Edgar Filing: Hilltop Holdings Inc.

Table of Contents

UNITED STATES

SECURITIES AND EXCHANGE COMMISSION

Washington, DC 20549

FORM 10-Q

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

For the quarterly period ended June 30, 2013

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

Commission File Number: 1-31987

Hilltop Holdings Inc.

(Exact name of registrant as specified in its charter)

Maryland		84-1477939
(State or other jurisdiction of incorporation or organization)		(I.R.S. Employer Identification No.)

200 Crescent Court, Suite 1330
Dallas, TX		75201
(Address of principal executive offices)		(Zip Code)

(214) 855-2177

(Registrant’s telephone number, including area code)

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

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

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

Large accelerated filer o		Accelerated filer x

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

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

The number of shares of the registrant’s common stock outstanding at August 2, 2013 was 83,958,844.

Table of Contents

HILLTOP HOLDINGS INC.

FORM 10-Q

FOR THE QUARTER ENDED JUNE 30, 2013

TABLE OF CONTENTS

PART I — FINANCIAL INFORMATION

		Item 1.	Financial Statements.
			Consolidated Balance Sheets	3
			Consolidated Statements of Operations	4
			Consolidated Statements of Comprehensive Income (Loss)	5
			Consolidated Statements of Stockholders’ Equity	6
			Consolidated Statements of Cash Flows	7
			Notes to Consolidated Financial Statements	8

		Item 2.	Management’s Discussion and Analysis of Financial Condition and Results of Operations	37

		Item 3.	Quantitative and Qualitative Disclosures About Market Risk	57

		Item 4.	Controls and Procedures	59

PART II — OTHER INFORMATION

	Item 1.		Legal Proceedings	60

	Item 1A.		Risk Factors	60

	Item 2.		Unregistered Sales of Equity Securities and Use of Proceeds	61

	Item 6.		Exhibits	61

Table of Contents

HILLTOP HOLDINGS INC. AND SUBSIDIARIES

CONSOLIDATED BALANCE SHEETS

(in thousands, except share and per share data)

	June 30,			December 31,
	2013			2012
	(Unaudited)
Assets
Cash and due from banks	$	596,351		$	722,039
Federal funds sold and securities purchased under agreements to resell	32,939			4,421
Securities:
Trading, at fair value	32,857			90,113
Available for sale, at fair value (amortized cost of $1,103,289 and $978,502, respectively)	1,073,522			990,953
	1,106,379			1,081,066

Loans held for sale	1,412,960			1,401,507
Loans, net of unearned income	3,253,001			3,152,396
Allowance for loan losses	(26,237		)	(3,409		)
Loans, net	3,226,764			3,148,987

Broker-dealer and clearing organization receivables	208,011			145,564
Insurance premiums receivable	26,987			24,615
Deferred policy acquisition costs	21,680			19,812
Reinsurance receivable, net of uncollectible amounts	6,340			18,567
Premises and equipment, net	110,937			111,381
Other assets	329,302			277,398
Goodwill	251,808			253,770
Other intangible assets, net	72,345			77,738
Total assets	$	7,402,803		$	7,286,865

Liabilities and Stockholders’ Equity
Deposits:
Noninterest-bearing	$	208,702		$	323,367
Interest-bearing	4,287,767			4,377,094
Total deposits	4,496,469			4,700,461

Broker-dealer and clearing organization payables	246,681			187,990
Reserve for losses and loss adjustment expenses	42,458			34,012
Unearned insurance premiums	90,411			82,598
Short-term borrowings	1,003,804			728,250
Notes payable	139,938			141,539
Junior subordinated debentures	67,012			67,012
Other liabilities	144,230			198,453
Total liabilities	6,231,003			6,140,315
Commitments and contingencies (see Notes 9 and 10)
Stockholders’ equity:
Hilltop Holdings stockholders’ equity:
Preferred stock, $0.01 par value, 10,000,000 shares authorized;
Series B, liquidation value per share of $1,000; 114,068 shares issued and outstanding, respectively	114,068			114,068
Common stock, $0.01 par value, 100,000,000 shares authorized; 83,955,870 and 83,487,340 shares issued and outstanding, respectively	840			835
Additional paid-in capital	1,303,118			1,304,448
Accumulated other comprehensive income (loss)	(19,347		)	8,094
Accumulated deficit	(227,784		)	(282,949		)
Total Hilltop Holdings stockholders’ equity	1,170,895			1,144,496
Noncontrolling interest	905			2,054
Total stockholders’ equity	1,171,800			1,146,550
Total liabilities and stockholders’ equity	$	7,402,803		$	7,286,865

See accompanying notes.

Table of Contents

HILLTOP HOLDINGS INC. AND SUBSIDIARIES

CONSOLIDATED STATEMENTS OF OPERATIONS

(in thousands, except per share data)

(Unaudited)

	Three Months Ended June 30,					Six Months Ended June 30,
	2013		2012			2013		2012
Interest income:
Loans, including fees	$	65,213	$	—		$	130,099	$	—
Securities:
Taxable	6,480		3,366			12,392		6,742
Tax-exempt	1,189		—			2,536		—
Federal funds sold and securities purchased under agreements to resell	35		—			56		—
Interest-bearing deposits with banks	242		—			575		—
Other	3,009		—			5,114		—
Total interest income	76,168		3,366			150,772		6,742

Interest expense:
Deposits	3,406		—			6,856		—
Short-term borrowings	591		—			1,104		—
Notes payable	2,308		2,131			4,630		4,270
Junior subordinated debentures	612		—			1,220		—
Other	826		—			1,276		—
Total interest expense	7,743		2,131			15,086		4,270

Net interest income	68,425		1,235			135,686		2,472
Provision for loan losses	11,289		—			24,294		—
Net interest income after provision for loan losses	57,136		1,235			111,392		2,472

Noninterest income:
Net gains from sale of loans and other mortgage production income	142,531		—			270,127		—
Mortgage loan origination fees	22,695		—			41,588		—
Net insurance premiums earned	38,590		36,195			76,063		71,350
Investment and securities advisory fees and commissions	25,964		—			47,973		—
Other	9,453		1,851			16,760		3,562
Total noninterest income	239,233		38,046			452,511		74,912

Noninterest expense:
Employees’ compensation and benefits	132,715		2,272			248,905		4,498
Loss and loss adjustment expenses	48,160		39,071			69,345		61,613
Policy acquisition and other underwriting expenses	11,627		10,842			22,430		21,743
Occupancy and equipment, net	20,154		248			39,566		492
Other	47,744		2,800			95,145		4,444
Total noninterest expense	260,400		55,233			475,391		92,790

Income (loss) before income taxes	35,969		(15,952		)	88,512		(15,406		)
Income tax expense (benefit)	13,309		(5,243		)	32,479		(5,040		)

Net income (loss)	22,660		(10,709		)	56,033		(10,366		)
Less: Net income attributable to noncontrolling interest	568		—			868		—

Income (loss) attributable to Hilltop Holdings	22,092		(10,709		)	55,165		(10,366		)
Dividends on preferred stock	1,149		—			1,852		—
Income (loss) applicable to Hilltop Holdings common stockholders	$	20,943	$	(10,709	)	$	53,313	$	(10,366	)

Earnings (loss) per common share:
Basic	$	0.25	$	(0.19	)	$	0.64	$	(0.18	)
Diluted	$	0.24	$	(0.19	)	$	0.61	$	(0.18	)

Weighted average share information:
Basic	83,490		56,362			83,489		56,431
Diluted	90,294		56,362			90,125		56,431

See accompanying notes.

Table of Contents

HILLTOP HOLDINGS INC. AND SUBSIDIARIES

CONSOLIDATED STATEMENTS OF COMPREHENSIVE INCOME (LOSS)

(in thousands)

(Unaudited)

	Three Months Ended June 30,						Six Months Ended June 30,
	2013			2012			2013			2012
Net income (loss)	$	22,660		$	(10,709	)	$	56,033		$	(10,366	)
Other comprehensive income (loss):
Unrealized losses on securities available for sale, net of tax of $(15,249), $(1,075), $(14,776) and $(2,906)	(28,320		)	(1,996		)	(27,441		)	(5,397		)
Comprehensive income (loss)	(5,660		)	(12,705		)	28,592			(15,763		)
Less: comprehensive income attributable to noncontrolling interest	568			—			868			—

Comprehensive income (loss) applicable to Hilltop Holdings	$	(6,228	)	$	(12,705	)	$	27,724		$	(15,763	)

See accompanying notes.

Table of Contents

HILLTOP HOLDINGS INC. AND SUBSIDIARIES

CONSOLIDATED STATEMENTS OF STOCKHOLDERS’ EQUITY

(in thousands)

(Unaudited)

												Accumulated						Total
									Additional			Other						Hilltop Holdings						Total
	Preferred Stock			Common Stock					Paid-in			Comprehensive			Accumulated			Stockholders’			Noncontrolling			Stockholders’
	Shares	Amount		Shares		Amount			Capital			Income (Loss)			Deficit			Equity			Interest			Equity
Balance, December 31, 2011	—	$	—	56,501		$	565		$	918,192		$	13,983		$	(277,357	)	$	655,383		$	—		$	655,383
Net loss	—	—		—		—			—			—			(10,366		)	(10,366		)	—			(10,366		)
Other comprehensive loss	—	—		—		—			—			(5,397		)	—			(5,397		)	—			(5,397		)
Common stock issued to board members	—	—		2		—			24			—			—			24			—			24
Repurchase and retirement of common stock	—	—		(141	)	(1		)	(1,161		)	—			—			(1,162		)	—			(1,162		)
Stock-based compensation expense	—	—		—		—			244			—			—			244			—			244
Balance, June 30, 2012	—	$	—	56,362		$	564		$	917,299		$	8,586		$	(287,723	)	$	638,726		$	—		$	638,726

Balance, December 31, 2012	114	$	114,068	83,487		$	835		$	1,304,448		$	8,094		$	(282,949	)	$	1,144,496		$	2,054		$	1,146,550
Net income	—	—		—		—			—			—			55,165			55,165			868			56,033
Other comprehensive loss	—	—		—		—			—			(27,441		)	—			(27,441		)	—			(27,441		)
Stock-based compensation expense	—	—		—		—			480			—			—			480			—			480
Common stock issued to board members	—	—		4		—			47			—			—			47			—			47
Issuance of restricted common stock	—	—		465		5			(5		)	—			—			—			—			—
Dividends on preferred stock	—	—		—		—			(1,852		)	—			—			(1,852		)	—			(1,852		)
Cash distributions to noncontrolling interest	—	—		—		—			—			—			—			—			(2,017		)	(2,017		)
Balance, June 30, 2013	114	$	114,068	83,956		$	840		$	1,303,118		$	(19,347	)	$	(227,784	)	$	1,170,895		$	905		$	1,171,800

See accompanying notes.

Table of Contents

HILLTOP HOLDINGS INC. AND SUBSIDIARIES

CONSOLIDATED STATEMENTS OF CASH FLOWS

(in thousands)

(Unaudited)

	Six Months Ended June 30,
	2013			2012
Operating Activities
Net income (loss)	$	56,033		$	(10,366	)
Adjustments to reconcile net income (loss) to net cash provided by (used in) operating activities
Provision for loan losses	24,294			—
Depreciation, amortization and accretion, net	(18,032		)	690
Deferred income taxes	(11,528		)	(5,040		)
Other, net	533			321
Net change in securities purchased under resale agreements	(3,237		)	—
Net change in trading securities	57,256			—
Net change in broker-dealer and clearing organization receivables	(76,430		)	—
Net change in other assets	34,972			(507		)
Net change in broker-dealer and clearing organization payables	17,281			—
Net change in loss and loss adjustment expense reserve	8,446			7,252
Net change in unearned insurance premiums	7,813			5,973
Net change in other liabilities	(37,247		)	105
Net gains from sale of loans	(270,127		)	—
Loans originated for sale	(6,545,177		)	—
Proceeds from loans sold	6,769,795			—
Net cash provided by (used in) operating activities	14,645			(1,572		)

Investing Activities
Proceeds from sales, maturities and principal reductions of securities available for sale	96,069			3,436
Purchases of securities available for sale	(223,570		)	(2,717		)
Net change in loans	(51,027		)	—
Purchases of premises and equipment and other assets	(11,417		)	(93		)
Proceeds from sales of premises and equipment and other real estate owned	4,859			—
Net cash paid for Federal Home Loan Bank and Federal Reserve Bank stock	(21,219		)	—
Net cash provided by (used in) investing activities	(206,305		)	626

Financing Activities
Net change in deposits	(179,826		)	—
Net change in short-term borrowings	275,554			—
Payments on notes payable	(1,601		)	—
Payments to repurchase common stock	—			(1,162		)
Dividends paid	(703		)	—
Net cash distributed to noncontrolling interest	(2,017		)	—
Other, net	(154		)	—
Net cash provided by (used in) financing activities	91,253			(1,162		)

Net change in cash and cash equivalents	(100,407		)	(2,108		)
Cash and cash equivalents, beginning of period	726,460			578,520
Cash and cash equivalents, end of period	$	626,053		$	576,412

Supplemental Disclosures of Cash Flow Information
Cash paid for interest	$	14,889		$	4,180
Cash paid for income taxes, net of refunds	$	40,949		$	—
Supplemental Schedule of Non-Cash Activities
Conversion of loans to other real estate owned	$	1,718		$	—

See accompanying notes.

Table of Contents

Hilltop Holdings Inc. and Subsidiaries

Notes to Consolidated Financial Statements

(Unaudited)

1. Summary of Significant Accounting and Reporting Policies

Nature of Operations

Hilltop Holdings Inc. (“Hilltop” or the “Company”) is a holding company that endeavors to make acquisitions or effect business combinations. In connection with this strategy, on November 30, 2012, Hilltop became a financial holding company registered under the Bank Holding Company Act of 1956, as amended by the Gramm-Leach-Bliley Act of 1999, and acquired PlainsCapital Corporation pursuant to an agreement and plan of merger whereby PlainsCapital Corporation merged with and into our wholly owned subsidiary (the “Merger”), which survived the Merger under the name “PlainsCapital Corporation” (“PlainsCapital”).

PlainsCapital is a financial holding company, headquartered in Dallas, Texas, that provides, through its subsidiaries, an array of financial products and services. In addition to traditional banking services, PlainsCapital provides residential mortgage lending, investment banking, public finance advisory, wealth and investment management, treasury management, capital equipment leasing, fixed income sales, asset management, and correspondent clearing services. Certain disclosures within the notes to consolidated financial statements are specific to financial products and services of PlainsCapital and its subsidiaries and therefore include information at June 30, 2013 and December 31, 2012 and relating to the three and six months ended June 30, 2013.

Prior to the consummation of the Merger, Hilltop’s primary operations were limited to providing fire and homeowners insurance to low value dwellings and manufactured homes primarily in Texas and other areas of the southern United States through Hilltop’s wholly owned property and casualty insurance holding company, National Lloyds Corporation (“NLC”), formerly known as NLASCO, Inc.

Basis of Presentation

The accompanying unaudited consolidated financial statements have been prepared in conformity with accounting principles generally accepted in the United States (“GAAP”), and in conformity with the rules and regulations of the Securities and Exchange Commission (the “SEC”). In the opinion of management, these financial statements contain all adjustments (consisting primarily of normal recurring accruals) 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, 2012. 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 loan losses, the fair values of financial instruments, reserves for losses and loss adjustment expenses, the mortgage loan indemnification liability and the potential impairment of assets are particularly subject to change.

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

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

Table of Contents

Hilltop Holdings Inc. and Subsidiaries

Notes to Consolidated Financial Statements (continued)

(Unaudited)

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

PrimeLending owns a 100% membership interest in PrimeLending Ventures Management, LLC, the controlling and sole managing member of PrimeLending Ventures, LLC (“Ventures”). Through a series limited liability company structure, Ventures establishes one or more separate operating divisions with select business partners, such as home builders, to originate residential mortgage loans.

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

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

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

2. PlainsCapital Acquisition

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

The Merger was accounted for using the purchase method of accounting, and accordingly, purchased assets, including identifiable intangible assets, and assumed liabilities were recorded at their respective acquisition date fair values. The Company initially recorded $230.1 million of goodwill in connection with the Merger, representing the inherent long-term value expected from the business opportunities created from combining PlainsCapital with Hilltop. The amount of goodwill recorded in connection with the Company’s acquisition of PlainsCapital Corporation is not deductible for tax purposes. The Company used significant estimates and assumptions to value the identifiable assets acquired and liabilities assumed. The purchase date valuations are considered preliminary and are subject to change for up to one year after the acquisition date. During the three months ended March 31, 2013, the Company reduced goodwill related to the PlainsCapital acquisition by $2.0 million for a purchase accounting adjustment related to the valuation of a capital lease obligation. The Company made no adjustments to its purchase price allocation during the three months ended June 30, 2013.

The operations acquired in the Merger have been included in Hilltop’s financial results since December 1, 2012. The following table presents pro forma results for the three and six months ended June 30, 2012 had the acquisition taken place on January 1, 2011 (in thousands). The pro forma financial information combines the historical results of Hilltop and PlainsCapital Corporation and includes the estimated impact of purchase accounting adjustments. The purchase accounting adjustments reflect the impact of recording the acquired loans at fair value, including the estimated accretion of the purchase discount on the loan portfolio and related adjustments to PlainsCapital’s provision for loan losses. Accretion estimates were based on the acquisition date purchase discount on the loan portfolio, as it was not practicable to determine the amount of discount that would have been recorded based on economic conditions that existed on January 1,

Table of Contents

Hilltop Holdings Inc. and Subsidiaries

Notes to Consolidated Financial Statements (continued)

(Unaudited)

2011. The pro forma results do not include any potential operating cost savings as a result of the Merger. Further, certain costs associated with any restructuring or integration activities are also not reflected in the pro forma results. Pro forma results include the acquisition-related merger and restructuring charges incurred during the period. The pro forma results are not indicative of what would have occurred had the acquisition taken place on the indicated date.

	Three Months Ended		Six Months Ended
	June 30, 2012		June 30, 2012
Net interest income	$	54,205	$	107,768
Other revenues	206,465		393,437
Net income	16,042		38,729

3. Fair Value Measurements

Fair Value Measurements and Disclosures

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

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

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

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

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

Fair Value Option

Hilltop has elected to measure substantially all of PrimeLending’s mortgage loans held for sale at fair value under the provisions of the Fair Value Option Subsections of the ASC (“Fair Value Option”). Hilltop 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. Hilltop determines the fair value of the financial instruments accounted for under the provisions of the Fair Value Option in compliance with the provisions of the Fair Value Topic of the ASC discussed above.

Table of Contents

Hilltop Holdings Inc. and Subsidiaries

Notes to Consolidated Financial Statements (continued)

(Unaudited)

At June 30, 2013, the aggregate fair value of PrimeLending’s mortgage loans held for sale accounted for under the Fair Value Option and the unpaid principal balance of those loans was $1.41 billion. At December 31, 2012, the aggregate fair value of PrimeLending’s mortgage loans held for sale accounted for under the Fair Value Option was $1.40 billion, while the unpaid principal balance of those loans was $1.36 billion. The interest component of fair value is reported as interest income on loans in the accompanying consolidated statements of operations.

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

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

	Level 1		Level 2		Level 3		Total
	Inputs		Inputs		Inputs		Fair Value
June 30, 2013
Cash and cash equivalents	$	629,290	$	—	$	—	$	629,290
Trading securities	—		32,857		—		32,857
Available for sale securities	20,798		997,214		55,510		1,073,522
Loans held for sale	—		1,412,293		—		1,412,293
Derivative assets	—		51,348		—		51,348
Mortgage servicing asset	—		—		7,111		7,111
Trading liabilities	—		47		—		47
Derivative liabilities	—		2,686		—		2,686

	Level 1		Level 2		Level 3		Total
	Inputs		Inputs		Inputs		Fair Value
December 31, 2012
Cash and cash equivalents	$	726,460	$	—	$	—	$	726,460
Trading securities	—		90,113		—		90,113
Available for sale securities	20,428		914,248		56,277		990,953
Loans held for sale	—		1,400,737		—		1,400,737
Derivative assets	—		15,697		—		15,697
Mortgage servicing asset	—		—		2,080		2,080
Time deposits	—		1,073		—		1,073
Trading liabilities	—		3,164		—		3,164
Derivative liabilities	—		1,080		—		1,080

Table of Contents

Hilltop Holdings Inc. and Subsidiaries

Notes to Consolidated Financial Statements (continued)

(Unaudited)

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

							Total Gains or Losses
							(Realized or Unrealized)
	Balance at								Included in Other
	Beginning of						Included in		Comprehensive			Balance at
	Period		Purchases		Issuances		Net Income (Loss)		Income (Loss)			End of Period
Three months ended June 30, 2013
Available for sale securities	$	58,801	$	—	$	—	$	—	$	(3,291	)	$	55,510
Mortgage servicing asset	4,430		—		2,180		501		—			7,111
Total	$	63,231	$	—	$	2,180	$	501	$	(3,291	)	$	62,621

Six months ended June 30, 2013
Available for sale securities	$	56,277	$	—	$	—	$	—	$	(767	)	$	55,510
Mortgage servicing asset	2,080		—		4,305		726		—			7,111
Total	$	58,357	$	—	$	4,305	$	726	$	(767	)	$	62,621

Three months ended June 30, 2012
Available for sale securities	$	56,560	$	—	$	—	$	—	$	(1,983	)	$	54,577
Total	$	56,560	$	—	$	—	$	—	$	(1,983	)	$	54,577

Six months ended June 30, 2012
Available for sale securities	$	60,377	$	—	$	—	$	—	$	(5,800	)	$	54,577
Total	$	60,377	$	—	$	—	$	—	$	(5,800	)	$	54,577

All net unrealized gains (losses) in the table above are reflected in the accompanying consolidated financial statements. The unrealized gains (losses) relate to financial instruments still held at June 30, 2013. The available for sale securities noted in the tables above reflect Hilltop’s note receivable and warrant with SWS Group, Inc. (“SWS”) as discussed in Note 4 to the consolidated financial statements.

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

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

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

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

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

	Changes in Fair Value for Assets and Liabilities Reported at Fair Value under Fair Value Option
	Three Months Ended June 30, 2013								Three Months Ended June 30, 2012
				Other		Total					Other		Total
	Net Gains from			Noninterest		Changes in			Net Gains from		Noninterest		Changes in
	Sale of Loans			Income		Fair Value			Sale of Loans		Income		Fair Value
Loans held for sale	$	(36,203	)	$	—	$	(36,203	)	$	—	$	—	$	—
Mortgage servicing asset	2,681			—		2,681			—		—		—
Time deposits	—			4		4			—		—		—

Table of Contents

Hilltop Holdings Inc. and Subsidiaries

Notes to Consolidated Financial Statements (continued)

(Unaudited)

	Changes in Fair Value for Assets and Liabilities Reported at Fair Value under Fair Value Option
	Six Months Ended June 30, 2013								Six Months Ended June 30, 2012
				Other		Total					Other		Total
	Net Gains from			Noninterest		Changes in			Net Gains from		Noninterest		Changes in
	Sale of Loans			Income		Fair Value			Sale of Loans		Income		Fair Value
Loans held for sale	$	(41,641	)	$	—	$	(41,641	)	$	—	$	—	$	—
Mortgage servicing asset	5,031			—		5,031			—		—		—
Time deposits	—			12		12			—		—		—

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

Impaired Loans — Hilltop reports impaired loans based on underlying fair value of the collateral through specific allowances within the allowance for loan losses. Hilltop acquired impaired, or purchased credit impaired (“PCI”) loans with a fair value of $172.9 million upon completion of the Merger. The fair value of PCI loans was determined using Level 3 inputs, including estimates of expected cash flows that incorporated assumptions regarding default rates, loss severity rates assuming default, prepayment speeds and estimated collateral values. At June 30, 2013, PCI loans with a carrying amount of $138.3 million had been reduced by specific allowances within the allowance for loan losses of $0.7 million, resulting in a reported fair value of $137.6 million.

Other Real Estate Owned — Hilltop reports other real estate owned at fair value less estimated cost to sell. Any excess of recorded investment over fair value less cost to sell is charged against the allowance for loan losses when property is initially transferred to other real estate owned. Subsequent to the initial transfer to other real estate owned, downward valuation adjustments are charged against earnings. Hilltop primarily determines fair value using Level 2 inputs consisting of independent appraisals. At June 30, 2013, the estimated fair value of other real estate owned was $8.1 million.

The Fair Value of Financial Instruments Subsection of the ASC requires disclosure of the fair value of financial assets and liabilities, including the financial assets and liabilities previously discussed. The methods for determining estimated fair value for financial assets and liabilities is described in detail in Note 3 to the consolidated financial statements included in our Annual Report on Form 10-K filed with the SEC on March 15, 2013.

Table of Contents

Hilltop Holdings Inc. and Subsidiaries

Notes to Consolidated Financial Statements (continued)

(Unaudited)

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

			Estimated Fair Value
	Carrying		Level 1		Level 2		Level 3
	Amount		Inputs		Inputs		Inputs		Total
June 30, 2013
Financial assets:
Loans, net	$	3,226,764	$	—	$	—	$	3,253,776	$	3,253,776
Broker-dealer and clearing organization receivables	208,011		—		208,011		—		208,011
Other assets	58,145		—		58,145		—		58,145

Financial liabilities:
Deposits	4,496,469		—		4,499,430		—		4,499,430
Broker-dealer and clearing organization payables	246,681		—		246,681		—		246,681
Short-term borrowings	1,003,804		—		1,003,804		—		1,003,804
Debt	206,950		—		222,627		—		222,627
Other liabilities	4,497		—		4,497		—		4,497

			Estimated Fair Value
	Carrying		Level 1		Level 2		Level 3
	Amount		Inputs		Inputs		Inputs		Total
December 31, 2012
Financial assets:
Loans, net	$	3,148,987	$	—	$	—	$	3,148,987	$	3,148,987
Broker-dealer and clearing organization receivables	145,564		—		145,564		—		145,564
Other assets	59,094		—		59,094		—		59,094

Financial liabilities:
Deposits	4,700,461		—		4,698,848		—		4,698,848
Broker-dealer and clearing organization payables	187,990		—		187,990		—		187,990
Short-term borrowings	728,250		—		728,250		—		728,250
Debt	208,551		—		217,092		—		217,092
Other liabilities	4,400		—		4,400		—		4,400

4. Securities

The amortized cost and fair value of available for sale securities are summarized as follows (in thousands).

			Gross		Gross
	Amortized		Unrealized		Unrealized
	Cost		Gains		Losses			Fair Value
June 30, 2013
U.S. Treasury securities	$	8,751	$	96	$	(33	)	$	8,814
U.S. government agencies:
Bonds	625,906		573		(30,716		)	595,763
Residential mortgage-backed securities	16,192		348		(453		)	16,087
Collateralized mortgage obligations	146,165		322		(1,607		)	144,880
Corporate debt securities	71,176		5,045		(262		)	75,959
States and political subdivisions	161,026		282		(6,540		)	154,768
Commercial mortgage-backed securities	879		64		—			943
Equity securities	19,575		1,223		—			20,798
Note receivable	41,551		1,860		—			43,411
Warrant	12,068		31		—			12,099
Totals	$	1,103,289	$	9,844	$	(39,611	)	$	1,073,522

Table of Contents

Hilltop Holdings Inc. and Subsidiaries

Notes to Consolidated Financial Statements (continued)

(Unaudited)

			Gross		Gross
	Amortized		Unrealized		Unrealized
	Cost		Gains		Losses			Fair Value
December 31, 2012
U.S. Treasury securities	$	7,046	$	141	$	(2	)	$	7,185
U.S. government agencies:
Bonds	524,888		1,663		(314		)	526,237
Residential mortgage-backed securities	18,473		490		(70		)	18,893
Collateralized mortgage obligations	97,812		191		(79		)	97,924
Corporate debt securities	79,716		7,461		—			87,177
States and political subdivisions	177,701		196		(2,138		)	175,759
Commercial mortgage-backed securities	1,001		72		—			1,073
Equity securities	19,289		1,139		—			20,428
Note receivable	40,508		3,652		—			44,160
Warrant	12,068		49		—			12,117
Totals	$	978,502	$	15,054	$	(2,603	)	$	990,953

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

Information regarding available for sale securities that were in an unrealized loss position is shown in the following table (dollars in thousands).

	June 30, 2013					December 31, 2012
	Number of			Unrealized		Number of			Unrealized
	Securities	Fair Value		Losses		Securities	Fair Value		Losses
U.S. treasury securities:
Unrealized loss for less than twelve months	4	$	6,345	$	33	2	$	2,427	$	2
Unrealized loss for twelve months or longer	—	—		—		—	—		—
	4	6,345		33		2	2,427		2
U.S. government agencies:
Bonds:
Unrealized loss for less than twelve months	38	567,672		30,716		14	236,305		314
Unrealized loss for twelve months or longer	—	—		—		—	—		—
	38	567,672		30,716		14	236,305		314
Residential mortgage-backed securities:
Unrealized loss for less than twelve months	6	11,345		453		7	12,279		70
Unrealized loss for twelve months or longer	—	—		—		—	—		—
	6	11,345		453		7	12,279		70
Collateralized mortgage obligations:
Unrealized loss for less than twelve months	13	102,242		1,607		8	38,887		79
Unrealized loss for twelve months or longer	—	—		—		—	—		—
	13	102,242		1,607		8	38,887		79
Corporate debt securities:
Unrealized loss for less than twelve months	5	5,955		262		—	—		—
Unrealized loss for twelve months or longer	—	—		—		—	—		—
	5	5,955		262		—	—		—
States and political subdivisions:
Unrealized loss for less than twelve months	194	129,529		6,540		225	156,664		2,138
Unrealized loss for twelve months or longer	—	—		—		—	—		—