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HTH > SEC Filings for HTH > Form 10-K on 16-Feb-2017All Recent SEC Filings

Show all filings for HILLTOP HOLDINGS INC.

Form 10-K for HILLTOP HOLDINGS INC.


16-Feb-2017

Annual Report


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

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

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 that was formerly known as Southwest Securities, Inc.), references to "HTS Independent Network" refer to Hilltop Securities Independent Network Inc. (a wholly owned subsidiary of Securities Holdings that was formerly known as SWS Financial Services, Inc.), 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 "First Southwest" refer to First Southwest Holdings, LLC (a wholly owned subsidiary of Securities Holdings) and its subsidiaries as a whole, references to "FSC" refer to First Southwest Company, LLC (a former wholly owned subsidiary of First Southwest), references to "PrimeLending" refer to PrimeLending, a PlainsCapital Company (a wholly owned subsidiary of the Bank) and its subsidiaries as a whole, references to "NLC" refer to National Lloyds Corporation (a wholly owned subsidiary of Hilltop) and its subsidiaries as a whole, references to "NLIC" refer to National Lloyds Insurance Company (a wholly owned subsidiary of NLC) and references to "ASIC" refer to American Summit Insurance Company (a wholly owned subsidiary of NLC).


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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, mortgage origination and insurance segments.

In connection with our acquisition of SWS, we modified our organizational structure into three primary business units, PCC (banking and mortgage origination), Securities Holdings (broker-dealer) and NLC (insurance). The PCC unit continues to include the Bank and its wholly owned subsidiary, PrimeLending (collectively referred to herein as "PlainsCapital"), while the Securities Holdings unit includes our broker-dealer operations transferred from the PCC unit effective January 1, 2015, and two entities acquired in the SWS Merger (as defined below), Hilltop Securities and HTS Independent Network.

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 headquartered in Dallas, Texas that provides, through its subsidiaries, traditional banking and wealth, investment management and treasury management services primarily in Texas and residential mortgage loans throughout the United States.

Securities Holdings. 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. 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.

During 2016, our net income to common stockholders was $145.9 million, or $1.48 per diluted share.

We reported $231.4 million of consolidated income before income taxes during 2016, including the following contributions from our four reportable operating segments.

The banking segment contributed $130.3 million of income before income taxes during 2016;

The broker-dealer segment contributed $39.5 million of income before income taxes during 2016;

The mortgage origination segment contributed $77.8 million of income before income taxes during 2016; and

The insurance segment contributed $21.4 million of income before income taxes during 2016.

During 2016, the Bank discovered irregularities with respect to a non-covered loan that is currently in default, including the genuineness of certain underlying documents that supported the loan and the operations of the borrower's business. As a result of the payment default and other irregularities, the Bank increased its provision for loan losses and recorded a $24.5 million charge-off during the second quarter of 2016, representing the entire outstanding principal balance of the loan. The banking segment's financial results for 2016 reflect this charge-off. The Bank continues to investigate the loan relationship and is pursuing legal remedies to recover losses arising from this isolated incident, including litigation against the borrower and guarantors. Given the preliminary nature of the investigation and related legal proceedings, the Bank cannot currently estimate the amount of any future recoveries or additional expenses related to this charged-off loan.

In addition, the broker-dealer segment's operating results during 2016 included a specific legal reserve of $16.0 million related to one matter that was settled in the first quarter of 2017.

As a financial institution providing products and services through our banking, broker-dealer, mortgage origination and insurance 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 financial position includes changes in the level of interest rates in addition to twists in the shape of the yield curve with the magnitude and direction of the impact varying across the


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different lines of business. Other factors include, but are not limited to, fluctuations in volume and price levels of securities, inflation, political events, investor confidence, investor participation levels, legal and regulatory, and compliance requirements and competition. All of these factors have the potential to impact on 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.

At December 31, 2016, on a consolidated basis, we had total assets of $12.7 billion, total deposits of $7.1 billion, total loans, including loans held for sale, of $7.8 billion and stockholders' equity of $1.9 billion.

On October 27, 2016, we announced that, for the first time in our history, Hilltop's board of directors authorized a dividend program and declared our first quarterly cash dividend of $0.06 per common share, or $5.8 million, paid on November 30, 2016. On January 26, 2017, our board of directors declared a quarterly cash dividend of $0.06 per common share, payable on February 28, 2017 to all common stockholders of record as of the close of business on February 15, 2017.

Company Background

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

On November 30, 2012, we acquired PlainsCapital Corporation pursuant to a plan of merger whereby PlainsCapital Corporation merged with and into our wholly owned subsidiary (the "PlainsCapital Merger"), which continued as the surviving entity under the name "PlainsCapital Corporation". Concurrent with the consummation of the PlainsCapital Merger, Hilltop became a financial holding company registered under the Bank Holding Company Act of 1956.

On September 13, 2013 (the "Bank Closing Date"), the Bank assumed substantially all of the liabilities, including all of the deposits, and acquired substantially all of the assets of Edinburg, Texas-based FNB from the Federal Deposit Insurance Corporation (the "FDIC"), as receiver, and reopened former branches of FNB acquired from the FDIC under the "PlainsCapital Bank" name (the "FNB Transaction"). Pursuant to the Purchase and Assumption Agreement by and among the FDIC as receiver for FNB, the FDIC and the Bank (the "P&A Agreement"), the Bank and the FDIC entered into loss-share agreements whereby the FDIC agreed to share in the losses of certain covered loans and covered other real estate owned ("OREO") that the Bank acquired in the FNB Transaction.

On January 1, 2015, we acquired SWS in a stock and cash transaction (the "SWS Merger"), whereby SWS's broker-dealer subsidiaries, Southwest Securities, Inc. and SWS Financial Services, Inc., became subsidiaries of Securities Holdings and SWS's banking subsidiary, Southwest Securities, FSB ("SWS FSB"), was merged into the Bank, an indirect wholly owned subsidiary of Hilltop. On October 5, 2015, Southwest Securities, Inc. and SWS Financial Services, Inc. were renamed "Hilltop Securities Inc." and "Hilltop Securities Independent Network Inc.", respectively. As a result of the SWS Merger, each outstanding share of SWS common stock was converted into the right to receive 0.2496 shares of Hilltop common stock and $1.94 in cash, equating to $6.92 per share based on Hilltop's closing price on December 31, 2014 and resulting in an aggregate purchase price of $349.1 million, consisting of 10.1 million shares of common stock, $78.2 million in cash and $70.3 million associated with our existing investment in SWS common stock. Based on purchase date valuations, the fair value of the assets acquired was $3.3 billion, including $707.5 million in securities, $863.8 million in non-covered loans and $1.2 billion in broker-dealer and clearing organization receivables. The fair value of liabilities assumed was $2.9 billion, consisting primarily of deposits of $1.3 billion and $1.1 billion in broker-dealer and clearing organization payables. The operations acquired in the SWS Merger, including a bargain purchase gain of $81.3 million, are included in our operating results beginning January 1, 2015.

On October 22, 2015, the Financial Industry Regulatory Authority ("FINRA") granted approval to combine FSC and Hilltop Securities, subject to customary conditions. Following this approval, we integrated the back-office systems of FSC and Hilltop Securities and, on January 22, 2016, merged FSC and Hilltop Securities into a combined firm operating under the "Hilltop Securities" name. We use the term "Hilltop Broker-Dealers" to refer to FSC, Hilltop Securities and HTS Independent Network prior to such date and Hilltop Securities and HTS Independent Network after such date.


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Segment Information

We have three primary business units, PCC (banking and mortgage origination), Securities Holdings (broker-dealer) and NLC (insurance). Under accounting principles generally accepted in the United States ("GAAP"), our business units are comprised of four reportable business segments organized primarily by the core products offered to the segments' respective customers: banking, broker-dealer, mortgage origination and insurance. The SWS Merger did not result in changes to our four reportable business segments. 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, mortgage origination and insurance segments. Operating results for the mortgage origination segment have historically been more volatile than operating results for the banking, broker-dealer and insurance segments.

The banking segment includes the operations of the Bank, and since January 1, 2015, the operations of the former SWS FSB. 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, while also deriving revenue from other sources, including service charges on customer deposit accounts and trust fees.

The broker-dealer segment includes the operations of FSC through January 22, 2016, and since January 1, 2015, the operations of Hilltop Securities and HTS Independent Network. 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 Securities and Exchange Commission (the "SEC") and 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.

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 of loans and from selling these loans in the secondary market.

The insurance segment includes the operations of NLC, which operates through its wholly owned subsidiaries, NLIC and ASIC. Insurance segment income is primarily generated from revenue earned on net insurance premiums less loss and loss adjustment expenses ("LAE") and policy acquisition and other underwriting expenses in Texas and other areas of the southern United States.

Corporate includes certain activities not allocated to specific business segments. These activities include holding company financing and investing activities, and management and administrative services to support the overall operations of the Company including, but not limited to, certain executive management, corporate relations, legal, finance, and acquisition costs.

The elimination of intercompany transactions are included in "All Other and Eliminations." Additional information concerning our reportable segments is presented in Note 30, Segment and Related Information, in the notes to our consolidated financial statements. The following tables present certain information about the operating results of our reportable segments (in thousands).

                                                                            Mortgage                                     All Other and        Hilltop
Year Ended December 31, 2016              Banking       Broker-Dealer      Origination     Insurance      Corporate      Eliminations       Consolidated
Net interest income (expense)            $  363,083    $        31,172    $    (11,589)    $    3,164    $   (7,257)    $        18,958    $      397,531
Provision for loan losses                    40,673               (53)                -             -              -                  -            40,620
Noninterest income                           52,579            385,766          704,126       164,841              2           (20,349)         1,286,965
Noninterest expense                         244,715            377,524          614,741       146,601         29,938            (1,048)         1,412,471
Income (loss) before income taxes        $  130,274    $        39,467    $      77,796    $   21,404    $  (37,193)    $         (343)    $      231,405

                                                                            Mortgage                                    All Other and        Hilltop
Year Ended December 31, 2015              Banking       Broker-Dealer      Origination     Insurance     Corporate      Eliminations       Consolidated
Net interest income (expense)            $  369,493    $        32,971    $    (10,423)    $    3,187    $  (5,109)    $        18,464    $      408,583
Provision for loan losses                    12,795               (80)                -             -             -                  -            12,715
Noninterest income                           62,639            334,495          597,163       171,185        81,289           (19,129)         1,227,642
Noninterest expense                         243,926            367,812          539,257       158,720        31,926            (1,625)         1,340,016
Income (loss) before income taxes        $  175,411    $         (266)    $      47,483    $   15,652    $   44,254    $           960    $      283,494


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                                                                            Mortgage                                    All Other and        Hilltop
Year Ended December 31, 2014              Banking       Broker-Dealer      Origination     Insurance     Corporate      Eliminations       Consolidated
Net interest income (expense)            $  334,377    $        12,144    $    (12,591)    $    3,672    $    5,219    $        18,320    $      361,141
Provision for loan losses                    16,916                 17                -             -             -                  -            16,933
Noninterest income                           67,438            119,451          456,776       173,577         5,985           (23,916)           799,311
Noninterest expense                         245,790            124,715          431,820       151,541        13,878            (2,391)           965,353
Income (loss) before income taxes        $  139,109    $         6,863    $      12,365    $   25,708    $  (2,674)    $       (3,205)    $      178,166

How We Generate Revenue

We generate revenue from net interest income and from noninterest income. Net interest income represents the difference between the income earned on our assets, including our loans and investment securities, and our cost of funds, including the interest paid on the deposits and borrowings that are used to support our assets. Net interest income is a significant contributor to our operating results. Fluctuations in interest rates, as well as the amounts and types of interest-earning assets and interest-bearing liabilities we hold, affect net interest income. We generated $397.5 million in net interest income during 2016, compared with net interest income of $408.6 million and $361.1 million during 2015 and 2014, respectively. Changes in net interest income during 2016, compared with 2015, included decreases within our banking and broker-dealer segments, as well as interest expense incurred on our $150.0 million aggregate principal amount of 5% senior notes due 2025 ("Senior Notes") that were not issued until the second quarter of 2015. The increase in net interest income during 2015, compared with 2014, was primarily due to the inclusion of the operations acquired in the SWS Merger within our broker-dealer and banking segments.

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

(i) Income from broker-dealer operations. Through the Hilltop Broker-Dealers, we provide investment banking and other related financial services. We generated $273.9 million, $276.6 million and $101.9 million in securities brokerage commissions and fees and investment advisory fees and commissions, and $102.2 million, $56.8 million and $17.6 million in gains on derivative and trading portfolio activities (included within other noninterest income) during 2016, 2015 and 2014, respectively.

(ii) Income from mortgage operations. Through PrimeLending, we generate noninterest income by originating and selling mortgage loans. During 2016, 2015 and 2014, we generated $703.3 million, $596.8 million and $453.4 million, respectively, in net gains from sale of loans, other mortgage production income (including income associated with retained mortgage servicing rights), and mortgage loan origination fees.

(iii) Income from insurance operations. Through NLC, we provide fire and limited homeowners insurance for low value dwellings and manufactured homes. We generated $155.5 million, $162.1 million and $164.5 million in net insurance premiums earned during 2016, 2015 and 2014, respectively.

In the aggregate, we generated $1.3 billion, $1.2 billion and $799.3 million in noninterest income during 2016, 2015 and 2014, respectively. Excluding the bargain purchase gain of $81.3 million related to the SWS Merger in 2015, our noninterest income during 2015 was $1.1 billion. We are presenting this financial measure because certain investors may use it to evaluate our business and financial results. The increase in noninterest income during 2016, compared with 2015, other than bargain purchase gain, was predominantly attributable to increases in noninterest income in our mortgage origination and broker-dealer segments. The increase in noninterest income during 2015, compared with 2014, other than bargain purchase gain, was primarily due to an increase in noninterest income in our broker-dealer segment associated with the inclusion of the operations acquired in the SWS Merger and an increase in noninterest income in 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.


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Consolidated Operating Results

Net income applicable to common stockholders during 2016 was $145.9 million, or $1.48 per diluted share, compared with net income applicable to common stockholders of $209.1 million, or $2.09 per diluted share, during 2015, and net income applicable to common stockholders of $105.9 million, or $1.17 per diluted share, during 2014. The consolidated operating results during 2016 included the previously mentioned $24.5 million charge-off of a single large loan by the Bank during the second quarter of 2016 and a specific legal reserve of $16.0 million related to one matter involving Hilltop Securities that was settled in the first quarter of 2017. The consolidated operating results during 2015 include the recognition of a bargain purchase gain related to the SWS Merger of $81.3 million, or $0.81 per diluted share. Included in the bargain purchase gain is a reversal of a $33.4 million valuation allowance against SWS deferred tax assets. This amount is based on our expected ability to realize these acquired deferred tax assets through our consolidated core earnings, the implementation of certain tax planning strategies and reversal of timing differences. SWS's net operating loss carryforwards are subject to an annual limitation on their usage because of the ownership change effected in connection with the SWS Merger. In addition, the bargain purchase gain reflects our acquisition date fair value allocation to identifiable intangible assets of $7.5 million.

Our consolidated operating results during 2016, 2015 and 2014 also included transaction costs related to the SWS Merger, and integration-related costs associated with employee expenses (such as severance and retention), professional fees (such as consulting and legal) and contractual costs (such as vendor contract termination and lease), incurred as a result of the integration of the operations and systems acquired in the SWS Merger. During 2016, we incurred $7.4 million in pre-tax transaction costs related to the SWS Merger, while pre-tax integration-related costs associated with employee, professional fee and contractual expenses during this same period were $2.9 million, $2.9 million, and $0.1 million, respectively. During 2015, we incurred $31.6 million in pre-tax transaction costs related to the SWS Merger, while pre-tax integration-related costs associated with employee, professional fee and contractual expenses during this same period were $8.7 million, $6.5 million and $2.7 million, respectively. During 2014, we incurred $1.4 million in pre-tax transaction costs related to the SWS Merger. On October 22, 2015, FINRA granted approval to combine FSC and Hilltop Securities, subject to customary conditions. Since this approval, we have integrated the back-office systems of FSC and Hilltop Securities and, effective as of the close of business on January 22, 2016, we merged FSC and Hilltop Securities into a combined firm operating under the "Hilltop Securities" name. As a result, we began realizing cost savings in 2016, although these cost savings were partially offset by additional integration costs that we incurred during 2016.

Certain items included in net income for 2016, 2015 and 2014 resulted from purchase accounting associated with the PlainsCapital Merger, the FNB Transaction and the SWS Merger (collectively, the "Bank Transactions"). Income before income taxes during 2016 includes net accretion of $9.7 million, $50.7 million and $4.6 million on earning assets and liabilities acquired in the PlainsCapital Merger, FNB Transaction and SWS Merger, respectively, offset by amortization of identifiable intangibles of $1.9 million, $0.2 million and $0.2 million, respectively. Income before income taxes during 2015 includes net accretion of $15.3 million, $60.4 million and $17.3 million on earning assets and liabilities acquired in the PlainsCapital Merger, FNB Transaction and SWS Merger, respectively, offset by amortization of identifiable intangibles of $8.7 million, $0.9 million and $1.0 million, respectively. Income before income taxes during 2014 includes net accretion of $33.9 million and $49.2 million on earning assets and liabilities acquired in the PlainsCapital Merger and FNB Transaction, respectively, offset by amortization of identifiable intangibles of $9.2 million and $1.0 million, respectively.


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