Edgar Filing: Hilltop Holdings Inc.

hth_Current folio_10Q

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UNITED STATES

SECURITIES AND EXCHANGE COMMISSION

Washington, DC 20549

FORM 10-Q

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

For the quarterly period ended March 31, 2017

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

Commission File Number: 1-31987

Hilltop Holdings Inc.

(Exact name of registrant as specified in its charter)


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

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

(214) 855-2177

(Registrant’s telephone number, including area code)

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

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 ☒ No ☐

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


Large accelerated filer ☒		Accelerated filer ☐

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


Emerging growth company ☐

If an emerging growth company, indicate by check mark if the registrant has elected not to use the extended transition period for complying with any new or revised financial accounting standards provided pursuant to Section 13(a) of the Exchange Act. ☐

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

The number of shares of the registrant's common stock outstanding at April 25, 2017 was 98,529,976.

Table of Contents

HILLTOP HOLDINGS INC.

FORM 10-Q

FOR THE QUARTER ENDED MARCH 31, 2017

TABLE OF CONTENTS


PART I — FINANCIAL INFORMATION

Item 1.	Financial Statements
	Consolidated Balance Sheets	3
	Consolidated Statements of Operations	4
	Consolidated Statements of Comprehensive Income	5
	Consolidated Statements of Stockholders’ Equity	6
	Consolidated Statements of Cash Flows	7
	Notes to Consolidated Financial Statements	8
	Schedule I - Insurance Incurred and Cumulative Paid Losses and Allocated Loss and Loss Adjustment Expenses, Net of Reinsurance	53

Item 2.	Management’s Discussion and Analysis of Financial Condition and Results of Operations	54

Item 3.	Quantitative and Qualitative Disclosures About Market Risk	86

Item 4.	Controls and Procedures	89


PART II — OTHER INFORMATION

Item 1.	Legal Proceedings	90

Item 1A.	Risk Factors	90

Item 2.	Unregistered Sales of Equity Securities and Use of Proceeds	90

Item 6.	Exhibits	90

Table of Contents

HILLTOP HOLDINGS INC. AND SUBSIDIARIES

CONSOLIDATED BALANCE SHEETS

(in thousands, except share and per share data)

(Unaudited)


	March 31,		December 31,
	2017		2016
Assets
Cash and due from banks	$	545,928	$	669,357
Federal funds sold		24,404		21,407
Securities purchased under agreements to resell		113,228		89,430
Assets segregated for regulatory purposes		166,395		180,993
Securities:
Trading, at fair value		373,300		265,534
Available for sale, at fair value (amortized cost of $755,290 and $598,198, respectively)		755,546		598,007
Held to maturity, at amortized cost (fair value of $331,387 and $345,088, respectively)		337,357		351,831
		1,466,203		1,215,372

Loans held for sale		1,329,493		1,795,463
Non-covered loans, net of unearned income		5,783,853		5,843,499
Allowance for non-covered loan losses		(55,157)		(54,186)
Non-covered loans, net		5,728,696		5,789,313

Covered loans, net of allowance of $753 and $413, respectively		234,681		255,714
Broker-dealer and clearing organization receivables		1,574,031		1,497,741
Premises and equipment, net		184,091		190,361
FDIC indemnification asset		47,940		71,313
Covered other real estate owned		45,374		51,642
Other assets		583,554		613,453
Goodwill		251,808		251,808
Other intangible assets, net		42,601		44,695
Total assets	$	12,338,427	$	12,738,062

Liabilities and Stockholders' Equity
Deposits:
Noninterest-bearing	$	2,272,905	$	2,199,483
Interest-bearing		5,056,957		4,864,328
Total deposits		7,329,862		7,063,811

Broker-dealer and clearing organization payables		1,437,548		1,347,128
Short-term borrowings		753,777		1,417,289
Securities sold, not yet purchased, at fair value		144,193		153,889
Notes payable		324,701		317,912
Junior subordinated debentures		67,012		67,012
Other liabilities		392,025		496,501
Total liabilities		10,449,118		10,863,542
Commitments and contingencies (see Notes 12 and 13)
Stockholders' equity:
Hilltop stockholders' equity:
Common stock, $0.01 par value, 125,000,000 shares authorized; 98,407,385 and 98,543,774 shares issued and outstanding, respectively		984		985
Additional paid-in capital		1,570,329		1,572,877
Accumulated other comprehensive income		897		485
Retained earnings		313,197		295,568
Deferred compensation employee stock trust, net		893		903
Employee stock trust (15,057 and 15,492 shares, at cost, respectively)		(300)		(309)
Total Hilltop stockholders' equity		1,886,000		1,870,509
Noncontrolling interests		3,309		4,011
Total stockholders' equity		1,889,309		1,874,520
Total liabilities and stockholders' equity	$	12,338,427	$	12,738,062

See accompanying notes.

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HILLTOP HOLDINGS INC. AND SUBSIDIARIES

CONSOLIDATED STATEMENTS OF OPERATIONS

(in thousands, except per share data)

(Unaudited)


	Three Months Ended March 31,
	2017		2016
Interest income:
Loans, including fees	$	89,991	$	91,533
Securities borrowed		8,053		7,589
Securities:
Taxable		7,027		6,367
Tax-exempt		1,244		1,637
Other		1,926		1,028
Total interest income		108,241		108,154

Interest expense:
Deposits		4,690		3,839
Securities loaned		6,340		5,987
Short-term borrowings		1,418		1,085
Notes payable		2,814		2,582
Junior subordinated debentures		711		645
Other		168		176
Total interest expense		16,141		14,314

Net interest income		92,100		93,840
Provision for loan losses		1,705		3,407
Net interest income after provision for loan losses		90,395		90,433

Noninterest income:
Net realized gains on securities		—		46
Net gains from sale of loans and other mortgage production income		124,150		127,297
Mortgage loan origination fees		19,556		18,813
Securities commissions and fees		39,057		38,317
Investment and securities advisory fees and commissions		22,202		23,819
Net insurance premiums earned		36,140		39,733
Other		30,334		29,350
Total noninterest income		271,439		277,375

Noninterest expense:
Employees' compensation and benefits		186,559		182,761
Occupancy and equipment, net		27,293		27,833
Loss and loss adjustment expenses		21,700		21,959
Policy acquisition and other underwriting expenses		11,229		11,252
Other		73,711		81,384
Total noninterest expense		320,492		325,189

Income before income taxes		41,342		42,619
Income tax expense		15,035		14,423

Net income		26,307		28,196
Less: Net income (loss) attributable to noncontrolling interest		(127)		629
Income attributable to Hilltop	$	26,434	$	27,567

Earnings per common share:
Basic	$	0.27	$	0.28
Diluted	$	0.27	$	0.28

Cash dividends declared per common share	$	0.06	$	—

Weighted average share information:
Basic		98,441		98,153
Diluted		98,757		98,669

See accompanying notes.

Table of Contents

HILLTOP HOLDINGS INC. AND SUBSIDIARIES

CONSOLIDATED STATEMENTS OF COMPREHENSIVE INCOME

(in thousands)

(Unaudited)


	Three Months Ended March 31,
	2017		2016
Net income	$	26,307	$	28,196
Other comprehensive income:
Net unrealized gains on securities available for sale, net of tax of $231 and $2,390, respectively		412		4,279
Reclassification adjustment for gains included in net income, net of tax of $0 and $(16), respectively		—		(30)
Comprehensive income		26,719		32,445
Less: comprehensive income (loss) attributable to noncontrolling interest		(127)		629

Comprehensive income applicable to Hilltop	$	26,846	$	31,816

See accompanying notes.

Table of Contents

HILLTOP HOLDINGS INC. AND SUBSIDIARIES

CONSOLIDATED STATEMENTS OF STOCKHOLDERS’ EQUITY

(in thousands)

(Unaudited)


						Accumulated				Deferred					Total
				Additional		Other				Compensation		Employee			Hilltop				Total
	Common Stock			Paid-in		Comprehensive		Retained		Employee Stock		Stock Trust			Stockholders’		Noncontrolling		Stockholders’
	Shares	Amount		Capital		Income		Earnings		Trust, Net		Shares	Amount		Equity		Interest		Equity
Balance, December 31, 2015	98,896	$	989	$	1,577,270	$	2,629	$	155,475	$	1,034	22	$	(443)	$	1,736,954	$	1,171	$	1,738,125
Net income	—		—		—		—		27,567		—	—		—		27,567		629		28,196
Other comprehensive income	—		—		—		4,249		—		—	—		—		4,249		—		4,249
Issuance of common stock	500		5		3,845		—		—		—	—		—		3,850		—		3,850
Stock-based compensation expense	—		—		2,228		—		—		—	—		—		2,228		—		2,228
Common stock issued to board members	6		—		108		—		—		—	—		—		108		—		108
Issuance of common stock related to share-based awards, net	(1)		—		(33)		—		—		—	—		—		(33)		—		(33)
Retirement of common stock	(816)		(8)		(16,268)		—		—		—	—		—		(16,276)		—		(16,276)
Deferred compensation plan	—		—		—		—		—		(14)	(1)		15		1		—		1
Net cash distributed to noncontrolling interest	—		—		—		—		—		—	—		—		—		(437)		(437)
Balance, March 31, 2016	98,585	$	986	$	1,567,150	$	6,878	$	183,042	$	1,020	21	$	(428)	$	1,758,648	$	1,363	$	1,760,011

Balance, December 31, 2016	98,544	$	985	$	1,572,877	$	485	$	295,568	$	903	15	$	(309)	$	1,870,509	$	4,011	$	1,874,520
Net income	—		—		—		—		26,434		—	—		—		26,434		(127)		26,307
Other comprehensive income	—		—		—		412		—		—	—		—		412		—		412
Stock-based compensation expense	—		—		2,577		—		—		—	—		—		2,577		—		2,577
Common stock issued to board members	3		—		105		—		—		—	—		—		105		—		105
Issuance of common stock related to share-based awards, net	122		2		(1,031)		—		—		—	—		—		(1,029)		—		(1,029)
Repurchase of common stock	(262)		(3)		(4,199)		—		(3,003)		—	—		—		(7,205)		—		(7,205)
Dividends on common stock	—		—		—		—		(5,802)		—	—		—		(5,802)		—		(5,802)
Deferred compensation plan	—		—		—		—		—		(10)	—		9		(1)		—		(1)
Net cash distributed to noncontrolling interest	—		—		—		—		—		—	—		—		—		(575)		(575)
Balance, March 31, 2017	98,407	$	984	$	1,570,329	$	897	$	313,197	$	893	15	$	(300)	$	1,886,000	$	3,309	$	1,889,309

See accompanying notes.

Table of Contents

HILLTOP HOLDINGS INC. AND SUBSIDIARIES

CONSOLIDATED STATEMENTS OF CASH FLOWS

(in thousands)

(Unaudited)


	Three Months Ended March 31,
	2017		2016
Operating Activities
Net income	$	26,307	$	28,196
Adjustments to reconcile net income to net cash provided by operating activities:
Provision for loan losses		1,705		3,407
Depreciation, amortization and accretion, net		(1,031)		(11,830)
Net realized gains on securities		—		(46)
Deferred income taxes		1,531		494
Other, net		1,990		8,320
Net change in securities purchased under agreements to resell		(23,798)		9,014
Net change in assets segregated for regulatory purposes		14,598		37,899
Net change in trading securities		(107,766)		(154,279)
Net change in broker-dealer and clearing organization receivables		(39,422)		130,858
Net change in FDIC indemnification asset		19,424		11,214
Net change in other assets		(8,702)		(50,550)
Net change in broker-dealer and clearing organization payables		110,694		(162,722)
Net change in other liabilities		(104,858)		(48,283)
Net change in securities sold, not yet purchased		(9,696)		35,660
Proceeds from sale of mortgage servicing rights asset		17,499		—
Net gains from sales of loans		(124,150)		(127,297)
Loans originated for sale		(2,939,349)		(3,052,579)
Proceeds from loans sold		3,514,340		3,352,409
Net cash provided by operating activities		349,316		9,885
Investing Activities
Proceeds from maturities and principal reductions of securities held to maturity		15,152		21,398
Proceeds from sales, maturities and principal reductions of securities available for sale		83,048		64,918
Purchases of securities held to maturity		(831)		—
Purchases of securities available for sale		(240,757)		(51,531)
Net change in loans		57,902		(233,309)
Purchases of premises and equipment and other assets		(4,951)		(9,948)
Proceeds from sales of premises and equipment and other real estate owned		11,438		22,068
Net cash paid for Federal Home Loan Bank and Federal Reserve Bank stock		34,953		12,311
Net cash used in investing activities		(44,046)		(174,093)
Financing Activities
Net change in deposits		245,777		139,925
Net change in short-term borrowings		(663,512)		(114,452)
Proceeds from notes payable		72,382		5,553
Payments on notes payable		(65,573)		(12,028)
Proceeds from issuance of common stock		—		3,850
Payments to repurchase common stock		(7,205)		—
Dividends paid on common stock		(5,802)		—
Net cash distributed to noncontrolling interest		(575)		(437)
Taxes paid on employee stock awards netting activity		(838)		(33)
Other, net		(356)		(106)
Net cash provided by (used in) financing activities		(425,702)		22,272

Net change in cash and cash equivalents		(120,432)		(141,936)
Cash and cash equivalents, beginning of period		690,764		669,445
Cash and cash equivalents, end of period	$	570,332	$	527,509

Supplemental Disclosures of Cash Flow Information
Cash paid for interest	$	14,407	$	16,377
Cash paid for income taxes, net of refunds	$	1,262	$	831
Supplemental Schedule of Non-Cash Activities
Conversion of loans to other real estate owned	$	1,945	$	4,726
Additions to mortgage servicing rights	$	1,224	$	1,639

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” 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, mortgage origination and insurance subsidiaries.

The Company provides its products and services through three primary business units, PlainsCapital Corporation (“PCC”), Hilltop Securities Holdings LLC (“Securities Holdings”) and National Lloyds Corporation (“NLC”). PCC is a financial holding company, headquartered in Dallas, Texas, 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, headquartered in Dallas, Texas, that provides, through its subsidiaries, investment banking and other related financial services, including municipal advisory, sales, trading and underwriting of taxable and tax-exempt fixed income securities, equity trading, clearing, securities lending, structured finance and retail brokerage services throughout the United States. NLC is a property and casualty insurance holding company, headquartered in Waco, Texas, that provides, through its subsidiaries, fire and homeowners insurance to low value dwellings and manufactured homes primarily in Texas and other areas of the southern United States.

Basis of Presentation

The accompanying unaudited consolidated financial statements have been prepared in conformity with accounting principles generally accepted in the United States (“GAAP”), and in conformity with the rules and regulations of the Securities and Exchange Commission (the “SEC”). In the opinion of management, these financial statements contain all adjustments necessary for a fair statement of the results of the interim periods presented. Accordingly, the financial statements do not include all of the information and footnotes required by GAAP for complete financial statements and should be read in conjunction with the audited consolidated financial statements and notes thereto included in the Company’s Annual Report on Form 10-K for the year ended December 31, 2016 (“2016 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 loan losses, the fair values of financial instruments, the amounts receivable from the Federal Deposit Insurance Corporation (the “FDIC”) under loss-share agreements (the “FDIC Indemnification Asset”), reserves for losses and loss adjustment expenses (“LAE”), the mortgage loan indemnification liability, and the potential impairment of assets are particularly subject to change. The Company has applied its critical accounting policies and estimation methods consistently in all periods presented in these consolidated financial statements.

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 PlainsCapital Equity, LLC. 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”). Ventures Management is the managing member and owns 51% of the membership interest in both PrimeLending Ventures, LLC (“Ventures”) and Mutual of Omaha Mortgage, LLC.

PCC also owns 100% of the outstanding common securities of PCC Statutory Trusts I, II, III and IV (the “Trusts”), which are not included in the consolidated financial statements under the requirements of the Variable Interest Entities

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Hilltop Holdings Inc. and Subsidiaries

Notes to Consolidated Financial Statements (continued)

(Unaudited)

Subsections of the Financial Accounting Standards Board (“FASB”) Accounting Standards Codification (“ASC”), because the primary beneficiaries of the Trusts are not within the consolidated group.

Hilltop has a 100% membership interest in Securities Holdings, which operates through its wholly-owned subsidiaries, Hilltop Securities Inc. (“Hilltop Securities”), Hilltop Securities Independent Network Inc. (“HTS Independent Network”) (collectively, the “Hilltop Broker-Dealers”) and First Southwest Asset Management, LLC. Hilltop Securities is a broker-dealer registered with the Securities and Exchange Commission (the “SEC”) and Financial Industry Regulatory Authority (“FINRA”) and a member of the New York Stock Exchange (“NYSE”), HTS Independent Network is an introducing broker-dealer that is also registered with the SEC and FINRA, and First Southwest Asset Management, LLC is a registered investment adviser under the Investment Advisers Act of 1940.

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

The consolidated financial statements include the accounts of the above-named entities. Intercompany transactions and balances have been eliminated. Noncontrolling interests have been recorded for minority ownership in entities that are not wholly owned and are presented in compliance with the provisions of Noncontrolling Interest in Subsidiary Subsections of the ASC.

Certain reclassifications have been made to the prior period consolidated financial statements to conform with the current period presentation. In preparing these consolidated financial statements, subsequent events were evaluated through the time the financial statements were issued. Financial statements are considered issued when they are widely distributed to all stockholders and other financial statement users, or filed with the SEC.

2. Recently Issued Accounting Standards

In April 2017, FASB issued ASU 2017-08 which shortens the amortization period for the premium on certain purchased callable debt securities to the earliest call date. The amendment is effective for annual periods, and interim reporting periods within those annual periods, beginning after December 15, 2018, using the using the modified retrospective transaction method. As permitted within the amendment, the Company elected to early adopt and apply the provisions of this amendment as of January 1, 2017. This adoption had no effect on the Company’s consolidated financial statements.

In January 2017, FASB issued ASU 2017-01 which provides guidance to assist entities with evaluating whether transactions should be accounted for as acquisitions (or disposals) of assets or businesses. The amendment is effective for annual periods, and interim reporting periods within those annual periods, beginning after December 15, 2017, using the prospective method. Early adoption is permitted. Adoption of the amendment is not expected to have a significant effect on the Company’s consolidated financial statements.

In October 2016, FASB issued ASU No. 2016-16 which addresses improvement in accounting for income tax consequences of intra-equity transfers of assets other than inventory. The amendment requires that an entity recognize the income tax consequences of the intra-equity transfer of an asset other than inventory when the transfer occurs. The amendments are effective for annual periods, and interim reporting periods within those annual periods, beginning after December 15, 2017, using the modified retrospective transaction method. Early adoption is permitted. The Company does not intend to adopt the provisions of the amendment early and does not expect such provisions to have a significant effect on the Company’s consolidated financial statements.

In August 2016, FASB issued ASU 2016-15 to add or clarify guidance on the classification of certain cash receipts and payments in the statement of cash flows and to eliminate the diversity in practice related to such classifications. The amendments are effective for annual periods, and interim reporting periods within those annual periods, beginning after December 15, 2017 using a retrospective transition method. Early adoption is permitted. The Company does not intend to adopt the provisions of the amendment early and does not expect such provisions to have a significant effect on the Company’s consolidated financial statements.

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Hilltop Holdings Inc. and Subsidiaries

Notes to Consolidated Financial Statements (continued)

(Unaudited)

In June 2016, FASB issued ASU 2016-13 which sets forth a “current expected credit loss” (CECL) model which requires entities to measure all credit losses expected over the life of an exposure (or pool of exposures) for financial instruments held at the reporting date based on historical experience, current conditions, and reasonable and supportable forecasts. This replaces the existing incurred loss model and is applicable to the measurement of credit losses on financial assets measured at amortized cost and applies to some off-balance sheet credit exposures. The amendment also requires enhanced disclosures to help financial statement users better understand significant estimates and judgments used in estimating credit losses, as well as the credit quality and underwriting standards of an entity’s portfolio. The amendments are effective for annual periods, and interim reporting periods within those annual periods, beginning after December 15, 2019 with a cumulative-effect adjustment to retained earnings as of the beginning of the reporting period of adoption. Although the Company does not intend to adopt the provisions of the amendment early. A cross-functional team is evaluating the provisions of the amendment and the impact on its future consolidated financial statements through the identification of data requirements and determination of necessary modifications to its existing credit loss model and processes. The extent of the change in allowance for loan losses will be impacted by the portfolio composition and quality at the adoption date as well as economic conditions and forecasts at that time.

In February 2016, FASB issued ASU 2016-02 related to leases. The new standard is intended to increase transparency and comparability among organizations and require lessees to record a right-to-use asset and liability representing the obligation to make lease payments for long-term leases. Accounting by lessors will remain largely unchanged. The amendments are effective for annual periods, and interim periods within those annual periods, beginning after December 15, 2018. Early adoption is permitted. Adoption will require a modified retrospective transition where the lessees and lessors are required to recognize and measure leases at the beginning of the earliest period presented. The Company does not intend to adopt the provisions of the amendment early. The Company is currently evaluating the provisions of the amendment on its consolidated financial statements, but upon adoption, expects to report higher assets and liabilities as a result of including additional leases on the consolidated balance sheets.

In January 2016, FASB issued ASU 2016-01 related to financial instruments. This amendment requires that most equity investments be measured at fair value, with subsequent changes in fair value recognized in net income. The amendment also impacts financial liabilities under the Fair Value Option and the presentation and disclosure requirements for financial instruments. The amendment is effective for annual periods, and interim periods within those annual periods, beginning after December 15, 2017. Adoption of the amendment is not expected to have a significant effect on the Company’s consolidated financial statements.

In July 2015, the FASB issued ASU 2015-14, which deferred the effective date of ASU 2014-09 by one year, to clarify the principles for recognizing revenue from contracts with customers. The amendment outlines a single comprehensive model for entities to depict the transfer of goods or services to customers in amounts that reflect the payment to which a company expects to be entitled in exchange for those goods or services. The amendment also requires additional disclosure about the nature, amount, timing and uncertainty of revenue and cash flows arising from customer contracts, including significant judgments and changes in judgments and assets recognized from costs incurred to obtain or fulfill a contract. The amendment is effective for annual periods, and interim reporting periods within those annual periods, beginning after December 15, 2017 and may be adopted using either a full retrospective transition method or a modified, cumulative-effect approach wherein the guidance is applied only to existing contracts as of the date of initial application and to new contracts entered into thereafter. The Company does not intend to adopt the provisions of the amendment early and expects to adopt using the cumulative-effect approach. The Company is currently in the process of gathering an inventory of contracts with customers and performing an in-depth assessment. The preliminary assessment suggests that the revenue recognition policies within the Company’s broker-dealer and banking segments are most likely to be effected when adopted. However, there are many aspects of this new accounting guidance that are still being interpreted to clarify and address certain implementation issues. The Company will continue to evaluate the impact on its future consolidated financial statements of both current and newly issued guidance associated with the amendment.

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Hilltop Holdings Inc. and Subsidiaries

Notes to Consolidated Financial Statements (continued)

(Unaudited)

3. Fair Value Measurements

Fair Value Measurements and Disclosures

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

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

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

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

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

Fair Value Option

The Company has elected to measure substantially all of PrimeLending’s mortgage loans held for sale and retained mortgage servicing rights (“MSR”) asset at fair value, under the provisions of the Fair Value Option. The Company elected to apply the provisions of the Fair Value Option to these items so that it would have the opportunity to mitigate volatility in reported earnings caused by measuring related assets and liabilities differently without having to apply complex hedge accounting provisions. At March 31, 2017 and December 31, 2016, the aggregate fair value of PrimeLending’s mortgage loans held for sale accounted for under the Fair Value Option was $1.27 billion and $1.75 billion, respectively, and the unpaid principal balance of those loans was $1.22 billion and $1.71 billion, respectively. The interest component of fair value is reported as interest income on loans in the accompanying consolidated statements of operations.

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

Table of Contents

Hilltop Holdings Inc. and Subsidiaries

Notes to Consolidated Financial Statements (continued)

(Unaudited)

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


	Level 1		Level 2		Level 3		Total
March 31, 2017	Inputs		Inputs		Inputs		Fair Value
Trading securities	$	3,640	$	369,660	$	—	$	373,300
Available for sale securities		20,263		735,283		—		755,546
Loans held for sale		—		1,244,018		30,214		1,274,232
Derivative assets		—		72,906		—		72,906
MSR asset		—		—		45,573		45,573
Securities sold, not yet purchased		75,047		69,146		—		144,193
Derivative liabilities		—		37,024		—		37,024


	Level 1		Level 2		Level 3			Total
December 31, 2016	Inputs		Inputs		Inputs			Fair Value
Trading securities	$	9,481	$	256,053	$	—	$	265,534
Available for sale securities		19,840		578,167		—		598,007
Loans held for sale		—		1,712,697		35,801		1,748,498
Derivative assets		—		57,036		—		57,036
MSR asset		—		—		61,968		61,968
Securities sold, not yet purchased		60,715		93,174		—		153,889
Derivative liabilities		—		35,737		—		35,737

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

Total Gains or Losses

(Realized or Unrealized)

Balance at

Included in Other

Beginning of

Purchases/

Sales/

Included in

Comprehensive

Balance at

Period

Additions

Reductions

Net Income

Income (Loss)

End of Period

Three months ended March 31, 2017

Loans held for sale

35,801

7,828

(10,701)

(2,714)

—

30,214

MSR asset