating activities

 

(91,420

)

396,705

 

115,219

 

 

 

 

 

 

 

 

 

Investing Activities

 

 

 

 

 

 

 

Proceeds from maturities and principal reductions of securities held to maturity

 

5,203

 

 

 

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

 

315,166

 

381,890

 

77,445

 

Purchases of securities held to maturity

 

(123,520

)

 

 

Purchases of securities available for sale

 

(49,156

)

(372,998

)

(224,893

)

Net change in loans

 

103,031

 

(140,437

)

10,673

 

Purchases of premises and equipment and other assets

 

(43,186

)

(33,066

)

(17,412

)

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

 

69,400

 

21,233

 

1,377

 

Net cash paid (received) for Federal Home Loan Bank and Federal Reserve Bank stock

 

(17,114

)

4,600

 

 

Net cash from acquisitions

 

 

362,695

 

165,679

 

Net cash provided by investing activities

 

259,824

 

223,917

 

12,869

 

 

 

 

 

 

 

 

 

Financing Activities

 

 

 

 

 

 

 

Net change in deposits

 

(518,417

)

(210,491

)

207,997

 

Net change in short-term borrowings

 

420,609

 

(386,163

)

(185,812

)

Proceeds from notes payable

 

3,000

 

2,000

 

 

Payments on notes payable

 

(2,643

)

(3,262

)

(766

)

Payments to repurchase common stock

 

 

 

(1,298

)

Dividends paid on preferred stock

 

(5,619

)

(2,985

)

 

Net cash distributed to noncontrolling interest

 

(902

)

(2,640

)

(229

)

Other, net

 

2,620

 

2,482

 

(40

)

Net cash provided by (used in) financing activities

 

(101,352

)

(601,059

)

19,852

 

 

 

 

 

 

 

 

 

Net change in cash and cash equivalents

 

67,052

 

19,563

 

147,940

 

Cash and cash equivalents, beginning of year

 

746,023

 

726,460

 

578,520

 

Cash and cash equivalents, end of year

 

$

813,075

 

$

746,023

 

$

726,460

 

 

 

 

 

 

 

 

 

Supplemental Disclosures of Cash Flow Information

 

 

 

 

 

 

 

Cash paid for interest

 

$

28,846

 

$

31,805

 

$

10,371

 

Cash paid for income taxes, net of refunds

 

$

26,859

 

$

73,802

 

$

(184

)

Supplemental Schedule of Non-Cash Activities

 

 

 

 

 

 

 

Conversion of available for sale investment to SWS common stock

 

$

71,502

 

$

 

$

 

Redemption of senior exchangeable notes for common stock

 

$

 

$

83,950

 

$

 

Conversion of loans to other real estate owned

 

$

67,542

 

$

25,639

 

$

 

Preferred stock issued in acquisition

 

$

 

$

 

$

114,068

 

Common stock issued in acquisition

 

$

 

$

 

$

387,583

 

 

See accompanying notes.

 

F-9



Table of Contents

 

Hilltop Holdings Inc. and Subsidiaries

Notes to Consolidated Financial Statements

 

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, 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.

 

The operating results of Hilltop for the year ended December 31, 2012 include the results from the operations acquired in the PlainsCapital Merger for the month ended December 31, 2012. Certain disclosures within the notes to consolidated financial statements are specific to financial products and services of PlainsCapital and its subsidiaries and therefore include information at December 31, 2014 and 2013 and relating to the post-acquisition years ended December 31, 2014 and 2013 and one month period ended December 31, 2012.

 

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 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.

 

Basis of Presentation

 

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 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.

 

The presentation of the Company’s historical consolidated financial statements has been modified and certain items in the 2012 financial statements have been reclassified to conform to the current period presentation, which is more consistent with that of a financial institution that provides an array of financial products and services.

 

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”), PCB-ARC, Inc. and RGV-ARC, Inc. The Bank has a 100% membership interest in First Southwest Holdings, LLC (“First Southwest”) and PlainsCapital Securities, LLC.

 

F-10



Table of Contents

 

Hilltop Holdings Inc. and Subsidiaries

Notes to Consolidated Financial Statements (continued)

 

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, LLC (“FSC”), a broker-dealer registered with the Securities and Exchange Commission (the “SEC”) and the Financial Industry Regulatory Authority and a member of the New York Stock Exchange (“NYSE”), and First Southwest Asset Management, LLC, 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”).

 

On October 2, 2014, as discussed in Note 4 to the consolidated financial statements, Hilltop exercised the SWS Warrant (defined hereafter) in full and paid the aggregate exercise price by the automatic elimination of the $50.0 million aggregate principal amount note due to Hilltop under the credit agreement. Consequently, Hilltop owned approximately 21% of the outstanding shares of SWS Group, Inc. (“SWS”) common stock. Contemporaneous with the exercise of the SWS Warrant, Hilltop changed the accounting method for its investment in SWS common stock and elected to account for its investment in accordance with the provisions of the Fair Value Option Subsections of the ASC (“Fair Value Option”) as permitted by GAAP. Hilltop had previously accounted for its investment in SWS common stock as an available for sale security. Under the Fair Value Option, Hilltop’s investment in SWS common stock is recorded at fair value effective October 2, 2014, with changes in fair value being recorded in other noninterest income within the consolidated statement of operations rather than as a component of other comprehensive income. Hilltop’s election to apply the provisions of the Fair Value Option resulted in Hilltop recording those unrealized gains previously associated with its investment in SWS common stock of $7.2 million. For the period from October 3, 2014 through December 31, 2014, the change in fair value of Hilltop’s investment in SWS common stock resulted in a loss of $1.2 million. In the aggregate, Hilltop recorded a $6.0 million net gain in other noninterest income within the consolidated statement of operations during 2014. At December 31, 2014, Hilltop’s investment in SWS common stock is included in other assets within the consolidated balance sheet and is recorded at fair value.

 

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.

 

Acquisition Accounting

 

Acquisitions are accounted for under the acquisition method of accounting. Purchased assets, including identifiable intangible assets, and assumed liabilities are recorded at their respective acquisition date fair values. If the fair value of net assets purchased exceeds the consideration given, a “bargain purchase gain” is recognized. If the consideration given exceeds the fair value of the net assets received, goodwill is recognized.

 

Securities Purchased Under Agreements to Resell

 

Securities purchased under agreements to resell (reverse repurchase agreements or reverse repos) are treated as collateralized financings and are carried at the amounts at which the securities will subsequently be resold as specified in the agreements. PlainsCapital is in possession of collateral with a fair value equal to or in excess of the contract amounts.

 

F-11



Table of Contents

 

Hilltop Holdings Inc. and Subsidiaries

Notes to Consolidated Financial Statements (continued)

 

Securities

 

Management classifies securities at the time of purchase and reassesses such designation at each balance sheet date. Transfers between categories from these reassessments are rare.  Securities held for resale to facilitate principal transactions with customers, as well as certain securities acquired in the PlainsCapital Merger, are classified as trading, and are carried at fair value, with changes in fair value reflected in the consolidated statements of operations. Hilltop reports interest income on trading securities as interest income on securities and other changes in fair value as other noninterest income.

 

Securities held but not intended to be held to maturity or on a long-term basis are classified as available for sale. Securities included in this category are those that management intends to use as part of its asset/liability management strategy and that may be sold in response to changes in interest rates, resultant prepayment risk, and other factors related to interest rate and resultant prepayment risk changes. Securities available for sale are carried at fair value. Unrealized holding gains and losses on securities available for sale, net of taxes, are reported in other comprehensive income (loss) until realized. Premiums and discounts are recognized in interest income using the effective interest method and consider any optionality that may be embedded in the security.

 

Purchases and sales (and related gain or loss) of securities are recorded on the trade date, based on specific identification. Declines in the fair value of available-for-sale securities below their cost that are deemed to be other than temporary are reflected in earnings as realized losses to the extent the other-than-temporary impairment (“OTTI”) is related to credit losses. The amount of the OTTI related to other factors is recognized in other comprehensive income (loss). In estimating OTTI, management considers in developing its best estimate of cash flows, among other things, (i) the length of time and the extent to which the fair value has been less than cost, (ii) the financial condition and near-term prospects of the issuer, (iii) the historic and implied volatility of the security, (iv) failure of the issuer to make scheduled interest payments and (v) changes to the rating of the security by a rating agency.

 

Loans Held for Sale

 

Loans held for sale consist primarily of single-family residential mortgages funded through PrimeLending. These loans are generally on the consolidated balance sheet for no more than 30 days. Substantially all mortgage loans originated by PrimeLending are sold in the secondary market, the majority with servicing released. Mortgage loans held for sale are carried at fair value under the provisions of the Fair Value Option. Changes in the fair value of the loans held for sale are recognized in earnings and fees and costs associated with origination are recognized as incurred. The specific identification method is used to determine realized gains and losses on sales of loans, which are reported as net gains (losses) in noninterest income. Loans sold are subject to certain indemnification provisions with investors, including the repurchase of loans sold and repayment of certain sales proceeds to investors under certain conditions. In addition, certain mortgage loans guaranteed by U.S. Government agencies and sold into Government National Mortgage Association (“GNMA”) pools may, under certain conditions specified in the government programs, become subject to repurchase by PrimeLending. Such loans subject to repurchase no longer qualify for sale accounting and are reported as loans held for sale in the consolidated balance sheets.

 

Loans

 

Originated Loans

 

Loans that management has the intent and ability to hold for the foreseeable future or until maturity or payoff are stated at the amount of unpaid principal reduced by unearned income, net unamortized deferred fees and an allowance for loan losses. Unearned income on installment loans and interest on other loans is recognized using the effective interest method. Net fees received for providing loan commitments and letters of credit that result in loans are deferred and amortized to interest income over the life of the related loan, beginning with the initial borrowing. Net fees on commitments and letters of credit that are not expected to be funded are amortized to noninterest income over the commitment period. Income on direct financing leases is recognized on a basis that achieves a constant periodic rate of return on the outstanding investment.

 

Impaired loans include non-accrual loans, troubled debt restructurings and partially charged-off loans. The accrual of interest on impaired loans is discontinued when, in management’s opinion, there is a clear indication that the borrower’s cash flow may not be sufficient to meet principal and interest payments as they become due according to the terms of the loan

 

F-12



Table of Contents

 

Hilltop Holdings Inc. and Subsidiaries

Notes to Consolidated Financial Statements (continued)

 

agreement, which is generally when a loan is 90 days past due unless the loan is both well secured and in the process of collection. When a loan is placed on non-accrual status, all previously accrued and unpaid interest is charged against income. If the ultimate collectability of principal, wholly or partially, is in doubt, any payment received on a loan on which the accrual of interest has been suspended is applied to reduce principal to the extent necessary to eliminate such doubt. Once the collection of the remaining recorded loan balance is fully expected, interest income is recognized on a cash basis.

 

The Bank originates loans to customers primarily in Texas. Although the Bank has diversified loan and leasing portfolios and, generally, holds collateral against amounts advanced to customers, its debtors’ ability to honor their contracts is substantially dependent upon the general economic conditions of the region and of the industries in which its debtors operate, which consist primarily of energy, agribusiness, wholesale/retail trade, construction and real estate. PrimeLending originates loans to customers in its offices, which are located throughout the United States. Substantially all mortgage loans originated by PrimeLending are sold in the secondary market, the majority with servicing released, although PrimeLending does retain servicing in certain circumstances. FSC makes loans to customers through margin transactions. FSC controls risk by requiring customers to maintain margin collateral in compliance with various regulatory and internal guidelines, which may vary based upon market conditions. Securities owned by customers and held as collateral for margin loans are not included in the consolidated financial statements.

 

Acquired Loans

 

Management has defined the loans acquired in a business combination as acquired loans. Acquired loans are recorded at estimated fair value on their purchase date with no carryover of the related allowance for loan losses. Acquired loans were segregated between those considered to be credit impaired and those without credit impairment at acquisition. To make this determination, management considered such factors as past due status, nonaccrual status and credit risk ratings. The fair value of acquired performing loans was determined by discounting expected cash flows, both principal and interest, at prevailing market interest rates. The difference between the fair value and principal balances due at acquisition date, the fair value discount, is accreted into income over the estimated life of each loan.

 

Purchased credit impaired (“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 on an individual loan basis. The Company has established under its 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.

 

PCI loans showed evidence of credit deterioration that makes it probable that all contractually required principal and interest payments will not be collected. Their fair value was initially based on an estimate of cash flows, both principal and interest, expected to be collected, discounted at prevailing market rates of interest. Management estimated cash flows using key assumptions such as default rates, loss severity rates assuming default, prepayment speeds and estimated collateral values. The excess of cash flows expected to be collected from a loan or pool over its estimated fair value at acquisition is referred to as the accretable yield and is recognized in interest income using an effective yield method over the remaining life of the loan or pool. Subsequent to acquisition, management must update these estimates of cash flows expected to be collected at each reporting date. These updates require the continued use of key assumptions and estimates, similar to those used in the initial estimate of fair value.

 

The Bank accretes the discount for PCI loans for which it can predict the timing and amount of cash flows. PCI loans for which a discount is accreted are considered performing.

 

Allowance for Loan Losses

 

Originated Loans

 

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. The allowance, in the judgment of management, is necessary to reserve for estimated loan losses inherent in the loan portfolio at the balance sheet

 

F-13



Table of Contents

 

Hilltop Holdings Inc. and Subsidiaries

Notes to Consolidated Financial Statements (continued)

 

date. The allowance for loan losses includes allowance allocations calculated in accordance with the Receivables and Contingencies Topics of the ASC. The level of the allowance reflects management’s continuing evaluation of industry concentrations, specific credit risks, loan loss experience, current loan portfolio quality, present economic, political and regulatory conditions, and unidentified losses inherent in the current loan portfolio. Portions of the allowance may be allocated for specific credits; however, the entire allowance is available for any credit that, in management’s judgment, should be charged off. While management utilizes its best judgment and information available, the ultimate adequacy of the allowance is dependent upon a variety of factors beyond the Bank’s control, including the performance of the Bank’s loan portfolio, the economy and changes in interest rates.

 

The Bank’s allowance for loan losses consists of three elements: (i) specific valuation allowances established for probable losses on impaired loans; (ii) general historical valuation allowances calculated based on historical loan loss experience for homogenous loans with similar collateral; and (iii) valuation allowances to adjust general reserves based on recent economic conditions and other qualitative risk factors both internal and external to the Bank.

 

Acquired Loans

 

Purchased loans acquired in a business combination are recorded at their estimated fair value on their purchase date 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.

 

For PCI loans, cash flows expected to be collected are recast at each reporting date 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 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 or pool.

 

Assets Segregated for Regulatory Purposes

 

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 Securities Exchange Act of 1934, as amended (the “Exchange Act”). Assets segregated under the provisions of the Exchange Act are not available for general corporate purposes. FSC was required to segregate $76.0 million in cash and securities at December 31, 2014, which is included in other assets within the consolidated balance sheet. At December 31, 2013, FSC was not required to segregate cash and securities.

 

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 December 31, 2014 and 2013.

 

Broker-Dealer and Clearing Organization Transactions

 

Amounts recorded in broker-dealer and clearing organization receivables and payables include securities lending activities, as well as amounts related to securities transactions for either FSC customers or for the account of FSC. Securities-borrowed and securities-loaned transactions are generally reported as collateralized financings except where letters of credit or other securities are used as collateral. Securities-borrowed transactions require FSC to deposit cash, letters of credit, or other collateral with the lender. With respect to securities loaned, FSC receives collateral in the form of cash or other assets in an amount generally in excess of the market value of securities loaned. FSC monitors the market value of securities borrowed and loaned on a daily basis, with additional collateral obtained or refunded as necessary. Interest income and interest expense associated with collateralized financings is included in the accompanying consolidated statements of operations.

 

F-14



Table of Contents

 

Hilltop Holdings Inc. and Subsidiaries

Notes to Consolidated Financial Statements (continued)

 

Insurance Premiums Receivable

 

Insurance premiums receivable include premiums written and not yet collected. NLC routinely evaluates the receivable balance to determine if an allowance for uncollectible amounts is necessary. At December 31, 2014 and 2013, NLC determined that no valuation allowance was necessary.

 

Deferred Policy Acquisition Costs

 

Costs of acquiring insurance vary with and are primarily related to the successful acquisition of new and renewal business, primarily consisting of commissions, premium taxes and underwriting expenses, and are deferred and amortized over the terms of the policies or reinsurance treaties to which they relate. Proceeds from reinsurance transactions that represent recovery of acquisition costs reduce applicable unamortized acquisition costs in such a manner that net acquisition costs are capitalized and charged to expense in proportion to net revenue recognized. Future investment income is considered in determining the recoverability of deferred policy acquisition costs. NLC regularly reviews the categories of acquisition costs that are deferred and assesses the recoverability of this asset. A premium deficiency and a corresponding charge to income is recognized if the sum of the expected loss and loss adjustment expenses, unamortized policy acquisition costs, and maintenance costs exceed related unearned insurance premiums and anticipated investment income. At December 31, 2014 and 2013, there was no premium deficiency.

 

Reinsurance

 

In the normal course of business, NLC seeks to reduce the loss that may arise from catastrophes or other events that could cause unfavorable underwriting results by reinsuring certain levels of risk in various areas of exposure with other insurance enterprises or reinsurers. Amounts recoverable from reinsurers are estimated in a manner consistent with the reinsured policy. NLC routinely evaluates the receivable balance to determine if any uncollectible balances exist.

 

Net insurance premiums earned, losses and loss adjustment expenses (“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 included in other assets within the consolidated balance sheets. Reinsurance assumed from other companies, including assumed premiums written and earned and losses and LAE, is accounted for in the same manner as direct insurance written.

 

Premises and Equipment

 

Premises and equipment are stated at cost less accumulated depreciation and amortization computed principally on the straight-line method over the estimated useful lives of the assets, which range between 3 and 40 years. Gains or losses on disposals of premises and equipment are included in results of operations.

 

FDIC Indemnification Asset

 

The Company has elected to account for the FDIC Indemnification Asset in accordance with FASB ASC 805. The FDIC Indemnification Asset is initially recorded at fair value, based on the discounted value of expected future cash flows under the loss-share agreements. The difference between the present value and the undiscounted cash flows the Company expects to collect from the FDIC will be accreted into noninterest income within the consolidated statements of operations over the life of the FDIC Indemnification Asset. The FDIC Indemnification Asset is reviewed quarterly and adjusted for any changes in expected cash flows based on recent performance and expectations for future performance of the covered portfolio. These adjustments are measured on the same basis as the related covered loans and covered OREO. Any increases in cash flow of the covered assets over those expected will reduce the FDIC Indemnification Asset, and any decreases in cash flow of the covered assets under those expected will increase the FDIC Indemnification Asset. Any amortization of changes in value is limited to the contractual term of the loss-share agreements. Increases and decreases to the FDIC Indemnification Asset are recorded as adjustments to noninterest income within the consolidated statements of operations over the life of the loss-share agreements.

 

F-15



Table of Contents

 

Hilltop Holdings Inc. and Subsidiaries

Notes to Consolidated Financial Statements (continued)

 

Covered Other Real Estate Owned

 

Acquired OREO subject to FDIC loss-share agreements is referred to as “covered OREO” and reported separately in the consolidated balance sheets. Covered OREO is reported exclusive of expected reimbursement cash flows from the FDIC. Foreclosed covered loan collateral is transferred into covered OREO at the collateral’s fair value, less selling costs. Covered OREO was initially recorded at its estimated fair value based on similar market comparable valuations, less estimated selling costs. Subsequently, loan collateral transferred to OREO is recorded at its net realizable value. Any subsequent valuation adjustments due to declines in fair value of the covered OREO will be charged to noninterest expense, and will be partially offset by noninterest income representing the corresponding increase to the FDIC Indemnification Asset for loss reimbursements. Any recoveries of previous valuation decreases will be credited to noninterest expense with a corresponding charge to noninterest income for the portion of the recovery that is due to the FDIC.

 

Other Real Estate Owned

 

Real estate acquired through foreclosure is included in other assets within the consolidated balance sheets and is carried at management’s estimate of fair value less costs 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, valuation adjustments are charged against earnings. Valuation adjustments, revenue and expenses from operations of the properties and resulting gains or losses on sale are included in other noninterest expense within the consolidated statements of operations.

 

Debt Issuance Costs

 

The Company capitalizes debt issuance costs associated with financing of debt. These costs are amortized on a straight-line basis, which approximates the effective interest method, over the repayment term of the loans. Debt issuance costs of $2.3 million and $0.2 million in 2013 and 2012 were amortized and included in interest expense within the consolidated statements of operations. In November 2013, the total remaining unamortized balance of $2.1 million was expensed as a result of the redemption of all outstanding 7.5% Senior Exchangeable Notes due 2025 (“the Notes”), as further described in Note 13 to the consolidated financial statements.

 

Goodwill

 

Goodwill, which represents the excess of cost over the fair value of the net assets acquired, is allocated to reporting units and tested for impairment annually, or whenever events or changes in circumstances indicate that the carrying amount should be assessed. The Company performs required annual impairment tests of its goodwill and other intangible assets as of October 1st for each of its reporting units. Prior to testing goodwill for impairment, the Company has the option to assess on a qualitative basis whether it is more likely than not that the fair value of a reporting unit is less than its carrying amount. If determined, based on its assessment of qualitative factors that it is more likely than not that fair value of a reporting unit is less than its carrying amount, the Company will proceed to test goodwill for impairment as a part of a two-step process. First, the Company determines the fair value of a reporting unit and compares it to its carrying amount. Second, if the carrying amount of a reporting unit exceeds its fair value, an impairment loss is recognized for any excess of the carrying amount of the reporting unit’s goodwill over the implied fair value of that goodwill. The implied fair value of goodwill is determined by allocating the fair value of the reporting unit in a manner similar to a purchase price allocation. The residual fair value after this allocation is the implied fair value of the reporting unit goodwill.

 

Intangibles and Other Long-Lived Assets

 

Intangible assets are acquired assets that lack physical substance but can be distinguished from goodwill because of contractual or other legal rights or because the asset is capable of being sold or exchanged either on its own or in combination with a related contract, asset or liability. The Company’s intangible assets primarily relate to core deposits, trade names, customer and agent relationships and noncompete agreements. Intangible assets with definite useful lives are generally amortized on the straight-line method over their estimated lives, although certain intangibles, including core deposits and customer and agent relationships, are amortized on an accelerated basis. Amortization of intangible assets is recorded in other noninterest expense within the consolidated statements of operations. Intangible assets with indefinite useful lives are tested

 

F-16



Table of Contents

 

Hilltop Holdings Inc. and Subsidiaries

Notes to Consolidated Financial Statements (continued)

 

for impairment annually, or more often if events or circumstances indicate there may be impairment, and not amortized until their lives are determined to be definite. Intangible assets with definite useful lives, premises and equipment, and other long-lived assets are tested for impairment whenever events or changes in circumstances indicate the carrying amount of the assets may not be recoverable from future undiscounted cash flows. If impaired, the assets are recorded at fair value.

 

Mortgage Servicing Rights

 

The Company determines its classes of residential mortgage servicing assets based on the asset type being serviced along with the methods used to manage the risk inherent in the servicing assets, which includes the market inputs used to value the servicing assets. The Company measures its servicing assets at fair value and reports changes in fair value through earnings. Fair value adjustments that encompass market-driven valuation changes and the runoff in value that occurs from the passage of time are each separately reported.

 

Retained mortgage servicing rights (“MSR”) are measured at fair value as of the date of sale of the related mortgage loan. Subsequent fair value measurements are determined using a discounted cash flow model. In order to determine the fair value of the MSR, the present value of expected future cash flows is estimated. Assumptions used include market discount rates, anticipated prepayment speeds, delinquency and foreclosure rates, and ancillary fee income.

 

The model assumptions and the MSR fair value estimates are compared to observable trades of similar portfolios as well as to MSR broker valuations and industry surveys, as available. The expected life of the loan can vary from management’s estimates due to prepayments by borrowers, especially when rates fall. Prepayments in excess of management’s estimates would negatively impact the recorded value of the MSR. The value of the MSR is also dependent upon the discount rate used in the model, which is based on current market rates. Management reviews this rate on an ongoing basis based on current market rates. A significant increase in the discount rate would reduce the value of the MSR.

 

Derivative Financial Instruments

 

The Company’s hedging policies permit the use of various derivative financial instruments, including forward commitments, and interest rate swaps and swaptions, to manage interest rate risk or to hedge specified assets and liabilities. The Company’s derivative financial instruments also include interest rate lock commitments (“IRLCs”) executed with its customers that allow those customers to obtain a mortgage loan on a future date at an agreed-upon interest rate. The IRLCs, forward commitments, and interest rate swaps and swaptions meet the definition of a derivative under the provisions of the Derivatives and Hedging Topic of the ASC.

 

Derivatives are recorded at fair value in the consolidated balance sheets. To qualify for hedge accounting, derivatives must be highly effective at reducing the risk associated with the exposure being hedged and must be designated as a hedge at the inception of the derivative contract. If derivative instruments are designated as hedges of fair values, the change in the fair value of both the derivative instrument and the hedged item are included in current earnings. Changes in the fair value of derivatives designated as hedges of cash flows are recorded in other comprehensive income (loss). Actual cash receipts and/or payments and related accruals on derivatives related to hedges are recorded as adjustments to the line item where the hedged item’s effect on earnings is recorded.

 

Reserve for Losses and Loss Adjustment Expenses

 

The liability for losses and LAE includes an amount determined from loss reports and individual cases and an amount, based on past experience, for losses incurred but not reported. Such liabilities are necessarily based on estimates and, while management believes that the amount is adequate, the ultimate liability may be in excess of or less than the amounts provided. The methods for making such estimates and for establishing the resulting liability are continually reviewed, and any adjustments are reflected in earnings currently. The liability for losses and loss adjustment expenses has not been reduced for reinsurance recoverable.

 

F-17



Table of Contents

 

Hilltop Holdings Inc. and Subsidiaries

Notes to Consolidated Financial Statements (continued)

 

Loss Contingencies

 

Loss contingencies, including claims and legal actions arising in the ordinary course of business, are recorded as liabilities when the likelihood of loss is probable and an amount or range of loss can be reasonably estimated.

 

Stock-Based Compensation

 

Stock-based compensation expense for all share-based awards granted is based on the grant date fair value estimated in accordance with the provisions of the Stock Compensation Topic of the ASC. The Company recognizes these compensation costs for only those awards expected to vest over the service period of the award.

 

Advertising

 

Advertising costs are expensed as incurred. Advertising expense totaled $4.6 million, $5.3 million and $0.4 million during 2014, 2013 and 2012, respectively.

 

Income Taxes

 

Income taxes are accounted for under the asset and liability method. Deferred tax assets and liabilities are recorded for the estimated future tax effects of the temporary difference between the tax basis and book basis of assets and liabilities reported in the accompanying consolidated balance sheets. The provision for income tax expense or benefit differs from the amounts of income taxes currently payable because certain items of income and expense included in the consolidated financial statements are recognized in different time periods by taxing authorities. Interest and penalties incurred related to tax matters are charged to other interest expense or other noninterest expense, respectively.

 

Benefits from uncertain tax positions are recognized in the consolidated financial statements only when it is more likely than not that the tax position will be sustained upon examination by the appropriate taxing authority having full knowledge of all relevant information. A tax position that meets the more-likely-than-not recognition threshold is measured at the largest amount of cumulative benefit that is greater than fifty percent likely of being realized upon ultimate settlement. Tax positions that previously failed to meet the more-likely-than-not recognition threshold are recognized in the reporting period in which that threshold is met. Previously recognized tax positions that no longer meet the more-likely-than-not recognition threshold are derecognized in the reporting period in which that threshold is no longer met. The Company did not recognize certain tax benefits from uncertain tax positions within the provision for income taxes. At December 31, 2014, the net unrecognized tax benefit was $0.4 million. If the Company were to prevail on all uncertain tax positions, the effect would be a benefit to the Company’s effective tax rate. Due to uncertainties in any tax audit outcome, estimates of the ultimate settlement of unrecognized tax positions may change and the actual tax benefits may differ significantly from the estimate.

 

Deferred tax assets, including net operating loss and tax credit carry forwards, are reduced by a valuation allowance when, in the opinion of management, it is more-likely-than-not that any portion of these tax attributes will not be realized. Periodic reviews of the carrying amount of deferred tax assets are made when it is more likely than not that all or a portion of a deferred tax asset will not be realized. Based on that evaluation, management determined at December 31, 2014 that it was appropriate to establish a valuation allowance on the portion of the deferred tax asset associated with its capital losses from investments that could not be carried back to prior tax years. The Company has no valuation allowance on the remainder of its deferred tax assets at December 31, 2014 or 2013.

 

Cash Flow Reporting

 

For the purpose of presentation in the consolidated statements of cash flows, cash and cash equivalents are defined as the amount included in the consolidated balance sheets caption “Cash and due from banks” and the portion of the amount in the caption “Federal funds sold and securities purchased under agreements to resell” that represents federal funds sold. Cash equivalents have original maturities of three months or less.

 

F-18



Table of Contents

 

Hilltop Holdings Inc. and Subsidiaries

Notes to Consolidated Financial Statements (continued)

 

Basic and Diluted Net Income (Loss) Per 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. During 2013, as discussed in Note 20 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. During 2014, stock options and RSUs are the only potentially dilutive non-participating instruments issued by Hilltop, while potentially dilutive non-participating instruments during 2013 included stock options, RSUs and the Notes, which were called for redemption during the fourth quarter of 2013. Next, the Company determines and includes 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.

 

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 sheets. Collectively, covered loans and covered OREO are referred 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. The asset arising from the loss-share agreements, referred 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.

 

The operations of FNB are included in the Company’s operating results beginning September 14, 2013. For the period from September 14, 2013 through December 31, 2013, FNB’s operations included net interest income of $32.0 million, other revenues of $20.4 million and net income of $18.5 million. Such operating results included a bargain purchase gain of $12.6 million, before taxes of $4.5 million, and are not necessarily indicative of future operating results. FNB’s results of operations prior to the Bank Closing Date are not included in the Company’s consolidated operating results.

 

F-19



Table of Contents

 

Hilltop Holdings Inc. and Subsidiaries

Notes to Consolidated Financial Statements (continued)

 

During 2013, transaction-related expenses of $0.1 million associated with the FNB Transaction are included in noninterest expense within the consolidated statement of operations. Such expenses were for professional services and other incremental costs associated with the integration of FNB’s operations.

 

The FNB Transaction was accounted for using the acquisition 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.

 

A summary of the net assets received from the FDIC in the FNB Transaction and the estimated fair value adjustments resulting in the bargain purchase gain are presented below (in thousands).

 

Cost basis net assets on September 13, 2013

 

$

215,000

 

Cash payment received from the FDIC

 

45,000

 

Fair value adjustments:

 

 

 

Securities

 

(3,341

)

Loans

 

(343,068

)

Premises and equipment

 

3,565

 

Other real estate owned

 

(79,273

)

FDIC indemnification asset

 

185,680

 

Other intangible assets

 

4,270

 

Deposits

 

(8,282

)

Other

 

(6,966

)

Bargain purchase gain

 

$

12,585

 

 

In FDIC-assisted transactions, only certain assets and liabilities are transferred to the acquirer and, depending on the nature and amount of the acquirer’s bid, the FDIC may be required to make a cash payment to the acquirer or the acquirer may be required to make a payment to the FDIC. In the FNB Transaction, cost basis net assets of $215.0 million and an initial cash payment received from the FDIC of $45.0 million were transferred to the Bank. This initial cash payment from the FDIC is subject to adjustment and settlement. The bargain purchase gain represents the excess of the estimated fair value of the assets acquired over the estimated fair value of the liabilities assumed.

 

The FDIC bid form provided a list of properties (branches and support facilities) owned by FNB for sale at fixed prices. The Bank purchased 44 properties owned by FNB in connection with its bid for an aggregate purchase price of $59.5 million. For those properties owned by FNB that the Bank declined to purchase in its bid, the Bank had exclusive options to purchase those properties following the Bank Closing Date. In connection with those options, the Bank purchased an additional seven properties owned by FNB during 2013, for an aggregate purchase price of $4.9 million. The Bank also had an option to assume the leases of properties leased by FNB. The Bank was required to purchase all data management equipment and, other certain special assets, furniture, fixtures and equipment, in each case at an appraised value for any properties purchased or leased by the Bank. The Bank paid $10.3 million to the FDIC during 2013 for furniture, fixtures and data management equipment. The Bank was required to pay rent to the FDIC on properties owned or leased by FNB and furniture and equipment at such properties until it surrendered such properties to the FDIC.

 

F-20



Table of Contents

 

Hilltop Holdings Inc. and Subsidiaries

Notes to Consolidated Financial Statements (continued)

 

The resulting fair values of the identifiable assets acquired, and liabilities assumed, of FNB at September 13, 2013 are summarized in the following table (in thousands).

 

Cash and due from banks

 

$

362,695

 

Securities

 

286,214

 

Non-covered loans

 

42,884

 

Covered loans

 

1,116,583

 

Premises and equipment

 

78,399

 

FDIC indemnification asset

 

185,680

 

Covered other real estate owned

 

135,187

 

Other assets

 

26,300

 

Other intangible assets

 

4,270

 

Total identifiable assets acquired

 

2,238,212

 

 

 

 

 

Deposits

 

(2,211,740

)

Other liabilities

 

(13,887

)

Total liabilities assumed

 

(2,225,627

)

Net identifiable assets acquired/bargain purchase gain

 

$

12,585

 

 

The Bank acquired loans both with and without evidence of credit quality deterioration since origination. Based on purchase date valuations, the Bank’s portfolio of acquired loans had a fair value of $1.2 billion as of the Bank Closing Date, with no carryover of any allowance for loan losses. Acquired loans were segregated between those considered to be PCI loans and those without credit impairment at acquisition. The following table presents details on acquired loans at the Bank Closing Date (in thousands).

 

 

 

Loans, excluding

 

PCI

 

Total

 

 

 

PCI Loans

 

Loans

 

Loans

 

Commercial and industrial

 

$

47,874

 

$

47,751

 

$

95,625

 

Real estate

 

242,998

 

611,219

 

854,217

 

Construction and land development

 

26,669

 

158,247

 

184,916

 

Consumer

 

19,095

 

5,614

 

24,709

 

Total

 

$

336,636

 

$

822,831

 

$

1,159,467

 

 

The following table presents information about the acquired PCI loans at the Bank Closing Date (in thousands).

 

Contractually required principal and interest payments

 

$

1,533,667

 

Nonaccretable difference

 

542,241

 

Cash flows expected to be collected

 

991,426

 

Accretable difference

 

168,595

 

Fair value of loans acquired with a deterioration of credit quality

 

$

822,831

 

 

The following table presents information about the acquired loans without credit impairment at the Bank Closing Date (in thousands).

 

Contractually required principal and interest payments

 

$

466,754

 

Contractual cash flows not expected to be collected

 

43,783

 

Fair value at acquisition

 

336,636

 

 

F-21



Table of Contents

 

Hilltop Holdings Inc. and Subsidiaries

Notes to Consolidated Financial Statements (continued)

 

PlainsCapital Merger

 

After the close of business on November 30, 2012, Hilltop acquired PlainsCapital Corporation in a stock and cash transaction. PlainsCapital Corporation merged with and into a wholly owned subsidiary of Hilltop, which continued as the surviving entity under the name “PlainsCapital Corporation”. Based on Hilltop’s closing stock price on November 30, 2012, the total purchase price was $813.5 million, consisting of 27.1 million shares of common stock, $311.8 million in cash and the issuance of 114,068 shares of Hilltop Non-Cumulative Perpetual Preferred Stock, Series B (the “Hilltop Series B Preferred Stock”) in exchange on a one-for-one basis for the outstanding shares of PlainsCapital Non-Cumulative Perpetual Preferred Stock, Series C, all of which were held by the United States Department of the Treasury (the “U.S. Treasury”).

 

The PlainsCapital Merger was accounted for using the acquisition method of accounting, and accordingly, purchased assets, including identifiable intangible assets, and assumed liabilities were recorded at their respective acquisition date fair values. The components of the consideration paid are shown in the following table (in thousands).

 

Fair value of consideration paid:

 

 

 

Common stock issued

 

$

387,584

 

Preferred stock issued

 

114,068

 

Cash

 

311,805

 

Total consideration paid

 

$

813,457

 

 

The resulting fair values of the identifiable assets acquired, and liabilities assumed, of PlainsCapital at December 1, 2012 are summarized in the following table (in thousands).

 

Cash and due from banks

 

$

393,132

 

Federal funds sold and securities purchased agreements to resell

 

84,352

 

Securities

 

730,779

 

Loans held for sale

 

1,520,833

 

Loans, net

 

3,195,309

 

Broker-dealer and clearing organization receivables

 

149,457

 

Premises and equipment

 

96,886

 

Other intangible assets

 

70,650

 

Other assets

 

241,876

 

Total identifiable assets acquired

 

6,483,274

 

 

 

 

 

Deposits

 

4,463,069

 

Broker-dealer and clearing organization payables

 

263,894

 

Short-term borrowings

 

914,062

 

Notes payable

 

10,855

 

Junior subordinated debentures

 

67,012

 

Other liabilities

 

180,998

 

Total liabilities assumed

 

5,899,890

 

 

 

 

 

Net identifiable assets acquired

 

583,384

 

Goodwill resulting from the acquisition

 

230,073

 

Net assets acquired

 

$

813,457

 

 

The amount of goodwill recorded in connection with the PlainsCapital Merger is not deductible for tax purposes. For further information regarding goodwill recorded in connection with the PlainsCapital Merger, refer to Note 9, Goodwill and Other Intangible Assets.

 

During 2012, transaction expenses of $6.6 million associated with the PlainsCapital Merger are included in noninterest expense within the consolidated statement of operations. Such expenses were for professional services and other incremental costs associated with the integration of PlainsCapital’s operations.

 

F-22



Table of Contents

 

Hilltop Holdings Inc. and Subsidiaries

Notes to Consolidated Financial Statements (continued)

 

In connection with the PlainsCapital Merger, Hilltop acquired loans both with and without evidence of credit quality deterioration since origination. The acquired loans were initially recorded at fair value with no carryover of any allowance for loan losses. Acquired loans were segregated between those considered to be PCI loans and those without credit impairment at acquisition. The following table presents details on acquired loans at the acquisition date (in thousands).

 

 

 

Loans, excluding

 

PCI

 

Total

 

 

 

PCI Loans

 

Loans

 

Loans

 

Commercial and industrial

 

$

1,684,706

 

$

74,911

 

$

1,759,617

 

Real estate

 

1,077,295

 

63,866

 

1,141,161

 

Construction and land development

 

232,313

 

34,008

 

266,321

 

Consumer

 

28,131

 

79

 

28,210

 

Total

 

$

3,022,445

 

$

172,864

 

$

3,195,309

 

 

The following table presents information about the PCI loans at acquisition (in thousands).

 

Contractually required principal and interest payments

 

$

252,818

 

Nonaccretable difference

 

61,527

 

Cash flows expected to be collected

 

191,291

 

Accretable difference

 

18,427

 

Fair value of loans acquired with a deterioration of credit quality

 

$

172,864

 

 

The following table presents information about the acquired loans without credit impairment at acquisition (in thousands).

 

Contractually required principal and interest payments

 

$

3,498,554

 

Contractual cash flows not expected to be collected

 

92,526

 

Fair value at acquisition

 

3,022,445

 

 

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 pervasive as to substantially reduce the relevance of such information to an assessment of future operations. Therefore, no additional historical pro forma information regarding FNB is provided below.

 

The results of operations acquired in the PlainsCapital Merger have been included in the Company’s consolidated financial results since December 1, 2012. The following table discloses the impact of PlainsCapital on the Company’s results of operations (excluding the impact of acquisition-related merger and restructuring charges discussed below) since the acquisition date through December 31, 2012 (in thousands). The table also presents pro forma results had the PlainsCapital Merger taken place on January 1, 2011 and includes the estimated impact of purchase accounting adjustments. The purchase accounting adjustments reflect the impact of recording the acquired loans at fair value, including the estimated accretion of the purchase discount on the loan portfolio. Accretion estimates were based on the acquisition date purchase discount on the loan portfolio, as it was not practicable to determine the amount of discount that would have been recorded based on economic conditions that existed on January 1, 2011. The pro forma results do not include any potential operating cost savings as a result of the PlainsCapital Merger. Further, certain costs associated with any restructuring or integration

 

F-23



Table of Contents

 

Hilltop Holdings Inc. and Subsidiaries

Notes to Consolidated Financial Statements (continued)

 

activities are also not reflected in the pro forma results. Pro forma results include any acquisition-related merger and restructuring charges incurred during the period. The pro forma results are not indicative of what would have occurred had the PlainsCapital Merger taken place on the indicated date.

 

 

 

PlainsCapital

 

Pro Forma Combined

 

 

 

Acquisition Date

 

Twelve Months

 

 

 

through

 

Ended

 

 

 

December 31, 2012

 

December 31, 2012

 

Net interest income

 

$

24,029

 

$

221,635

 

Other revenues

 

70,085

 

901,347

 

Net income

 

8,361

 

75,138

 

 

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.

 

·                  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 MSR at fair value, 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. At December 31, 2014, the aggregate fair value of PrimeLending’s mortgage loans held for sale accounted for under the Fair Value Option was $1.27 billion, and the unpaid principal balance of those loans was $1.22 billion. At December 31, 2013, the aggregate fair value of PrimeLending’s mortgage loans held for sale accounted for under the Fair Value Option was $1.06 billion, and the unpaid principal balance of those loans was $1.04 billion. The interest component of fair value is reported as interest income on loans in the accompanying consolidated statements of operations.

 

F-24



Table of Contents

 

Hilltop Holdings Inc. and Subsidiaries

Notes to Consolidated Financial Statements (continued)

 

On October 2, 2014, as discussed in Note 1 to the consolidated financial statements, Hilltop elected to measure its investment in SWS common stock under the provisions of the Fair Value Option. At December 31, 2014, the fair value of Hilltop’s investment in SWS common stock was $70.3 million and is included in other assets within the consolidated balance sheet.

 

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, as further described below.

 

Available For Sale Securities — Most securities available for sale are reported at fair value using Level 2 inputs. The Company obtains fair value measurements from independent pricing services. As the Company is responsible for the determination of fair value, control processes are designed to ensure that the fair values received from independent pricing services are reasonable and the valuation techniques and assumptions used appear reasonable and consistent with prevailing market conditions. The fair value measurements consider observable data that may include dealer quotes, market spreads, cash flows, the U.S. Treasury yield curve, live trading levels, trade execution data, market consensus prepayment speeds, credit information and the financial instruments’ terms and conditions, among other things. For public common and preferred equity stocks, the determination of fair value uses Level 1 inputs based on observable market transactions. Regarding the  note receivable from SWS and the SWS Warrant prior to October 2, 2014, the determination of fair value used Level 3 inputs such as internal or external fund manager valuations based on unobservable inputs including recent filings, operating results, balance sheet stability, growth and other business and market sector fundamentals.

 

Trading Securities — Trading securities are reported at fair value using either Level 1 or Level 2 inputs in the same manner as discussed previously for securities available for sale.

 

Loans Held for Sale — Mortgage loans held for sale are reported at fair value, as discussed above, using Level 2 inputs that consist of commitments on hand from investors or prevailing market prices. These instruments are held for relatively short periods, typically no more than 30 days. As a result, changes in instrument-specific credit risk are not a significant component of the change in fair value. Mortgage loans that are non-performing, including monitored loans, are reported at fair value using Level 3 inputs.

 

Derivatives — Derivatives are reported at fair value using either Level 2 or Level 3 inputs. PrimeLending and FSC use dealer quotes to value forward purchase commitments and forward sale commitments, respectively, executed for both hedging and non-hedging purposes. PrimeLending also issues IRLCs to its customers and FSC issues forward purchase commitments to its clients that are valued based on the change in the fair value of the underlying mortgage loan from inception of the IRLC or purchase commitment to the balance sheet date, adjusted for projected loan closing rates. PrimeLending determines the value of the underlying mortgage loan as discussed in “Loans Held for Sale”, above. FSC determines the value of the underlying mortgage loan from prices of comparable securities used to value forward sale commitments. Additionally, PrimeLending uses dealer quotes to value interest rate swaps and swaptions executed to hedge its MSR asset and First Southwest entered into a derivative option agreement (“Fee Award Option”) valued using discounted cash flow and probability of exercise. The Fee Award Option was exercised during the fourth quarter of 2014.

 

Mortgage servicing rights asset — The MSR asset is reported at fair value using Level 3 inputs. Fair value is determined 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. Prepayment rates and discount rates, the most significant unobservable inputs, are discussed further in Note 10 to the consolidated financial statements.

 

Investment in SWS Common Stock — The investment in SWS common stock is reported at fair value using quoted market prices for SWS’s common stock as traded on the NYSE, which is considered a Level 1 input.

 

F-25



Table of Contents

 

Hilltop Holdings Inc. and Subsidiaries

Notes to Consolidated Financial Statements (continued)

 

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

 

December 31, 2014

 

Inputs

 

Inputs

 

Inputs

 

Fair Value

 

Trading securities

 

$

39

 

$

65,678

 

$

 

$

65,717

 

Available for sale securities

 

13,762

 

911,773

 

 

925,535

 

Loans held for sale

 

 

1,263,135

 

9,017

 

1,272,152

 

Derivative assets

 

 

23,805

 

 

23,805

 

MSR asset

 

 

 

36,155

 

36,155

 

Investment in SWS common stock

 

70,282

 

 

 

70,282

 

Trading liabilities

 

 

48

 

 

48

 

Derivative liabilities

 

 

12,849

 

 

12,849

 

 

 

 

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

 

 

1,031,988

 

27,729

 

1,059,717

 

Derivative assets

 

 

23,564

 

 

23,564

 

MSR asset

 

 

 

20,149

 

20,149

 

Trading liabilities

 

 

46

 

 

46

 

Derivative liabilities

 

 

139

 

5,600

 

5,739

 

 

The following table includes a rollforward 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/

 

Transfers into

 

Included in

 

Comprehensive

 

Balance at

 

 

 

Year

 

Additions

 

Reductions

 

Level 3

 

Net Income

 

Income (Loss)

 

End of Year

 

Year ended December 31, 2014

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

Available for sale securities

 

$

60,053

 

$

 

$

(61,283

)

$

 

$

1,848

 

$

(618

)

$

 

Loans held for sale

 

27,729

 

24,851

 

(44,597

)

 

1,034

 

 

9,017

 

MSR asset

 

20,149

 

35,056

 

(11,387

)

 

(7,663

)

 

36,155

 

Derivative liabilities

 

(5,600

)

(177

)

6,827

 

 

(1,050

)

 

 

Total

 

$

102,331

 

$

59,730

 

$

(110,440

)

$

 

$

(5,831

)

$

(618

)

$

45,172

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

Year ended December 31, 2013

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

Available for sale securities

 

$

56,277

 

$

 

$

 

$

 

$

2,166

 

$

1,610

 

$

60,053

 

Loans held for sale

 

 

 

 

27,729

 

 

 

27,729

 

MSR asset

 

2,080

 

13,886

 

 

 

4,183

 

 

20,149

 

Derivative liabilities

 

(4,490

)

 

 

 

(1,110

)

 

(5,600

)

Total

 

$

53,867

 

$

13,886

 

$

 

$

27,729

 

$

5,239

 

$

1,610

 

$

102,331

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

Year ended December 31, 2012

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

Available for sale securities

 

$

60,377

 

$

 

$

 

$

 

$

1,867

 

$

(5,967

)

$

56,277

 

MSR asset

 

 

2,204

 

 

 

(124

)

 

2,080

 

Derivative liabilities

 

 

(4,455

)

 

 

(35

)

 

(4,490

)

Total

 

$

60,377

 

$

(2,251

)

$

 

$

 

$

1,708

 

$

(5,967

)

$

53,867

 

 

All net realized and unrealized gains (losses) in the table above are reflected in the accompanying consolidated financial statements. The available for sale securities noted in the table above reflect Hilltop’s note receivable from SWS and the SWS Warrant. On October 2, 2014, as discussed in Note 1 to the consolidated financial statements, Hilltop exercised the SWS Warrant in full and paid the aggregate exercise price by the automatic elimination of the $50.0 million aggregate principal amount note due to Hilltop under the credit agreement. Excluding these available for sale securities and derivative liabilities representing the Fee Award Option entered into by First Southwest, the unrealized gains (losses) relate to financial instruments still held at December 31, 2014.

 

F-26



Table of Contents

 

Hilltop Holdings Inc. and Subsidiaries

Notes to Consolidated Financial Statements (continued)

 

For Level 3 financial instruments measured at fair value on a recurring basis at December 31, 2014, the significant unobservable inputs used in the fair value measurements were as follows.

 

 

 

 

 

 

 

Weighted

 

Financial instrument

 

Valuation Technique

 

Unobservable Input

 

Average / Range

 

Loans held for sale

 

Discounted cash flow / Market comparable

 

Projected price

 

82 - 92%

 

 

 

 

 

 

 

 

 

Mortgage servicing rights asset

 

Discounted cash flow

 

Constant prepayment rate Discount rate

 

12.17%
11.01%

 

 

The fair value of certain loans held for sale that are either non-standard (i.e. loans that cannot be sold through normal sale channels) or non-performing is measured using unobservable inputs. The fair value of such loans is generally based upon estimates of expected cash flows using unobservable inputs including listing prices of comparable assets, uncorroborated expert opinions, and/or management’s knowledge of underlying collateral.

 

The MSR asset, as discussed previously, 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. Prepayment rates and discount rates, the most significant unobservable inputs, are discussed further in Note 10 to the consolidated financial statements.

 

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).

 

 

 

Year Ended December 31, 2014

 

Year Ended December 31, 2013

 

Year Ended December 31, 2012

 

 

 

 

 

Other

 

Total

 

 

 

Other

 

Total

 

 

 

Other

 

Total

 

 

 

Net

 

Noninterest

 

Changes in

 

Net

 

Noninterest

 

Changes in

 

Net

 

Noninterest

 

Changes in

 

 

 

Gains (Losses)

 

Income

 

Fair Value

 

Gains (Losses)

 

Income

 

Fair Value

 

Gains (Losses)

 

Income

 

Fair Value

 

Loans held for sale

 

$

31,805

 

$

 

$

31,805

 

$

(19,353

)

$

 

$

(19,353

)

$

(3,297

)

$

 

$

(3,297

)

Investment in SWS common stock

 

 

5,985

 

5,985

 

 

 

 

 

 

 

Mortgage servicing rights asset

 

(7,663

)

 

(7,663

)

4,183

 

 

4,183

 

(124

)

 

(124

)

Time deposits

 

 

 

 

 

12

 

12

 

 

7

 

7

 

 

The Company also determines the fair value of certain assets and liabilities on a non-recurring basis. In particular, the fair value of all of the assets and liabilities purchased in the PlainsCapital Merger was determined at the acquisition date, while fair value of all assets acquired and liabilities assumed in the FNB Transaction was determined at the Bank Closing Date. 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. 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 significant unobservable inputs regarding default rates, loss severity rates assuming default, prepayment speeds and estimated collateral values. At December 31, 2014, these inputs included estimated weighted average default rates, loss severity rates and prepayment speed assumptions of 47%, 51% and 0%, respectively, for those PCI loans acquired in the PlainsCapital Merger and 63%, 38% and 4%, respectively, for those PCI loans acquired in the FNB Transaction. The resulting weighted average expected loss on PCI loans associated with each of the PlainsCapital Merger and the FNB Transaction was 24%.

 

The Company obtains updated appraisals of the fair value of collateral securing impaired collateral dependent loans at least annually, in accordance with regulatory guidelines. The Company also reviews the fair value of such collateral on a quarterly basis. If the quarterly review indicates that the fair value of the collateral may have deteriorated, the Company will order an updated appraisal of the fair value of the collateral. Since the Company obtains updated appraisals when evidence of a decline in the fair value of collateral exists, it typically does not adjust appraised values.

 

F-27



Table of Contents

 

Hilltop Holdings Inc. and Subsidiaries

Notes to Consolidated Financial Statements (continued)

 

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 either the allowance for loan losses or the related PCI pool discount 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. At December 31, 2014, the most significant unobservable input used in the determination of fair value of OREO was a discount to independent appraisals for estimated holding periods of OREO properties. Such discount was 1% per month for estimated holding periods of 6 to 24 months. Level 3 inputs were used to determine the fair value of a large group of smaller balance properties that were acquired in the FNB Transaction. In the FNB Transaction, the Bank acquired OREO of $135.2 million, all of which is covered by FDIC loss-share agreements. At December 31, 2014 and 2013, the estimated fair value of covered OREO was $136.9 million and $142.8 million, respectively, and the underlying fair value measurements utilize Level 2 and Level 3 inputs. The fair value of non-covered OREO at December 31, 2014 and 2013 was $0.8 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 (Losses) for the

 

 

 

Level 1

 

Level 2

 

Level 3

 

Total

 

Year Ended December 31,

 

December 31, 2014

 

Inputs

 

Inputs

 

Inputs

 

Fair Value

 

2014

 

2013

 

Non-covered impaired loans

 

$

 

$

 

$

26,823

 

$

26,823

 

$

(2,182

)

$

(3,558

)

Covered impaired loans

 

 

 

55,213

 

55,213

 

(3,652

)

 

Non-covered other real estate owned

 

 

409

 

 

409

 

(372

)

430

 

Covered other real estate owned

 

 

47,198

 

15,855

 

63,052

 

(19,672

)

 

 

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 measured at fair value on a recurring or non-recurring basis are discussed above. For other financial assets and liabilities, the Company utilizes quoted market prices, if available, to estimate the fair value of financial instruments. Because no quoted market prices exist for a significant portion of the Company’s financial instruments, the fair value of such instruments has been derived based on management’s assumptions with respect to future economic conditions, the amount and timing of future cash flows, and estimated discount rates. Different assumptions could significantly affect these estimates. Accordingly, the estimates provided herein do not necessarily indicate amounts which could be realized in a current transaction. Further, as it is management’s intent to hold a significant portion of its financial instruments to maturity, it is not probable that the fair values shown below will be realized in a current transaction.

 

Because of the wide range of permissible valuation techniques and the numerous estimates which must be made, it may be difficult to make reasonable comparisons of the Company’s fair value information to that of other financial institutions. The aggregate estimated fair value amount should in no way be construed as representative of the underlying value of Hilltop and its subsidiaries. The following methods and assumptions are typically used in estimating the fair value disclosures for financial instruments:

 

Cash and Cash Equivalents — For cash and due from banks and federal funds sold, the carrying amount is a reasonable estimate of fair value.

 

Held to Maturity Securities — For securities held to maturity, estimated fair value equals quoted market price, if available. If a quoted market price is not available, fair value is estimated using quoted market prices for similar securities.

 

F-28



Table of Contents

 

Hilltop Holdings Inc. and Subsidiaries

Notes to Consolidated Financial Statements (continued)

 

Loans Held for Sale — Loans held for sale consist primarily of certain mortgage loans held for sale that are subject to purchase by related parties. Such loans are reported at fair value, as discussed above, using Level 2 inputs that consist of commitments on hand from investors or prevailing market prices.

 

Loans — The fair value of non-covered and covered loans is estimated by discounting the future cash flows using the current rates at which similar loans would be made to borrowers with similar credit ratings and for the same remaining maturities.

 

Broker-Dealer and Clearing Organization Receivables — The carrying amount approximates their fair value.

 

FDIC Indemnification Asset — The fair value of the FDIC Indemnification Asset is based on Level 3 inputs, including the discounted value of expected future cash flows under the loss-share agreements. The discount rate contemplates the credit worthiness of the FDIC as counterparty to this asset, and considers an incremental discount rate risk premium reflective of the inherent uncertainty associated with the timing of the cash flows.

 

Deposits — The estimated fair value of demand deposits, savings accounts and NOW accounts is the amount payable on demand at the reporting date. The fair value of fixed-maturity certificates of deposit is estimated using the rates currently offered for deposits of similar remaining maturities. The carrying amount for variable-rate certificates of deposit approximates their fair values.

 

Broker-Dealer and Clearing Organization Payables — The carrying amount approximates their fair value.

 

Short-Term Borrowings — The carrying amounts of federal funds purchased, borrowings under repurchase agreements, Federal Home Loan Bank (“FHLB”) and other short-term borrowings approximate their fair values.

 

Debt — The fair values are estimated using discounted cash flow analysis based on current incremental borrowing rates for similar types of borrowing arrangements.

 

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

 

 

 

December 31, 2014

 

Amount

 

Inputs

 

Inputs

 

Inputs

 

Total

 

Financial assets:

 

 

 

 

 

 

 

 

 

 

 

Cash and cash equivalents

 

$

813,075

 

$

813,075

 

$

 

$

 

$

813,075

 

Held to maturity securities

 

118,209

 

 

118,345

 

 

118,345

 

Loans held for sale

 

37,541

 

 

37,541

 

 

37,541

 

Non-covered loans, net

 

3,883,435

 

 

378,425

 

3,528,769

 

3,907,194

 

Covered loans, net

 

638,029

 

 

 

767,751

 

767,751

 

Broker-dealer and clearing organization receivables

 

167,884

 

 

167,884

 

 

167,884

 

FDIC indemnification asset

 

130,437

 

 

 

130,437

 

130,437

 

Other assets

 

59,432

 

 

43,937

 

15,495

 

59,432

 

 

 

 

 

 

 

 

 

 

 

 

 

Financial liabilities:

 

 

 

 

 

 

 

 

 

 

 

Deposits

 

6,369,892

 

 

6,365,555

 

 

6,365,555

 

Broker-dealer and clearing organization payables

 

179,042

 

 

179,042

 

 

179,042

 

Short-term borrowings

 

762,696

 

 

762,696

 

 

762,696

 

Debt

 

123,696

 

 

117,028

 

 

117,028

 

Other liabilities

 

2,144

 

 

2,144

 

 

2,144

 

 

F-29



Table of Contents

 

Hilltop Holdings Inc. and Subsidiaries

Notes to Consolidated Financial Statements (continued)

 

 

 

 

 

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

 

Loans held for sale

 

29,322

 

 

29,322

 

 

29,322

 

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

 

6,722,918

 

 

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

 

 

The deferred income amounts arising from unrecognized financial instruments are not significant. These financial instruments also have contractual interest rates at or above current market rates. Therefore, no fair value disclosure is provided for these items.

 

4. Securities

 

The amortized cost and fair value of available for sale and held to maturity securities are summarized as follows (in thousands). No securities were classified as held to maturity at December 31, 2013.

 

 

 

Available for Sale

 

 

 

 

 

Gross

 

Gross

 

 

 

 

 

Amortized

 

Unrealized

 

Unrealized

 

 

 

December 31, 2014

 

Cost

 

Gains

 

Losses

 

Fair Value

 

U.S. Treasury securities

 

$

19,382

 

$

264

 

$

(33

)

$

19,613

 

U.S. government agencies:

 

 

 

 

 

 

 

 

 

Bonds

 

522,008

 

1,749

 

(7,516

)

516,241

 

Residential mortgage-backed securities

 

51,363

 

1,672

 

(137

)

52,898

 

Collateralized mortgage obligations

 

89,291

 

133

 

(2,300

)

87,124

 

Corporate debt securities

 

93,406

 

5,125

 

(59

)

98,472

 

States and political subdivisions

 

135,419

 

2,083

 

(717

)

136,785

 

Commercial mortgage-backed securities

 

593

 

47

 

 

640

 

Equity securities

 

13,293

 

469

 

 

13,762

 

Totals

 

$

924,755

 

$

11,542

 

$

(10,762

)

$

925,535

 

 

 

 

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

 

 

F-30



Table of Contents

 

Hilltop Holdings Inc. and Subsidiaries

Notes to Consolidated Financial Statements (continued)

 

 

 

Held to Maturity

 

 

 

Amortized

 

Unrealized

 

Unrealized

 

 

 

December 31, 2014

 

Cost

 

Gains

 

Losses

 

Fair Value

 

U.S. Treasury securities

 

$

25,008

 

$

 

$

(6

)

$

25,002

 

U.S. government agencies:

 

 

 

 

 

 

 

 

 

Residential mortgage-backed securities

 

29,782

 

528

 

 

30,310

 

Collateralized mortgage obligations

 

57,328

 

 

(430

)

56,898

 

States and political subdivisions

 

6,091

 

47

 

(3

)

6,135

 

Totals

 

$

118,209

 

$

575

 

$

(439

)

$

118,345

 

 

At December 31, 2013, available for sale securities included 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 (the “SWS Warrant”). SWS issued the note in July 2011 under a credit agreement pursuant to a senior unsecured loan from Hilltop. The note bore interest at a rate of 8.0% per annum, was prepayable by SWS subject to certain conditions after three years, and had a maturity of five years. The SWS Warrant provided 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. On October 2, 2014, Hilltop exercised the SWS Warrant in full and paid the aggregate exercise price by the automatic elimination of the $50.0 million aggregate principal amount note due to Hilltop under the credit agreement. Consequently, Hilltop owned 10,171,039 shares of SWS common stock, representing approximately 21% of the outstanding shares of SWS common stock as of October 4, 2014, and is no longer a lender under the credit agreement. As discussed in Note 1 to the consolidated financial statements, Hilltop’s investment in SWS common stock is accounted for under the provisions of the Fair Value Option effective October 2, 2014. Hilltop’s election to apply the provisions of the Fair Value Option resulted in Hilltop recording those unrealized gains previously associated with its investment in SWS common stock of $7.2 million. At December 31, 2014, Hilltop’s investment in SWS common stock is included in other assets within the consolidated balance sheet and is recorded at a fair value of $70.3 million.

 

Information regarding available for sale securities that were in an unrealized loss position is shown in the following table (dollars in thousands).

 

 

 

December 31, 2014

 

December 31, 2013

 

 

 

Number of

 

 

 

Unrealized

 

Number of

 

 

 

Unrealized

 

Available for Sale

 

Securities

 

Fair Value

 

Losses

 

Securities

 

Fair Value

 

Losses

 

U.S. treasury securities:

 

 

 

 

 

 

 

 

 

 

 

 

 

Unrealized loss for less than twelve months

 

4

 

$

7,703

 

$

27

 

6

 

$

12,748

 

$

238

 

Unrealized loss for twelve months or longer

 

1

 

1,706

 

6

 

 

 

 

 

 

5

 

9,409

 

33

 

6

 

12,748

 

238

 

U.S. government agencies:

 

 

 

 

 

 

 

 

 

 

 

 

 

Bonds:

 

 

 

 

 

 

 

 

 

 

 

 

 

Unrealized loss for less than twelve months

 

3

 

34,847

 

153

 

35

 

526,817

 

45,274

 

Unrealized loss for twelve months or longer

 

22

 

373,035

 

7,363

 

5

 

90,931

 

10,453

 

 

 

25

 

407,882

 

7,516

 

40

 

617,748

 

55,727

 

Residential mortgage-backed securities:

 

 

 

 

 

 

 

 

 

 

 

 

 

Unrealized loss for less than twelve months

 

 

 

 

2

 

2,194

 

54

 

Unrealized loss for twelve months or longer

 

4

 

11,056

 

137

 

3

 

9,309

 

530

 

 

 

4

 

11,056

 

137

 

5

 

11,503

 

584

 

Collateralized mortgage obligations:

 

 

 

 

 

 

 

 

 

 

 

 

 

Unrealized loss for less than twelve months

 

3

 

7,141

 

40

 

7

 

84,054

 

4,320

 

Unrealized loss for twelve months or longer

 

8

 

61,108

 

2,260

 

2

 

4,995

 

70

 

 

 

11

 

68,249

 

2,300

 

9

 

89,049

 

4,390

 

Corporate debt securities:

 

 

 

 

 

 

 

 

 

 

 

 

 

Unrealized loss for less than twelve months

 

 

 

 

7

 

10,754

 

378

 

Unrealized loss for twelve months or longer

 

1

 

1,939

 

59

 

 

 

 

 

 

1

 

1,939

 

59

 

7

 

10,754

 

378

 

States and political subdivisions:

 

 

 

 

 

 

 

 

 

 

 

 

 

Unrealized loss for less than twelve months

 

7

 

4,432

 

7

 

46

 

30,245

 

669

 

Unrealized loss for twelve months or longer

 

81

 

54,178

 

710

 

150

 

96,882

 

5,839

 

 

 

88

 

58,610

 

717

 

196

 

127,127

 

6,508

 

Total available for sale:

 

 

 

 

 

 

 

 

 

 

 

 

 

Unrealized loss for less than twelve months

 

17

 

54,123

 

227

 

103

 

666,812

 

50,933

 

Unrealized loss for twelve months or longer

 

117

 

503,022

 

10,535

 

160

 

202,117

 

16,892

 

 

 

134

 

$

557,145

 

$

10,762

 

263

 

$

868,929

 

$

67,825

 

 

F-31



Table of Contents

 

Hilltop Holdings Inc. and Subsidiaries

Notes to Consolidated Financial Statements (continued)

 

 

 

December 31, 2014

 

December 31, 2013

 

 

 

Number of

 

 

 

Unrealized

 

Number of

 

 

 

Unrealized

 

 

 

Securities

 

Fair Value

 

Losses

 

Securities

 

Fair Value

 

Losses

 

Held to Maturity

 

 

 

 

 

 

 

 

 

 

 

 

 

U.S. treasury securities:

 

 

 

 

 

 

 

 

 

 

 

 

 

Residential mortgage-backed securities:

 

 

 

 

 

 

 

 

 

 

 

 

 

Unrealized loss for less than twelve months

 

1

 

$

25,002

 

$

6

 

 

$

 

$

 

Unrealized loss for twelve months or longer

 

 

 

 

 

 

 

 

 

1

 

25,002

 

6

 

 

 

 

Collateralized mortgage obligations:

 

 

 

 

 

 

 

 

 

 

 

 

 

Unrealized loss for less than twelve months

 

2

 

56,898

 

430

 

 

 

 

Unrealized loss for twelve months or longer

 

 

 

 

 

 

 

 

 

2

 

56,898

 

430

 

 

 

 

States and political subdivisions:

 

 

 

 

 

 

 

 

 

 

 

 

 

Unrealized loss for less than twelve months

 

4

 

1,899

 

3

 

 

 

 

Unrealized loss for twelve months or longer

 

 

 

 

 

 

 

 

 

4

 

1,899

 

3

 

 

 

 

Total held to maturity:

 

 

 

 

 

 

 

 

 

 

 

 

 

Unrealized loss for less than twelve months

 

7

 

83,799

 

439

 

 

 

 

Unrealized loss for twelve months or longer

 

 

 

 

 

 

 

 

 

7

 

$

83,799

 

$

439

 

 

$

 

$

 

 

During 2014, 2013 and 2012, 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 significant 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 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 December 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, at December 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

 

$

24,639

 

$

24,881

 

$

25,008

 

$

25,002

 

Due after one year through five years

 

69,196

 

72,671

 

 

 

Due after five years through ten years

 

64,048

 

67,345

 

1,195

 

1,194

 

Due after ten years

 

612,332

 

606,214

 

4,896

 

4,941

 

 

 

770,215

 

771,111

 

31,099

 

31,137

 

 

 

 

 

 

 

 

 

 

 

Residential mortgage-backed securities

 

51,363

 

52,898

 

29,782

 

30,310

 

Collateralized mortgage obligations

 

89,291

 

87,124

 

57,328

 

56,898

 

Commercial mortgage-backed securities

 

593

 

640

 

 

 

 

 

$

911,462

 

$

911,773

 

$

118,209

 

$

118,345

 

 

The Company realized a net gain of $2.1 million and net losses of $2.8 million and $0.7 million from its trading securities portfolio during the years ended December 31, 2014 and 2013 and the month ended December 31, 2012, respectively, which are recorded as a component of other noninterest income within the consolidated statements of operations.

 

F-32



Table of Contents

 

Hilltop Holdings Inc. and Subsidiaries

Notes to Consolidated Financial Statements (continued)

 

Securities with a carrying amount of $895.5 million and $1.0 billion (with a fair value of $890.3 million and $938.1 million, respectively) at December 31, 2014 and 2013, 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 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 December 31, 2014 and 2013, NLC had investments on deposit in custody for various state insurance departments with carrying values of $9.2 million and $9.4 million, respectively.

 

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).

 

 

 

December 31,

 

 

 

2014

 

2013

 

Commercial and industrial

 

$

1,758,851

 

$

1,637,266

 

Real estate

 

1,694,835

 

1,457,253

 

Construction and land development

 

413,643

 

364,551

 

Consumer

 

53,147

 

55,576

 

 

 

3,920,476

 

3,514,646

 

Allowance for non-covered loan losses

 

(37,041

)

(33,241

)

Total non-covered loans, net of allowance

 

$

3,883,435

 

$

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.

 

F-33



Table of Contents

 

Hilltop Holdings Inc. and Subsidiaries

Notes to Consolidated Financial Statements (continued)

 

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).

 

 

 

December 31,

 

 

 

2014

 

2013

 

Carrying amount

 

$

48,909

 

$

100,392

 

Outstanding balance

 

67,740

 

141,983

 

 

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

 

 

 

Year Ended December 31,

 

Month Ended

 

 

 

2014

 

2013

 

December 31, 2012

 

Balance, beginning of period

 

$

17,601

 

$

17,553

 

$

18,427

 

Additions

 

 

622

 

 

Reclassifications from (to) nonaccretable difference, net (1)

 

15,225

 

18,793

 

 

Disposals of loans

 

(4,927

)

(3,692

)

(22

)

Accretion

 

(15,085

)

(15,675

)

(852

)

Balance, end of period

 

$

12,814

 

$

17,601

 

$

17,553

 

 


(1)  Reclassifications from nonaccretable difference are primarily due to net increases in expected cash flows in the quarterly recasts. Reclassifications to nonaccretable difference occur when accruing loans are moved to nonaccrual and expected cash flows are no longer predictable and the accretable yield is eliminated.

 

The remaining nonaccretable difference for non-covered PCI loans was $18.4 million and $38.6 million at December 31, 2014 and 2013, respectively.

 

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 impaired loans include non-accrual loans, TDRs, PCI loans and partially charged-off loans.  The amounts shown in following tables include loans accounted for on an individual basis, as well as acquired loans accounted for in pools (“Pooled Loans”). For Pooled Loans, the recorded investment with allowance and the related allowance consider impairment measured at the pool level. Non-covered impaired loans are summarized by class in the following tables (in thousands).

 

 

 

Unpaid

 

Recorded

 

Recorded

 

Total

 

 

 

 

 

Contractual

 

Investment with

 

Investment with

 

Recorded

 

Related

 

December 31, 2014

 

Principal Balance

 

No Allowance

 

Allowance

 

Investment

 

Allowance

 

Commercial and industrial:

 

 

 

 

 

 

 

 

 

 

 

Secured

 

$

51,036

 

$

14,096

 

$

11,783

 

$

25,879

 

$

3,341

 

Unsecured

 

4,120

 

92

 

68

 

160

 

 

Real estate:

 

 

 

 

 

 

 

 

 

 

 

Secured by commercial properties

 

29,865

 

7,243

 

15,536

 

22,779

 

1,878

 

Secured by residential properties

 

4,701

 

1,583

 

1,390

 

2,973

 

85

 

Construction and land development:

 

 

 

 

 

 

 

 

 

 

 

Residential construction loans

 

 

 

 

 

 

Commercial construction loans and land development

 

16,108

 

8,062

 

1,819

 

9,881

 

154

 

Consumer

 

5,785

 

171

 

1,967

 

2,138

 

282

 

 

 

$

111,615

 

$

31,247

 

$

32,563

 

$

63,810

 

$

5,740

 

 

F-34



Table of Contents

 

Hilltop Holdings Inc. and Subsidiaries

Notes to Consolidated Financial Statements (continued)

 

 

 

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

 

$

63,636

 

$

21,540

 

$

17,147

 

$

38,687

 

$

3,126

 

Unsecured

 

11,865

 

336

 

1,204

 

1,540

 

15

 

Real estate:

 

 

 

 

 

 

 

 

 

 

 

Secured by commercial properties

 

49,437

 

20,317

 

16,070

 

36,387

 

339

 

Secured by residential properties

 

5,407

 

1,745

 

1,648

 

3,393

 

39

 

Construction and land development:

 

 

 

 

 

 

 

 

 

 

 

Residential construction loans

 

33

 

 

 

 

 

Commercial construction loans and land development

 

48,628

 

15,337

 

4,592

 

19,929

 

39

 

Consumer

 

7,946

 

4,509

 

 

4,509

 

 

 

 

$

186,952

 

$

63,784

 

$

40,661

 

$

104,445

 

$

3,558

 

 

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

 

 

 

Year Ended December 31,

 

 

 

2014

 

2013

 

Commercial and industrial:

 

 

 

 

 

Secured

 

$

30,626

 

$

51,670

 

Unsecured

 

802

 

2,432

 

Real estate:

 

 

 

 

 

Secured by commercial properties

 

29,517

 

45,887

 

Secured by residential properties

 

2,984

 

4,862

 

Construction and land development:

 

 

 

 

 

Residential construction loans

 

 

354

 

Commercial construction loans and land development

 

14,849

 

26,090

 

Consumer

 

3,324

 

2,293

 

 

 

$

82,102

 

$

133,588

 

 

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

 

 

 

December 31,

 

 

 

2014

 

2013

 

Commercial and industrial:

 

 

 

 

 

Secured

 

$

16,488

 

$

15,430

 

Unsecured

 

160

 

1,300

 

Real estate:

 

 

 

 

 

Secured by commercial properties

 

438

 

2,638

 

Secured by residential properties

 

1,253

 

398

 

Construction and land development:

 

 

 

 

 

Residential construction loans

 

 

 

Commercial construction loans and land development

 

703

 

112

 

Consumer

 

 

 

 

 

$

19,042

 

$

19,878

 

 

At December 31, 2014 and 2013, non-covered non-accrual loans included non-covered PCI loans of $6.6 million and $15.8 million, respectively, for which discount accretion has been suspended because the extent and timing of cash flows from

 

F-35



Table of Contents

 

Hilltop Holdings Inc. and Subsidiaries

Notes to Consolidated Financial Statements (continued)

 

these non-covered PCI loans can no longer be reasonably estimated. In addition to the non-covered non-accrual loans in the table above, $3.0 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 December 31, 2014 and 2013, respectively.

 

Interest income including recoveries and cash payments recorded on non-covered impaired loans was $3.3 million, $3.2 million and $0.9 million for the years ended December 31, 2014 and 2013 and the month ended December 31, 2012, respectively.

 

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.

 

The outstanding balance of TDRs granted in the twelve months ended December 31, 2014 and 2013, respectively, is shown in the following tables (in thousands). There were no TDRs granted during the month ended December 31, 2012. At December 31, 2014 and 2013, the Bank had $0.5 million and $0.5 million in unadvanced commitments to borrowers whose loans have been restructured in TDRs.

 

 

 

Recorded Investment in Loans Modified by

 

 

 

 

 

Interest Rate

 

Payment Term

 

Total

 

Year Ended December 31, 2014

 

A/B Note

 

Adjustment

 

Extension

 

Modification

 

Commercial and industrial:

 

 

 

 

 

 

 

 

 

Secured

 

$

 

$

 

$

2,465

 

$

2,465

 

Unsecured

 

 

 

 

 

Real estate:

 

 

 

 

 

 

 

 

 

Secured by commercial properties

 

 

 

317

 

317

 

Secured by residential properties

 

 

 

248

 

248

 

Construction and land development:

 

 

 

 

 

 

 

 

 

Residential construction loans

 

 

 

 

 

Commercial construction loans and land development

 

 

 

128

 

128

 

Consumer

 

 

 

 

 

 

 

$

 

$

 

$

3,158

 

$

3,158

 

 

 

 

Recorded Investment in Loans Modified by

 

 

 

 

 

Interest Rate

 

Payment Term

 

Total

 

Year Ended December 31, 2013

 

A/B Note

 

Adjustment

 

Extension

 

Modification

 

Commercial and industrial:

 

 

 

 

 

 

 

 

 

Secured

 

$

 

$

 

$

10,390

 

$

10,390

 

Unsecured

 

 

 

 

 

Real estate:

 

 

 

 

 

 

 

 

 

Secured by commercial properties

 

 

 

279

 

279

 

Secured by residential properties

 

 

 

777

 

777

 

Construction and land development:

 

 

 

 

 

 

 

 

 

Residential construction loans

 

 

 

 

 

Commercial construction loans and land development

 

 

 

 

 

Consumer

 

 

 

 

 

 

 

$

 

$

 

$

11,446

 

$

11,446

 

 

There were no TDRs granted in the twelve months preceding December 31, 2014 and 2013, for which a payment was at least 30 days past due in 2014 and 2013, respectively.

 

F-36



Table of Contents

 

Hilltop Holdings Inc. and Subsidiaries

Notes to Consolidated Financial Statements (continued)

 

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

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

Accruing Loans

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

(Non-PCI)

 

 

 

Loans Past Due

 

Loans Past Due

 

Loans Past Due

 

Total

 

Current

 

PCI

 

Total

 

Past Due

 

December 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

 

$

6,073

 

$

964

 

$

8,022

 

$

15,059

 

$

1,620,000

 

$

13,374

 

$

1,648,433

 

$

 

Unsecured

 

35

 

3

 

 

38

 

110,312

 

68

 

110,418

 

 

Real estate:

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

Secured by commercial properties

 

67

 

 

 

67

 

1,173,504

 

22,341

 

1,195,912

 

 

Secured by residential properties

 

454

 

1,187

 

 

1,641

 

495,472

 

1,810

 

498,923

 

 

Construction and land development:

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

Residential construction loans

 

175

 

 

 

175

 

64,871

 

 

65,046

 

 

Commercial construction loans and land development

 

4,319

 

 

575

 

4,894

 

334,525

 

9,178

 

348,597

 

 

Consumer

 

414

 

37

 

 

451

 

50,558

 

2,138

 

53,147

 

 

 

 

$

11,537

 

$

2,191

 

$

8,597

 

$

22,325

 

$

3,849,242

 

$

48,909

 

$

3,920,476

 

$

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

Accruing Loans

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

(Non-PCI)

 

 

 

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

 

 

In addition to the non-covered loans shown in the table above, $19.2 million and $6.8 million of loans included in loans held for sale were 90 days past due and accruing interest at December 31, 2014 and 2013, respectively. These loans, which are guaranteed by U.S. government agencies and were previously sold into GNMA loan pools, are subject to repurchase by PrimeLending.

 

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.

 

F-37



Table of Contents

 

Hilltop Holdings Inc. and Subsidiaries

Notes to Consolidated Financial Statements (continued)

 

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

 

December 31, 2014

 

Pass

 

Special Mention

 

Substandard

 

PCI

 

Total

 

Commercial and industrial:

 

 

 

 

 

 

 

 

 

 

 

Secured

 

$

1,566,208

 

$

1,105

 

$

67,746

 

$

13,374

 

$

1,648,433

 

Unsecured

 

110,256

 

 

94

 

68

 

110,418

 

Real estate:

 

 

 

 

 

 

 

 

 

 

 

Secured by commercial properties

 

1,151,454

 

712

 

21,405

 

22,341

 

1,195,912

 

Secured by residential properties

 

492,549

 

 

4,564

 

1,810

 

498,923

 

Construction and land development:

 

 

 

 

 

 

 

 

 

 

 

Residential construction loans

 

65,046

 

 

 

 

65,046

 

Commercial construction loans and land development

 

338,078

 

 

1,341

 

9,178

 

348,597

 

Consumer

 

50,968

 

 

41

 

2,138

 

53,147

 

 

 

$

3,774,559

 

$

1,817

 

$

95,191

 

$

48,909

 

$

3,920,476

 

 

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

 

 

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 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, 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. 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 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

 

F-38



Table of Contents

 

Hilltop Holdings Inc. and Subsidiaries

Notes to Consolidated Financial Statements (continued)

 

scope of the Contingencies Topic. Estimates of loss for the Contingencies Topic are calculated based on historical loss, adjusted for qualitative or environmental factors. The Bank uses a rolling three year average net loss rate to calculate historical loss factors. The analysis is conducted by call report category, and further disaggregates commercial and industrial loans by collateral type. The analysis considers charge-offs and recoveries in determining the loss rate; therefore net charge-off experience is used. The historical loss calculation for the quarter is calculated by dividing the current quarter net charge-offs for each loan category by the quarter ended loan category balance. The Bank utilizes a weighted average loss rate to better represent recent trends. The Bank weights the most recent four quarter average at 120% versus the oldest four quarters at 80%.

 

While historical loss experience provides a reasonable starting point for the analysis, historical losses are not the sole basis upon which the Company determines 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 the volume and severity of past due, nonaccrual and classified loans;

·                  changes in the nature, volume and terms of loans in the portfolio;

·                  changes in lending policies and procedures;

·                  changes in economic and business conditions and developments that affect the collectability of the portfolio;

·                  changes in lending management and staff;

·                  changes in the loan review system and the degree of oversight by the Bank’s board of directors; and

·                  any concentrations of credit and changes in the level of such concentrations.

 

Changes in the volume and severity of past due, nonaccrual and classified loans, as well as changes in the nature, volume and terms of loans in the portfolio are key indicators of changes that could indicate a necessary adjustment to the historical loss factors. The magnitude of the impact of these factors on the qualitative assessment of the allowance for loan loss changes from quarter to quarter.

 

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 December 31, 2014 and 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

 

F-39



Table of Contents

 

Hilltop Holdings Inc. and Subsidiaries

Notes to Consolidated Financial Statements (continued)

 

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 for both originated and acquired loans 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.

 

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

 

 

 

Commercial and

 

 

 

Construction and

 

 

 

 

 

Year Ended December 31, 2014

 

Industrial

 

Real Estate

 

Land Development

 

Consumer

 

Total

 

Balance, beginning of year

 

$

16,865

 

$

8,331

 

$

7,957

 

$

88

 

$

33,241

 

Provision charged to operations

 

6,116

 

2,696

 

(1,692

)

627

 

7,747

 

Loans charged off

 

(6,926

)

(114

)

 

(359

)

(7,399

)

Recoveries on charged off loans

 

2,944

 

218

 

185

 

105

 

3,452

 

Balance, end of year

 

$

18,999

 

$

11,131

 

$

6,450

 

$

461

 

$

37,041

 

 

 

 

Commercial and

 

 

 

Construction and

 

 

 

 

 

Year Ended December 31, 2013

 

Industrial

 

Real Estate

 

Land Development

 

Consumer

 

Total

 

Balance, beginning of year

 

$

1,845

 

$

977

 

$

582

 

$

5

 

$

3,409

 

Provision charged to operations

 

20,940

 

7,281

 

7,634

 

238

 

36,093

 

Loans charged off

 

(9,359

)

(209

)

(524

)

(216

)

(10,308

)

Recoveries on charged off loans

 

3,439

 

282

 

265

 

61

 

4,047

 

Balance, end of year

 

$

16,865

 

$

8,331

 

$

7,957

 

$

88

 

$

33,241

 

 

 

 

Commercial and

 

 

 

Construction and

 

 

 

 

 

Month Ended December 31, 2012

 

Industrial

 

Real Estate

 

Land Development

 

Consumer

 

Total

 

Balance, beginning of period

 

$

 

$

 

$

 

$

 

$

 

Provision charged to operations

 

2,236

 

977

 

582

 

5

 

3,800

 

Loans charged off

 

(391

)

 

 

 

(391

)

Recoveries on charged off loans

 

 

 

 

 

 

Balance, end of period

 

$

1,845

 

$

977

 

$

582

 

$

5

 

$

3,409

 

 

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

 

 

 

Commercial and

 

 

 

Construction and

 

 

 

 

 

December 31, 2014

 

Industrial

 

Real Estate

 

Land Development

 

Consumer

 

Total

 

Loans individually evaluated for impairment

 

$

11,842

 

$

1,420

 

$

703

 

$

 

$

13,965

 

Loans collectively evaluated for impairment

 

1,733,567

 

1,669,264

 

403,762

 

51,009

 

3,857,602

 

PCI Loans

 

13,442

 

24,151

 

9,178

 

2,138

 

48,909

 

 

 

$

1,758,851

 

$

1,694,835

 

$

413,643

 

$

53,147

 

$

3,920,476

 

 

 

 

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

 

 

F-40



Table of Contents

 

Hilltop Holdings Inc. and Subsidiaries

Notes to Consolidated Financial Statements (continued)

 

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

 

 

 

Commercial and

 

 

 

Construction and

 

 

 

 

 

December 31, 2014

 

Industrial

 

Real Estate

 

Land Development

 

Consumer

 

Total

 

Loans individually evaluated for impairment

 

$

421

 

$

 

$

 

$

 

$

421

 

Loans collectively evaluated for impairment

 

15,658

 

9,168

 

6,296

 

179

 

31,301

 

PCI Loans

 

2,920

 

1,963

 

154

 

282

 

5,319

 

 

 

$

18,999

 

$

11,131

 

$

6,450

 

$

461

 

$

37,041

 

 

 

 

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

 

 

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, referred 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 the FNB Transaction 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.

 

F-41



Table of Contents

 

Hilltop Holdings Inc. and Subsidiaries

Notes to Consolidated Financial Statements (continued)

 

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

 

 

 

December 31,

 

 

 

2014

 

2013

 

Commercial and industrial

 

$

30,780

 

$

66,943

 

Real estate

 

552,850

 

787,982

 

Construction and land development

 

59,010

 

151,444

 

Consumer

 

 

 

Total covered loans

 

642,640

 

1,006,369

 

Allowance for covered loans

 

(4,611

)

(1,061

)

Total covered loans, net of allowance

 

$

638,029

 

$

1,005,308

 

 

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

 

 

 

December 31,

 

 

 

2014

 

2013

 

Carrying amount

 

$

435,388

 

$

729,156

 

Outstanding balance

 

685,393

 

1,022,514

 

 

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

 

 

 

 

 

Period from

 

 

 

Year Ended

 

September 14, 2013

 

 

 

December 31,

 

through December 31,

 

 

 

2014

 

2013

 

Balance, beginning of period

 

$

156,548

 

$

 

Additions

 

 

167,974

 

Reclassifications from (to) nonaccretable difference, net (1)

 

105,470

 

3,492

 

Transfer of loans to covered OREO (2)

 

7,703

 

4,407

 

Accretion

 

(76,228

)

(19,325

)

Balance, end of period

 

$

193,493

 

$

156,548

 

 


(1)  Reclassifications from nonaccretable difference are primarily due to net increases in expected cash flows in the quarterly recasts. Reclassifications to nonaccretable difference occur when accruing loans are moved to nonaccrual and expected cash flows are no longer predictable and the accretable yield is eliminated.

 

(2)  Transfer of loans to covered OREO is the difference between the value removed from the pool and the expected cash flows for the loan.

 

The remaining nonaccretable difference for covered PCI loans was $382.5 million and $517.9 million at December 31, 2014 and 2013, respectively.

 

Covered impaired loans include non-accrual loans, TDRs, PCI loans and partially charged-off loans. Substantially all covered impaired loans are PCI loans. The amounts shown in following tables include Pooled Loans, as well as loans accounted for on an individual basis. For Pooled Loans, the recorded investment with allowance and the related allowance consider impairment measured at the pool level.

 

F-42



Table of Contents

 

Hilltop Holdings Inc. and Subsidiaries

Notes to Consolidated Financial Statements (continued)

 

Covered impaired loans are summarized by class in the following tables (in thousands).

 

 

 

Unpaid

 

Recorded

 

Recorded

 

Total

 

 

 

 

 

Contractual

 

Investment with

 

Investment with

 

Recorded

 

Related

 

December 31, 2014

 

Principal Balance

 

No Allowance

 

Allowance

 

Investment

 

Allowance

 

Commercial and industrial:

 

 

 

 

 

 

 

 

 

 

 

Secured

 

$

26,447

 

$

7,436

 

$

6,636

 

$

14,072

 

$

265

 

Unsecured

 

14,111

 

2,107

 

4,697

 

6,804

 

882

 

Real estate:

 

 

 

 

 

 

 

 

 

 

 

Secured by commercial properties

 

387,302

 

193,111

 

35,142

 

228,253

 

2,381

 

Secured by residential properties

 

235,505

 

129,571

 

12,918

 

142,489

 

937

 

Construction and land development:

 

 

 

 

 

 

 

 

 

 

 

Residential construction loans

 

2,749

 

1,018

 

354

 

1,372

 

69

 

Commercial construction loans and land development

 

94,949

 

45,646

 

 

45,646

 

 

Consumer

 

 

 

 

 

 

 

 

$

761,063

 

$

378,889

 

$

59,747

 

$

438,636

 

$

4,534

 

 

 

 

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

 

$

43,957

 

$

28,611

 

$

 

$

28,611

 

$

 

Unsecured

 

16,280

 

9,008

 

882

 

9,890

 

882

 

Real estate:

 

 

 

 

 

 

 

 

 

 

 

Secured by commercial properties

 

528,825

 

365,346

 

 

365,346

 

 

Secured by residential properties

 

289,094

 

199,581

 

 

199,581

 

 

Construction and land development:

 

 

 

 

 

 

 

 

 

 

 

Residential construction loans

 

8,920

 

5,280

 

 

5,280

 

 

Commercial construction loans and land development

 

183,117

 

121,363

 

 

121,363

 

 

Consumer

 

 

 

 

 

 

 

 

$

1,070,193

 

$

729,189

 

$

882

 

$

730,071

 

$

882

 

 

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

 

 

 

Year Ended December 31,

 

 

 

2014

 

2013

 

Commercial and industrial:

 

 

 

 

 

Secured

 

$

21,296

 

$

14,260

 

Unsecured

 

8,347

 

4,945

 

Real estate:

 

 

 

 

 

Secured by commercial properties

 

296,780

 

182,653

 

Secured by residential properties

 

170,931

 

99,686

 

Construction and land development:

 

 

 

 

 

Residential construction loans

 

3,039

 

2,353

 

Commercial construction loans and land development

 

83,505

 

60,682

 

Consumer

 

 

 

 

 

$

583,898

 

$

364,579

 

 

F-43



Table of Contents

 

Hilltop Holdings Inc. and Subsidiaries

Notes to Consolidated Financial Statements (continued)

 

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

 

 

 

December 31,

 

 

 

2014

 

2013

 

Commercial and industrial:

 

 

 

 

 

Secured

 

$

442

 

$

91

 

Unsecured

 

883

 

882

 

Real estate:

 

 

 

 

 

Secured by commercial properties

 

30,823

 

40

 

Secured by residential properties

 

1,046

 

209

 

Construction and land development:

 

 

 

 

 

Residential construction loans

 

1,018

 

575

 

Commercial construction loans and land development

 

11

 

 

Consumer

 

 

 

 

 

$

34,223

 

$

1,797

 

 

At December 31, 2014, covered non-accrual loans included covered PCI loans of $31.2 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 covered accruing impaired loans and on covered non-accrual loans during 2014 and 2013 was nominal. Except as noted above, covered PCI loans are considered to be performing due to the application of the accretion method.

 

The Bank classifies loan modifications of covered loans as TDRs in a manner consistent with that of non-covered loans as discussed in Note 5 to the consolidated financial statements. The outstanding balance of TDRs granted in the twelve months ended December 31, 2014 is shown in the following table (in thousands). Pooled Loans are not in the scope of the disclosure requirements for TDRs. There were no TDRs granted during the year ended December 31, 2013. At December 31, 2014, the Bank had nominal unadvanced commitments to borrowers whose loans have been restructured in TDRs.

 

 

 

Recorded Investment in Loans Modified by

 

 

 

 

 

Interest Rate

 

Payment Term

 

Total

 

Year Ended December 31, 2014

 

A/B Note

 

Adjustment

 

Extension

 

Modification

 

Commercial and industrial:

 

 

 

 

 

 

 

 

 

Secured

 

$

 

$

 

$

 

$

 

Unsecured

 

 

 

 

 

Real estate:

 

 

 

 

 

 

 

 

 

Secured by commercial properties

 

 

 

 

 

Secured by residential properties

 

369

 

326

 

 

695

 

Construction and land development:

 

 

 

 

 

 

 

 

 

Residential construction loans

 

 

 

 

 

Commercial construction loans and land development

 

 

 

 

 

Consumer

 

 

 

 

 

 

 

$

369

 

$

326

 

$

 

$

695

 

 

F-44



Table of Contents

 

Hilltop Holdings Inc. and Subsidiaries

Notes to Consolidated Financial Statements (continued)

 

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

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

Accruing Loans

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

(Non-PCI)

 

 

 

Loans Past Due

 

Loans Past Due

 

Loans Past Due

 

Total

 

Current

 

PCI

 

Total

 

Past Due

 

December 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

 

$

 

$

 

$

454

 

$

454

 

$

8,681

 

$

13,630

 

$

22,765

 

$

11

 

Unsecured

 

10

 

 

 

10

 

1,200

 

6,805

 

8,015

 

 

Real estate:

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

Secured by commercial properties

 

876

 

 

105

 

981

 

41,576

 

227,772

 

270,329

 

 

Secured by residential properties

 

3,089

 

493

 

405

 

3,987

 

137,342

 

141,192

 

282,521

 

48

 

Construction and land development:

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

Residential construction loans

 

 

 

896

 

896

 

390

 

354

 

1,640

 

 

Commercial construction loans and land development

 

39

 

25

 

8

 

72

 

11,663

 

45,635

 

57,370

 

8

 

Consumer

 

 

 

 

 

 

 

 

 

 

 

$

4,014

 

$

518

 

$

1,868

 

$

6,400

 

$

200,852

 

$

435,388

 

$

642,640

 

$

67

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

Accruing Loans

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

(Non-PCI)

 

 

 

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).

 

December 31, 2014

 

Pass

 

Special Mention

 

Substandard

 

PCI

 

Total

 

Commercial and industrial:

 

 

 

 

 

 

 

 

 

 

 

Secured

 

$

7,712

 

$

 

$

1,423

 

$

13,630

 

$

22,765

 

Unsecured

 

1,210

 

 

 

6,805

 

8,015

 

Real estate:

 

 

 

 

 

 

 

 

 

 

 

Secured by commercial properties

 

35,973

 

 

6,584

 

227,772

 

270,329

 

Secured by residential properties

 

133,756

 

 

7,573

 

141,192

 

282,521

 

Construction and land development:

 

 

 

 

 

 

 

 

 

 

 

Residential construction loans

 

268

 

 

1,018

 

354

 

1,640

 

Commercial construction loans and land development

 

9,501

 

 

2,234

 

45,635

 

57,370

 

Consumer

 

 

 

 

 

 

 

 

$

188,420

 

$

 

$

18,832

 

$

435,388

 

$

642,640

 

 

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 reversed and any remaining difference increases the accretable yield which will be taken into income over the remaining life of the loan.

 

F-45



Table of Contents

 

Hilltop Holdings Inc. and Subsidiaries

Notes to Consolidated Financial Statements (continued)

 

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.

 

Changes in the allowance for covered loan losses, distributed by portfolio segment, are shown below (in thousands). The year ended December 31, 2013 below refers to the period from September 14, 2013 through December 31, 2013.

 

 

 

Commercial and

 

 

 

Construction and

 

 

 

 

 

Year Ended December 31, 2014

 

Industrial

 

Real Estate

 

Land Development

 

Consumer

 

Total

 

Balance, beginning of year

 

$

1,053

 

$

8

 

$

 

$

 

$

1,061

 

Provision charged to operations

 

230

 

8,725

 

231

 

 

9,186

 

Loans charged off

 

(90

)

(5,399

)

(147

)

 

(5,636

)

Recoveries on charged off loans

 

 

 

 

 

 

Balance, end of year

 

$

1,193

 

$

3,334

 

$

84

 

$

 

$

4,611

 

 

 

 

Commercial and

 

 

 

Construction and

 

 

 

 

 

Year Ended December 31, 2013

 

Industrial

 

Real Estate

 

Land Development

 

Consumer

 

Total

 

Balance, beginning of year

 

$

 

$

 

$

 

$

 

$

 

Provision charged to operations

 

1,057

 

8

 

 

 

1,065

 

Loans charged off

 

(4

)

 

 

 

(4

)

Recoveries on charged off loans

 

 

 

 

 

 

Balance, end of year

 

$

1,053

 

$

8

 

$

 

$

 

$

1,061

 

 

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

 

 

 

Commercial and

 

 

 

Construction and

 

 

 

 

 

December 31, 2014

 

Industrial

 

Real Estate

 

Land Development

 

Consumer

 

Total

 

Loans individually evaluated for impairment

 

$

 

$

 

$

801

 

$

 

$

801

 

Loans collectively evaluated for impairment

 

10,345

 

183,886

 

12,220

 

 

206,451

 

PCI Loans

 

20,435

 

368,964

 

45,989

 

 

435,388

 

 

 

$

30,780

 

$

552,850

 

$

59,010

 

$

 

$

642,640

 

 

 

 

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

 

 

 

 

 

December 31, 2014

 

Industrial

 

Real Estate

 

Land Development

 

Consumer

 

Total

 

Loans individually evaluated for impairment

 

$

 

$

 

$

 

$

 

$

 

Loans collectively evaluated for impairment

 

46

 

16

 

15

 

 

77

 

PCI Loans

 

1,147

 

3,318

 

69

 

 

4,534

 

 

 

$

1,193

 

$

3,334

 

$

84

 

$

 

$

4,611

 

 

 

 

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

 

 

F-46



Table of Contents

 

Hilltop Holdings Inc. and Subsidiaries

Notes to Consolidated Financial Statements (continued)

 

Covered Other Real Estate Owned

 

A summary of the activity in covered OREO is as follows (in thousands).

 

 

 

 

 

Period from

 

 

 

Year Ended

 

September 14, 2013

 

 

 

December 31,

 

through December 31,

 

 

 

2014

 

2013

 

Balance, beginning of period

 

$

142,833

 

$

 

Fair value of assets acquired as of Bank Closing Date

 

 

135,187

 

Additions to covered OREO

 

64,934

 

19,185

 

Dispositions of covered OREO

 

(51,150

)

(11,539

)

Valuation adjustments in the period

 

(19,672

)

 

Balance, end of period

 

$

136,945

 

$

142,833

 

 

During 2014, the Bank wrote down certain covered OREO assets to fair value to reflect new appraisals on certain OREO acquired in the FNB Transaction and OREO acquired from the foreclosure on certain loans acquired in the FNB Transaction. Although the Bank recorded a fair value discount on the acquired assets upon acquisition, in some cases additional downward valuations were required.

 

These additional downward valuation adjustments reflect changes to the assumptions regarding the fair value of the OREO, including in some cases the intended use of the OREO due to the availability of more information as well as the passage of time. The process of determining fair value is subjective in nature and requires the use of significant estimates and assumptions. Although the Bank makes market-based assumptions when valuing acquired assets, new information may come to light that causes estimates to increase or decrease. When the Bank determines, based on subsequent information, that its estimates require adjustment, the Bank records the adjustment. The accounting for such adjustments requires that the decreases to fair value be recorded at the time such new information is received, while increases to fair value are recorded when the asset is subsequently sold. All of the impairments recorded during 2014 related to covered assets subject to the loss-share agreements with the FDIC.

 

A summary of the activity in the FDIC Indemnification Asset is as follows (in thousands).

 

 

 

 

 

Period from

 

 

 

Year Ended

 

September 14, 2013

 

 

 

December 31,

 

through December 31,

 

 

 

2014

 

2013

 

Balance, beginning of period

 

$

188,291

 

$

 

Fair value of assets acquired as of Bank Closing Date

 

 

185,680

 

FDIC Indemnification Asset accretion (amortization)

 

3,445

 

1,699

 

Transfers to due from FDIC and other

 

(61,299

)

912

 

Balance, end of period

 

$

130,437

 

$

188,291

 

 

As of December 31, 2014, the Bank had billed $60.4 million to the FDIC, which represented covered losses and expenses through September 30, 2014, of which $38.5 million had been collected as of December 31, 2014. The remaining $21.9 million was received during January 2015.

 

F-47



Table of Contents

 

Hilltop Holdings Inc. and Subsidiaries

Notes to Consolidated Financial Statements (continued)

 

7. Cash and Due from Banks

 

Cash and due from banks consisted of the following (in thousands).

 

 

 

December 31,

 

 

 

2014

 

2013

 

Cash on hand

 

$

47,947

 

$

59,451

 

Clearings and collection items

 

76,381

 

64,193

 

Deposits at Federal Reserve Bank

 

425,704

 

364,709

 

Deposits at Federal Home Loan Bank

 

1,500

 

1,500

 

Deposits in FDIC-insured institutions

 

230,941

 

223,246

 

 

 

$

782,473

 

$

713,099

 

 

The amounts above include interest-bearing deposits of $628.3 million and $565.3 million at December 31, 2014 and 2013, respectively. Cash on hand and deposits at the Federal Reserve Bank satisfy regulatory reserve requirements at December 31, 2014.

 

8. Premises and Equipment

 

The components of premises and equipment are summarized as follows (in thousands).

 

 

 

December 31,

 

 

 

2014

 

2013

 

Land and premises

 

$

122,560

 

$

121,211

 

Furniture and equipment

 

142,255

 

107,644

 

 

 

264,815

 

228,855

 

Less accumulated depreciation and amortization

 

(57,824

)

(28,149

)

 

 

$

206,991

 

$

200,706

 

 

The amounts shown above include assets recorded under capital leases of $6.6 million and $7.1 million, net of accumulated amortization of $1.2 million and $0.6 million at December 31, 2014 and 2013, respectively.

 

Occupancy expense was reduced by rental income of $2.4 million, $1.8 million and $0.1 million during 2014, 2013 and 2012, respectively. Depreciation and amortization expense on premises and equipment, which includes amortization of capital leases, amounted to $30.7 million, $24.8 million and $1.9 million in 2014, 2013 and 2012, respectively.

 

9. Goodwill and Other Intangible Assets

 

At both December 31, 2014 and 2013, the carrying amount of goodwill of $251.8 million was comprised of $24.0 million recorded in connection with the acquisition of NLC, and as discussed in Note 2 to the consolidated financial statements, $227.8 million recorded in connection with the PlainsCapital Merger.

 

Other intangible assets of $59.8 million and $70.9 million at December 31, 2014 and 2013, respectively, include an indefinite lived intangible asset with an estimated fair value of $3.0 million related to state licenses acquired as a part of the NLC acquisition in January 2007.

 

The Company tests goodwill and other intangible assets having an indefinite useful life for impairment on an annual basis, or more often if events or circumstances indicate there may be impairment. Goodwill impairment testing is performed at the reporting unit level, which is one level below an operating segment. Goodwill is assigned to reporting units at the date the goodwill is initially recorded. Once goodwill has been assigned to reporting units, it no longer retains its association with a particular acquisition, and all of the activities within a reporting unit, whether acquired or internally generated, are available

 

F-48



Table of Contents

 

Hilltop Holdings Inc. and Subsidiaries

Notes to Consolidated Financial Statements (continued)

 

to support the value of the goodwill. The Company performs required annual impairment tests of its goodwill and other intangible assets as of October 1st for each of its reporting units.

 

The goodwill impairment analysis is a two-step test. The first step, used to identify potential impairment, involves comparing each reporting unit’s estimated fair value to its carrying value, including goodwill. If the estimated fair value of a reporting unit exceeds its carrying value, goodwill is considered not to be impaired. If the carrying value exceeds estimated fair value, there is an indication of potential impairment and the second step is performed to measure the amount of impairment. The Company has estimated fair values of reporting units based on both a market and income approach using historic, normalized actual and forecast results.

 

The second step involves calculating an implied fair value of goodwill for each reporting unit for which the first step indicated impairment. The implied fair value of goodwill is determined in a manner similar to the amount of goodwill calculated in a business combination, by measuring the excess of the estimated fair value of the reporting unit, as determined in the first step, over the aggregate estimated fair values of the individual assets, liabilities and identifiable intangibles as if the reporting unit was being acquired in a business combination. If the implied fair value of goodwill exceeds the carrying value of goodwill assigned to the reporting unit, there is no impairment. If the carrying value of goodwill assigned to a reporting unit exceeds the implied fair value of the goodwill, an impairment charge is recorded for the excess. An impairment loss cannot exceed the carrying value of goodwill assigned to a reporting unit, and the loss establishes a new basis in the goodwill. Subsequent reversal of goodwill impairment losses is not permitted.

 

At October 1, 2014, the Company determined that the estimated fair value of each of its reporting units exceeded its carrying value and therefore the second step as described above was not performed. Based on this evaluation, the Company concluded that the goodwill and other identifiable intangible assets were fully realizable at December 31, 2014.

 

The Company’s evaluation includes multiple assumptions, including estimated discounted cash flows and other estimates that may change over time. If future discounted cash flows become less than those projected by the Company, future impairment charges may become necessary that could have a materially adverse impact on the Company’s results of operations and financial condition. As quoted market prices in active stock markets are relevant evidence of fair value, a significant decline in the Company’s common stock trading price may indicate an impairment of goodwill.

 

The carrying value of intangible assets subject to amortization was as follows (in thousands).

 

 

 

Estimated

 

Gross

 

 

 

Net

 

 

 

Useful Life

 

Intangible

 

Accumulated

 

Intangible

 

December 31, 2014

 

(Years)

 

Assets

 

Amortization

 

Assets

 

Core deposits

 

7-12

 

$

38,770

 

$

(12,104

)

$

26,666

 

Trademarks and trade names

 

10-20

 

20,000

 

(3,723

)

16,277

 

Noncompete agreements

 

4-6

 

11,650

 

(4,794

)

6,856

 

Customer contracts and relationships

 

8-12

 

14,100

 

(7,729

)

6,371

 

Agent relationships

 

13

 

3,600

 

(2,987

)

613

 

 

 

 

 

$

88,120

 

$

(31,337

)

$

56,783

 

 

 

 

Estimated

 

Gross

 

 

 

Net

 

 

 

Useful Life

 

Intangible

 

Accumulated

 

Intangible

 

December 31, 2013

 

(Years)

 

Assets

 

Amortization

 

Assets

 

Core deposits

 

7-12

 

$

38,770

 

$

(6,159

)

$

32,611

 

Trademarks and trade names

 

10-20

 

20,000

 

(2,589

)

17,411

 

Noncompete agreements

 

4-6

 

11,650

 

(2,492

)

9,158

 

Customer contracts and relationships

 

8-12

 

14,100

 

(6,210

)

7,890

 

Agent relationships

 

13

 

3,600

 

(2,749

)

851

 

 

 

 

 

$

88,120

 

$

(20,199

)

$

67,921

 

 

Amortization expense related to intangible assets during 2014, 2013 and 2012 was $11.1 million, $11.1 million and $2.0 million, respectively.

 

F-49



Table of Contents

 

Hilltop Holdings Inc. and Subsidiaries

Notes to Consolidated Financial Statements (continued)

 

The estimated aggregate future amortization expense for intangible assets at December 31, 2014 is as follows (in thousands).

 

2015

 

$

11,020

 

2016

 

10,182

 

2017

 

9,254

 

2018

 

7,429

 

2019

 

6,489

 

Thereafter

 

12,409

 

 

 

$

56,783

 

 

10. Mortgage Servicing Rights

 

The following tables present the changes in fair value of the Company’s MSR and other information related to the serviced portfolio (dollars in thousands).

 

 

 

Year Ended December 31,

 

Month Ended

 

 

 

2014

 

2013

 

December 31, 2012

 

Balance, beginning of period

 

$

20,149

 

$

2,080

 

$

 

Additions

 

35,056

 

13,886

 

2,204

 

Sales

 

(11,387

)

 

 

Changes in fair value:

 

 

 

 

 

 

 

Due to changes in model inputs or assumptions (1)

 

(5,267

)

4,782

 

(51

)

Due to customer payments

 

(2,396

)

(599

)

(73

)

Balance, end of period

 

$

36,155

 

$

20,149

 

$

2,080

 

 

 

 

December 31,

 

 

 

2014

 

2013

 

Mortgage loans serviced for others

 

$

3,645,220

 

$

1,965,883

 

MSR as a percentage of serviced mortgage loans

 

0.99

%

1.02

%

 


(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.

 

 

 

December 31,

 

 

 

2014

 

2013

 

Weighted average constant prepayment rate

 

12.17

%

9.72

%

Weighted average discount rate

 

11.01

%

12.37

%

Weighted average life (in years)

 

6.3

 

7.6

 

 

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

 

 

 

December 31,

 

 

 

2014

 

2013

 

Constant prepayment rate:

 

 

 

 

 

Impact of 10% adverse change

 

$

(1,648

)

$

(601

)

Impact of 20% adverse change

 

(3,169

)

(1,170

)

Discount rate:

 

 

 

 

 

Impact of 100 basis point adverse change

 

(1,431

)

(631

)

Impact of 200 basis point adverse change

 

(2,753

)

(1,236

)

 

F-50



Table of Contents

 

Hilltop Holdings Inc. and Subsidiaries

Notes to Consolidated Financial Statements (continued)

 

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.

 

Contractually specified servicing fees, late fees and ancillary fees earned of $13.3 million, $3.2 million and $0.4 million during the years ended December 31, 2014 and 2013 and the month ended December 31, 2012, respectively, were included in other noninterest income within the consolidated statements of operations.

 

11. Deposits

 

Deposits are summarized as follows (in thousands).

 

 

 

December 31,

 

 

 

2014

 

2013

 

Noninterest-bearing demand

 

$

2,076,385

 

$

1,773,749

 

Interest-bearing:

 

 

 

 

 

NOW accounts

 

1,242,110

 

1,083,596

 

Money market

 

861,851

 

878,578

 

Brokered - money market

 

79,937

 

276,760

 

Demand

 

136,886

 

47,636

 

Savings

 

299,051

 

357,325

 

Time

 

1,575,910

 

2,110,947

 

Brokered - time

 

97,762

 

194,327

 

 

 

$

6,369,892

 

$

6,722,918

 

 

At December 31, 2014, the scheduled maturities of interest-bearing time deposits are as follows (in thousands).

 

2015

 

$

1,066,373

 

2016

 

179,185

 

2017

 

380,913

 

2018

 

41,185

 

2019 and thereafter

 

6,016

 

 

 

$

1,673,672

 

 

12. Short-term Borrowings

 

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

 

 

 

December 31,

 

 

 

2014

 

2013

 

Federal funds purchased

 

$

128,100

 

$

137,225

 

Securities sold under agreements to repurchase

 

136,396

 

107,462

 

Federal Home Loan Bank notes

 

375,000

 

 

Short-term bank loans

 

123,200

 

97,400

 

 

 

$

762,696

 

$

342,087

 

 

F-51



Table of Contents

 

Hilltop Holdings Inc. and Subsidiaries

Notes to Consolidated Financial Statements (continued)

 

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).

 

 

 

Year Ended December 31,

 

Month Ended

 

 

 

2014

 

2013

 

December 31, 2012

 

Average balance during the period

 

$

319,806

 

$

281,067

 

$

277,470

 

Average interest rate during the period

 

0.17

%

0.19

%

0.25

%

Maximum month-end balance during the period

 

535,232

 

415,730

 

355,350

 

 

 

 

December 31,

 

 

 

2014

 

2013

 

Average interest rate at end of period

 

0.15

%

0.16

%

Securities underlying the agreements at end of period:

 

 

 

 

 

Carrying value

 

$

166,734

 

$

144,991

 

Estimated fair value

 

$

163,852

 

$

138,719

 

 

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. At December 31, 2014, the Bank had available collateral of $1.4 billion, substantially all of which was blanket collateral. Other information regarding FHLB notes is shown in the following tables (dollars in thousands).

 

 

 

Year Ended December 31,

 

Month Ended

 

 

 

2014

 

2013

 

December 31, 2012

 

Average balance during the period

 

$

261,550

 

$

106,415

 

$

301,613

 

Average interest rate during the period

 

0.18

%

0.13

%

0.14

%

Maximum month-end balance during the period

 

575,000

 

525,000

 

250,000

 

 

 

 

December 31,

 

 

 

2014

 

2013

 

Average interest rate at end of period

 

0.16

%

 

 

FSC uses short-term bank loans periodically to finance securities owned, margin loans to customers and correspondents, and underwriting activities. Interest on the borrowings varies with the federal funds rate. The weighted average interest rate on the borrowings at December 31, 2014 and 2013 was 1.07% and 1.15%, respectively.

 

F-52



Table of Contents

 

Hilltop Holdings Inc. and Subsidiaries

Notes to Consolidated Financial Statements (continued)

 

13. Notes Payable

 

Notes payable consisted of the following (in thousands).

 

 

 

December 31,

 

 

 

2014

 

2013

 

NLIC note payable due May 2033, three-month LIBOR plus 4.10% (4.35% at December 31, 2014) with interest payable quarterly

 

$

10,000

 

$

10,000

 

NLIC note payable due September 2033, three-month LIBOR plus 4.05% (4.30% at December 31, 2014) with interest payable quarterly

 

10,000

 

10,000

 

ASIC note payable due April 2034, three-month LIBOR plus 4.05% (4.30% at December 31, 2014) with interest payable quarterly

 

7,500

 

7,500

 

First Southwest nonrecourse notes, due January 2035 with interest payable quarterly

 

4,184

 

6,827

 

Insurance company note payable due March 2035, three-month LIBOR plus 3.40% (3.65% at December 31, 2014) with interest payable quarterly

 

20,000

 

20,000

 

Insurance company line of credit due December 31, 2015, 3.25% plus a calculated index rate (4.00% at December 31, 2014) with interest payable quarterly

 

5,000

 

2,000

 

 

 

$

56,684

 

$

56,327

 

 

NLIC, ASIC and Insurance Company Notes Payable

 

The NLIC and ASIC notes payable to unaffiliated companies are each subordinated in right of payment to all policy claims and other indebtedness of NLIC and ASIC, respectively. Further, all payments of principal and interest require the prior approval of the Insurance Commissioner of the State of Texas and are only payable to the extent that the statutory surplus of NLIC exceeds $30 million and ASIC exceeds $15 million.

 

The NLIC, ASIC and Insurance Company loan agreements relating to the notes payable contain various covenants pertaining to limitations on additional debt, dividends, officer and director compensation, and minimum capital requirements. The Company was in compliance with the covenants at December 31, 2014.

 

NLC has entered into an indenture relating to the NLIC, ASIC and Insurance Company notes payable which provides that (i) if a person or group becomes the beneficial owner directly or indirectly of 50% or more of its equity securities and (ii) if NLC’s ratings are downgraded by a nationally recognized statistical rating organization (as defined in the Exchange Act), then each holder of the notes governed by such indenture has the right to require that NLC purchase such holder’s notes in whole or in part at a price equal to 100% of the outstanding principal amount.

 

First Southwest Nonrecourse Notes

 

In 2005, First Southwest participated in a monetization of future cash flows totaling $95.3 million from several tobacco companies owed to a law firm under a settlement agreement (“Fee Award”). In connection with the transaction, a special purpose entity that is consolidated with First Southwest issued $30.3 million of nonrecourse notes to finance the purchase of the Fee Award, to establish a reserve account and to fund issuance costs. Cash flows from the settlement are the sole source of payment for the notes. The notes carry an interest rate of 8.58% that can increase to 10.08% under certain credit conditions. The First Southwest nonrecourse notes were paid off in January 2015.

 

Insurance Company Line of Credit

 

The Company’s insurance subsidiary has a line of credit with a financial institution which allows for borrowings by NLC of up to $7.5 million and is collateralized by substantially all of NLC’s assets. The loan agreements relating to the line of credit contain various financial and other covenants which must be maintained until all indebtedness to the financial institution is repaid. The Company was in compliance with the covenants at December 31, 2014.

 

F-53



Table of Contents

 

Hilltop Holdings Inc. and Subsidiaries

Notes to Consolidated Financial Statements (continued)

 

Principal Maturities

 

At December 31, 2014, notes payable outstanding of $56.7 million includes scheduled maturities of $5.0 million during 2015 and $51.7 million during 2033 and thereafter.

 

Senior Exchangeable Notes Due 2025

 

In August 2005, HTH Operating Partnership LP, a wholly owned subsidiary of Hilltop (“OP”), entered into an Indenture under which OP issued $96.6 million aggregate principal amount of 7.5% Senior Exchangeable Notes due 2025, or the Notes, to qualified institutional buyers in a private transaction. On October 15, 2013, OP called for redemption all outstanding Notes on November 14, 2013 (the “Redemption Date”). The outstanding Notes at October 15, 2013 of $90.9 million, including $6.9 million aggregate principal amount held by the Company’s insurance company subsidiaries, were redeemed at a redemption price equal to the principal amount of the Notes, plus accrued and unpaid interest up to, but excluding, the Redemption Date. At any time prior to the Redemption Date, holders of the Notes could exchange the Notes for shares of Hilltop common stock at the rate of 73.94998 shares per $1,000 principal amount of the Notes (or approximately $13.52 per share). In lieu of delivery of Hilltop common stock upon the exercise by a holder of its exchange right, OP could elect to pay such holder of the Notes an amount in cash (or a combination of Hilltop common stock and cash) in respect of all or a portion of such holder’s Notes equal to the closing price of Hilltop’s common stock for the five consecutive trading days commencing on and including the third business day following the exercise of such exchange right. As of the closing of the redemption, the Notes held by third party investors were exchanged for 6,208,005 shares of Hilltop common stock and an aggregate cash payment of $11.1 million was made in exchange for the Notes held by the Company’s insurance company subsidiaries.

 

The Notes were senior unsecured obligations of OP and were exchangeable, at the option of the holders, into shares of Hilltop common stock at an initial exchange rate of 69.8812 shares per $1,000 principal amount of the Notes (equal to an initial exchange price of approximately $14.31 per share), subject to adjustment and, in the event of specified corporate transactions involving Hilltop or OP, an additional make-whole premium. Upon exchange, OP had the option to deliver, in lieu of shares of common stock, cash or a combination of cash and shares of common stock. The Notes were treated as a combined instrument at the date of issuance and not bifurcated to separately account for any embedded derivative instruments principally because, in accordance with ASC 815, Derivatives and Hedging, (i) the conversion feature is indexed to Hilltop’s common stock and would be classified in stockholders’ equity if it were a freestanding derivative and (ii) the put and call option features were clearly and closely related to the Notes at fixed conversion amounts.

 

According to the terms of the Notes, their initial exchange rate was adjustable for certain events, including the issuance to all holders of Hilltop common stock of rights entitling them to purchase Hilltop common stock at less than their current market price. Accordingly, as a result of a rights offering in January 2007, in which all holders of Hilltop common stock were offered the right to purchase shares at $8.00 per share, the initial exchange rate of the Notes was adjusted to 73.94998 shares per $1,000 principal amount of the Notes (equal to an exchange rate of $13.52 per share).

 

In November 2011, Hilltop’s insurance company subsidiaries purchased $6.9 million, par value, of the Notes in open market transactions at an average cost of 107.26% of par.

 

On October 15, 2013, Hilltop entered into a First Supplemental Indenture pursuant to which Hilltop guaranteed the obligations of OP under the Indenture.

 

14. Junior Subordinated Debentures and Trust Preferred Securities

 

PlainsCapital has four statutory Trusts, three of which were formed under the laws of the state of Connecticut and one of which, PCC Statutory Trust IV, was formed under the laws of the state of Delaware. The Trusts were created for the sole purpose of issuing and selling preferred securities and common securities, using the resulting proceeds to acquire junior subordinated debentures issued by PlainsCapital (the “Debentures”). Accordingly, the Debentures are the sole assets of the Trusts, and payments under the Debentures are the sole revenue of the Trusts. All of the common securities are owned by PlainsCapital; however, PlainsCapital is not the primary beneficiary of the Trusts. Accordingly, the Trusts are not included in the Company’s consolidated financial statements.

 

F-54



Table of Contents

 

Hilltop Holdings Inc. and Subsidiaries

Notes to Consolidated Financial Statements (continued)

 

The Trusts have issued $65,000,000 of floating rate preferred securities and $2,012,000 of common securities and have invested the proceeds from the securities in floating rate Debentures of PlainsCapital. Information regarding the PlainsCapital Debentures is shown in the following table (in thousands).

 

Investor 

 

Issue Date

 

Amount

 

PCC Statutory Trust I

 

July 31, 2001

 

$

18,042

 

PCC Statutory Trust II

 

March 26, 2003

 

$

18,042

 

PCC Statutory Trust III

 

September 17, 2003

 

$

15,464

 

PCC Statutory Trust IV

 

February 22, 2008

 

$

15,464

 

 

The stated term of the Debentures is 30 years with interest payable quarterly. The rate on the Debentures, which resets quarterly, is 3-month LIBOR plus an average spread of 3.22%. The total average interest rate at December 31, 2014 was 3.47%. The term, rate and other features of the preferred securities are the same as the Debentures. PlainsCapital’s obligations under the Debentures and related documents, taken together, constitute a full and unconditional guarantee of the Trust’s obligations under the preferred securities.

 

15. Income Taxes

 

The significant components of the income tax provision (benefit) are as follows (in thousands).

 

 

 

Year Ended December 31,

 

 

 

2014

 

2013

 

2012

 

Current:

 

 

 

 

 

 

 

Federal

 

$

85,303

 

$

51,441

 

$

4,346

 

State

 

3,087

 

3,414

 

935

 

 

 

88,390

 

54,855

 

5,281

 

Deferred:

 

 

 

 

 

 

 

Federal

 

(21,851

)

14,573

 

(5,649

)

State

 

(931

)

1,256

 

(777

)

 

 

(22,782

)

15,829

 

(6,426

)

 

 

$

65,608

 

$

70,684

 

$

(1,145

)

 

The income tax provision (benefit) differs from the amount that would be computed by applying the statutory Federal income tax rate of 35% to income (loss) before income taxes as a result of the following (in thousands).

 

 

 

Year Ended December 31,

 

 

 

2014

 

2013

 

2012

 

Computed tax at federal statutory rate

 

$

62,358

 

$

69,088

 

$

(2,185

)

Tax effect of:

 

 

 

 

 

 

 

Tax-exempt income, net

 

(2,085

)

(2,042

)

(151

)

State income taxes

 

1,401

 

3,035

 

103

 

Valuation allowance

 

1,950

 

 

 

Nondeductible expenses

 

2,201

 

2,363

 

352

 

Minority interest

 

(318

)

(479

)

(174

)

Nondeductible transaction costs

 

102

 

 

1,151

 

Prior year return to provision adjustment

 

360

 

(1,141

)

(150

)

Other

 

(361

)

(140

)

(91

)

 

 

$

65,608

 

$

70,684

 

$

(1,145

)

 

F-55



Table of Contents

 

Hilltop Holdings Inc. and Subsidiaries

Notes to Consolidated Financial Statements (continued)

 

The components of the tax effects of temporary differences that give rise to the net deferred tax asset included in other assets within the consolidated balance sheets are as follows (in thousands).

 

 

 

December 31,

 

 

 

2014

 

2013

 

Deferred tax assets:

 

 

 

 

 

Net operating loss carryforward

 

$

15,919

 

$

15,919

 

Covered loans

 

53,195

 

47,770

 

Purchase accounting adjustment - loans

 

15,110

 

27,997

 

Allowance for loan losses

 

15,255

 

12,383

 

Compensation and benefits

 

22,498

 

16,946

 

Indemnification agreements

 

6,631

 

8,308

 

Foreclosed property

 

13,458

 

13,589

 

Capital loss carryforward

 

1,950

 

 

Net unrealized change in securities and other investments

 

 

19,428

 

Other

 

14,793

 

16,216

 

 

 

158,809

 

178,556

 

 

 

 

 

 

 

Deferred tax liabilities:

 

 

 

 

 

Premises and equipment

 

13,567

 

13,269

 

FDIC Indemnification Asset

 

38,546

 

67,841

 

Intangible assets

 

18,989

 

22,708

 

Derivatives

 

9,368

 

9,428

 

Net unrealized change in securities and other investments

 

260

 

 

Loan servicing

 

13,531

 

7,480

 

Other

 

19,646

 

17,972

 

 

 

113,907

 

138,698

 

 

 

 

 

 

 

Total net deferred tax asset

 

44,902

 

39,858

 

Less valuation allowance

 

(1,950

)

 

Net deferred tax asset

 

$

42,952

 

$

39,858

 

 

At December 31, 2014 and 2013, the Company had net operating loss carryforwards for Federal income tax purposes of $45.5 million. The net operating loss carryforwards are subject to separate return limitations on their usage. These net operating loss carry-forwards expire in 2023 and later years. The Company expects to realize its current deferred tax asset for these net operating loss carryforwards through the implementation of certain tax planning strategies, core earnings, and reversal of timing differences. The Company recorded a valuation allowance of $1.9 million during 2014 against its gross deferred tax asset for capital loss carryforwards. The amount of the deferred tax asset considered realizable, however, could increase during the carryforward period if unexpected capital gains are recognized. The Company has no valuation allowance on the remainder of its deferred tax assets at December 31, 2014 or 2013.

 

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. At December 31, 2014, the total amount of gross unrecognized tax benefits established in the current year was $0.6 million, of which $0.4 million if recognized, would favorably impact the Company’s effective tax rate. There were no uncertain tax positions at December 31, 2013. The Company does not anticipate a significant change in the unrecognized tax benefits within the next twelve months.

 

The Company files income tax returns in U.S. federal and numerous state jurisdictions. The Company is subject to tax audits in numerous jurisdictions in the U.S. until the applicable statute of limitations expires. The Company is no longer subject to U.S. federal tax examinations for tax years prior to 2011. The Company is open for various state tax audits for tax years 2010 and later. The Company is currently under income tax examination by several state authorities for tax years 2010, 2011 and 2012. The Company does not expect any significant liability to arise as a result of the examinations.

 

F-56



Table of Contents

 

Hilltop Holdings Inc. and Subsidiaries

Notes to Consolidated Financial Statements (continued)

 

16. Employee Benefits

 

Hilltop and its subsidiaries have benefit plans that provide for elective deferrals by employees under Section 401(k) of the Internal Revenue Code. Employee contributions are determined by the level of employee participation and related salary levels per Internal Revenue Service regulations. Hilltop and its subsidiaries match a portion of employee contributions to the plan based on entity-specific factors including the level of normal operating earnings and the amount of eligible employees’ contributions and salaries. In addition, Hilltop, PlainsCapital and the Bank make additional contributions to employees’ 401(k) accounts based on achievement of certain corporate objectives. The amount charged to operating expense for these matching contributions totaled $8.8 million, $7.5 million and $0.7 million during 2014, 2013 and 2012, respectively.

 

In connection with the PlainsCapital Merger, PlainsCapital terminated its employee stock ownership plan (“ESOP”) and distributed the assets held by the ESOP (consisting of cash and shares of Hilltop common stock) to ESOP participants.

 

Effective upon the completion of the PlainsCapital Merger, the Company recorded a liability of $8.9 million associated with separate retention agreements entered into between Hilltop and two executive officers of PlainsCapital.

 

The Bank purchased $15.0 million of flexible premium universal life insurance in 2001 to help finance the annual expense incurred in providing various employee benefits. At December 31, 2014 and 2013, the carrying value of the policies included in other assets was $24.8 million and $24.5 million, respectively. For the years ended December 31, 2014 and 2013 and the month ended December 31, 2012, the Bank recorded income of $0.4 million, $0.4 million and $0.1 million, respectively, related to the policies that was reported in other noninterest income within the consolidated statement of operations.

 

17. Related Party Transactions

 

Pursuant to a Management Services Agreement, as amended, Diamond A Administration Company LLC, or Diamond A, an affiliate of Gerald J. Ford, the current Chairman of the Board of Hilltop and the beneficial owner of 17.2% of Hilltop common stock at December 31, 2014, provided certain management services to the Company, including, among others, financial and acquisition evaluation, and office space to Hilltop. The services and office space were provided at a cost of $91,500 per month, plus reasonable out-of-pocket expenses. The services provided under this agreement include those of Hilltop directors, including Gerald J. Ford, Kenneth Russell and Carl B. Webb. Prior to Jeremy B. Ford assuming the role of Chief Executive Officer of Hilltop, he provided services to Hilltop under the Management Services Agreement. Hilltop also agreed to indemnify and hold harmless Diamond A for its performance or provision of these services, except for gross negligence and willful misconduct. Further, Diamond A’s maximum aggregate liability for damages under this agreement is limited to the amounts paid to Diamond A under this agreement during twelve months prior to that cause of action. In connection with the PlainsCapital Merger on November 30, 2012, the Management Services Agreement was terminated. However, pursuant to a Sublease Agreement, Diamond A currently provides office space to Hilltop at a cost of $24,030 per month. This Sublease Agreement continues in effect until July 31, 2018 or such earlier date that the base lease expires.

 

Jeremy B. Ford, a director and the Chief Executive Officer of Hilltop, is the beneficiary of a trust that owns a 49% limited partnership interest in Diamond A Financial, L.P.  Diamond A Financial, L.P. owned 17.2% of the outstanding Hilltop common stock at December 31, 2014. He also is a director and the Secretary of Diamond A Administration Company, LLC, which has provided management services and office space to Hilltop as described the preceding paragraph. Diamond A Administration Company, LLC is owned by Hunter’s Glen/Ford, Ltd., a limited partnership in which a trust for the benefit of Jeremy B. Ford is a 46% limited partner.

 

Jeremy B. Ford is the son of Gerald J. Ford. Corey G. Prestidge, Hilltop’s General Counsel and Secretary, is the son-in-law of Gerald J. Ford. Accordingly, Messrs. Jeremy Ford and Corey Prestidge are brothers-in-law.

 

In the ordinary course of business, the Bank has granted loans to certain directors, executive officers and their affiliates (collectively referred to as related parties) totaling $32.7 million and $8.0 million at December 31, 2014 and 2013, respectively. These loans were made on substantially the same terms, including interest rates and collateral, as those prevailing at the time for comparable transactions with other unaffiliated persons and do not involve more than normal risk of collectability. For such loans during 2014, total principal additions were $11.9 million, total principal payments were $10.4 million and additions due to changes in status as a related party were $23.2 million.

 

F-57



Table of Contents

 

Hilltop Holdings Inc. and Subsidiaries

Notes to Consolidated Financial Statements (continued)

 

At December 31, 2014 and 2013, the Bank held deposits of related parties of $161.9 million and $154.0 million, respectively.

 

A related party is the lessor in an operating lease with the Bank. The Bank’s minimum payment under the lease is $0.5 million annually through 2028, for an aggregate remaining obligation of $7.0 million.

 

The Bank purchases loans from a company for which a related party serves as a director, president and chief executive officer. At both December 31, 2014 and 2013, the outstanding balance of the purchased loans was $6.0 million. The loans were purchased with recourse to the company in the ordinary course of business and the related party had no direct financial interest in the transactions.

 

PlainsCapital Equity, LLC is a limited partner in certain limited partnerships that have received loans from the Bank.  The Bank made those loans in the normal course of business, using underwriting standards and offering terms that are substantially the same as those used or offered to non-affiliated borrowers. At December 31, 2014 and 2013, the Bank had outstanding loans of $0.2 million and $3.0 million, respectively, in which PlainsCapital Equity, LLC had a limited partnership interest. The investment of PlainsCapital Equity, LLC in these limited partnerships was $3.8 million and $3.7 million at December 31, 2014 and 2013, respectively.

 

18. Commitments and Contingencies

 

The Bank acts as agent on behalf of certain correspondent banks in the purchase and sale of federal funds that aggregated $7.5 million at December 31, 2013. At December 31, 2014, there were no such amounts outstanding.

 

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.

 

Each of Hilltop, Hilltop Securities Holdings LLC (“Hilltop Securities”), formerly Peruna LLC (wholly owned subsidiary of Hilltop), SWS and the individual members of the board of directors of SWS have been named as defendants in two purported stockholder class action lawsuits arising out of the merger. 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). On May 13, 2014, the Delaware Chancery Court consolidated the two actions (the “Consolidated Action”) for all purposes. On June 10, 2014, plaintiffs filed a consolidated amended complaint. The complaint generally alleges, among other things, that the SWS board of directors breached its fiduciary duties to stockholders by failing to take steps to maximize stockholder value or to engage in a fair sale process before approving the merger, that the SWS board of directors labored

 

F-58



Table of Contents

 

Hilltop Holdings Inc. and Subsidiaries

Notes to Consolidated Financial Statements (continued)

 

under conflicts of interest, that certain provisions of the merger agreement unduly restrict SWS’s ability to negotiate with other potential bidders, and that the other defendants aided and abetted the SWS board of director’s breaches of fiduciary duty. The complaint further alleges, among other things, that the proxy statement/prospectus filed by Hilltop on May 29, 2014 omits or misstates certain material information. The complaints seek relief that includes, among other things, an injunction prohibiting the consummation of the merger, rescission to the extent the merger terms have already been implemented, damages for the alleged breaches of fiduciary duty, and the payment of plaintiffs’ attorneys’ fees and costs.

 

On November 13, 2014, the parties to the Consolidated Action entered into a memorandum of understanding (the “MOU”) reflecting the terms of an agreement, subject to final approval by the Court and certain other conditions, to settle the Consolidated Action. Pursuant to the MOU, defendants, without admitting any wrongdoing, agreed to make certain supplemental disclosures requested by plaintiffs in the Consolidated Action, as set forth in SWS’s Current Report on Form 8-K dated November 14, 2014. In addition, Hilltop agreed to forbear from asserting certain rights under the Agreement and Plan of Merger, dated as of March 31, 2014, by and among Hilltop, Hilltop Securities and SWS. The MOU further contemplates that, following confirmatory discovery, the parties will enter into a stipulation of settlement, which will be subject to customary conditions, including court approval following notice to the former stockholders of SWS. If the parties enter into a stipulation of settlement, a hearing will be scheduled at which the court will consider the fairness, reasonableness and adequacy of the settlement. There can be no assurance that the parties will ultimately enter into a stipulation of settlement, that the applicable court will approve any proposed settlement, or that any eventual settlement will be under the same terms as those contemplated by the MOU.

 

Following completion of Hilltop’s acquisition of SWS, several purported holders of shares of SWS common stock, representing a total of approximately 8.43 million shares of common stock of SWS, filed petitions in the Court of Chancery of the State of Delaware seeking appraisal for their shares pursuant to Section 262 of the Delaware General Corporation Law. The actions are captioned as follows:  Highland Select Equity Master Fund, L.P. et al. v. SWS Group, Inc. et al., C.A. No. 10554-VCG; Lone Star Value Investors, LP et al. v. SWS Group, Inc. et al., C.A. No. 10572-VCG; Merlin Partners, LP et al. v. SWS Group, Inc. et al., C.A. No. 10578-VCG. The Company believes these claims are without merit and intends to vigorously defend these actions.

 

On or about November 2, 2012, FSC, along with thirteen other defendants, was named in a lawsuit pending in the state of Rhode Island Superior Court styled Rhode Island Economic Development Corporation v. Wells Fargo Securities, LLC, et al. FSC is included in connection with its role as financial advisor to the State of Rhode Island, specifically in connection with the Rhode Island Economic Development Corporation’s issuance of $75 million in bonds to finance a loan to 38 Studios, LLC. FSC intends to defend itself vigorously in this action.

 

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 certain of its businesses, 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 Inquiries, the Company receives document requests, subpoenas and other requests for information. The Inquiries, including the Inquiry 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.

 

As a part of an industry-wide inquiry, PrimeLending 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 (the “FHA”). On August 20, 2014, PrimeLending received a Civil Investigative Demand from the United States Department of Justice (the “DOJ”) related to this Inquiry. According to the Civil Investigative Demand, the DOJ is conducting an investigation to determine whether PrimeLending has violated the False Claims Act in connection with originating and underwriting single-family residential mortgage loans insured by the FHA. No allegations have been asserted against PrimeLending. PrimeLending cannot predict the ultimate outcome of this investigation, and cannot make a reasonable estimate of potential liability, if any, at this time. PrimeLending is cooperating with the investigation and continues to respond to the Civil Investigative Demand.

 

F-59



Table of Contents

 

Hilltop Holdings Inc. and Subsidiaries

Notes to Consolidated Financial Statements (continued)

 

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 December 31, 2014 and 2013, the mortgage origination segment’s indemnification liability reserve totaled $17.6 million and $21.1 million, respectively. The provision for indemnification losses was $3.1 million, $3.5 million and $0.4 million during the years ended December 31, 2014 and 2013 and the month ended December 31, 2012, respectively.

 

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

 

 

 

Year Ended December 31,

 

Month Ended

 

 

 

2014

 

2013

 

December 31, 2012

 

Balance, beginning of period

 

$

51,912

 

$

39,693

 

$

35,217

 

Claims made

 

50,558

 

40,001

 

6,463

 

Claims resolved with no payment

 

(29,257

)

(17,746

)

(1,565

)

Repurchases

 

(15,439

)

(6,255

)

(422

)

Indemnification payments

 

(3,868

)

(3,781

)

 

Balance, end of period

 

$

53,906

 

$

51,912

 

$

39,693

 

 

F-60



Table of Contents

 

Hilltop Holdings Inc. and Subsidiaries

Notes to Consolidated Financial Statements (continued)

 

 

 

Indemnification Liability Reserve Activity

 

 

 

Year Ended December 31,

 

Month Ended

 

 

 

2014

 

2013

 

December 31, 2012

 

Balance, beginning of period

 

$

21,121

 

$

18,964

 

$

18,544

 

Additions for new sales

 

3,109

 

3,539

 

420

 

Repurchases

 

(1,593

)

(251

)

(31

)

Early payment defaults

 

(143

)

(528

)

(51

)

Indemnification payments

 

(1,708

)

(1,003

)

 

Change in estimate

 

(3,167

)

400

 

82

 

Balance, end of period

 

$

17,619

 

$

21,121

 

$

18,964

 

 

 

 

 

 

 

 

 

December 31,

 

 

 

 

 

2014

 

2013

 

 

 

Reserve for Indemnification Liability:

 

 

 

 

 

 

 

Specific claims

 

$

7,912

 

$

12,179

 

 

 

Incurred but not reported claims

 

9,707

 

8,942

 

 

 

Total

 

$

17,619

 

$

21,121

 

 

 

 

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. As of December 31, 2014, the Bank estimated that covered losses and reimbursable expenses exceed $240.4 million, but do not exceed $365.7 million. Unless the estimates of covered losses and reimbursable expenses exceed $365.7 million, the Bank will not record additional reimbursement receivable from the FDIC. As of December 31, 2014, the Bank had billed $75.5 million of covered net losses to the FDIC, of which 80%, or $60.4 million, are reimbursable under the loss-share agreements. As of December 31, 2014, the Bank had received aggregate reimbursements of $38.5 million from the FDIC.

 

As discussed in Note 16 to the consolidated financial statements, effective upon completion of the PlainsCapital Merger, Hilltop entered into separate retention agreements with two executive officers of PlainsCapital, one having an initial term of three years (with automatic one-year renewals at the end of two years and each anniversary thereof) and the other having an initial term of two years (with automatic one-year renewals at the end of the first year and each anniversary thereof). Each of these retention agreements provides for severance pay benefits if the executive officer’s employment is terminated without “cause”.

 

In addition to these retention agreements, Hilltop and its subsidiaries maintain employment contracts with certain officers that provide for benefits in the event of a “change in control” as defined in these agreements.

 

Hilltop and its subsidiaries lease space, primarily for branch facilities and automated teller machines, under noncancelable operating leases with remaining terms, including renewal options, of 1 to 15 years and under capital leases with remaining

 

F-61



Table of Contents

 

Hilltop Holdings Inc. and Subsidiaries

Notes to Consolidated Financial Statements (continued)

 

terms of 11 to 15 years. Rental expense under the operating leases was $31.4 million, $29.2 million and $2.9 million in 2014, 2013 and 2012, respectively. Future minimum lease payments under these agreements follow (in thousands).

 

 

 

Operating Leases

 

Capital Leases

 

2015

 

$

24,588

 

$

1,090

 

2016

 

19,677

 

1,103

 

2017

 

14,561

 

1,129

 

2018

 

12,565

 

1,167

 

2019

 

7,211

 

1,187

 

Thereafter

 

28,169

 

10,348

 

Total minimum lease payments

 

$

106,771

 

16,024

 

Amount representing interest

 

 

 

(6,126

)

Present value of minimum lease payments

 

 

 

$

9,898

 

 

19. 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 $1.4 billion at December 31, 2014 and outstanding financial and performance standby letters of credit of $45.1 million at December 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, use of derivatives to support certain non-profit housing organization clients, clearing agreements between FSC and various clearinghouses and broker-dealers, secured financing arrangements that involve pledged securities, and when-issued underwriting and purchase commitments.

 

20. 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

 

F-62



Table of Contents

 

Hilltop Holdings Inc. and Subsidiaries

Notes to Consolidated Financial Statements (continued)

 

awards granted under the 2012 Plan. At December 31, 2014, 3,078,374 shares of common stock remain available for issuance pursuant to the 2012 Plan.

 

During 2014, the Compensation Committee of the Board of Directors of the Company awarded certain executives and key employees an aggregate of 444,175 restricted stock units (“RSUs”) pursuant to the 2012 Plan, of which 434,864 remain outstanding at December 31, 2014. At December 31, 2014, 364,827 of the outstanding RSUs are subject to time-based vesting conditions and generally cliff vest on the third anniversary of the grant date, and 70,037 outstanding 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 $23.16 per share. At December 31, 2014, unrecognized compensation expense related to these RSUs was $7.9 million, which will be amortized through December 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.

 

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, of which 466,000 remain outstanding at December 31, 2014. 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 December 31, 2014, unrecognized compensation expense related to these Restricted Stock Awards was $2.7 million, which will be amortized through September 2016. The award agreements governing these Restricted Stock Awards provide for accelerated vesting under certain conditions.

 

During 2014, 2013 and 2012, Hilltop granted 9,519, 9,343 and 5,183 shares of common stock, respectively, to independent members of the Company’s Board of Directors for services rendered to the Company pursuant to the 2012 Plan.

 

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 December 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 December 31, 2014, unrecognized compensation expense related to these Stock Option Awards was $49 thousand, which will be amortized through October 2015. These Stock Option Awards expire on November 2, 2016. The fair value for these Stock Option Awards granted was estimated using the Black-Scholes option pricing model with an expected volatility of 25%, a risk-free interest rate of 0.96%, a dividend yield rate of zero, a five-year expected life of the options and a forfeiture rate of 15%.

 

Compensation expense related to the plans was $4.7 million, $1.7 million and $0.5 million during 2014, 2013 and 2012, respectively.

 

21. 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).

 

F-63



Table of Contents

 

Hilltop Holdings Inc. and Subsidiaries

Notes to Consolidated Financial Statements (continued)

 

In July 2013, federal banking regulators released final rules for the regulation of capital and liquidity for U.S. banking organizations, establishing a new comprehensive capital framework (“Basel III”) for U.S. banking organizations that will become effective for reporting periods beginning after January 1, 2015 (subject to a phase-in period through January 2019).

 

In addition, under the final rules, bank holding companies with less than $15 billion in assets as of December 31, 2009 are allowed to continue to include junior subordinated debentures in Tier 1 capital, subject to certain restrictions. However, if an institution grows to above $15 billion in assets as a result of an acquisition, or organically grows to above $15 billion in assets and then makes an acquisition, the combined trust preferred issuances must be phased out of Tier 1 and into Tier 2 capital (75% in 2015 and 100% in 2016). All of the debentures issued to the Trusts, less the common stock of the Trusts, qualified as Tier 1 capital as of December 31, 2014, under guidance issued by the Board of Governors of the Federal Reserve System.

 

Management believes that, as of December 31, 2014, Hilltop and the Bank would meet all applicable capital adequacy requirements under the Basel III capital rules for banks with less than $15 billion in assets on a fully phased-in basis as if such requirements were currently in effect.

 

During September 2013, Hilltop and PlainsCapital contributed capital of $35.0 million and $25.0 million, respectively, to the Bank to provide additional capital in connection with the FNB Transaction.

 

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.

 

 

 

 

 

 

 

 

 

 

 

To Be Well Capitalized

 

 

 

 

 

 

 

Minimum Capital

 

Minimum Capital

 

 

 

Actual

 

Requirements

 

Requirements

 

 

 

Amount

 

Ratio

 

Amount

 

Ratio

 

Amount

 

Ratio

 

December 31, 2014

 

 

 

 

 

 

 

 

 

 

 

 

 

Tier 1 capital (to average assets):

 

 

 

 

 

 

 

 

 

 

 

 

 

Bank

 

$

845,656

 

10.31

%

$

328,025

 

4

%

$

410,031

 

5

%

Hilltop

 

1,231,724

 

14.17

%

347,619

 

4

%

N/A

 

N/A

 

Tier 1 capital (to risk-weighted assets):

 

 

 

 

 

 

 

 

 

 

 

 

 

Bank

 

845,656

 

13.74

%

246,099

 

4

%

369,148

 

6

%

Hilltop

 

1,231,724

 

19.02

%

259,078

 

4

%

N/A

 

N/A

 

Total capital (to risk-weighted assets):

 

 

 

 

 

 

 

 

 

 

 

 

 

Bank

 

888,744

 

14.45

%

492,198

 

8

%

615,247

 

10

%

Hilltop

 

1,275,023

 

19.69

%

518,157

 

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.

 

F-64



Table of Contents

 

Hilltop Holdings Inc. and Subsidiaries

Notes to Consolidated Financial Statements (continued)

 

A reconciliation of equity capital to Tier 1 and total capital (as defined) is as follows (in thousands).

 

 

 

December 31, 2014

 

December 31, 2013

 

 

 

Bank

 

Hilltop

 

Bank

 

Hilltop

 

Total equity capital

 

$

1,104,048

 

$

1,460,452

 

$

985,519

 

$

1,311,141

 

Add:

 

 

 

 

 

 

 

 

 

Minority interests

 

787

 

787

 

781

 

781

 

Trust preferred securities

 

 

65,000

 

 

65,000

 

Net unrealized holding losses on securities available for sale and held in trust

 

3,484

 

(651

)

42,901

 

34,863

 

Deduct:

 

 

 

 

 

 

 

 

 

Goodwill and other disallowed intangible assets

 

(259,048

)

(290,052

)

(264,822

)

(297,174

)

Other

 

(3,615

)

(3,812

)

(2,015

)

(2,187

)

Tier 1 capital (as defined)

 

845,656

 

1,231,724

 

762,364

 

1,112,424

 

Add: Allowable Tier 2 capital

 

 

 

 

 

 

 

 

 

Allowance for loan losses

 

43,088

 

43,088

 

35,407

 

35,407

 

Net unrealized holding losses on equity securities

 

 

211

 

 

905

 

Total capital (as defined)

 

$

888,744

 

$

1,275,023

 

$

797,771

 

$

1,148,736

 

 

Broker-Dealer

 

Pursuant to the net capital requirements of 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 December 31, 2014, FSC had net capital of $64.3 million (the minimum net capital requirement was $5.3 million), net capital maintained by FSC was 24% of aggregate debits, and net capital in excess of the minimum requirement was $59.0 million.

 

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 December 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.

 

F-65



Table of Contents

 

Hilltop Holdings Inc. and Subsidiaries

Notes to Consolidated Financial Statements (continued)

 

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

 

 

 

December 31,

 

 

 

 

 

2014

 

2013

 

 

 

Capital and surplus:

 

 

 

 

 

 

 

National Lloyds Insurance Company

 

$

113,023

 

$

98,602

 

 

 

American Summit Insurance Company

 

28,966

 

26,452

 

 

 

 

 

 

Year Ended December 31,

 

 

 

2014

 

2013

 

2012

 

Statutory net income (loss):

 

 

 

 

 

 

 

National Lloyds Insurance Company

 

$

14,893

 

$

3,583

 

$

(3,858

)

American Summit Insurance Company

 

2,554

 

521

 

972

 

 

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 December 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, 2014, the Company’s insurance subsidiaries’ RBC ratio exceeded the level at which regulatory action would be required.

 

22. Stockholders’ Equity

 

The Bank is subject to certain restrictions on the amount of dividends it may declare without prior regulatory approval. At December 31, 2014, $225.6 million of its earnings was available for dividend declaration without prior regulatory approval.

 

At December 31, 2014, the maximum aggregate dividend that may be paid to NLC from its insurance company subsidiaries in 2015 without regulatory approval is $17.8 million.

 

Series B Preferred Stock

 

As discussed in Note 2, and as a result of the PlainsCapital Merger, the outstanding shares of PlainsCapital’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 the Hilltop 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 Hilltop common stock with respect to dividends and liquidation preference, and qualify as Tier 1 Capital for regulatory purposes. At both December 31, 2014 and 2013, $114.1 million of Hilltop Series B Preferred Stock was outstanding.

 

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 the 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.

 

The terms of the Hilltop Series B Preferred Stock restrict Hilltop’s ability to pay dividends on, make distributions with respect to, or redeem, purchase or acquire, or make a liquidation payment on its common stock and other Hilltop capital stock ranking junior to the Hilltop Series B Preferred Stock, and on other preferred stock and other stock ranking on a parity with the Hilltop Series B Preferred Stock, in the event that Hilltop does not declare dividends on the Hilltop Series B Preferred Stock during any dividend period.

 

F-66



Table of Contents

 

Hilltop Holdings Inc. and Subsidiaries

Notes to Consolidated Financial Statements (continued)

 

As long as shares of Hilltop Series B Preferred Stock remain outstanding, Hilltop may not pay dividends to its common stockholders (nor may Hilltop repurchase or redeem any shares of its common stock) during any quarter in which the Company fails to declare and pay dividends on the Hilltop Series B Preferred Stock and for the next three quarters following such failure. In addition, under the terms of the Hilltop Series B Preferred Stock, Hilltop may only declare and pay dividends on its common stock (or repurchase shares of Hilltop common stock), if, after payment of such dividend, the dollar amount of Hilltop’s Tier 1 capital would be at least ninety percent (90%) of Tier 1 capital as of September 27, 2011, excluding any charge-offs and redemptions of the Hilltop Series B Preferred Stock.

 

The Company may redeem the Hilltop Series B Preferred Stock at any time at its option, at a redemption price of 100% of the liquidation amount plus accrued but unpaid dividends, subject to the approval of the Company’s federal banking regulator.

 

23. Other Noninterest Income and Expense

 

The following tables show the components of other noninterest income and expense (in thousands).

 

 

 

Year Ended December 31,

 

 

 

2014

 

2013

 

2012

 

Other noninterest income:

 

 

 

 

 

 

 

Change in fair value of FSC derivatives

 

$

16,228

 

$

11,427

 

$

238

 

Commission and insurance agency income

 

3,380

 

2,765

 

2,159

 

Direct bill fees and insurance service fee income

 

5,719

 

5,697

 

5,174

 

FDIC Indemnification Asset accretion

 

3,445

 

1,699

 

 

Net gain (loss) from trading securities portfolio

 

2,126

 

(2,773

)

(646

)

Net gain on investment in SWS common stock

 

5,985

 

 

 

Rent and other income from other real estate owned

 

5,703

 

625

 

 

Revenue from check and stored value cards

 

7,614

 

4,682

 

276

 

Service charges on depositor accounts

 

16,730

 

11,376

 

724

 

Trust fees

 

6,330

 

5,050

 

411

 

Other

 

6,281

 

4,122

 

237

 

 

 

$

79,541

 

$

44,670

 

$

8,573

 

 

 

 

 

 

 

 

 

Other noninterest expense:

 

 

 

 

 

 

 

Accounting fees

 

$

5,247

 

$

5,455

 

$

2,269

 

Acquisition costs

 

1,406

 

117

 

6,570

 

Amortization of intangible assets

 

11,138

 

11,087

 

1,986

 

Data processing

 

23,096

 

17,922

 

4,033

 

Funding fees

 

2,521

 

4,403

 

593

 

Management fees

 

 

 

1,025

 

Marketing

 

21,372

 

17,257

 

2,245

 

Other professional services

 

39,310

 

32,526

 

5,004

 

Printing, stationery and supplies

 

4,902

 

4,583

 

735

 

Repossession and foreclosure

 

17,621

 

3,546

 

47

 

Telecommunications

 

11,249

 

8,350

 

834

 

Unreimbursed loan closing costs

 

32,669

 

30,095

 

5,944

 

Other

 

61,048

 

52,606

 

3,083

 

 

 

$

231,579

 

$

187,947

 

$

34,368

 

 

F-67



Table of Contents

 

Hilltop Holdings Inc. and Subsidiaries

Notes to Consolidated Financial Statements (continued)

 

24. 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 managing the re-pricing characteristics of certain assets and liabilities to mitigate potential adverse impacts from changes in interest rates on the net interest margin. PrimeLending has interest rate risk relative to 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”). Additionally, PrimeLending has interest rate risk relative to its MSR asset. During the three months ended September 30, 2014, PrimeLending began using derivative instruments, including interest rate swaps and swaptions, to hedge this risk. 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, forward commitments, and interest rate swaps and swaptions are recorded in other assets or other liabilities, as appropriate, and changes in the fair values of these derivative instruments are recorded as a component of net gains from sale of loans and other mortgage production income. The fair value of PrimeLending’s derivative instruments decreased $16.3 million during the year ended December 31, 2014, compared with an increase of $8.2 million during the year ended December 31, 2013 and a decrease of $5.9 million during the month ended December 31, 2012. 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 MSR, and changes in market interest rates. Changes in market interest rates also conversely affect the value of PrimeLending’s mortgage loans held for sale and its MSR asset, 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 and MSR asset 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 the fair values of FSC’s derivatives increased $16.2 million, $11.4 million and $0.2 million for the years ended December 31, 2014 and 2013 and the month ended December 31, 2012, respectively. The changes in fair value were recorded as a component of other noninterest income.

 

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

 

 

 

December 31, 2014

 

December 31, 2013

 

 

 

Notional

 

Estimated

 

Notional

 

Estimated

 

 

 

Amount

 

Fair Value

 

Amount

 

Fair Value

 

Derivative instruments:

 

 

 

 

 

 

 

 

 

IRLCs

 

$

621,216

 

$

17,057

 

$

602,467

 

$

12,151

 

Commitments to purchase MBSs

 

510,553

 

6,040

 

236,305

 

(109

)

Commitments to sell MBSs

 

1,968,768

 

(12,566

)

1,645,332

 

11,383

 

Interest rate swaps and swaptions

 

83,000

 

425

 

 

 

Fee Award Option

 

 

 

20,432

 

(5,600

)

 

PrimeLending has advanced cash collateral totaling $6.6 million and $1.3 million to offset net liability derivative positions on its commitments to sell MBSs at December 31, 2014 and 2013, respectively. In addition, PrimeLending has advanced cash collateral totaling $3.3 million in initial margin on its interest rate swaps and swaptions at December 31, 2014. These amounts are included in other assets within the consolidated balance sheets.

 

F-68



Table of Contents

 

Hilltop Holdings Inc. and Subsidiaries

Notes to Consolidated Financial Statements (continued)

 

25. 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

 

December 31, 2014

 

 

 

 

 

 

 

 

 

 

 

 

 

Securities borrowed:

 

 

 

 

 

 

 

 

 

 

 

 

 

Institutional counterparties

 

$

152,899

 

$

 

$

152,899

 

$

(152,899

)

$

 

$

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

Interest rate swaps and swaptions:

 

 

 

 

 

 

 

 

 

 

 

 

 

Institutional counterparties

 

425

 

 

425

 

 

 

425

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

Forward MBS derivatives:

 

 

 

 

 

 

 

 

 

 

 

 

 

Institutional counterparties

 

41

 

 

41

 

 

 

41

 

 

 

$

153,365

 

$

 

$

153,365

 

$

(152,899

)

$

 

$

466

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

December 31, 2013

 

 

 

 

 

 

 

 

 

 

 

 

 

Securities borrowed:

 

 

 

 

 

 

 

 

 

 

 

 

 

Institutional counterparties

 

$

107,365

 

$

 

$

107,365

 

$

(107,365

)

$

 

$

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

Forward MBS 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

 

December 31, 2014

 

 

 

 

 

 

 

 

 

 

 

 

 

Securities loaned:

 

 

 

 

 

 

 

 

 

 

 

 

 

Institutional counterparties

 

$

117,822

 

$

 

$

117,822

 

$

(117,822

)

$

 

$

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

Repurchase agreements:

 

 

 

 

 

 

 

 

 

 

 

 

 

Customer counterparties

 

136,396

 

 

136,396

 

(136,396

)

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

Forward MBS derivatives:

 

 

 

 

 

 

 

 

 

 

 

 

 

Institutional counterparties

 

12,829

 

(223

)

12,606

 

 

(6,137

)

6,469

 

 

 

$

267,047

 

$

(223

)

$

266,824

 

$

(254,218

)

$

(6,137

)

$

6,469

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

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 derivatives:

 

 

 

 

 

 

 

 

 

 

 

 

 

Institutional counterparties

 

30

 

 

30

 

 

(17

)

13

 

 

 

$

182,405

 

$

 

$

182,405

 

$

(182,375

)

$

(17

)

$

13

 

 

F-69



Table of Contents

 

Hilltop Holdings Inc. and Subsidiaries

Notes to Consolidated Financial Statements (continued)

 

26. Broker-Dealer and Clearing Organization Receivables and Payables

 

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

 

 

 

December 31,

 

 

 

2014

 

2013

 

Receivables:

 

 

 

 

 

Securities borrowed

 

$

152,899

 

$

107,365

 

Securities failed to deliver

 

3,497

 

7,160

 

Clearing organizations

 

11,471

 

4,698

 

Due from dealers

 

17

 

94

 

 

 

$

167,884

 

$

119,317

 

 

 

 

 

 

 

Payables:

 

 

 

 

 

Securities loaned

 

$

117,822

 

$

74,913

 

Correspondents

 

51,930

 

44,852

 

Securities failed to receive

 

5,960

 

5,523

 

Clearing organizations

 

3,330

 

4,390

 

 

 

$

179,042

 

$

129,678

 

 

27. Deferred Policy Acquisition Costs

 

Policy acquisition expenses, primarily commissions, premium taxes and underwriting expenses related to the successful issuance of a new or renewal policy incurred by NLC are deferred and charged against income ratably over the terms of the related policies. A summary of the activity in deferred policy acquisition costs is as follows (in thousands).

 

 

 

Year Ended December 31,

 

 

 

2014

 

2013

 

Balance, beginning of year

 

$

20,991

 

$

19,812

 

Acquisition expenses capitalized

 

41,034

 

41,771

 

Amortization charged to income

 

(41,609

)

(40,592

)

Balance, end of year

 

$

20,416

 

$

20,991

 

 

Amortization is included in policy acquisition and other underwriting expenses in the accompanying consolidated statements of operations.

 

F-70



Table of Contents

 

Hilltop Holdings Inc. and Subsidiaries

Notes to Consolidated Financial Statements (continued)

 

28. Reserve for Losses and Loss Adjustment Expenses

 

A rollforward of NLC’s reserve for unpaid losses and LAE is as follows (in thousands).

 

 

 

Year Ended December 31,

 

 

 

2014

 

2013

 

2012

 

 

 

 

 

 

 

 

 

Balance, beginning of year

 

$

27,468

 

$

34,012

 

$

44,835

 

Less reinsurance recoverables

 

(4,508

)

(10,385

)

(25,083

)

Net balance, beginning of year

 

22,960

 

23,627

 

19,752

 

 

 

 

 

 

 

 

 

Incurred related to:

 

 

 

 

 

 

 

Current year

 

86,642

 

110,096

 

109,328

 

Prior years

 

7,787

 

659

 

(169

)

Total incurred

 

94,429

 

110,755

 

109,159

 

 

 

 

 

 

 

 

 

Payments related to:

 

 

 

 

 

 

 

Current year

 

(73,841

)

(96,284

)

(90,743

)

Prior years

 

(18,147

)

(15,138

)

(14,541

)

Total payments

 

(91,988

)

(111,422

)

(105,284

)

 

 

 

 

 

 

 

 

Net balance, end of year

 

25,401

 

22,960

 

23,627

 

Plus reinsurance recoverables

 

4,315

 

4,508

 

10,385

 

Balance, end of year

 

$

29,716

 

$

27,468

 

$

34,012

 

 

The increase in the NLC’s reserves at December 31, 2014 as compared with December 31, 2013 of $2.2 million is primarily due to increased reserves attributable to the prior period adverse development. This prior period adverse development totaled $7.8 million during 2014 and was primarily related to litigation emerging from a series of hail storms within the 2012 accident year.

 

29. 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 December 31 2014, reinsurance receivables have a carrying value of $4.9 million, which is included in other assets within the consolidated balance sheet. There was no allowance for uncollectible accounts at December 31, 2014, based on NLC’s quality requirements.

 

F-71



Table of Contents

 

Hilltop Holdings Inc. and Subsidiaries

Notes to Consolidated Financial Statements (continued)

 

Reinsurers with a balance in excess of 5% of the Company’s outstanding reinsurance receivables at December 31, 2014 are listed below (in thousands).

 

 

 

Balances

 

 

 

 

 

Due From

 

A.M. Best

 

 

 

Reinsurers

 

Rating

 

 

 

 

 

 

 

Federal Emergency Management Agency

 

$

3,476

 

N/A

 

Everest Re

 

480

 

A+

 

Lloyd’s Syndicate # 2001

 

432

 

A+

 

R+V Versicherung AG

 

360

 

N/A

 

General Reinsurance

 

320

 

A++

 

Lloyd’s Syndicate #2791

 

273

 

N/A

 

 

 

$

5,341

 

 

 

 

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

 

 

 

Year Ended December 31,

 

 

 

2014

 

2013

 

2012

 

 

 

Written

 

Earned

 

Written

 

Earned

 

Written

 

Earned

 

Premiums from direct business

 

$

172,464

 

$

173,496

 

$

173,982

 

$

168,942

 

$

163,780

 

$

162,383

 

Reinsurance assumed

 

9,746

 

8,960

 

7,987

 

7,202

 

6,422

 

5,882

 

Reinsurance ceded

 

(17,845

)

(17,932

)

(18,528

)

(18,611

)

(19,751

)

(21,564

)

Net premiums

 

$

164,365

 

$

164,524

 

$

163,441

 

$

157,533

 

$

150,451

 

$

146,701

 

 

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

 

 

 

Year Ended December 31,

 

 

 

2014

 

2013

 

2012

 

Loss and LAE incurred

 

$

97,011

 

$

117,089

 

$

115,347

 

Reinsurance recoverables

 

(2,582

)

(6,334

)

(6,188

)

Net loss and LAE incurred

 

$

94,429

 

$

110,755

 

$

109,159

 

 

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

 

NLC’s liabilities for losses and loss adjustment expenses include liabilities for reported losses, liabilities for incurred but not reported, or IBNR, losses and liabilities for loss adjustment expenses, or LAE, less a reduction for reinsurance recoverables related to those liabilities. The amount of liabilities for reported claims is based primarily on a claim-by-claim evaluation of coverage, liability, injury severity or scope of property damage, and any other information considered relevant to estimating exposure presented by the claim. The amounts of liabilities for IBNR losses and LAE are estimated on the basis of historical trends, adjusted for changes in loss costs, underwriting standards, policy provisions, product mix and other factors. Estimating the liability for unpaid losses and LAE is inherently judgmental and is influenced by factors that are subject to significant variation. Liabilities for LAE are intended to cover the ultimate cost of settling claims, including investigation and defense of lawsuits resulting from such claims. Based upon the contractual terms of the reinsurance agreements, reinsurance recoverables offset, in part, NLC’s gross liabilities.

 

F-72



Table of Contents

 

Hilltop Holdings Inc. and Subsidiaries

Notes to Consolidated Financial Statements (continued)

 

At December 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 December 31, 2014, total retention for any one catastrophe that affects both NLIC and ASIC was limited to $8 million in the aggregate.

 

Effective July 1, 2013, NLC renewed its catastrophic reinsurance contract for its third and fourth layers of reinsurance for a two year period. In the contract renewal, the coverage provided by the fourth layer changed to reflect the reduction of exposure in Texas primarily as a result of NLIC exiting the Texas coast and reducing its exposure in Harris County, Texas. The coverage provides $40 million in excess of $100 million loss, resulting in catastrophic excess of loss reinsurance coverage up to $140 million. Effective January 1, 2014, NLC renewed its reinsurance contract for its first and second layers of reinsurance for an eighteen month period.

 

Effective January 1, 2015, NLC renewed its underlying excess of loss contract that provides $10 million aggregate coverage for sub-catastrophic events. NLC retains a 9% participation in this coverage.

 

During 2014, NLC experienced no significant catastrophes that resulted in losses in excess of retention at NLIC, compared to two significant catastrophes during 2013 and one significant catastrophe during 2012. NLC did not experience any significant catastrophe that resulted in losses in excess of retention at ASIC during 2014, 2013 or 2012. There were eight tornado, hail and wind storms during 2014 that fit the coverage criteria for the underlying excess of loss contract providing aggregate coverage for sub-catastrophic events. These events had a gross incurred loss total of $21.7 million, which developed a reinsured recoverable of $1.8 million at the 66% subscription level. The two tornado, hail and wind storms that exceeded retention in 2013 had incurred losses of $18.3 million. The Texas hail storm that exceeded retention in 2012 had incurred losses of $8.3 million. These losses have no effect on net loss and LAE incurred because the catastrophic events exceeded retention levels and are fully recoverable. The primary financial effect beyond the reinsurance retention is additional reinstatement premium payable to the affected reinsurers. Reinstatement premiums during 2014, 2013 and 2012 of $0.2 million, $0.3 million and $0.5 million, respectively, are recorded as ceded premiums.

 

30. 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.

 

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

 

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.

 

F-73



Table of Contents

 

Hilltop Holdings Inc. and Subsidiaries

Notes to Consolidated Financial Statements (continued)

 

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

 

 

 

 

 

All Other and

 

Hilltop

 

Year Ended December 31, 2014

 

Banking

 

Broker-Dealer

 

Origination

 

Insurance

 

Corporate

 

Eliminations

 

Consolidated

 

Net interest income (expense)

 

$

334,377

 

$

12,144

 

$

(12,591

)

$

3,672

 

$

5,219

 

$

18,320

 

$

361,141

 

Provision for loan losses

 

16,916

 

17

 

 

 

 

 

16,933

 

Noninterest income

 

67,438

 

119,451

 

456,776

 

173,577

 

5,985

 

(23,916

)

799,311

 

Noninterest expense

 

245,790

 

124,715

 

431,820

 

151,541

 

13,878

 

(2,391

)

965,353

 

Income (loss) before income taxes

 

$

139,109

 

$

6,863

 

$

12,365

 

$

25,708

 

$

(2,674

)

$

(3,205

)

$

178,166

 

 

 

 

 

 

 

 

Mortgage

 

 

 

 

 

All Other and

 

Hilltop

 

Year Ended December 31, 2013

 

Banking

 

Broker-Dealer

 

Origination

 

Insurance

 

Corporate

 

Eliminations

 

Consolidated

 

Net interest income (expense)

 

$

293,254

 

$

12,064

 

$

(37,840

)

$

7,442

 

$

(1,597

)

$

22,878

 

$

296,201

 

Provision for loan losses

 

37,140

 

18

 

 

 

 

 

37,158

 

Noninterest income

 

71,045

 

102,714

 

537,497

 

166,163

 

 

(27,334

)

850,085

 

Noninterest expense

 

155,102

 

112,360

 

472,284

 

166,006

 

10,439

 

(4,456

)

911,735

 

Income (loss) before income taxes

 

$

172,057

 

$

2,400

 

$

27,373

 

$

7,599

 

$

(12,036

)

$

 

$

197,393

 

 

 

 

 

 

 

 

Mortgage

 

 

 

 

 

All Other and

 

Hilltop

 

Year Ended December 31, 2012

 

Banking

 

Broker-Dealer

 

Origination

 

Insurance

 

Corporate

 

Eliminations

 

Consolidated

 

Net interest income (expense)

 

$

24,885

 

$

1,191

 

$

(4,987

)

$

4,730

 

$

39

 

$

2,984

 

$

28,842

 

Provision for loan losses

 

3,670

 

130

 

 

 

 

 

3,800

 

Noninterest income

 

4,601

 

10,909

 

57,618

 

154,147

 

 

(3,043

)

224,232

 

Noninterest expense

 

16,130

 

11,078

 

50,296

 

163,585

 

14,487

 

(59

)

255,517

 

Income (loss) before income taxes

 

$

9,686

 

$

892

 

$

2,335

 

$

(4,708

)

$

(14,448

)

$

 

$

(6,243

)

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

December 31, 2014

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

Goodwill

 

$

207,741

 

$

7,008

 

$

13,071

 

$

23,988

 

$

 

$

 

$

251,808

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

Total assets

 

$

8,036,729

 

$

758,636

 

$

1,498,846

 

$

328,693

 

$

1,522,655

 

$

(2,903,142

)

$

9,242,416

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

December 31, 2013

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

Goodwill

 

$

207,741

 

$

7,008

 

$

13,071

 

$

23,988

 

$

 

$

 

$

251,808

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

Total assets

 

$

7,981,517

 

$

520,412

 

$

1,249,091

 

$

308,160

 

$

1,316,398

 

$

(2,471,456

)

$

8,904,122

 

 

31. Earnings (Loss) per Common Share

 

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

 

 

 

Year Ended December 31,

 

 

 

2014

 

2013

 

2012

 

Basic earnings (loss) per share:

 

 

 

 

 

 

 

Income (loss) applicable to Hilltop common stockholders

 

$

105,947

 

$

121,015

 

$

(5,851

)

Less: income applicable to participating shares

 

(547

)

(672

)

 

Net earnings (loss) available to Hilltop common stockholders

 

$

105,400

 

$

120,343

 

$

(5,851

)

 

 

 

 

 

 

 

 

Weighted average shares outstanding - basic

 

89,710

 

84,382

 

58,754

 

 

 

 

 

 

 

 

 

Basic earnings (loss) per common share

 

$

1.18

 

$

1.43

 

$

(0.10

)

 

 

 

 

 

 

 

 

Diluted earnings (loss) per share:

 

 

 

 

 

 

 

Income (loss) applicable to Hilltop common stockholders

 

$

105,947

 

$

121,015

 

$

(5,851

)

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

 

 

5,059

 

 

Net earnings (loss) available to Hilltop common stockholders

 

$

105,947

 

$

126,074

 

$

(5,851

)

 

 

 

 

 

 

 

 

Weighted average shares outstanding - basic

 

89,710

 

84,382

 

58,754

 

Effect of potentially dilutive securities

 

863

 

5,949

 

 

Weighted average shares outstanding - diluted

 

90,573

 

90,331

 

58,754

 

 

 

 

 

 

 

 

 

Diluted earnings (loss) per common share

 

$

1.17

 

$

1.40

 

$

(0.10

)

 

F-74



Table of Contents

 

Hilltop Holdings Inc. and Subsidiaries

Notes to Consolidated Financial Statements (continued)

 

During 2012, the computation of diluted loss 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 prices for the noted period. Additionally, options to purchase 688,000 weighted average outstanding shares of Hilltop’s common stock were not included in the computation of diluted loss per common share during 2012, as their inclusion would have been anti-dilutive.

 

32. Condensed Financial Statements of Parent

 

Condensed financial statements of Hilltop (parent only) follow (in thousands). Investments in subsidiaries are determined using the equity method of accounting.

 

Condensed Statements of Operations and Comprehensive Income (Loss)

 

 

 

Year Ended December 31,

 

 

 

2014

 

2013

 

2012

 

Investment income

 

$

5,219

 

$

6,635

 

$

7,035

 

Interest expense

 

 

8,232

 

6,996

 

Net gain on investment in SWS common stock

 

5,985

 

 

 

General and administrative expense

 

13,878

 

10,439

 

14,488

 

Loss before income taxes, equity in undistributed earnings of subsidiaries and preferred stock activity

 

(2,674

)

(12,036

)

(14,449

)

Income tax benefit

 

(592

)

(4,680

)

(3,313

)

Equity in undistributed earnings of subsidiaries

 

114,640

 

134,065

 

6,038

 

Net income (loss)

 

$

112,558

 

$

126,709

 

$

(5,098

)

Other comprehensive income (loss), net

 

35,514

 

(43,418

)

(4,900

)

Comprehensive income (loss)

 

$

148,072

 

$

83,291

 

$

(9,998

)

 

Condensed Balance Sheets

 

 

 

December 31,

 

 

 

2014

 

2013

 

2012

 

Assets

 

 

 

 

 

 

 

Cash and cash equivalents

 

$

145,948

 

$

163,856

 

$

204,754

 

Securities, available for sale

 

 

69,023

 

64,082

 

Investment in subsidiaries

 

1,218,182

 

1,069,226

 

944,546

 

Investment in SWS common stock

 

70,282

 

 

 

Other assets

 

88,243

 

14,293

 

27,743

 

Total assets

 

$

1,522,655

 

$

1,316,398

 

$

1,241,125

 

 

 

 

 

 

 

 

 

Liabilities and Stockholders’ Equity

 

 

 

 

 

 

 

Accounts payable and accrued expenses

 

$

62,203

 

$

5,257

 

$

5,779

 

Notes payable

 

 

 

90,850

 

Stockholders’ equity

 

1,460,452

 

1,311,141

 

1,144,496

 

Total liabilities and stockholders’ equity

 

$

1,522,655

 

$

1,316,398

 

$

1,241,125

 

 

F-75



Table of Contents

 

Hilltop Holdings Inc. and Subsidiaries

Notes to Consolidated Financial Statements (continued)

 

Condensed Statements of Cash Flows

 

 

 

Year Ended December 31,

 

 

 

2014

 

2013

 

2012

 

Operating Activities

 

 

 

 

 

 

 

Net income (loss)

 

$

112,558

 

$

126,709

 

$

(5,098

)

Adjustments to reconcile net income (loss) to net cash provided by (used in) operating activities:

 

 

 

 

 

 

 

Equity in undistributed earnings of subsidiaries

 

(114,640

)

(134,065

)

(6,038

)

Deferred income taxes

 

156

 

8,850

 

(1,011

)

Net gain on investment in SWS common stock

 

(5,985

)

 

 

Loss on redemption of senior exchangeable notes

 

 

3,733

 

 

Other, net

 

(1,379

)

132

 

(3,370

)

Net cash provided by (used in) operating activities

 

(9,290

)

5,359

 

(15,517

)

 

 

 

 

 

 

 

 

Investing Activities

 

 

 

 

 

 

 

Advance to subsidiary

 

(6,000

)

 

 

Capital contribution to subsidiary

 

 

(35,000

)

 

Cash paid for acquisition

 

 

 

(311,805

)

Net cash used in investing activities

 

(6,000

)

(35,000

)

(311,805

)

 

 

 

 

 

 

 

 

Financing Activities

 

 

 

 

 

 

 

Payments to repurchase common stock

 

 

 

(1,298

)

Redemption of senior exchangeable notes

 

 

(11,088

)

 

Dividends paid on preferred stock

 

(5,619

)

(2,985

)

 

Other, net

 

3,001

 

2,816

 

 

Net cash used in financing activities

 

(2,618

)

(11,257

)

(1,298

)

 

 

 

 

 

 

 

 

Net change in cash and cash equivalents

 

(17,908

)

(40,898

)

(328,620

)

Cash and cash equivalents, beginning of year

 

163,856

 

204,754

 

533,374

 

Cash and cash equivalents, end of year

 

$

145,948

 

$

163,856

 

$

204,754

 

 

 

 

 

 

 

 

 

Supplemental Schedule of Non-Cash Activities

 

 

 

 

 

 

 

Conversion of available for sale investment in SWS common stock

 

$

71,502

 

$

 

$

 

Redemption of senior exchangeable notes for common stock

 

$

 

$

83,950

 

$

 

Preferred stock issued in acquisition

 

$

 

$

 

$

114,068

 

Common stock issued in acquisition

 

$

 

$

 

$

387,583

 

 

During September 2013, Hilltop contributed capital of $35.0 million to the Bank to provide additional capital in connection with the FNB Transaction.

 

As discussed in Note 1 to the consolidated financial statements, Hilltop’s investment in SWS common stock is accounted for under the provisions of the Fair Value Option effective October 2, 2014. Hilltop had previously accounted for its investments in SWS as available for sale securities. Under the Fair Value Option, Hilltop’s investment in SWS common stock is recorded at fair value, with changes in fair value being recorded in other noninterest income within Hilltop’s condensed statement of operations rather than as a component of other comprehensive income. Hilltop’s election to apply the provisions of the Fair Value Option resulted in Hilltop recording those unrealized gains previously associated with its investment in SWS common stock of $7.2 million. For the period from October 3, 2014 through December 31, 2014, the change in fair value of Hilltop’s investment in SWS common stock resulted in a loss of $1.2 million. In the aggregate, Hilltop recorded a $6.0 million net gain in income within Hilltop’s condensed statement of operations during 2014.

 

F-76



Table of Contents

 

Hilltop Holdings Inc. and Subsidiaries

Notes to Consolidated Financial Statements (continued)

 

33. Recently Issued Accounting Standards

 

In November 2014, the FASB issued ASU 2014-17 to provide companies with the option to apply pushdown accounting in its separate financial statements upon occurrence of an event in which an acquirer obtains control of the acquired entity. The election to apply pushdown accounting can be made either in the period in which the change of control occurred, or in a subsequent period. If the election is made in a subsequent period, the application of this guidance would be considered a change in accounting principle. The amendments in this ASU are effective as of November 18, 2014. The adoption will not have a significant impact on the Company’s consolidated financial statements.

 

In August 2014, the FASB issued ASU No. 2014-14 to reduce diversity in practice by clarifying how to classify and measure certain government-guaranteed mortgage loans upon foreclosure. The amendment is 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. The Company adopted the amendment as of January 1, 2015 using the prospective transition method and does not expect the amendment to have a significant effect on its future consolidated financial statements.

 

In May 2014, the FASB issued ASU No. 2014-09 which clarifies the principles for recognizing revenue from contracts with customers. The amendment outlines a single comprehensive model for entities to depict the transfer of goods or services to customers in amounts that reflect the payment to which a company expects to be entitled in exchange for those goods or services. The amendment also requires additional disclosure about the nature, amount, timing and uncertainty of revenue and cash flows arising from customer contracts, including significant judgments and changes in judgments and assets recognized from costs incurred to obtain or fulfill a contract. The amendment is effective for annual periods, and interim reporting periods within those annual periods, beginning after December 15, 2016 and may be adopted using either a full retrospective transition method or a modified retrospective transition method. Early adoption is not permitted. The Company is currently evaluating the provisions of the amendment and the impact on its future consolidated financial statements.

 

In April 2014, the FASB issued ASU No. 2014-08 which raises the threshold for a disposal to qualify as a discontinued operation and requires new disclosures of both discontinued operations and certain other disposals that do not meet the definition of a discontinued operation. The amendment is intended to reduce the frequency of disposals reported as discontinued operations by focusing on strategic shifts that have or will have a major effect on an entity’s operations and financial results and will permit companies to have continuing cash flows and significant continuing involvement with the disposed component. The amendment is effective for disposals (or classifications as held for sale) and acquired businesses or nonprofit activities that are classified as held for sale upon acquisition that occur within annual periods beginning on or after December 15, 2014, and interim periods within those years. As such, the Company will evaluate the provisions of the amendment as it relates to any potential disposals or acquisitions beginning on or after January 1, 2015.

 

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. The Company adopted the amendment as of January 1, 2015 using the prospective transition method and does not expect the amendment 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

 

F-77



Table of Contents

 

Hilltop Holdings Inc. and Subsidiaries

Notes to Consolidated Financial Statements (continued)

 

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.

 

34. Selected Quarterly Financial Information (Unaudited)

 

Selected quarterly financial information is summarized as follows (in thousands, except per share data).

 

 

 

Year Ended December 31, 2014

 

 

 

 

 

Fourth

 

Third

 

Second

 

First

 

Full

 

 

 

Quarter

 

Quarter

 

Quarter

 

Quarter

 

Year

 

Interest income

 

$

99,316

 

$

93,217

 

$

104,408

 

$

91,828

 

$

388,769

 

Interest expense

 

7,802

 

7,457

 

5,962

 

6,407

 

27,628

 

Net interest income

 

91,514

 

85,760

 

98,446

 

85,421

 

361,141

 

Provision for loan losses

 

4,125

 

4,033

 

5,533

 

3,242

 

16,933

 

Noninterest income

 

213,795

 

212,135

 

203,281

 

170,100

 

799,311

 

Noninterest expense

 

246,768

 

254,744

 

251,212

 

212,629

 

965,353

 

Income before income taxes

 

54,416

 

39,118

 

44,982

 

39,650

 

178,166

 

Income tax provision

 

20,950

 

14,010

 

16,294

 

14,354

 

65,608

 

Net income

 

33,466

 

25,108

 

28,688

 

25,296

 

112,558

 

Less: Net income attributable to noncontrolling interest

 

325

 

296

 

177

 

110

 

908

 

Income attributable to Hilltop

 

$

33,141

 

$

24,812

 

$

28,511

 

$

25,186

 

$

111,650

 

Dividends on preferred stock

 

1,425

 

1,426

 

1,426

 

1,426

 

5,703

 

Income applicable to Hilltop common stockholders

 

$

31,716

 

$

23,386

 

$

27,085

 

$

23,760

 

$

105,947

 

 

 

 

 

 

 

 

 

 

 

 

 

Earnings per common share:

 

 

 

 

 

 

 

 

 

 

 

Basic

 

$

0.35

 

$

0.26

 

$

0.30

 

$

0.26

 

$

1.18

 

Diluted

 

$

0.35

 

$

0.26

 

$

0.30

 

$

0.26

 

$

1.17

 

 

 

 

Year Ended December 31, 2013

 

 

 

 

 

Fourth

 

Third

 

Second

 

First

 

Full

 

 

 

Quarter

 

Quarter

 

Quarter

 

Quarter

 

Year

 

Interest income

 

$

98,601

 

$

79,702

 

$

76,168

 

$

74,604

 

$

329,075

 

Interest expense

 

10,002

 

7,786

 

7,743

 

7,343

 

32,874

 

Net interest income

 

88,599

 

71,916

 

68,425

 

67,261

 

296,201

 

Provision for loan losses

 

2,206

 

10,658

 

11,289

 

13,005

 

37,158

 

Noninterest income

 

182,479

 

215,095

 

239,233

 

213,278

 

850,085

 

Noninterest expense

 

219,752

 

216,592

 

260,400

 

214,991

 

911,735

 

Income before income taxes

 

49,120

 

59,761

 

35,969

 

52,543

 

197,393

 

Income tax provision

 

18,090

 

20,115

 

13,309

 

19,170

 

70,684

 

Net income

 

31,030

 

39,646

 

22,660

 

33,373

 

126,709

 

Less: Net income attributable to noncontrolling interest

 

160

 

339

 

568

 

300

 

1,367

 

Income attributable to Hilltop

 

$

30,870

 

$

39,307

 

$

22,092

 

$

33,073

 

$

125,342

 

Dividends on preferred stock

 

1,342

 

1,133

 

1,149

 

703

 

4,327

 

Income applicable to Hilltop common stockholders

 

$

29,528

 

$

38,174

 

$

20,943

 

$

32,370

 

$

121,015

 

 

 

 

 

 

 

 

 

 

 

 

 

Earnings per common share:

 

 

 

 

 

 

 

 

 

 

 

Basic

 

$

0.34

 

$

0.45

 

$

0.25

 

$

0.39

 

$

1.43

 

Diluted

 

$

0.34

 

$

0.43

 

$

0.24

 

$

0.39

 

$

1.40

 

 

F-78



Table of Contents

 

Hilltop Holdings Inc. and Subsidiaries

Notes to Consolidated Financial Statements (continued)

 

35. Subsequent Events

 

On January 1, 2015, Hilltop completed its acquisition of SWS in a stock and cash transaction, whereby SWS merged with and into Hilltop Securities, a wholly owned subsidiary of Hilltop formed for the purpose of facilitating this transaction (the “SWS Merger”). SWS’s broker-dealer subsidiaries, Southwest Securities, Inc. (“Southwest Securities”) and SWS Financial Services, Inc. (“SWS Financial”), became subsidiaries of Hilltop Securities. Immediately following the SWS Merger, SWS’s banking subsidiary, Southwest Securities, FSB, was merged into the Bank, an indirect wholly owned subsidiary of Hilltop. As a result of the SWS Merger, each outstanding share of SWS common stock was converted into the right to receive 0.2496 shares of Hilltop common stock and $1.94 in cash, equating to $6.92 per share based on Hilltop’s closing price on December 31, 2014 and resulting in an aggregate purchase price of $349.0 million, consisting of 10.0 million shares of common stock, $78.2 million in cash and $70.3 million associated with Hilltop’s existing investment in SWS common stock. Additionally, due to appraisal rights proceedings filed in connection with the SWS Merger, the merger consideration is subject to change, and is therefore, preliminary as of the date of this report. The SWS Merger will be accounted for using the acquisition method of accounting, and accordingly, purchased assets, including identifiable intangible assets and assumed liabilities will be recorded at their respective acquisition date fair values. Because of (i) the short time period between the acquisition date and the date the Company’s financial statements were issued (February 26, 2015) and (ii) the work of third party specialists engaged to assist in valuing certain assets and liabilities, along with management’s review and approval, not being complete, the Company used significant estimates and assumptions to value certain identifiable assets acquired and liabilities assumed. The acquisition date valuations related to loans, premises and equipment, intangible assets, assumed liabilities and taxes are considered preliminary and could differ significantly when finalized.

 

A summary of the preliminary estimated fair values of the identifiable assets acquired, and liabilities assumed, of SWS at January 1, 2015 are summarized in the following table (in thousands).

 

Cash and due from banks

 

$

118,538

 

Federal funds sold and securities purchased agreements to resell

 

44,741

 

Assets segregated for regulatory purposes

 

181,610

 

Securities

 

707,476

 

Non-covered loans, net

 

854, 778

 

Broker-dealer and clearing organization receivables

 

1,261,022

 

Other assets

 

118,910

 

Total identifiable assets acquired

 

3,287,075

 

 

 

 

 

Deposits

 

(1,287,394

)

Broker-dealer and clearing organization payables

 

(1,113,075

)

Short-term borrowings

 

(164,240

)

Advances from Federal Home Loan Bank

 

(76,643

)

Other liabilities

 

(216,411

)

Total liabilities assumed

 

(2,857,763

)

Preliminary estimated bargain purchase gain

 

(80,326

)

 

 

348,986

 

Less Hilltop existing investment in SWS

 

(70,282

)

Net identifiable assets acquired

 

$

278,704

 

 

The following table discloses the impact of SWS on the Company’s results of operations (excluding the impact of acquisition-related merger and restructuring charges discussed below). The table also presents unaudited pro forma results had the SWS Merger taken place on January 1, 2014 and includes the estimated impact of purchase accounting adjustments (in thousands). The purchase accounting adjustments reflect the impact of recording the acquired loans at fair value, including the estimated accretion of the purchase discount on the loan portfolio. The unaudited pro forma results do not include any potential operating cost savings as a result of the SWS Merger. Further, certain costs associated with any restructuring or integration activities are also not reflected in the unaudited pro forma results. Unaudited pro forma results exclude nonrecurring items resulting directly from the SWS Merger and that do not have a continuing impact on results of operations.

 

F-79



Table of Contents

 

Hilltop Holdings Inc. and Subsidiaries

Notes to Consolidated Financial Statements (continued)

 

The unaudited pro forma results are not indicative of what would have occurred had the SWS Merger taken place on the indicated date.

 

 

 

Twelve Months

 

 

 

Ended

 

 

 

December 31, 2014

 

Net interest income

 

$

420,894

 

Other revenues

 

1,005,701

 

Net income

 

110,279

 

 

 

 

 

 

In connection with the SWS Merger, FSC and its related entities also became subsidiaries of Hilltop Securities. First Southwest, Southwest Securities and SWS Financial will continue to operate as separate broker-dealers, under coordinated leadership, until such time as the necessary regulatory approvals are obtained and systems integrations are complete.

 

F-80