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 September 30, 2024
☐
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, a 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 October 24, 2024 was 64,961,742.
HILLTOP HOLDINGS INC.
FOR THE QUARTER ENDED SEPTEMBER 30, 2024
TABLE OF CONTENTS
PART I — FINANCIAL INFORMATION
Item 1.
Financial Statements
3
Consolidated Balance Sheets
Consolidated Statements of Operations
4
Consolidated Statements of Comprehensive Income
5
Consolidated Statements of Stockholders’ Equity
6
Consolidated Statements of Cash Flows
8
Notes to Consolidated Financial Statements
9
Item 2.
Management’s Discussion and Analysis of Financial Condition and Results of Operations
47
Item 3.
Quantitative and Qualitative Disclosures About Market Risk
92
Item 4.
Controls and Procedures
96
PART II — OTHER INFORMATION
Legal Proceedings
97
Item 1A.
Risk Factors
Unregistered Sales of Equity Securities and Use of Proceeds
Item 5.
Other Information
Item 6.
Exhibits
98
2
PART I. FINANCIAL INFORMATION
Item 1. Financial Statements.
HILLTOP HOLDINGS INC. AND SUBSIDIARIES
CONSOLIDATED BALANCE SHEETS
(in thousands, except share and per share data)
(Unaudited)
September 30,
December 31,
2024
2023
Assets
Cash and due from banks
$
1,961,627
1,858,700
Federal funds sold
3,650
650
Assets segregated for regulatory purposes
55,628
57,395
Securities purchased under agreements to resell
81,766
80,011
Securities:
Trading, at fair value
540,836
515,991
Available for sale, at fair value, net (amortized cost of $1,489,070 and $1,621,747, respectively)
1,405,700
1,507,595
Held to maturity, at amortized cost, net (fair value of $690,846 and $731,858, respectively)
754,824
812,677
Equity, at fair value
287
321
2,701,647
2,836,584
Loans held for sale
933,724
943,846
Loans held for investment, net of unearned income
7,979,630
8,079,745
Allowance for credit losses
(110,918)
(111,413)
Loans held for investment, net
7,868,712
7,968,332
Broker-dealer and clearing organization receivables
1,220,784
1,573,931
Premises and equipment, net
157,803
168,856
Operating lease right-of-use assets
92,041
88,580
Mortgage servicing rights
45,742
96,662
Other assets
528,839
517,545
Goodwill
267,447
Other intangible assets, net
6,995
8,457
Total assets
15,926,405
16,466,996
Liabilities and Stockholders' Equity
Deposits:
Noninterest-bearing
2,831,539
3,007,101
Interest-bearing
7,959,908
8,056,091
Total deposits
10,791,447
11,063,192
Broker-dealer and clearing organization payables
1,110,373
1,430,734
Short-term borrowings
914,645
900,038
Securities sold, not yet purchased, at fair value
47,773
34,872
Notes payable
347,533
347,145
Operating lease liabilities
110,799
109,002
Other liabilities
397,976
431,684
Total liabilities
13,720,546
14,316,667
Commitments and contingencies (see Notes 13 and 14)
Stockholders' equity:
Hilltop stockholders' equity:
Common stock, $0.01 par value, 125,000,000 shares authorized; 64,959,743 and 65,153,092 shares issued and outstanding at September 30, 2024 and December 31, 2023, respectively
652
Additional paid-in capital
1,050,497
1,054,662
Accumulated other comprehensive loss
(98,168)
(121,505)
Retained earnings
1,224,117
1,189,222
Deferred compensation employee stock trust, net
—
228
Employee stock trust (0 and 10,290 shares, at cost, at September 30, 2024 and December 31, 2023, respectively)
(292)
Total Hilltop stockholders' equity
2,177,096
2,122,967
Noncontrolling interests
28,763
27,362
Total stockholders' equity
2,205,859
2,150,329
Total liabilities and stockholders' equity
See accompanying notes.
CONSOLIDATED STATEMENTS OF OPERATIONS
(in thousands, except per share data)
Three Months Ended September 30,
Nine Months Ended September 30,
Interest income:
Loans, including fees
139,821
142,402
412,779
404,179
Securities borrowed
19,426
17,683
60,293
53,265
Taxable
26,265
27,166
77,795
79,487
Tax-exempt
2,438
2,464
7,242
8,218
Other
23,092
27,040
69,690
76,459
Total interest income
211,042
216,755
627,799
621,608
Interest expense:
Deposits
70,641
64,290
207,880
154,840
Securities loaned
18,499
16,169
56,207
47,928
10,878
14,212
33,142
44,361
3,555
4,026
10,749
11,852
2,426
2,408
7,507
7,005
Total interest expense
105,999
101,105
315,485
265,986
Net interest income
105,043
115,650
312,314
355,622
Provision for (reversal of) credit losses
(1,270)
(40)
6,793
17,127
Net interest income after provision for (reversal of) credit losses
106,313
115,690
305,521
338,495
Noninterest income:
Net gains from sale of loans and other mortgage production income
47,816
47,262
146,468
135,763
Mortgage loan origination fees
32,119
41,478
92,955
111,695
Securities commissions and fees
30,434
22,864
90,317
73,152
Investment and securities advisory fees and commissions
42,220
39,662
105,438
98,546
47,854
45,583
140,188
130,838
Total noninterest income
200,443
196,849
575,366
549,994
Noninterest expense:
Employees' compensation and benefits
177,987
173,195
513,815
517,920
Occupancy and equipment, net
22,317
21,912
65,526
67,802
Professional services
11,645
12,639
31,646
35,930
52,363
52,271
159,812
155,812
Total noninterest expense
264,312
260,017
770,799
777,464
Income before income taxes
42,444
52,522
110,088
111,025
Income tax expense
9,539
13,211
24,762
24,008
Net income
32,905
39,311
85,326
87,017
Less: Net income attributable to noncontrolling interest
3,212
2,269
7,632
6,042
Income attributable to Hilltop
29,693
37,042
77,694
80,975
Earnings per common share:
Basic
0.46
0.57
1.19
1.25
Diluted
Weighted average share information:
64,928
65,106
65,070
65,011
64,946
65,108
65,080
65,014
CONSOLIDATED STATEMENTS OF COMPREHENSIVE INCOME
(in thousands)
Other comprehensive income (loss):
Change in fair value of cash flow hedges, net taxes of $(1,304), $(91), $(1,656) and $(87), respectively
(4,434)
(306)
(5,476)
(169)
Net unrealized gains (losses) on securities available-for-sale, net taxes of $6,707, $(4,349), $7,246 and $(4,497), respectively
22,818
(14,585)
23,424
(15,819)
Reclassification adjustment for gains (losses) included in net income, net taxes of $0, $0, $34 and $1, respectively
(2)
114
Amortization of unrealized losses on securities transferred from available-for-sale to held-to-maturity, net taxes of $787, $459, $1,585 and $1,332, respectively
2,619
1,528
5,275
4,432
Comprehensive income
53,908
25,946
108,663
75,465
Less: comprehensive income attributable to noncontrolling interest
Comprehensive income applicable to Hilltop
50,696
23,677
101,031
69,423
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
Loss
Earnings
Trust, Net
Equity
Interest
Balance, June 30, 2023
65,071
651
1,050,191
(131,718)
1,144,624
450
21
(599)
2,063,599
26,655
2,090,254
Other comprehensive loss
(13,365)
Stock-based compensation expense
2,936
Common stock issued to board members
128
Issuance of common stock related to share-based awards, net
95
1
(388)
(387)
Dividends on common stock ($0.16 per share)
(10,416)
Deferred compensation plan
(110)
(5)
153
43
Net cash distributed to noncontrolling interest
(1,642)
Balance, September 30, 2023
65,170
1,052,867
(145,083)
1,171,250
340
16
(446)
2,079,580
27,282
2,106,862
Balance, June 30, 2024
64,953
1,047,523
(119,171)
1,205,467
(1)
2,134,469
28,142
2,162,611
Other comprehensive income
21,003
2,886
120
(32)
Dividends on common stock ($0.17 per share)
(11,043)
(2,591)
Balance, September 30, 2024
64,960
CONSOLIDATED STATEMENTS OF STOCKHOLDERS’ EQUITY (continued)
Balance, December 31, 2022
64,685
647
1,046,331
(133,531)
1,123,636
481
23
(640)
2,036,924
26,605
2,063,529
(11,552)
12,967
14
428
616
7
(4,542)
(4,535)
Repurchases of common stock
(145)
(2,317)
(2,184)
(4,503)
Dividends on common stock ($0.48 per share)
(31,177)
(141)
(7)
194
53
(5,365)
Balance, December 31, 2023
65,153
10
23,337
8,551
12
362
435
(2,805)
(2,801)
(6)
(10,273)
(9,585)
(19,864)
Dividends on common stock ($0.51 per share)
(33,214)
(228)
(10)
292
64
(6,231)
CONSOLIDATED STATEMENTS OF CASH FLOWS
Operating Activities
Adjustments to reconcile net income to net cash provided by operating activities:
Provision for credit losses
Depreciation, amortization and accretion, net
15,097
15,267
Equity in undistributed earnings of merchant banking subsidiaries
(9,044)
(6,369)
Deferred income taxes
(11,570)
5,268
Other, net
3,358
12,531
Net change in securities purchased under agreements to resell
(1,755)
(5,649)
Net change in trading securities
(24,845)
176,131
Net change in broker-dealer and clearing organization receivables
356,675
(348,318)
Net change in other assets
(38,748)
(33,796)
Net change in broker-dealer and clearing organization payables
(285,960)
360,433
Net change in other liabilities
(15,508)
(13,295)
Net change in securities sold, not yet purchased
12,901
(1,496)
Proceeds from sale of mortgage servicing rights asset
45,129
19,055
Change in valuation of mortgage servicing rights asset
14,913
678
Net gains from sales of loans
(146,468)
(135,763)
Loans originated for sale
(7,300,426)
(7,297,473)
Proceeds from loans sold
7,445,251
7,328,562
Net cash provided by operating activities
151,119
179,910
Investing Activities
Proceeds from maturities and principal reductions of securities held to maturity
63,633
55,006
Proceeds from sales, maturities and principal reductions of securities available for sale
169,443
204,903
Proceeds from sales, maturities and principal reductions of equity securities
12,663
Purchases of securities available for sale
(30,289)
(31,567)
Purchases of equity securities
(1,475)
Net change in loans held for investment
61,630
(184,341)
Purchases of premises and equipment and other assets
(6,215)
(6,090)
Proceeds from sales of premises and equipment, other real estate owned, and other assets
7,385
3,431
Proceeds from sale of loans held for sale transferred from loans held for investment
30,103
Net cash received from (paid to) Federal Home Loan Bank and Federal Reserve Bank stock
(42)
689
Net cash provided by investing activities
306,836
42,031
Financing Activities
Net change in deposits
(306,146)
(171,491)
Net change in short-term borrowings
15,132
(87,251)
Proceeds from notes payable
490,151
Payments on notes payable
(490,151)
Payments to repurchase common stock
Dividends paid on common stock
(3,472)
(5,165)
Net cash used in financing activities
(353,795)
(304,952)
Net change in cash, cash equivalents and restricted cash
104,160
(83,011)
Cash, cash equivalents and restricted cash, beginning of period
1,916,745
1,647,899
Cash, cash equivalents and restricted cash, end of period
2,020,905
1,564,888
Reconciliation of Cash, Cash Equivalents and Restricted Cash to Consolidated Balance Sheets
1,513,747
47,491
Total cash, cash equivalents and restricted cash
Supplemental Disclosures of Cash Flow Information
Cash paid for interest
319,231
252,409
Cash paid for income taxes, net of refunds
11,449
14,076
Supplemental Schedule of Non-Cash Activities
Conversion of loans to other real estate owned
2,871
5,168
Additions to mortgage servicing rights
9,122
23,859
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.
The Company, headquartered in Dallas, Texas, provides its products and services through two primary business units, 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.
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 (“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, 2023 (“2023 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 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 a controlling ownership interest in and is the managing member of certain affiliated business arrangements (“ABAs”).
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
Notes to Consolidated Financial Statements (continued)
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 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 requirements of the Variable Interest Entities (“VIE”) Subsections of the Financial Accounting Standards Board (“FASB”) Accounting Standards Codification (“ASC”). These entities are related to the Hilltop Plaza investment discussed in detail in Note 17 to the consolidated financial statements included in the Company’s 2023 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.
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 2023 Form 10-K.
Revision of Previously Issued Financial Statements
During the second quarter of 2024, the Company identified an immaterial error related to the classification within noninterest income associated with the allocation of earned revenue between commission and principal gains on certain principal trades of fixed income securities. As a result, certain prior period amounts have been corrected for consistency with the current period presentation. The Company assessed the materiality of this error and change in presentation on prior period consolidated financial statements in accordance with the SEC Staff Accounting Bulletin No. 108, “Considering the Effects of Prior Year Misstatements when Quantifying Misstatements in the Current Year Financial Statements.” Based on this assessment, the Company concluded that previously issued financial statements were not materially misstated based upon overall considerations of both quantitative and qualitative factors. The revisions had no impact on the Consolidated Balance Sheets, Consolidated Statements of Cash Flows, Consolidated Statements of Comprehensive Income or Consolidated Statements of Changes in Stockholders’ Equity within these financial statements, or within previously filed financial statements. Further, the revisions did not result in a change in quarterly or year-to-date net income, basic or diluted earnings per share, or regulatory capital ratios. Accordingly, the Company corrected the immaterial error for the previously reported three and nine months ended September 30, 2023 in this Quarterly Report on Form 10-Q. The following table presents the impact of the revisions of the previously filed financial statements for the three and nine months ended September 30, 2023 to correct for prior period immaterial errors (in thousands).
Three Months Ended September 30, 2023
Nine Months Ended September 30, 2023
As previously
Impact of
reported
Revision
As adjusted
Securities commission and fees
28,044
(5,180)
88,873
(15,721)
40,403
5,180
115,117
15,721
The following tables present line items for prior period impacts to the Company’s Consolidated Statements of Operations that have been affected by the immaterial error discussed above and will be revised in conjunction with future filings (in thousands).
Three Months Ended March 31, 2024
Three Months Ended March 31, 2023
35,557
(5,184)
30,373
31,223
(5,290)
25,933
49,200
5,184
54,384
35,680
5,290
40,970
Year Ended December 31, 2023
Year Ended December 31, 2022
Year Ended December 31, 2021
(unaudited)
121,875
(21,343)
100,532
139,122
(23,941)
115,181
143,827
(36,412)
107,415
156,082
21,343
177,425
113,957
23,941
137,898
128,034
36,412
164,446
The following table presents line items for prior period impacts to the components of other noninterest income as included in the Company’s Notes to Consolidated Financial Statements that have been affected by the immaterial error discussed above (in thousands).
Other noninterest income:
Net gains from Hilltop Broker-Dealer structured product and derivative activities
42,284
1,844
44,128
37,407
3,911
41,318
48,816
5,908
54,724
Net gain from trading securities portfolio
54,750
19,499
74,249
23,666
20,030
43,696
26,353
30,504
56,857
2. Recently Issued Accounting Standards
Accounting Standards Issued But Not Yet Adopted
In August 2023, the FASB issued Accounting Standards Update (“ASU”) 2023-05 to require joint ventures to initially measure all contributions received and liabilities assumed upon its formation at fair value. The guidance is applicable to joint venture entities with a formation date on or after January 1, 2025, with early adoption permitted. The Company does not expect the future adoption of this amendment to have a material impact on its future consolidated statements.
In October 2023, the FASB issued ASU 2023-06 to clarify or improve disclosure and presentation requirements of a variety of topics, which will allow users to more easily compare entities subject to the SEC's existing disclosures with those entities that were not previously subject to the requirements, and align the requirements in the FASB accounting standard codification with the SEC's regulations. The amendments will be effective on the date the SEC removes related disclosure requirements from Regulation S-X or Regulation S-K. If by June 30, 2027, the SEC has not removed the applicable disclosure requirements, the pending amendments will not become effective. Early adoption is prohibited. The Company does not expect the future adoption of this amendment to have a material impact on its consolidated financial statements since the Company is currently subject to the SEC’s disclosure and presentation requirements under Regulation S-X and Regulation S-K.
In November 2023, the FASB issued ASU 2023-07 to enhance disclosures of significant expense and segment profitability categories and amounts for each of the Company’s reportable business segments. The amendments are effective in annual periods beginning after December 15, 2023 and subsequent interim periods, with early adoption permitted. The Company does not expect the adoption of the provisions of the amendments to have an impact on its financial condition or results of operations. The Company expects to adopt this guidance beginning with the Annual Report on Form 10-K for the year ending December 31, 2024.
11
In December 2023, the FASB issued ASU 2023-09 to improve disclosures and presentation requirements to the transparency of the income tax disclosures by requiring consistent categories and greater disaggregation of information in the rate reconciliation and income taxes paid disaggregated by jurisdiction. The amendments are effective in annual periods beginning after December 15, 2024, with early adoption permitted. The Company is currently evaluating the provisions of the amendments, which are not expected to have an impact on its financial condition or results of operations. The Company expects to adopt this guidance in its Annual Report on Form 10-K for the year ending December 31, 2025.
In March 2024, the FASB issued ASU 2024-01 to clarify how an entity should determine whether a profits interest or similar award should be accounted for as a share-based payment arrangement or similar to a cash bonus or profit-sharing arrangement. The amendments are effective in annual periods beginning after December 15, 2024, and interim periods within those annual periods, with early adoption permitted. The Company is currently evaluating the new guidance and the impact on its future consolidated statements.
3. Fair Value Measurements
Fair Value Measurements and Disclosures
The Company determines fair values in compliance with The Fair Value Measurements and Disclosures Topic of the ASC (the “Fair Value Topic”). The Fair Value Topic defines fair value, establishes a framework for measuring fair value in GAAP and expands disclosures about fair value measurements. The Fair Value Topic defines fair value as the price that would be received to sell an asset or paid to transfer a liability in an orderly transaction between market participants. The Fair Value Topic assumes that transactions upon which fair value measurements are based occur in the principal market for the asset or liability being measured. Further, fair value measurements made under the Fair Value Topic exclude transaction costs and are not the result of forced transactions.
The Fair Value Topic 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.
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 Subsections of the ASC (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 September 30, 2024 and December 31, 2023, the aggregate fair value of PrimeLending’s mortgage loans held for sale accounted for under the Fair Value Option was $768.2 million and $822.2 million, respectively, and the unpaid principal balance of those loans was $754.1 million and $802.3 million, 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. 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
September 30, 2024
Inputs
Fair Value
Trading securities
5,515
535,321
Available for sale securities
1,376,614
29,086
Equity securities
746,840
48,304
795,144
Derivative assets
67,968
MSR asset
Equity investments
22,547
Securities sold, not yet purchased
44,886
2,887
Derivative liabilities
13,093
December 31, 2023
8,929
507,062
1,483,177
24,418
784,158
38,036
822,194
Loans held for investment
10,858
76,778
820
77,598
19,540
14,027
20,845
27,106
13
The following tables include a rollforward for those material financial instruments measured at fair value using Level 3 inputs (in thousands).
Total Gains or Losses
(Realized or Unrealized)
Balance,
Transfers
Included in Other
Beginning of
Purchases/
Sales/
to (from)
Included in
Period
Additions
Reductions
Net Income
Income (Loss)
End of Period
Three Months Ended September 30, 2024
21,145
6,250
691
1,000
56,168
23,979
(30,740)
(1,103)
52,902
3,033
(10,193)
Equity investment
1,475
1,532
149,755
34,737
(9,073)
145,679
Nine Months Ended September 30, 2024
(4,702)
1,942
1,178
70,086
(47,925)
(11,893)
(11,352)
494
(2,598)
1,778
(45,129)
(14,913)
190,334
86,933
(111,706)
(21,060)
11,696
304
12,000
41,292
17,219
(9,171)
(13,142)
36,198
9,714
285
9,999
95,101
3,759
6,091
104,951
146,107
32,674
(6,462)
163,148
40,707
54,727
(39,900)
(18,890)
9,181
818
100,825
(19,055)
(678)
150,713
90,282
(58,955)
(18,446)
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 September 30, 2024.
For material Level 3 financial instruments measured at fair value on a recurring basis at September 30, 2024 and December 31, 2023, the significant unobservable inputs used in the fair value measurements were as follows.
Range (Weighted-Average)
Financial Instrument
Valuation Technique
Unobservable Inputs
22,789
Discounted cash flow
Discount rate
12.50
-
13.25
%
14.25
15.50
6,297
Recent transaction
Market comparable
Projected price
78
94
(
93
%)
90
10.00
15.00
Constant prepayment rate
9.74
8.65
16.55
11.67
21,072
Market multiple
10.4x
The fair value of certain available for sale securities, and loans held for investment prior to the sale of such instrument during the second quarter of 2024, held by the Company’s merchant bank subsidiary are measured, under the provisions of the Fair Value Option, using the income approach with Level 3 inputs. The fair value of such financial instruments are based upon estimates of expected cash flows using unobservable inputs, including credit spreads derived from comparable securities and benchmark credit curves, and management’s knowledge of underlying collateral.
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 fair value of certain derivatives held by the Company’s merchant bank subsidiary were measured using Level 3 inputs based upon estimates of expected cash flows using unobservable inputs, including management’s knowledge of underlying collateral prior to the sale of such instruments during the second quarter of 2024.
The MSR asset is reported at fair value, under the provisions of the Fair Value Option, 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 7 to the consolidated financial statements.
The Company has elected to measure certain equity investments held by the Company’s merchant bank subsidiary under the provisions of the Fair Value Option using Level 3 inputs to mitigate volatility in reported earnings changes in fair value and better align with merchant bank investment strategy. Changes in fair value are reported within other noninterest income in the accompanying consolidated statements of operations.
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.
The following table presents those changes in fair value of material instruments recognized in the consolidated statements of operations that are accounted for under the Fair Value Option (in thousands).
Net
Gains
Noninterest
Changes in
(Losses)
Income
(4,666)
(3,330)
(7,789)
(5,563)
Financial Assets and Liabilities Not Measured at Fair Value on Recurring or Non-Recurring Basis
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 3 to the consolidated financial statements included in the Company’s 2023 Form 10-K.
15
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
1,965,277
Held to maturity securities
690,846
138,580
119,914
19,413
139,327
340,644
7,727,873
8,068,517
71,742
Financial liabilities:
10,788,548
Debt
335,970
21,059
1,859,350
731,858
121,652
99,358
22,882
122,240
7,957,474
344,172
7,696,393
8,040,565
74,613
11,045,957
319,505
24,280
The Company held equity investments other than securities of $34.7 million and $59.2 million at September 30, 2024 and December 31, 2023, respectively, which are included within other assets in the consolidated balance sheets. Of the $34.7 million of such equity investments held at September 30, 2024, $2.8 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
6,549
22,654
6,608
27,264
Additional investments
374
Upward adjustments
186
611
Impairments and downward adjustments
(1,433)
(21)
(1,492)
(5,056)
Dispositions
(2,324)
Balance, end of period
2,792
23,193
4. Securities
The fair value of trading securities is summarized as follows (in thousands).
U.S. Treasury securities
127
3,736
U.S. government agencies:
Bonds
9,141
12,867
Residential mortgage-backed securities
127,499
124,768
Collateralized mortgage obligations
55,061
86,281
23,381
13,079
Corporate debt securities
41,867
37,569
States and political subdivisions
260,323
180,890
Private-label securitized product
13,130
47,768
10,307
9,033
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 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 $47.8 million and $34.9 million at September 30, 2024 and December 31, 2023, 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
Losses
4,990
4,762
115,645
381
(343)
115,683
358,539
449
(29,321)
329,667
Commercial mortgage-backed securities
204,089
744
(6,673)
198,160
741,458
606
(46,066)
695,998
29,408
215
(537)
34,941
40
(2,637)
32,344
1,489,070
2,435
(85,805)
17
4,985
(368)
4,617
166,617
360
(811)
166,166
389,160
25
(39,315)
349,870
200,236
468
(8,958)
191,746
797,876
291
(61,686)
736,481
25,919
(1,501)
36,954
39
(2,696)
34,297
1,621,747
1,183
(115,335)
Held to Maturity
261,526
(20,625)
240,901
152,657
(7,777)
144,880
263,546
(30,857)
232,689
77,095
107
(4,826)
72,376
(64,085)
278,172
(25,765)
252,407
172,879
(12,670)
160,209
284,208
(37,189)
247,019
77,418
149
(5,344)
72,223
(80,968)
Additionally, the Company had unrealized net gains of $0.2 million and $0.3 million at September 30, 2024 and December 31, 2023, respectively, from equity securities with fair values of $0.3 million and $0.3 million held at September 30, 2024 and December 31, 2023, respectively. The Company recognized nominal net gains during the three months ended September 30, 2024 and 2023, respectively, and recognized nominal net losses and net gains of $0.1 million during the nine months ended September 30, 2024 and 2023, respectively, due to changes in the fair value of equity securities still held at the balance sheet date. During the three and nine months ended September 30, 2024 and 2023, net gains and losses recognized from equity securities sold were nominal.
18
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
U.S. treasury securities:
Unrealized loss for less than twelve months
Unrealized loss for twelve months or longer
368
Bonds:
28,988
103
77,173
343
20
112,502
708
24
141,490
811
Residential mortgage-backed securities:
7,804
448
8,989
305,146
28,873
109
338,769
38,699
312,950
29,321
123
347,758
39,315
Commercial mortgage-backed securities:
10,413
282
196,733
6,673
162,470
8,676
172,883
8,958
Collateralized mortgage obligations:
810
11,560
22
134
662,145
46,064
138
709,571
61,665
135
662,955
46,066
140
721,131
61,687
Corporate debt securities:
8,618
537
13,483
1,501
States and political subdivisions:
7,023
55
52
25,648
2,637
50
20,857
2,640
60
27,880
2,695
Total available for sale:
17,232
987
34
80,456
2,579
329
1,271,607
84,818
336
1,348,786
112,756
344
1,288,839
85,805
370
1,429,242
115,335
45
20,625
44
25,765
27
7,777
31
160,208
12,670
54
232,688
30,857
37,189
6,223
56
15,506
479
158
58,520
4,770
45,208
4,865
169
64,743
4,826
167
60,714
5,344
Total held to maturity:
284
676,989
64,029
257
730,607
80,489
295
683,212
64,085
296
746,113
80,968
19
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 September 30, 2024 are shown by contractual maturity below (in thousands).
Due in one year or less
21,587
21,579
Due after one year through five years
63,709
63,311
3,823
3,693
Due after five years through ten years
54,250
53,730
49,427
47,044
Due after ten years
45,438
43,255
23,845
21,639
184,984
181,875
The Company recognized net gains of $7.4 million and $9.4 million from its trading portfolio during the three months ended September 30, 2024 and 2023, respectively, and net gains of $27.4 million and $39.0 million during the nine months ended September 30, 2024 and 2023, respectively. In addition, the Hilltop Broker-Dealers realized net gains from structured product trading activities of $14.6 million and $8.2 million during the three months ended September 30, 2024 and 2023, respectively, and net gains from structured product trading activities of $55.4 million and $52.8 million during the nine months ended September 30, 2024 and 2023, respectively. The Company had no other realized gains and losses on securities during the three and nine months ended September 30, 2024 and nominal other realized losses on securities during the three and nine months ended September 30, 2023, 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 $590.5 million and $537.2 million (with a fair value of $556.1 million and $503.1 million, respectively) at September 30, 2024 and December 31, 2023, 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 September 30, 2024 and December 31, 2023.
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 agencies, and conditionally guaranteed by the full faith and credit of the United States.
5. 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 real estate (including construction and land development), wholesale/retail trade, agribusiness and energy. 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:
Non-owner occupied
1,874,641
1,889,882
Owner occupied
1,427,628
1,422,234
Commercial and industrial
1,662,225
1,607,833
Construction and land development
870,764
1,031,095
1-4 family residential
1,774,891
1,757,178
Consumer
28,837
27,351
Broker-dealer (1)
Total loans held for investment, net of allowance
Past Due Loans and Nonaccrual Loans
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
236
3,483
795
4,514
1,870,127
1,427,619
4,108
8,901
30,029
43,038
1,619,187
10,092
2,225
877
13,194
857,570
3,275
1,495
2,382
7,152
1,767,739
110
116
28,721
Broker-dealer
17,821
16,110
34,092
68,023
7,911,607
6,125
799
6,924
1,882,958
6,823
386
3,897
11,106
1,411,128
3,348
1,496
2,074
6,918
1,600,915
767
1,554
276
2,597
1,028,498
8,625
1,292
3,203
13,120
1,744,058
28
37
27,314
25,716
4,732
10,254
40,702
8,039,043
In addition to the loans shown in the tables above, PrimeLending had $140.8 million and $115.1 million of loans included in loans held for sale (with an aggregate unpaid principal balance of $141.6 million and $115.7 million, respectively) that were 90 days past due and accruing interest at September 30, 2024 and December 31, 2023, respectively. These loans are guaranteed by U.S. government agencies and include loans that are subject to repurchase, or have been repurchased, by PrimeLending.
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
412
7,630
8,042
33,728
2,712
36,440
155
83
1,666
264
87
2,323
2,410
4,630
5,098
82
141
845
465
32,493
34,436
66,929
5,216
4,286
9,502
1,056
1,564
1,619
1,833
1,607
2,484
533
2,749
3,282
(13)
49
478
7,398
7,876
726
9,283
10,009
256
432
1,328
1,267
34,347
53,394
87,741
44,839
19,498
64,337
1,536
2,229
5,507
3,874
At September 30, 2024 and December 31, 2023, $3.4 million and $4.0 million, respectively, of real estate loans secured by residential properties and classified as held for sale were in non-accrual status.
As shown in the table above, loans accounted for on a non-accrual basis increased from December 31, 2023 to September 30, 2024 by $23.4 million. The change in non-accrual loans was primarily due to increases in commercial and industrial loans of $57.4 million, partially offset by decreases in commercial real estate non-owner occupied loans of $28.4 million, commercial real estate owner occupied loans of $2.7 million and 1-4 family residential loans of $2.1 million. The increase in commercial and industrial loans in non-accrual status since December 31, 2023 was primarily due to the addition of loans with an aggregate loan balance of $64.5 million, partially offset by principal payoffs. Of the $57.4 million increase in commercial and industrial loans in non-accrual status, $54.0 million was due to the addition of two credit relationships from the auto note financing industry subsector. The decrease in commercial real estate non-owner occupied loans in non-accrual status since December 31, 2023 was primarily due to the reclassification of a single non-accrual loan from loans held for investment during the first quarter of 2024. This loan was subsequently sold in the second quarter of 2024. The decrease in commercial real estate owner occupied loans in non-accrual status was primarily due to the payoff of a single relationship with a loan balance of $3.9 million since December 31, 2023. The decrease in 1-4 family residential loans in non-accrual status since December 31, 2023 was primarily due to principal payoffs.
For non-accrual loans that are considered to be collateral-dependent, the Company has implemented the practical expedient to measure the allowance using the fair value of the collateral. For non-accrual loans that are not collateral dependent, the Company measures the allowance based on discounted expected cash flows.
Loan Modifications
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 following table presents the amortized cost basis of the loans held for investment modified for borrowers experiencing financial difficulty grouped by portfolio segment and type of modification granted during the periods presented (in thousands).
Combination
Modifications as a
Interest Rate
Term
Principal
Payment
Term Extension and
% of Portfolio
Reduction
Extension
Forgiveness
Delay
Rate Reduction
Segment
1,448
0.1
332
34,030
2.0
142
35,952
0.5
500
43,819
469
2.7
170
45,937
0.6
Payment Delay
382
11,440
0.7
11,834
34,784
1.9
2,205
0.2
15,057
2,868
1.1
286
52,332
As shown in the tables above, loans modified for borrowers experiencing financial difficulty during the three and nine months ended September 30, 2024 included a term extension modification for a single loan of $25 million in the auto note financing subsector within the commercial and industrial loan portfolio.
For those loans held for investment modified for borrowers experiencing financial difficulty during the last twelve months, the following table provides aging and non-accrual details grouped by portfolio segment (in thousands).
Modified Loans Past Due
Total Modified
Modified
Past Due Loans
372
111
775
33,605
34,116
The following tables present the financial effects of the loans held for investment modified for borrowers experiencing financial difficulty during the periods presented (in thousands).
Weighted-Average
Term Extension
(in months)
26
35
Credit Risk Profile
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 5 to the consolidated financial statements in the Company’s 2023 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
2019 and
Converted to
2022
2021
2020
Prior
Revolving
Term Loans
Commercial real estate: non-owner occupied
Internal Grade 1-3 (Pass low risk)
5,063
4,968
45,238
83,544
2,764
4,434
146,011
Internal Grade 4-7 (Pass normal risk)
173,720
105,605
237,394
261,324
93,358
84,684
5,405
16,523
978,013
Internal Grade 8-11 (Pass high risk and watch)
59,430
119,065
189,049
77,901
115,557
55,670
36,718
1,241
654,631
Internal Grade 12 (Special mention)
4,384
5,211
36,458
46,053
Internal Grade 13 (Substandard accrual)
3,330
4,530
7,585
23,698
993
1,657
41,891
Internal Grade 14 (Substandard non-accrual)
3,784
1,361
1,228
1,297
Current period gross charge-offs
1,647
Commercial real estate: owner occupied
14,479
48,275
12,584
13,889
37,182
43,027
7,226
12,735
189,397
81,510
111,922
134,368
213,090
57,241
185,094
15,915
9,139
808,279
32,636
43,824
116,225
57,707
78,557
48,715
4,418
509
382,591
353
440
1,191
99
2,083
2,063
4,199
8,619
7,487
4,970
15,530
42,868
602
619
26,114
12,011
11,891
50,400
3,426
208
24,563
128,613
63,665
28,951
55,852
26,620
19,018
26,279
339,359
2,608
562,352
115,792
66,415
57,699
82,790
15,758
7,254
220,097
3,462
569,267
758
827
268
1,193
3,046
5,549
3,146
3,385
3,242
1,251
714
5,262
5,799
28,348
10,422
8,029
7,912
1,991
311
171
2,399
35,694
623
383
749
312
1,487
1,095
2,611
7,370
4,961
2,790
864
204
8,819
129,816
147,471
133,448
50,029
5,899
2,727
5,681
475,071
167,470
130,653
32,683
6,409
2,821
2,404
3,536
345,976
272
12,758
1,923
156
105
14,942
1,138
1,264
Construction and land development - individuals
FICO less than 620
FICO between 620 and 720
4,473
836
5,309
FICO greater than 720
10,072
7,535
118
48
17,773
Substandard non-accrual
Other (1)
305
628
1,147
467
734
21,583
25,072
15,080
20,856
17,912
9,187
4,165
26,764
1,512
1,102
96,578
88,185
132,526
501,830
677,934
80,890
73,566
2,997
654
1,558,582
1,103
6,745
39,253
14,523
5,219
1,344
4,515
1,573
20,356
86,783
642
230
253
377
1,582
1,639
812
231
1,958
32
7,438
2,275
1,522
547
185
2,692
11,248
6,313
1,211
644
8,569
79
211
Total loans with credit quality measures
1,082,335
1,028,497
1,588,918
1,657,863
533,068
651,316
683,361
109,958
7,335,316
Commercial and industrial (mortgage warehouse lending)
303,670
Broker-dealer (margin loans and correspondent receivables)
Total loans held for investment
(1) Loans classified in this category were assigned a FICO score for credit modeling purposes.
6. 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 September 30, 2024. In addition, as of September 30, 2024, 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.
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 the Company’s existing portfolio. Management’s methodology for determining the allowance for credit losses uses 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 September 30, 2024. While the Company believes it has an appropriate allowance for the existing loan portfolio at September 30, 2024, 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 changes in macroeconomic forecasts and loan cash flow assumptions. 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 2023 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 the Company’s best estimate of expected credit losses as of September 30, 2024, the Company utilized a single macroeconomic alternative scenario, or S5, published by Moody’s Analytics in September 2024 that was updated to reflect the U.S. economic outlook. During our previous macroeconomic assessment as of December 31, 2023, we utilized a single macroeconomic alternative scenario, or S7, published by Moody’s Analytics in December 2023. The S5 alternative economic scenario expects the economy to underperform in the long-term. In this alternative scenario, elevated borrowing costs reduce credit-sensitive spending, upcoming fiscal disputes in Congress weaken business and consumer sentiment, and concerns grow about broader international conflicts. Significant variables that impact the modeled losses across the Company’s 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.
During the three months ended September 30, 2023, the slight reversal of credit losses reflected improvements to the U.S. economic outlook and decreases in specific reserves of $0.7 million within our broker dealer segment, offset by increases in specific reserves and net portfolio changes within the banking segment. The increase in the provision for credit losses during the nine months ended September 30, 2023 reflected a significant build in the allowance related to loan portfolio changes since December 31, 2022 and a deteriorating outlook for commercial real estate markets. Specific to the Bank, the net impact to the allowance of changes associated with collectively evaluated loans during the three and nine months ended September 30, 2023 included a reversal of credit losses of $0.3 million, compared to a provision for credit losses of $14.2 million, respectively, on collectively evaluated loans, while the net impact to the allowance of changes associated with individually evaluated loans during the three and nine months ended September 30, 2023 included a provision for credit losses of $0.9 million and $3.0 million, respectively. The changes in the allowance for credit losses during the noted periods were primarily attributable to the Bank and also reflected other factors including, but not limited to, loan mix, and changes in loan balances and qualitative factors from the prior quarter. The changes in the allowance during the three and nine months ended September 30, 2023 were also impacted by net recoveries of $1.6 million and net charge-offs of $1.7 million, respectively.
During the three months ended September 30, 2024, the reversal of credit losses was primarily driven by net charge-offs and loan portfolio changes, including a change in the macroeconomic outlook scenario utilized, associated with collectively evaluated loans, partially offset by a build in the allowance related to specific reserves within the banking segment since the prior quarter. The provision for credit losses during the nine months ended September 30, 2024 reflected a build in the allowance related to specific reserves and loan portfolio changes within the banking segment since the prior period, partially offset by the change in the macroeconomic outlook scenario utilized. Specific to the Bank, the net impact to the allowance of changes associated with individually evaluated loans during the three and nine months ended September 30, 2024 included a provision for credit losses of $1.2 million and $13.3 million, respectively, while the net impact to the allowance of changes associated with collectively evaluated loans during the three and nine months ended September 30, 2024 included a reversal of credit losses of $2.5 million and $6.5 million, respectively. The changes in the allowance for credit losses during the noted periods were primarily attributable to the Bank and also reflected other factors including, but not limited to, loan mix, and changes in loan balances and qualitative factors from the prior quarter. The changes in the allowance during the three and nine months ended September 30, 2024 were also impacted by net charge-offs of $2.9 million and $7.3 million, respectively.
Changes in the allowance for credit losses for loans held for investment, distributed by portfolio segment, are shown below (in thousands).
Provision for
Recoveries on
(Reversal of)
Charged Off
End of
Credit Losses
37,321
(4,991)
32,330
32,772
1,593
34,378
28,869
(3,772)
888
28,308
7,594
330
7,924
(756)
7,161
61
(65)
580
67
237
115,082
(3,837)
943
110,918
40,061
(6,084)
(1,647)
28,114
6,236
20,926
13,070
(7,370)
1,682
12,102
(4,180)
9,461
(2,408)
648
(211)
101
136
111,413
(9,229)
1,941
43,582
(3,116)
(34)
40,433
1,549
29,438
17,315
838
(936)
2,505
19,722
7,395
1,575
8,970
11,618
(179)
33
11,472
615
(152)
130
601
901
(715)
109,306
(1,122)
2,678
110,822
39,247
1,210
6,376
(977)
16,035
4,417
(4,015)
3,285
6,051
2,919
9,313
2,147
(73)
85
554
106
(274)
234
(48)
95,442
(5,373)
3,626
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).
8,585
7,992
8,876
7,784
Other noninterest expense
(153)
559
(444)
8,432
The increases in the reserve for unfunded commitments during the three and nine months ended September 30, 2023 were primarily due to increases in expected loss rates. During the three and nine months ended September 30, 2024, the decreases in the reserve for unfunded commitments were primarily due to decreases in commitment balances.
7. 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)
(9,541)
7,373
(11,549)
2,834
Due to customer payoffs
(652)
(1,282)
(3,364)
(3,512)
Mortgage loans serviced for others (2)
2,547,659
5,227,404
MSR asset as a percentage of serviced mortgage loans
1.80
1.85
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)
7.6
8.2
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
(1,677)
(3,511)
Impact of 20% adverse change
(3,252)
(6,796)
Discount rate:
(2,466)
(4,474)
(4,668)
(8,537)
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 $4.2 million and $8.5 million during the three months ended September 30, 2024 and 2023, respectively, and $20.9 million and $24.2 million during the nine months ended September 30, 2024 and 2023, respectively, were included in net gains from sale of loans and other mortgage production income within the consolidated statements of operations.
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8. Deposits
Deposits are summarized as follows (in thousands).
Noninterest-bearing demand
Interest-bearing:
Demand accounts
4,011,842
4,496,682
Brokered - demand
4,722
156,692
Money market
2,437,731
1,869,809
Brokered - money market
8,828
Savings
224,633
259,745
Time
1,270,567
1,221,935
Brokered - time
42,400
At September 30, 2024, remaining maturities of estimated uninsured time deposits greater than $250,000 were $610.7 million.
9. Short-term Borrowings
Short-term borrowings are summarized as follows (in thousands).
Federal funds purchased
495,258
459,658
Securities sold under agreements to repurchase
198,804
240,050
Federal Home Loan Bank
Short-term bank loans
Commercial paper
220,583
200,330
Federal Funds Purchased and Securities Sold under Agreements to Repurchase
Federal funds purchased and securities sold under agreements to repurchase generally mature one to ninety days from the transaction date, 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.
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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
722,752
797,489
Average interest rate during the period
5.50
5.40
Average interest rate at end of period
5.21
5.60
Securities underlying the agreements at end of period:
Carrying value
198,619
239,103
Estimated fair value
218,915
262,408
Federal Home Loan Bank (“FHLB”)
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 table (dollars in thousands).
180,861
5.73
5.08
Short-Term Bank Loans
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. At September 30, 2024 there were no outstanding short-term bank loans.
Commercial Paper
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 September 30, 2024, the weighted average maturity of the CP Notes was 155 days at a rate of 5.80%, with a weighted average remaining life of 71 days. At September 30, 2024, the aggregate amount outstanding under these secured arrangements was $220.6 million, which was collateralized by securities held for Hilltop Securities accounts valued at $241.1 million.
10. Notes Payable
Notes payable consisted of the following (in thousands).
Senior Notes due April 2025, net of discount of $347 and $502, respectively
149,653
149,498
Subordinated Notes due May 2030, net of discount of $432 and $511, respectively
49,568
49,489
Subordinated Notes due May 2035, net of discount of $1,688 and $1,842, respectively
148,312
148,158
11. Leases
Supplemental balance sheet information related to finance leases is as follows (in thousands).
Finance leases:
Premises and equipment
4,780
7,780
Accumulated depreciation
(3,959)
(6,537)
821
1,243
The components of lease costs, including short-term lease costs, are as follows (in thousands).
Operating lease cost
8,231
8,488
25,214
26,231
Less operating lease and sublease income
(454)
(655)
(1,805)
(1,965)
Net operating lease cost
7,833
23,409
24,266
Finance lease cost:
Amortization of ROU assets
126
147
421
442
Interest on lease liabilities
104
271
324
Total finance lease cost
251
692
766
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
25,290
27,899
Operating cash flows from finance leases
275
326
Financing cash flows from finance leases
666
Right-of-use assets obtained in exchange for lease obligations:
Operating leases
22,723
11,396
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
5.69
5.3
4.59
Finance
2.9
5.09
3.3
4.98
Future minimum lease payments under lease agreements as of September 30, 2024, are presented below (in thousands).
Operating Leases
Finance Leases
7,670
222
2025
29,863
886
2026
24,105
813
2027
19,181
2028
14,716
Thereafter
33,835
Total minimum lease payments
129,370
2,518
Less amount representing interest
(18,571)
(639)
Lease liabilities
1,879
As of September 30, 2024, the Company had additional operating leases that have not yet commenced with aggregate future minimum lease payments of approximately $0.2 million. Certain of these operating leases commenced in October 2024 with an additional operating lease expected to commence in January 2025 with lease terms ranging from two to three years.
12. 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 were 22.5% and 25.2% for the three months ended September 30, 2024 and 2023, respectively, and 22.5% and 21.6% for the nine months ended September 30, 2024 and 2023, respectively. The effective tax rate during the three months ended September 30, 2023 was higher than the applicable statutory rate primarily due to the impact of non-deductible compensation expense and other permanent adjustments. During the nine months ended September 30, 2023, the effective tax rate differed from the applicable statutory rate primarily due to the impacts of excess tax benefits on share-based payment awards, investments in tax-exempt instruments and changes in accumulated tax reserves, partially offset by nondeductible expenses and the booking of additional taxes from a recent change in the source of funding for an acquired non-qualified, deferred compensation plan. During the three and nine months ended September 30, 2024, the effective tax rate was higher than the applicable statutory rate primarily due to the impact of nondeductible expenses, nondeductible compensation expense and other permanent adjustments, partially offset by the discrete impact of restricted stock vesting during the quarter and investments in tax-exempt instruments.
13. 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 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.
In September 2020, PrimeLending received an investigative inquiry from the United States Attorney for the Western District of Virginia regarding PrimeLending’s float down option. The United States Attorney issued grand jury subpoenas to PrimeLending and PlainsCapital Bank for additional materials regarding this matter. PrimeLending and PlainsCapital Bank are continuing to cooperate with requests for information with respect to this matter.
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 Inquiries, 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.
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 September 30, 2024 and December 31, 2023, the mortgage origination segment’s indemnification liability reserve totaled $8.5 million and $11.7 million, respectively. The provision for indemnification losses was $0.9 million and $0.5 million during the three months ended September 30, 2024 and 2023, respectively, and $2.0 million and $1.3 million during the nine months ended September 30, 2024 and 2023, 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
22,990
27,567
26,909
31,244
Claims made
10,773
6,572
27,925
37,582
Claims resolved with no payment
(2,871)
(1,633)
(10,330)
(11,418)
Repurchases
(6,430)
(4,430)
(18,747)
(25,430)
Indemnification payments
(1,434)
(386)
(2,729)
(4,288)
23,028
27,690
Indemnification Liability Reserve Activity
9,095
15,058
11,691
20,528
Additions for new sales
856
480
1,966
1,317
(1,308)
(1,896)
(4,391)
(7,781)
Early payment defaults
(74)
(565)
(295)
(59)
(27)
(191)
(219)
8,510
13,550
Reserve for Indemnification Liability:
Specific claims
1,083
951
Incurred but not reported claims
7,427
10,740
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.
14. 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 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 September 30, 2024 and outstanding financial and performance standby letters of credit of $69.7 million at September 30, 2024.
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.
15. Stock-Based Compensation
During the nine months ended September 30, 2024 and 2023, Hilltop granted 11,779 and 14,440 shares of common stock, respectively, pursuant to the Hilltop Holdings Inc. 2020 Equity Incentive Plan (the “2020 Equity Plan”) to certain non-employee members of the Company’s board of directors for services rendered to the Company.
36
Restricted Stock Units
The following table summarizes information about stock-based incentive awards issued pursuant to the 2020 Equity Plan and nonvested restricted stock unit (“RSU”) activity for the nine months ended September 30, 2024 (shares in thousands).
RSUs
Weighted
Average
Grant Date
Outstanding
1,252
34.10
Granted
556
30.62
Vested/Released
(526)
33.02
Forfeited
(19)
32.86
1,263
33.04
Vested/Released RSUs include an aggregate of 90,923 shares withheld to satisfy employee statutory tax obligations during the nine months ended September 30, 2024.
During the nine months ended September 30, 2024, the Compensation Committee of the board of directors of the Company awarded certain executives and key employees an aggregate of 458,676 RSUs pursuant to the 2020 Equity Plan. Of the RSUs granted during the nine months ended September 30, 2024, 347,946 that were outstanding at September 30, 2024, are subject to time-based vesting conditions and generally cliff vest on the third anniversary of the grant date. Of the RSUs granted during the nine months ended September 30, 2024, 103,995 that were outstanding at September 30, 2024, provide for cliff vesting based upon the achievement of certain performance goals over a three-year period.
At September 30, 2024, in the aggregate, 934,915 of the outstanding RSUs are subject to time-based vesting conditions and generally cliff vest on the third anniversary of the grant date, and 327,626 outstanding RSUs cliff vest based upon the achievement of certain performance goals over a three-year period. At September 30, 2024, unrecognized compensation expense related to outstanding RSUs of $17.6 million is expected to be recognized over a weighted average period of 1.39 years.
16. 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 the 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 September 30, 2024 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 through December 31, 2024.
Minimum
Requirements
Including
Conservation
To Be Well
Buffer
Capitalized
Ratio
Tier 1 capital (to average assets):
PlainsCapital
1,312,378
10.34
1,407,660
10.55
4.0
5.0
2,004,620
12.95
1,974,918
12.23
N/A
Common equity Tier 1 capital (to risk-weighted assets):
14.94
15.44
7.0
6.5
20.48
19.32
Tier 1 capital (to risk-weighted assets):
8.5
8.0
Total capital (to risk-weighted assets):
1,416,982
16.13
1,511,239
16.58
10.5
10.0
2,318,545
23.68
2,284,357
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 $1,000,000 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 September 30, 2024, the net capital position of each of the Hilltop Broker-Dealers was as follows (in thousands).
Momentum
Independent
Network
Net capital
227,445
3,641
Less: required net capital
319
Excess net capital
220,450
3,322
Net capital as a percentage of aggregate debit items
65.0
Net capital in excess of 5% aggregate debit items
209,957
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 September 30, 2024 and December 31, 2023, the Hilltop Broker-Dealers held cash of $55.6 million and $57.4 million,
38
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 September 30, 2024.
Mortgage Origination
As a mortgage originator, PrimeLending and its subsidiaries are subject to minimum capital, net worth and liquidity requirements established by the Department of Housing and Urban Development (“HUD”) and GNMA, as applicable. On an annual basis, PrimeLending and its subsidiaries submit audited financial statements to HUD and GNMA documenting their respective compliance with minimum capital, net worth and liquidity requirements, including timely reporting if a quarter’s operating loss exceeds more than 20% of its previous quarter or year-end net worth (the “operating loss ratio”) and/or if a quarter’s capital ratio is below 6% (the “GNMA capital ratio”). If this occurs, certain additional financial reporting submissions are required. During the third quarter of 2024, PrimeLending received a $10 million capital infusion from its parent company, PlainsCapital Bank, in September 2024 and reported a HUD operating gain. As of September 30, 2024, PrimeLending exceeded the GNMA minimum capital ratio requirement of 6% with a ratio of 6.38%. This trend has been reported to GNMA. As of September 30, 2024, PrimeLending and its subsidiaries’ net worth and liquidity exceeded the amounts required by both HUD and GNMA, as applicable.
17. Stockholders’ Equity
Dividends
During the nine months ended September 30, 2024 and 2023, the Company declared and paid cash dividends of $0.51 and $0.48 per common share, or an aggregate of $33.2 million and $31.2 million, respectively.
On October 24, 2024, Hilltop’s board of directors declared a quarterly cash dividend of $0.17 per common share, payable on November 22, 2024, to all common stockholders of record as of the close of business on November 8, 2024.
Stock Repurchases
In January 2024, the Hilltop board of directors authorized a new stock repurchase program through January 2025, pursuant to which the Company is authorized to repurchase, in the aggregate, up to $75.0 million of the Company’s outstanding common stock, inclusive of repurchases to offset dilution related to grants of stock-based compensation. During the nine months ended September 30, 2024, Hilltop paid $19.9 million to repurchase an aggregate of 640,042 shares of the Company’s common stock at an average price of $31.04 per share pursuant to the stock repurchase program.
The Company’s stock repurchase program, prior year repurchases, and related accounting policy are discussed in detail in Note 1 and Note 22 to the consolidated financial statements included in the Company’s 2023 Form 10-K.
18. 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 futures contracts. Additionally, PrimeLending has interest rate risk relative to its MSR asset and uses derivative instruments, including 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, futures contracts, credit default swaps and municipal market data 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 3 to the consolidated financial statements, the Company has elected to measure substantially all mortgage loans held for sale at fair value under the provisions of the Fair Value Option. The election provides the opportunity to mitigate volatility in reported earnings caused by measuring related assets and liabilities differently without applying 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 7 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
(29)
(946)
11,177
5,840
Hilltop Broker-Dealers
10,570
13,214
5,949
(4,016)
Bank
76
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 portfolio layer, 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 cash flow 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 derivatives designated as hedges of cash flows are included as a component of accumulated other comprehensive income
or loss on the Company’s consolidated balance sheets, and changes in the fair value of the derivatives designated as hedges of fair value are included in current earnings. 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
625,180
8,321
383,767
7,734
Commitments to purchase MBSs
2,486,073
15,563
1,470,142
15,666
Commitments to sell MBSs
2,874,891
102
2,222,225
(17,870)
Interest rate swaps
44,770
(2,607)
33,500
(5,349)
Interest rate swaps back-to-back (asset) (1)
10,247
192
1,421
176
Interest rate swaps back-to-back (liability) (1)
(201)
U.S. Treasury bond futures and options (2)
80,600
306,200
430
Interest rate and other futures (2)
199,900
224,800
Credit default swaps
15,000
Warrants
866
Derivative instruments (designated as hedges):
Interest rate swaps designated as cash flow hedges
335,000
7,039
410,000
14,277
Interest rate swaps designated as fair value hedges (3)
361,153
26,466
325,193
34,799
The Bank and PrimeLending held aggregate cash collateral advances of $35.3 million and $51.8 million to offset net asset derivative positions on its commitments to sell MBSs and derivative instruments designated as hedges at September 30, 2024 and December 31, 2023, respectively. PrimeLending had advanced cash collateral totaling $2.8 million and $14.7 million to offset net liability positions on its commitments to sell MBSs at September 30, 2024 and December 31, 2023, respectively. In addition, PrimeLending and the Hilltop Broker-Dealers had advanced cash collateral totaling $4.3 million and $7.6 million on various derivative instruments at September 30, 2024 and December 31, 2023, respectively. These cash collateral amounts are included in either other assets or other liabilities within the consolidated balance sheets.
Derivatives on Behalf of Customers
The Bank offers derivative contracts to certain customers in connection with their risk management needs. These derivatives include back-to-back interest rate swaps. The Bank manages the risk associated with these contracts by entering into an equal and offsetting derivative with a third-party dealer bank. These derivatives generally work together as an economic interest rate hedge, but the Bank does not designate them for hedge accounting treatment. Consequently, changes in fair value of the corresponding derivative financial asset or liability were recorded as either a charge or credit to current earnings during the period in which the changes in fair value occurred, typically resulting in no net earnings impact.
41
19. 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 Company’s accounting policy is to present required disclosures related to collateral and derivative positions on a gross basis.
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
1,077,956
(1,023,786)
54,170
Interest rate swaps:
34,195
(34,195)
Reverse repurchase agreements:
(81,340)
426
Forward MBS derivatives:
19,156
(845)
18,311
1,213,073
(1,105,971)
72,907
1,406,937
(1,332,856)
74,081
49,253
(49,253)
(80,011)
16,755
(194)
16,561
Treasury futures and options derivatives:
1,553,386
(1,413,061)
91,072
42
of Liabilities
Liabilities
Securities loaned:
1,066,651
(1,010,533)
56,118
3,306
Repurchase agreements:
(198,619)
3,490
(264)
2,381
1,272,066
(1,209,997)
61,805
1,371,896
(1,296,828)
75,068
5,349
(239,103)
18,958
(10,515)
8,249
1,635,306
(1,541,474)
83,317
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 September 30, 2024 and December 31, 2023.
Remaining Contractual Maturities
Overnight and
Greater Than
Continuous
Up to 30 Days
30-90 Days
90 Days
Repurchase agreement transactions:
U.S. Treasury and agency securities
33,886
Asset-backed securities
76,487
88,246
164,733
Securities lending transactions:
Corporate securities
1,066,591
1,177,024
1,265,270
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
8,389
81,419
149,295
230,714
1,371,844
1,461,704
1,610,999
20. 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
15,592
28,120
Trades in process of settlement
110,530
123,722
16,706
15,152
Payables:
Correspondents
26,152
33,286
Securities failed to receive
11,272
18,135
6,298
7,417
21. Segment and Related Information
The Company has two primary business units, PCC (banking and mortgage origination) and Securities Holdings (broker-dealer). Under GAAP, the Company’s 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.
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 reportable business segment revenues, operating results, goodwill and assets (in thousands).
Mortgage
All Other and
Origination
Corporate
Eliminations
Consolidated
Net interest income (expense)
93,536
12,409
(4,417)
(3,303)
6,818
(1,440)
Noninterest income
10,726
111,849
79,922
4,962
(7,016)
Noninterest expense
57,557
107,094
84,223
15,631
(193)
Income (loss) before taxes
48,145
16,994
(8,718)
(13,972)
277,600
36,896
(13,240)
(9,560)
20,618
6,657
31,884
308,480
239,489
16,747
(21,234)
171,527
302,102
250,067
47,731
(628)
131,300
43,138
(23,818)
(40,544)
99,047
12,215
(5,482)
(3,175)
13,045
675
11,668
106,488
88,747
3,159
(13,213)
56,887
97,865
91,505
13,937
(177)
53,153
21,553
(8,240)
(13,953)
304,804
39,279
(15,590)
(9,976)
37,105
17,175
34,046
297,164
247,655
8,944
(37,815)
170,450
283,063
278,918
45,750
(717)
151,225
53,428
(46,853)
(46,782)
247,368
7,008
13,071
13,112,176
2,607,105
1,057,679
2,616,401
(3,466,956)
13,288,627
2,929,296
1,181,316
2,543,057
(3,475,300)
22. 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:
Weighted average shares outstanding - basic
Basic earnings per common share:
Diluted earnings per share:
Effect of potentially dilutive securities
Weighted average shares outstanding - diluted
Diluted earnings per common share:
46
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.
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, information technology expenses, cybersecurity incidents, 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, expected future benchmark rates, anticipated investment yields, our expectations regarding accretion of discount on loans in future periods, the collectability of loans, 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, 2023 (“2023 Form 10-K”), which was filed with the Securities and Exchange Commission (“SEC”) on February 14, 2024, 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.
The following historical consolidated data for the periods indicated has been derived from our historical consolidated financial statements included elsewhere in this Quarterly Report (dollars and shares in thousands, except per share data).
Statement of Operations Data:
Per Share Data:
Diluted earnings per common share
Diluted weighted average shares outstanding
Cash dividends declared per common share
0.17
0.16
0.51
0.48
Dividend payout ratio (1)
37.17
28.12
42.71
38.54
Book value per common share (end of period)
33.51
31.91
Tangible book value per common share (2) (end of period)
29.29
27.67
Balance Sheet Data:
Capital Ratios:
Common equity to assets ratio
13.67
12.89
Tangible common equity to tangible assets (2)
12.16
11.41
(1) Dividend payout ratio is defined as cash dividends declared per common share divided by basic earnings per common share.
(2) For a reconciliation to the nearest GAAP measure, see “—Reconciliation and Management’s Explanation of Non-GAAP Financial Measures.”
Consolidated income before income taxes during the three and nine months ended September 30, 2024 included the following contributions from our reportable business segments.
During the nine months ended September 30, 2024, we declared and paid total common dividends of $33.2 million.
On October 24, 2024, our board of directors declared a quarterly cash dividend of $0.17 per common share, payable on November 22, 2024 to all common stockholders of record as of the close of business on November 8, 2024.
In January 2024, our board of directors authorized a new stock repurchase program through January 2025, 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. During the nine months ended September 30, 2024, we paid $19.9 million to repurchase an aggregate of 640,042 shares of our common stock at an average price of $31.04 per share pursuant to the stock repurchase program.
Reconciliation and Management’s Explanation of Non-GAAP Financial Measures
We present certain measures in our selected financial data that are not measures of financial performance recognized by accounting principles generally accepted in the United States (“GAAP”). “Tangible book value per common share” is defined as our total stockholders’ equity reduced by goodwill and other intangible assets, divided by total common shares outstanding. “Tangible common equity to tangible assets” is defined as our total stockholders’ equity reduced by goodwill and other intangible assets, divided by total assets reduced by goodwill and other intangible assets. These measures are important to investors interested in changes from period to period in tangible common equity per share exclusive of changes in intangible assets. For companies such as ours that have engaged in business combinations, purchase accounting can result in the recording of significant amounts of goodwill and other intangible assets related to those transactions. You should not view this disclosure as a substitute for results determined in accordance with GAAP, and our disclosure is not necessarily comparable to that of other companies that use non-GAAP measures. The following table reconciles these non-GAAP financial measures to the most comparable GAAP financial measures, “book value per common share” and “equity to total assets” (dollars in thousands, except per share data).
Book value per common share
Effect of goodwill and intangible assets per share
(4.22)
(4.24)
Tangible book value per common share
Hilltop stockholders’ equity
Less: goodwill and intangible assets, net
274,442
275,904
Tangible common equity
1,902,654
1,847,063
Tangible assets
15,651,963
16,191,092
Equity to assets
Tangible common equity to tangible assets
Recent Developments
Economic Environment
The extent of the impacts of uncertain economic conditions on our financial performance that began in 2022, and have continued into 2024, will depend in part on developments outside of our control including, among others, the timing and significance of further changes in U.S. Treasury yields and mortgage interest rates, changes in funding costs, inflationary pressures, and international armed conflicts and their impact on supply chains.
As discussed in more detail within “Item 7. Management’s Discussion and Analysis of Financial Condition and Results of Operations” of our 2023 Form 10-K, events in early 2023 relating to the failures of certain banking entities caused general uncertainty and concern regarding the liquidity adequacy of the banking sector as a whole. In light of these events, we have continued our efforts to monitor deposit flows and balance sheet trends to ensure that our liquidity needs and financial flexibility are maintained. During 2023, we increased interest-bearing deposit rates to address rising market interest rates and intense competition for liquidity to combat deposit outflows. Throughout 2023 and into the third quarter of 2024, we experienced net interest margin compression reflecting deposit repricing activity and demand deposit migration into interest-bearing accounts. Deposit costs remained elevated through the third quarter of 2024; however, the interest paid on our deposits increased at a slower pace during the second and third quarters of 2024 as we reduced higher cost brokered deposits and our interest-bearing deposits yield flattened and market expectations for a decrease in the Federal Reserve funds emerged. Additionally, at September 30, 2024, we continued to access core deposits from our Hilltop Securities Federal Deposit Insurance Corporation (“FDIC”) insured sweep program, while the Bank was not utilizing any of its Federal Home Loan Bank (“FHLB”) borrowing capacity.
Market conditions and external factors may unpredictably impact the competitive landscape for deposits such as those experienced during the first quarter of 2023. Additionally, throughout 2023 and into the third quarter of 2024, the market interest rate environment increased competition for liquidity and the premium at which liquidity was available to meet funding needs. While funding costs will continue to be influenced by various factors, including competitive pressures and broader economic conditions, with the recent 50-basis point decrease in the target range for the federal funds rate in September 2024 and the possibility of additional rate cuts in 2024, we anticipate that our cost of deposits will begin to trend modestly downward. An unexpected influx of withdrawals of deposits could adversely impact our ability to rely on organic deposits to primarily fund our operations, potentially requiring greater reliance on secondary sources of liquidity to meet withdrawals of deposits or to fund continuing operations. These sources may include proceeds from FHLB advances, sales of investment securities and loans, federal fund lines of credit with correspondent banks, securities sold under agreements to repurchase, brokered time deposits, borrowings from the Federal Reserve and borrowings under lines of credit with other financial institutions. Refer to the discussions in the “Segment Results – Banking Segment” and “Liquidity and Capital Resources – Banking Segment” sections that follow for more details regarding the Bank’s deposits, available liquidity and borrowing capacity at September 30, 2024.
We expect uncertainties discussed above, the impact of interest rate movements on the shape and inversions of the yield curve and challenge for deposits that persisted through 2023 and during the first three quarters of 2024, to continue during the remainder of 2024.
Asset Valuation
As discussed in more detail within “Item 7. Management’s Discussion and Analysis of Financial Condition and Results of Operations” of our 2023 Form 10-K, at each reporting date between annual impairment tests, we consider potential indicators of impairment including 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.
Given the potential impacts as a result of the operating performance of our reporting segments and overall economic conditions, actual results may differ materially from our current estimates as the scope of such impacts evolves or if the duration of business disruptions is longer than currently anticipated. We continue to monitor developments regarding overall economic conditions, market capitalization, and any other triggering events or circumstances that may indicate an impairment in the future. Specifically, the mortgage origination segment experienced operating losses during 2023, which have continued at a lesser extent into the first nine months of 2024 due to conditions and challenges discussed in detail within the discussion of segment results that follow.
51
To the extent future operating performance of our reporting segments remain challenged and below forecasted projections during 2024, significant assumptions such as expected future cash flows or the risk-adjusted discount rate used to estimate fair value are adversely impacted, or upon 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, an impairment charge may be 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.
Outlook
Our balance sheet, operating results and certain metrics during 2023 and the first nine months of 2024 reflected economic conditions that remain uncertain, and will depend in part on several developments outside of our control including, among others, the timing and significance of further changes in U.S. Treasury yields and mortgage interest rates, and a volatile economic forecast. As noted within our 2023 Form 10-K, these conditions, coupled with exposure to changes in funding costs, inflationary pressures, and international armed conflicts and their impact on supply chains within our business segments during 2023 have had, and are expected to continue to have, an adverse impact on our operating results during 2024.
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 is 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.
Segment Information
The Company has two primary business units, PCC (banking and mortgage origination) and Securities Holdings (broker-dealer). Under GAAP, the Company’s 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 business segments is presented in Note 21, “Segment and Related Information”, in the notes to our consolidated financial statements.
The following table presents certain information about the results of our reportable business segments (in thousands). This table serves as a basis for the discussion and analysis in the segment operating results sections that follow.
Variance 2024 vs 2023
Percent
Net interest income (expense):
(5,511)
(27,204)
(9)
(2,383)
1,065
2,350
(128)
(4)
416
All Other and Eliminations (1)
(6,227)
(16,487)
(44)
Hilltop Consolidated
(10,607)
(43,308)
(12)
Provision for (reversal of) credit losses:
(2,115)
(313)
(10,518)
(61)
885
124
184
All Other and Eliminations
(1,230)
NM
(10,334)
(60)
(942)
(8)
(2,162)
5,361
11,316
(8,825)
(8,166)
(3)
1,803
57
7,803
6,197
16,581
3,594
25,372
670
1,077
9,229
19,039
(7,282)
(28,851)
1,694
1,981
(16)
89
4,295
(6,665)
Income (loss) before taxes:
(5,008)
(19,925)
(4,559)
(10,290)
(478)
23,035
(0)
6,238
(14)
(156)
71
(10,078)
(937)
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.
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 recoveries (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. 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. The change in reportable business segment net interest income during the nine months ended September 30, 2024, compared with the same period in 2023, primarily reflected decreases within our banking and broker-dealer segments, partially offset by a decrease in net interest expense within our mortgage origination segment.
The other component of our revenue is noninterest income, which is primarily comprised of the following:
In the aggregate, we experienced an increase in noninterest income during the nine months ended September 30, 2024, compared to the same period in 2023, as noted in the segment results table previously presented, primarily due to an increase in gains from investment and securities advisory fees and commissions within our broker-dealer segment, an increase in net gains from sale of loans within our mortgage loan origination segment and an increase in pre-tax gains associated with the sale of merchant bank equity investments within corporate, partially offset by decreases of mortgage loan origination fees and other mortgage production income 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 applicable to common stockholders during the three months ended September 30, 2024 was $29.7 million, or $0.46 per diluted share, compared with $37.0 million, or $0.57 per diluted share, during the three months ended September 30, 2023. Income applicable to common stockholders during the nine months ended September 30, 2024 was $77.7 million, or $1.19 per diluted share, compared to $81.0 million, or $1.25 per diluted share, during nine months ended September 30, 2023.
Hilltop’s financial results for the three months ended September 30, 2024, compared with the same period in 2023, included a decline in net interest income, partially offset by changes in the provision for credit losses within the banking segment, an increase in net revenues in the structured finance and fixed income services business lines, a decline in net revenues in the wealth management business line and higher noninterest expenses within the broker-dealer segment, while the mortgage origination segment had declines in both noninterest income and expense. During the nine months ended September 30, 2024, compared to the same period in 2023, Hilltop’s financial results included changes consistent with those noted above within our banking and mortgage origination segments, and within our broker-dealer segment an increase in net revenues in the structured finance business line, a decline in net revenues in the wealth management and fixed income services business lines and higher noninterest expenses within the broker-dealer segment.
Certain items included in net income for the three and nine months ended September 30, 2024 and 2023 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 September 30, 2024 and 2023 included net accretion on earning assets and liabilities of $0.7 million and $2.5 million, respectively, and amortization of identifiable intangibles of $0.4 million and $0.7 million, respectively, related to the Bank Transactions. During the nine months ended September 30, 2024 and 2023, income before income taxes included net accretion on earning assets and liabilities of $4.0 million and $7.6 million, respectively, and amortization of identifiable intangible of $1.5 million and $2.2 million, respectively, related to the Bank transactions.
The information shown in the table below includes certain key performance indicators on a consolidated basis.
Return on average stockholders' equity (1)
5.51
7.11
4.88
5.26
Return on average assets (2)
0.84
0.94
0.72
0.70
Net interest margin (3) (4)
2.84
3.02
3.11
Leverage ratio (5) (end of period)
11.92
Common equity Tier 1 risk-based capital ratio (6) (end of period)
18.60
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 Company performs periodic reviews of the classification and categorization of the components impacting the calculation of net interest margin. 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 September 30, 2024 and 2023, purchase accounting contributed 2 and 7 basis points, respectively, to our consolidated taxable equivalent net interest margin of 2.85% and 3.04%, respectively. During the nine months ended September 30, 2024 and 2023, purchase accounting contributed 4 and 7 basis points, respectively, to our consolidated taxable equivalent net interest margin of 2.86% and 3.12%, respectively. The purchase accounting
activity was primarily related to the accretion of discount of loans which totaled $0.7 million and $2.2 million during the three months ended September 30, 2024 and 2023, respectively, and $4.0 million and $7.4 million during the nine months ended September 30, 2024 and 2023, respectively, associated with the Bank Transactions.
The tables below provide additional details regarding our consolidated net interest income (dollars in thousands).
Annualized
Earned
Yield or
Balance
or Paid
Rate
Interest-earning assets
990,902
14,645
5.91
1,075,518
15,649
5.82
Loans held for investment, gross (1)
8,024,771
125,176
6.19
7,972,604
126,753
6.31
Investment securities - taxable
2,477,014
26,264
4.24
2,690,977
4.04
Investment securities - non-taxable (2)
323,479
3,020
3.73
315,294
3,069
3.89
Federal funds sold and securities purchased under agreements to resell
97,686
1,845
7.49
142,324
2,313
6.45
Interest-bearing deposits in other financial institutions
1,373,051
17,800
5.14
1,550,991
20,320
5.20
1,260,420
6.03
1,371,625
5.04
137,105
3,447
9.97
69,827
4,407
25.04
Interest-earning assets, gross (2)
14,684,428
211,623
5.72
15,189,160
217,360
5.68
(115,113)
(110,398)
Interest-earning assets, net
14,569,315
15,078,762
Noninterest-earning assets
1,070,833
1,448,834
15,640,148
16,527,596
Interest-bearing liabilities
Interest-bearing deposits
7,744,588
3.62
7,893,384
3.23
1,247,392
5.88
1,303,883
4.92
Notes payable and other borrowings
1,333,671
16,859
5.02
1,527,371
20,646
5.36
Total interest-bearing liabilities
10,325,651
4.07
10,724,638
3.74
Noninterest-bearing liabilities
Noninterest-bearing deposits
2,737,942
3,347,752
405,768
362,133
13,469,361
14,434,523
Stockholders’ equity
2,143,252
2,066,564
Noncontrolling interest
27,535
26,509
Net interest income (2)
105,624
116,255
Net interest spread (2)
1.65
1.94
Net interest margin (2)
2.85
3.04
909,446
39,795
5.83
979,099
40,497
7,918,156
372,984
6.30
7,967,075
363,682
6.17
2,569,408
2,759,436
3.84
312,617
8,972
3.83
380,269
10,306
3.61
99,100
5,436
7.33
142,970
6,872
6.43
1,356,604
52,581
5.18
1,581,345
57,708
1,353,564
5.87
1,422,798
4.94
168,716
11,673
9.25
71,909
11,879
22.09
14,687,611
629,529
15,304,901
623,696
5.45
(110,101)
(101,664)
14,577,510
15,203,237
1,151,827
1,380,989
15,729,337
16,584,226
7,703,843
7,625,569
2.71
1,329,098
5.65
1,333,652
4.80
1,396,686
51,398
1,626,306
63,218
10,429,627
10,585,527
3.36
2,834,140
3,557,765
309,635
357,547
13,573,402
14,500,839
2,128,683
2,056,885
27,252
26,502
314,044
357,710
1.69
2.09
2.86
3.12
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 reduces 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, such as securities borrowed in the broker-dealer segment and securities loaned 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 lines of credit extended to other operating segments by the banking segment, are eliminated from the consolidated financial statements.
On a consolidated basis, the change in net interest income during the three and nine months ended September 30, 2024, compared with the same periods in 2023, was primarily due to increased costs of deposits from rate increases and the shift from noninterest-bearing deposits into interest-bearing products during the year-over-year period, and increased net yields on loans held for investment within the banking segment for the nine months ended September 30, 2024. 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. During the three months ended June 30, 2024, the provision for credit losses reflected a build in the allowance related to specific reserves and loan portfolio changes within the banking segment since the prior quarter, slightly offset by improvements to the U.S. economic outlook, while during the three months ended September 30, 2024, the reversal of credit losses was primarily driven by net charge-offs and loan
portfolio changes, including a change in the macroeconomic outlook scenario utilized, associated with collectively evaluated loans, partially offset by a build in the allowance related to specific reserves within the banking segment since the prior quarter. The provision for credit losses during the nine months ended September 30, 2024 reflected a build in the allowance related to specific reserves and loan portfolio changes within the banking segment since the prior period, partially offset by the change in the macroeconomic outlook scenario utilized. Refer to the discussion under the heading “Financial Condition – Allowance for Credit Losses on Loans” for more details regarding the significant assumptions and estimates involved in estimating credit losses.
Noninterest income increased during the three months ended September 30, 2024, compared with the same period in 2023, primarily due to net increases within the broker-dealer segment’s structured finance and fixed income services business lines, partially offset by a decline within the broker-dealer segment’s wealth management business line and a decline in mortgage loan origination fees within our mortgage origination segment. Noninterest income increased during the nine months ended September 30, 2024, compared with the same period in 2023, primarily due to net increases within the broker-dealer segment’s structured finance and public finance services business lines, an increase in pre-tax gains associated with the sale of merchant bank equity investments within corporate, and increases in mortgage loan gains from sale of loans within our mortgage origination segment, partially offset by declines in mortgage loan origination fees and other related income within the mortgage origination segment and by declines within the broker-dealer segment’s fixed income services and wealth management business lines.
Noninterest expense increased during the three months ended September 30, 2024, compared with the same period in 2023, primarily due to increases in both variable and non-variable compensation and other segment operating costs within our broker-dealer segment, partially offset by decreases in both variable and non-variable compensation and other segment costs within our mortgage origination segment associated with decreased mortgage loan originations. Noninterest expense decreased during the nine months ended September 30, 2024, compared with the same period in 2023, primarily due to changes noted above within our mortgage origination segment, partially offset by increases in both variable and non-variable compensation and other segment operating costs within our broker-dealer segment. We have experienced an increase in certain noninterest expenses during 2024 and 2023, compared with respective prior periods, including compensation, occupancy, and software costs, due to inflationary pressures. We expect such inflationary headwinds to continue and result in higher fixed costs during the remainder of 2024.
Effective income tax rates during the three months ended September 30, 2024 and 2023 were 22.5% and 25.2%, respectively, and for the nine months ended September 30, 2024 and 2023 were 22.5% and 21.6%, respectively. The effective tax rate during the three months ended September 30, 2023 was higher than the applicable statutory rate primarily due to the impact of non-deductible compensation expense and other permanent adjustments. During the nine months ended September 30, 2023, the effective tax rate differed from the applicable statutory rate primarily due to the impacts of excess tax benefits on share-based payment awards, investments in tax-exempt instruments and changes in accumulated tax reserves, partially offset by nondeductible expenses and the booking of additional taxes from a recent change in the source of funding for an acquired non-qualified, deferred compensation plan. During the three and nine months ended September 30, 2024, the effective tax rate was higher than the applicable statutory rate primarily due to the impact of nondeductible expenses, nondeductible compensation expense and other permanent adjustments, partially offset by the discrete impact of restricted stock vesting during the quarter and investments in tax-exempt instruments.
Segment Results
Banking Segment
The following table presents certain information about the operating results of our banking segment (in thousands).
Variance
2024 vs 2023
The decreases in income before income taxes during the three and nine months ended September 30, 2024, compared with the same periods in 2023, were primarily due to declines in net interest income and noninterest income, partially offset by the changes in the provision for credit losses. Changes to net interest income related to the component changes
58
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.
As discussed in more detail below, the banking segment’s cost of deposits increased during the first nine months of 2024, due to intense competition for liquidity and customers seeking higher yields on deposits. While we expect deposit costs during the remainder of 2024 to continue to be driven by various factors, including competitive pressures and broader economic conditions, with the recent 50-basis point decrease in the target range for the federal funds rate in September 2024 and the possibility of additional rate cuts in 2024, we anticipate that our cost of deposits will begin to trend modestly downward. The resulting net interest income spread compression has had, and is expected to continue to have, a negative impact on banking segment operating results.
The information shown in the table below includes certain key indicators of the performance and asset quality of our banking segment.
Efficiency ratio (1)
55.20
51.38
55.42
50.30
1.14
1.20
1.05
1.17
Net interest margin (3)
3.05
3.08
3.06
3.19
Net recoveries (charge-offs) to average loans outstanding (4)
(0.15)
0.08
(0.13)
(0.03)
The banking segment presents net interest margin and net interest income in the following discussion and table 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 banking segment performs periodic reviews of the classification and categorization of the components impacting the calculation of net interest margin. 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 September 30, 2024 and 2023, purchase accounting contributed 3 and 8 basis points, respectively, to the banking segment’s taxable equivalent net interest margin of 3.06% and 3.09%, respectively. During the nine months ended September 30, 2024 and 2023, purchase accounting contributed 4 and 9 basis points, respectively, to the banking segment’s taxable equivalent net interest margin of 3.06% and 3.20%, 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.
59
The tables below provide additional details regarding our banking segment’s net interest income (dollars in thousands).
7,057
7.20
7,698,935
117,861
6.07
7,831,250
118,307
5.99
Subsidiary warehouse lines of credit
920,245
18,766
7.98
982,621
20,515
8.17
2,064,919
17,281
3.35
2,227,564
18,070
3.24
109,494
926
3.38
112,161
960
3.42
84,493
1,197
5.62
51,518
725
5.58
1,229,597
16,910
5.46
1,496,590
5.39
38,347
4.55
54,599
649
4.72
12,153,087
173,508
5.66
12,756,303
179,546
(114,911)
(109,798)
12,038,176
12,646,505
773,262
841,953
12,811,438
13,488,458
Liabilities and Stockholders’ Equity
7,685,509
76,273
3.94
7,774,751
75,728
3.86
475,309
3,557
2.97
494,660
4,611
3.70
8,160,818
79,830
3.88
8,269,411
80,339
3.85
2,971,442
3,493,995
109,513
159,681
11,241,773
11,923,087
1,569,665
1,565,371
Total liabilities and stockholders’ equity
93,678
99,207
1.78
1.73
3.09
8,988
1.89
7,716,784
351,307
6.09
7,797,199
337,811
5.79
856,280
52,048
8.02
889,810
53,147
7.88
2,111,439
53,184
2,328,786
54,541
110,181
2,794
113,257
2,970
3.50
73,556
3,121
5.67
55,788
2,142
5.19
1,214,926
49,725
5.47
1,525,746
5.06
37,855
1,313
4.64
55,261
1,880
12,130,009
513,619
12,765,847
510,199
5.34
(109,970)
(100,653)
12,020,039
12,665,194
790,731
849,505
12,810,770
13,514,699
7,620,040
224,673
7,481,101
186,557
3.33
489,640
10,912
2.98
623,179
18,293
3.92
8,109,680
235,585
8,104,280
204,850
3,024,169
3,696,399
100,788
150,247
11,234,637
11,950,926
1,576,133
1,563,773
278,034
305,349
1.96
3.20
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, such as securities borrowed in the broker-dealer segment and securities loaned 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 lines of credit extended to other operating segments by the banking segment, are eliminated from the consolidated financial statements.
The following table summarizes the changes in the banking segment’s net interest income for the periods indicated below, including the component changes in the volume of average interest-earning assets and interest-bearing liabilities and changes in the rates earned or paid on those items (in thousands).
2024 vs. 2023
Change Due To (1)
Volume
Yield/Rate
Change
Interest income
Loans held for investment, gross (2)
(1,998)
1,552
(3,495)
16,991
13,496
Subsidiary warehouse lines of credit (3)
(1,284)
(465)
(1,749)
(1,982)
883
(1,099)
(1,330)
541
(789)
(5,095)
3,738
(1,357)
Investment securities - non-taxable (4)
(23)
(11)
(81)
(95)
(176)
464
472
979
(3,625)
(3,410)
(11,799)
3,816
(7,983)
(209)
(594)
(567)
Total interest income (4)
(7,989)
1,951
(6,038)
(22,354)
25,774
3,420
Interest expense
(869)
1,414
545
3,477
34,639
38,116
(180)
(874)
(1,054)
(3,934)
(3,447)
(7,381)
(1,049)
540
(509)
(457)
31,192
30,735
Net interest income (4)
(6,940)
1,411
(5,529)
(21,897)
(5,418)
(27,315)
With regard to net interest income, as of September 30, 2024, the banking segment maintained an asset sensitive rate risk position, meaning 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. During a period of declining interest rates, being asset sensitive tends to result in a decrease in net interest income, but during a period of rising interest rates, being asset sensitive tends to result in an increase in net interest income. Given projected impacts on net interest income associated with the expected transition into the next phase of the interest rate cycle, we continue to evaluate our current GAP position, which may result in a repositioning of the banking segment towards a more neutral or liability sensitive balance sheet.
The decreases in net interest income, as noted in the table above, were primarily driven by the increased funding costs on our deposit products from rate increases in 2023 and the migration from non-interest-bearing deposits into interest-bearing products during the year over year period, partially offset by increased earnings on interest-earning assets, primarily loan yields. The average rate paid on interest-bearing liabilities increased 50 basis points from 3.38% for the nine months ended September 30, 2023 to 3.88% for the nine months ended September 30, 2024, while the average yield
on interest-earning assets increased 32 basis points from 5.34% for the nine months ended September 30, 2023 to 5.66% for the nine months ended September 30, 2024.
Our portfolio includes loans that periodically reprice or mature prior to the end of an amortized term. The extent and timing of this impact on interest income 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. At September 30, 2024, approximately $599 million of our floating rate loans held for investment remained at or below their applicable rate floor, exclusive of our mortgage warehouse lending program, of which approximately 66% are not scheduled to reprice for more than one year based upon agreed-upon terms. If interest rates were to continue to fall, the impact on our interest income for certain variable-rate loans would be limited by these rate floors. If interest rates 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, unless such loans are refinanced or repaid. Competition for loan growth could also continue to put pressure on new loan origination rates.
Additionally, within our banking segment, the composition of the deposit base and ultimate cost of funds on deposits and net interest income 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. Deposit products and pricing structures relative to the market are regularly evaluated to maintain competitiveness over time. As discussed above, our cost of deposits increased during the three and nine months ended September 30, 2024, compared to the same periods of 2023. While we expect such costs during 2024 to continue to be driven by various factors, including competitive pressures and broader economic conditions, with the recent 50-basis point decrease in the target range of the federal funds rate in September 2024 and the possibility of additional rate cuts in 2024, we anticipate that our cost of deposits will begin to trend modestly downward. The Bank’s deposit base primarily includes a combination of commercial, wealth and public funds deposits, without a high level of industry concentration. At September 30, 2024, total estimated uninsured deposits were $5.3 billion, or approximately 49% of total deposits, while estimated uninsured deposits, excluding collateralized deposits of $312.3 million, were $5.0 billion, or approximately 46% of total deposits.
Refer to the discussion in the “Liquidity and Capital Resources – Banking Segment” section that follows for more detail regarding the Bank’s activities regarding deposits, available liquidity and borrowing capacity.
To help mitigate net interest income spread volatility between our assets and liabilities, management maintains derivative trades, as either cash flow hedges or fair value hedges, that better align repricing characteristics. Despite having these hedges in place, changes in interest rates across the term structure may 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.
The banking segment retained approximately $7.3 million and $8.8 million in mortgage loans originated by the mortgage origination segment during the three months ended September 30, 2024 and 2023, respectively, and $79.2 million and $135.2 million in mortgage loans originated by the mortgage origination segment during the nine months ended September 30, 2024 and 2023, respectively. 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. 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 provision for (reversal of) credit losses has been subject to significant year-over-year and quarterly changes primarily attributable to the effects of changes in economic outlook, macroeconomic forecast assumptions and the resulting impact on reserves. During the three months ended September 30, 2024, the reversal of credit losses was primarily driven by net charge-offs and loan portfolio changes, including a change in the macroeconomic outlook scenario utilized, associated with collectively evaluated loans, partially offset by a build in the allowance related to specific reserves within the banking segment since the prior quarter. The increase in the provision for credit losses during the nine months ended September 30, 2024 reflected a build in the allowance related to specific reserves and loan portfolio changes within the banking segment since the prior period, partially offset by the change in the macroeconomic outlook scenario utilized. The net impact to the allowance of changes associated with individually evaluated loans during the three and nine months ended September 30, 2024 included a provision for credit losses of $1.2 million and $13.3 million, respectively, while collectively evaluated loans included a reversal of credit losses of
62
$2.5 million and $6.5 million, respectively. The change in the allowance for credit losses during the three and nine months ended September 30, 2024 was also impacted by net charge-offs of $2.9 million and $7.3 million, respectively. During the three months ended September 30, 2023, the banking segment’s provision for credit losses reflected increases in specific reserves and net portfolio changes since the prior period, while the provision for credit losses during the nine months ended September 30, 2023, reflected a significant build in the allowance related to loan portfolio changes since December 31, 2022 and a deteriorating outlook for commercial real estate markets. The net impact to the allowance of changes associated with collectively evaluated loans during the three and nine months ended September 30, 2023 included a reversal of credit losses of $0.3 million, compared to a provision for credit losses of $14.2 million, respectively, while individually evaluated loans included a provision for credit losses of $0.9 million and $3.0 million, respectively. The change in the allowance for credit losses during the three and nine months ended September 30, 2023 were also impacted by net recoveries of $1.6 million and net charge-offs of $1.7 million, respectively. The changes in the allowance for credit losses during the noted periods also reflected other factors including, but not limited to, loan growth, loan mix and changes in risk grades and qualitative factors 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.
The banking segment’s noninterest income decreased during the three months ended September 30, 2024, compared to the same period in 2023, primarily due to a decrease in oil and gas management fees. The decrease in noninterest income during the nine months ended September 30, 2024, compared to the same period in 2023, was primarily due to valuation adjustments associated with the sale of a single loan from loans held for sale during the second quarter of 2024.
The banking segment’s noninterest expense increased during the three months ended September 30, 2024, compared to the same period in 2023, primarily due to increases in employees’ compensation and benefits and occupancy and equipment expenses, partially offset by decreases in professional fees. The increase in noninterest expense during the nine months ended September 30, 2024, compared to the same period in 2023, was primarily due to one-time compensation expenses associated with Bank leadership changes, partially offset by decreases in professional fees.
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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
927
1,514
(587)
4,086
5,337
(1,251)
Clearing services
2,601
2,458
143
7,918
5,416
2,502
Structured finance
1,603
200
5,980
(882)
Fixed income services
(895)
974
(1,231)
1,827
(3,058)
6,999
(536)
21,025
20,719
306
Total net interest income
Securities commissions and fees by business line (1) (5):
5,305
1,856
20,712
16,436
4,276
Retail
15,806
17,149
(1,343)
49,336
53,115
(3,779)
8,616
10,073
(1,457)
26,642
30,501
(3,859)
3,999
2,378
1,621
10,007
6,286
3,721
1,426
2,272
1,086
37,008
35,511
1,497
110,055
108,610
1,445
Investment and securities advisory fees and commissions by business line:
Public finance services
29,251
29,317
(66)
70,491
68,858
1,633
3,096
1,477
5,995
4,481
9,019
7,888
1,131
26,457
23,068
3,389
427
1,355
1,250
325
(154)
918
698
220
74
252
191
42,248
2,586
105,468
6,922
Other (5):
20,678
17,987
2,691
56,319
49,083
7,236
7,334
8,741
(1,407)
20,109
26,004
(5,895)
4,581
4,587
16,529
14,921
1,608
32,593
31,315
1,278
92,957
90,008
2,949
Net revenue (2)
124,258
118,703
5,555
345,376
336,443
8,933
Variable compensation (3)
42,569
39,929
110,578
105,548
5,030
Non-variable compensation and benefits
33,343
30,001
3,342
100,973
92,101
8,872
Segment operating costs (4)
31,352
27,220
4,132
90,687
85,366
5,321
107,264
97,150
10,114
302,238
283,015
19,223
The changes in net revenue and income before income taxes for the nine months ended September 30, 2024, compared with the same period in 2023, were primarily due to improved period-over-period results within our structured finance and public finance services business lines, partially offset by declines within our fixed income services and wealth management business lines. The increase in the structured finance business line’s net revenues was primarily due to an increase in unrealized gains from the U.S. Agency to-be-announced (“TBA”) business and commissions earned on commodities transactions. The increase in net revenues in the broker-dealer segment’s public finance services business line was primarily due to fees earned from managed assets and municipal advisory revenues. The wealth management business line’s net revenue decrease was driven by decreases in commissions earned from our FDIC sweep program on lower customer balances. These decreases were partially offset by improved advisory fees revenues generated from customer assets under management. The decrease in net revenues in the broker-dealer segment’s fixed income services business line was primarily due to declines in revenues from net interest income earned on inventory positions and
trading profits, particularly from a decrease in underwriting activities. Income before income taxes was impacted by increased noninterest expense primarily due to increased segment compensation.
The changes in net revenue and income before income taxes for the three months ended September 30, 2024, compared with the same period in 2023, were primarily due to improved period-over-period results within our structured finance and fixed income services business lines, partially offset by declines within our wealth management business line. Public finance remained relatively flat period-over-period. The structured finance business line’s net revenues increase was primarily due to an increase in our structured housing business due to gains from the U.S. Agency TBA business and commissions earned on commodities transactions. The wealth management business line’s net revenue decline was driven by a reduction in the FDIC program sweep revenue resulting from an overall decrease in customer assets. These decreases were partially offset by improved advisory fees revenues generated from customer assets under management. The increase in net revenues in the broker-dealer segment’s fixed income services business line was primarily due to increases in revenues from net interest income earned on inventory positions and investment banking and advisory fees, partially offset from decreases in trading profits from underwriting activities.
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. The broker-dealer segment is also exposed to interest rate risk through its structured finance business line, which is dependent on mortgage loan production that tends to be adversely impacted by increasing interest rates and resulting in valuation-related adjustments.
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 nine months ended September 30, 2024, compared with the same period in 2023, was primarily due to the decrease in net interest income from the fixed income services business line due to decreases in net interest earned on inventory positions. Net interest income during the three months ended September 30, 2024, compared with the same period in 2023 remained relatively flat.
Noninterest income increased during the three and nine months ended September 30, 2024, compared with the same periods in 2023, due to increases in securities commissions and fees, investment and securities advisory fees and other income.
Securities commissions and fees increased during the three months ended September 30, 2024, compared with the same period in 2023, primarily due to an increase in commodities and insurance product sales commissions, partially offset by decreases in FDIC sweep revenues and net clearing revenues. Securities commissions and fees increased during the nine months ended September 30, 2024, compared with the same period in 2023 due to increases in both the broker-dealer segment’s structured finance and fixed income services business lines. The increase in the structured finance business line was primarily due to an increase in commissions earned on commodities transactions, and the increase in the fixed income services business line was primarily due to increased volumes. These increases were partially offset by declines in securities commissions and fees in the broker-dealer segment’s wealth management business line due to decreases in FDIC sweep revenues and net clearing revenues, as well as a decline in commissions earned on insurance product sales.
Investment and securities advisory fees and commissions increased during the three and nine months ended September 30, 2024, compared with the same periods in 2023, primarily due to increases in fees earned from managed assets and municipal advisory transactions.
The increases in other noninterest income during the three and nine months ended September 30, 2024, compared with the same periods in 2023, were primarily due to increases in trading gains earned from structured finance trading activities and distributions received on investments, partially offset by decreases in trading gains earned from fixed
65
income trading activities. Both mortgage originations and buy-side demand have increased in the third quarter of fiscal year 2024, resulting in increases in noninterest income in the structured finance service line for both the three and nine months ended September 30, 2024, when compared to the same periods in 2023. Decreased fixed income trading gains for the three and nine months ended September 30, 2024, compared with the same periods in 2023, were primarily driven by municipal and taxable securities trading.
The increases in noninterest expense during the three and nine months ended September 30, 2024, compared with the same periods in 2023, were primarily due to increases in segment compensation and other segment operating costs, primarily quotation expenses.
Selected information concerning the broker-dealer segment, including key performance indicators, follows (dollars in thousands).
Total compensation as a % of net revenue (1)
61.1
58.9
61.3
58.7
Pre-tax margin (2)
13.7
18.2
12.5
15.9
FDIC insured program balances at the Bank (end of period)
762,209
1,382,088
Other FDIC insured program balances (end of period)
1,034,984
686,920
Customer funds on deposit, including short credits (end of period)
224,538
223,582
Public finance services:
Number of issues (3)
723
Aggregate amount of offerings (3)
23,946,330
16,853,446
52,327,828
37,884,255
Structured finance:
Lock production/TBA volume (3)
2,512,400
2,517,155
3,961,102
5,285,003
Fixed income services:
Total volumes
95,389,537
69,964,657
298,689,423
177,028,598
Net inventory (end of period)
493,009
527,302
Wealth management (Retail and Clearing services groups):
Retail employee representatives (end of period)
91
Independent registered representatives (end of period)
188
Correspondents (end of period)
Correspondent receivables (end of period)
124,541
125,874
Customer margin balances (end of period)
210,670
231,369
Wealth management (Securities lending group):
Interest-earning assets - stock borrowed (end of period)
1,368,945
Interest-bearing liabilities - stock loaned (end of period)
1,304,884
Mortgage Origination Segment
The following table presents certain information regarding the operating results of our mortgage origination segment (in thousands).
Loss before income taxes
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. While changes in mortgage interest rates have historically had a lesser impact on home purchases volume than on refinancing volume, net increases in mortgage interest rates since 2022 have continued to negatively impact home purchase volume through the first nine months of 2024. A modest decline in mortgage rates experienced since the fourth
66
quarter of 2023 has had a slight impact on loan origination volume in 2024, with a minor increase in refinancings as a percentage of total loan origination volume. See details regarding loan origination volume in the table below.
Recent trends, as well as typical historical patterns in loan origination volume from purchases of homes or from refinancings because of movements in mortgage interest rates, may not be indicative of future loan origination volumes. During 2023, and continuing through the first nine months of 2024, certain events have adversely impacted total mortgage market origination volumes because of their effect on the economy, including inflation and an increase in average interest rates during these periods when compared to the average of the three years prior to 2023, geopolitical events, and the Federal Reserve’s actions and communications. These events have also adversely impacted the willingness and ability of the mortgage origination segment’s customers to conduct mortgage transactions. Specifically, current home inventory shortages and affordability challenges are impacting customers’ abilities to purchase homes. In September 2024, the Federal Reserve cut the target range for the federal funds rate by 50 basis points to 4.75% - 5.0%, the first reduction since March 2022 when the target range was 0.25% - 0.50%. Since this cut occurred during the later part of the third quarter of 2024, it had minimal impact on loan origination volumes during the nine months ended September 30, 2024. We expect the fourth quarter of 2024 to more closely follow loan production experienced during the first quarter of 2024. PrimeLending continues to evaluate its cost structure to address the current mortgage environment.
We believe that ongoing initiatives are critical to improving PrimeLending’s short- and long-term financial condition and operating results. The mortgage origination segment experienced operating losses during 2023 due to conditions and challenges discussed in detail within this discussion of segment results. Operating losses have continued into the first nine months of 2024 due to the same conditions and challenges, but at a lesser extent than during the nine months ended September 30, 2023. In light of these macroeconomic challenges in the mortgage industry including tight housing inventories and mortgage interest rate levels, the fair value of the mortgage origination reporting unit may decline, and we may be required to record a goodwill impairment charge. These conditions will continue to be considered during future impairment evaluations of reporting unit goodwill.
As a Government National Mortgage Association (“GNMA”) approved lender, we are subject to certain Department of Housing and Urban Development (“HUD”) and GNMA minimum capital ratio reporting requirements, including timely reporting if a quarter’s operating loss exceeds more than 20% of its previous quarter or year-end net worth (the “operating loss ratio”) and/or if a quarter’s capital ratio is below 6% (the “GNMA capital ratio”). If this occurs, certain additional financial reporting submissions are required. During the first and fourth quarters of 2023, the HUD operating loss ratio was 21.2% and 20.5%, respectively, while during the second and third quarters of 2023, the HUD operating loss ratio decreased to 15.8% and 10.0%, respectively. During the first quarter of 2024, the HUD operating loss ratio was 22.6%, while during the second quarter of 2024, PrimeLending reported a HUD operating gain. During the third quarter of 2024, the operating loss ratio was below the 20% threshold at 14.4%. During each quarter of 2023, the GNMA capital ratio exceeded the required 6%. However, during the first and second quarters of 2024, the GNMA capital ratio decreased to 5.56% and 4.41%, respectively. Including a $10 million capital infusion received by PrimeLending from its parent company, PlainsCapital Bank, in September 2024, the GNMA capital ratio increased to 6.38%. All trends requiring notification to GNMA and HUD have been reported to those entities, respectively. Such capital infusions are likely in future periods, including those in the near-term, based on various factors including PrimeLending’s financial performance.
In addition, as a Federal National Mortgage Association (“FNMA”) and Federal Home Loan Mortgage Corporation (“FHLMC”) approved lender, we are subject to certain minimum capital, net worth and liquidity requirements established by FNMA and FHLMC, including maintaining a minimum capital ratio of 6% (the “FNMA/FHLMC capital ratio”). During each quarter of 2023 and the first quarter of 2024, the FNMA/FHLMC capital ratio exceeded the required 6%, however during the second quarter of 2024, the FNMA/FHLMC capital ratio decreased to 5.52%. During the third quarter of 2024, the capital ratio, including the capital infusion previously noted, exceeded the required 6%. FNMA and FHLMC may also monitor additional financial performance trends at their discretion, including risk-based analyses focused on loans that the mortgage origination segment is currently responsible for representations and warranties that agency loans sold meet certain requirements, including representations as to underwriting standards and the validity of certain borrower representations in connection with the loan. One FNMA discretionary performance trend monitors the change in adjusted net worth during the prior twelve months. FNMA’s acceptable threshold for this performance trend is less than minus 30%, but is only considered if a company has four consecutive quarterly losses. During the second, third and fourth quarters of 2023, PrimeLending experienced four consecutive quarterly losses; the loss ratio during these periods were 50.2%, 37.6% and 39.8%, respectively. PrimeLending also recognized four consecutive quarterly losses during the first, second and third quarters of 2024; the loss ratio during these periods was 37.5%, 29.9% and 23.9%, respectively. All trends requiring notification to FNMA and FHLMC have been reported to those entities, respectively.
The loss before income taxes during the three months ended September 30, 2024, approximated the loss before income taxes PrimeLending reported during the same period in 2023. Decreases in noninterest income and noninterest expense approximated each other during these periods. The loss before income taxes decreased during the nine months ended September 30, 2024, compared with the same period in 2023, primarily as a result of a decrease in noninterest expense.
During 2022 and continuing through the beginning of the fourth quarter of 2023, the U.S. 10-Year Treasury Rate and mortgage interest rates increased significantly. During the later part of the fourth quarter of 2023, both rates decreased to levels that approximated rates at the beginning of 2023. Between January 1 and September 30, 2024, both rates decreased slightly. Average interest rates during the three months ended September 30, 2024, decreased slightly compared to average interest rates during the same period in 2023, while average interest rates during the nine months ended September 30, 2024, were comparable to the same period in 2023. Refinancing volume as a percentage of total origination volume was slightly higher during the three and nine months ended September 30, 2024, as compared to the same periods in 2023. Although we anticipate a slightly higher percentage of refinancing volume relative to total loan origination volume during 2024, as compared to 2023, an even 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 existing home inventory shortages and affordability challenges related to new home construction, and/or an increase in all-cash buyers.
The mortgage origination segment primarily originates its mortgage loans through a retail channel, with limited lending through its affiliated business arrangements (“ABAs”). For the nine months ended September 30, 2024, funded volume through ABAs was approximately 15% of the mortgage origination segment’s total loan volume. Currently, PrimeLending owns a greater than 50% membership interest in two ABAs. We expect total production within the ABA channel to continue to approximate 15% of loan volume of the mortgage origination segment during the remainder of 2024.
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
7,270
7,353
(83)
20,119
21,004
(885)
Mortgage Loan Originations - volume:
Conventional
1,434,323
62.16
1,403,008
62.53
3,874,308
60.89
4,038,367
62.82
(164,059)
Government
467,082
20.24
497,055
22.15
(29,973)
1,353,183
21.27
1,486,169
23.12
(132,986)
Jumbo
110,139
4.77
73,769
3.29
36,370
321,462
5.05
237,304
3.69
84,158
295,919
12.83
269,869
12.03
26,050
814,294
12.79
666,264
10.37
148,030
2,307,463
100.00
2,243,701
63,762
6,363,247
6,428,104
(64,857)
Home purchases
2,096,009
90.84
2,091,444
93.21
4,565
5,850,106
91.94
6,003,749
93.40
(153,643)
Refinancings
211,454
9.16
152,257
6.79
59,197
513,141
8.06
424,355
6.60
88,786
Texas
692,919
30.03
624,953
27.85
67,966
1,979,994
31.12
1,762,179
27.41
217,815
California
183,239
7.94
176,879
6,360
499,387
7.85
536,718
8.35
(37,331)
South Carolina
112,023
4.85
119,124
5.31
(7,101)
336,242
5.28
344,224
(7,982)
Missouri
95,882
4.16
79,735
3.55
16,147
278,985
4.38
225,068
53,917
New York
115,987
5.03
101,560
4.53
14,427
269,159
4.23
271,929
(2,770)
Florida
77,800
3.37
96,945
4.32
(19,145)
242,934
3.82
308,155
4.79
(65,221)
Arizona
76,291
3.31
84,103
3.75
(7,812)
203,943
3.21
290,972
(87,029)
Ohio
73,053
3.17
71,467
1,586
192,029
200,273
(8,244)
Washington
68,010
2.95
53,532
2.39
14,478
180,112
2.83
153,705
26,407
North Carolina
41,753
1.81
67,342
3.00
(25,589)
133,972
2.11
196,764
(62,792)
All other states
770,506
33.38
768,061
34.23
2,445
2,046,490
32.15
2,138,117
33.26
(91,627)
Mortgage Loan Sales - volume:
Third parties
2,562,350
99.71
2,386,552
99.63
175,798
6,079,164
98.71
6,037,382
97.81
41,782
Banking segment
7,328
0.29
8,805
0.37
(1,477)
79,213
1.29
135,201
2.19
(55,988)
2,569,678
2,395,357
174,321
6,158,377
6,172,583
(14,206)
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, mortgage loan origination fees, and other mortgage production income.
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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.
The mortgage origination segment’s total loan origination volume increased 2.8% and decreased 1.0%, respectively, during the three and nine months ended September 30, 2024, compared to the same periods in 2023. The loss before taxes increased 5.8% and decreased 49.2%, respectively, during the three and nine months ended September 30, 2024, compared to the same periods in 2023. The increase in loss before income taxes during the three months ended September 30, 2024, when compared to the same period in 2023, was primarily due to an increase in the loss on the change in the net fair value and related derivative activity related to mortgage servicing rights assets and a decrease in servicing fees, almost entirely offset by decreases in non-variable compensation and benefits expense, segment operating costs, and servicing fee expense. The decrease in loss before income taxes during the nine months ended September 30, 2024, when compared to the same period in 2023, was primarily due to decreases in non-variable compensation and benefits expense and segment operating costs, partially offset by an increase in the loss on the change in the net fair value and related derivative activity related to mortgage servicing rights assets.
The information shown in the table below includes certain additional key performance indicators for the mortgage origination segment.
Net gains from mortgage loan sales (basis points):
Loans sold to third parties
224
199
226
Impact of loans retained by banking segment
0
As reported
198
223
196
Variable compensation as a percentage of total compensation
55.9
51.7
52.0
48.1
Mortgage servicing rights asset ($000's) (end of period) (1)
Net interest expense 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. Net interest expense decreased during the three and nine months ended September 30, 2024, as compared to the same periods in 2023, primarily due to a decrease in the negative net interest margin.
Noninterest income was comprised of the items set forth in the table below (in thousands).
Net gains from sale of loans
57,456
47,494
9,962
137,338
120,857
16,481
Mortgage loan origination fees and other related income
(9,359)
(18,740)
Other mortgage production income:
Change in net fair value and related derivative activity:
IRLCs and loans held for sale
(8,332)
(5,774)
(2,558)
6,975
3,719
3,256
Mortgage servicing rights asset
(5,473)
(2,987)
(2,486)
(18,628)
(12,797)
(5,831)
Servicing fees
4,152
8,536
(4,384)
20,849
24,181
(3,332)
Net gains from sale of loans increased 13.6%, while total loans sales volume was flat during the nine months ended September 30, 2024, compared with the same period in 2023. The increase in net gains from sales of loans was primarily the result of an increase in average loan sale margin.
The 16.8% decrease in mortgage loan origination fees during the nine months ended September 30, 2024, compared with the same period in 2023, was primarily the result of a decrease in average mortgage loan origination fees as loan origination volume was flat during the same period, and to a lesser extent, a decrease in loan origination volume during both periods.
Fluctuations in mortgage loan origination fees and net gains on sale of loans are not always aligned with fluctuations in loan origination and loan sale volumes, respectively, since customers may opt to pay PrimeLending discount fees on their mortgage loans, which are included in mortgage loan origination fees, in exchange for a lower interest rate, which decreases the value of a loan in the secondary market.
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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 mortgage loan sales margin is defined as net gains from sale of loans divided by mortgage loan sales volume. The net gains from sale of loans is central to the segment’s generation of income and may include loans sold to third parties and loans sold to and retained by the banking segment. For origination services provided, the mortgage origination segment was reimbursed direct origination costs associated with loans retained by the banking segment, in addition to payment of a correspondent fee. The reimbursed origination costs and correspondent fees are included in the mortgage origination segment operating results, and the correspondent fees are eliminated in consolidation. Loan volumes to be originated on behalf of and retained by the banking segment are evaluated each quarter. Loans sold to and retained by the banking segment during the three months ended September 30, 2024 and 2023 were $7.3 million and $8.8 million, respectively, and $79.2 million and $135.2 million during the nine months ended September 30, 2024 and 2023, respectively. Loan volumes to be originated on behalf of and retained by the banking segment are expected to 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.
Noninterest income included changes in the net fair value of the mortgage origination segment’s interest rate lock commitments (“IRLCs”) and loans held for sale and the related activity associated with forward commitments used by the mortgage origination segment to mitigate interest rate risk associated with its IRLCs and mortgage loans held for sale (“net fair value of IRLCs and loans held for sale”). The decrease in net fair value of IRLCs and loans held for sale during the three months ended September 30, 2024, was the result of a decrease in the total volume of individual IRLCs and loans held for sale since June 30, 2024, while the average value of individual IRLCs and loans held for sale was flat since June 30, 2024. The increase in net fair value of IRLCs and loans held for sale during the nine months ended September 30, 2024, was the result of an increase in the total volume of individual IRLCs and loans held for sale and the average value of individual IRLCs and loans held for sale since December 31, 2023.
The mortgage origination segment sells substantially all mortgage loans it originates to various investors in the secondary market. 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, refinancing and market activity, and balance sheet positioning at Hilltop. During the three and nine months ended September 30, 2024, PrimeLending retained servicing on approximately 6% and 8%, respectively, of the loans sold, compared with approximately 9% and 20%, respectively, of loans sold during the same periods in 2023. A reduction in third-party mortgage servicers purchasing mortgage servicing rights, even if modest, may result in PrimeLending increasing the rate of retained servicing on mortgage loans sold at any time. 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 and retained by 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 and MBS commitments, to mitigate interest rate risk associated with its MSR asset. During the three and nine months ended September 30, 2024, changes in the net fair value of the MSR asset and the related derivatives resulted in net losses of $5.5 million and $18.6 million, respectively. In addition to normal customer payments and customer payoffs, these changes were primarily driven by losses of $4.2 million and $12.3 million during the three and nine months ended September 30, 2024, respectively, to account for MSR valuation assumption changes, including prepayment and discount rates used as inputs to value the MSR asset, and differences between MSR carrying values and sales prices related to the sale of MSR assets. Fluctuations in the net fair value of the MSR asset driven by net changes in long-term U.S. Treasury bond rates and the related derivatives used to hedge the MSR during the respective periods resulted in net losses of $0.7 million and $3.0 million, respectively. During June 2024, the mortgage origination segment sold MSR assets of $45.1 million, which represented $2.9 billion of its serviced loan volume at the time. In addition, on September 17, 2024, the mortgage origination segment signed a letter of intent to sell MSR assets of $42.6 million, which represented $2.3 billion of its serviced loan volume and is scheduled to be completed during the fourth quarter of 2024. As a result, the mortgage origination segment does not currently expect the level of MSR assets to be significant in the short-term. In addition to gains and losses generated by changes in the net fair value of the MSR asset and related derivatives, net servicing income of $1.5 million and $8.7 million was recognized during the three and nine months ended September 30, 2024, respectively.
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During the three and nine months ended September 30, 2023, the operating results of the mortgage origination segment were impacted by an increase of $6.1 million and a decrease of $0.7 million, respectively, in the net fair value of the MSR asset, of which $5.5 million of the decrease during the nine months ended September 30, 2023, was primarily driven by market sales trends during the first quarter of 2023. The remaining fluctuations in the net fair value of the MSR asset during the respective periods were primarily due to the net gains driven by the net changes in long-term U.S. Treasury bond rates and customer payoffs during the three and nine months ended September 30, 2023, and losses of $9.1 million and $12.3 million generated by the derivatives used to hedge the MSR. During June 2023, the mortgage origination segment sold MSR assets of $19.1 million, which represented $991.0 million of its serviced loan volume at the time. In addition to gains and losses generated by changes in the net fair value of the MSR asset, net servicing income of $3.7 million and $10.5 million was recognized during the three and nine months ended September 30, 2023, respectively.
Noninterest expenses were comprised of the items set forth in the table below (in thousands).
Variable compensation
33,862
33,070
792
90,934
94,892
(3,958)
26,711
30,946
(4,235)
83,957
102,461
(18,504)
Segment operating costs
18,205
21,471
(3,266)
56,952
64,125
(7,173)
Lender paid closing costs
2,840
1,179
1,661
6,093
3,741
2,352
Servicing expense
2,605
4,839
(2,234)
12,131
13,699
(1,568)
Total employees’ compensation and benefits accounted for the majority of noninterest expenses incurred during all periods presented. Historically, variable compensation comprises the majority of total employees’ compensation and benefits expenses. 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.
While total loan origination volume increased 2.8% and decreased 1.0% during the three and nine months ended September 30, 2024, respectively, compared to the same periods in 2023, the aggregate non-variable compensation and benefits of the mortgage origination segment decreased by 13.7% and 18.1% during the same periods. These decreases during the three and nine months ended September 30, 2024, compared to the same periods in 2023, were primarily due to a decrease in salaries associated with a reduction in underwriting and loan fulfillment, operations and corporate staff as PrimeLending continued to evaluate its cost structure to address the current mortgage environment. Segment operating costs decreased during the three and nine months ended September 30, 2024, compared to the same periods in 2023, primarily due to decreases in occupancy and equipment 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, 2015 and September 30, 2024, the mortgage origination segment sold mortgage loans totaling $144.1 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 2015, it does not anticipate experiencing significant losses in the future on loans originated prior to 2015 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.
The following is a summary of the mortgage origination segment’s claims resolution activity relating to loans sold between January 1, 2015 and September 30, 2024 (dollars in thousands).
Original Loan Balance
Loss Recognized
Loans Sold
227,260
Claims resolved because of a loan repurchase or payment to an investor for losses incurred (1)
328,167
0.23
26,041
0.02
555,427
0.39
For each loan, when the mortgage origination segment 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. 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 inquiries, 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.
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. During the second quarter of 2024, PrimeLending increased the indemnification reserve rate applied to loans sold subsequent to April 30, 2024, to address recent loss trends. During the third quarter of 2024, there was no adjustment made to the indemnification liability reserve. PrimeLending will continue to monitor agency claim inquiry trends and assess its potential impact on the indemnification liability reserve.
At September 30, 2024 and December 31, 2023, the mortgage origination segment’s total indemnification liability reserve totaled $8.5 million and $11.7 million, respectively. The related provision for indemnification losses was $0.9 million and $0.5 million during the three months ended September 30, 2024 and 2023, respectively, and $2.0 million and $1.3 million during the nine months ended September 30, 2024 and 2023, respectively.
The following table presents certain financial information regarding the operating results of corporate (in thousands).
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. These merchant banking activities currently include investments within various industries, including power generation, youth sports and entertainment, dental health, and industrial equipment manufacturing, with an aggregate carrying value of approximately $75 million at September 30, 2024.
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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 and nine months ended September 30, 2024 was primarily comprised of dividend income from merchant banking investment activities, in addition to interest income earned on intercompany notes.
Interest expense during each of the three months ended September 30, 2024 and 2023 included recurring quarterly interest expense of $5.0 million incurred on our $150.0 million aggregate principal amount of 5% senior notes due 2025 (“Senior Notes”), on our $50 million aggregate principal amount of subordinated notes due 2030 (“2030 Subordinated Notes”) and on our $150 million aggregate principal amount of subordinated notes due 2035 (“2035 Subordinated Notes,” the 2030 Subordinated Notes and the 2035 Subordinated Notes, collectively, the “Subordinated Notes”).
Noninterest income during each period 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. During the three and nine months ended September 30, 2024, noninterest income included pre-tax gains of $0.6 million and $5.3 million, respectively, associated with the sale of merchant bank equity investments.
Noninterest expenses were primarily comprised of employees’ compensation and benefits, occupancy expenses and professional fees, including corporate governance, legal and transaction costs. During the three and nine months ended September 30, 2024, noninterest expenses increased, compared to the same periods in 2023, primarily due to increases associated with employees’ compensation and benefits and software costs.
Financial Condition
The following discussion contains a more detailed analysis of our financial condition at September 30, 2024, as compared with December 31, 2023.
Securities Portfolio
At September 30, 2024, 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.
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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 net unrealized losses of $83.4 million and $114.2 million at September 30, 2024 and December 31, 2023, respectively, related to the available for sale investment portfolio, and net unrealized losses of $64.0 million and $80.8 million at September 30, 2024 and December 31, 2023, respectively, associated with the securities held to maturity portfolio. Equity securities included net unrealized gains of $0.2 million and $0.3 million at September 30, 2024 and December 31, 2023, respectively. In future periods, we expect changes in prevailing market interest rates, coupled with changes in the aggregate size of the investment portfolio, to be significant drivers of changes in the unrealized losses or gains in these portfolios, and therefore accumulated other comprehensive income (loss).
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 September 30, 2024, the banking segment’s securities portfolio of $2.1 billion was comprised of trading securities of $0.1 million, available for sale securities of $1.4 billion, held to maturity securities of $754.8 million and equity securities of $0.3 million, in addition to $10.4 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 to the statement of operations. Accordingly, the securities portfolio of the Hilltop Broker-Dealers included trading securities of $540.8 million at September 30, 2024. 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 $47.8 million at September 30, 2024.
At September 30, 2024, the corporate portfolio included other investments, including those associated with merchant banking, of available for sale securities of $29.1 million and other assets of $45.3 million 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 September 30, 2024. In addition, as of September 30, 2024, we 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 September 30, 2024.
Loan Portfolio
Consolidated loans held for investment are detailed in the table below, classified by portfolio segment (in thousands).
Loans held for investment, gross
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. As discussed in more detail within the section captioned “Financial Condition – Allowance for Credit Losses on Loans” set forth in Part II, Item 7 of our 2023 Form 10-K and further within the section captioned “Financial Condition – Allowance for Credit Losses on Loans” below, the banking segment’s credit policies emphasize strong underwriting and governance standards and early detection of potential problem credits in order to develop and implement action plans on a timely basis to mitigate potential losses.
To manage the credit risks associated with its loan portfolio, management may, depending upon current or anticipated economic conditions and related exposures, apply enhanced risk management measures to loans through analysis of a
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specific borrower’s financial condition, including cash flow, collateral values, and guarantees, among other credit factors. Given the current market dynamics, including economic uncertainties, the heightened level of market interest rates since 2022, and a deteriorating outlook for commercial real estate markets, management has heightened its specific review procedures of credits maturing in the next six to twelve months as well as those credits associated with real estate.
The banking segment’s total loans held for investment, net of the allowance for credit losses, were $8.3 billion and $8.5 billion at September 30, 2024 and December 31, 2023, respectively. At September 30, 2024, the banking segment’s loan portfolio included warehouse lines of credit extended to PrimeLending and its ABAs of $1.3 billion, of which $758.7 million was drawn. At December 31, 2023, amounts drawn on the available warehouse lines of credit was $0.9 billion. 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.
A significant portion of the banking segment’s loan portfolio at September 30, 2024, consisted of commercial real estate loans secured by properties. Such loans can involve high principal loan amounts, and the repayment of these loans is dependent, in large part, on a borrower’s ongoing business operations or on income generated from the properties that are leased to third parties.
The table below sets forth the banking segment’s commercial real estate loan portfolio, by portfolio industry sector and collateral location as of September 30, 2024 (in thousands).
Brownsville-
Dallas-
Harlingen-
San
Outside
Commercial Real Estate
Fort Worth
Austin
Houston
McAllen
Antonio
Lubbock
Non-owner occupied:
Office
136,092
186,246
33,947
16,027
21,184
2,925
57,233
318
453,972
155,454
73,905
27,060
19,815
20,514
8,868
44,227
8,368
358,211
Hotel/Motel
53,388
24,405
34,622
17,210
17,160
35,207
13,734
195,831
Multifamily
10,981
53,705
38,898
49,434
44,355
35,717
55,292
16,438
304,820
Industrial
87,452
66,234
2,501
794
21,515
7,012
197,937
All other
97,391
57,865
33,774
11,636
19,595
49,010
59,991
34,608
363,870
540,758
462,360
177,488
117,364
108,254
114,474
273,465
80,478
Owner occupied:
137,042
86,822
21,742
13,176
33,673
7,337
10,418
4,377
314,587
11,059
15,179
3,191
1,012
681
5,791
967
38,033
199,745
42,802
34,480
7,703
22,453
6,772
29,195
20,411
363,561
321,508
66,653
73,092
47,815
16,707
141,986
22,343
711,447
669,354
211,456
132,505
43,234
104,622
30,969
187,390
48,098
Total commercial real estate loans
1,210,112
673,816
309,993
160,598
212,876
145,443
460,855
128,576
3,302,269
At September 30, 2024, 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, non-construction residential real estate loans, and construction and land development loans, which represented 43.2%, 23.2% and 11.4%, respectively, of the banking segment’s total loans held for investment at September 30, 2024. The banking segment’s loan concentrations were within regulatory guidelines at September 30, 2024.
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. Crude oil prices remain uncertain given future supply and demand for oil are influenced by international armed conflicts, return to business travel, new energy policies and government regulation, and the pace of transition towards renewable energy resources. At September 30, 2024, the Bank’s energy loan exposure was approximately $53 million of loans held for investment with unfunded commitment balances of approximately $15 million. The allowance for credit losses on the Bank’s energy portfolio was $0.2 million, or 0.4% of loans held for investment at September 30, 2024.
The following table provides information regarding the maturities of the banking segment’s gross loans held for investment, net of unearned income (in thousands). The commercial and industrial portfolio segment includes amounts advanced against the warehouse lines of credit extended to PrimeLending.
Due Within
Due From One
Due from Five
Due After
One Year
To Five Years
To Fifteen Years
Fifteen Years
712,366
885,454
276,624
197
402,271
508,952
498,645
17,760
2,046,721
298,827
81,441
2,426,989
755,775
100,646
13,477
188,686
537,430
326,361
722,414
16,371
12,393
4,122,190
2,343,702
1,196,611
741,247
8,403,750
The following table provides information regarding the interest rate composition, based on contractual terms, of the banking segment's loans held for investment, net of unearned income (in thousands).
Loans maturing after one year
Fixed Interest
Floating Interest
643,428
518,847
1,162,275
677,436
347,921
1,025,357
283,928
96,340
380,268
74,067
40,922
114,989
947,477
638,728
1,586,205
12,466
2,638,802
1,642,758
4,281,560
In the table above, floating interest rate loans totaling $397.4 million as of September 30, 2024 had reached their applicable rate floor and are expected to reprice, subject to their scheduled repricing timing and frequency terms. The majority of floating rate loans carry an interest rate tied to a SOFR rate or The Wall Street Journal Prime Rate, as published in The Wall Street Journal.
The loan portfolio of the broker-dealer segment consists primarily of margin loans to customers and correspondents that are due within one year. The interest rate on margin accounts is computed on the settled margin balance at a fixed rate established by management. 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 $340.4 million and $344.1 million at September 30, 2024 and December 31, 2023, respectively. This decrease from December 31, 2023 to September 30, 2024 was primarily attributable to a decrease of $12.7 million, or 6%, in customer margin accounts, partially offset by increases of $4.6 million from non-customer cash accounts and $4.5 million, or 4%, in receivables from correspondents.
77
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
754,110
802,348
Fair value adjustment
14,045
19,846
768,155
IRLCs:
633,501
391,501
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 September 30, 2024 and December 31, 2023 were $1.0 billion and $1.0 billion, respectively, while the related estimated fair values were $0.9 million and ($10.2) million, respectively.
Allowance for Credit Losses on Loans
For additional information regarding the allowance for credit losses, refer to the section captioned “Critical Accounting Estimates” set forth in Part II, Item 7 of our 2023 Form 10-K.
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. As discussed in more detail within the section captioned “Financial Condition – Allowance for Credit Losses on Loans” set forth in Part II, Item 7 of our 2023 Form 10-K, the Bank’s underwriting procedures address financial components based on the size and complexity of the credit, while 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 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.
Significant judgment is required to estimate the severity and duration of the current economic uncertainties, as well as its potential impact on borrower defaults and loss severity. In particular, macroeconomic conditions and forecasts are rapidly changing and remain highly 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 September 30, 2024, we utilized a single macroeconomic alternative scenario, or S5, published by Moody’s Analytics in September 2024. During our previous quarterly macroeconomic assessment as of June 30, 2024, we utilized a single macroeconomic alternative scenario, or S7, published by Moody’s Analytics in June 2024. Management determined it appropriate to utilize the S5 macroeconomic alternative scenario as of September 30, 2024 given that the
ongoing resilience of the U.S. economy, continued moderation of inflation, and recent 50-basis point decrease in the target range for the federal funds rate set by the Federal Reserve best align with our internal economic outlook.
The following table and paragraphs summarize the U.S. Real Gross Domestic Product (“GDP”) growth rates and unemployment rate assumptions used in our economic forecast, and based on the single macroeconomic alternative scenario selected for respective period, to determine our best estimate of expected credit losses.
As of
June 30,
March 31,
GDP growth rates:
Q3 2023
2.9%
Q4 2023
1.1%
0.2%
Q1 2024
2.4%
(1.6)%
(1.9)%
Q2 2024
2.1%
0.7%
(2.4)%
(3.0)%
Q3 2024
2.0%
1.2%
0.4%
(1.3)%
(1.5)%
Q4 2024
1.3%
0.6%
0.0%
1.4%
Q1 2025
1.0%
(1.8)%
2.6%
3.1%
Q2 2025
1.5%
(2.0)%
(2.8)%
3.0%
Q3 2025
(2.5)%
(1.7)%
Q4 2025
Q1 2026
Unemployment rates:
3.8%
4.1%
4.8%
4.9%
4.0%
5.6%
5.7%
4.3%
6.1%
6.0%
4.4%
4.7%
5.2%
5.3%
5.0%
5.1%
As of September 30, 2024, our U.S. economic forecast assumes elevated borrowing costs reduce credit-sensitive spending, upcoming fiscal disputes in Congress weaken business and consumer sentiment, and concerns grow about broader international conflicts. As a result, the economy underperforms in the long run. The changes in real GDP on an annual average basis are 2.6% in 2024 and 1.5% in 2025. The unemployment rate increases in 2025 and reaches a peak of 5.2% in second half of 2025 before slowly receding. Our forecast considers the potential for monetary policy to ease from the Federal Reserve with the federal funds rate at 4.9% by year end 2024 and 3.8% by year end 2025. Vacancy rates for several commercial real estate sectors remain elevated, and the interest rate outlook challenges the recovery.
Since December 31, 2023, we updated our U.S. economic outlook for recent consumer and business spending. Real GDP growth was assumed to contract more modestly (0.0%) on an annual average basis and (1.3%) peak to trough in 2024. Labor market conditions remained tighter than expected as the unemployment rate decreased to 3.7% in December despite several downward revisions to recent payroll data. We expected monetary policy to remain restrictive at 5.25% to 5.5% in the near term but revert to 3.5% by year end 2025 as the Federal Reserve balances slower economic growth with its inflation and unemployment mandates.
During the three months ended September 30, 2024, the reversal of credit losses was primarily driven by net charge-offs and loan portfolio changes, including a change in the macroeconomic outlook scenario utilized, associated with collectively evaluated loans, partially offset by a build in the allowance related to specific reserves within the banking segment since the prior quarter. The increase in the provision for credit losses during the nine months ended September 30, 2024 reflected a build in the allowance related to specific reserves and loan portfolio changes within the banking segment since the prior period, partially offset by the change in the macroeconomic outlook scenario utilized. Specific to the Bank, the net impact to the allowance of changes associated with individually evaluated loans during the three and nine months ended September 30, 2024 included a provision for credit losses of $1.2 million and $13.3 million, respectively, while the net impact to the allowance of changes associated with collectively evaluated loans during the
three and nine months ended September 30, 2024 included a reversal of credit losses of $2.5 million and $6.5 million, respectively. The changes in the allowance for credit losses during the noted periods were primarily attributable to the Bank and also reflected other factors including, but not limited to, loan mix, and changes in loan balances and qualitative factors from the prior quarter. The changes in the allowance during the three and nine months ended September 30, 2024 were also impacted by net charge-offs of $2.9 million and $7.3 million, respectively.
As noted above, the combined impacts of specific reserves and loan portfolio changes within the banking segment and changes in the U.S. economic outlook since December 31, 2023 have resulted in a net decrease in the allowance at September 30, 2024, compared to December 31, 2023. The resulting 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 programs, was 1.51% and 1.47% as of September 30, 2024 and December 31, 2023. While changes in the U.S. economic outlook have been reflected in our current allowance at September 30, 2024, uncertainties that include, among others, the uncertain timing, duration and significance of further changes in market interest rates and an uncertain macroeconomic forecast could adversely impact borrower cash flows and result in increases in the allowance during future periods. While all industries could experience adverse impacts, certain of our loan portfolio industry sectors and subsectors, including real estate collateralized by office buildings and auto note financing, have an increased level of risk.
The respective distribution of the 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 programs, are presented in the following table (dollars in thousands).
cv
Allowance For
as a % of
Total Loans
Loans Held
for Credit
Held For
For Investment
Investment
Non-owner occupied (1)
1.72
Owner occupied (2)
2.41
Commercial and industrial (3)
1,358,555
28,153
2.07
Construction and land development (4)
0.91
Total commercial loans
5,531,588
102,785
1.86
0.40
2.01
Total retail loans
1,803,728
7,741
0.43
Total commercial and retail loans
110,526
1.51
0.07
Mortgage warehouse lending
0.05
1.39
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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 inputs 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 September 30, 2024, excluding margin loans in the broker-dealer segment, and the banking segment mortgage warehouse 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 the economic impacts from international armed conflicts recede faster than expected and an increased demand for U.S. exports and manufacturing. Business sentiment and consumer confidence rise significantly. Real GDP is expected to grow 4.1% in the fourth quarter of 2024, 3.7% in the first quarter of 2025, 3.4% in the second quarter of 2025, and 3.5% in the third quarter of 2025. Average unemployment rates are expected to decline to 3.7% by the fourth quarter of 2024 and to 3.1% by the fourth quarter of 2025 before reverting to historical data. Inflation is expected to trend back toward the Federal Reserve’s target sooner than expected, and we expect the federal funds rate to peak at 5.3% during 2024.
Compared to our economic forecast, the downside scenario assumes the Federal Reserve’s efforts to resolve bank failures are not successful at restoring consumer and business confidence, causing banks to tighten lending standards while the Federal Reserve keeps the federal funds rate elevated due to inflation concerns. The international armed conflicts persist longer than anticipated and global supply chain issues worsen causing weaker manufacturing, increased good shortages, and the economy to fall back into recession. Real GDP is expected to decrease 3.4% in the fourth quarter of 2024, 3.5% in the first quarter of 2025, and 3.4% in the second quarter of 2025. Average unemployment rates are expected to increase to 6.0% by the fourth quarter of 2024, and to 8.3% by the fourth quarter of 2025 and then revert back to historical average rates over time. The Federal Reserve reduces the federal funds rate to support the economy to a 4.6% target by the fourth quarter of 2024 and to a 1.0% target by the first quarter of 2026.
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 $22 million or a weighted average expected loss rate of 1.2% as a percentage of our total loan portfolio, excluding margin loans in the broker-dealer segment and the banking segment mortgage warehouse 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 $52 million or a weighted average expected loss rate of 2.2% as a percentage of our total loan portfolio, excluding margin loans in the broker-dealer segment and the banking segment mortgage warehouse 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.
Our allowance for credit losses reflects our best estimate of current expected credit losses, which is highly dependent on several assumptions, including the macroeconomic outlook, inflationary pressures and labor market conditions, international armed conflicts and their impact on supply chains, the U.S elections and other various fiscal and monetary policy decisions. The sensitivities of many of these assumptions are often correlated and nonlinear so these results should not be simply extrapolated to estimate the allowance for credit losses accurately for more severe changes in economic scenarios. Future allowance for credit losses may vary considerably for these reasons.
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Allowance Activity
The following table presents the activity in our allowance for credit losses and selected credit metrics within our loan portfolio for the periods presented (in thousands). Substantially all of the activity shown within the allowance for credit losses below occurred within the banking segment.
Loans Held for Investment:
Recoveries of loans previously charged off:
Total recoveries
Loans charged off:
977
3,772
936
4,015
152
274
Total charge-offs
3,837
1,122
5,373
Net recoveries (charge-offs)
(2,894)
1,556
(7,288)
(1,747)
Average loans held for investment for the period
Total loans held for investment (end of period)
8,204,052
Loans Held for Sale:
Average loans held for sale for the period
Total loans held for sale (end of period)
1,058,806
Selected Credit Metrics:
Net recoveries (charge-offs) to average total loans held for investment (1)
(0.14)
(0.12)
Non-accrual loans:
Loans held for investment (end of period)
27,569
Loans held for sale (end of period)
3,445
3,929
Non-accrual loans to total loans (end of period)
1.02
0.34
Allowance for credit losses on loans held for investment to:
Total loans (end of period)
1.24
1.35
Total non-accrual loans (end of period)
121.64
351.84
Non-accrual loans held for investment (end of period)
126.42
401.98
Total non-accrual loans classified as loans held for investment increased by $23.4 million from December 31, 2023 to September 30, 2024. This increase was primarily due to the addition of commercial and industrial loans to non-accrual status, partially offset by a decrease due to the reclassification of a single commercial real estate non-owner occupied loan
from loans held for investment to loans held for sale, which was sold during the second quarter of 2024, and decreases in commercial real estate owner occupied loans and 1-4 family residential loans.
As previously discussed in detail within this section, the allowance for credit losses has fluctuated from period to period, which impacted the resulting ratios noted in the table above. 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).
Allocation of the Allowance for Credit Losses
Reserve
Gross Loans
23.49
23.39
17.89
17.60
20.83
19.90
10.91
12.76
22.25
21.75
0.36
4.27
4.26
The following table summarizes historical levels of the allowance for credit losses on loans held for investment, distributed by portfolio segment (in thousands).
39,563
28,737
16,552
10,008
8,744
544
104,231
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. Letters of credit are not currently reserved because they are issued primarily as credit enhancements and the likelihood of funding is low.
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 or whether repayment may depend on collateral or other risk mitigation. 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 include those loans assigned a grade of special mention and substandard accrual 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.
At September 30, 2024, we had $197.9 million of potential problem loans, compared to $207.4 million at December 31, 2023. Our potential problem loans designated as substandard accrual at September 30, 2024 and December 31, 2023, totaled $146.4 million and $204.1 million, respectively. The decrease from December 31, 2023 to September 30, 2024 was primarily attributable to decreases in commercial and industrial loans and construction and land development loans, partially offset by increases in commercial real estate owner occupied loans and 1-4 family residential loans. Of the $146.4 million of potential problem loans designated as substandard accrual at September 30, 2024, $42.9 million, $41.9 million and $28.3 million were associated with commercial real estate owner occupied loans, commercial real estate non-owner occupied loans and commercial and industrial loans.
Potential problem loans designated as special mention were comprised of ten credit relationships totaling $51.5 million at September 30, 2024, compared with three credit relationships totaling $3.2 million at December 31, 2023. Of the $51.5 million of potential problem loans at September 30, 2024, $44.4 million was associated with four credit relationships included in our commercial real estate non-owner occupied loan portfolio within the office and hotel/motel industry subsectors, commercial and industrial loan portfolio and commercial real estate owner occupied loan portfolio within the retail industry subsector.
Non-Performing Assets
The following table presents components of our non-performing assets (dollars in thousands).
Loans accounted for on a non-accrual basis:
(28,398)
(2,688)
57,427
2,682
3,480
(798)
11,123
13,801
(2,678)
Non-accrual loans
91,186
68,327
22,859
Non-accrual loans as a percentage of total loans
0.76
0.26
Other real estate owned
2,744
5,095
(2,351)
Other repossessed assets
413
Non-performing assets
94,343
73,422
20,921
Non-performing assets as a percentage of total assets
0.59
0.45
0.14
Loans past due 90 days or more and still accruing
140,763
115,090
25,673
84
At September 30, 2024, non-accrual loans included 25 commercial and industrial relationships with loans secured by finance company notes receivable, accounts receivable, inventory and equipment. Commercial and industrial non-accrual loans increased by $57.4 million from December 31, 2023 to September 30, 2024 primarily due to the additions of two credit relationships within our auto note financing industry subsector with an aggregate loan balance of $54.0 million. Non-accrual loans at September 30, 2024 also included $3.4 million of loans secured by residential and commercial real estate which were classified as loans held for sale. At December 31, 2023, non-accrual loans included 40 commercial and industrial relationships with loans secured primarily by notes receivable, accounts receivable and equipment. Non-accrual loans at December 31, 2023 also included $4.0 million of loans secured by residential real estate which were classified as loans held for sale.
Other real estate owned (“OREO”) decreased from December 31, 2023 to September 30, 2024, primarily due to disposals and valuation adjustments totaling $4.7 million, offset by additions totaling $2.4 million. At both September 30, 2024 and December 31, 2023, OREO was primarily comprised of commercial properties.
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 titled “Liquidity and Capital Resources — Banking Segment” below, is constantly changing due to the banking segment’s needs and market conditions. Currently, the banking segment is facing intense competition for its deposit base as customers seek higher yields on deposits. Consistent with the consolidated trend in average rates paid on interest-bearing deposits noted in the table below, the banking segment’s average rate paid on interest-bearing deposits during the three months ended September 30, 2024 was 3.94%, compared to 3.92% during the three months ended June 30, 2024 and 3.86% during the three months ended September 30, 2023.
Given the significance of the increases in interest rates that began during the first quarter of 2022 and which remained elevated until the Federal Reserve announced the recent 50-basis point decrease in the target range for the federal funds rate in September 2024, the Bank’s cumulative interest-bearing deposit pricing beta, excluding deposits from the Hilltop Securities FDIC-insured sweep program and brokered deposits, has approximated 68%. The deposit pricing beta represents the change in interest-bearing deposit pricing in response to a change in market interest rates. The historical interest-bearing deposit pricing beta for the Bank, excluding deposits from our Hilltop Securities FDIC-insured sweep program and brokered deposits, has approximated 55%. We expect that the Bank’s cost related to interest-bearing deposits during 2024 to continue to be driven by various factors, including competition as well as economic and market area factors.
The table below presents the average balance of, and rate paid on, consolidated deposits (dollars in thousands).
Rate Paid
Noninterest-bearing demand deposits
0.00
Interest-bearing deposits:
Demand
6,244,342
6,324,203
2.76
241,405
289,191
1,218,096
4.37
1,012,175
2.90
10,537,983
2.64
11,183,334
The table above includes interest-bearing brokered deposits with balances of approximately $15 million at September 30, 2024, compared with approximately $208 million at December 31, 2023. As previously discussed, to bolster our liquidity position given banking sector uncertainties in early 2023, we increased brokered deposits at the Bank by approximately $390 million during the second quarter of 2023, which have subsequently matured during the first and second quarters of 2024. The variability in the level of brokered deposits has been, and will continue to be, managed through asset/liability strategy and policies that address diversification of funding sources and market conditions, including demand by customers and other investors for those deposits, and the cost of funds available from alternative sources at the time.
At September 30, 2024, total estimated uninsured deposits were $5.3 billion, or approximately 49% of total deposits, while estimated uninsured deposits, excluding collateralized deposits of $312.3 million, were $5.0 billion, or approximately 46% of total deposits. Total estimated uninsured deposits were $4.7 billion, or approximately 42% of total deposits, as of December 31, 2023. The increase in estimated uninsured deposit balances during 2024 was primarily due to the increase in existing deposit customers’ balances, while estimated uninsured deposit balances were also impacted by new commercial and consumer depositors of approximately $200 million and $130 million, respectively.
The following table presents the scheduled maturities of the portion of our time deposits that are in excess of the FDIC insurance limit of $250,000 as of September 30, 2024 (in thousands).
Months to maturity:
3 months or less
315,881
3 months to 6 months
116,765
6 months to 12 months
75,023
Over 12 months
102,985
610,654
Borrowings
Our consolidated borrowings are shown in the table below (dollars in thousands).
4.75
14,607
4.13
388
1,262,178
4.56
1,247,183
14,995
Short-term borrowings consisted of federal funds purchased, securities sold under agreements to repurchase, borrowings at the FHLB, short-term bank loans and commercial paper. The increase in short-term borrowings at September 30, 2024, compared with December 31, 2023, primarily reflected increases in federal funds purchased by the banking segment and commercial paper by the broker dealer segment, offset by a decrease in securities sold under agreements to repurchase by the broker-dealer segment. Notes payable at September 30, 2024 was comprised of $149.7 million related to the Senior Notes, net of loan origination fees, and Subordinated Notes, net of origination fees, of $197.9 million.
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 September 30, 2024, Hilltop had $227.1 million in cash and cash equivalents, an increase of $35.5 million from $191.6 million at December 31, 2023. This increase in cash and cash equivalents was primarily due to the receipt of $114.3 million of dividends from subsidiaries, partially offset by cash outflows of $33.2 million in cash dividends declared, $19.9 million in 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 discussed in more detail below, our Senior Notes mature in April 2025, and we have the ability to redeem the 2030 Subordinated Notes, in whole or in part, beginning in May 2025. We continue to evaluate our options, including early redemption of these notes per their respective indentures, and may choose to refinance and/or utilize available cash on hand to satisfy such existing indebtedness. Although it is difficult in the current economic environment to predict the terms and conditions of financing that may be available in the future, we believe that we have sufficient access to credit from financial institutions and/or financing from public and private debt and equity markets to refinance or repay our Senior Notes.
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As previously discussed, operational and financial headwinds during 2023 have had, and are expected to continue to have, an adverse impact on our operating results during 2024. The extent of the impacts of uncertain economic conditions on our financial performance that began in 2022, and have continued into 2024, will depend in part on developments outside of our control, including, among others, the timing and significance of further changes in U.S. Treasury yields and mortgage interest rates, changes in funding costs, inflationary pressures, and international armed conflicts and their impact on supply chains. As demonstrated during both the extreme volatility and disruptions in the capital and credit markets beginning in March 2020 resulting from the pandemic and banking sector-related uncertainty and concerns associated with liquidity primarily due to high-profile bank failures during early 2023 and their respective negative impacts on the economy, we will continue to monitor the economic environment and evaluate appropriate actions to enhance our financial flexibility, protect capital, minimize losses and ensure target liquidity levels.
Dividend Declaration
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 2024, our board of directors authorized a new stock repurchase program through January 2025, 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. During the nine months ended September 30, 2024, Hilltop paid $19.9 million to repurchase an aggregate of 640,042 shares of our common stock at an average price of $31.04 per share pursuant to the stock repurchase program.
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 September 30, 2024, $150.0 million of our Senior Notes was outstanding.
Subordinated Notes due 2030 and 2035
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 that mature on May 15, 2030 and May 15, 2035, respectively. 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.
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 September 30, 2024, $200.0 million of our Subordinated Notes was 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.
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 the conservation buffer ratio in effect at September 30, 2024 (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 September 30, 2024 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 current expected credit losses over a five-year transitionary period through December 31, 2024.
Minimum Capital
Requirements Including
Conservation Buffer
We discuss regulatory capital requirements in more detail in Note 16 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 1, of our 2023 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
88
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.
The above sources of liquidity allow the banking segment to meet increased liquidity demands without adversely affecting daily operations. The Bank’s borrowing capacity through access to secured funding sources is summarized in the following table (in millions). Available liquidity noted below does not include borrowing capacity available through the discount window at the Federal Reserve.
FHLB capacity
4,374
4,205
Investment portfolio (available)
1,405
1,594
Fed deposits (excess daily requirements)
1,750
1,612
7,529
7,411
As previously discussed, the banking sector experienced increased uncertainty and concerns associated with its liquidity positions primarily due to high-profile bank failures during early 2023 as depositors sought to reduce risks associated with uninsured deposits and withdraw such deposits from existing bank relationships. As a result, both regulatory scrutiny and market focus on liquidity increased. These failures underscore the importance of maintaining access to diverse sources of funding. In light of these events, we have continued our efforts to monitor deposit flows and balance sheet trends to ensure that our liquidity needs are maintained. During 2023, we began increasing interest-bearing deposit rates to address rising market interest rates and intense competition for liquidity to combat deposit outflows. During the first nine months of 2024, our deposit funding costs increased due to intense competition for liquidity and customers seeking higher yields on deposits. While we expect deposit costs during 2024 to continue to be driven by various factors, including competitive pressures and broader economic conditions, with the recent 50-basis point decrease in the target range of the federal funds rate in September 2024 and the possibility of additional rate cuts in 2024, we anticipate that our cost of deposits will begin to trend modestly downward. At September 30, 2024, the Bank also accessed and included approximately $760 million of core deposits on its balance sheet from our Hilltop Securities FDIC-insured sweep program, while the Bank is not utilizing any of its FHLB borrowing capacity noted above through the use of short-term borrowings.
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. 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. Currently, the Bank is facing intense competition from bank and non-bank competitors for its deposit base and expects that its interest expense on certain deposits will continue to be driven by various factors, including competition as well as economic and market area factors.
The Bank’s 15 largest depositors, excluding Hilltop and Hilltop Securities, collectively accounted for 12.14% of the Bank’s total deposits, and the Bank’s five largest depositors, excluding Hilltop and Hilltop Securities, collectively accounted for 6.42% of the Bank’s total deposits at September 30, 2024. 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 September 30, 2024, Hilltop Securities had credit arrangements with two unaffiliated banks, with maximum aggregate commitments of up to $425.0 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 two unaffiliated banks, with aggregate availability of up to $200.0 million. At September 30, 2024, Hilltop Securities had no borrowings under its credit arrangements or 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 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 September 30, 2024, the weighted average maturity of the CP Notes was 155 days at a rate of 5.80% with a weighted average remaining life of 71 days. At September 30, 2024, the aggregate amount outstanding under these secured arrangements was $220.6 million, which was collateralized by securities held for Hilltop Securities accounts valued at $241.1 million.
PrimeLending funds the mortgage loans it originates through a warehouse line of credit maintained with the Bank, which had a total commitment of $1.2 billion, of which $717.7 million was drawn at September 30, 2024. 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 September 30, 2024.
PrimeLending owns a 100% membership interest in PrimeLending Ventures Management, LLC (“Ventures Management”), which holds a controlling ownership interest in and is the managing member of certain ABAs. At September 30, 2024, these ABAs had combined available lines of credit totaling $65.0 million, all of which was with the Bank, with outstanding borrowings of $41.0 million.
Other Material Contractual Obligations, Off-Balance Sheet Arrangements, Commitments and Guarantees
Since December 31, 2023, there have been no material changes in other material contractual obligations disclosed within the section captioned “Other Material Contractual Obligations, Off-Balance Sheet Arrangements, Commitments and Guarantees” set forth in Part II, Item 7 of our 2023 Form 10-K.
Additionally, 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.
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.
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. Historically, changes in interest rates affect the financial condition of a financial institution to a far greater degree than changes in the inflation rate. However, inflation rose sharply at the end of 2021 and continued to rise in 2023 at levels not seen for over 40 years. Inflationary pressures have moderated in recent periods with the inflation rate coming down from its peak with the expectation that there will be continued moderation of inflation during the remainder of 2024. Furthermore, a prolonged period of inflation has, and could continue to cause our costs, including compensation, occupancy and software costs, to increase, which could adversely affect our results of operations and financial condition.
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.
Critical Accounting Estimates
We have identified certain accounting estimates which involve a significant level of estimation uncertainty and have had or are reasonably likely to have a material impact on our financial condition or results of operations. Our accounting policies are more fully described in Note 1 to the 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. The critical accounting estimates, as summarized below, which we believe to be the most critical in preparing our consolidated financial statements relate to allowance for credit losses, mortgage servicing rights asset, goodwill and identifiable intangible assets, mortgage loan indemnification liability and acquisition accounting. Since December 31, 2023, there have been no changes in critical accounting estimates as further described under “Critical Accounting Estimates” in our 2023 Form 10-K.
Item 3. Quantitative and Qualitative Disclosures About Market Risk.
Our assessment of market risk as of September 30, 2024 indicates there are no material changes in the quantitative and qualitative disclosures from those previously reported in our 2023 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. To help mitigate net interest income spread volatility between our assets and liabilities, management maintains derivative trades, as either cash flow hedges or fair value hedges, that better align repricing characteristics. Any changes in interest rates across the term structure may 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.
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.
As illustrated in the table below, the banking segment is currently 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:
4,238,159
1,263,344
1,725,246
699,880
504,385
8,431,014
491,545
204,333
414,966
310,341
878,065
2,299,250
1,918,893
Other interest sensitive assets
8,783
59,504
68,287
Total interest sensitive assets
6,657,380
1,467,677
2,140,212
1,010,221
1,441,954
12,717,444
Interest sensitive liabilities:
Interest bearing checking
6,400,270
Time deposits
636,900
461,577
122,335
49,756
1,270,568
495,477
Total interest sensitive liabilities
7,757,280
8,390,948
Interest sensitivity gap
(1,099,900)
1,006,100
2,017,877
960,465
4,326,496
Cumulative interest sensitivity gap
(93,800)
1,924,077
2,884,542
Percentage of cumulative gap to total interest sensitive assets
(8.65)
(0.74)
15.13
22.68
34.02
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 September 30, 2024 (dollars in thousands).
Change in
Interest Rates
Net Interest Income
Economic Value of Equity
(basis points)
+200
41,508
10.63
212,679
16.49
+100
21,813
128,357
9.95
-50
(10,649)
(2.73)
(89,086)
(6.91)
-100
(21,368)
(5.47)
(198,272)
(15.37)
-200
(34,897)
(8.93)
(424,294)
(32.89)
The projected changes in the table above were in compliance with established internal policy guidelines, with the exception of the estimated change in economic value of equity impact based on a -200 basis points change in interest rates, which marginally exceeded management’s internal policy limit. These projected changes are based on numerous assumptions. Upon implementation of pending assumption updates based on the expected transition into the next interest rate cycle, management anticipates that over time the estimated change in economic value of equity impact will return to compliance with established internal policy limit. Furthermore, the projected changes in net interest income are being impacted by the heightened level of cash balances, which represent a significant portion of the Bank’s sensitivity given simulation analysis assumptions/limitations. As a result, the timing and magnitude of future changes in interest rates and any runoff of deposits, and related decline in cash, may impact projected changes in net interest income as noted in the table above. Given projected impacts on net interest income associated with the expected transition into the next phase of
the interest rate cycle, we continue to evaluate our current GAP position, which may result in a repositioning of the banking segment towards a more neutral or liability sensitive balance sheet.
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
6,195
28,449
38,405
187,274
U.S. government and government agency obligations
(669)
(6,123)
(7,084)
184,146
170,270
Corporate obligations
11,983
8,653
10,320
23,707
54,663
Total debt securities
17,509
30,979
41,641
395,127
485,256
Corporate equity securities
7,753
25,262
Weighted average yield
0.61
4.18
4.97
4.10
4.22
3.68
2.60
6.41
4.09
4.54
4.47
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.
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.
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, and 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 MSR portfolio exposes us to 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.
At September 30, 2024, total debt obligations on our consolidated balance sheet, excluding short-term borrowings and unamortized debt issuance costs and premiums, were $350 million, and was all subject to fixed interest rates. If interest rates were to increase by one eighth of one percent (0.125%), the increase in interest expense on the variable rate debt would not have a significant impact on our future consolidated earnings or cash flows.
As noted above within the discussion for each business segment, on a consolidated basis, our primary component of market risk is sensitivity to changes in interest rates. Consequently, and in large part due to the significance of our banking segment, our consolidated earnings depend to a significant extent on our net interest income. Refer to the discussion in the “Banking Segment” section above that provides more details regarding sources of interest rate risk and asset/liability management policies and procedures employed to manage our interest-earning assets and interest-bearing liabilities, and potential future repositioning of our GAP position, thereby attempting to control the volatility of net interest income, without having to incur unacceptable levels of risk.
The table below shows the estimated impact of a range of changes in interest rates on net interest income on a consolidated basis at September 30, 2024 (dollars in thousands).
53,934
12.85
27,972
6.66
(13,695)
(3.26)
(27,440)
(6.54)
(51,206)
(12.20)
The projected changes in the table above were in compliance with established internal policy guidelines. These projected changes are based on numerous assumptions of growth and changes in the mix of assets or liabilities. The projected changes in net interest income are being impacted by the heightened level of cash balances, which represent a significant portion of our asset sensitivity given simulation analysis assumptions/limitations. As a result, the timing and magnitude of future changes in interest rates including runoff of deposits, and related decline in cash, may impact projected changes in net interest income as noted in the table above.
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 the third 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 13 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 2023 Form 10-K. For additional information concerning our risk factors, please refer to “Item 1A. Risk Factors” of our 2023 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 September 30, 2024.
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)
July 1 - July 31, 2024
55,152,099
August 1 - August 31, 2024
September 1 - September 30, 2024
Item 5. Other Information
Pursuant to Item 408(a) of Regulation S-K, none of our directors or executive officers adopted, terminated or modified a Rule 10b5-1 trading arrangement or a non-Rule 10b5-1 trading arrangement during the three months ended September 30, 2024.
Item 6. Exhibits.
ExhibitNumber
Description of Exhibit
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.
** Furnished herewith.
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: October 25, 2024
By:
/s/ William B. Furr
William B. Furr
Chief Financial Officer
(Principal Financial Officer and duly authorized officer)