Table of Contents
UNITED STATES
SECURITIES AND EXCHANGE COMMISSION
Washington, DC 20549
FORM 10-Q
☒
QUARTERLY REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES EXCHANGE ACT OF 1934
For the quarterly period ended March 31, 2021
☐
TRANSITION REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES EXCHANGE ACT OF 1934
Commission File Number: 1-31987
Hilltop Holdings Inc.
(Exact name of registrant as specified in its charter)
Maryland
84-1477939
(State or other jurisdiction of incorporation or
(I.R.S. Employer Identification No.)
organization)
6565 Hillcrest Avenue
Dallas, TX
75205
(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
Trading symbol
Name of each exchange on which registered
Common Stock, par value $0.01 per share
HTH
New York Stock Exchange
Indicate by check mark whether the registrant (1) has filed all reports required to be filed by Section 13 or 15(d) of the Securities Exchange Act of 1934 during the preceding 12 months (or for such shorter period that the registrant was required to file such reports), and (2) has been subject to such filing requirements for the past 90 days. Yes ☒ No ◻
Indicate by check mark whether the registrant has submitted electronically every Interactive Data File required to be submitted 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 such files). Yes ☒ No ◻
Indicate by check mark whether the registrant is a large accelerated filer, an accelerated filer, a non-accelerated filer, smaller reporting company or an emerging growth company. See the definitions of “large accelerated filer,” “accelerated filer,” “smaller reporting company” and “emerging growth company” in Rule 12b-2 of the Exchange Act.
Large accelerated filer ⌧
Accelerated filer ◻
Non-accelerated filer ◻
Smaller reporting company ☐
Emerging growth company ☐
If an emerging growth company, indicate by check mark if the registrant has elected not to use the extended transition period for complying with any new or revised financial accounting standards provided pursuant to Section 13(a) of the Exchange Act. ☐
Indicate by check mark whether the registrant is a shell company (as defined in Rule 12b-2 of the Act). Yes ☐ No ⌧
The number of shares of the registrant's common stock outstanding at April 23, 2021 was 82,260,548.
HILLTOP HOLDINGS INC.
FOR THE QUARTER ENDED March 31, 2021
TABLE OF CONTENTS
PART I — FINANCIAL INFORMATION
Item 1.
Financial Statements
Consolidated Balance Sheets
3
Consolidated Statements of Operations
4
Consolidated Statements of Comprehensive Income
5
Consolidated Statements of Stockholders’ Equity
6
Consolidated Statements of Cash Flows
7
Notes to Consolidated Financial Statements
8
Item 2.
Management’s Discussion and Analysis of Financial Condition and Results of Operations
42
Item 3.
Quantitative and Qualitative Disclosures About Market Risk
84
Item 4.
Controls and Procedures
87
PART II — OTHER INFORMATION
Legal Proceedings
88
Item 1A.
Risk Factors
Unregistered Sales of Equity Securities and Use of Proceeds
Item 6.
Exhibits
89
2
HILLTOP HOLDINGS INC. AND SUBSIDIARIES
CONSOLIDATED BALANCE SHEETS
(in thousands, except share and per share data)
(Unaudited)
March 31,
December 31,
2021
2020
Assets
Cash and due from banks
$
1,564,489
1,062,560
Federal funds sold
396
386
Assets segregated for regulatory purposes
273,393
290,357
Securities purchased under agreements to resell
106,342
80,319
Securities:
Trading, at fair value
528,712
694,255
Available for sale, at fair value, net (amortized cost of $1,715,428 and 1,435,919, respectively)
1,715,406
1,462,205
Held to maturity, at amortized cost, net (fair value of $311,402 and $326,671, respectively)
300,088
311,944
Equity, at fair value
189
140
2,544,395
2,468,544
Loans held for sale
2,538,986
2,788,386
Loans held for investment, net of unearned income
7,810,657
7,693,141
Allowance for credit losses
(144,499)
(149,044)
Loans held for investment, net
7,666,158
7,544,097
Broker-dealer and clearing organization receivables
1,596,817
1,404,727
Premises and equipment, net
213,304
211,595
Operating lease right-of-use assets
101,055
105,757
Mortgage servicing rights
142,125
143,742
Other assets
648,895
555,983
Goodwill
267,447
Other intangible assets, net
19,035
20,364
Total assets
17,682,837
16,944,264
Liabilities and Stockholders' Equity
Deposits:
Noninterest-bearing
4,031,181
3,612,384
Interest-bearing
7,701,598
7,629,935
Total deposits
11,732,779
11,242,319
Broker-dealer and clearing organization payables
1,546,227
1,368,373
Short-term borrowings
676,652
695,798
Securities sold, not yet purchased, at fair value
97,055
79,789
Notes payable
401,713
381,987
Operating lease liabilities
120,339
125,450
Junior subordinated debentures
67,012
Other liabilities
595,045
632,889
Total liabilities
15,236,822
14,593,617
Commitments and contingencies (see Notes 14 and 15)
Stockholders' equity:
Hilltop stockholders' equity:
Common stock, $0.01 par value, 125,000,000 shares authorized; 82,260,548 and 82,184,893 shares issued and outstanding at March 31, 2021 and December 31, 2020, respectively
823
822
Additional paid-in capital
1,319,518
1,317,929
Accumulated other comprehensive income
3,486
17,763
Retained earnings
1,094,727
986,792
Deferred compensation employee stock trust, net
752
771
Employee stock trust (6,060 and 6,930 shares, at cost, at March 31, 2021 and December 31, 2020, respectively)
(121)
(138)
Total Hilltop stockholders' equity
2,419,185
2,323,939
Noncontrolling interests
26,830
26,708
Total stockholders' equity
2,446,015
2,350,647
Total liabilities and stockholders' equity
See accompanying notes.
CONSOLIDATED STATEMENTS OF OPERATIONS
(in thousands, except per share data)
Three Months Ended March 31,
Interest income:
Loans, including fees
104,277
111,168
Securities borrowed
28,972
13,327
Taxable
10,251
15,695
Tax-exempt
2,102
1,610
Other
1,321
3,075
Total interest income
146,923
144,875
Interest expense:
Deposits
7,741
15,124
Securities loaned
25,486
11,277
2,013
4,744
4,797
2,418
562
850
642
126
Total interest expense
41,241
34,539
Net interest income
105,682
110,336
Provision for (reversal of) credit losses
(5,109)
34,549
Net interest income after provision for (reversal of) credit losses
110,791
75,787
Noninterest income:
Net gains from sale of loans and other mortgage production income
267,080
150,486
Mortgage loan origination fees
43,155
28,554
Securities commissions and fees
38,314
40,069
Investment and securities advisory fees and commissions
27,695
23,180
41,341
29,424
Total noninterest income
417,585
271,713
Noninterest expense:
Employees' compensation and benefits
270,353
196,356
Occupancy and equipment, net
24,429
19,522
Professional services
13,585
14,798
58,295
51,225
Total noninterest expense
366,662
281,901
Income from continuing operations before income taxes
161,714
65,599
Income tax expense
37,770
15,148
Income from continuing operations
123,944
50,451
Income from discontinued operations, net of income taxes
—
3,151
Net income
53,602
Less: Net income attributable to noncontrolling interest
3,599
3,966
Income attributable to Hilltop
120,345
49,636
Earnings per common share:
Basic:
Earnings from continuing operations
1.46
0.51
Earnings from discontinued operations
0.04
0.55
Diluted:
Weighted average share information:
Basic
82,169
90,509
Diluted
82,657
90,550
CONSOLIDATED STATEMENTS OF COMPREHENSIVE INCOME
(in thousands)
Other comprehensive income:
Change in fair value of cash flow and fair value hedges, net of tax of $505 and $(933), respectively
6,035
(3,200)
Net unrealized gains (losses) on securities available for sale, net of tax of $(5,974) and $3,726, respectively
(20,241)
12,605
Reclassification adjustment for gains (losses) included in net income, net of tax of $(21) and $34, respectively
(71)
115
Comprehensive income
109,667
63,122
Less: comprehensive income attributable to noncontrolling interest
Comprehensive income applicable to Hilltop
106,068
59,156
CONSOLIDATED STATEMENTS OF STOCKHOLDERS’ EQUITY
Accumulated
Deferred
Total
Additional
Compensation
Employee
Hilltop
Common Stock
Paid-in
Comprehensive
Retained
Employee Stock
Stock Trust
Stockholders’
Noncontrolling
Shares
Amount
Capital
Income
Earnings
Trust, Net
Equity
Interest
Balance, December 31, 2019
90,641
906
1,445,233
11,419
644,860
776
(155)
2,103,039
25,757
2,128,796
Other comprehensive income
9,520
Stock-based compensation expense
3,642
Common stock issued to board members
10
146
Issuance of common stock related to share-based awards, net
158
(471)
(469)
Repurchases of common stock
(701)
(7)
(11,249)
(3,701)
(14,957)
Dividends on common stock ($0.09 per share)
(8,158)
Deferred compensation plan
(2)
Adoption of accounting standards
(5,691)
Net cash distributed to noncontrolling interest
(2,701)
Balance, March 31, 2020
90,108
901
1,437,301
20,939
676,946
774
(150)
2,136,711
27,022
2,163,733
Balance, December 31, 2020
82,185
Other comprehensive loss
(14,277)
4,594
147
222
(748)
(746)
(1)
(2,404)
(2,545)
(4,950)
Dividends on common stock ($0.12 per share)
(9,865)
(19)
17
(3,477)
Balance, March 31, 2021
82,261
CONSOLIDATED STATEMENTS OF CASH FLOWS
Operating Activities
Adjustments to reconcile net income to net cash provided by (used in) operating activities:
Depreciation, amortization and accretion, net
5,930
1,883
Deferred income taxes
1,424
(2,053)
Other, net
5,775
(2,410)
Net change in securities purchased under agreements to resell
(26,023)
35,675
Net change in trading securities
165,543
295,995
Net change in broker-dealer and clearing organization receivables
(275,257)
11,768
Net change in other assets
(97,606)
(243,683)
Net change in broker-dealer and clearing organization payables
171,709
(281,891)
Net change in other liabilities
(13,289)
(73,963)
Net change in securities sold, not yet purchased
17,266
(21,049)
Proceeds from sale of mortgage servicing rights asset
52,783
18,650
Change in valuation of mortgage servicing rights asset
(16,865)
11,030
Net gains from sales of loans
(267,080)
(150,486)
Loans originated for sale
(6,960,572)
(4,256,981)
Proceeds from loans sold
7,431,243
3,983,089
Net cash provided by (used in) operating activities for continuing operations
313,816
(586,275)
Net cash provided by operating activities for discontinued operations
3,505
Net cash provided by (used in) operating activities
(582,770)
Investing Activities
Proceeds from maturities and principal reductions of securities held to maturity
11,707
37,624
Proceeds from sales, maturities and principal reductions of securities available for sale
249,628
73,889
Purchases of securities held to maturity
(6,532)
Purchases of securities available for sale
(531,701)
(119,778)
Net change in loans held for investment
(29,151)
(19,692)
Purchases of premises and equipment and other assets
(8,341)
(17,754)
Proceeds from sales of premises and equipment and other real estate owned
867
15,350
Net cash received from (paid to) Federal Home Loan Bank and Federal Reserve Bank stock
(35)
18,685
Net cash used in investing activities for continuing operations
(307,026)
(18,208)
Net cash provided by investing activities for discontinued operations
1,794
Net cash used in investing activities
(16,414)
Financing Activities
Net change in deposits
496,605
850,829
Net change in short-term borrowings
(18,834)
(94,062)
Proceeds from notes payable
239,020
273,386
Payments on notes payable
(219,401)
(285,639)
Payments to repurchase common stock
Dividends paid on common stock
(913)
(624)
Net cash provided by financing activities
478,185
718,074
Net change in cash, cash equivalents and restricted cash
484,975
118,890
Cash, cash equivalents and restricted cash, beginning of period
1,353,303
642,789
Cash, cash equivalents and restricted cash, end of period
1,838,278
761,679
Reconciliation of Cash, Cash Equivalents and Restricted Cash to Consolidated Balance Sheets
524,370
Cash and due from banks, included within assets of discontinued operations
58,103
401
178,805
Total cash, cash equivalents and restricted cash
Supplemental Disclosures of Cash Flow Information
Cash paid for interest
37,095
37,041
Cash paid for income taxes, net of refunds
1,622
1,771
Supplemental Schedule of Non-Cash Activities
Conversion of loans to other real estate owned
461
182
Additions to mortgage servicing rights
34,301
4,475
Hilltop Holdings Inc. and Subsidiaries
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. The Company’s primary line of business is to provide business and consumer banking services from offices located throughout Texas through PlainsCapital Bank (the “Bank”). In addition, the Company provides an array of financial products and services through its broker-dealer and mortgage origination subsidiaries.
On June 30, 2020, Hilltop completed the sale of all of the outstanding capital stock of National Lloyds Corporation (“NLC”), which comprised the operations of the former insurance segment, for cash proceeds of $154.1 million, and was subject to post-closing adjustments. Accordingly, NLC’s results for the three months ended March 31, 2020 have been presented as discontinued operations in the consolidated financial statements. For further details, see Note 3 to the consolidated financial statements.
The Company, headquartered in Dallas, Texas, provides its products and services through two primary business units within continuing operations, PlainsCapital Corporation (“PCC”) and Hilltop Securities Holdings LLC (“Securities Holdings”). PCC is a financial holding company that provides, through its subsidiaries, traditional banking, wealth and investment management and treasury management services primarily in Texas and residential mortgage lending throughout the United States. Securities Holdings is a holding company 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, clearing, securities lending, structured finance and retail brokerage services throughout the United States. Unless otherwise noted, the Company’s notes to the consolidated financial statements present information limited to continuing operations.
As a result of the spread of the novel coronavirus (“COVID-19”) pandemic, economic uncertainties have contributed to significant volatility in the global economy, as well as banking and other financial activity in the areas in which the Company operates. The effects of COVID-19 and the governmental and societal response to the virus have negatively impacted financial markets and overall economic conditions on an unprecedented scale, resulting in the shuttering of businesses across the country and significant job loss. Many of these businesses reopened but may be operating at limited capacity. The Company’s business is dependent upon the willingness and ability of its employees and customers to conduct banking and other financial transactions. The rapid development and fluidity of this situation precludes any prediction as to the ultimate adverse impact of COVID-19. COVID-19 presents material uncertainty which could have a material adverse effect on the Company’s business, financial condition, results of operations and cash flows.
Basis of Presentation
The accompanying unaudited consolidated financial statements have been prepared in conformity with accounting principles generally accepted in the United States (“GAAP”), and in conformity with the rules and regulations of the Securities and Exchange Commission (the “SEC”). In the opinion of management, these financial statements contain all adjustments necessary for a fair statement of the results of the interim periods presented. Accordingly, the financial statements do not include all of the information and footnotes required by GAAP for complete financial statements and should be read in conjunction with the audited consolidated financial statements and notes thereto included in the Company’s Annual Report on Form 10-K for the year ended December 31, 2020 (“2020 Form 10-K”). Results for interim periods are not necessarily indicative of results to be expected for a full year or any future period.
The preparation of financial statements in conformity with 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 credit losses, the fair values of financial instruments, the mortgage loan indemnification liability, and the potential impairment of goodwill and identifiable intangible assets are particularly subject to change. The Company has applied its critical accounting policies
Notes to Consolidated Financial Statements (continued)
and estimation methods consistently in all periods presented in these consolidated financial statements. Actual amounts and values as of the balance sheet dates may be materially different than the amounts and values reported due to the inherent uncertainty in the estimation process. Also, future amounts and values could differ materially from those estimates due to changes in values and circumstances after the balance sheet date.
Hilltop owns 100% of the outstanding stock of PCC. PCC owns 100% of the outstanding stock of the Bank and 100% of the membership interest in Hilltop Opportunity Partners LLC, a merchant bank utilized to facilitate investments in companies engaged in non-financial activities. The Bank owns 100% of the outstanding stock of PrimeLending, a PlainsCapital Company (“PrimeLending”).
PrimeLending owns a 100% membership interest in PrimeLending Ventures Management, LLC (“Ventures Management”), which holds an ownership interest in and is the managing member of certain affiliated business arrangements (“ABAs”).
PCC 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 (“VIE”) Subsections of the Financial Accounting Standards Board (“FASB”) Accounting Standards Codification (“ASC”) because the primary beneficiaries of the Trusts are not within the consolidated group.
Hilltop has a 100% membership interest in Securities Holdings, which operates through its wholly owned subsidiaries, Hilltop Securities Inc. (“Hilltop Securities”), Momentum Independent Network Inc. (“Momentum Independent Network” and collectively with Hilltop Securities, the “Hilltop Broker-Dealers”) and Hilltop Securities Asset Management, LLC. Hilltop Securities is a broker-dealer registered with the SEC and Financial Industry Regulatory Authority (“FINRA”) and a member of the New York Stock Exchange (“NYSE”), Momentum Independent Network is an introducing broker-dealer that is also registered with the SEC and FINRA. Hilltop Securities, Momentum Independent Network and Hilltop Securities Asset Management, LLC are registered investment advisers under the Investment Advisers Act of 1940.
In addition, Hilltop owns 100% of the membership interest in each of HTH Hillcrest Project LLC (“HTH Project LLC”) and Hilltop Investments I, LLC. Hilltop Investments I, LLC owns 50% of the membership interest in HTH Diamond Hillcrest Land LLC (“Hillcrest Land LLC”) which is consolidated under the aforementioned VIE Subsections of the ASC. These entities are related to the Hilltop Plaza investment discussed in detail in Note 20 to the consolidated financial statements included in the Company’s 2020 Form 10-K and are collectively referred to as the “Hilltop Plaza Entities.”
The consolidated financial statements include the accounts of the above-named entities. 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 ASC.
Certain reclassifications have been made to the prior period consolidated financial statements to conform with the current period presentation. In preparing these consolidated financial statements, subsequent events were evaluated through the time the financial statements were issued. Financial statements are considered issued when they are widely distributed to all stockholders and other financial statement users, or filed with the SEC.
Significant accounting policies are detailed in Note 1 to the consolidated financial statements included in the Company’s 2020 Form 10-K.
9
2. Recently Issued Accounting Standards
Accounting Standards Adopted During 2021
In January 2020, FASB issued ASU 2020-01 to clarify the interaction among ASC 321, ASC 323, and ASC 815 for equity securities, equity method investments, and certain financial instruments to acquire equity securities. ASU 2020-01 clarifies whether re-measurement of equity investments is appropriate when observable transactions cause the equity method to be triggered or discontinued. ASU 2020-01 also provides that certain forward contracts and purchased options to acquire equity securities will be measured under ASC 321 without an assessment of subsequent accounting upon settlement or exercise. The amendment is effective in periods beginning after December 15, 2020. The Company adopted the provisions of this amendment as of January 1, 2021. The adoption of these provisions did not have a material impact on its consolidated financial statements.
T
3. Discontinued Operations
NLC Sale
On June 30, 2020, Hilltop completed the sale of all of the outstanding capital stock of NLC, which comprised the operations of the insurance segment, for cash proceeds of $154.1 million. During 2020, Hilltop recognized an aggregate gain associated with this transaction of $36.8 million, net of customary transaction costs of $5.1 million and was subject to post-closing adjustments. The resulting book gain from this sale transaction was not recognized for tax purposes due to the excess tax basis over book basis being greater than the recorded book gain. Any tax loss related to this transaction is deemed disallowed pursuant to the rules under the Internal Revenue Code.
During the first quarter of 2020, management determined that the then-pending sale of NLC met the criteria to be presented as discontinued operations. Therefore, NLC’s results for the three months ended March 31, 2020 have been presented as discontinued operations in the consolidated financial statements. All related notes to the consolidated financial statements for discontinued operations have been included in this note. The following table presents the results of discontinued operations for NLC for the three months ended March 31, 2020.
938
67
1,005
406
Net insurance premiums earned
32,637
(2,246)
30,391
2,777
247
8,527
Loss and loss adjustment expenses
12,949
2,476
26,976
Income from discontinued operations before income taxes
4,014
863
Reinsurance Activity
The effects of reinsurance on premiums written and earned are included within discontinued operations and are summarized as follows (in thousands).
Three Months Ended
March 31, 2020
Written
Earned
Premiums from direct business
29,980
30,746
Reinsurance assumed
2,952
3,244
Reinsurance ceded
(1,353)
Net premiums
31,579
The effects of reinsurance on incurred losses and LAE are included within discontinued operations and are as follows (in thousands).
Losses and LAE incurred
12,763
Reinsurance recoverables
186
Net loss and LAE incurred
4. 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 includes 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.
11
Fair Value Option
The Company has elected to measure substantially all of PrimeLending’s mortgage loans held for sale and the retained mortgage servicing rights (“MSR”) asset 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 March 31, 2021 and December 31, 2020, the aggregate fair value of PrimeLending’s mortgage loans held for sale accounted for under the Fair Value Option was $2.25 billion and $2.52 billion, respectively, and the unpaid principal balance of those loans was $2.21 billion and $2.41 billion, respectively. The interest component of fair value is reported as interest income on loans in the accompanying consolidated statements of operations.
The Company holds a number of financial instruments that are measured at fair value on a recurring basis, either by the application of the Fair Value Option or other authoritative pronouncements. The fair values of those instruments are determined primarily using Level 2 inputs, as further described below. Those inputs include quotes from mortgage loan investors and derivatives dealers and data from independent pricing services. The fair value of loans held for sale is determined using an exit price method.
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
March 31, 2021
Inputs
Fair Value
Trading securities
5,364
523,348
Available for sale securities
Equity securities
2,171,792
77,275
2,249,067
Derivative assets
136,508
MSR asset
Securities sold, not yet purchased
66,090
30,965
Derivative liabilities
54,455
December 31, 2020
45,390
648,865
2,449,588
71,816
2,521,404
126,898
54,494
25,295
74,598
12
The following tables include 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 to
Included in
Period
Additions
Reductions
(from) Level 3
Net Income
Income (Loss)
End of Period
Three months ended March 31, 2021
12,494
(7,239)
741
(537)
(52,783)
16,865
215,558
46,795
(60,022)
16,328
219,400
Three months ended March 31, 2020
67,195
14,285
(4,175)
6,220
(3,937)
79,588
55,504
(18,650)
(11,030)
30,299
122,699
18,760
(22,825)
(14,967)
109,887
All net realized and unrealized gains (losses) in the tables above are reflected in the accompanying consolidated financial statements. The unrealized gains (losses) relate to financial instruments still held at March 31, 2021.
For Level 3 financial instruments measured at fair value on a recurring basis at March 31, 2021 and December 31, 2020, the significant unobservable inputs used in the fair value measurements were as follows.
Range (Weighted-Average)
Financial instrument
Valuation Technique
Unobservable Inputs
Market comparable
Projected price
91
-
94
%
(
%)
Discounted cash flows
Constant prepayment rate
11.28
12.15
Discount rate
13.68
14.60
The fair value of certain loans held for sale that cannot be sold through normal sale channels or are non-performing is measured using Level 3 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 is reported at fair value using Level 3 inputs. The MSR asset is valued by projecting net servicing cash flows, which are then discounted to estimate the fair value. The fair value of the MSR asset is impacted by a variety of factors. Prepayment and discount rates, the most significant unobservable inputs, are discussed further in Note 8 to the consolidated financial statements. The decreases in the weighted average prepayment and discount rates used to value the MSR asset at March 31, 2021, compared to December 31, 2020, reflect the effect of increased mortgage rates reducing consumer refinancing activity and an increase in third-party servicing outlets.
The Company had no transfers between Levels 1 and 2 during the periods presented. Any transfers are based on changes in the observability and/or significance of the valuation inputs and are assumed to occur at the beginning of the quarterly reporting period in which they occur.
13
The following table presents those changes in fair value of instruments recognized in the consolidated statements of operations that are accounted for under the Fair Value Option (in thousands).
Three Months Ended March 31, 2021
Three Months Ended March 31, 2020
Net
Noninterest
Changes in
Gains (Losses)
(67,956)
33,979
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. There have been no changes to the methods for determining estimated fair value for financial assets and liabilities as described in detail in Note 5 to the consolidated financial statements included in the Company’s 2020 Form 10-K.
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
Financial assets:
Cash and cash equivalents
1,564,885
Held to maturity securities
311,402
289,919
520,175
7,342,590
7,862,765
73,208
71,499
1,709
Financial liabilities:
11,742,710
Debt
468,725
11,067
14
1,062,946
326,671
266,982
437,007
7,351,411
7,788,418
74,881
73,111
1,770
11,256,629
448,999
6,133
The Company held equity investments other than securities of $63.7 million and $63.6 million at March 31, 2021 and December 31, 2020, respectively, which are included within other assets in the consolidated balance sheets. Of the $63.7 million of such equity investments held at March 31, 2021, $22.9 million do not have readily determinable fair values and each is measured at cost, less any impairment, plus or minus changes resulting from observable price changes in orderly transactions for the identical or a similar investment of the same issuer. The following table presents the adjustments to the carrying value of these investments during the periods presented (in thousands).
Balance, beginning of period
22,844
19,771
Upward adjustments
121
106
Impairments and downward adjustments
(60)
(789)
Balance, end of period
22,905
19,088
5. Securities
The fair value of trading securities is summarized as follows (in thousands).
U.S. Treasury securities
465
40,491
U.S. government agencies:
Bonds
20,376
40
Residential mortgage-backed securities
161,557
336,081
Commercial mortgage-backed securities
861
876
Collateralized mortgage obligations
80,729
69,172
Corporate debt securities
64,535
62,481
States and political subdivisions
183,385
171,573
Private-label securitized product
11,655
8,571
5,149
4,970
Totals
In addition to the securities shown above, the Hilltop Broker-Dealers enter into transactions that represent commitments to purchase and deliver securities at prevailing future market prices to facilitate customer transactions and satisfy such
15
commitments. Accordingly, the Hilltop Broker-Dealers’ ultimate obligations may exceed the amount recognized in the financial statements. These securities, which are carried at fair value and reported as securities sold, not yet purchased in the consolidated balance sheets, had a value of $97.1 million and $79.8 million at March 31, 2021 and December 31, 2020, respectively.
The amortized cost and fair value of available for sale and held to maturity securities are summarized as follows (in thousands).
Available for Sale
Amortized
Unrealized
Cost
Gains
Losses
76,527
970
(334)
77,163
897,085
13,009
(9,811)
900,283
157,906
594
(9,551)
148,949
536,548
5,327
(2,057)
539,818
47,362
2,045
(214)
49,193
1,715,428
21,945
(21,967)
82,036
1,095
(325)
82,806
624,863
17,194
(446)
641,611
124,929
768
(1,159)
124,538
559,362
6,916
(370)
565,908
44,729
2,613
47,342
1,435,919
28,586
(2,300)
Held to Maturity
12,541
603
13,144
152,309
6,792
159,101
65,043
1,738
66,781
70,195
2,211
(30)
72,376
11,344
13,547
708
14,255
152,820
9,205
162,025
74,932
2,036
76,968
70,645
2,778
73,423
14,727
Additionally, the Company had unrealized net gains of $0.1 million at both March 31, 2020 and December 31, 2020 from equity securities with fair values of $0.2 million and $0.1 million held at March 31, 2021 and December 31, 2020, respectively. The Company recognized nominal net gains and nominal net losses during the three months ended March 31,
16
2021 and 2020, respectively, due to changes in the fair value of equity securities still held at the balance sheet date. During the three months ended March 31, 2021 and 2020, net gains recognized from equity securities sold were nominal.
Information regarding available for sale and held to maturity securities that were in an unrealized loss position is shown in the following tables (dollars in thousands).
Number of
Securities
Bonds:
Unrealized loss for less than twelve months
34,739
334
60,298
325
Unrealized loss for twelve months or longer
Residential mortgage-backed securities:
54
604,251
9,811
86,287
429
Commercial mortgage-backed securities:
137,123
9,551
105,386
1,176
Collateralized mortgage obligations:
18
160,376
2,027
101,990
324
3,852
30
13,611
46
21
164,228
2,057
115,601
370
States and political subdivisions:
24
8,421
214
Total available for sale:
944,910
21,937
43
353,961
2,254
118
948,762
21,967
48
367,572
2,300
2,093
578
Total held to maturity:
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 equity securities, at March 31, 2021 are shown by contractual maturity below (in thousands).
Due in one year or less
20,331
20,392
843
877
Due after one year through five years
40,512
41,809
1,185
1,213
Due after five years through ten years
17,013
17,501
9,850
10,183
Due after ten years
46,033
46,654
58,317
60,103
123,889
126,356
The Company recognized net gains of $8.7 million and $7.0 million from its trading portfolio during the three months ended March 31, 2021 and 2020, respectively. In addition, the Hilltop Broker-Dealers realized net gains of $44.1 million and $21.3 million during the three months ended March 31, 2021 and 2020, respectively, from structured product trading activities. The Company had $0.1 million in other realized losses on securities and $0.2 million in other realized gains on securities during the three months ended March 31, 2021 and 2020, respectively. All such realized gains and losses are recorded as a component of other noninterest income within the consolidated statements of operations.
Securities with a carrying amount of $732.5 million and $712.3 million (with a fair value of $750.5 million and $733.8 million, respectively) at March 31, 2021 and December 31, 2020, respectively, were pledged by the Bank 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. Substantially all of these pledged securities were included in the available for sale and held to maturity securities portfolios at March 31, 2021 and December 31, 2020.
Mortgage-backed securities and collateralized mortgage obligations consist primarily of Government National Mortgage Association (“GNMA”), Federal National Mortgage Association (“FNMA”) and Federal Home Loan Mortgage Corporation (“FHLMC”) pass-through and participation certificates. GNMA securities are guaranteed by the full faith and credit of the United States, while FNMA and FHLMC securities are fully guaranteed by those respective United States government-sponsored enterprises, and conditionally guaranteed by the full faith and credit of the United States.
6. Loans Held for Investment
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 agribusiness, construction, energy, real estate and wholesale/retail trade. The Hilltop Broker-Dealers make loans to customers and correspondents through transactions originated by both employees and independent retail representatives throughout the United States. The Hilltop Broker-Dealers control risk by requiring customers to maintain 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 loans are not included in the consolidated financial statements.
Loans held for investment summarized by portfolio segment are as follows (in thousands).
Commercial real estate
3,114,936
3,133,903
Commercial and industrial (1)
2,574,229
2,627,774
Construction and land development
821,883
828,852
1-4 family residential
745,544
629,938
Consumer
33,890
35,667
Broker-dealer (2)
Total loans held for investment, net of allowance
The following table provides details associated with non-accrual loans, excluding those classified as held for sale (in thousands).
Non-accrual Loans
Interest Income Recognized
With
With No
Allowance
Commercial real estate:
Non-owner occupied
997
368
1,365
445
1,658
74
(97)
Owner occupied
3,363
5,940
9,303
3,473
6,002
9,475
90
Commercial and industrial
12,572
23,572
36,144
10,821
23,228
34,049
143
300
101
400
501
102
405
507
22
2,852
19,801
22,653
4,726
16,651
21,377
924
983
26
28
(5)
Broker-dealer
19,911
50,081
69,992
20,363
46,731
67,094
1,246
1,219
At March 31, 2021 and December 31, 2020, $8.3 million and $10.9 million, respectively, of real estate loans secured by residential properties and classified as held for sale were in non-accrual status.
Loans accounted for on a non-accrual basis increased $2.9 million from December 31, 2020 to March 31, 2021, primarily due to an increase in commercial and industrial loans of $2.1 million and an increase in 1-4 family residential loans of $1.3 million. The increase in commercial and industrial loans in non-accrual status since December 31, 2020 was primarily due to four relationships that included six loans totaling $2.9 million and had a $1.0 million reserve at
19
March 31, 2021. The increase in 1-4 family residential loans in non-accrual status at March 31, 2021, compared to December 31, 2020, was primarily related to the classification of $3.6 million of loans as non-accrual, that were previously classified as accruing.
The Company considers non-accrual loans to be collateral-dependent unless there are underlying mitigating circumstances. The practical expedient to measure the allowance using the fair value of the collateral has been implemented.
The Bank classifies loan modifications as troubled debt restructurings (“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 may also reconfigure 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.
In March 2020, the CARES Act was passed, which, among other things, allows the Bank to suspend the requirements for certain loan modifications to be categorized as a TDR, including the related impairment for accounting purposes. On December 27, 2020, the Consolidated Appropriations Act 2021 was signed into law. Section 541 of this legislation, “Extension of Temporary Relief From Troubled Debt Restructurings and Insurer Clarification,” extends certain relief provisions from the March CARES Act that were set to expire at the end of 2020. This new legislation extends the relief to financial institutions to suspend TDR assessment and reporting requirements under GAAP for loan modifications to the earlier of 60 days after the national emergency termination date or January 1, 2022. The Bank’s COVID-19 payment deferral programs allow for a deferral of principal and/or interest payments with such deferred principal payments due and payable on maturity date of the existing loan. The Bank’s actions included approval of approximately $1.0 billion in COVID-19 related loan modifications as of December 31, 2020. During the first quarter of 2021, the Bank continued to support its impacted banking clients through the approval of COVID-19 related loan modifications, which resulted in an additional $8 million of new COVID-19 related loan modifications since December 31, 2020. The portfolio of active deferrals that have not reached the end of their deferral period was approximately $130 million as of March 31, 2021. While the majority of the portfolio of COVID-19 related loan modifications no longer require deferral, such loans may represent elevated risk, and therefore management continues to monitor these loans. The extent to which these measures will impact the Bank is uncertain, and any progression of loans, whether receiving COVID-19 payment deferrals or not, into non-accrual status during future periods is uncertain and will depend on future developments that cannot be predicted.
There were no TDRs granted during the three months ended March 31, 2021 that do not qualify for the CARES Act exemption. There was one TDR granted during the three months ended March 31, 2020 with a balance at date of extension of $1.1 million and a balance at March 31, 2020 of $1.2 million. The Bank had nominal unadvanced commitments to borrowers whose loans had been restructured in TDRs at March 31, 2021 and at December 31, 2020. There were no TDRs granted during the twelve months preceding March 31, 2021 and March 31, 2020, for which a payment was at least 30 days past due.
An analysis of the aging of the Company’s loan portfolio is shown in the following tables (in thousands).
Accruing Loans
Loans Past Due
Total Past
Current
Past Due
30-59 Days
60-89 Days
90 Days or More
Due Loans
Loans
4,618
199
4,817
1,769,495
1,774,312
3,270
79
7,436
10,785
1,329,839
1,340,624
2,021
868
9,744
12,633
2,561,596
821,864
8,148
1,807
10,943
20,898
724,646
38
23
33,803
18,114
28,348
49,239
7,761,418
20
1,919
2,118
1,786,193
1,788,311
195
522
8,328
9,045
1,336,547
1,345,592
3,114
407
7,318
10,839
2,616,935
828,833
8,110
3,040
12,420
23,570
606,368
172
123
321
35,346
13,529
4,092
28,291
45,912
7,647,229
In addition to the loans shown in the tables above, PrimeLending had $265.2 million and $243.6 million of loans included in loans held for sale (with an aggregate unpaid principal balance of $267.0 million and $245.5 million, respectively) that were 90 days past due and accruing interest at March 31, 2021 and December 31, 2020, respectively. These loans are guaranteed by U.S. government agencies and include loans that are subject to repurchase, or have been repurchased, by PrimeLending.
In response to the ongoing COVID-19 pandemic, the Company allowed modifications, such as payment deferrals for up to 90 days and temporary forbearance, to credit-worthy borrowers who are experiencing temporary hardship due to the effects of COVID-19. These short-term modifications generally meet the criteria of the CARES Act and, therefore, they are not reported as past due or placed on non-accrual status (provided the loans were not past due or on non-accrual status prior to the deferral). The Company elected to accrue and recognize interest income on these modifications during the payment deferral period.
Additionally, the Company granted temporary forbearance to borrowers of a federally backed mortgage loan experiencing financial hardship due, directly or indirectly, to the COVID-19 pandemic. The CARES Act, which among other things, established the ability for financial institutions to grant a forbearance for up to 180 days, which can be extended for an additional 180-day period upon the request of the borrower. During that time, no fees, penalties or interest beyond the amounts scheduled or calculated as if the borrower made all contractual payments on time and in full under the mortgage contract will accrue on the borrower’s account. As of March 31, 2021, PrimeLending had $152.0 million of loans subject to repurchase under a forbearance agreement related to delinquencies on or after April 1, 2020.
Management tracks credit quality trends on a quarterly basis related to: (i) past due levels, (ii) non-performing asset levels, (iii) classified loan levels, and (iv) general economic conditions in state and local markets. The Company defines classified loans as loans with a risk rating of substandard, doubtful or loss. There have been no changes to the risk rating internal grades utilized for commercial loans as described in detail in Note 7 to the consolidated financial statements in the Company’s 2020 Form 10-K.
The following table presents loans held for investment grouped by asset class and credit quality indicator, segregated by year of origination or renewal (in thousands).
Amortized Cost Basis by Origination Year
2016 and
2019
2018
2017
Prior
Revolving
Commercial real estate: non-owner occupied
Internal Grade 1-3 (Pass low risk)
1,315
21,584
25,522
2,967
1,543
25,102
1
78,034
Internal Grade 4-7 (Pass normal risk)
77,105
215,239
118,279
80,556
87,046
141,703
29,881
749,809
Internal Grade 8-11 (Pass high risk and watch)
47,159
254,256
144,782
90,039
87,938
159,420
1,060
784,654
Internal Grade 12 (Special mention)
953
3,147
4,100
Internal Grade 13 (Substandard accrual)
15,569
16,863
16,114
27,690
24,912
55,090
112
156,350
Internal Grade 14 (Substandard non-accrual)
Commercial real estate: owner occupied
53,912
62,479
20,802
9,650
40,569
39,802
228,167
14,627
160,608
140,191
132,548
55,572
129,848
33,823
667,217
9,537
117,480
75,922
45,331
22,478
47,365
1,285
319,398
3,128
9,554
5,578
70,928
10,222
17,129
116,539
504
1,260
360
5,316
1,844
6,841
32,861
26,279
7,850
5,176
3,202
20,597
102,806
37,973
162,663
50,894
49,216
26,491
25,428
398,758
751,423
28,608
73,506
43,507
16,768
11,714
15,336
202,553
391,992
735
2,082
9,227
3,356
10,492
5,394
5,612
19,248
55,411
6,851
18,791
4,398
1,927
283
3,793
4,088
10,353
2,538
4,075
256
4,316
1,203
26,829
46,669
193,481
94,295
62,581
2,129
5,547
35,272
439,974
33,597
164,634
58,067
48,030
630
3,609
14,223
322,790
366
2,106
1,423
5,391
5,485
14,771
Construction and land development - individuals
FICO less than 620
FICO between 620 and 720
181
1,244
127
1,626
FICO greater than 720
4,276
9,738
14,014
Substandard non-accrual
Other (1)
25
1,353
1,378
1,249
787
3,668
55
30,157
311
36,227
6,205
14,019
16,317
9,396
8,291
46,118
1,270
101,616
137,140
141,403
72,909
55,977
26,799
88,019
4,337
526,584
162
142
21,527
11,736
26,093
9,456
5,717
1,371
3,050
1,041
58,464
179
828
923
92
59
315
2,483
2,419
3,012
1,774
375
513
111
2,075
10,279
1,339
6,283
1,407
2,681
72
2,835
14,729
1,600
3,440
873
80
35
317
6,373
Total loans with credit quality measures
555,843
1,733,681
939,428
740,238
433,630
871,196
780,748
6,054,764
Commercial and industrial (mortgage warehouse lending)
743,347
Commercial and industrial (Paycheck Protection Program loans)
492,371
Broker-Dealer (margin loans and correspondent receivables)
Total loans held for investment
(1) Loans classified in this category were assigned a FICO score based on various factors specific to the borrower for credit modeling purposes.
7. Allowance for Credit Losses
Available for Sale Securities and Held to Maturity Securities
The Company has evaluated available for sale debt securities that are in an unrealized loss position and has determined that any decline in value is unrelated to credit loss and related to changes in market interest rates since purchase. None of the available for sale debt securities held were past due at March 31, 2021. In addition, as of March 31, 2021, the Company had not made a decision to sell any of its debt securities held, nor did the Company consider it more likely than not that it would be required to sell such securities before recovery of their amortized cost basis. The Company does not expect to have credit losses associated with the debt securities and no allowance was recognized on the debt securities portfolio at transition.
Loans Held for Investment
The allowance for credit losses for loans held for investment represents management’s best estimate of all expected credit losses over the expected contractual life of our existing portfolio. Management revised its methodology for determining the allowance for credit losses upon the implementation of the current expected credit losses (“CECL”) standard. Management considers the level of allowance for credit losses to be a reasonable and supportable estimate of expected credit losses inherent within the loans held for investment portfolio as of March 31, 2021. While the Company believes it has an appropriate allowance for the existing loan portfolio at March 31, 2021, additional provision for losses on existing loans may be necessary in the future. Future changes in the allowance for credit losses are expected to be volatile given dependence upon, among other things, the portfolio composition and quality, as well as the impact of significant drivers, including prepayment assumptions and macroeconomic conditions and forecasts. In addition to the allowance for credit losses, the Company maintains a separate allowance for credit losses related to off-balance sheet credit exposures, including unfunded loan commitments, and this amount is included in other liabilities within the consolidated balance sheets. For further information on the policies that govern the estimation of the allowances for credit losses levels, see Note 1 to the consolidated financial statements in the Company’s 2020 Form 10-K.
One of the most significant judgments involved in estimating the Company’s allowance for credit losses relates to the macroeconomic forecasts used to estimate credit losses over the reasonable and supportable forecast period. To determine our best estimate of expected credit losses as of March 31, 2021, the Company utilized a single macroeconomic consensus scenario published by Moody’s Analytics in March 2021 that was updated to reflect the U.S. economic outlook. This consensus scenario utilizes multiple economic variables in forecasting the economic outlook and is based on Moody’s Analytics’ review of a variety of surveys of baseline forecasts of the U.S. economy. Significant variables that impact the modeled losses across our loan portfolios are the U.S. Real Gross Domestic Product, or GDP, growth rates and unemployment rate assumptions. Changes in these assumptions and forecasts of economic conditions could significantly affect the estimate of expected credit losses at the balance sheet date or between reporting periods.
The COVID-19 pandemic has resulted in a weak labor market and weak overall economic conditions that have affected borrowers across our lending portfolios. Significant judgment is required to estimate the severity and duration of the current economic downturn, as well as its potential impact on borrower defaults and loss severity. In particular, macroeconomic conditions and forecasts regarding the duration and severity of the economic downturn are rapidly changing and remain highly uncertain as COVID-19 cases and vaccine effectiveness evolve nationally and in key geographies.
During the first quarter of 2020, the Company adopted the new CECL standard and recorded transition adjustment entries that resulted in an allowance for credit losses of $73.7 million as of January 1, 2020, an increase of $12.6 million. This increase included an increase in credit losses of $18.9 million from the expansion of the loss horizon to life of loan, partially offset by the elimination of the non-credit component within the historical allowance related to previously categorized PCI loans of $6.3 million.
During the three months ended March 31, 2020, reserves on individually evaluated loans increased $17.6 million, while reserves on expected losses of collectively evaluated loans increased primarily due to the increase in the expected
lifetime credit losses under CECL attributable to the deteriorating economic outlook associated with the impact of the market disruption caused by the COVID-19 pandemic. While not material, the change in the allowance for credit losses during the three months ended March 31, 2020 was also attributable to other factors including, but not limited to, loan growth, loan mix and changes in risk rating grades. The change in the allowance during the three months ended March 31, 2020 was also impacted by net charge-offs of $1.5 million.
During the three months ended March 31, 2021, the allowance was primarily comprised of a net reversal of credit losses on expected losses of collectively evaluated loans of $6.5 million primarily due to improvements in the macroeconomic forecast assumptions from the prior quarter, partially offset by slower prepayment assumptions on certain commercial real estate and construction and land portfolios, as well as an increase in the provision for credit losses on individually evaluated loans of $1.4 million primarily related to changes in risk rating grades and updated realizable values. The change in the allowance for credit losses during the current period was primarily attributable to the Bank and also reflected other factors including, but not limited to, loan growth, loan mix, and changes in qualitative factors from the prior quarter. The change in the allowance during the three months ended March 31, 2021 was also impacted by net recoveries of $0.6 million.
Changes in the allowance for credit losses for loans held for investment, distributed by portfolio segment, are shown below (in thousands).
Balance,
Transition
Provision for
Recoveries on
Adjustment
(Reversal of)
Charged Off
End of
CECL
Credit Losses
109,629
(5,517)
104,126
27,703
556
(179)
433
28,513
6,677
572
7,249
3,946
(857)
(110)
409
3,388
71
(79)
76
944
213
66
279
149,044
(368)
932
144,499
31,595
8,073
14,475
53,939
17,964
3,193
18,446
(1,440)
387
38,550
4,878
577
907
6,360
6,386
(29)
201
(203)
6,365
265
748
246
(176)
120
274
322
61,136
12,562
(2,035)
527
106,739
Unfunded Loan Commitments
The Bank uses a process similar to that used in estimating the allowance for credit losses on the funded portion to estimate the allowance for credit loss on unfunded loan commitments. The allowance is based on the estimated exposure at default, multiplied by the lifetime Probability of Default grade and Loss Given Default grade for that particular loan segment. The Bank estimates expected losses by calculating a commitment usage factor based on industry usage factors. The commitment usage factor is applied over the relevant contractual period. Loss factors from the underlying loans to which commitments are related are applied to the results of the usage calculation to estimate any liability for credit losses related for each loan type. The expected losses on unfunded commitments align with statistically calculated parameters used to calculate the allowance for credit losses on the funded portion. There is no reserve calculated for letters of credit as they are issued primarily as credit enhancements and the likelihood of funding is low.
Changes in the allowance for credit losses for loans with off-balance sheet credit exposures are shown below (in thousands).
8,388
Transition adjustment CECL accounting standard
3,837
Other noninterest expense
419
1,297
8,807
7,209
As previously discussed, the Company adopted the new CECL standard and recorded a transition adjustment entry that resulted in an allowance for credit losses of $5.9 million as of January 1, 2020. During three months ended March 31, 2020, the increase in the reserve for unfunded commitments was primarily due to the macroeconomic uncertainties associated with the impact of the market disruption caused by COVID-19 conditions. During the three months ended March 31, 2021, the increase in the reserve for unfunded commitments was primarily due to increases in available commitment balances.
8. Mortgage Servicing Rights
The following tables present the changes in fair value of the Company’s MSR asset and other information related to the serviced portfolio (dollars in thousands).
Sales
Changes in fair value:
Due to changes in model inputs or assumptions (1)
24,137
(9,594)
Due to customer payoffs
(7,272)
(1,436)
Mortgage loans serviced for others (2)
12,124,282
14,643,623
MSR asset as a percentage of serviced mortgage loans
1.17
0.98
The key assumptions used in measuring the fair value of the Company’s MSR asset were as follows.
Weighted average constant prepayment rate
Weighted average discount rate
Weighted average life (in years)
6.6
6.3
A sensitivity analysis of the fair value of the Company’s MSR asset to certain key assumptions is presented in the following table (in thousands).
Constant prepayment rate:
Impact of 10% adverse change
(4,229)
(5,639)
Impact of 20% adverse change
(8,497)
(11,164)
Discount rate:
(6,418)
(6,435)
(12,254)
(12,287)
This sensitivity analysis presents the effect of hypothetical changes in key assumptions on the fair value of the MSR asset. 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 asset 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 $16.2 million and $5.9 million during the three months ended March 31, 2021 and 2020, respectively, were included in net gains from sale of loans and other mortgage production income within the consolidated statements of operations.
9. Deposits
Deposits are summarized as follows (in thousands).
Noninterest-bearing demand
Interest-bearing:
Demand accounts
2,568,355
2,399,341
Brokered - demand
186,011
282,426
Money market
2,895,070
2,716,878
Brokered - money market
213,978
124,243
Savings
271,910
276,327
Time
1,327,177
1,506,435
Brokered - time
239,097
324,285
10. Short-term Borrowings
Short-term borrowings are summarized as follows (in thousands).
Federal funds purchased
158,835
180,325
Securities sold under agreements to repurchase
123,437
237,856
Federal Home Loan Bank
Short-term bank loans
58,000
Commercial paper
336,380
277,617
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 the Hilltop Broker-Dealers execute transactions to sell securities under
agreements to repurchase with both customers and other broker-dealers. Securities involved in these transactions are held by the Bank, the Hilltop Broker-Dealers or a third-party dealer.
Information concerning federal funds purchased and securities sold under agreements to repurchase is shown in the following tables (dollars in thousands).
Average balance during the period
367,313
732,954
Average interest rate during the period
0.36
1.78
Average interest rate at end of period
0.25
Securities underlying the agreements at end of period:
Carrying value
123,392
237,913
Estimated fair value
134,558
262,554
FHLB short-term borrowings mature over terms not exceeding 365 days and are collateralized by FHLB Dallas stock, nonspecified real estate loans and certain specific commercial real estate loans. Other information regarding FHLB short-term borrowings is shown in the following tables (dollars in thousands).
153,736
1.63
The Hilltop Broker-Dealers use 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 March 31, 2021 was 1.25%.
Hilltop Securities uses the net proceeds (after deducting related issuance expenses) from the sale of two commercial paper programs for general corporate purposes, including working capital and the funding of a portion of its securities inventories. The commercial paper notes (“CP Notes”) may be issued with maturities of 14 days to 270 days from the date of issuance. The CP Notes are issued under two separate programs, Series 2019-1 CP Notes and Series 2019-2 CP Notes, in maximum aggregate amounts of $300 million and $200 million, respectively. The CP Notes are not redeemable prior to maturity or subject to voluntary prepayment and do not bear interest, but are sold at a discount to par. The CP Notes are secured by a pledge of collateral owned by Hilltop Securities. As of March 31, 2021, the weighted average maturity of the CP Notes was 157 days at a rate of 1.13%, with a weighted average remaining life of 106 days. At March 31, 2021, the aggregate amount outstanding under these secured arrangements was $336.4 million, which was collateralized by securities held for firm accounts valued at $364.1 million.
11. Notes Payable
Notes payable consisted of the following (in thousands).
Senior Notes due April 2025, net of discount of $1,020 and $1,063, respectively
148,980
148,937
Subordinated Notes due May 2030, net of discount of $771 and $793, respectively
49,229
49,207
Subordinated Notes due May 2035, net of discount of $2,350 and $2,392, respectively
147,650
147,608
Ventures Management lines of credit
55,854
36,235
27
12. Leases
Supplemental balance sheet information related to finance leases is as follows (in thousands).
Finance leases:
Premises and equipment
7,780
Accumulated depreciation
(4,915)
(4,768)
2,865
The components of lease costs, including short-term lease costs, are as follows (in thousands).
Operating lease cost
9,718
10,630
Less operating lease and sublease income
(339)
(618)
Net operating lease cost
9,379
10,012
Finance lease cost:
Amortization of ROU assets
Interest on lease liabilities
134
144
Total finance lease cost
281
291
Supplemental cash flow information related to leases is as follows (in thousands).
Cash paid for amounts included in the measurement of lease liabilities:
Operating cash flows from operating leases
9,240
9,951
Operating cash flows from finance leases
Financing cash flows from finance leases
167
155
Right-of-use assets obtained in exchange for lease obligations:
Operating leases
6,334
4,049
Finance leases
Information regarding the lease terms and discount rates of the Company’s leases is as follows.
Weighted Average
Remaining Lease
Lease Classification
Term (Years)
Discount Rate
Operating
5.4
4.56
5.5
4.67
Finance
4.82
5.6
4.81
Future minimum lease payments under lease agreements as of March 31, 2021, are presented below (in thousands).
Operating Leases
Finance Leases
26,677
911
2022
29,233
1,241
2023
23,488
1,280
2024
15,875
1,163
2025
11,593
886
Thereafter
29,884
1,411
Total minimum lease payments
136,750
6,892
Less amount representing interest
(16,411)
(2,199)
Lease liabilities
4,693
As of March 31, 2021, the Company had additional operating leases that have not yet commenced with aggregate future minimum lease payments of approximately $23.2 million. These operating leases are expected to commence between April 2021 and October 2021 with lease terms ranging from three to eleven years.
13. Income Taxes
The Company applies an estimated annual effective rate to interim period pre-tax income to calculate the income tax provision for the quarter in accordance with the principal method prescribed by the accounting guidance established for computing income taxes in interim periods. The Company’s effective tax rates from continuing operations were 23.4% and 23.1% for the three months ended March 31, 2021 and 2020, respectively, and approximated the applicable statutory rates for such periods.
14. Commitments and Contingencies
Legal Matters
The Company is subject to loss contingencies related to litigation, claims, investigations and legal and administrative cases and proceedings arising in the ordinary course of business. The Company evaluates these contingencies based on information currently available, including advice of counsel. The Company establishes accruals for those matters when a loss contingency is considered probable and the related amount is reasonably estimable. Any accruals are periodically reviewed and may be adjusted as circumstances change. A portion 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, 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 probable 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. As available information changes, however, 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 is complete; whether meaningful settlement discussions have commenced; and whether the claim involves a class action and if so, how the class is defined. As a result of some of these factors, the Company may be unable to estimate reasonably possible losses with respect to some or all of the pending and threatened litigation and claims asserted against the Company.
The 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
29
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 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.
PrimeLending received an investigative inquiry from the United States Attorney for the Western District of Virginia regarding PrimeLending’s float down option. At this time, the United States Attorney has requested certain materials with respect to this matter, and PrimeLending is fully cooperating with such requests.
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, except related to specific matters disclosed above, 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 matter, including 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.
Indemnification Liability Reserve
The mortgage origination segment may be responsible to agencies, investors, or other parties 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 or indemnifies the claimant against loss. The mortgage origination segment has established an indemnification liability reserve for such probable losses.
Generally, the mortgage origination segment first becomes aware that an agency, investor, or other party believes a loss has been incurred on a sold loan when it receives a written request from the claimant to repurchase the loan or reimburse the claimant’s losses. Upon completing its review of the claimant’s request, the mortgage origination segment establishes a specific claims reserve for the loan if it concludes its obligation to the claimant is both probable and reasonably estimable.
An additional reserve has been established for probable agency, investor or other party 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 claimant requests, actual 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 claim requests. In addition, the mortgage origination segment has considered that GNMA, FNMA and FHLMC have imposed certain restrictions on loans the agencies will accept under a forbearance agreement resulting from the COVID-19 pandemic, which could increase the magnitude of indemnification losses on these loans.
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 claims to date, and therefore, are not a primary factor considered in the calculation of this reserve.
At March 31, 2021 and December 31, 2020, the mortgage origination segment’s indemnification liability reserve totaled $24.3 million and $21.5 million, respectively. The provision for indemnification losses was $3.0 million and $0.7 million during the three months ended March 31, 2021 and 2020, respectively.
The following tables provide for a rollforward 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
30,085
32,144
Claims made
5,112
6,071
Claims resolved with no payment
(2,914)
(984)
Repurchases
(1,811)
(2,330)
Indemnification payments
(335)
(122)
30,137
34,779
Indemnification Liability Reserve Activity
21,531
11,776
Additions for new sales
3,007
725
(124)
(271)
Early payment defaults
(12)
(39)
(141)
(43)
Change in reserves for loans sold in prior years
24,261
12,148
Reserve for Indemnification Liability:
Specific claims
881
961
Incurred but not reported claims
23,380
20,570
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.
15. Financial Instruments with Off-Balance Sheet Risk
Banking
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
31
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 $2.0 billion at March 31, 2021 and outstanding financial and performance standby letters of credit of $83.7 million at March 31, 2021.
The Bank uses the same credit policies in making commitments and standby letters of credit as it does for loans held for investment. 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.
Broker-Dealer
In the normal course of business, the Hilltop Broker-Dealers execute, settle, and finance various securities transactions that may expose the Hilltop Broker-Dealers 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 accounts of the Hilltop Broker-Dealers, use of derivatives to support certain non-profit housing organization clients and to hedge changes in the fair value of certain securities, clearing agreements between the Hilltop Broker-Dealers and various clearinghouses and broker-dealers, secured financing arrangements that involve pledged securities, and when-issued underwriting and purchase commitments.
16. Stock-Based Compensation
Since 2012, the Company has issued stock-based incentive awards pursuant to the Hilltop Holdings Inc. 2012 Equity Incentive Plan (the “2012 Plan”). In July 2020, pursuant to stockholders’ approval, the Company adopted the Hilltop Holdings Inc. 2020 Equity Incentive Plan (the “2020 Plan”). The 2020 Plan serves as successor to the 2012 Plan. The 2012 Plan and the 2020 Plan are referred to collectively as “the Equity Plans.”
During the three months ended March 31, 2021 and 2020, Hilltop granted 4,181 and 10,291 shares of common stock, respectively, pursuant to the Equity Plans to certain non-employee members of the Company’s board of directors for services rendered to the Company.
Restricted Stock Units
The following table summarizes information about nonvested restricted stock unit (“RSU”) activity for the three months ended March 31, 2021 (shares in thousands).
RSUs
Weighted
Average
Grant Date
Outstanding
1,833
21.48
Granted
532
32.93
Vested/Released
(248)
24.69
Forfeited
(6)
22.17
2,111
23.99
Vested/Released RSUs include an aggregate of 26,694 shares withheld to satisfy employee statutory tax obligations during the three months ended March 31, 2021.
During the three months ended March 31, 2021, the Compensation Committee of the board of directors of the Company awarded certain executives and key employees an aggregate of 471,505 RSUs pursuant to the Equity Plans. Of the RSUs granted during the three months ended March 31, 2021, 320,377 that were outstanding at March 31, 2021, are subject to time-based vesting conditions and generally cliff vest on the third anniversary of the grant date. Of the RSUs granted
32
during the three months ended March 31, 2021, 150,668 that were outstanding at March 31, 2021, provide for cliff vesting based upon the achievement of certain performance goals over a three-year period.
At March 31, 2021, in the aggregate, 1,746,622 of the outstanding RSUs are subject to time-based vesting conditions and generally cliff vest on the third anniversary of the grant date, and 364,149 outstanding RSUs cliff vest based upon the achievement of certain performance goals over a three-year period. At March 31, 2021, unrecognized compensation expense related to outstanding RSUs of $32.9 million is expected to be recognized over a weighted average period of 1.72 years.
17. Regulatory Matters
Banking and Hilltop
PlainsCapital, which includes the Bank and PrimeLending, and Hilltop are subject to various regulatory capital requirements administered by 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 PlainsCapital and Hilltop 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 Company performs reviews of the classification and calculation of risk-weighted assets to ensure accuracy and compliance with the Basel III regulatory capital requirements as implemented by the Board of Governors of the Federal Reserve System. 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 common equity Tier 1, Tier 1 and total capital (as defined) to risk-weighted assets (as defined).
In order to avoid limitations on capital distributions, including dividend payments, stock repurchases and certain discretionary bonus payments to executive officers, Basel III requires banking organizations to maintain a capital conservation buffer above minimum risk-based capital requirements measured relative to risk-weighted assets.
The following table shows PlainsCapital’s and Hilltop’s actual capital amounts and ratios in accordance with Basel III compared to the regulatory minimum capital requirements including conservation buffer ratio in effect at the end of the period (dollars in thousands). Based on actual capital amounts and ratios shown in the following table, PlainsCapital’s ratios place it in the “well capitalized” (as defined) capital category under regulatory requirements. Actual capital amounts and ratios as of March 31, 2021 reflect PlainsCapital’s and Hilltop’s decision to elect the transition option as issued by the federal banking regulatory agencies in March 2020 that permits banking institutions to mitigate the estimated cumulative regulatory capital effects from CECL over a five-year transitionary period.
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Minimum Capital
Requirements
Including
To Be Well
Actual
Conservation Buffer
Capitalized
Ratio
Tier 1 capital (to average assets):
PlainsCapital
1,429,465
10.50
1,385,842
10.44
4.0
5.0
2,221,143
13.01
2,111,580
12.64
N/A
Common equity Tier 1 capital (to risk-weighted assets):
14.74
14.40
7.0
6.5
2,156,143
19.63
2,046,580
18.97
Tier 1 capital (to risk-weighted assets):
8.5
8.0
20.22
19.57
Total capital (to risk-weighted assets):
1,515,894
15.64
1,470,364
15.27
10.5
10.0
2,522,752
22.96
2,409,684
22.34
Pursuant to the net capital requirements of the Securities Exchange Act of 1934, as amended (the “Exchange Act”), Hilltop Securities has elected to determine its net capital requirements using the alternative method. Accordingly, Hilltop Securities 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 and $1,000,000, respectively, or 2% of aggregate debit balances, as defined in Rule 15c3-3 promulgated under the Exchange Act. Additionally, the net capital rule of the NYSE provides that equity capital may not be withdrawn or cash dividends paid if resulting net capital would be less than 5% of the aggregate debit items. Momentum Independent Network follows the primary (aggregate indebtedness) method, as defined in Rule 15c3-1 promulgated under the Exchange Act, which requires the maintenance of the larger of $250,000 or 6-2/3% of aggregate indebtedness.
At March 31, 2021, the net capital position of each of the Hilltop Broker-Dealers was as follows (in thousands).
Momentum
Independent
Network
Net capital
310,528
4,348
Less: required net capital
9,220
264
Excess net capital
301,308
4,084
Net capital as a percentage of aggregate debit items
67.4
Net capital in excess of 5% aggregate debit items
287,477
Under certain conditions, Hilltop Securities may be required to segregate cash and securities in a special reserve account for the benefit of customers under Rule 15c3-3 promulgated under the Exchange Act. Assets segregated for regulatory purposes under the provisions of the Exchange Act are restricted and not available for general corporate purposes. At March 31, 2021 and December 31, 2020, the Hilltop Broker-Dealers held cash of $273.4 million and $290.4 million, respectively, segregated in special reserve bank accounts for the benefit of customers. The Hilltop Broker-Dealers were not required to segregate cash and securities in special reserve accounts for the benefit of proprietary accounts of introducing broker-dealers at March 31, 2021 or December 31, 2020.
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Mortgage Origination
As a mortgage originator, PrimeLending and its subsidiaries are subject to minimum net worth and liquidity requirements established by HUD and GNMA, as applicable. On an annual basis, PrimeLending and its subsidiaries submit audited financial statements to HUD and GNMA, as applicable, documenting their respective compliance with minimum net worth and liquidity requirements. As of March 31, 2021, PrimeLending and its subsidiaries’ net worth and liquidity exceeded the amounts required by both HUD and GNMA, as applicable.
18. Stockholders’ Equity
Dividends
During the three months ended March 31, 2021 and 2020, the Company declared and paid cash dividends of $0.12 and $0.09 per common share, or an aggregate of $9.9 million and $8.2 million, respectively.
On April 22, 2021, Hilltop’s board of directors declared a quarterly cash dividend of $0.12 per common share, payable on May 28, 2021, to all common stockholders of record as of the close of business on May 14, 2021.
Stock Repurchases
In January 2021, the Hilltop board of directors authorized a new stock repurchase program through January 2022, pursuant to which the Company is authorized to repurchase, in the aggregate, up to $75.0 million of its outstanding common stock, inclusive of repurchases to offset dilution related to grants of stock-based compensation.
During the three months ended March 31, 2021, the Company paid $5.0 million to repurchase an aggregate of 149,878 shares of common stock at an average price of $33.01 per share. The Company’s stock repurchase program, prior year repurchases and related accounting policy are discussed in detail in Note 1 and Note 25 to the consolidated financial statements included in the Company’s 2020 Form 10-K.
19. 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 Bank’s net interest margin. Additionally, the Bank manages variability of cash flows associated with its variable rate debt in interest-related cash outflows with interest rate swap contracts. PrimeLending has interest rate risk relative to interest rate lock commitments (“IRLCs”) and its inventory of mortgage loans held for sale. PrimeLending is exposed to such interest 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”) and Eurodollar futures. Additionally, PrimeLending has interest rate risk relative to its MSR asset and uses derivative instruments, including interest rate swaps and U.S. Treasury bond futures and options to hedge this risk. The Hilltop Broker-Dealers use 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. Additionally, Hilltop Securities uses various derivative instruments, including U.S. Treasury bond futures and options, Eurodollar futures and municipal market data, or MMD, rate locks, to hedge changes in the fair value of its securities.
Non-Hedging Derivative Instruments and the Fair Value Option
As discussed in Note 4 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 hedge accounting provisions. The fair values of PrimeLending’s IRLCs and forward commitments are recorded in other assets or other liabilities, as appropriate, and changes in the fair values of these derivative instruments are recorded as a component of net gains from sale of loans and other mortgage production income. These 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 assets, 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 8 to the consolidated financial statements. The fair values of the Hilltop Broker-Dealers’ and the Bank’s derivative instruments are recorded in other assets or other liabilities, as appropriate. Changes in the fair value of derivatives are presented in the following table (in thousands).
Increase (decrease) in fair value of derivatives during period:
PrimeLending
43,839
19,876
Hilltop Broker-Dealers
(22,194)
(8,141)
Bank
(135)
Hedging Derivative Instruments
The Company has entered into interest rate swap contracts to manage the exposure to changes in fair value associated with certain available for sale fixed rate collateralized mortgage backed securities and fixed rate loans held for investment attributable to changes in the designated benchmark interest rate. Certain of these fair value hedges have been designated as a last-of-layer hedge, which provides the Company the ability to execute a fair value hedge of the interest rate risk associated with a portfolio of similar prepayable assets whereby the last dollar amount estimated to remain in the portfolio of assets is identified as the hedged item. Additionally, the Company has outstanding interest rate swap contracts designated as cash flow hedges and utilized to manage the variability of cash flows associated with its variable rate borrowings.
Under each of its interest rate swap contracts designated as hedges, the Company receives a floating rate and pays a fixed rate on the outstanding notional amount. The Company assesses the hedge effectiveness both at the onset of the hedge and at regular intervals throughout the life of the derivative. To the extent that the derivative instruments are highly effective in offsetting the variability of the hedged cash flows or fair value, changes in the fair value of the derivative are included as a component of other comprehensive loss on our consolidated balance sheets. Although the Company has determined at the onset of the hedges that the derivative instruments will be highly effective hedges throughout the term of the contract, any portion of derivative instruments subsequently determined to be ineffective will be recognized in earnings.
Derivative positions are presented in the following table (in thousands).
Notional
Estimated
Derivative instruments (not designated as hedges):
IRLCs
2,673,869
48,809
2,470,013
76,048
Commitments to purchase MBSs
2,075,777
(20,185)
2,478,041
22,311
Commitments to sell MBSs
5,837,856
50,638
6,141,079
(40,621)
Interest rate swaps
58,256
(502)
43,786
(2,196)
U.S. Treasury bond futures and options (1)
324,000
225,400
Eurodollar and other futures (1)
201,616
Derivative instruments (designated as hedges):
Interest rate swaps designated as cash flow hedges
125,000
(885)
105,000
(3,112)
Interest rate swaps designated as fair value hedges (2)
77,118
4,178
60,618
(130)
36
The decrease in the estimated fair value of the IRLCs at March 31, 2021, compared to December 31, 2020, was driven by a decrease in the average value of individual IRLCs. The impact of this decrease was partially offset by a slight increase in the total volume of IRLCs. The decrease in the average value of individual IRLCs was due to an increase in mortgage interest rates throughout the three months ended March 31, 2021.
PrimeLending held cash collateral advances totaling $58.5 million to offset net asset derivative positions on its commitments to sell MBSs at March 31, 2021. This amount is included in other liabilities within the consolidated balance sheets. PrimeLending had advanced cash collateral totaling $26.1 million to offset net liability positions on its commitments to sell MBSs at December 31, 2020. In addition, PrimeLending and the Hilltop Broker-Dealers had advanced cash collateral totaling $4.9 million and $2.7 million on various derivative instruments at March 31, 2021 and December 31, 2020, respectively. The advanced cash collateral amounts are included in other assets within the consolidated balance sheets.
20. 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
of Assets
Cash
of Recognized
Offset in the
Presented in the
Financial
Collateral
Balance Sheet
Instruments
Pledged
Securities borrowed:
Institutional counterparties
1,545,730
(1,539,833)
5,897
Reverse repurchase agreements:
(103,439)
2,903
Forward MBS derivatives:
50,960
(322)
(7,512)
43,126
1,703,032
1,702,710
(1,650,784)
51,926
1,338,855
(1,273,955)
64,900
(79,925)
394
(22,311)
1,441,485
(1,376,191)
65,294
37
of Liabilities
Liabilities
Securities loaned:
1,464,186
(1,457,134)
7,052
Interest rate swaps:
829
(327)
502
(440)
62
Repurchase agreements:
(123,392)
20,185
1,608,592
1,608,265
(1,601,151)
7,114
1,245,066
(1,179,090)
65,976
2,196
(2,123)
73
(237,856)
40,741
(120)
40,621
(12,670)
27,951
1,525,859
1,525,739
(1,431,739)
94,000
Secured Borrowing Arrangements
Secured Borrowings (Repurchase Agreements) — The Company participates in transactions involving securities sold under repurchase agreements, which are secured borrowings and generally mature one to ninety days from the transaction date or involve arrangements with no definite termination date. Securities sold under repurchase agreements are reflected at the amount of cash received in connection with the transactions. The Company may be required to provide additional collateral based on the fair value of the underlying securities, which is monitored on a daily basis.
Securities Lending Activities — The Company’s securities lending activities include lending securities for other broker-dealers, lending institutions and its own clearing and retail operations. These activities involve lending securities to other broker-dealers to cover short sales, to complete transactions in which there has been a failure to deliver securities by the required settlement date and as a conduit for financing activities.
When lending securities, the Company receives cash or similar collateral and generally pays interest (based on the amount of cash deposited) to the other party to the transaction. Securities lending transactions are executed pursuant to written agreements with counterparties that generally require securities loaned to be marked-to-market on a daily basis. The Company receives collateral in the form of cash in an amount generally in excess of the fair value of securities loaned. The Company monitors the fair value of securities loaned on a daily basis, with additional collateral obtained or refunded, as necessary. Collateral adjustments are made on a daily basis through the facilities of various clearinghouses. The Company is a principal in these securities lending transactions and is liable for losses in the event of a failure of any other party to honor its contractual obligation. Management sets credit limits with each counterparty and reviews these limits regularly to monitor the risk level with each counterparty. The Company is subject to credit risk through its securities lending activities if securities prices decline rapidly because the value of the Company’s collateral could fall below the amount of the indebtedness it secures. In rapidly appreciating markets, credit risk increases due to short positions. The Company’s securities lending business subjects the Company to credit risk if a counterparty fails to perform or if collateral securing its obligations is insufficient. In securities transactions, the Company is subject to credit risk during the period between the execution of a trade and the settlement by the customer.
The following tables present the remaining contractual maturities of repurchase agreement and securities lending transactions accounted for as secured borrowings (in thousands). The Company had no repurchase-to-maturity transactions outstanding at both March 31, 2021 and December 31, 2020.
Remaining Contractual Maturities
Overnight and
Greater Than
Continuous
Up to 30 Days
30-90 Days
90 Days
Repurchase agreement transactions:
Asset-backed securities
12,523
25,571
85,298
Securities lending transactions:
Corporate securities
5,874
1,458,312
1,476,709
1,587,578
Gross amount of recognized liabilities for repurchase agreement and securities lending transactions in offsetting disclosure above
Amount related to agreements not included in offsetting disclosure above
110,831
127,025
113
1,244,953
1,355,897
1,482,922
21. Broker-Dealer and Clearing Organization Receivables and Payables
Broker-dealer and clearing organization receivables and payables consisted of the following (in thousands).
Receivables:
Securities failed to deliver
24,333
58,244
Trades in process of settlement
14,379
12,375
7,628
Payables:
Correspondents
42,448
33,547
Securities failed to receive
28,445
61,589
21,765
11,148
6,406
39
22. Segment and Related Information
Following the sale of NLC on June 30, 2020, we have two primary business units within continuing operations, PCC (banking and mortgage origination) and Securities Holdings (broker-dealer). Under GAAP, our continuing operations business units are comprised of three reportable business segments organized primarily by the core products offered to the segments’ respective customers: banking, broker-dealer and mortgage origination. These segments reflect the manner in which operations are managed and the criteria used by the chief operating decision maker, the Company’s President and Chief Executive Officer, to evaluate segment performance, develop strategy and allocate resources.
The banking segment includes the operations of the Bank. The broker-dealer segment includes the operations of Securities Holdings and the mortgage origination segment is composed of PrimeLending.
As discussed in Note 3 to the consolidated financial statements, during the first quarter of 2020, management had determined that the insurance segment met the criteria to be presented as discontinued operations. On June 30, 2020, Hilltop completed the sale of NLC, which comprised the operations of the former insurance segment. As a result, insurance segment results for the three months ended March 31, 2020 have been presented as discontinued operations in the consolidated financial statements. Income from discontinued operations before taxes was $4.0 million during the three months ended March 31, 2020.
Corporate includes certain activities not allocated to specific business segments. These activities include holding company financing and investing activities, merchant banking investment opportunities and management and administrative services to support the overall operations of the Company.
Balance sheet amounts not discussed previously and the elimination of intercompany transactions are included in “All Other and Eliminations.” The following tables present certain information about continuing operations reportable business segment revenues, operating results, goodwill and assets (in thousands).
Mortgage
All Other and
Continuing
Origination
Corporate
Eliminations
Operations
Net interest income (expense)
103,884
10,514
(7,098)
(4,692)
3,074
(5,175)
Noninterest income
11,324
98,623
310,444
506
(3,312)
Noninterest expense
55,788
91,404
210,334
9,588
(452)
Income (loss) from continuing operations before taxes
64,595
17,667
93,012
(13,774)
93,923
13,173
(1,656)
4,528
Provision for credit losses
34,275
8,771
86,209
178,968
2,309
(4,544)
56,967
80,939
139,552
4,853
(410)
11,452
18,169
39,784
(4,200)
247,368
7,008
13,071
13,963,896
3,305,933
3,178,650
2,969,691
(5,735,333)
13,338,930
3,196,346
3,285,005
2,823,374
(5,699,391)
23. Earnings per Common Share
The following table presents the computation of basic and diluted earnings per common share (in thousands, except per share data).
Basic earnings per share:
46,485
Income from discontinued operations
Weighted average shares outstanding - basic
Basic earnings per common share:
Diluted earnings per share:
Effect of potentially dilutive securities
488
41
Weighted average shares outstanding - diluted
Diluted earnings per common share:
Item 2. Management’s Discussion and Analysis of Financial Condition and Results of Operations.
The following discussion should be read in conjunction with the consolidated historical financial statements and notes appearing elsewhere in this Quarterly Report on Form 10-Q (this “Quarterly Report”) and the financial information set forth in the tables herein.
Unless the context otherwise indicates, all references in this 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 “PCC” refer to PlainsCapital Corporation (a wholly owned subsidiary of Hilltop), references to “Securities Holdings” refer to Hilltop Securities Holdings LLC (a wholly owned subsidiary of Hilltop), references to “Hilltop Securities” refer to Hilltop Securities Inc. (a wholly owned subsidiary of Securities Holdings), references to “Momentum Independent Network” refer to Momentum Independent Network Inc. (a wholly owned subsidiary of Securities Holdings), Hilltop Securities and Momentum Independent Network are collectively referred to as the “Hilltop Broker-Dealers”, references to the “Bank” refer to PlainsCapital Bank (a wholly owned subsidiary of PCC), references to “FNB” refer to First National Bank, references to “SWS” refer to the former SWS Group, Inc., references to “PrimeLending” refer to PrimeLending, a PlainsCapital Company (a wholly owned subsidiary of the Bank) and its subsidiaries as a whole, references to “NLC” refer to National Lloyds Corporation (formerly a wholly owned subsidiary of Hilltop) and its wholly owned subsidiaries.
FORWARD-LOOKING STATEMENTS
This Quarterly Report includes “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 Quarterly Report that address results or developments that we expect or anticipate will or may occur in the future, and statements that are preceded by, followed by or include, words such as “anticipates,” “believes,” “could,” “estimates,” “expects,” “forecasts,” “goal,” “intends,” “may,” “might,” “plan,” “probable,” “projects,” “seeks,” “should,” “target,” “view” or “would” or the negative of these words and phrases or similar words or phrases, including such things as our business strategy, our financial condition, our revenue, our liquidity and sources of funding, market trends, operations and business, taxes, the impact of natural disasters or public health emergencies, such as the current global outbreak of a novel strain of coronavirus (“COVID-19”), information technology expenses, capital levels, mortgage servicing rights (“MSR”) assets, stock repurchases, dividend payments, expectations concerning mortgage loan origination volume, servicer advances and interest rate compression, expected levels of refinancing as a percentage of total loan origination volume, projected losses on mortgage loans originated, total expenses, the effects of government regulation applicable to our operations, the appropriateness of, and changes in, our allowance for credit losses and provision for (reversal of) credit losses, including as a result of the “current expected credit losses” (CECL) model, expected future benchmark rates, anticipated investment yields, our expectations regarding accretion of discount on loans in future periods, the collectability of loans, cybersecurity incidents and the outcome of litigation 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:
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 “Risk Factors” in Part I, Item 1A of our Annual Report on Form 10-K for the year ended December 31, 2020 (“2020 Form 10-K”), which was filed with the Securities and Exchange Commission (the “SEC”) on February 16, 2021, this Item 2, “Management’s Discussion and Analysis of Financial Condition and Results of Operations,” and other filings we have made with the SEC. We caution that the foregoing list of factors is not exhaustive, and new factors may emerge, or changes to the foregoing factors may occur, that could impact our business. All subsequent written and oral forward-looking statements concerning our business attributable to us or any person acting on our behalf are expressly qualified in their entirety by the cautionary statements above. We do not undertake any obligation to update any forward-looking statement, whether written or oral, relating to the matters discussed in this Quarterly Report except to the extent required by federal securities laws.
OVERVIEW
We are a financial holding company registered under the Bank Holding Company Act of 1956. 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 and mortgage origination segments. The following includes additional details regarding the financial products and services provided by each of our primary business units.
PCC. PCC is a financial holding company that provides, through its subsidiaries, traditional banking and wealth, investment and treasury management services primarily in Texas and residential mortgage loans throughout the United States.
Securities Holdings. Securities Holdings is a holding company 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, clearing, securities lending, structured finance and retail brokerage services throughout the United States.
During the first quarter of 2020, management determined that the then-pending sale of NLC met the criteria to be presented as discontinued operations. As a result, NLC’s results for the three months ended March 31, 2020 have been presented as discontinued operations in the consolidated financial statements. On June 30, 2020, we completed the sale of all of the outstanding capital stock of NLC, which comprised the operations of our former insurance segment, for cash proceeds of $154.1 million. During 2020, Hilltop recognized an aggregate gain associated with this transaction of $36.8 million, net of $5.1 million in transaction costs and was subject to post-closing adjustments. The resulting book gain from this sale transaction was not recognized for tax purposes due to the excess tax basis over book basis being greater than the recorded book gain. Any tax loss related to this transaction is deemed disallowed pursuant to the rules under the Internal Revenue Code. We also entered into an agreement at closing to refrain for a specified period from certain activities that compete with the business of NLC. Unless otherwise noted, for purposes of this Management’s Discussion and Analysis of Financial Condition and Results of Operations, “consolidated” refers to our consolidated financial position and consolidated results of operations, including discontinued operations and assets and liabilities of the discontinued operations.
During the three months ended March 31, 2021, income applicable to common stockholders was $120.3 million, or $1.46 per diluted share. We declared total common dividends of $0.12 per share during the three months ended March 31, 2021, resulting in a dividend payout ratio of 8.19%. Dividend payout ratio is defined as cash dividends declared per common share divided by basic earnings per common share, including discontinued operations. We also paid an aggregate of $5.0 million to repurchase shares of our common stock during the three months ended March 31, 2021.
We reported $161.7 million of income from continuing operations before income taxes during the three months ended March 31, 2021, including the following contributions from our reportable business segments.
At March 31, 2021, on a consolidated basis, we had total assets of $17.7 billion, total deposits of $11.7 billion, total loans, including loans held for sale, of $10.2 billion and stockholders’ equity of $2.4 billion.
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Recent Developments
COVID-19
The COVID-19 pandemic and related governmental control measures severely disrupted financial markets and overall economic conditions throughout 2020. While the impact of the pandemic and the uncertainties have remained into 2021, there have been varying degrees of easing of restrictive measures in the United States and an increasing reopening of businesses, in addition to millions of Americans receiving the COVID-19 vaccine. Further, the U.S. federal government continued to enact policies to provide fiscal stimulus to the economy and relief to those affected by the pandemic, with the most recent stimulus expected to bolster household finances as well as those of small businesses, states and municipalities. Throughout the pandemic, we have taken a number of precautionary steps to safeguard our business and our employees from COVID-19, including, but not limited to, banking by appointment, implementing employee travel restrictions and telecommuting arrangements, while maintaining business continuity so that we can continue to deliver service to and meet the demands of our clients. Since the start of the pandemic, most of our employees have been working remotely, with only certain operationally critical employees working on site at our principal business headquarters and business segment locations. We expect to begin the process of returning a majority of our employees to their respective office locations beginning in the second quarter of 2021 based initially on a rotational team schedule to better ensure that appropriate social distancing measures are followed. We will continue to monitor and assess the impact of the COVID-19 pandemic on a regular basis to ensure that we adhere to guidelines and orders issued by federal, state and local governments.
In light of the extreme volatility and disruptions in the capital and credit markets in March 2020 resulting from the COVID-19 crisis and its negative impact on the economy, including a significant decline in corporate debt and equity issuances and a deterioration in the mortgage servicing and commercial paper markets, we took a number of precautionary actions beginning in March 2020 to enhance our financial flexibility by bolstering our cash position to ensure that we maintained adequate cash readily available to meet both expected and unexpected funding needs without adversely affecting our daily operations.
The Federal Open Market Committee (“FOMC”) reduced the target range for short-term rates by 150 basis points to a range of 0% to 0.25% during March 2020 to support the economy and potentially reduce the impacts from the COVID-19 pandemic. As a result of these rate adjustments and the stressed economic outlook, mortgage rates fell to historically low levels. Given our exposure to the mortgage market, this precipitous decline in rates resulted in significant growth in mortgage originations at both PrimeLending and Hilltop Securities through its partnerships with certain housing finance authorities. To improve our already strong liquidity position, we raised brokered and other wholesale funding to support the enhanced mortgage activity. To meet increased liquidity demands, we raised brokered deposits during 2020 that have a remaining balance of approximately $639 million at March 31, 2021, down from approximately $731 million at December 31, 2020. Further, beginning in March 2020, additional deposits were swept from Hilltop Securities into the Bank. Since June 30, 2020, given the continued strong cash and liquidity levels at the Bank, the total funds swept from Hilltop Securities into the Bank was reduced, and was approximately $700 million as of March 31, 2021.
Further, during March 2020, we substantially reduced the trading portfolio inventory limits at Hilltop Securities in an effort to protect capital, minimize losses and ensure target liquidity levels throughout the crisis. During March 2020, the capital markets experienced significant friction and in certain portions of the market, liquidity was not prevalent. In particular for us, the market for municipal securities, collateralized mortgage obligations, mortgage derivatives and Government National Mortgage Association (“GNMA”) mortgage pools experienced significant liquidity stress at points during the month. The Federal Reserve, in partnership with the Treasury of the United States, stepped in to provide additional liquidity in each of these critical markets. We continue to evaluate market conditions to determine the appropriateness of capital market inventory limits.
Asset Valuation
At each reporting date between annual impairment tests, we consider potential indicators of impairment. Given the current economic uncertainty and volatility surrounding COVID-19, we considered whether the events and circumstances resulted in it being more likely than not that the fair value of any reporting unit and other intangible assets were less than their respective carrying value. Impairment indicators considered comprised the condition of the economy and financial services industry; government intervention and regulatory updates; the impact of recent events to financial performance and cost factors of the reporting unit; performance of our stock and other relevant events.
45
Given the potential impacts as a result of COVID-19, actual results may differ materially from our current estimates as the scope of COVID-19 evolves or if the duration of business disruptions is longer than currently anticipated. While certain valuation assumptions and judgments will change to account for pandemic-related circumstances, we do not anticipate significant changes in methodology used to determine the fair value of our goodwill, intangible assets and other long-lived assets. We will continue to monitor developments regarding the COVID-19 pandemic and measures implemented in response to the pandemic, market capitalization, overall economic conditions and any other triggering events or circumstances that may indicate an impairment in the future.
To the extent a sustained decline in our stock price or the occurrence of what management would deem to be a triggering event that could, under certain circumstances, cause us to perform impairment tests on our goodwill and other intangible assets, and result in an impairment charge being recorded for that period. In the event that we conclude that all or a portion of our goodwill and other intangible assets are impaired, a non-cash charge for the respective amount of such impairment would be recorded to earnings. Such a charge would have no impact on tangible capital or regulatory capital.
Loan Portfolio
In response to the COVID-19 pandemic, the Coronavirus Aid, Relief, and Economic Security Act (“CARES Act”) and the Paycheck Protection Program and Health Care Enhancement Act (the “PPP/HCE Act”) were passed in March 2020, which were intended to provide emergency relief to several groups and individuals impacted by the COVID-19 pandemic. Among the numerous provisions contained in the CARES Act was the creation of a $349 billion Paycheck Protection Program (“PPP”) that provides federal government loan forgiveness for Small Business Administration (“SBA”) Section 7(a) loans for small businesses, which may include our customers, to pay up to eight weeks of employee compensation and other basic expenses such as electric and telephone bills. Further, the CARES Act allows the Bank to suspend the troubled debt restructuring (“TDR”) requirements for certain loan modifications to be categorized as a TDR.
Starting in March 2020, the Bank implemented several actions to better support our impacted banking clients and allow for loan modifications such as principal and/or interest payment deferrals, participation in the PPP as an SBA preferred lender and personal banking assistance including waived fees, increased daily spending limits and suspension of residential foreclosure activities. The COVID-19 payment deferment programs allow for a deferral of principal and/or interest payments with such deferred principal payments due and payable on the maturity date of the existing loan. The Bank’s actions during 2020 included approval of approximately $1.0 billion in COVID-19 related loan modifications as of December 31, 2020.
During the first quarter of 2021, the Bank continued to support its impacted banking clients through the approval of COVID-19 related loan modifications, which resulted in an additional $8 million of new COVID-19 related loan modifications since December 31, 2020. The portfolio of active deferrals that have not reached the end of their deferral period was approximately $130 million as of March 31, 2021. While the majority of the portfolio of COVID-19 related loan modifications no longer require deferral, such loans represent elevated risk, and therefore management continues to monitor these loans. The extent to which these measures will impact the Bank is uncertain, and any progression of loans, whether receiving COVID-19 payment deferrals or not, into non-performing assets, during future periods is uncertain and will depend on future developments that cannot be predicted.
While all industries could experience adverse impacts due to the COVID-19 pandemic, certain of our loan portfolio industry sectors and subsectors, including real estate collateralized by office buildings, have an increased level of risk. The following table provides information on those loans held for investment balances, by portfolio industry sector, including collectively evaluated allowance for credit losses, that include active COVID-19 payment deferrals (dollars in thousands).
Allowance for
Active
90 Day
Classified
as a % of
Interest and
and
for
Principal
Active Modifications
Criticized
Credit
and Criticized
Deferrals
($)
(#)
Modifications
Hotel
107,471
87,271
15,599
14.5
17.9
Restaurants
Transportation & Warehousing
7,683
1,301
16.9
1-4 Family Residential
9,493
6,718
60
0.6
0.9
Retail
Real Estate & Rental & Leasing
888
63
7.1
Healthcare and Social Assistance
729
1,604
2,333
303
13.0
All Other
2,420
104
4.3
118,303
11,985
130,288
124
107,313
17,430
13.4
16.2
In addition, the Bank’s loan portfolio includes collateralized loans extended to businesses that depend on the energy industry, including those within the exploration and production, field services, pipeline construction and transportation sectors. Historical volatility in crude oil prices coupled with the economic uncertainties associated with COVID-19 has resulted in an increased level of risk related to the energy industry. The following table summarizes energy loan portfolio exposures by sector (dollars in thousands).
Loans Held for Investment Balances
Allowance For Credit Losses as
a Percentage of
Loans Held
Unfunded
For Credit
Total Loans Held
Classified and
For Investment
Commitments
Criticized Loans
Exploration / Production
9,042
7,549
16,591
1,551
17.2
Midstream
11,611
2,500
14,111
3,773
0.1
0.3
Services
26,828
8,225
35,053
6,840
1,129
4.2
16.5
24,804
53,249
3,801
109
0.4
2.9
75,926
43,078
119,004
14,414
2,800
3.7
19.4
As noted above, the Bank’s actions during the second quarter of 2020 also included supporting our impacted banking clients through the initial PPP effort. These efforts included approval and funding of over 2,800 PPP loans ranging from approximately $1 thousand to $8.4 million, with approximately $314 million remaining outstanding at March 31, 2021. The PPP loans made by the Bank are guaranteed by the SBA and, if used by the borrower for authorized purposes, may be fully forgiven. On October 2, 2020, the SBA began approving the Bank’s PPP forgiveness applications and remitting forgiveness payments to PPP lenders for PPP borrowers. Through April 16, 2021, the SBA had approved approximately 2,270 initial round PPP forgiveness applications totaling approximately $420 million, with PPP loans of approximately $185 million pending SBA review and approval.
In addition, given updates from the SBA regarding the second round of the PPP effort, the Bank has been accepting new applications from impacted banking clients since January 2021. While the majority of these applications are second draw loans, the Bank has received some first draw loan requests. These efforts have included approval and funding of over 1,160 second round PPP loans ranging from approximately $1 thousand to $2.4 million, with approximately $178 million and $199 million outstanding at March 31, 2021 and April 16, 2021, respectively, with an additional approximately $28 million under review.
Refer to the discussion in the “Financial Condition – Allowance for Credit Losses on Loans” section that follows for more details regarding the significant assumptions and estimates involved in estimating credit losses given the economic uncertainties associated with COVID-19.
Outlook for 2021
The COVID-19 pandemic has negatively impacted financial markets and overall economic conditions, and is expected to continue to have implications on our business and operations. The extent of the impact of COVID-19 on our operational and financial performance for the remainder of 2021 is dependent on certain developments, including, among others, the ongoing distribution and effectiveness of vaccines, government stimulus, the ultimate impact of COVID-19 on our
47
customers and clients, potential further disruption and deterioration in the financial services industry, including the mortgage servicing and commercial paper markets, and additional, or extended, federal, state and local government orders and regulations that might be imposed in response to the pandemic, all of which are uncertain.
See “Item 1A. Risk Factors” of our 2020 Form 10-K for additional discussion of the potential adverse impact of COVID-19 on our business, results of operations and financial condition.
Factors Affecting Results of Operations
As a financial institution providing products and services through our banking, broker-dealer and mortgage origination segments, we are directly affected by general economic and market conditions, many of which are beyond our control and unpredictable. A key factor impacting our results of operations includes changes in the level of interest rates in addition to twists in the shape of the yield curve with the magnitude and direction of the impact varying across the different lines of business. Other factors impacting our results of operations include, but are not limited to, fluctuations in volume and price levels of securities, inflation, political events, investor confidence, investor participation levels, legal, regulatory, and compliance requirements and competition. All of these factors have the potential to impact our financial position, operating results and liquidity. In addition, the recent economic and political environment has led to legislative and regulatory initiatives, both enacted and proposed, that could substantially change the regulation of the financial services industry and may significantly impact us.
Factors Affecting Comparability of Results of Operations
As previously discussed, on June 30, 2020, we completed the sale of all of the outstanding capital stock of NLC, which comprised the operations of our insurance segment. Accordingly, NLC’s results for the three months ended March 31, 2020 have been presented as discontinued operations in the consolidated financial statements.
Tender Offer
On September 23, 2020, we announced the commencement of a modified “Dutch auction” tender offer to purchase shares of our common stock for an aggregate cash purchase price of up to $350 million. On November 17, 2020, we completed our tender offer, repurchasing 8,058,947 shares of outstanding common stock at a price of $24.00 per share for a total of $193.4 million excluding fees and expenses. We funded the tender offer with cash on hand.
Subordinated Notes due 2030 and 2035
On May 7, 2020, we completed a public offering of $50 million aggregate principal amount of 5.75% fixed-to-floating rate subordinated notes due May 15, 2030 (the “2030 Subordinated Notes”) and $150 million aggregate principal amount of 6.125% fixed-to-floating rate subordinated notes due May 15, 2035 (the “2035 Subordinated Notes”). We collectively refer to the 2030 Subordinated Notes and the 2035 Subordinated Notes as the “Subordinated Notes”. The price for the Subordinated Notes was 100% of the principal amount of the Subordinated Notes. The net proceeds from the offering, after deducting underwriting discounts and fees and expenses of $3.4 million, were $196.6 million. We intend to use the net proceeds of the offerings for general corporate purposes.
Technology Enhancements and Corporate Initiatives
In furtherance of our goal of building a premier, diversified financial services company, we regularly evaluate strategic opportunities to invest in our business and technology platforms. Such investments are intended to support long-term technological competitiveness and improve operational efficiencies throughout our organization. During 2018, we began the significant investment in new technological solutions, substantial core system upgrades and other technology enhancements. Such significant investments specifically include single enterprise-wide general ledger and procurement solutions, a mortgage loan origination system and a core system replacement within our broker-dealer segment (collectively referred to as “Core System Improvements”). In combination with these technology enhancements, we are continuing our efforts to consolidate common back office functions. Costs incurred related to these Core System Improvements and the consolidation of common back office functions represented a significant portion of our noninterest expenses throughout 2020. We believe that such non-recurring costs will decline by the end of 2021. We
have made such investments with the expectation that they will result in cost savings over the long term. Beginning in the second quarter of 2019, the mortgage origination segment began the implementation of a new mortgage loan origination system. The transition from the previous mortgage loan origination system was completed during the fourth quarter of 2020. During the second quarter of 2020, we implemented the core system replacement within our broker-dealer segment. This was a highly complex endeavor and the broker-dealer segment continues to work with the technology vendors, clients and internal stakeholders. Additionally, through the third quarter of 2020, we made significant progress in our transition to a single, enterprise-wide general ledger solution by replacing legacy ledgers at our banking and mortgage origination segments, as well as corporate, and recently, in April 2021, we replaced our only remaining legacy ledger and transitioned our broker-dealer segment to the enterprise-wide general ledger solution.
LIBOR
In July 2017, the Financial Conduct Authority (“FCA”) announced that it intends to cease compelling banks to submit rates for the calculation of LIBOR after 2021. Most recently in March 2021, the FCA and the Intercontinental Exchange (“ICE”) Benchmark Administration concurrently confirmed their original intention to stop requesting banks to submit the rates required to calculate LIBOR after the 2021 calendar year and additionally announced firm target dates for the phase out of various LIBOR tenors. Pursuant to the announcement, one week and two-month LIBOR will cease to be published or lose representativeness immediately after December 31, 2021, and all remaining USD LIBOR tenors will cease to be published or lose representativeness immediately after June 30, 2023.
Working groups comprised of various regulators and other industry groups have been formed in the United States and other countries in order to provide guidance on this topic. In particular, the Alternative Reference Rates Committee (“ARRC”) has proposed that the Secured Overnight Financing Rate (“SOFR”) is the rate that represents best practice as the alternative to LIBOR for use in derivatives and other financial contracts that are currently indexed to LIBOR. The ARRC has also published recommended fall-back language for LIBOR-linked financial instruments, among numerous other areas of guidance.
The Financial Accounting Standards Board (“FASB”) issued guidance in March 2020 intended to provide temporary optional expedients and exceptions to the accounting principles generally accepted in the United States (“GAAP”) guidance on contract modifications and hedge accounting to ease the financial reporting burdens related to the expected market transition from LIBOR and other interbank offered rates to alternative reference rates. Additionally, the FASB issued specific accounting guidance that permits the use of the Overnight Index Swap rate based on the SOFR to be designated as a benchmark interest rate for hedge accounting purposes.
Certain loans we originate bear interest at a floating rate based on LIBOR. We also pay interest on certain borrowings, are counterparty to derivative agreements, and have existing contracts with payment calculations that use LIBOR as the reference rate. These changes will create various risks surrounding the financial, operational, compliance and legal aspects associated with changing certain elements of existing contracts.
ARRC has proposed a paced market transition plan to SOFR from LIBOR, and organizations are currently working on industry-wide and company-specific transition plans as it relates to derivatives and cash markets exposed to LIBOR. However, at this time, no consensus exists as to what rate or rates may become acceptable alternatives to LIBOR and it is impossible to predict the effect of any such alternatives on the value of LIBOR-based securities and variable rate loans, debentures, or other securities or financial arrangements, given LIBOR’s role in determining market interest rates globally.
We have made a preliminary assessment of areas across the organization that will be affected by the migration away from LIBOR and have transitioned to the impact assessment and early implementation stages. In light of the above described recent changes to the LIBOR phase out dates being pushed out to 2023, we are considering the actions that will be required, including negotiating certain of our agreements based on an alternative benchmark rate that may be established, if any. During the third quarter of 2020, PrimeLending began originating conventional adjustable-rate mortgage, or ARM, loan products utilizing a SOFR rate with terms consistent with government-sponsored enterprise, or GSE, guidelines. In addition, the Bank’s management team is currently working with its commercial relationships who have LIBOR-based contracts maturing after 2021 to amend terms and establish an alternative benchmark rate. We are also continuing work on an enterprise-wide contract model and software review to better evaluate both the impacts of the LIBOR phase-out and transition requirements. As a result of this effort, we may incur significant expenses in effecting the transition, including, but not limited to, changes to our agreements and our agreements with customers that do not contemplate LIBOR being unavailable, systems and processes.
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Brokered Deposits
In December 2020, the Federal Deposit Insurance Corporation (“FDIC”) finalized revisions to its rules and prior guidance regarding brokered deposits (the “Revisions”). The Revisions are intended to modernize the FDIC's framework for regulating brokered deposits and ensure that the classification of a deposit as brokered appropriately reflects changes in the banking landscape. They also modify the interest rate restrictions applicable to certain depository institutions and clarify the application of the brokered deposit requirements to non-maturity deposits. The Revisions became effective on April 1, 2021, but full compliance is not required during a transitionary period ending January 1, 2022. We are currently evaluating the Revisions, and any future financial impacts on our banking and broker-dealer segments, compared to our current brokered deposit and funds sweep relationships.
Segment Information
As previously discussed, on June 30, 2020, we completed the sale of all of the outstanding capital stock of NLC, which comprised the operations of the insurance segment. Accordingly, insurance segment results for the three months ended March 31, 2020 have been presented as discontinued operations in the consolidated financial statements and we no longer have an insurance segment. Additional details are presented in Note 3, Discontinued Operations, in the notes to our consolidated financial statements.
Following the above-noted sale of NLC, we have two primary business units within continuing operations, PCC (banking and mortgage origination) and Securities Holdings (broker-dealer). Under GAAP, our business units are comprised of three reportable business segments organized primarily by the core products offered to the segments’ respective customers: banking, broker-dealer and mortgage origination. Consistent with our historical segment operating results, we anticipate that future revenues will be driven primarily from the banking segment, with the remainder being generated by our broker-dealer and mortgage origination segments. Operating results for the mortgage origination segment have historically been more volatile than operating results for the banking and broker-dealer segments.
The banking segment includes the operations of the Bank. The banking segment primarily provides business and consumer banking 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. The Bank also derives revenue from other sources, including service charges on customer deposit accounts and trust fees.
The broker-dealer segment includes the operations of Securities Holdings, which operates through its wholly owned subsidiaries Hilltop Securities, Momentum Independent Network and Hilltop Securities Asset Management, LLC. The broker-dealer segment generates a majority of its revenues from fees and commissions earned from investment advisory and securities brokerage services. Hilltop Securities is a broker-dealer registered with the SEC and the Financial Industry Regulatory Authority (“FINRA”) and a member of the New York Stock Exchange (“NYSE”). Momentum Independent Network is an introducing broker-dealer that is also registered with the SEC and FINRA. Hilltop Securities, Momentum Independent Network and Hilltop Securities Asset Management, LLC are registered investment advisers under the Investment Advisers Act of 1940.
The mortgage origination segment includes the operations of PrimeLending, which offers a variety of loan products and generates revenue predominantly from fees charged on the origination and servicing of loans and from selling these loans in the secondary market.
Corporate includes certain activities not allocated to specific business segments. These activities include holding company financing and investing activities, merchant banking investment opportunities, and management and administrative services to support the overall operations of the Company.
The eliminations of intercompany transactions are included in “All Other and Eliminations.” Additional information concerning our reportable segments is presented in Note 22, Segment and Related Information, in the notes to our consolidated financial statements.
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The following table presents certain information about the continuing operating results of our reportable segments (in thousands). This table serves as a basis for the discussion and analysis in the segment operating results sections that follow.
Variance 2021 vs 2020
Percent
Net interest income (expense):
9,961
(2,659)
(20)
(7,466)
NM
(3,036)
(183)
All Other and Eliminations
(1,454)
(32)
Hilltop Continuing Operations
(4,654)
(4)
Provision for (reversal of) credit losses:
(39,450)
(115)
(208)
(76)
(39,658)
2,553
12,414
131,476
(1,803)
(78)
1,232
145,872
(1,179)
10,465
70,782
51
4,735
98
(42)
(10)
84,761
Income (loss) from continuing operations before taxes:
53,143
464
(3)
53,228
(9,574)
(228)
(180)
(46)
96,115
Not meaningful.
Key Performance Indicators
We utilize several key indicators of financial condition and operating performance to evaluate the various aspects of our business. In addition to traditional financial metrics, such as revenue and growth trends, we monitor several other financial measures and non-financial operating metrics to help us evaluate growth trends, measure the adequacy of our capital based on regulatory reporting requirements, measure the effectiveness of our operations and assess operational efficiencies. These indicators change from time to time as the opportunities and challenges in our businesses change.
Specifically, performance ratios and asset quality ratios are typically used for measuring the performance of banking and financial institutions. We consider return on average stockholders’ equity, return on average assets and net interest margin to be important supplemental measures of operating performance that are commonly used by securities analysts, investors and other parties interested in the banking and financial industry. The net charge-offs to average loans outstanding ratio is also considered a key measure for our banking segment as it indicates the performance of our loan portfolio.
In addition, we consider regulatory capital ratios to be key measures that are used by us, as well as banking regulators, investors and analysts, to assess our regulatory capital position and to compare our regulatory capital to that of other financial services companies. We monitor our capital strength in terms of both leverage ratio and risk-based capital ratios based on capital requirements administered by the federal banking agencies. The risk-based capital ratios are minimum supervisory ratios generally applicable to banking organizations, but banking organizations are widely
expected to operate with capital positions well above the minimum ratios. Failure to meet minimum capital requirements can initiate certain mandatory actions by regulators that, if undertaken, could have a material effect on our financial condition or results of operations.
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 and is primarily earned by our banking segment. 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. Net interest income from continuing operations decreased during the three months ended March 31, 2021, compared with the same period in 2020, primarily due to decreases within our mortgage origination segment, broker-dealer segment and corporate, partially offset by an increase within our banking segment.
The other component of our revenue is noninterest income, which is primarily comprised of the following:
In the aggregate, we generated an increase in noninterest income from continuing operations during the three months ended March 31, 2021, compared to the same period in 2020, noted in the segment results table previously presented, primarily due to an increase of $131.2 million in net gains from sale of loans, other mortgage production income and mortgage loan origination fees within our mortgage origination segment.
We also incur noninterest expenses in the operation of our businesses. Our businesses engage in labor intensive activities and, consequently, employees’ compensation and benefits represent the majority of our noninterest expenses.
Consolidated Operating Results
Income from continuing operations applicable to common stockholders during the three months ended March 31, 2021 was $120.3 million, or $1.46 per diluted share, compared with $46.5 million, or $0.51 per diluted share, during the three months ended March 31, 2020. Hilltop’s financial results from continuing operations for the three months ended March 31, 2021 reflect a significant increase in mortgage origination segment net gains from sales of loans and other mortgage production income, while the three months ended March 31, 2020 results included a build in the allowance for credit losses associated with the impact of macroeconomic forecast assumptions attributable to the market disruption and economic uncertainties caused by COVID-19.
Including income from discontinued operations, net of income taxes, income applicable to common stockholders was $49.6 million, or $0.55 per diluted share, during the three months ended March 31, 2020.
Certain items included in net income for the three months ended March 31, 2021 and 2020 resulted from purchase accounting associated with the merger of PlainsCapital Corporation with and into a wholly owned subsidiary of Hilltop on November 30, 2012, the FDIC-assisted transaction whereby the Bank acquired certain assets and assumed certain liabilities of FNB, the acquisition of SWS Group, Inc. in a stock and cash transaction, and the acquisition of The Bank of River Oaks in an all-cash transaction (collectively, the “Bank Transactions”). Income before income taxes during the three months ended March 31, 2021 and 2020 included net accretion on earning assets and liabilities of $4.9 million and $6.6 million, respectively, and amortization of identifiable intangibles of $1.3 million and $1.8 million, respectively, related to the Bank Transactions.
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The information shown in the table below includes certain key performance indicators on a consolidated basis.
Return on average stockholders' equity (1)
20.58
9.38
Return on average assets (2)
2.90
1.47
Net interest margin (3) (4)
2.69
3.41
Leverage ratio (5) (end of period)
13.03
Common equity Tier 1 risk-based capital ratio (6) (end of period)
15.96
We present net interest margin and net interest income below, on a taxable-equivalent basis. Net interest margin (taxable equivalent), a non-GAAP measure, is defined as taxable equivalent net interest income divided by average interest-earning assets. Taxable equivalent adjustments are based on the applicable corporate federal income tax rate of 21% for all periods presented. The interest income earned on certain earning assets is completely or partially exempt from federal income tax. As such, these tax-exempt instruments typically yield lower returns than taxable investments. To provide more meaningful comparisons of net interest margins for all earning assets, we use net interest income on a taxable-equivalent basis in calculating net interest margin by increasing the interest income earned on tax-exempt assets to make it fully equivalent to interest income earned on taxable investments.
During the three months ended March 31, 2021 and 2020, purchase accounting contributed 13 and 22 basis points, respectively, to our consolidated taxable equivalent net interest margin of 2.69% and 3.42%, respectively. The purchase accounting activity was primarily related to the accretion of discount of loans which totaled $4.9 million and $6.6 million during the three months ended March 31, 2021 and 2020, respectively, associated with the Bank Transactions.
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The table below provides additional details regarding our consolidated net interest income (dollars in thousands).
Annualized
Earned or
Yield or
Balance
Paid
Rate
Interest-earning assets
2,573,085
16,233
2.52
1,619,644
15,631
3.86
Loans held for investment, gross (1)
7,645,883
88,044
4.62
7,262,282
95,538
5.23
Investment securities - taxable
2,267,709
10,233
1.80
1,798,897
16,606
3.69
Investment securities - non-taxable (2)
284,001
2,280
3.21
208,863
1,902
3.64
Federal funds sold and securities purchased under agreements to resell
93,525
0.00
60,943
0.89
Interest-bearing deposits in other financial institutions
1,565,879
582
0.15
461,775
1,512
1.32
1,452,704
7.98
1,568,737
3.36
49,916
762
6.18
78,595
7.72
Interest-earning assets, gross (2)
15,932,702
147,106
3.70
13,059,736
146,162
4.45
(149,397)
(74,430)
Interest-earning assets, net
15,783,305
12,985,306
Noninterest-earning assets
1,559,039
1,633,387
17,342,344
14,618,693
Interest-bearing liabilities
Interest-bearing deposits
7,626,575
0.41
6,264,827
15,125
0.97
1,355,945
7.62
1,474,988
3.07
Notes payable and other borrowings
1,130,068
8,014
2.85
1,368,038
8,544
2.50
Total interest-bearing liabilities
10,112,588
1.65
9,107,853
34,946
1.54
Noninterest-bearing liabilities
Noninterest-bearing deposits
3,729,994
2,730,975
1,101,972
633,722
14,944,554
12,472,550
Stockholders’ equity
2,371,281
2,121,877
Noncontrolling interest
26,509
24,266
Net interest income (2)
105,865
111,216
Net interest spread (2)
2.05
2.91
Net interest margin (2)
3.42
The banking segment’s net interest margin exceeds our consolidated net interest margin shown above. Our consolidated net interest margin includes certain items that are not reflected in the calculation of our net interest margin within our banking segment and reduce our consolidated net interest margin, such as the borrowing costs of Hilltop and the yields and costs associated with certain items within interest-earning assets and interest-bearing liabilities in the broker-dealer segment, including items related to securities financing operations that particularly decrease net interest margin. In addition, yields and costs on certain interest-earning assets, such as warehouse lines of credit extended to subsidiaries (operating segments) by the banking segment, are eliminated from the consolidated financial statements. Our consolidated net interest margins for the three months ended March 31, 2021 were also negatively impacted by certain actions taken by management during 2020 to strengthen our available liquidity position. Such actions, including increasing overall cash balances by raising brokered money market and brokered time deposits and raising capital through the issuance of subordinated debt, were taken out of an abundance of caution as the pandemic continues to create significant uncertainty in the banking and capital markets.
On a consolidated basis, net interest income decreased during the three months ended March 31, 2021, compared with the same period in 2020, primarily due to the effects of decreased net yields on mortgage loans held for sale and interest incurred beginning in May 2020 related to the Subordinated Notes at corporate, partially offset by the decrease in market interest rates on deposits within the banking segment. Refer to the discussion in the “Banking Segment” section that follows for more details on the changes in net interest income, 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.
The provision for (reversal of) credit losses is determined by management as the amount necessary to maintain the allowance for credit losses at the amount of expected credit losses inherent within the loans held for investment portfolio. The amount of expense and the corresponding level of allowance for credit losses for loans are based on our
evaluation of the collectability of the loan portfolio based on historical loss experience, reasonable and supportable forecasts, and other significant qualitative and quantitative factors. Substantially all of our consolidated provision for (reversal of) credit losses is related to the banking segment. During the three months ended March 31, 2021 the reversal of credit losses was primarily impacted by the banking segment’s reduction in reserves associated with collectively evaluated loans within the portfolio attributable to improvements in macroeconomic forecast assumptions from the prior quarter. Refer to the discussion in the “Financial Condition – Allowance for Credit Losses on Loans” section that follows for more details regarding the significant assumptions and estimates involved in estimating credit losses.
Noninterest income from continuing operations increased during the three months ended March 31, 2021, compared with the same period in 2020, primarily due to increases in total mortgage loan sales volume, changes in net fair value and related derivative activity, and increases in average loan sales margin, partially offset by a decrease in average mortgage loan origination fees within our mortgage origination segment, as well as increases in structured finance net revenues within our broker-dealer segment.
Noninterest expense from continuing operations increased during the three months ended March 31, 2021, compared with the same period in 2020, primarily due to increases in variable compensation and segment operating costs associated with the increased mortgage loan originations within our mortgage origination segment and increases in both variable and non-variable compensation within our broker-dealer segment.
Effective income tax rates from continuing operations during the three months ended March 31, 2021 and 2020 were 23.4% and 23.1%, respectively, and approximated the applicable statutory rates for such periods which approximated statutory rates.
Segment Results from Continuing Operations
Banking Segment
The following table presents certain information about the operating results of our banking segment (in thousands).
Variance
2021 vs 2020
Income before income taxes
The increase in income before income taxes during the three months ended March 31, 2021, compared with the same period in 2020, was primarily due to the combined impact of both a reversal of credit losses during the first quarter of 2021, which reflected improvements in macroeconomic forecast assumptions from the prior quarter and the significant increase in provision for credit losses during the first quarter of 2020 associated with the adoption of CECL and the market disruption caused by COVID-19. Changes to net interest income related to 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 are discussed in more detail below.
The information shown in the table below includes certain key indicators of the performance and asset quality of our banking segment.
Efficiency ratio (1)
48.42
55.47
1.48
0.33
Net interest margin (3)
3.30
3.81
Net recoveries (charge-offs) to average loans outstanding (4)
0.03
(0.09)
The banking segment presents net interest margin and net interest income in the following discussion and tables below on a taxable equivalent basis. Net interest margin (taxable equivalent), a non-GAAP measure, is defined as taxable equivalent net interest income divided by average interest-earning assets. Taxable equivalent adjustments are based on the applicable corporate federal income tax rate of 21% for all periods presented. The interest income earned on certain earning assets is completely or partially exempt from federal income tax. As such, these tax-exempt instruments typically yield lower returns than taxable investments. To provide more meaningful comparisons of net interest margins for all earning assets, we use net interest income on a taxable equivalent basis in calculating net interest margin by increasing the interest income earned on tax-exempt assets to make it fully equivalent to interest income earned on taxable investments.
During the three months ended March 31, 2021 and 2020, purchase accounting contributed 17 and 30 basis points, respectively, to the banking segment’s taxable equivalent net interest margin of 3.31% and 3.82%, respectively. These purchase accounting items are primarily related to accretion of discount of loans associated with the Bank Transactions presented in the Consolidated Operating Results section.
The table below provides additional details regarding our banking segment’s net interest income (dollars in thousands).
7,185,414
84,519
4.72
6,738,086
89,929
5.30
Subsidiary warehouse lines of credit
2,338,614
21,910
3.75
1,467,498
14,435
3.89
1,786,911
6,272
1.40
1,213,777
7,402
2.44
115,069
985
107,079
900
560
1,286,353
0.10
295,692
1.23
36,813
0.81
58,055
552
3.80
12,749,560
114,081
3.58
9,880,747
114,125
4.59
(149,082)
(74,345)
12,600,478
9,806,402
996,312
919,788
13,596,790
10,726,190
Liabilities and Stockholders’ Equity
7,511,096
9,581
0.52
6,023,604
18,758
1.25
149,144
402
1.09
323,555
1,266
1.55
7,660,240
9,983
0.53
6,347,159
20,024
1.27
4,077,479
2,740,033
188,586
99,289
11,926,305
9,186,481
1,670,485
1,539,709
Total liabilities and stockholders’ equity
104,098
94,101
3.05
3.32
3.31
3.82
The banking segment’s net interest margin exceeds our consolidated net interest margin. Our consolidated net interest margin includes certain items that are not reflected in the calculation of our net interest margin within our banking segment and reduce our consolidated net interest margin, such as the borrowing costs of Hilltop and the yields and costs associated with certain items within interest-earning assets and interest-bearing liabilities in the broker-dealer segment, including items related to securities financing operations that particularly decrease net interest margin. In addition, the banking segment’s interest-earning assets include warehouse lines of credit extended to other subsidiaries, which are eliminated from the consolidated financial statements. The banking segment’s net interest margin for the three months ended March 31, 2021 was negatively impacted by certain actions taken by management during 2020 to strengthen the Bank’s available liquidity position. Such actions, including increasing overall cash balances by raising brokered money
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market and brokered time deposits, were taken out of an abundance of caution as the pandemic continues to create significant uncertainty in the banking and capital markets.
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).
2021 vs. 2020
Change Due To (1)
Volume
Yield/Rate
Change
Interest income
Loans held for investment, gross
5,846
(11,256)
(5,410)
8,358
(883)
7,475
3,447
(4,577)
(1,130)
85
3,011
(3,596)
(585)
(199)
(279)
(478)
Total interest income (2)
20,529
(20,573)
(44)
Interest expense
(13,771)
(9,177)
(667)
(197)
(864)
3,927
(13,968)
(10,041)
16,602
(6,605)
9,997
Changes in the yields earned on interest-earning assets decreased taxable equivalent net interest income during the three months ended March 31, 2021, compared to the same period in 2020, primarily as a result of lower loan yields due to decreased market rates, the addition of 1% note rate PPP loans, and the decrease in accretion of discount on loans of $1.8 million. Accretion of discount on loans is expected to continue to decrease in future periods as loans acquired in the Bank Transactions are repaid, refinanced or renewed. Changes in the volume of interest-earning assets, primarily due to the significant increase in mortgage warehouse lending volume and new PPP loan originations, increased taxable equivalent net interest income during the three months ended March 31, 2021, compared with the same period in 2020. Changes in rates paid on interest-bearing liabilities increased taxable equivalent net interest income during the three months ended March 31, 2021, compared with the same period in 2020, due to decreases in market interest rates. Our portfolio includes loans that periodically reprice or mature prior to the end of an amortized term. Some of our variable-rate loans remain at applicable rate floors, which may delay and/or limit changes in net interest income during a period of changing rates. If interest rates were to fall further, the impact on our net interest income for certain variable-rate loans would be limited by these rate floors. In addition, declining interest rates may reduce our cost of funds on deposits. The extent of this impact will ultimately be driven by the timing, magnitude and frequency of interest rate and yield curve movements, as well as changes in market conditions and timing of management strategies. If interest rates were to rise, yields on the portion of our loan portfolio that remain at applicable rate floors would rise more slowly than increases in market interest rates. Any changes in interest rates across the term structure will continue to impact net interest income and net interest margin. The impact of rate movements will change with the shape of the yield curve, including any changes in steepness or flatness and inversions at any points on the yield curve.
In response to the COVID-19 pandemic, the Bank implemented several actions to better support our impacted banking clients. Such programs include loan modifications such as principal and/or interest payment deferrals, participation in the PPP as an SBA preferred lender and personal banking assistance including waived fees, increased daily spending limits and suspension of residential foreclosure activities. The adverse economic conditions caused by the COVID-19 pandemic have negatively impacted the banking segment’s business and results of operations, including significantly reduced demand for loan products and services from customers, recognition of credit losses and increases in allowance for credit losses. In the event future operating performance is below our projections, there are negative changes to projected provision for credit losses on loans, long-term loan and deposit growth rates or discount rates increase, the
57
estimated fair value of the banking reporting unit may decline below carrying value, and we may be required to record a goodwill impairment charge. Additionally, with respect to its core deposit intangible assets, in the event that the deposit retention levels and derived cost savings from available core deposits at the Bank relative to an alternative cost of funds falls to a level that cannot support the remaining carrying value, we may be required to record an impairment charge. We will continue to monitor developments regarding the COVID-19 pandemic and measures implemented in response to the pandemic, market capitalization, overall economic conditions, effectiveness of vaccinations, government stimulus, payment deferral programs and any other triggering events or circumstances that may indicate an impairment in the future. See further detail in the “Recent Developments” section above.
During the three months ended March 31, 2021 and 2020, the banking segment retained approximately $159 million and $131 million, respectively, in mortgage loans originated by the mortgage origination segment. These loans are purchased by the banking segment at par. For origination services provided, the banking segment reimburses the mortgage origination segment for direct origination costs associated with these mortgage loans, in addition to payment of a correspondent fee. The correspondent fees are eliminated in consolidation. In March 2020, the Bank made a decision to sell the previously purchased mortgage loans to the mortgage origination segment, instead of holding them for investment. In October 2020, the Bank began purchasing and retaining mortgage loans originated by the mortgage origination segment again. During 2021, we expect loans originated by the mortgage origination segment on behalf of and retained by the banking segment to increase based on approved authority for up to 5% of the mortgage origination segment’s total origination volume. The determination of mortgage loan retention levels by the banking segment will be impacted by, among other things, an ongoing review of the prevailing mortgage rates, balance sheet positioning at Hilltop and the banking segment’s outlook for commercial loan growth.
The banking segment’s reversal of credit losses during the three months ended March 31, 2021 reflected a net reversal of credit losses of $5.2 million on loans held for investment. This net reversal of credit losses was primarily comprised of a net reversal of credit losses on expected losses of collectively evaluated loans of $6.5 million primarily due to improvements in the macroeconomic forecast assumptions from the prior quarter, partially offset by slower prepayment assumptions on certain commercial real estate and construction and land portfolios, as well as an increase in the provision for credit losses on individually evaluated loans of $1.3 million primarily related to changes in risk rating grades and updated realizable values. The change in credit losses during the noted period was also attributable to other factors including, but not limited to, loan growth, loan mix and changes in qualitative factors from the prior quarter. The change in the allowance during the three months ended March 31, 2021 was also impacted by net recoveries of $0.6 million. Refer to the discussion in the “Financial Condition – Allowance for Credit Losses on Loans” section that follows for more details regarding the significant assumptions and estimates involved in estimating credit losses.
The banking segment’s noninterest income increased during the three months ended March 31, 2021, compared to the same period in 2020, primarily due to increased other real estate owned (“OREO”) income as well as changes in our intercompany financing charges.
The banking segment’s noninterest expense decreased during the three months ended March 31, 2021, compared to the same period in 2020, primarily due to a decrease in the reserve for unfunded commitments attributable to year-over-year changes in macroeconomic uncertainties and available commitment balances and reductions in salary and employee benefits, legal, and business development expenses, partially offset by an increase in FDIC assessment and OREO expenses.
58
Broker-Dealer Segment
The following table provides additional details regarding our broker-dealer segment operating results (in thousands).
Net interest income:
Wealth management:
Securities lending
2,050
1,436
Clearing services
1,449
2,578
(1,129)
Structured finance (5)
2,923
(2,527)
Fixed income services (5)
4,128
2,524
Other (5)
1,055
3,098
(2,043)
Total net interest income
Securities commissions and fees by business line (1):
Fixed income services
13,674
13,156
518
Retail (5)
18,754
20,352
(1,598)
6,242
9,006
(2,764)
412
1,044
(16)
40,048
43,986
(3,938)
Investment and securities advisory fees and commissions by business line:
Public finance services (5)
17,463
16,507
956
1,904
7,250
5,981
1,269
380
65
441
77
(8)
4,515
Other:
Structured finance
24,551
9,357
15,194
10,744
(4,709)
294
(1,058)
1,352
30,880
19,043
11,837
Net revenue (2)
109,137
99,382
9,755
Variable compensation (3)
37,412
32,024
5,388
Non-variable compensation and benefits
28,615
24,526
4,089
Segment operating costs (4)
25,443
24,663
780
91,470
81,213
10,257
Despite the continued economic disruptions related to the pandemic, during the first quarter of 2021, the broker-dealer segment’s public finance services business line experienced improved net revenues of $1.3 million which was in line with modest improvements in both Texas and national issuance activity and market share compared to the same period during the prior year. The structured finance business line experienced comparatively improved results with strong issuance volumes and increased demand for mortgage products in the first quarter of 2021 as compared to the market volatility experienced in the first quarter of 2020. However, interest rate volatility late in the quarter is expected to present headwinds to the business going forward. Additionally, although the fixed income services business line’s net revenues improved $1.1 million, compared with the same period in 2020, this improvement was offset by the wind-down of the equity capital market business line, resulting in an offsetting decline of net revenues of $1.6 million. The wealth management business line’s net revenues were lower in the three months ended March 31, 2021, compared to the same period in 2020, as customer balance revenues were driven lower due to the current low interest rate environment. Additional information related to the impact of COVID-19 is included within the “Recent Developments” section above.
The $0.5 million decrease in the broker-dealer segment’s income before income taxes during the three months ended March 31, 2021, compared with the same period in 2020, was primarily as a result of the following:
The broker-dealer segment is subject to interest rate risk as a consequence of maintaining inventory positions, trading in interest rate sensitive financial instruments and maintaining a matched stock loan book. Changes in interest rates are likely to have a meaningful impact on our overall financial performance. Our broker-dealer segment has historically earned a significant portion of its revenues from advisory fees upon the successful completion of client transactions, which could be adversely impacted by interest rate volatility. Rapid or significant changes in interest rates could adversely affect the broker-dealer segment’s bond trading, sales, underwriting activities and other interest spread-sensitive activities described below. The broker-dealer segment also receives administrative fees for providing money market and FDIC investment alternatives to clients, which tend to be sensitive to short term interest rates. In addition, the profitability of the broker-dealer segment depends, to an extent, on the spread between revenues earned on customer loans and excess customer cash balances, and the interest expense paid on customer cash balances, as well as the interest revenue earned on trading securities, net of financing costs.
In the broker-dealer segment, interest is earned from securities lending activities, interest charged on customer margin loan balances and interest earned on investment securities used to support sales, underwriting and other customer activities. The decrease in net interest income during the three months ended March 31, 2021, compared with the same period in 2020, was primarily due to decreases in net interest income from our structured finance business and the interest earned from customer activities. With the 118 basis point decrease in the three-month weighted average Federal Funds interest rate from March 31, 2020 to March 31, 2021, the amount of interest earned on customer investment activities decreased as well. This decrease was partially offset by an increase in net interest earned from the broker-dealer’s taxable securities and our stock lending business. The net interest spread in our stock lending business increased 21 basis points from March 31, 2020 to March 31, 2021.
Noninterest income increased during the three months ended March 31, 2021, compared to the same period in 2020, primarily due to increases in other noninterest income and investment and securities advisory fees and commissions, partially offset by a decrease in securities commissions and fees.
Securities commissions and fees decreased during the three months ended March 31, 2021, compared with the same period in 2020, primarily due to a decrease in commissions earned in our wealth management line of business given declines in our money market and FDIC sweep revenues of $4.5 million.
Investment and securities advisory fees and commissions increased during the three months ended March 31, 2021, compared with the same period in 2020, primarily due to increases in fees earned from our underwriting activities of $2.0 million and management fees earned by our wealth management business line from advisory services of $1.3 million.
Other noninterest income increased during the three months ended March 31, 2021, compared with the same period in 2020. The increase during the period was primarily the result of a $15.2 million increase in trading gains earned from our structured finance business line’s derivative activities due to strong year-over-year volumes and robust customer
demand compared to the heightened market volatility from the sudden shift in the housing market in March 2020 brought on by the COVID-19 pandemic. An additional $1.3 million of the increase was noted in our deferred compensation plan investments due to the increase in the financial markets from the prior year comparable period. These year-over-year increases were partially offset by a $4.7 million decrease in other interest income within our fixed income services business line within both our taxable and municipal securities trading portfolios.
Noninterest expenses increased during the three months ended March 31, 2021, compared to the same period in 2020, primarily due to increases in variable compensation and an increase in our deferred compensation expenses of $1.7 million. Additionally, other noninterest expense increased during the three months ended March 31, 2021, compared to the same period in 2020, primarily due to increased expenses in 2021 associated with the deployment of the new back-office system.
Selected information concerning the broker-dealer segment, including key performance indicators, follows (dollars in thousands).
Total compensation as a % of net revenue (1)
60.5
56.9
Pre-tax margin (2)
18.3
FDIC insured program balances at the Bank (end of period)
734,685
1,500,117
Other FDIC insured program balances (end of period)
1,839,707
761,452
Customer funds on deposit, including short credits (end of period)
476,537
341,815
Public finance services:
Number of issues
231
217
Aggregate amount of offerings
15,592,020
11,393,139
Structured finance:
Lock production/TBA volume
1,933,214
1,954,482
Fixed income services:
Total volumes
63,330,195
25,591,017
Net inventory (end of period)
430,633
368,445
Wealth management (Retail and Clearing services groups):
Retail employee representatives (end of period)
Independent registered representatives (end of period)
188
194
Correspondents (end of period)
125
Correspondent receivables (end of period)
217,889
245,316
Customer margin balances (end of period)
301,219
260,476
Wealth management (Securities lending group):
Interest-earning assets - stock borrowed (end of period)
1,275,774
Interest-bearing liabilities - stock loaned (end of period)
1,167,559
61
Mortgage Origination Segment
The following table presents certain information regarding the operating results of our mortgage origination segment (in thousands).
The mortgage lending business is subject to variables that can impact loan origination volume, including seasonal transaction volumes and interest rate fluctuations. Historically, the mortgage origination segment has experienced increased loan origination volume from purchases of homes during the spring and summer months, 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 loan origination volume from refinancings. Changes in mortgage interest rates have historically had a lesser impact on home purchases volume than on refinancing volume. See details regarding refinancing volume in the table below.
As discussed in more detail in the “Recent Developments” section above, since March 2020, economic uncertainties resulting from the spread of COVID-19 have had disruptive effects on the financial markets in which the mortgage origination segment operates as well as the global economy. In response to the COVID-19 pandemic, during the first quarter of 2020, the FOMC reduced short-term rates by 150 basis points to a range of 0% to 0.25%. 10-year interest rates declined significantly during the first quarter 2020, which was followed by a steady decrease in mortgage interest rates during the remainder of 2020. Since December 2020, mortgage rates have increased, but remained lower during the first quarter of 2021 compared to the same period in 2020. Recent trends, as well as typical historical patterns in loan origination volume from purchases of homes or from refinancings as a result of movements in mortgage interest rates, may not be indicative of future loan origination volumes given the economic uncertainties stemming from the COVID-19 pandemic. The mortgage origination segment’s business is dependent upon the willingness and ability of its employees and customers to conduct mortgage transactions. The continuing impact of the COVID-19 pandemic on such customers could have a material adverse effect on the operations of the mortgage origination segment. A further increase in mortgage interest rates during the remainder of 2021 could impact the percentage mix of refinancing and purchase volumes relative to total loan origination volume compared to 2020.
Income before income taxes increased $53.2 million, or 133.8%, during the three months ended March 31, 2021, compared with the same period in 2020. This increase was primarily the result of a slight increase in interest rate lock commitments (“IRLCs”) related to an increase in mortgage loan applications, and to a greater extent an increase in the average value of individual IRLCs.
The CARES Act provides borrowers the ability to request forbearance of residential mortgage loan payments, placing a significant strain on mortgage servicers as they may be required to fund missed or deferred payments related to loans in forbearance. A significant increase in nationwide forbearance requests since March 2020 resulted in the reduction of third-party mortgage servicers willing to purchase mortgage servicing rights. As a result of this market dynamic, beginning in the second quarter of 2020, we increased the amount of retained servicing on mortgage loans sold, as discussed in more detail below. Beginning in the fourth quarter of 2020 and continuing into the first quarter of 2021, PrimeLending began to reduce the amount of retained servicing. However, amounts retained during the first quarter of 2021 continued to exceed amounts retained prior to the second quarter 2020. PrimeLending utilizes a third-party to manage its servicing portfolio, and we therefore do not expect significant fluctuations in infrastructure costs to manage changes in PrimeLending’s servicing portfolio. PrimeLending’s liquidity has not been, and we do not expect that it will be significantly impacted by forbearance requests resulting from the CARES Act. GNMA, Federal National Mortgage Association and Federal Home Loan Mortgage Corporation may impose restrictions on loans the agencies will accept, including loans under a forbearance agreement, which could result in PrimeLending seeking non-agency investors or choosing to retain these loans.
As average mortgage interest rates decreased between the three months ended March 31, 2020 and 2021, refinancing volume as a percentage of total origination volume increased from 35.4% to 53.1%. Since December 2020, mortgage interest rates have increased. If current mortgage interest rates remain relatively unchanged, we anticipate a lower percentage of refinancing volumes relative to total loan origination volume during the last three quarters of 2021 as
compared to the first quarter of 2021. A higher refinance percentage could be driven by a slowing of purchase volume due to the negative impact on new and existing home sales resulting from the COVID-19 pandemic.
The mortgage origination segment primarily originates its mortgage loans through a retail channel, with limited lending through its affiliated business arrangements (“ABAs”). For the three months ended March 31, 2021, funded volume through ABAs was approximately 5% of the mortgage origination segment’s total loan volume. As of March 31, 2021, PrimeLending owns a greater than 50% membership interest in three ABAs. We expect total production within the ABA channel to increase slightly to 7% of loan volume of the mortgage origination segment during the remainder of 2021.
The following table provides further details regarding our mortgage loan originations and sales for the periods indicated below (dollars in thousands).
% of
Mortgage Loan Originations - units
21,741
13,738
8,003
Mortgage Loan Originations - volume
6,184,105
3,622,588
2,561,517
Mortgage Loan Originations:
Conventional
4,482,763
72.49
2,315,487
63.92
2,167,276
Government
803,172
12.99
890,176
24.57
(87,004)
Jumbo
707,543
11.44
244,958
6.76
462,585
190,627
3.08
171,967
4.75
18,660
100.00
Home purchases
2,902,710
46.94
2,341,847
64.65
560,863
Refinancings
3,281,395
53.06
1,280,741
35.35
2,000,654
Texas
1,076,892
17.41
705,357
19.47
371,535
California
795,060
12.86
380,063
10.49
414,997
Arizona
290,436
4.70
174,724
115,712
Florida
280,907
4.54
271,185
7.49
9,722
South Carolina
261,218
4.22
151,845
4.19
109,373
North Carolina
226,466
3.66
113,645
3.14
112,821
Ohio
222,639
3.60
126,193
3.48
96,446
Washington
215,460
123,042
3.40
92,418
195,113
3.16
133,370
3.68
61,743
Missouri
189,012
3.06
115,659
3.19
73,353
All other states
2,430,902
39.31
1,327,505
36.65
1,103,397
Mortgage Loan Sales - volume:
External third parties
6,192,073
97.50
3,355,689
96.26
2,836,384
Banking segment
158,764
130,560
3.74
28,204
6,350,837
3,486,249
2,864,588
We consider the mortgage origination segment’s total loan origination volume to be a key performance measure. Loan origination volume is central to the segment’s ability to generate income by originating and selling mortgage loans, resulting in net gains from the sale of loans, other mortgage production income and mortgage loan origination fees. Total loan origination volume is a measure utilized by management, our investors and analysts in assessing market share and growth of the mortgage origination segment.
While the mortgage origination segment’s loan applications and IRLCs increased slightly during the three months ended March 31, 2021, compared to the same period in 2020, total loan origination volume and income before income taxes increased 70.7% and 133.8% during that time, respectively. The increase in income before income taxes in the three months ended March 31, 2021 was primarily due to an increase in the average value of individual IRLCs, which is ultimately reflected in net gains from sale of loans. This increase was partially offset by an increase in compensation that varies with the volume of mortgage loans originations (“variable compensation”) and a decrease in change in net fair value of interest rate lock commitments and loans held for sale.
Net interest expense during the three months ended March 31, 2021 and 2020 was comprised of interest income earned on loans held for sale offset by interest incurred on warehouse lines of credit primarily held with the Bank, and related intercompany financing costs. The decrease in net interest expense during the three months ended March 31, 2021 and 2020 included the effects of decreased net yields on mortgage loans held for sale between the two periods.
Noninterest income was comprised of the items set forth in the table below (in thousands).
Net gains from sale of loans
246,588
113,538
133,050
Mortgage loan origination fees and other related income
14,601
Other mortgage production income:
Change in net fair value and related derivative activity:
IRLCs and loans held for sale
(4,606)
34,028
(38,634)
Mortgage servicing rights asset
9,132
(3,027)
12,159
Servicing fees
16,175
5,875
10,300
The increase in net gains from sale of loans during the three months ended March 31, 2021, compared with the same period in 2020, was primarily a result of an increase in total loan sales volume, in addition to an increase in average loan sales margin. Since PrimeLending sells substantially all mortgage loans it originates to various investors in the secondary market, the increases in loan sales volume during the three months ended March 31, 2021 is consistent with the increase in loan origination volume during the period. The increase in average loans sales margin was primarily driven by PrimeLending managing increased loan origination volumes to a level that could be supported by its loan fulfillment operations and addressing anticipated enhanced credit and liquidity risks triggered by the economic impact of the COVID-19 pandemic. The increase in mortgage loan origination fees during the three months ended March 31, 2021, compared with the same period in 2020, were primarily the result of an increase in loan origination volume, partially offset by a decrease in average mortgage loan origination fees.
We consider the mortgage origination segment’s net gains from sale of loans margin, in basis points, to be a key performance measure. Net gains from sale of loans margin is defined as net gains from sale of loans divided by loan sales volume. The net gains from sale of loans is central to the segment’s generation of income. The mortgage origination segment’s net gains from sale of loans margin, including loans sold to the banking segment, during the three months ended March 31, 2021 and 2020 was 388 bps and 325 bps, respectively. During the three months ended March 31, 2021 and 2020, the mortgage origination segment originated approximately $159 million and $131 million, respectively, in loans on behalf of the banking segment, representing 2.5% and 3.6%, respectively, of PrimeLending’s total loan origination volume during each respective period. These loans were sold to the banking segment at par. For origination services provided, the mortgage origination segment was reimbursed direct origination costs associated with these loans, in addition to payment of a correspondent fee. The reimbursed origination costs and correspondent fee are included in the mortgage origination segment operating results, and the correspondent fees are eliminated in consolidation. The impact of loans sold to the banking segment at par was a decrease to the net gain from sale of loans margin of 10 basis points and 13 basis points during the three months ended March 31, 2021 and 2020, respectively. Loan volumes to be originated on behalf of and retained by the banking segment are evaluated each quarter. While we anticipate an increase in loans sold to the banking segment during the remainder of 2021, we do not expect these sales to exceed 5% of total origination volume during this time. In March 2020, the mortgage origination segment executed a letter of intent with the banking segment to purchase mortgage loans previously sold to the banking segment with an unpaid principal balance of approximately $210 million. Such original sales of approximately $121 million are reflected in the previous mortgage loan details table within the mortgage loan sales volume to the banking segment during the three months ended March 31, 2020. The remaining $91 million of such original sales were sold to the banking segment during 2019. When these loans were sold at par by the mortgage origination segment, the banking segment’s intent was to hold these loans for investment. The mortgage origination segment completed the repurchase of these loans from the banking segment and in turn sold the loans to investors in the secondary market during the second quarter of 2020.
Noninterest income included changes in the net fair value of the mortgage origination segment’s 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. The decrease during the three months ended March 31, 2021 was the result of a decrease in the average value of individual IRLCs and loans held for sale, partially offset by an increase in the total volume of individual IRLCs and loans held for sale.
The mortgage origination segment sells substantially all mortgage loans it originates to various investors in the secondary market, historically with the majority servicing released. In addition, the mortgage origination segment originates loans on behalf of the Bank. The mortgage origination segment’s determination of whether to retain or release servicing on mortgage loans it sells is impacted by, among other things, changes in mortgage interest rates, and
64
refinancing and market activity. During the three months ended March 31, 2020, PrimeLending retained servicing on 9% of loans sold. Beginning in the second quarter of 2020, we increased the amount of retained servicing on mortgage loan sales. During both the second and third quarters of 2020, PrimeLending retained servicing on 89% of total mortgage loans sold. The increase in rates of retained servicing during this time was due to the reduction in third-party servicing outlets during the second quarter of 2020 resulting from the impact of the CARES Act. The CARES Act permits borrowers of federally-backed mortgage loans to forbear payments, which could negatively impact servicers’ liquidity and their ability to purchase servicing. As forbearance requests leveled off during the latter part of 2020, the third-party market for mortgage servicing rights improved, increasing demand, which allowed PrimeLending to reduce retained servicing to 57% of total mortgage loans sold during the fourth quarter of 2020 and 50% of total mortgage loans sold during the first quarter 2021. If the third-party market for mortgage servicing rights continues to improve, we expect that PrimeLending will continue to reduce retained servicing on mortgage loans sold during the remainder of 2021. The related MSR asset was valued at $142.5 million on $12.2 billion of serviced loan volume at March 31, 2021, compared with a value of $144.2 million on $14.7 billion of serviced loan volume at December 31, 2020. 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. The mortgage origination segment has also retained servicing on certain loans sold to the banking segment. Gains and losses associated with such sales to the banking segment and the related MSR asset are eliminated in consolidation. The mortgage origination segment uses derivative financial instruments, including U.S. Treasury bond futures and options, as a means to mitigate interest rate risk associated with its MSR asset. Changes in the net fair value of the MSR asset and the related derivatives associated with normal customer payments, changes in discount rates, prepayment speed assumptions and customer payoffs resulted in a net gain of $9.1 million and a net loss of $3.0 million during the three months ended March 31, 2021 and 2020, respectively. Additionally, net servicing income was $7.9 million during the three months ended March 31, 2021, compared with $2.7 million during the same period in 2020. On March 31, 2021, the mortgage origination segment sold MSR assets of $52.8 million, which represented $4.9 billion of its serviced loan volume at the time.
Noninterest expenses were comprised of the items set forth in the table below (in thousands).
Variable compensation
115,486
58,280
57,206
50,762
42,048
8,714
Segment operating costs
30,420
31,652
(1,232)
Lender paid closing costs
5,468
4,360
1,108
Servicing expense
8,198
3,212
4,986
Total employees’ compensation and benefits accounted for the majority of noninterest expenses incurred during all periods presented. Specifically, variable compensation comprised 69.5% and 58.1% of total employees’ compensation and benefits expenses during the three months ended March 31, 2021 and 2020, respectively. The increase in the percentage concentration of variable compensation and benefits was primarily due to an increase in loan origination volume. Variable compensation, which is primarily driven by loan origination volume, tends to fluctuate to a greater degree than loan origination volume because mortgage loan originator and fulfillment staff incentive compensation plans are structured to pay at increasing rates as higher monthly volume tiers are achieved. However, certain other incentive compensation plans driven by non-mortgage production criteria may alter this trend. In addition to an increase in loan origination volume primarily driving the increase in variable compensation and benefits, an increase in the average incentive rate paid and the impact of incentive plans driven by non-mortgage production criteria contributed to the increase in variable compensation.
While total loan origination volume increased 70.7% for the three months ended March 31, 2021, compared to the same period in 2020, the aggregate non-variable compensation and benefits of the mortgage origination segment increased by 20.7%. This increase was primarily due to an increase in salaries resulting from increased underwriting and loan fulfillment staff and an increase in overtime expense incurred to support the increase in loan origination volume during the first quarter of 2021. Segment operating costs decreased slightly during the three months ended March 31, 2021, compared to the same period in 2020, primarily as a result of a decrease in advertising and business development expense.
In exchange for a higher interest rate, customers may opt to have PrimeLending pay certain costs associated with the origination of their mortgage loans (“lender paid closing costs”). Fluctuations in lender paid closing costs are not always aligned with fluctuations in loan origination volume. Other loan pricing conditions, including the mortgage loan interest
rate, loan origination fees paid by the customer, and a customer’s willingness to pay closing costs, may influence fluctuations in lender paid closing costs.
Between January 1, 2012 and March 31, 2021, the mortgage origination segment sold mortgage loans totaling $135.2 billion. These loans were sold under sales contracts that generally include provisions that 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 2012, it does not anticipate experiencing significant losses in the future on loans originated prior to 2012 as a result of investor claims under these provisions of its sales contracts.
When a claim for indemnification of a loan sold is made by an agency, investor, or other party, the mortgage origination segment evaluates the claim and determines if the claim can be satisfied through additional documentation or other deliverables. If the claim is valid and cannot be satisfied in that manner, the mortgage origination segment negotiates with the claimant to reach a settlement of the claim. Settlements typically result in either the repurchase of a loan or reimbursement to the claimant 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, 2012 and March 31, 2021 (dollars in thousands).
Original Loan Balance
Loss Recognized
Sold
192,704
0.14%
0.00%
Claims resolved because of a loan repurchase or payment to an investor for losses incurred (1)
215,463
0.16%
8,165
0.01%
408,167
0.30%
For each loan it concludes its obligation to a claimant is both probable and reasonably estimable, the mortgage origination segment has established a specific claims indemnification liability reserve. An additional indemnification liability reserve has been established for probable agency, investor or other party losses that may have been incurred, but not yet reported to the mortgage origination segment based upon a reasonable estimate of such losses. In addition to other factors, the mortgage origination segment has considered that GNMA, Federal National Mortgage Association and Federal Home Loan Mortgage Corporation have imposed certain restrictions on loans the agencies will accept under a forbearance agreement resulting from the COVID-19 pandemic, which could increase the magnitude of indemnification losses on these loans.
At March 31, 2021 and December 31, 2020, the mortgage origination segment’s total indemnification liability reserve totaled $24.3 million and $21.5 million, respectively. The related provision for indemnification losses was $3.0 million and $0.7 million during the three months ended March 31, 2021 and 2020, respectively.
The following table presents certain financial information regarding the operating results of corporate (in thousands).
Net interest expense
Income (loss) from continuing operations before income taxes
Corporate includes certain activities not allocated to specific business segments. These activities include holding company financing and investing activities, merchant banking investment opportunities and management and administrative services to support the overall operations of the Company. Hilltop’s merchant banking investment
activities include the identification of attractive opportunities for capital deployment in companies engaged in non-financial activities through its merchant bank subsidiary, Hilltop Opportunity Partners LLC.
As a holding company, Hilltop’s primary investment objectives are to support capital deployment for organic growth and to preserve capital to be deployed through acquisitions, dividend payments and potential stock repurchases. Investment and interest income earned during the three months ended March 31, 2021 was primarily comprised of dividend income from merchant banking investment activities, in addition to interest income earned on intercompany notes.
Interest expense during each period included recurring quarterly interest expense of $1.9 million incurred on our $150.0 million aggregate principal amount of 5% senior notes due 2025 (“Senior Notes”). During the three months ended March 31, 2021, we incurred interest expense of $3.1 million on our $200 million aggregate principal amount of Subordinated Notes, which were issued in May 2020. Additionally, we incurred interest expense of $0.6 million and $0.8 million during the three months ended March 31, 2021 and 2020, respectively, on junior subordinated debentures of $67.0 million issued by PCC (the “Debentures”).
Noninterest income from continuing operations during the three months ended March 31, 2021 and 2020 included activity related to our investment in a real estate development in Dallas’ University Park, which also serves as headquarters for both Hilltop and the Bank, and net noninterest income associated with activity within our merchant bank subsidiary.
Noninterest expenses from continuing operations were primarily comprised of employees’ compensation and benefits, occupancy expenses and professional fees, including corporate governance, legal and transaction costs. Noninterest expenses increased during the three months ended March 31, 2021, compared to the same period in 2020, primarily due to a prior year non-recurring gain on sale transaction, partially offset by an increase in expenses associated with professional fees.
Results from Discontinued Operations
Insurance Segment
As previously discussed, on June 30, 2020, we completed the sale of NLC. Accordingly, insurance segment results for the three months ended March 31, 2020 have been presented as discontinued operations in the consolidated financial statements. Additional details are presented in Note 3, Discontinued Operations, in the notes to our consolidated financial statements. All activity associated with the insurance segment was recognized in 2020, therefore, there are no results in the three months ended March 31, 2021. Income from discontinued operations before income taxes was $4.0 million during the three months ended March, 31 2020.
As a result of the previously noted sale of NLC on June 30, 2020 for cash proceeds of $154.1 million, Hilltop recognized an aggregate pre-tax gain on sale within discontinued operations of corporate of $36.8 million, net of customary transaction costs of $5.1 million. The resulting book gain from this sale transaction was not recognized for tax purposes pursuant to the rules under the Internal Revenue Code. All income from discontinued operations before income taxes associated with corporate was recognized beginning in the second quarter of 2020.
Financial Condition
The following discussion contains a more detailed analysis of our financial condition at March 31, 2021, as compared with December 31, 2020.
Securities Portfolio
At March 31, 2021, 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, as well as mortgage-backed, corporate debt, and equity securities. We may categorize investments as trading, available for sale, held to maturity and equity securities.
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 the Hilltop Broker-Dealers. Securities classified as available for sale may, from time to time, be bought and sold in response to changes in market interest rates, changes in securities’ prepayment risk, increases in loan demand, general liquidity needs and to take advantage of market conditions that create more economically attractive returns. Such securities are carried at estimated fair value, with unrealized gains and losses recorded in accumulated other comprehensive income (loss). Equity investments are carried at fair value, with all changes in fair value recognized in net income. Securities are classified as held to maturity based on the intent and ability of our management, at the time of purchase, to hold such securities to maturity. These securities are carried at amortized cost.
The table below summarizes our securities portfolio (in thousands).
Trading securities, at fair value
Securities available for sale, at fair value
Securities held to maturity, at amortized cost
Equity securities, at fair value
Total securities portfolio
We had nominal net unrealized losses at March 31, 2021 and net unrealized gains of $26.3 million at December 31, 2020 related to the available for sale investment portfolio, and net unrealized gains of $11.3 million and $14.7 million associated with the securities held to maturity portfolio at March 31, 2021 and December 31, 2020, respectively. Equity securities included net unrealized gains of $0.1 million at both March 31, 2021 and December 31, 2020.
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 and equity securities portfolios serve as a source of liquidity. Historically, the Bank’s policy has been to invest primarily in securities of the U.S. government and its agencies, obligations of municipalities in the State of Texas and other high grade fixed income securities to minimize credit risk. At March 31, 2021, the banking segment’s securities portfolio of $2.0 billion was comprised of trading securities of $1.0 million, available for sale securities of $1.7 billion, equity securities of $0.2
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million and held to maturity securities of $300.1 million, in addition to $15.0 million of other investments included in other assets within the consolidated balance sheets.
The broker-dealer segment holds securities to support sales, underwriting and other customer activities. The interest rate risk inherent in holding these securities is managed by setting and monitoring limits on the size and duration of positions and on the length of time the securities can be held. The Hilltop Broker-Dealers are required to carry their securities at fair value and record changes in the fair value of the portfolio in operations. Accordingly, the securities portfolio of the Hilltop Broker-Dealers included trading securities of $527.7 million at March 31, 2021. In addition, the Hilltop Broker-Dealers enter into transactions that represent commitments to purchase and deliver securities at prevailing future market prices to facilitate customer transactions and satisfy such commitments. Accordingly, the Hilltop Broker-Dealers’ ultimate obligation may exceed the amount recognized in the financial statements. These securities, which are carried at fair value and reported as securities sold, not yet purchased in the consolidated balance sheets, had a value of $97.1 million at March 31, 2021.
At March 31, 2021, the corporate portfolio included other investments, including those associated with merchant banking, of $38.8 million in other assets within the consolidated balance sheets.
Allowance for Credit Losses for Available for Sale Securities and Held to Maturity Securities
We have evaluated available for sale debt securities that are in an unrealized loss position and have determined that any declines in value are unrelated to credit loss and related to changes in market interest rates since purchase. None of the available for sale debt securities held were past due at March 31, 2021. In addition, as of March 31, 2021, we had evaluated our held to maturity debt securities, considering the current credit ratings and recognized losses, and determined the potential credit loss to be minimal. With respect to these securities, we considered the risk of credit loss to be negligible, and therefore, no allowance was recognized on the debt securities portfolio at March 31, 2021.
Consolidated loans held for investment are detailed in the tables below, classified by portfolio segment.
Loans held for investment, net of allowance
The loan portfolio constitutes the primary 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 total loans held for investment, net of the allowance for credit losses, were $9.5 billion and $9.6 billion at March 31, 2021 and December 31, 2020, respectively. The banking segment’s loan portfolio includes warehouse lines of credit extended to PrimeLending of $3.3 billion, of which $2.3 billion and $2.5 billion was drawn at March 31, 2021 and December 31, 2020, respectively. Amounts advanced against the warehouse lines of credit are eliminated from net loans held for investment on our consolidated balance sheets. The banking segment does not generally participate in syndicated loan transactions and has no foreign loans in its portfolio.
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The banking segment’s loan portfolio included $492.4 million related to both initial and second round PPP loans at March 31, 2021. While these loans have terms up to 60 months, borrowers can apply for forgiveness of these loans with the SBA. Through April 16, 2021, the SBA had approved approximately 2,270 initial round PPP forgiveness applications from the Bank totaling approximately $420 million, with PPP loans of approximately $185 million pending SBA review and approval. We anticipate a significant amount of these remaining initial round PPP loans pending approval being forgiven over the next quarter. The Bank has not commenced the submission of PPP forgiveness applications on second round PPP loans. The forgiveness/payoff of the PPP loans would generate an increase in interest income as we would recognize the remaining unamortized origination fee at the time of payoff or forgiveness.
At March 31, 2021, the banking segment had loan concentrations (loans to borrowers engaged in similar activities) that exceeded 10% of total loans in its real estate portfolio. The areas of concentration within our real estate portfolio were non-construction commercial real estate loans, construction and land development loans, and non-construction residential real estate loans, which represented 42.7%, 11.3% and 10.2%, respectively, of the banking segment’s total loans held investment at March 31, 2021. The banking segment’s loan concentrations were within regulatory guidelines at March 31, 2021.
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 the Hilltop Broker-Dealers’ internal policies. The broker-dealer segment’s total loans held for investment, net of the allowance for credit losses, were $519.9 million and $436.8 million at March 31, 2021 and December 31, 2020, respectively. This increase from December 31, 2020 to March 31, 2021 was primarily attributable to an increase of $44.5 million, or 17%, in customer margin accounts and an increase of $37.7 million, or 21%, in receivables from correspondents.
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 customers 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).
Loans held for sale:
Unpaid principal balance
2,207,245
2,411,626
Fair value adjustment
41,822
109,778
IRLCs:
2,722,678
2,546,061
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 March 31, 2021 and December 31, 2020 were $3.9 billion and $4.0 billion, respectively, while the related estimated fair values were $43.1 million and ($28.0) million, respectively.
Allowance for Credit Losses on Loans
For additional information regarding the allowance for credit losses, refer to the section captioned “Critical Accounting Policies and Estimates” set forth in Part II, Item 7 of our 2020 Form 10-K.
70
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 and 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. The Bank’s loan policy provides specific underwriting guidelines by portfolio segment, including commercial and industrial, real estate, construction and land development, and consumer loans. The guidelines for each individual portfolio segment set forth permissible and impermissible loan types. With respect to each loan type, the guidelines within the Bank’s loan policy provide minimum requirements for the underwriting factors listed above. The Bank’s underwriting procedures also include an analysis of any collateral and guarantor. Collateral analysis includes a complete description of the collateral, as well as determined 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 evaluation based on the significance with which the guarantors are expected to serve as secondary repayment sources.
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, the Bank’s board of directors and the Risk Committee of the board of directors of the Company.
The allowance for credit losses for loans held for investment represents management’s best estimate of all expected credit losses over the expected contractual life of our existing portfolio. Determining the appropriateness of the allowance is complex and requires judgment by management about the effect of matters that are inherently uncertain. Subsequent evaluations of the then-existing loan portfolio, in light of the factors then prevailing, may result in significant changes in the allowance for credit losses in those future periods. Such future changes in the allowance for credit losses are expected to be volatile given dependence upon, among other things, the portfolio composition and quality, as well as the impact of significant drivers, including prepayment assumptions and macroeconomic conditions and forecasts.
The COVID-19 pandemic has resulted in a weak labor market and weak overall economic conditions that have affected borrowers across our lending portfolios. Significant judgment is required to estimate the severity and duration of the current economic downturn, as well as its potential impact on borrower defaults and loss severity. In particular, macroeconomic conditions and forecasts regarding the duration and severity of the economic downturn are rapidly changing and remain highly uncertain as COVID-19 cases and vaccine effectiveness evolve nationally and in key geographies. It is difficult to predict exactly how borrower behavior will be impacted by these economic conditions as the effectiveness of vaccinations, government stimulus, customer relief and enhanced unemployment benefits should help mitigate in the short term, but the extent and duration of government stimulus as well as performance of recently implemented payment deferral programs remains uncertain.
One of the most significant judgments involved in estimating our allowance for credit losses relates to the macroeconomic forecasts used to estimate credit losses over the reasonable and supportable forecast period. To determine the allowance for credit losses as of March 31, 2021, we utilized a single macroeconomic consensus scenario published by Moody’s Analytics in March 2021.
During previous quarterly macroeconomic assessments through December 31, 2020, we utilized a single baseline scenario published by Moody’s Analytics. The change to the consensus scenario was based on our evaluation of the Moody’s economic forecast compared to other industry surveys over the reasonable and supportable period and our assessment of the reasonableness of impacts associated with the key monetary and government stimulus policy assumptions. The consensus economic scenario considered several industry surveys in the near-term forecasts and assumes reversion to the long-term trends embedded in the baseline economic scenario before reverting to historical data.
The following table summarizes the U.S. Real Gross Domestic Product (“GDP”) growth rates and unemployment rate assumptions used in our economic forecast to determine our best estimate of expected credit losses.
As of
September 30,
June 30,
GDP growth rates:
Q1 2020
(2.5)%
Q2 2020
(33.4)%
(18.3)%
Q3 2020
26.6%
19.8%
10.9%
Q4 2020
4.0%
2.9%
0.1%
2.4%
Q1 2021
5.0%
1.6%
3.6%
0.2%
2.6%
Q2 2021
6.5%
4.5%
3.1%
1.8%
3.3%
Q3 2021
6.7%
4.7%
4.4%
8.5%
5.1%
Q4 2021
4.8%
5.8%
6.0%
7.3%
Q1 2022
3.2%
5.5%
Q2 2022
2.5%
Q3 2022
2.1%
Unemployment rates:
3.8%
14.0%
8.7%
8.9%
9.1%
6.3%
9.5%
6.9%
9.7%
6.2%
7.1%
7.0%
8.3%
9.2%
6.6%
5.4%
6.8%
7.8%
4.9%
As of March 31, 2021, our near-term economic forecast improved from December 31, 2020, reflecting better than expected economic and COVID case data and the approval of a third round of $1.9 trillion in government stimulus in March 2021. As a result, projected real GDP growth through the third quarter of 2021 was revised upward and unemployment rate forecasts were adjusted lower based on economic and employment data observed in February 2021. Forecasts for commercial real estate prices nationally were updated higher with declines through 2021 and recovery to pre-COVID levels in early 2024. Our new interest rate expectations assume monetary policy support from the Federal Reserve and a target range of the federal funds rate at 0% to 0.25% into mid-2023.
As of December 31, 2020, our near-term economic forecast improved from September 30, 2020, reflecting better than expected economic data and approval of additional government stimulus earlier than expected. As such, projected real GDP growth in the first quarter of 2021 was revised upward. However, we revised our near-term 2021 real GDP forecast to reflect approximately $900 billion of additional stimulus compared to $1.5 trillion planned as of September 30, 2020. Unemployment rate forecasts were adjusted lower based on economic data observed in October and November 2020, as well as recent COVID vaccine approvals showing progress towards the next phase of labor market recovery. Forecasts for commercial real estate prices nationally were updated lower as of December 31, 2020 to reflect declines through 2022 and recovery to pre-COVID levels in late 2024. Prior quarter forecasts as of September 30, 2020 assumed declines through 2021 and recovery to pre-COVID levels in mid-2023. Our interest rate expectations continued to assume monetary policy support from the Federal Reserve and a target range of the federal funds rate at 0% to 0.25% into late 2023.
Since December 31, 2019, our economic forecast changed significantly year-over-year in response to weak economic conditions caused by the COVID pandemic as developments occurred rapidly in February and March 2020 associated with fiscal and monetary stimulus measures and the expected beneficial impacts of the CARES Act and certain regulatory interagency guidance. As of December 31, 2019, we assumed the U.S. economy was in the late stages of the economic cycle with unemployment rates near historical lows of 3.6% increasing to 3.8% in the fourth quarter of 2020 and reverting to historical data in the fourth quarter of 2022. Downside risks to the economy were concerns over international trade war between the U.S. and its trading partners and potential fallout from a Brexit in 2020. Interest rate expectations assumed one rate cut in 2020 with the Federal Reserve target range of the federal funds rate at 1.25% to 1.50% before reverting to historical data in 2023. In response to the COVID pandemic, the Federal Reserve twice cut federal funds rate targets in March 2020 to 0% to 0.25% with interest rate expectations as of December 31, 2020
unchanged until late 2023. Several U.S. fiscal and monetary policy changes during early 2020 were enacted to counter a severe, but short U.S. recession during the first half of 2020 and support a strong economic recovery during the second half of 2020 with U.S. budget deficits increasing to more than $3 trillion during the year. U.S. unemployment rates reached 14.8% in April 2020 before declining to 6.7% as of December 31, 2020, which was 3.1% higher than the unemployment rate as of December 31, 2019. Annualized real GDP growth rates declined 31.4% in the second quarter of 2020 and increased 33.4% in the third quarter of 2020. The U.S. presidential election later in 2020 resulted in several changes, as Presidential Candidate Joe Biden won the electoral vote to replace President Donald Trump in 2021 and majority control of the U.S. Congress moved from Republican to Democratic parties. As economic growth slowed during the fourth quarter of 2020, additional government stimulus of approximately $900 billion was approved.
As previously discussed, we adopted the new CECL standard and recorded transition adjustment entries that resulted in an allowance for credit losses for loans held for investment of $73.7 million as of January 1, 2020, an increase of $12.6 million. This increase reflected credit losses of $18.9 million from the expansion of the loss horizon to life of loan and also takes into account forecasts of expected future macroeconomic conditions, partially offset by the elimination of the non-credit component within the historical allowance related to previously categorized PCI loans of $6.3 million. This increase, net of tax, was largely reflected within the banking segment and included a decrease of $5.7 million to opening retained earnings at January 1, 2020.
During the three months ended March 31, 2021, the allowance reflected a net reversal of credit losses of $5.1 million on loans held for investment. This net reversal of credit losses was primarily comprised of a net reversal of credit losses on expected losses of collectively evaluated loans of $6.5 million primarily due to improvements in the macroeconomic forecast assumptions from the prior quarter, partially offset by slower prepayment assumptions on certain commercial real estate and construction and land portfolios, as well as an increase in the provision for credit losses on individually evaluated loans of $1.4 million primarily related to changes in risk rating grades and updated realizable values. The change in the allowance for credit losses during the current period was primarily attributable to the Bank and also reflected other factors including, but not limited to, loan growth, loan mix, and changes in qualitative factors from the prior quarter. The change in the allowance during the three months ended March 31, 2021 was also impacted by net recoveries of $0.6 million.
As discussed under the section entitled “Loan Portfolio” earlier in this Item 2, the Bank’s actions beginning in the second and third quarters of 2020 included supporting our impacted banking clients experiencing an increased level of risk due to the COVID-19 pandemic through loan modifications. The significant build in the allowance included provision for credit losses associated with this deteriorating economic outlook and resulted in an allowance for credit losses as a percentage of our total loan portfolio, excluding margin loans in the broker-dealer segment and banking segment mortgage warehouse lending and PPP lending programs, of 2.38%.
The respective distribution of the allowance for credit losses as a percentage of our total loan portfolio and total active loan modifications, excluding margin loans in the broker-dealer segment and banking segment mortgage warehouse lending and PPP lending programs, are presented in the following table (dollars in thousands).
Allowance For
Losses on
Total Loans
for Credit
Held For
Loan
Investment
3.34
89,496
15,587
17.42
1,338,511
28,141
2.10
5,708
1,052
18.43
0.88
25,591
731
2.86
0.45
0.63
2.79
143,848
2.38
13.38
0.05
Mortgage warehouse lending
372
Paycheck Protection Program
1.85
Allowance Model Sensitivity
Our allowance model was designed to capture the historical relationship between economic and portfolio changes. As such, evaluating shifts in individual portfolio attributes or macroeconomic variables in isolation may not be indicative of past or future performance. It is difficult to estimate how potential changes in any one factor or input might affect the overall allowance for credit losses because we consider a wide variety of factors and inputs in the allowance for credit losses estimate. Changes in the factors and inputs considered may not occur at the same rate and may not be consistent across all geographies or product types, and changes in factors and input may be directionally inconsistent, such that improvement in one factor may offset deterioration in others.
However, to consider the sensitivity of credit loss estimates to alternative macroeconomic forecasts, we compared the Company’s allowance for credit loss estimates as of March 31, 2021, excluding margin loans in the broker-dealer segment, the banking segment mortgage warehouse, and PPP lending programs, with modeled results using both upside (“S1”) and downside (“S3”) economic scenario forecasts published by Moody’s Analytics.
Compared to our economic forecast, the upside scenario assumes consumer and business confidence increases as new cases, hospitalizations and deaths from COVID recede faster than expected, while vaccinations and consumer spending accelerate earlier than expected. Real GDP growth is expected to grow 8.9% in the second quarter of 2021, 10.0% in the third quarter of 2021 and 9.7% in the fourth quarter of 2021 and 9.4% in the first quarter 2022. Average unemployment rates decline to 3.5% by the end of 2021 and 3.2% by the end of 2022. Monetary and fiscal policy assumptions include the Federal Reserve maintaining a near 0% target for the federal funds rate until the fourth quarter of 2022 and additional government infrastructure and social program spending approved in the fourth quarter of 2021 of $1.5 trillion.
Compared to our economic forecast, the downside scenario assumes consumer and business confidence declines as hospitalizations and deaths from COVID rise again resulting in increased concerns associated with vaccine effectiveness. As the number of new cases rise, consumer confidence and spending erode causing the economy to fall back into recession. Real GDP growth is expected to decrease 3.5% in the second quarter of 2021, 2.3% in the third quarter of 2021 and 0.8% in the fourth quarter of 2021. Average unemployment rates increase to 8.2% by the fourth quarter of 2021 and improve modestly to 7.7% by the end of 2022. Unemployment is expected to remain elevated but improve to 6.2% in the fourth quarter of 2023 and reverts to historical average rates over time. Monetary and fiscal policy assumptions include the Federal Reserve maintaining a near 0% target for the federal funds rate through mid-2025, while disagreements in Congress prevent any additional stimulus from being enacted beyond the American Rescue Plan Act passed in March 2021.
The impact of applying all of the assumptions of the upside economic scenario during the reasonable and supportable forecast period would have resulted in a decrease in the allowance for credit losses of approximately $21 million or a weighted average expected loss rate of 1.62% as a percentage of our total loan portfolio, excluding margin loans in the broker-dealer segment and the banking segment mortgage warehouse lending and PPP lending programs.
The impact of applying all of the assumptions of the downside economic scenario during the reasonable and supportable forecast period would have resulted in an increase in the allowance for credit losses of approximately $73 million or a weighted average expected loss rate of 3.20% as a percentage of our total loan portfolio, excluding margin loans in the broker-dealer segment and the banking segment mortgage warehouse lending and PPP lending programs.
This analysis relates only to the modeled credit loss estimates and is not intended to estimate changes in the overall allowance for credit losses as they do not reflect any potential changes in the adjustment to the quantitative calculation, which would also be influenced by the judgment management applies to the modeled lifetime loss estimates to reflect the uncertainty and imprecision of these modeled lifetime loss estimates based on then-current circumstances and conditions. It also did not consider impacts from recent Bank deferral and customer accommodation efforts or government fiscal and monetary stimulus measures.
Our allowance for credit losses reflects our best estimate of current expected credit losses, which is highly dependent on the path of the virus and expectations around the production and distribution of reliable vaccines and medical treatments. We continue to monitor the impact of the COVID-19 pandemic and related policy measures on the economy and if pace and vigor of the expected recovery is worse than expected, further meaningful provisions could be required. Future allowance for credit losses may vary considerably for these reasons.
Allowance Activity
The following tables presents the activity in our allowance for credit losses within our loan portfolio for the periods presented (in thousands). Substantially all of the activity shown below occurred within the banking segment.
Transition adjustment for adoption of CECL accounting standard
Recoveries of loans previously charged off:
Total recoveries
Loans charged off:
1,440
110
203
176
Total charge-offs
2,035
Net recoveries (charge-offs)
564
(1,508)
Allowance for credit losses as a percentage of gross loans held for investment
1.45
The distribution of the allowance for credit losses among loan types and the percentage of the loans for that type to gross loans, excluding unearned income, within our loan portfolio are presented in the table below (dollars in thousands).
Gross
Reserve
39.88
40.74
33.00
34.16
10.52
10.77
9.51
8.19
0.43
0.46
6.66
5.68
The following table summarizes historical levels of the allowance for credit losses on loans held for investment, distributed by portfolio segment (in thousands).
104,566
106,551
38,178
31,863
6,270
8,393
5,052
7,399
1,002
1,429
155,214
156,383
75
The increase in the allowance for credit losses for loans held for investment during 2020 in the table above was primarily attributable to the adoption of the new CECL standard as of January 1, 2020 and a deteriorating economic outlook associated with the impact of the market disruption caused by COVID-19 conditions. As previously noted, the adoption of CECL requires that we reflect the expansion of the loss horizon to life of loan and take into account forecasts of expected future macroeconomic conditions in our determination of the allowance for credit losses.
In order to estimate the allowance for credit losses on unfunded loan commitments, the Bank uses a process similar to that used in estimating the allowance for credit losses on the funded portion. The allowance is based on the estimated exposure at default, multiplied by the lifetime probability of default grade and loss given default grade for that particular loan segment. The Bank estimates expected losses by calculating a commitment usage factor based on industry usage factors. The commitment usage factor is applied over the relevant contractual period. Loss factors from the underlying loans to which commitments are related are applied to the results of the usage calculation to estimate any liability for credit losses related for each loan type. The expected losses on unfunded commitments align with statistically calculated parameters used to calculate the allowance for credit losses on the funded portion. Letters of credit are not currently reserved because they are issued primarily as credit enhancements and the likelihood of funding is low.
As previously discussed, we adopted the new CECL standard and recorded a transition adjustment entry that resulted in an allowance for credit losses of $5.9 million as of January 1, 2020. During the three months ended March 31, 2021, the increase in the reserve for unfunded commitments was primarily due to increases in available commitment balances.
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. Potential problem loans are assigned a grade of special mention within our risk grading matrix. Potential problem loans do not include purchased credit deteriorated (“PCD”) loans because PCD loans exhibited evidence of more than insignificant credit deterioration at acquisition that made it probable that all contractually required principal payments would not be collected. Additionally, potential problem loans do not include loans that have been modified in connection with our COVID-19 payment deferment programs which allow for a deferral of principal and/or interest payments. Within our loan portfolio, we had three credit relationships totaling $4.8 million of potential problem loans at March 31, 2021, compared with seven credit relationships totaling $11.3 million of potential problem loans at December 31, 2020.
Non-Performing Assets
In response to the COVID-19 pandemic, the CARES Act was passed in March 2020, which among other things, allows the Bank to suspend the TDR requirements for certain loan modifications to be categorized as a TDR. Starting in March 2020, the Bank implemented several actions to better support our impacted banking clients and allow for loan modifications such as principal and/or interest payment deferrals, participation in the PPP as an SBA preferred lender and personal banking assistance including waived fees, increased daily spending limits and suspension of residential foreclosure activities. The COVID-19 payment deferment programs allow for a deferral of principal and/or interest payments with such deferred principal payments due and payable on the maturity date of the existing loan.
Specifically, as discussed under the section titled “Loan Portfolio” earlier in this Item 2, the Bank’s actions during 2020 included approval of $1.0 billion of COVID-19 related loan modifications. The portfolio of active deferrals that have not reached the end of their deferral period was approximately $130 million as of March 31, 2021. While the majority of the portfolio of COVID-19 related loan modifications no longer require deferral, such loans represent elevated risk, and therefore management continues to monitor these loans. The extent to which these measures will impact the Bank, and any progression of loans, whether receiving COVID-19 payment deferrals or not, into non-performing assets, during future periods is uncertain and will depend on future developments that cannot be predicted.
The following table presents components of our non-performing assets (dollars in thousands).
Loans accounted for on a non-accrual basis:
10,668
11,133
(465)
2,095
30,937
32,263
(1,326)
78,276
77,980
296
Troubled debt restructurings included in accruing loans held for investment
1,584
1,954
Non-performing loans
79,860
79,934
(74)
Non-performing loans as a percentage of total loans
0.77
0.76
0.01
Other real estate owned
19,899
21,289
(1,390)
Other repossessed assets
(101)
Non-performing assets
99,759
101,324
(1,565)
Non-performing assets as a percentage of total assets
0.56
0.60
(0.04)
Loans past due 90 days or more and still accruing
265,230
243,630
21,600
At March 31, 2021, non-accrual loans included 49 commercial and industrial relationships with loans secured by accounts receivable, life insurance, oil and gas, livestock and equipment. Non-accrual loans at March 31, 2021 also included $8.3 million of loans secured by residential real estate which were classified as loans held for sale. At December 31, 2020, non-accrual loans included 60 commercial and industrial relationships with loans secured by accounts receivable, life insurance, oil and gas, livestock and equipment. Non-accrual loans at December 31, 2020 also included $10.9 million of loans secured by residential real estate which were classified as loans held for sale.
At March 31, 2021, TDRs were comprised of $1.6 million of loans that are considered to be performing and accruing, and $15.8 million of loans considered to be non-performing reported in non-accrual loans. At December 31, 2020, TDRs were comprised of $2.0 million of loans that are considered to be performing and accruing, and $16.0 million of loans that were considered to be non-performing reported in non-accrual loans. In March 2020, the CARES Act was passed, which, among other things, allows the Bank to suspend the requirements for certain loan modifications to be categorized as a TDR. Therefore, the Bank is not reporting COVID-19 related modifications as TDRs in accordance with the CARES Act.
OREO decreased from December 31, 2020 to March 31, 2021, primarily due to disposals totaling $1.8 million, partially offset by additions of $0.5 million. At both March 31, 2021 and December 31, 2020, OREO was primarily comprised of commercial properties.
Loans past due 90 days or more and still accruing at March 31, 2021 and December 31, 2020, were primarily comprised of loans held for sale and guaranteed by U.S. government agencies, including GNMA-related loans subject to repurchase within our mortgage origination segment. As of March 31, 2021, $155.7 million of loans subject to repurchase were
under a forbearance agreement resulting from the COVID-19 pandemic. During May 2020, GNMA announced it will temporarily exclude any new GNMA lender delinquencies, occurring on or after April 2020, when calculating the delinquency ratios for the purposes of enforcing compliance with its delinquency rate thresholds. This exclusion is extended automatically to GNMA lenders that were compliant with GNMA’s delinquency rate thresholds as reflected by their April 2020 investor accounting report. The mortgage origination segment qualified for this exclusion as of March 31, 2021. As of March 31, 2021, $152.0 million of loans subject to repurchase under a forbearance agreement had delinquencies on or after April 2020.
The banking segment’s major source of funds and liquidity is its deposit base. Deposits provide funding for its investments 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.
The table below presents the average balance of, and rate paid on, consolidated deposits (dollars in thousands).
Rate Paid
Noninterest-bearing demand deposits
Interest-bearing demand deposits
5,625,682
0.24
4,589,046
0.71
Savings deposits
270,475
0.07
195,915
0.18
Time deposits
1,730,418
1.04
1,479,866
1.88
11,356,569
0.28
8,995,802
0.67
Borrowings
Our consolidated borrowings are shown in the table below (dollars in thousands).
1.22
(19,146)
4.95
19,726
4.13
1,145,377
2.66
1,144,797
2.51
580
Short-term borrowings consisted of federal funds purchased, securities sold under agreements to repurchase, borrowings at the Federal Home Loan Bank (“FHLB”), short-term bank loans and commercial paper. The decrease in short-term borrowings at March 31, 2021, compared with December 31, 2020, included a decrease in borrowings in our banking primarily associated with the continued utilization of available internal funds and a decrease in securities sold under agreements to repurchase by the Hilltop Broker-Dealers, partially offset by increases in short-term bank loans and commercial paper used by the Hilltop Broker-Dealers to finance their activities. Notes payable at March 31, 2021 was comprised of $149.0 million related to the Senior Notes, net of loan origination fees, Subordinated Notes, net of origination fees, of $196.9 million and mortgage origination segment borrowings of $55.9 million.
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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 support capital deployment for organic growth and to preserve capital to be deployed through acquisitions, dividend payments and stock repurchases. At March 31, 2021, Hilltop had $383.3 million in cash and cash equivalents, an increase of $8.5 million from $374.8 million at December 31, 2020. This increase in cash and cash equivalents was primarily due to the receipt of $40.0 million of dividends from subsidiaries, significantly offset by $9.9 million in cash dividends declared, $5.0 million of stock repurchases, and other general corporate expenses. Subject to regulatory restrictions, Hilltop has received, and may also continue to receive, dividends from its subsidiaries. If necessary or appropriate, we may also finance acquisitions with the proceeds from equity or debt issuances. We believe that Hilltop’s liquidity is sufficient for the foreseeable future, with current short-term liquidity needs including operating expenses, interest on debt obligations, dividend payments to stockholders and potential stock repurchases.
As previously discussed, in light of the extreme volatility and disruptions in the capital and credit markets beginning in March 2020 resulting from the COVID-19 crisis, including a significant decline in corporate debt and equity issuances and a deterioration in the mortgage servicing and commercial paper markets, we took a number of precautionary actions in March 2020 to enhance our financial flexibility by bolstering our cash position to ensure we have adequate cash readily available to meet both expected and unexpected funding needs without adversely affecting our daily operations.
To strengthen the Bank’s available liquidity position during 2020, we raised brokered deposits, as well as swept additional deposits from Hilltop Securities into the Bank. At March 31, 2021, given the continued strong cash and liquidity levels at the Bank, brokered deposits declined to $639 million and the total funds swept from Hilltop Securities into the Bank was approximately $700 million. In addition, we continue to evaluate market conditions to determine the appropriateness of capital market inventory limits at Hilltop Securities.
To meet demand for customer loan advances and satisfy our obligations to repay long-term debt maturing over the next 12 months, we believe we currently have sufficient liquidity from the available on- and off-balance sheet liquidity sources and our ability to issue debt in the capital markets. We continue to review actions that we may take to further enhance our financial flexibility in the event that market conditions deteriorate for an extended period.
Dividend Declaration
On April 22, 2021, our board of directors declared a quarterly cash dividend of $0.12 per common share, payable on May 28, 2021 to all common stockholders of record as of the close of business on May 14, 2021.
Future dividends on our common stock are subject to the determination by the board of directors based on an evaluation of 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.
In January 2021, our board of directors authorized a new stock repurchase program through January 2022 pursuant to which we are authorized to repurchase, in the aggregate, up to $75.0 million of our outstanding common stock, inclusive of repurchases to offset dilution related to grants of stock-based compensation. Under the stock repurchase program authorized, we may repurchase shares in the open market or through privately negotiated transactions as permitted under Rule 10b-18 promulgated under the Exchange Act. The extent to which we repurchase our shares and the timing of such repurchases depends upon market conditions and other corporate considerations, as determined by Hilltop’s management team. Repurchased shares will be returned to our pool of authorized but unissued shares of common stock.
During the three months ended March 31, 2021, we paid $5.0 million to repurchase an aggregate of 149,878 shares of common stock at an average price of $33.01 per share. The purchases were funded from available cash balances.
Senior Notes due 2025
The Senior Notes bear interest at a rate of 5% per year, payable semi-annually in arrears in cash on April 15 and October 15 of each year, commencing on October 15, 2015. The Senior Notes will mature on April 15, 2025, unless we redeem the Senior Notes, in whole at any time or in part from time to time, on or after January 15, 2025 (three months prior to the maturity date of the Senior Notes) at our election at a redemption price equal to 100% of the principal amount of the Senior Notes to be redeemed plus accrued and unpaid interest to, but excluding, the redemption date. At March 31, 2021, $150.0 million of our Senior Notes was outstanding.
On May 7, 2020, we completed a public offering of $50 million aggregate principal amount of 2030 Subordinated Notes and $150 million aggregate principal amount of 2035 Subordinated Notes. The price to the public for the Subordinated Notes was 100% of the principal amount of the Subordinated Notes. The net proceeds from the offering, after deducting underwriting discounts and fees and expenses of $3.4 million, were $196.6 million.
The 2030 Subordinated Notes and the 2035 Subordinated Notes will mature on May 15, 2030 and May 15, 2035, respectively. We may redeem the Subordinated Notes, in whole or in part, from time to time, subject to obtaining Federal Reserve approval, beginning with the interest payment date of May 15, 2025 for the 2030 Subordinated Notes and beginning with the interest payment date of May 15, 2030 for the 2035 Subordinated Notes at a redemption price equal to 100% of the principal amount of the Subordinated Notes being redeemed plus accrued and unpaid interest to but excluding, the date of redemption.
The 2030 Subordinated Notes bear interest at a rate of 5.75% per year, payable semi-annually in arrears commencing on November 15, 2020. The interest rate for the 2030 Subordinated Notes will reset quarterly beginning May 15, 2025 to an interest rate, per year, equal to the then-current benchmark rate, which is expected to be three-month term SOFR rate, plus 5.68%, payable quarterly in arrears. The 2035 Subordinated Notes bear interest at a rate of 6.125% per year, payable semi-annually in arrears commencing on November 15, 2020. The interest rate for the 2035 Subordinated Notes will reset quarterly beginning May 15, 2030 to an interest rate, per year, equal to the then-current benchmark rate, which is expected to be three-month term SOFR rate plus 5.80%, payable quarterly in arrears. At March 31, 2021, $200 million of our Subordinated Notes was outstanding.
Junior Subordinated Debentures
The Debentures have a stated term of 30 years with maturities ranging from July 2031 to February 2038 with interest payable quarterly. The rate on the Debentures, which resets quarterly, is three-month LIBOR plus an average spread of 3.22%. The total average interest rate at March 31, 2021 was 3.42%. The Debentures are callable at PCC’s discretion with a minimum of a 45- to 60- day notice. At March 31, 2021, $67.0 million of PCC’s Debentures were outstanding.
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.
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, because Hilltop has grown above $15 billion, if we make an acquisition in the future, the debentures issued to the Trusts may out of Tier 1 and into Tier 2 capital. All of the debentures issued to the PCC Statutory Trusts I, II, III and IV (the “Trusts”), less the common
stock of the Trusts, qualified as Tier 1 capital as of March 31, 2021, under guidance issued by the Board of Governors of the Federal Reserve System.
Actual capital amounts and ratios as of March 31, 2021 reflect PlainsCapital’s and Hilltop’s decision to elect the transition option as issued by the federal banking regulatory agencies in March 2020 that permits banking institutions to mitigate the estimated cumulative regulatory capital effects from CECL over a five-year transitionary period.
At March 31, 2021, Hilltop had a total capital to risk weighted assets ratio of 22.96%, Tier 1 capital to risk weighted assets ratio of 20.22%, common equity Tier 1 capital to risk weighted assets ratio of 19.63% and a Tier 1 capital to average assets, or leverage, ratio of 13.01%. Accordingly, Hilltop’s actual capital amounts and ratios in accordance with Basel III exceeded the regulatory capital requirements including conservation buffer in effect at the end of the period.
At March 31, 2021, PlainsCapital had a total capital to risk weighted assets ratio of 15.64%, Tier 1 capital to risk weighted assets ratio of 14.74%, common equity Tier 1 capital to risk weighted assets ratio of 14.74% and a Tier 1 capital to average assets, or leverage, ratio of 10.50%. Accordingly, PlainsCapital’s actual capital amounts and ratios in accordance with Basel III resulted in it being considered “well-capitalized” and exceeded the regulatory capital requirements including conservation buffer in effect at the end of the period.
We discuss regulatory capital requirements in more detail in Note 17 to our consolidated financial statements, as well as under the caption “Government Supervision and Regulation — Corporate — Capital Adequacy Requirements and BASEL III” set forth in Part I, Item I. of our 2020 Form 10-K.
Within our banking segment, our primary uses of cash are for customer withdrawals and extensions of credit as well as our borrowing costs and other operating expenses. Our corporate treasury group is responsible for continuously monitoring our liquidity position to ensure that our assets and liabilities are managed in a manner that will meet our short-term and long-term cash requirements. Our goal is to manage our liquidity position in a manner such that we can meet our customers’ short-term and long-term deposit withdrawals and anticipated and unanticipated increases in loan demand without penalizing earnings. 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 time deposits, term loans at the FHLB and borrowings under lines of credit with other financial institutions.
As previously discussed, to meet increased liquidity demands and ensure availability of adequate cash to meet both expected and unexpected funding needs without adversely affecting our daily operations and to improve the Bank’s already strong liquidity position, we raised brokered deposits during 2020 that have a remaining balance of approximately $639 million at March 31, 2021, down from approximately $731 million at December 31, 2020. Further, beginning in March 2020, additional deposits were swept from Hilltop Securities into the Bank. Since June 30, 2020, given the continued strong cash and liquidity levels at the Bank, the total funds swept from Hilltop Securities into the Bank was reduced, and is approximately $700 million as of March 31, 2021. As a result, the Bank was able to further fortify its borrowing capacity through access to secured funding sources as summarized in the following table (in millions).
FHLB capacity
4,378
4,410
Investment portfolio (available)
1,188
982
Fed deposits (excess daily requirements)
1,415
875
6,981
6,267
As noted in the table above, the Bank’s available liquidity position and borrowing capacity at March 31, 2021 continues to be at a heightened level given the uncertain outlook for 2021 due to the COVID-19 pandemic. While the extent to
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which COVID-19 will impact the Bank is uncertain, the Bank is targeting available liquidity of between approximately $5 billion and $6 billion during the remainder of 2021. Available liquidity does not include borrowing capacity available through the discount window at the Federal Reserve.
Within our banking segment, 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. While the Bank experienced an increase in non-brokered customer deposits during 2020, an economic recovery and improved commercial real estate investment outlook may result in an outflow of deposits at an accelerated pace as customers utilize such available funds for expanded operations and investment opportunities. The Bank regularly evaluates its deposit products and pricing structures relative to the market to maintain competitiveness over time.
The Bank’s 15 largest depositors, excluding Hilltop and Hilltop Securities, collectively accounted for 9.24% of the Bank’s total deposits, and the Bank’s five largest depositors, excluding Hilltop and Hilltop Securities, collectively accounted for 4.54% of the Bank’s total deposits at March 31, 2021. 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.
The Hilltop Broker-Dealers rely on their equity capital, short-term bank borrowings, interest-bearing and noninterest-bearing client credit balances, correspondent deposits, securities lending arrangements, repurchase agreement financing, commercial paper issuances and other payables to finance their assets and operations, subject to their respective compliance with broker-dealer net capital and customer protection rules. At March 31, 2021, Hilltop Securities had credit arrangements with four unaffiliated banks, with maximum aggregate commitments of up to $600.0 million. These credit arrangements 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. In addition, Hilltop Securities has committed revolving credit facilities with three unaffiliated banks, with aggregate availability of up to $250.0 million. At March 31, 2021, Hilltop Securities had borrowed $58.0 million under its credit arrangements and had no borrowings under its credit facilities.
Hilltop Securities uses the net proceeds (after deducting related issuance expenses) from the sale of two commercial paper programs for general corporate purposes, including working capital and the funding of a portion of its securities inventories. The commercial paper notes (“CP Notes”) may be issued with maturities of 14 days to 270 days from the date of issuance. The commercial paper notes (“CP Notes”) are issued under two separate programs, Series 2019-1 CP Notes and Series 2019-2 CP Notes, in maximum aggregate amounts of $300 million and $200 million, respectively. As of March 31, 2021, the weighted average maturity of the CP Notes was 157 days at a rate of 1.13% with a weighted average remaining life of 106 days. At March 31, 2021, the aggregate amount outstanding under these secured arrangements was $336.4 million, which was collateralized by securities held for firm accounts valued at $364.1 million.
PrimeLending funds the mortgage loans it originates through warehouse lines of credit maintained with the Bank, which have an aggregate commitment of $3.3 billion, of which $2.3 billion was drawn at March 31, 2021. PrimeLending sells substantially all mortgage loans it originates to various investors in the secondary market, historically with 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 an unaffiliated bank of up to $1.0 million, of which no borrowings were drawn at March 31, 2021.
PrimeLending owns a 100% membership interest in PrimeLending Ventures Management, LLC (“Ventures Management”) which holds an ownership interest in and is the managing member of certain ABAs. At March 31, 2021, these ABAs had combined available lines of credit totaling $175.0 million, $85.0 million of which was with a single unaffiliated bank, and the remaining $90.0 million of which was with the Bank. At March 31, 2021, Ventures Management had outstanding borrowings of $64.4 million, $8.6 million of which was with the Bank.
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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, 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 normal course of business, the Hilltop Broker-Dealers execute, settle and finance various securities transactions that may expose the Hilltop Broker-Dealers 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 the Hilltop Broker-Dealers, use of derivatives to support certain non-profit housing organization clients, clearing agreements between the Hilltop Broker-Dealers and various clearinghouses and broker-dealers, secured financing arrangements that involve pledged securities, and when-issued underwriting and purchase commitments.
Critical Accounting Estimates
Our accounting policies are fundamental to understanding our management’s discussion and analysis of our results of operations and financial condition. We have identified certain significant accounting policies which involve a higher degree of judgment and complexity in making certain estimates and assumptions that affect amounts reported in our consolidated financial statements. The significant accounting policies which we believe to be the most critical in preparing our consolidated financial statements relate to allowance for credit losses, goodwill and identifiable intangible assets, mortgage loan indemnification liability, mortgage servicing rights asset and acquisition accounting. Since
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December 31, 2020, there have been no changes in critical accounting policies as further described under “Critical Accounting Policies and Estimates” and Note 1 to the Consolidated Financial Statements in our 2020 Form 10-K.
Item 3. Quantitative and Qualitative Disclosures About Market Risk.
Our assessment of market risk as of March 31, 2021 indicates there are no material changes in the quantitative and qualitative disclosures from those previously reported in our 2020 Form 10-K, except as discussed below.
The primary objective of the following information is to provide forward-looking quantitative and qualitative information about our potential exposure to market risks. Market risk represents the risk of loss that may result from changes in value of a financial instrument as a result of changes in interest rates, market prices and the credit perception of an issuer. The disclosure is not meant to be a precise indicator of expected future losses, but rather an indicator of reasonably possible losses, and therefore our actual results may differ from any of the following projections. This forward-looking information provides an indicator of how we view and manage our ongoing market risk exposures.
The banking segment is engaged primarily in the business of investing funds obtained from deposits and borrowings in interest-earning loans and investments, and our primary component of market risk is sensitivity to changes in interest rates. Consequently, our earnings depend to a significant extent on our net interest income, which is the difference between interest income on loans and investments and our interest expense on deposits and borrowings. To the extent that our interest-bearing liabilities do not reprice or mature at the same time as our interest-bearing assets, we are subject to interest rate risk and corresponding fluctuations in net interest income.
There are several common sources of interest rate risk that must be effectively managed if there is to be minimal impact on our earnings and capital. Repricing risk arises largely from timing differences in the pricing of assets and liabilities. Reinvestment risk refers to the reinvestment of cash flows from interest payments and maturing assets at lower or higher rates. Basis risk exists when different yield curves or pricing indices do not change at precisely the same time or in the same magnitude such that assets and liabilities with the same maturity are not all affected equally. Yield curve risk refers to unequal movements in interest rates across a full range of maturities.
We have employed asset/liability management policies that attempt to manage our interest-earning assets and interest-bearing liabilities, thereby attempting to control the volatility of net interest income, without having to incur unacceptable levels of risk. We employ procedures which include interest rate shock analysis, repricing gap analysis and balance sheet decomposition techniques to help mitigate interest rate risk in the ordinary course of business. In addition, the asset/liability management policies permit the use of various derivative instruments to manage interest rate risk or hedge specified assets and liabilities.
An interest rate sensitive asset or liability is one that, within a defined time period, either matures or experiences an interest rate change in line with general market interest rates. The management of interest rate risk is performed by analyzing the maturity and repricing relationships between interest-earning assets and interest-bearing liabilities at specific points in time (“GAP”) and by analyzing the effects of interest rate changes on net interest income over specific periods of time by projecting the performance of the mix of assets and liabilities in varied interest rate environments. Interest rate sensitivity reflects the potential effect on net interest income resulting from a movement in interest rates. A company is considered to be asset sensitive, or have a positive GAP, when the amount of its interest-earning assets maturing or repricing within a given period exceeds the amount of its interest-bearing liabilities also maturing or repricing within that time period. Conversely, a company is considered to be liability sensitive, or have a negative GAP, when the amount of its interest-bearing liabilities maturing or repricing within a given period exceeds the amount of its interest-earning assets also maturing or repricing within that time period. During a period of rising interest rates, a negative GAP would tend to affect net interest income adversely, while a positive GAP would tend to result in an increase in net interest income. During a period of falling interest rates, a negative GAP would tend to result in an increase in net interest income, while a positive GAP would tend to affect net interest income adversely. However, it is our intent to remain relatively balanced so that changes in rates do not have a significant impact on earnings.
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).
3 Months or
> 3 Months to
> 1 Year to
> 3 Years to
Less
1 Year
3 Years
5 Years
> 5 Years
Interest sensitive assets:
5,831,382
1,272,479
1,759,078
624,047
113,503
9,600,489
243,895
223,652
495,426
343,779
680,197
1,986,949
Other interest sensitive assets
1,424,757
29,450
1,454,207
Total interest sensitive assets
7,500,430
1,496,131
2,254,504
967,826
823,150
13,042,041
Interest sensitive liabilities:
Interest bearing checking
5,715,596
474,647
941,381
114,605
35,641
1,566,274
158,900
207
801
2,977
163,527
Total interest sensitive liabilities
6,621,053
941,588
115,247
36,442
7,717,307
Interest sensitivity gap
879,377
554,543
2,139,257
931,384
820,173
5,324,734
Cumulative interest sensitivity gap
1,433,920
3,573,177
4,504,561
Percentage of cumulative gap to total interest sensitive assets
6.74
10.99
27.40
34.54
40.83
The positive GAP in the interest rate analysis indicates that banking segment net interest income would generally rise if rates increase. Because of inherent limitations in interest rate GAP analysis, the banking segment uses multiple interest rate risk measurement techniques. Simulation analysis is used to subject the current repricing conditions to rising and falling interest rates in increments and decrements of 50 to 100 basis points 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 a range of changes in interest rates on net interest income and on economic value of equity for the banking segment at March 31, 2021 (dollars in thousands).
Change in
Interest Rates
Net Interest Income
Economic Value of Equity
(basis points)
+300
107,701
29.11
665,753
33.97
+200
68,693
18.57
478,475
24.41
+100
31,121
8.41
261,669
13.35
-50
(9,027)
(2.44)
(291,115)
(14.85)
The projected changes in net interest income and economic value of equity to changes in interest rates at March 31, 2021 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.
Our portfolio includes loans that periodically reprice or mature prior to the end of an amortized term. Some of our variable-rate loans remain at applicable rate floors, which may delay and/or limit changes in interest income during a period of changing rates. If interest rates were to fall, the impact on our interest income would be limited by these rate floors. In addition, declining interest rates may negatively affect our cost of funds on deposits. The extent of this impact will ultimately be driven by the timing, magnitude and frequency of interest rate and yield curve movements, as well as changes in market conditions and timing of management strategies. If interest rates were to rise, yields on the portion of
our portfolio that remain at applicable rate floors would rise more slowly than increases in market interest rates. Any changes in interest rates across the term structure will continue to impact net interest income and net interest margin. The impact of rate movements will change with the shape of the yield curve, including any changes in steepness or flatness and inversions at any points on the yield curve.
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 receivables and securities borrowing activities. Our funding sources, which include customer and correspondent cash balances, bank borrowings, repurchase agreements and securities lending activities, also expose the broker-dealer to interest rate risk. Movement in short-term interest rates could reduce the positive spread between the broker-dealer segment’s interest income and interest expense.
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 and receivables are indexed and can vary daily. Our funding sources are generally short term with interest rates that can vary daily.
The following table categorizes the broker-dealer segment’s net trading securities which are subject to interest rate and market price risk (dollars in thousands).
> 1 Year
or Less
to 5 Years
to 10 Years
> 10 Years
Municipal obligations
3,713
34,870
144,718
U.S. government and government agency obligations
12,004
(7,601)
(19,376)
213,753
198,780
Corporate obligations
(4,786)
7,653
5,893
36,465
45,225
Total debt securities
7,302
3,765
21,387
394,936
427,390
Corporate equity securities
(1,905)
5,148
10,545
Weighted average yield
1.62
1.69
0.59
1.30
3.20
2.73
0.78
2.57
2.98
2.68
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.
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.
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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 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 U.S. Treasury bond futures and options, Eurodollar futures 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.
Item 4. Controls and Procedures.
Evaluation of Disclosure Controls and Procedures
Our management, with the supervision and participation of our Principal Executive Officer and Principal Financial Officer, has evaluated the effectiveness of the design and operation of our disclosure controls and procedures (as defined in Rules 13a-15(e) and 15d-15(e) under the Exchange Act) as of the end of the period covered by this report.
Based upon that evaluation, our Principal Executive Officer and Principal Financial Officer concluded that, as of the end of the period covered by this report, our disclosure controls and procedures were effective in recording, processing, summarizing and reporting, on a timely basis, information required to be disclosed by us in the reports that we file or submit under the Exchange Act and are effective in ensuring that information required to be disclosed by us in the reports that we file or submit under the Exchange Act is accumulated and communicated to the Company’s management, including our Principal Executive Officer and Principal Financial Officer, as appropriate to allow timely decisions regarding required disclosure.
Changes in Internal Control Over Financial Reporting
There were no changes in our internal control over financial reporting during our first fiscal quarter covered by this quarterly report that have materially affected, or are reasonably likely to materially affect, our internal control over financial reporting.
PART II. OTHER INFORMATION
Item 1. Legal Proceedings.
For a description of material pending legal proceedings, see the discussion set forth under the heading “Legal Matters” in Note 14 to our Consolidated Financial Statements, which is incorporated by reference herein.
Item 1A. Risk Factors.
There have been no material changes to the risk factors disclosed under “Item 1A. Risk Factors” of our 2020 Form 10-K. For additional information concerning our risk factors, please refer to “Item 1A. Risk Factors” of our 2020 Form 10-K.
Item 2. Unregistered Sales of Equity Securities and Use of Proceeds.
The following table details our repurchases of shares of common stock during the three months ended March 31, 2021.
Total Number of Shares Purchased
Average Price Paid per Share
Total Number of Shares Purchased as Part of Publicly Announced Plans or Programs
Approximate Dollar Value of Shares that May Yet Be Purchased Under the Plans or Programs (1)
January 1 - January 31, 2021
75,000,000
February 1 - February 28, 2021
108,682
32.98
71,415,668
March 1 - March 31, 2021
41,196
33.11
70,051,668
149,878
33.01
Item 6. Exhibits.
ExhibitNumber
Description of Exhibit
2.1#
Stock Purchase Agreement by and among Hilltop Holdings Inc., ARC Insurance Holdings, Inc., Align NL Holdings, LLC and, for limited purposes set forth therein, Align Financial Holdings, LLC and MGI Holdings, Inc., dated January 30, 2020 (filed as Exhibit 2.1 to the Registrant’s Current Report on Form 8-K filed February 5, 2020 (File No. 001-31987) and incorporated herein by reference).
2.2#
First Amendment to Stock Purchase Agreement by and among Hilltop Holdings Inc., ARC Insurance Holdings, Inc., Align NL Holdings, LLC and, for limited purposes set forth therein, Align Financial Holdings, LLC and MGI Holdings, Inc., dated June 30, 2020 (filed as Exhibit 2.2 to the Registrant’s Current Report on Form 8-K filed July 1, 2020 (File No. 001-31987) and incorporated herein by reference).
10.1*
Compensation arrangement of Jeremy B. Ford.
10.2*
Form of Restricted Stock Unit Award Agreement (Performance-Based) for awards beginning in 2021.
10.3*
Form of Restricted Stock Unit Award Agreement (Time-Based Vesting for Section 16 Officers) for awards beginning in 2021.
10.4*
Form of Restricted Stock Unit Award Agreement (Time-Based Vesting for Non-Section 16 Officers) for awards beginning in 2021.
31.1*
Certification of Principal Executive Officer pursuant to Rule 13a-14(a) of the Securities Exchange Act of 1934, as amended.
31.2*
Certification of Principal Financial Officer pursuant to Rule 13a-14(a) of the Securities Exchange Act of 1934, as amended.
32.1*
Certification of Principal Executive Officer and Principal Financial Officer pursuant to 18 U.S.C. Section 1350, as adopted pursuant to Section 906 of the Sarbanes-Oxley Act of 2002.
101.INS
XBRL Instance Document – the instance document does not appear in the Interactive Data File because its XBRL tags are embedded within the Inline XBRL document.
101.SCH*
Inline XBRL Taxonomy Extension Schema
101.CAL*
Inline XBRL Taxonomy Extension Calculation Linkbase
101.DEF*
Inline XBRL Taxonomy Extension Definition Linkbase
101.LAB*
Inline XBRL Taxonomy Extension Label Linkbase
101.PRE*
Inline XBRL Taxonomy Extension Presentation Linkbase
Cover Page Interactive File (formatted as Inline XBRL and contained in Exhibit 101)
*
Filed herewith.
#
Schedules and similar attachments have been omitted from this Exhibit pursuant to Item 601(b)(2) of Regulation S-K. A copy of any omitted schedule or similar attachment will be furnished to the SEC upon request.
SIGNATURES
Pursuant to the requirements of the Securities Exchange Act of 1934, the Registrant has duly caused this report to be signed on its behalf by the undersigned thereunto duly authorized.
Date: April 26, 2021
By:
/s/ William B. Furr
William B. Furr
Chief Financial Officer
(Principal Financial Officer and duly authorized officer)